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Paying International Contractors: A Quick Guide

By: Craig Lebrau

 

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What is an International Contractor?

An international contractor is a person who is not a citizen of your country and provides services for your company. An international contractor is not an employee but has an agreement to perform a certain scope of work for the company. This could be defined as a specific project, a specific role or function, and is usually limited to a specific period of time.

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International contractors, like local contractors, are not fully dedicated to your business. They are self-employed and run their own business and may have multiple customers in addition to your company. However, while this distinction sounds simple, in some cases it can be tricky to classify a worker as an employee or contractor, and this can have important implications for your business. I’ll expand on this in the considerations section below.

4 Ways to Pay Contractors Internationally

Bank Transfers

Banks can perform international wire transfers, but this is usually the most expensive way to pay offshore contractors. Bank transfers do not offer competitive exchange rates, and there is typically a service fee for each transfer.

In addition, banks tend to have hidden fees. Intermediate bank fees, also known as receiving bank fees, may be charged multiple times on a single transfer, depending on the transfer method. Fees can range from $15 to $30 per transfer and are difficult to predict. Banks also do not report transparently about the fees they charge. In many cases, contractors will receive less money than you actually transferred due to bank fees, and you should make an effort to identify these charges and compensate them.

International Money Orders

Wire transfers through companies like Western Union were once considered a fast and secure way to send money. However, in the modern digital economy they are not an ideal option, because they often have high deposit fees and might require the foreign contractor to physically arrive at a service desk to receive the payment. Although problematic, in countries that do not accept digital payments, this may be the only option.

Digital Payments

Digital wallets and payment services like PayPal are easy to set up and give both payers and recipients full control over money transfers. Currency conversion is easy and recipients can manage their funds in their preferred currency. However, most digital payment methods charge a commission, which typically changes depending on the volume of transactions.

Payroll Services

Another option to pay international contractors is to hire them as a salaried employee in their local country. International payroll services are available who can perform international payroll calculations and handle legal and tax aspects of hiring foreign citizens. Most of these services charge a per-contractor rate or flat per-month rate.

Modern payroll services offer a web-based platform for managing employees and viewing payroll reports, and foreign employees can view their paychecks and related information in their own language. However, carefully consult the legal terms of each payroll service to understand your legal exposure, who is considered the employer of the worker, and whether all compliance requirements are taken care of.

Considerations When Paying Foreign Contractors

Paying offshore contractors has legal and tax implications for your business. You need to understand the laws in each country you operate in and ensure you comply with them. Learn about additional considerations in this detailed guide to international contractor payments.

How Workers are Classified

Each country has its own rules and regulations determining who is considered an independent contractor and who is considered an employee.

Here are a few factors that might determine whether a worker is a contractor or employee (note that these factors might be different in the countries you operate):

  • If a worker works for an employer for a long period of time, or does most of their work for one company, they are often classified as an employee.
  • If a worker can work for multiple companies at the same time, work at the time and place of their choice, and freely move from one company to another, they are often classified as a contractor.

If, according to local law, the worker is classified as an employee, the company must pay them social benefits and might be required to pay additional taxes. The company is typically required to withhold income taxes from the worker’s salary and pay them to the local government. On the other hand, if the worker is classified as a contractor, they are usually responsible to pay their own benefits and pay their own income tax.

If you wrongly designate a foreign worker as a contractor, while in reality they should be considered an employee, your business might be subject to penalties. Common tax penalties imposed by foreign governments include back tax on wages, and a requirement to pay benefits such as pension, vacation, sick leave, and severance pay retroactively.

Forms

Each country has its own unique rules and regulations regarding taxes. In some cases, you may need to complete the relevant employment and tax forms for your international contractor’s country of residence. You should also ensure that the international contractor knows how properly and accurately report their income to the local authority in their country.

US-based international contractors must complete one of the following two forms:

  • W-8BEN—applies to individual international workers.
  • W-8BEN-E—applies to international workers who have a company.

The Internal Revenue Service (IRS) provides both of these forms for completion by international workers. While Form W-9 helps record payments to domestic independent contractors, W-8BEN and W-8BEN-E are longer and require international contractors to provide extensive information.

Once a foreign independent contractor completes this form, employers are not required to send it to the IRS. Instead, employers need to use it to ensure they withhold domestic taxes appropriately before paying international workers.

An independent contractor agreement

Employers are not required to sign an independent contractor agreement, but this practice is highly encouraged. This document defines:

  • The roles and responsibilities of all parties involved.
  • The relationship between the company and independent contractor.
  • The scope of work expected by the international worker.

This agreement serves to limit the employer’s risk of misclassification.

Permanent Establishment Risk

Companies operating in foreign countries face the risk that a local government will classify it as a local business, thus forcing it to pay local corporate tax and report on its income to the local authorities.

When a company starts operating in a territory and does not clarify its corporate status and the status of relevant worker tax and income designations, the foreign tax authority might decide to classify the company according to its own rules, often in a way that is not beneficial to the company.

This “permanent establishment risk” should be a key concern for global companies. They should be aware of all unique tax laws and income reporting obligations in each country, and take action to classify itself in the category most beneficial to the company, in line with local law.

Conclusion

In this article, I explained the basics of paying contractors located overseas. I described four common ways of paying a contractor abroad:

  1. Bank transfers – international wire transfers via your bank.
  2. International money orders – transferring funds through providers like Western Union.
  3. Digital payments – using services like PayPal and digital wallets.
  4. Payroll services – via specialized service providers that can set up your freelancer as an

In addition, I provided some important considerations your business needs to know about when hiring freelancers overseas – worker classification, tax forms, and the risk of being recognized as a permanent establishment by the local government.

I hope this will be useful as you expand your business with the help of overseas talent.

Published: August 29, 2022
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