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What are the Penalties for Misclassification?

30 Oct 15:00 by Capital GES

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As more and more companies look to take their operations overseas and expand into new and exciting International markets, hiring and employing workers in a cost-effective and compliant manner remains a key concern. Without the existence of a local entity, many companies in expansion mode believe that hiring an independent contractor (IC) is the best solution. In the right circumstances this may well work, but the risks (and penalties) with misclassification of workers can be enormous. 

What is misclassification?  

Employee misclassification occurs when an employer categorises an employee(s) as an independent contractor instead of an employee. This is also known as false self-employment or deemed employment. The rules around IC and employer relationships vary wildly from country to country, so before an organisation decides to hire an IC it’s always best to seek professional advice to make sure you remain completely compliant.  

Misclassification cases  

In order to avoid employee misclassification and the resulting fines and penalties, it’s important to understand whether the worker is an employee or a contractor? Over the last few years especially in the gig economy, we have seen in the US and Europe how costly misclassification cases can be. The tests used in misclassification cases are similar all over the world and there are many factors used in determining misclassification which can include:   

  • Does the worker use company’s materials/equipment? 

  • Does the worker have additional benefits such as holiday and sick pay? 

  • Where is the workers workplace? 

  • Does the worker take direction from a supervisor? 

  • How much control does the worker have?  

Misclassification can result in fines and penalties 

Once an employee has been misclassified as an IC, the employer is expected to pay a series of penalties and costs. As a result of not complying with the country’s regulations, misclassification costs can go back years and include:  

  • Back wages: The employer is now requested to pay back wages to the employee.  

  • Unpaid employment taxes: As the employer did not pay and withhold tax in respect of the employee’s salary, they are expected to pay back all unpaid taxes. Employers are also expected to pay back unpaid contributions.  

  • Statutory entitlements such as holiday pay, sick pay, etc.: Employers will be expected to pay back all unpaid holiday, sick pay and other statutory entitlements now that the contractor is classified as an employee.  

  • Penalties: Employers will be charged penalties for not operating compliantly in the country.  

  • Interest: The employer will also be expected to pay interest on the costs that are accrued. 

Below we have prepared an example of the costs involved in misclassifying workers. 

Europe

Improperly classifying a contractor in Germany

For this example, we are using a worker that has been deemed employed. Below you can see various costs to the employer due to this misclassification.

Contractor yearly salary 150,000 EUR
Unpaid Employer costs Up to 40% og gross salary retrospectively for up to four years.
Income tax Any outstanding unpaid income tax
Mandatory Benefits (holiday pay, sick pay, etc.) Maternity/Paternity leave, holiday pay, sick pay, notice period for termination
Penalties for not operating compliantly Depending on the salary and number of workers involced this can be hundreds of thousands.

Latin America 

Improperly classifying a contractor in Brazil

Below you can see the cost of misclassifying a worker in Brazil.  

Contractor Fee BRL 120,000 per year
Unpaid Employer Costs? From 26.8% to 28.8% depending on the company's core business
Income Tax Any outstanding unpaid income tax
Mandatory Benefits such as holiday pay, sick pay, etc. Holiday Pay, Sick Pay, Maternity/Paternity Leave, Overtime Pay, 13th Salary/Christmas Bonus, notice period for termination
Penatis for not operating compliantly FGTS: lack of monthly deposits: up to BRL 420.00 per employee
Lack of registration of the employee: up to BRL 3.500,00
Lack of registration in the employee's Booklet: BRL up to BRL 300.00
Labour Courts indemnifications (moral and material damages): uncountable

 

How Capital GES can help 

If you are planning on expanding into another country, or already have done, but are not sure whether you are at risk, you should contact Capital GES, as we will be able to assist you. We will ask questions, to judge whether the worker is an independent contractor or an employee and then propose a compliant solution for your company. With our Employer of Record (EOR) solution, you can have workers employed compliantly in a new country, in a matter of days. Through using Capital’s EOR solution, companies can have peace of mind knowing that they won’t be at any risk of misclassification.  

If you are thinking of expanding your business and looking to hire workers internationally, contact us at info@capital-ges.com or via phone: +41 32 732 97 00 or +1 833 972 6346 to see how we can help.