In ever-changing market conditions, entrepreneurs do their best to optimize expenses by finding a new income source, cutting costs and re-organizing teamwork. Co-founder Eugene Fedorov of EasyStaff, a freelance management platform, shares his view on business challenges of today. Read on to find out why labor law may be problematic for IT companies and how to save on payroll expenses without losing professionals and maintaining work quality.
Labor Contract Is Not Always an Option for IT Companies
Normally, an employer-employee work relationship is regulated by the government. It establishes the rules that regulate any labor market operations. The rules are the labor code of a country, and the code navigates market players’ decisions and actions. However, a homeland labor code doesn’t always favor market players, especially when competing globally. To stay legal, businesses need to meet every country’s labor code requirements, and this is exactly what may curb their international growth.
There are several countries where IT businesses can grow fast. Consider some of them:
- USA. Silicon Valley, California is the epicenter of IT/technology entrepreneurship. Famous IT startups, such as SoundHound and Wing, have their headquarters there. Importantly, the location buzzes with qualified specialists and offers investment opportunities to its residents.
- Israel. The country is renowned for its innovative approach to system development. Israel concentrates multiple technological startups and boasts government entrepreneurship support and tax exemption.
- Singapore. The place offers a wide variety of business development opportunities. IT entrepreneurs enjoy a favorable business environment with access to financial support and IT startup incubators and accelerators.
However, a company’s success depends not only on where the founders are, but also on their team. Hiring the right people and saving on taxes is possible if an educated decision is made on where exactly people are hired from.
If you are a European entrepreneur or you seek to hire European professionals, you know that salaries are not low. An average salary in the country helps an employer understand how much hires may demand. It is only natural to search for team members in countries with lower average salaries. An average IT salary
in Europe is 5,860 EUR. Moreover, there is a salary growth tendency in the region, with salaries having grown by 4.6% (Q1 2023 vs. Q4 2022). At the same time, in less economically successful states of South America high quality workers expect a satisfactory average salary. An average IT salary
in South America is 4,181 EUR.
An entrepreneur seeking to hire European teammates should also consider tax responsibilities. According to EuroDev
, European labor law keeps employers accountable for income tax payments. So in addition to salaries, European employers pay as much as 30% of taxes. In contrast, Latin America and the Caribbean islands make employees responsible for tax payments.
Apart from the financial load of hiring in Europe, there is red tape that an employer should be ready to comply with. HR management may be troublesome for smaller IT-companies that want to focus on achieving results, rather than completing tedious paperwork.
The question is, how to retain a great team of professionals that makes a company thrive, despite problematic and demanding tax and labor cost environments. A simple answer would be to avoid a labor contract and replace it with a service agreement. However, the letter may not always be an appropriate solution. A still better option is to go offshore to gain control over the founder and the teams’ work relationship.
Labor Offshore in a Nutshell
In simple words, labor offshore is used to:
- avoid a tax agent role;
- find workers speaking the founder’s language in countries with cheaper living costs.
Overall, labor offshore is a business practice where part of business processes is moved overseas to cut payroll costs. As a rule, offshore labor is moved to places where salaries and taxes are lower, and labor laws simpler. This step helps to save money and increase a company’s competitive performance.
It is crucial to mention that labor offshore is not a gray practice. On the contrary, it is a popular solution that is fully legal if carried out in compliance with national and international labor laws. To reduce their tax burden, many worldwide corporations set up overseas offices. For example, Google, Apple and Microsoft are partially based in Ireland to leverage taxation. Likewise, Starbucks and Amazon operate in the Netherlands for the same reasons. And these are not exceptional cases.
Importantly, the use of labor offshore is not always associated with tax liabilities. Offshore legal structures can also be used to reach professionals, cut labor cost and for other operational benefits.
Reduce Tax by Moving Business Offshore
One way is to build a separate international company with smart cash flows and to sign service agreements in countries where tax agent responsibilities are not laid on the company. One of the best counties for this is Lithuania.
A crucial benefit of opting for labor offshore is an opportunity to formalize the employer-employee relationship as a service agreement. Such agreement includes key regulations for the worker, e.g. work hours and annual vacation period. At the same time, if the company is not satisfied with the worker’s performance, a service agreement can be easily canceled. It may seem that the government’s regulatory power is eliminated.
The trouble is, such a relationship is still considered a work relationship in the European Union. At some point, regulatory government bodies will contact the company and require that the company make up for the missing taxes. At best, the company will receive a warning. At worst, it may need to pay a fine or even get sued. The question remains, how to make a service agreement a safe and scalable option for companies.
To optimize payroll expenses, you can structure the organization in such a way that salary payments will go through a foreign company that enters into an agreement on the provision of services with foreigners, e.g. your employees. Therefore, you will not be granted a legal agent status which is the case in Germany, Italy and other European countries.
In the USA, for example, it is drastically different. A service agreement can be signed with any worker of any nationality, as the company (a US company) is not a tax agent of its employees.
As a result, an optimal solution for IT-companies is to organize a service agreement so that it is signed in a country where labor law doesn’t make the employer the taxpayer - like in the USA, Lithuania, Cyprus and other countries.
Consider this simple case. An entrepreneur from Germany sets up a company in the USA where a share of its revenue is directed. The American company signs service agreements with any workers or teams, from anywhere in the world. It is not responsible for paying income taxes. The example serves to show that labor offshore brings the labor relationship with their employees back to the company’s hands to the most of its benefit.
Naturally, setting up a company in the USA or elsewhere overseas is not easy for small and medium IT-businesses. Thankfully, there are mediating services that can take over law compliance. Platform users pay their workers from any region through the service, and companies will not be held responsible for income tax payment, as technically it is the service that employs workers. This procedure is exactly what many IT-companies opt for to minimize their payroll costs.
Who Can Benefit from Payroll Costs Optimization with Labor Offshore
If a company manages remote freelancers from all over the world, it can certainly benefit from opportunities that labor offshore provides.
While core team leads, such as project managers and process architects, are located in one place, service specialists, such as legal specialists, designers or programmers, can be easily outsourced. Thus, more time and space is freed up for efficient managerial decisions.
With routine tasks and processes outsourced, intellectual property remains controlled by the core team members. Freelancers are managed through service agreements with mediators - online platforms that help legalize work relationships with outsource workforce. As a consequence, companies find professionals that bring less financial burden and produce high quality work, but also save on taxes.
The Actual Benefit of Labor Offshore
The real advantages of labor offshore are as follows:
- payroll costs are eliminated;
- HR expenses are eliminated;
- services provided in low-cost countries save money.
It has been calculated
that across Europe, employers in some places pay as much as 75% for every 1,000 EUR net salary paid. Naturally, there are differences and factors contributing to the eventual amount. However, it is clear that employing a team member officially may not always be the right decision, provided their work can be outsourced to a less expensive location. Additionally, signing a service agreement with an employee through a freelance management platform, companies further save on taxes. Below is a breakdown of how it happens.
Companies sign a service agreement with a mediating service. In turn, the platform signs the same contract with your worker from a different jurisdiction. In this case, the worker signs a B2B contract with the mediator thus getting the most out of labor offshore. Normally, mediating services charge 3-8% commissions or a fixed fee. Clearly, saving on taxes can’t get any simpler.
Of course, a company may instead develop their own presence in the necessary world regions. Yet not many small and medium IT businesses have resources to establish multiple international offices. The majority of IT companies opt for online services that let them hire the right people without legal risks and red tape.
The article focuses on European vs. South American markets and work relationships. However, online freelance management platforms support international payments on a much wider scale. It is, basically, a global labor offshore tool that makes freelance management easy and safe for both parties. The pandemic has taught millions of talented professionals to work efficiently from home. IT-companies are lucky to have these freelance management platforms to find the best professionals out there and work with them to drive companies forward, saving on taxes and not worrying about laws. https://medium.com/@easystaff/offshore-labor-in-it-source-talents-worldwide-and-save-on-taxes-157ac730111e