Employer of Record (EOR) and Professional Employment Organisation (PEO) arrangements have gained popularity over recent years as a method for businesses to engage employees internationally. In this article, we look at strategic considerations for a business considering engaging employees in this way.
What are PEOs and EORs?
PEOs have been a feature of the U.S labour market for many years. They offer a route for small and medium sized businesses with relatively few employees to make cost efficiencies in providing employee benefits such as healthcare. PEOs will also deal with payroll, employment taxes and social security on behalf of clients and assist with HR compliance issues. PEOs use a co-employment model, where employees are employed simultaneously by both the PEO and the end-user client. PEOs are usually used for employment arrangements within the U.S, where both the end-user client and the employees are based in the U.S. This article does not cover the legal considerations of using a PEO in the U.S. and clients considering using such arrangements should seek U.S. legal advice.
EORs are similar to PEOs but tend to be the arrangement for companies seeking to engage employees outside of the U.S. A crucial difference is that the EOR is said to be the sole employer of the employee. The EOR provides the employee to the end-user client who it is purported not to be the employer. Like PEOs, EORs deal with payroll, employment taxes, right to work issues and local employment related requirements. The end user's aim is often to effectively outsource dealing with some of the complicated issues that can arise when dealing with the employment, immigration, employment taxes and other legal differences that may exist in other jurisdictions where they do not have a presence and avoid the need for setting up a local entity.
For the remainder of this article, we focus on EORs (although these are often interchangeably referred to as PEOs due to greater familiarity in the U.S market with that term).
Why are EORs a popular option?
There has been significant growth in international workforce mobility in recent years as technology has developed to allow cross-border collaboration. This accelerated during the COVID-19 pandemic when companies across the world were thrust into remote working. Businesses are also increasingly taking a more global approach to finding talent and lower cost resources.
If an organisation finds that they would like to engage candidates in a country where they don't currently have a legal entity, they will need to consider how to engage those candidates in compliance with local tax, employment and immigration law. Traditionally, the go to option was to set up an entity in that country.
EORs have emerged to offer an alternative to setting up an entity. Their popularity grew particularly amongst fast growth U.S headquartered technology businesses looking to engage staff overseas, as EORs offered a seemingly simple and swift solution.
There is also a likelihood that this arrangement is relied on by some businesses as a way of avoiding any tax issues in the local country. However, as can be seen below, this may not be the solution some think it is.
Whilst EORs may be suitable in some circumstances, we suggest that clients strategically consider their long-term goals before entering these arrangements. Below, we set out some of the considerations when using EORs.
Considerations when using EORs
Co-employment: Even though the contractual arrangement with the EOR means that they are the employer, there is a risk that local law in the country of employment finds that the end-user client engaging the EOR is in fact the employer (either solely, or in addition to the EOR). This would mean that the end-user client could be directly responsible for certain employment rights and protections which they did not expect.
Tax: One of the attractions of using an EOR is that it might appear to avoid the risk of creating a "permanent establishment" for tax purposes in the local jurisdiction, thereby avoiding corporation tax in that jurisdiction. End-user clients should however seek independent legal or tax advice on this issue as it is unlikely that an EOR arrangement eliminates the risk of a permanent establishment and the contractual terms provided by most EOR organisations often do not offer any protection in relation to tax liabilities for the end-user client.
Protecting your business: For many businesses expanding internationally, protection of confidentiality, trade secrets, and from competitive activity will be high priority. Usually, employment contracts of staff who could pose a competitive threat to the business would contain post-termination restrictions on the extent to which staff can compete, poach clients and staff, and use confidential information for a period of time after their departure from the company. Whilst contracts between employees and the EOR can contain such restrictions, there are question marks around whether these are effective to protect the end-user company who is not a party to that contract. If a company is looking to hire personnel who could pose a significant competitive threat after they've left the business, it's worth seeking independent advice on how to mitigate this risk in the relevant country.
Protecting your intellectual property ("IP"): A business's IP might be one of its most valuable assets, whether this is code, designs, branding, products, software, or inventions. In the UK and many other countries, the IP that staff create in the course of their employment automatically vests in their employer. This means that in an EOR arrangement, the default position is that IP created by staff vests in the EOR rather than the company. The most common way to deal with this issue is to put an assignment of IP rights in place from the EOR to the end-user and it is important to ensure that a valid written assignment which covers the breadth of IP rights is in place.
Dismissing staff: If a business needs to dismiss staff engaged through an EOR (whether downsizing, for performance concerns, or if an individual has committed misconduct), the EOR would need to carry this out for the end-user client in line with local laws. In the UK for example, if the individual had more than two years of service, then the EOR would need to have one of the statutory "fair" reasons for dismissal (such as redundancy or misconduct) and would need to follow a fair process. There is some time and effort involved to achieve a fair dismissal and in circumstances where the end user client has likely provided the EOR with a full indemnity, cutting corners during the dismissal process may be attractive for the EOR but less so for the end-user. Businesses using an EOR should therefore keep in mind that some EORs can be more motivated (for obvious business reasons) to push end-user clients towards a severance agreement arrangement rather than trying to embark on a fair process, which may be expeditious in many cases but is not always the right approach when it comes to risk mitigation.
Incentives: It's typical for fast growth companies to seek to offer shares or share options to their new hires, particularly where significant future investment rounds are anticipated but current cashflow places limitations on the level of salary that can be offered. Again, if stock is offered to employees this might create a co-employment risk and tax implications for the end-user client, which should be considered carefully.
Defending employment claims: If a member of staff initiates a legal claim, for example for unfair dismissal, discrimination or whistleblowing, they would bring that claim against their employer who is the EOR and possibly the end-user client as well for good measure. However, the factual circumstances and decision making relating to the claim would almost certainly have taken place at the end-user client. Without having full conduct of the litigation, the end-user client will not only have challenges in defending the claim but they will also often have indemnified the EOR in relation to any losses suffered by it. Again, this may create motivation for an EOR to seek to settle rather than defend the claim in the way that the end-user would if they had full control of the claim.
Contracts with EORs: As with any contractual arrangement, it's important that end-user clients fully understand their contractual arrangement with EORs, in particular how the EOR has sought to apportion liability for tax and litigation risk through indemnities. It's also important to understand how the parties can exit the arrangement in various scenarios including how staff might transfer from an EOR to an entity of the end-user.
Strategic factors to consider
When weighing up whether to use an EOR or set up a legal entity in a jurisdiction, the following are important strategic factors:
What is the purpose of engaging staff in the desired country and what is the growth plan? The company may be seeking to test a new market for sales of its products, seeking to make use of a local talent pool, or simply have identified a single candidate who is unable to move location. If the intention is long term growth then it might make sense to establish an entity in the first instance.
What sort of roles will be filled in the desired country? This is likely to impact the assessment of permanent establishment risk for tax purposes. As examples, revenue generating employees, sales teams and senior managers are likely to create a greater risk of permanent establishment than a small team of software developers.
How many members of staff will be engaged? There is no magic number at which it becomes more suitable to set up a local entity rather than use an EOR or to put it another way, the point at which it becomes higher risk to continue using an EOR rather than set up a local entity. The other factors described above are likely more important. Certain local requirements will affect this number depending on the jurisdiction (for example, specific time periods after which local employees must be employed by a locally established entity instead of an EOR or thresholds for establishing a works council in certain European countries). In our view, any client wishing to engage more than around three staff should give serious consideration to whether setting up an entity may be more suitable and cost efficient.
Alternatives to EORs
Often the most suitable alternative to using an EOR is the more traditional route of setting up an entity in the country you would like to employ talent or employing employees using another existing legal entity in the region to employ people combined with a local payroll provider. In many countries, this is quicker and more straightforward than business leaders expect. Payroll providers can be engaged to deal with the payment of staff and calculation and deduction of employment taxes and social security. In some circumstances and in some countries, entity set up may not even be needed if a branch office of an existing overseas entity or similar arrangement is suitable. Setting up an entity can significantly reduce the tax risks.
Businesses might also choose to engage talent directly as independent contractors for short term and specific projects. This may be suitable particularly if it is not a priority that staff are working exclusively for the business. Advice should be sought on the risk of such individuals being deemed employees for tax purposes in the country in which they are engaged.
Conclusion
For companies looking to enter new markets or recruit talent in a number of countries, EORs may offer a convenient, short-term solution. However, as with all business decisions, it's important to fully consider all of the options and the short and long term impact of this route to market. For businesses choosing to use EORs, it's fundamental to balance the convenience of this option alongside protecting assets and understanding the risks, as well as ensuring that the company keeps the decision to opt for an EOR under review as its local presence grows.
