An easy checklist for avoiding misclassification of employees as independent contractors

Introduction

Independent contractors are business owners who offer a service to a client they contract with to complete that service. This service is then invoiced to the company, which then pays that invoice to the contractor. This payment is not a wage but, rather, a payment for services. The company does not have the contractor on its payroll and does not give the contractor statutory benefits as it does with employees. For these reasons and more, the independent contractor is not an employee of the company.

The erroneous — or intentional — misclassification of employees as independent contractors can result in expensive penalties for companies, including liabilities for unpaid salaries and statutory benefits, fines, being barred from doing business in a nation, and even potential criminal prosecution for fraud. Governments around the world are cracking down on companies who treat and pay their workers as contractors to avoid having to pay them statutory benefits. Skuad, a global human resources and payroll outsourcing company, can help keep your company in compliance — not just with classifying employees correctly but with all labor laws.

How Are Independent Contractors Misclassified?

Misclassification can happen when employers are receiving services from a worker who is not getting compensated with statutory benefits even though the authorities would consider the individual an employee who would be entitled to benefits and the protection of local labor laws. Benefits that must be given to employees by law in many countries include leave entitlements, health insurance, accident insurance, unemployment insurance, pensions, and termination rules that may include severance.

Since independent contractors do not receive these benefits, companies misclassifying employees as contractors will owe these benefits to the employees and may face additional fines. Companies may even face criminal fraud prosecution, depending on the country’s laws. Employers must make sure that if they are going to contract with independent contractors, the relationship would not be considered an employer and employee one, and the contractor would not qualify for benefits.

See the checklist in the article for more specific information on how governments scrutinize companies and figure out if companies are appropriately contracting with independent contractors, or if they are hiring employees who are entitled to mandatory benefits.

Differences Between Contractors and Employees

Each country has its own laws, and the local authorities may have their own set of rules and procedures for figuring out whether misclassification has occurred. There are a few generalities, however, common to most countries when considering the differences between contractors and employees.

Employees differ from independent contractors in a few ways.

Independent Contractors

• Work for themselves and offer a service to a client. They may have a registered or incorporated business.
• Are able to work for multiple entities.
• Can work their own hours and make their own schedules.
• Are not integrated into a company’s organization and are not on a payroll.
• Can stipulate the price of their labor and can specify the scope of the tasks performed.
• Bring their own tools and supplies for a job.
• Are not supervised and do not have bosses telling them what to do. They are not subordinate to an employer.
• Take on financial risks as they operate their business.
• Are typically not protected by labor laws including overtime laws and termination rules.
• Are not entitled to statutory benefits such as leave entitlements.

Employees

• Work for an employer, and their employment is their service to their employer. They do not operate their own business when they provide their labor.
• Only do work for one entity.
• Must follow an employer’s schedule and work on the company’s scheduled work time. They cannot choose their own hours.
• Are integrated into an employer’s organization and are on their payroll.
• Are paid a wage. Aside from some negotiation of salary, they cannot name the price of their labor.
• Are given tools. The employer supplies the tools necessary for the employee to do the job.
• Are supervised, have their work scrutinized, and can be punished by their bosses. Employees have a subordinate status.
• Do not take on financial risks for their labor.
• Are protected by labor laws, including overtime laws and overtime compensation and termination rules that sometimes include severance payments.
• Are entitled to statutory benefits such as mandatory leave that includes annual leave.

Different countries may have specific criteria when they audit companies to investigate potential misclassification. Since there are so many different laws in the countries in which your company will hire, it is important to seek legal counsel regarding the local laws when hiring in those countries to avoid misclassification. Alternatively, your company can use an employer of record such as Skuad, which could hire, onboard, and pay your employees or contract with independent contractors with compliant contracts to ensure misclassification does not occur.

Consequences of Misclassification of Independent Contractors

The specific consequences of misclassification would depend on the specific laws and government authorities in each country. Some of these consequences include fines, liabilities for unpaid salary and statutory benefits, payment of overtime to the employee, payment of severance to a terminated employee, and even criminal prosecution for fraud. Skuad helps employers hire in over 160 countries, all of which would have a local entity with a group of legal experts to consult the local laws. In any country in which you hire, your company will need to become familiar with the specific local labor laws. The differences outlined in the previous sections are generalities.

Checklist

The following checklist is a list of questions regarding the employment of employees, The answers to the questions can help guide your company in figuring out if the employee is appropriately classified.

1. Is there a legally compliant employment contract stipulating that the worker will be an employee of your organization?
2. Is the employee working for only your company and unable to enter into agreements with multiple entities?
3. Can the individual work for other companies or are there restrictions preventing providing a service for another company?
4. Is the individual a registered self-employed independent contractor or do they have a registered or incorporated business, or are they only in an employment agreement with your company?
5. Does the individual have a license, permit, or other authorization to do business?
6. Do they send reports to the government for their services such as business tax returns?
7. Does the individual have personal autonomy and independence or are they required to be somewhere by your company?
8. Is the individual on your company’s payroll as opposed to sending your company invoices for their labor?
9. Does the individual take on financial risks for the business activity or does your company bear the risks?
10. Does your company choose the nature and scope of the work for the individual to perform?
11. Does the individual dictate the price of the services rendered or does your company choose the price of the employee’s labor?
12. Does the individual have the ability to choose their work location?
13. Is the individual required to attend your company’s meetings?
14. Does the individual have a supervisor and are they subordinate in the organizational hierarchy?
15. Are tools and materials for the tasks provided to the employee?
16. Is the labor of the individual monitored and can there be punishments for the individual's performance?
17. Does anyone supervise the work and penalize or reward the individual working?
18. Are there rules in the agreement with regards to termination that the worker can control?
19. Can the individual be fired with or without just cause?
20. Is this individual paid statutory benefits, including but not limited to annual leave entitlements, paid holidays, health insurance, pensions, overtime, and severance?

The answers to the questions in the checklist can help your company to avoid misclassification when hiring employees. Your company may intend to contract with independent contractors, but if government authorities consider the relationship to be an employee and employer one, they may consider your company liable for unpaid salaries and benefits and other penalties. Use the checklist to make sure that if the intention is to contract with an independent contractor, the individual contracted to do the labor would not be considered an employee in actuality.

Conclusion

Misclassifying employees as independent contractors can be an expensive mistake for a company. It can result in consequences for employers such as fines and liabilities. It is therefore essential for a company to classify all of its workers properly, and if they satisfy the criteria to be considered an employee, the company must compensate them properly, including offering them mandatory benefits to which they are entitled by law, as well as complying with the rest of the country’s labor law protections.