European Expansion: The Consultant Trap

European ExpansionBy Sian Story

Sian Story – Osborne Clarke – Palo Alto, CA– Sian is a UK qualified lawyer, advising US clients on UK and European employment and stock options matters, and is based in California.

We all know that fast growing technology based businesses don’t just grow quickly within the US any more. Falling into overseas markets is increasingly common.  Plus, global domination is the ultimate goal. But expansion outside of the known territory is complicated, full of regulatory landmines and not something that can be achieved overnight.

As a result, companies frequently engage consultants when venturing to Europe for the first time, perceiving consultancy as a low-cost, easy option avoiding the need to establish formal operations, tax registrations and payroll overseas (not to mention avoiding the challenging employment laws found throughout Europe). Care should be taken though: consultancy arrangements are often not as straightforward as they appear.

Here are a few things to think about as you venture forward:

The Pseudo-Employee

Of course, the biggest challenge with engaging consultants the world over is that in many cases they look more like employees (thanks to the full time role they personally fulfill, the company’s reporting structures and processes, the company cell phone, laptop and business cards they are supplied with). The same is true in Europe: the test will vary from country to country but the existence of a test does not.

Advice should always be sought to confirm that the proposed consultancy agreements clearly reflect consultancy in the country in which they are to be applied. Even more importantly the relationship should be managed in line with that agreement as irrespective of what the contract says, the actual performance of the relationship will determine its status. In some cases that may simply not be possible (because the individual is being engaged as the General Manager, or because their work needs to be controlled by someone in the US) and then a risk analysis may be required.

What’s the worst that can happen? 

Where the relationship is deemed to reflect employment, the local tax authorities claim unpaid income taxes, social security contributions and state pension contributions, together with penalties and interest, from the company for the life of the relationship as these will not have been withheld as they should have been.

How would they find out? 

In most cases, this results from a claim by the individual consultant that they are actually an employee (often in the event of termination), enabling them to benefit from the employment laws and protections, which the company had hoped to avoid. This can result in the company facing substantial claims for breaches of employment laws as well as unpaid taxes.

Contracting with the consultant through a personal services company may help with the analysis, but is not necessarily conclusive, so taking time to get the agreement and arrangements right is still recommended. Obtaining advice from a lawyer in the particular jurisdiction is always recommended.

The Commercial Agent

A potential trap for companies engaging a consultant in a sales role within Europe is that the individual could be considered to be a commercial agent, and then benefit from the protections of the Commercial Agency Regulations (CARs) in the EU. The CARs apply to all agreements appointing a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods (but not of services) on behalf of his principal.

The CARs can afford consultants a range of benefits, some of which cannot be contracted out by the company. Those include rights to a specified period of notice on termination, the right to be paid commission including post-termination, and the right to receive a lump sum payment on termination (which if not specified in the agreement may be determined on a “compensation basis” more favourable to the consultant).

Care should therefore be taken to ensure that the relationship is structured in such a way that these can be minimized and/or avoided, or at the very least that the company can obtain as much protection in the contract as possible where rights can be contracted out. Again, obtaining the advice of counsel is critical in avoiding these potential liabilities.

The IP Risk

In Europe there is no concept of “works for hire”. However, as in the US, whilst IP created by an employee during the course of employment will be deemed to be owned by the company, works created by a consultant will be owned by the consultant unless specifically agreed to the contrary. Therefore companies using consultants as developers outside of the US should take care to ensure that the IP created is assigned to the company by contractual agreement, which is binding and enforceable in the relevant country. Given that a designation as “works for hire” will not be recognized in Europe, companies cannot assume that standard US IP protection agreements will protect their IP outside of the US.  Failure to localize properly could leave the company exposed, so tailoring agreements for the relevant country is essential to minimize the risks.

The Permanent Establishment Issue

It is easy to assume that when a company doesn’t have a subsidiary or registered branch office in a particular country, and doesn’t have any employees there, that there is no permanent establishment for tax purposes. The analysis is not quite so simple – a consultant can constitute a permanent establishment in most countries in the same way as an employee would – particularly likely if the consultant has the ability to negotiate or sign agreements on behalf of the company. Whilst the risk may remain low with just one consultant, it should always be considered so that a tax presence is not triggered unexpectedly. Tax advisors should always be consulted.

The Cost of Stock Options

Granting stock options to a genuine consultant is possible, but unusual in Europe. As a result, the grant of stock options is often seen as an indicator of an employment relationship if the consultant falls into the all-too-common grey area between employment and consultancy. Equally, where consultants are granted options those grants will not fall within the employee exemptions from regulations around financial promotion prohibitions, or prospectus requirements.  Where a deduction or expense against corporation tax may be available in respect of options granted to employees that may not apply where grants are made to consultants.

Furthermore, employment income arising on exercise of an option can be subject to withholding of tax and social security contributions in the same way as for ordinary employment income, and can include a liability for the company, where a consultant is later judged to actually be an employee. This may not be adequately provided for in the documentation and can unexpectedly increase potential liabilities, so companies should again ensure that they are aware of risks before they grant.  Again, counsel with professionals is always desirable.

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