Avoiding Misclassification of Employees and Contractors: 2023 Mauve Guide

World governments are constantly adjusting to the changing face of work, as the gig economy expands and the digitisation of globalisation takes full effect. One of their primary focuses, as always, is on the accidental and deliberate misclassification of employees by their employers.

In 2021, for example, the Netherlands passed the Balanced Labour Market Act (BLMA), changing how employees and contractors are legally classified in that country. Similarly, as of October 2022, US president Joe Biden has announced the formation of a special White House task force dedicated to ensuring fairer classification for independent contractors.

Evidently, it is more important than ever to know what employee and independent contractor misclassification means, what the risks involved are, and how best to avoid it.

What is Employee Misclassification From an International Recruitment Perspective?

Correct classification of employees and independent contractors – according to their country of residence and place of work – is the legal obligation of all businesses and HR departments around the world.

Misclassification of employees refers to the (deliberate or accidental) practice of recording an individual who should be classified as an employee as an independent contractor instead, or vice versa.

Whilst most companies would never dream of trying to cheat the system via deliberate misclassification, sadly there are those who would. The reasons why an international employer might misclassify their workers are as follows:

• Tax evasion
• Cost-cutting by saving on employee benefits
• Breaching employee rights to enforce longer working hours, etc.
• Accidental misunderstanding of differing definitions
• Lack of awareness of how international recruitment affects classification regulation

Classification regulations and definitions are not always set in stone, and the correct status of an employee versus an independent contractor is generally determined by a country’s local government or tax authorities.

However, because the rules surrounding classification differ from country to country – and in places like the US and Canada, from state to state – it is especially important that recruiters of international independent contractors, as well as global business leaders, are aware of the importance of misclassification, and how to avoid it.

Why Is Independent Contractor Misclassification Important?

Just as money is often the motivation behind deliberate misclassification of employees by their employers, so too is it the driving factor behind the strict regulation of this practice by local governments. Nevertheless, there are also other reasons why it’s important to classify your workers correctly and compliantly.

Legal and Financial Ramifications

As we’ll discuss in greater detail in the following section, there are a host of legal and financial penalties attached to employee misclassification.

Regardless of whether it is deliberate or accidental on the employers’ part, tax authorities like America’s IRS, the UK’s HMRC, or China’s STA will crack down hard and fast on any case of employee misclassification.

As such, it’s important to both the legal operation and financial security of your business that you are compliant with all classification discourse in the countries in which you and your workers operate.

Worker’s Rights

Employees are typically entitled to more employee benefits than independent contractors are. In addition to benefits – often determined on a company-to-company basis – there are also laws in place in most countries to control fair employment, pay and working hours, and which keep the rights of full- and part-time employees protected.

Here is a short list of benefits which most employees are legally entitled to:

• Minimum wage
• Holiday pay
• Medical and family leave (such as paternity and maternity leave)
• Pension schemes
• Termination protection
• Workplace safety
• Compensation for overtime
• Legal maximum of working hours

Classification is important because it ensures people who are employees receive their rightful protections and benefits.

Business Reputation

Misclassification is equally important to the reputation of your business, both at home and abroad. Even though misclassification of employees can happen accidentally, it is viewed unkindly by both current and prospective employees and clients.

Misclassifying your independent international contractors may not only incur high fines, but may also ruin your business’ global reputation.

The Risks of Misclassification

The risks of independent contractor misclassification are threefold:

Legal Action

Employees who have been wrongfully classified may take legal action against their employer under employment law, seeking retroactive reparation for wages and benefits they were denied due to misclassification.

Financial Penalties

Tax authorities, as well as local government regulators, may fine or otherwise financially penalise a business deemed to have grossly or knowingly misclassified its employees.

Back-Taxes

Tax authorities are likely to demand the back-payment of taxes which should have been withheld for the employee(s), but which were not because they had been misclassified as independent contractor(s).

How to Comply With International Classification Regulations

Having discussed the definition of, and risks associated with, misclassification, we can turn our attention to the various ways in which you can avoid employee misclassification, and comply with all of the regulations relevant to you and your business.

Know the Differences Between Employees and Independent Contractors

In order to correctly classify your workers, you must first know the key differences between employees and independent contractors (the latter also referred to at times as freelancers, 1099-employees, and non-employees, depending on the country).

Unfortunately, as previously discussed, the details of these differences differ from country to country and state to state. Correct classification of international independent contractors therefore requires that you are up to date with the specific regulations of their country of residence.

The following three core differences between these two types of worker are generalised, and may prove useful as a first point of reference for any global business leader looking to hire abroad compliantly.

Control of Behaviour

Employee: An employee’s behaviour at work – which encapsulates where, when and how they work, their training, and the tools they use – is dictated and controlled by the employer.

Independent Contractor: A freelancer’s behaviour at work is not dictated or controlled by the employer – they may choose to work when, where, and however they like, using their own knowledge and tools, provided they meet the project scope and deadlines.

Control of Finances

Employee: An employee’s income and payment timeframe is controlled by their employer. They are paid a fixed salaried or hourly rate in regular amounts and on a regular basis. The employer is likely also their sole source of income.

Independent Contractor: An independent contractor is in control of their own finances, sets their own rates, and has multiple income streams from an ever-changing portfolio of clients. Their income may be irregular and is paid on an invoice-by-invoice basis.

Relationship Between Business and Individual

Employee: An employee’s relationship with their employer is long-term and based on a contract of service, stating the working hours, pay, working conditions and expectations of the employer.

Independent Contractor: An independent contractor exists at arm’s length to their client, dealing with employers typically for a short period of time through a contract for services, and receiving no additional benefits from their relationship with their client(s).

Engage the Services of a Trusted Business Solutions Provider

The safest, most reliable and – often – most-affordable means of ensuring you adhere to all the myriad rules surrounding the classification of international independent contractors and employees is simply to hire the services of an expert.

Mauve Group has been providing global business expansion and HR solutions for almost three decades, across over 70 different sectors – from education and not-for-profit, to telecoms and IT – and in 150 different countries.

Today, Mauve Group enables business leaders to effortlessly hire the expertise of both employees and independent contractors anywhere in the world. What’s more, they ensure that all workers on your payroll are classified correctly according to the laws of the country in which each individual is based.

Employer of Record (EoR)

Mauve Group helped to pioneer the Employer of Record (EoR) model, which takes the hassle and stress out of hiring employees abroad. Their renowned EoR services cover tasks such as international payroll processing, overseas employment laws, and ensuring local compliance, making it easier than ever to expand your business globally.

Independent Contractor Solutions

In a similar vein to its EoR services, Mauve Group also provides a service tailored specifically to the recruitment of international independent contractors. As an Independent Contractor Solutions provider, Mauve Group covers the hiring and payment of international freelancers, as well as their legal classification, and compliance with all relevant labour and tax regulations in the countries of the contractors’ residence.

Review Your Classifications on a Regular Basis

Whether you opt to tackle the classification of employees and independent contractors by yourself, or with the help of professionals, be sure to review the relationships between your business and your workers on a regular basis.

As we discussed in the introduction, definitions, rules and regulations surrounding the classification of freelancers and employers are changing all the time. One of the easiest ways to accidentally misclassify an employee is to be unaware that either your relationship with them, or the law, has changed.

A Final Thought on Employee Misclassification

As the gig economy continues to develop in the aftermath of the Job Era, world governments seek to keep up to date with changing definitions of employment. Labour laws are changing, and at the same time, tax authorities are finding ways to classify workers as employees in order to increase revenue. The benefits to hiring independent talent abroad are countless, now more than ever, but this is also why it is so crucial that business leaders not only understand employee misclassification, but also know how to avoid it.