Foreign businesses entering the US market face a host of compliance issues surrounding business registration, employment, taxation and withholding.In order to simplify their sales and marketing efforts, some foreign companies will use independent contractors for certain types of business activity, avoiding the need to go through the process of running a compliant payroll for US based employees.
However, even if the use of contractors is valid (meaning they are not really disguised employees), there are still some reporting rules that must be adhered to under US law.A previousarticlediscusses the need for US businesses to file Form 1099 to report independent contractor payments over a certain threshold and in many instances those requirements will apply to a foreign company as well.
The basic analysis to determine if a 1099 should be filed by a foreign company depends on 1.) The Company, 2.) The Independent Contractor and 3.) Where the Work is Performed:
- Is theforeign companyrequired to file a US tax return?
- If no,then Form 1099 does not need to be filed for any type of contractor.
If yes, then…
2. Is thecontractor aUS citizen or resident?
- If yes, then Form 1099 needs to be filed.
If no, then…
3. Were theservices performedphysically in the US by the non-resident?
- If yes, then Form 1099 needs to be filed
- If no, then Form 1099 is not required.
When Do Foreign Companies Need to File a 1099 for Independent Contractors?
For a company to file a Form 1099, it must be subject to the taxing jurisdiction of the US, and obligated to file income tax returns and all related forms.A foreign company is generally required to pay tax if they are concluding contracts, sales or otherwise generating revenue within US borders.This is otherwise known as permanent establishment, which means that the company’s in-country business activity is sufficient to make it subject to US taxation.
Depending on the country where the company is based, there are tax treaties between the US and many countries regarding what type of activity will constitute permanent establishment (PE).The criteria under a tax treaty could be more lenient if the company’s home country extends the same treatment to US companies, and this could determine whether taxes must be paid and forms filed, including 1099s.
If a foreign company’s presence in the US is strictly exploratory then they will usually not be required to file US tax returns or forms, and that includes payments to US citizen contractors.For example, hiring a marketing consultant based in the US to assess the market for products or services would probably avoid triggering PE.However, the contractor as a US taxpayer is still must report the income on their tax return, even if the foreign company does not file a 1099.
What if the Foreign Company Is Required to File 1099s, But the Contractor Is a Non-resident?
If a company does fall within the US taxing regime, then it would have to file 1099s for all US resident contractors that are paid amounts above the 1099 filing threshold.In other words, once a foreign business falls under US tax laws, it has the same reporting requirements as a domestic US company.
If the contractor is a non-resident, then the necessity to file a 1099 will depend on where the work is performed.If the non-resident contractor performs services on US soil then they are required to file a US non-resident tax return for the amounts earned while inside the country.This in turn would require the foreign company to file a Form 1099 for that contractor.But, if the services are rendered remotely from a non-US location, then there is no need to file Form 1099, since the contractor has no ties to the US or its tax laws.
What Are the Risks of Non-compliance?
The penalties for failing to file Form 1099 are not extreme, but the greater risk for a foreign company is triggering permanent establishment.It is possible that simply hiring a contractor (resident or non-resident) and compensating them in the US could be sufficient to trigger PE, which would expose the company to US corporate taxes.
For example, if a contractor is hired on a commission basis to generate sales leads, then that could be enough to constitute “business activity” for the company, leading to the need to comply with all US tax reporting rules.The other hazard is that the contractor could be re-classified as an employee under IRS or Department of Labor guidelines, leading to other employment and payroll compliance issues.
Summary
While it may be tempting for companies to use contractors to avoid the logistical and regulatory hurdles of US payroll and tax compliance, there are pitfalls associated with overuse of contractors.This is especially true where a company might enlist the services of a US resident contractor, who in turn could file a claim for employee type benefits such as overtime, leave and healthcare.A foreign company could quickly find itself with a re-classified employee in the US, which could lead to numerous compliance issues.
For this reason, many foreign companies choose to use a PEO/GEO solution for hiring workers in the US, instead of risking the use of contractors.The GEO essentially employs the worker, ensures compliance with all tax and employment rules and eliminates the need for the 1099 filing, since the worker is now an employee and submits a W-2 form for wages.This also can lessen the risk of permanent establishment by the client, because the GEO (instead of the foreign company) is the local employer of record.
Please contact us for more information about Shield GEO and the solutions that we offer foreign companies entering the US business marketplace
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