Recorded on: July 2nd 2020. (UnaTerra regularly hosts webinars on a range of international expansion topics – to sign up for the next one, visit our Webinar page.)
Your company has decided to hire or sell internationally – now what?
International expansion can be complicated and difficult, but we’ve navigated the pitfalls and can help you avoid common mistakes.
In this free webinar, we went over what to consider when entering another market, common mistakes to avoid, and resources that are available to help you.
We went over a framework on how to approach international expansion and what questions to ask when your company grows beyond your home market.
- International expansion drivers
- International solutions at a glance
- What to consider for an international expansion plan
- What is permanent establishment risk?
- Common mistakes and misconceptions
- Resources to help you
Good morning, everybody, or afternoon or evening, depending on where you are in the world. My name’s Andrew Laing and I’m from UnaTerra. I’ll be explaining why companies go abroad and giving some options for market entry strategies.
Before we get started, a little bit about UnaTerra. We help our clients expand abroad by taking care of the business logistics that they don’t necessarily have the time to research or implement. It becomes difficult for teams to get these strategies going, and we aim to take care of it for them. So, they can focus on their business points and growing their business internationally.
What we offer is payroll, HR, financial reporting, compliance and more. We focus on setting up entities, doing HR work and HR one-offs, like employment contracts. We also offer Professional Employer Organisation (PEO) services as part of our total solution.
I’ll be going over why companies expand abroad and some of the drivers there. The options that they have for going into these international markets and establishing a presence.
I wanted to start by looking at what drives international expansion. Now, I’m sure a lot of people are familiar with these reasons, but maybe there are a few things that folks don’t know about that we can go over.
International expansion drivers
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Tapping into a global market
This is a really important one for a lot of companies. This is taking advantage of people or demand in other markets. Whether that is driven by a specific customer that has a need for the service or product in that market. Or it could be general market entry, where data shows that the service or product is really needed in that market. We’ve had clients who need support in a country because they’ve got either a complex product or service that could really benefit from having someone in country. Not just on the phone or over video chat.
Access to global talent pool
Obviously, this is another big reason. I’m based in the San Francisco Bay area, where living expenses are pretty ridiculous. It’s expensive to hire people and companies are starting to realize that you can take advantage of highly skilled, less expensive labour in different parts of the world. There’s also a need for specialization sometimes. So, we’ve had clients that are in the aerospace industry. They go into France, because France has a lot of training and education around that industry, this means US companies are able to take advantage of that.
Efficiencies from a global footprint
Governments provide a lot of incentives to bring companies into their region. They do things like tax credits for certain types of work, for example R&D, and also offer incentives for bringing business into that country. Some developing countries might have a better broadband infrastructure than some developed ones, just because everything is newer. It’s not built on top of an old infrastructure, but rather it’s new and that can really help you keep ahead of the global tech curve.
This doesn’t just mean translation. It’s about having a customer service function or a sales function in country, that’s really familiar with the way business works and local customs. They’ve got expertise in that product in that country, this can really be a big benefit. An example of this is from a client of ours, they’re an education platform and needed both language and regional expertise, in the countries that they were going into.
Easier than ever to have remote teams
Companies can connect with people over video chats. Leveraging that technology to bring all these things together is much easier than people anticipated ever before. So that’s something we’re seeing facilitate this international expansion.
What are the options for hiring employees internationally and establishing your presence in another country? This is central to the work we do at UnaTerra, and I’m just going to look at the principal ways of engaging with your international workforce.
International solutions at a glance
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There are three main ways to engage with your international workforce. It’s true to say that there are more than three ways to engage with them, but in our experience, 99% of them fall into one of these three categories. They range from relatively high touch, high cost, high commitment solutions to very quick, easy to implement and relatively inexpensive solutions. The right solution really depends on the circumstances.
1. Full Entity Setup
The creation of a legal entity, this is the all singing all dancing way to hire people from out of the country.
Creating a separate legal entity with a full range of tax registrations and exposures. So, not just payroll taxes and social security, there’ll also be a registration and a requirement to make filings around VAT or GST, depending on where you are. In some countries there is a consumption tax and of course, corporate tax. You’ll need to file full financial statements and corporate tax returns at the end of every year. It’s a fairly big commitment and often what we hear from clients is they want to shy away from creating legal entities, wherever they can avoid it.
The good thing about legal entities is that they’re fully scalable. You can employ as many people as you want through a legal entity. It can often be a sensible move to try and create a critical mass in one country. Europe is a classic example, create a full team in one country who can then serve the needs of all the countries in Europe. This negates the need for small teams in each of the different countries and can be an efficient way to go.
Manages PE Risk
I’ll mention later permanent establishment and permanent establishment risk, but it’s a risk that all companies face when they hire people in other countries. When they engage in international business and international business activity, the legal entity is the best way to manage permanent establishment risk.
Takes time to set up
The downside is that it can take a long time to set up and it’s quite a costly commitment. Classic example is Brazil, where it can take anywhere from four to six months just to get a legal entity off the ground and in a position to hire somebody. It’s a big commitment, a long timeline, and very complex, but you have to do it to have an employee on the ground in Brazil.
2. Payroll Only
It’s possible to hire people in a country without actually having a local legal entity. I have to offer this explanation frequently when talking to prospective clients. They’ve never come across this before. You can take a company in one country and register it as an employer in another country, thereby avoiding the need to create a legal entity in another country.
The big advantage is it’s fully compliant from the point of view of local employment law. And it also is fully compliant in terms of local taxes and local social security. It’s highly compliant specifically from the employment perspective. However, there are some limitations, particularly depending on how many people you’ve got and what their activities are. Again, that strays into this concept of permanent establishment which I’ll explain later.
The good thing about this payroll only solution is that it’s relatively inexpensive, and it’s quite common. We implement this a lot for our clients, who want to employ one or two or three people in a certain country. It avoids the need for unnecessary legal entities.
It’s not available everywhere. It’s freely available in Europe. You can use this solution in almost every European country. You can use it in Canada, but you can’t use it in the US. You can’t use it across the whole of Latin America, and for the rest of the world it’s very much on an exception basis. So, it’s a bit limited in that respect, but it is a very good solution if you’re hiring small head counts and they’re engaging in fairly non-commercial activity.
3. Global Professional Employer Organisation (PEO) / Employer of Record(EOR)
This involves engaging your employees through a third party. So rather than employing them directly and having them engage directly with your company, they actually engage and are employed by a third party. They represent your company in a different country, but they are not contracted from an employment perspective to your company. They are contracted to a third party who acts as a vendor to your company.
Good for small teams
A good thing about PEO is your company doesn’t have to create any sort of presence in terms of tax registrations, in terms of a legal entity in the other country. It is a very quick and immediate solution to implement.
Easy to set up
If you have somebody who wants to join your company next week, it’s pretty difficult to create a legal entity or even a simple payroll registration in time to onboard that employee. But the PEO solution will enable you to onboard that employee very quickly.
With speed comes expense. The downside is that it costs quite a lot. You’re generally talking somewhere between 10% and 25% of the total cost of employment for an individual. It’s not inexpensive and therefore from a scalability perspective, it’s not really scalable. In the longer term, it makes sense to seek alternative solutions.
Compliance/PE risk issues
The good thing is it’s fully compliant from an employment law and tax perspective. It’s a bit like the payroll only option as it’s fully compliant from the point of view of employment law, employment taxes and social security. But as with the second option, it can create a permanent establishment risk to your company. There can be compliance issues, for example, issuing stock options.
The cultural element is a bit less tangible. How do you get employees from other countries to enjoy your company culture? Problems arise for an employer if you are not able to extend the full range of employee benefits to that individual, because the PEO provider is limited in what they can offer. This can create cultural barriers between your HQ teams and your disparate foreign employees. It’s an intangible issue, but it’s one that we come across quite frequently and it’s commonly expressed by our clients.
So those are the three main options, there are others, but in our experience 99% of international hires are made through one of these three options.
What to consider for an international expansion plan?
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We’re focusing on employing people internationally as it applies to your company and which solutions you might engage with. So what you should consider? This is what we advise our clients on all the time. For example, you want to employ a team of five in a certain country. What are the options and which one will we solution for you? And it can be a blend of the following factors:
How urgent is it that you get somebody onboarded very quickly? All too often, our clients come to us and say, ‘Hey, we need to employ somebody in Spain. And by the way, we told them they can start next Monday.’ That’s a tricky situation to manage. There are workarounds and we can sometimes do it, but it’s quite difficult to do that in a way that’s fully compliant. PEO can meet that need. If it’s a very urgent situation, PEO is a really good solution, but it’s not inexpensive and it does come with its own limitations.
Cost and timeline sometimes conflict. We can payroll somebody in the UK for a couple of hundred dollars a month, and that’s a very low cost to your business. The PEO solution may be 10 times that, so as a decision maker, you really have to weigh up timeline versus cost.
In implementing a certain solution for your international workforce, are you exposing your company to inadvertent tax risk. A classic way of doing this is by engaging people as independent contractors. It can be a bit of a false economy by not having them on payroll properly as it can create tax risks.
Observing local employment law
It’s really important if you’re hiring internationally, to observe and make sure that you take on board the requirements of local employment law. It’s quite straight forward in the US, in all other countries it’s more complex and it’s very different from one country to the next. International expansion is littered with examples of when contravening employment law can create problems and great cost. We’re currently dealing with a client who terminated an employee while she was on a maternity leave. The settlement is 70,000 euros, all because they breached the local employment law. Obviously that’s not necessarily relevant when you’re hiring or terminating, but employment law in other countries is so variable. In a lot of countries, it’s stacked very heavily in favour of the employees. It’s very important to observe it, because litigation usually favours the employee rather than the employer.
Retaining business culture
It is very important your solution allows you to extend the key parts of your business culture to your international team. There are some options which facilitate this more than others. Certainly, being an independent contractor doesn’t allow them to enjoy your business culture. PEO can be an issue as well. If you want to maximize the extent to which you can extend your business culture to your employees. It’s really best to make sure they are employed directly, that they are your employees.
Those are the key points that I wanted to cover on international expansion and specifically what to choose for your international hires.
What is permanent establishment risk?
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I touched on this concept of permanent establishment risk. I have to talk about it all the time with clients or prospective clients. The extent to which they understand it is very variable. Some totally get it, but I have to say most don’t. It’s a critical thing to consider when you are hiring people in other countries. It really boils down to creating tax exposures for your company that you didn’t mean to create. So, what is permanent establishment?
A permanent establishment essentially exists when a business activity in a certain country exceeds some threshold beyond which, some sort of tax would apply. Usually corporate tax, but it could be VAT or some other tax as well. This can be intentional or unintentional. So, it’s quite easy for a company to create a permanent establishment without realizing it. Perhaps because they’re not aware of the concept or perhaps because they’re not aware of the triggers for permanent establishment.
Permanent establishment (PE) risk
PE risk looks at the risk of the activity your company is undertaking in another country, to see if it breaches some sort of tax nexus and exposes your company to attacks. These unintentional breaches are a tax exposure which are very difficult to manage.
What creates PE risk?
If you have somebody on the ground in a country who is your employee. If they are engaging in activity, which directly generates revenue and if that person breaches the nexus for corporate tax in that country inadvertently. Then, without a legal entity to manage the risk there is an exposure to corporate tax. So commercial activity, whether undertaken by an employee or a non-employee, for instance it can be undertaken by an independent contractor. This can still create a risk for your company. The way to protect against it, when you have this commercial activity going on is to register or incorporate a legal entity. This will have a corporate tax registration and that will give you what you need to manage the risk.
Senior management activity
If you have an executive decision maker, anything from a founder to a senior vice president who is making decisions about how the company is run, this activity in itself creates permanent establishment. There can be an interpretation that this person and their activity is contributing to the global revenue of the business. An example of this is from a client of ours. There were only two people in the company, they were both founders and they were in different countries. The founder is as senior as you can get within a business and in order to make sure that we gave them the protection they needed, we ended up incorporating legal entities in two countries. Because they were in Sweden and the UK, we actually ended up with two people employed by separate legal entities. This was done to specifically overcome the risk of the permanent establishment challenge from the tax authorities in one or the other countries. So, senior management activity automatically triggers permanent establishment.
A fixed place of business
This is a literal interpretation of permanent establishment. Even if you have an employee in a co-working space or two employees working in a short-term rental office, that creates permanent establishment. If you have that arrangement, it’s important to consider incorporating a legal entity. A legal entity is what’s going to enable you to manage your own permanent establishment risk and your own tax position.
It’s a technical area and it’s very theoretical. It’s quite difficult to quantify the risk or the extent to which this risk might crystallize in any given situation. But it’s a risk nonetheless and tax authorities in some countries, have grown very wise to it and regularly make corporate tax assessments, even when there is no legal entity
Common mistakes and misconceptions
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A legal entity is required to hire employees in another country
This is one that we run across all the time. This is not necessarily the case. It really depends on country to country and what the circumstances are of the company that’s doing the hiring abroad. You certainly can look at non-resident employer registration just to register the domestic company, whether that be US or anywhere else. Or you can look at PEO, depending on the circumstances. This is going to be a common theme for all of these misconceptions.
Hiring contractors avoids hassle and headaches
It’s an easy way to get started quickly in a market. By hiring someone you can get started in a couple of days, just by paying into their bank account. It isn’t always non-compliance, it really comes down to the work that the contractor is doing. You have to be aware of permanent establishment, if they’re doing sales work, that establishes PE risk. If they’re doing any kind of work that’s generating revenue and the employer is their sole client, this can cause exposure. This is another sign to foreign governments that maybe this person actually does have an employee employer relationship with the company. If there is exposure the authorities will generally go after the company first, before they go after the contractor.
PEO solutions deliver full compliance
It’s fully compliant from an HR standpoint but not necessarily compliant with tax law, depending on circumstances. It’s playing in the grey areas of tax law. For example, if the employee is carrying business cards for their employer instead of the PEO organization. The law can get that granular with looking at whether there is a PE risk. You always want to get in touch with an international advisor, like UnaTerra. These are questions to ask when you’re designing your international expansion strategy
Resources to help you along the international expansion journey
We deal with client teams all the time who are crunched, HR teams or finance teams who are given the instructions to hire someone abroad. There is a lot to consider depending on the country you’re going into. This is a general list of who can help you:
Establishment service providers
Companies like UnaTerra who provide fully compliance solutions. Whether that’s either registering a full legal entity, like a subsidiary or a branch, or just doing payroll registration. We’re always happy to jump on the phone for half an hour to an hour to understand what your circumstances are. We then can point you toward the right solution.
Global PEO services
They can help you establish a presence quickly but be careful of that PE risk. Make sure to ask the right questions when you’re in meetings with them.
Immigration attorneys and global mobility
They can help if you’re moving employees between countries. If you’re looking at bringing employees into the US, there is the L visa, whose future may be in jeopardy. But in the meantime, it’s a way of employing foreign workers abroad and then bringing them into the US after a year.
There may be several companies that have an established presence in a market, usually a region like Asia or the EU. They can help you determine who the best partners are going to be and give you business context. Sometimes, for example, an outsource sales team to help you test the waters.
I mentioned that governments try to curry favour with international businesses and bring investment into their country. There are organizations like DIT for the UK, Austrade for Australia and Invest in Bavaria in Germany. They have people whose job is to inform and educate people about the advantages of establishing in their markets. They’re always good contacts to have when you’re thinking about your international strategy.
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What sort of companies do you usually work with and where are they in their life cycle?
On the whole we work with companies who are engaging in international expansion, typically high growth companies. That means the tech community principally based out of the US, about 70% of our work is with that community. We also work with clients who are based in the UK, mainland Europe and Australia. They’re either starting or have embarked upon their expansion plan and are hiring overseas and growing their overseas teams. We provide the full range of support to them.
Why does setting up a foreign entity take such a long time?
It is a turnoff to a lot of companies because it can take a long time to get an entity set up and can be a lot of hassle. That’s what we help with, cutting through some of the red tape and we’ve got a lot of experience, we work in 90 plus countries now. The legal process for setting up in foreign countries includes a lot of steps, generates a lot of paperwork and applications. Places like India, Brazil, and China have a lot of steps that you have to go through, and you have to follow them sequentially. Other things that can delay setting up an entity, is bank setup. In a lot of countries there’s anti-money laundering regulations. Which are known as ‘know your customer regulations’, and these can cause bank set up to take a long time. You do need a local bank account in a lot of countries either to pay employees, pay suppliers, and receive payments. We do have solutions that can make it a lot less painful and quicker for companies. Those are just a couple of reasons of why things can take so long.
When do you think it’s good to use PEO?
A couple of specific examples come to mind. Firstly, if you’re looking to hire one or maybe two people who are in a very complex market, for example Brazil. If it’s your first hire there, you need to incorporate a legal entity which takes months and is very complex. Also, there is a lot of local tax and other compliance requirements that need to be fulfilled. For one or two people it’s not feasible to go through all of that. PEO is perfect for hiring small head counts in very complex markets like Brazil, China, Russia, and some countries in the Middle East.
Secondly, when a hiring requirement is immediate. Either a candidate presents themselves and they’re immediately available and you want to onboard them straight away. Or, unfortunately as is often the case, when either finance or HR teams deliver a bombshell from perhaps the head of sales. Who’s told somebody in another country that they can start really soon. That’s a bit of a hot potato and PEO is great for dealing with it. It’s pretty immediate and you can fulfil that expeditious requirement to onboard somebody. Moving forward there maybe the option to transition to a lower cost direct employment further down the track.
In summary, it’s either very complex markets or when the need is immediate and PEO is a very quick turn on solution.
I am always happy to take an hour-long phone call just to discuss what specific circumstances you have, what your need is, what your timeline is like and how we can help you meet that. If you do have any questions, feel free to reach out to me at Andrew.Laing@unaterra-global.com.