An ‘Employer of Record’ (EOR) is a third-party contracted by a client company to take on the core compliance responsibilities of an employer, as specified under the law. In this article, we explain what an Employer of Record, is and how it can benefit organizations.
Key Takeaways
1. An Employer of Record (EOR) solution means that a third party company takes over as the legal employer for a client company’s workforce.
2. Employer of Record solutions are commonly offered as an international expansion solution by Global Professional Employer Organizations (‘Global PEOs’).
3. An Employer of Record is generally responsible for payroll, ensuring that all necessary withholding and deductions are made, and meeting other compliance obligations of employers.
4. Employer of Record solutions are usually a more cost-effective, and more compliant, international expansion tool than setting up a separate company or subsidiary overseas.
Introduction: The History of Employer of Record solutions
1. Outsourcing and its impact
As ‘Employer of Record’ is a third party contracting solution, understanding this concept requires an understanding of the history of ‘contracting out’ or ‘outsourcing’, in general.
Businesses have been outsourcing tasks to third parties for centuries. As a trivial example, it has long been commonplace for businesses to outsource the cleaning of their office space to a third-party company.
This general tendency has only accelerated in the 20th and 21st centuries, with significant economic impacts. A recent working paper from the United States Bureau of Labor Statistics suggests that the outsourcing of ‘middle income’ jobs overseas has led to a ‘hollowing out’ of the employment market: An increasing fraction of employment over time is in the top quintile, with a decreasing fraction of in the middle three quintiles.
This is demonstrated in the figure below.
Hire globally in 24h with Horizons EOR services.
2. The role of the employer
Outsourcing of the employment function is a newer phenomenon. This reflects the fact that the very concept of an ’employer’, in a legal sense, is a recent phenomenon.
In response to atrocious working conditions and mass labor movements, from the mid-19th century onwards, the specific role of the ’employer’ arose. Prior to that point, workers were essentially independent contractors.
Along with the concept of the employer, came a stable set of functions and responsibilities. Employers, generally speaking:
- recruited and hired workers
- negotiated with employees or unions on working conditions
- directed the day-to-day activity of workers
- paid workers through an organized payroll process
- withheld income, and sometimes payroll taxes (first introduced in the U.S. in 1862). These taxes were then submitted to the tax authorities
- took responsibility for worker health and safety
- ensured compliance with labor/employment laws, such as anti-discrimination laws.
From the late 19th century onwards, companies began to explore which functions or responsibilities of the employer might be contracted or ‘outsourced’ to a third party.
3. Outsourcing employer functions
The modern recruitment agency — a firm to whom client companies outsource the task of finding staff — came about in 1873 in the UK with the recruitment of private school teachers by the firm Gabbitas & Thring¹. In subsequent decades, recruitment firms tended to focus on engaging temporary labor, becoming ‘contract staffing‘ or ‘temp’ agencies.
Another famous outsourcing example is Automatic Payrolls Inc, founded in 1949 as a payroll outsourcing company. Today this firm is known as the Fortune 500 company ‘Automatic Data Processing’ or ‘ADP’.² This company took on the employer’s practical payroll tasks, printing checks and pay slips en masse for the employees of client companies. With the increase in computing power over the years, this changed from a manual to an automatic process.
To read about how the covid pandemic accelerated the pace of outsourcing employer functions, such as payroll, check out the ABC’s investigation in the video below.
4. From employee leasing to employer of record
At some point, enterprising individuals in the US started experimenting with the outsourcing of the compliance and tax responsibilities of the employer. This is the beginning of the ‘Employer of Record’ service or solution.
No one can say, precisely when the first Employer of Record services were introduced as (a), the term ‘Employer of Record’ was not used at the time and (b), the practice was largely unregulated until the 1980s, so few records were kept.
Arguably, the concept first came to public attention in the late 1960s with the rise of ‘labor leasing’. In labor leasing, employees of a third party managed services company where ‘leased’ to client firms, either temporarily or for extended periods of time (for more on this check out What Is Employee Leasing?).
Client companies, by asserting that they were not the legal employer of staff avoided the pension plan obligations of regular employers. Initially, this was simply asserted by client companies (and rarely, it appears, tested in court). However, federal laws in 1982 and 1986 formalized this arrangement, and provided a ‘safe harbor’ for client firms to avoid the pension obligations that would otherwise apply to an employer (as long as leased employees represented no more than 20 percent of the workforce within a client company).³
In the US at least, this is arguably the point at which the ‘Employer of Record’ was born.
What is an Employer of Record Definition
Put most simply, the meaning of ‘Employer of Record’ is simply the legal, official, employer of a workforce. In traditional employment, the Employer of Record is simply the legal entity that workers work for.
In more sophisticated HR arrangements, such as a Professional Employer Organization’s (PEO’s) EOR solution, co-employment, or umbrella companies, the Employer of Record is a third-party company. In these arrangements, the day-to-day work of the employee is supervised by a client company that is not the Employer of Record.
When operating internationally, supporting a company in their global expansion or globalization strategy, these companies are commonly referred to as ‘Global Employment Organizations‘.
What exactly EOR means, depends on the country and industry in question. For example, in the US, this means that state tax authorities will have the Employe of Record registered as the employer (usually with an Employer Identification Number), and liable for withholding payroll taxes. An EOR may also be required to register with the state Department of Labor for unemployment taxes. In other countries, such as the United Kingdom, registration as the Employer of Record occurs on a national basis.
How Does an Employer of Record Work
The Employer of Record is defined by their legal obligations in the country or jurisdiction in question.
While the client company retains day-to-day supervision of workers, the EOR, in consultation with client companies carries out the following actions:
- Tax registration
- The EOR is registered with the tax authorities as the employer of staff. This means they are required to withhold certain taxes from employee payments (namely income tax and payroll tax contributions). In addition, they are required to submit those amounts to athorities on a regular basis and comply with any reporting requirements.
- Payroll processing
- The EOR processes the payroll of all employees in line with the legal requirements applying in that jurisdiction. This includes managaing necessary deductions, garnishments, expense re-imbursements and leave entitlements.
- Payment method and cycle will follow legal obligations, local custom and the wishes of the client company.
- Benefits and social contributions
- The EOR registers with pension funds, health insurance, and workers’ compensation providers, and other providers of benefits for employees. This may be to comply with legal requirements for employers (that depends on jurisdiction), or it may be to provide benefits in addition to a legal mandate.
- Employment contracts
- The EOR will employ staff under jurisdiction-complaint employment contracts. These may be indefinite, casual, or fixed-term employment contracts.
- Termination or re-hire
- The EOR will terminate employees, on advice from client companies and when permitted under the law. Similarly, they can renew contracts on expiration.
Employer of record vs PEO: What’s the Difference?
No. It would be more accurate to say that an Employer of Record is a specific solution commonly offered by a PEO.
In addition to EOR solutions, a PEO also often offers recruitment, payroll outsourcing, global mobility, HR strategy and company incorporation services.
Employer of Record solutions can also be distinguished from:
- Contract staffing
- While this term is sometimes used as a synonym for PEO, it is usually considered a distinct form of HR solution. In contract staffing, the third-party company employs a workforce that it leases out to clients, often on a temporary basis. By contrast, in an Employer of Record solution, the workforce is often exclusive to one client.
- Umbrella company
- An umbrella company provides compliant payment solutions for self-employed workers. This is a particularly popular payment model in the UK. While an umbrella company pays workers, those workers are not on the umbrella company’s payroll: This is the crucial difference with an Employer of Record solution.
What Are the Benefits of Employer of Record Solutions?
An EOR solution, whether applied locally, or internationally, has a range of potential benefits:
- Easing international expansion
- If seeking to employ professionals in multiple countries or locations, it is usually a requirement to have a local entity in place to formally employ staff.
- An International Employer of Record solution can employ professionals in multiple countries, without the need to incorporate locally. This saves on the cost of establishing multiple international subsidiaries and allows new employees to be onboarded within days.
- An International Employer of Record solution also ensures that all staff is hired in full visa and immigration compliance.
- Payroll and social contributions compliance
- Payroll obligations, health insurance and pension contribution requirements are complex, and the law that governs them changes frequently.
- Some tax issues, such as how to treat options granted to foreign employees, are particularly complicated.
- An EOR, as a compliance expert, understands all applicable legal requirements and is liable for non-compliance.
- Competitive benefits packages
- Especially for small and medium-sized enterprises (SMEs), it can be difficult to access competitive insurance packages on behalf of employees. For example, improving access to pension plans was one of the key reasons given for introducing EOR services (in the context of labor leasing), in the first place.⁴
- Avoid employee misclassification
- Some enterprises may be inclined to avoid employing staff altogether and instead engage those individuals as independent contractors. This is a risky move. If the tax or employment regulators, or courts, consider the true nature of the professional’s engagement to be employment, a company could have serious penalties and liabilities.
- As employees of an EOR are bona fide employees, there is a reduced risk of misclassification.
- Equitable HR and compliance access
- EOR solutions have been especially popular in the US in industries where it isn’t feasible for individuals to provide their own payroll and HR solutions.
- For example, EOR solutions have been especially popular in the US for in-home support services: Those with disabilities would often prefer that care is provided by family members or other individuals they know, rather than agencies. Through an EOR solution, a carer of choice can be paid compliantly under medicaid and tax laws.⁵
- Employer of Record solutions can also provide an affordable compliance solution in industries where workers would otherwise (perhaps illegally) be classified as contractors, rather than employees. For example, the absence of EOR has been seen as a contributor to non-compliance in the construction industry in the US.⁶
What Are the Disadvantages of Employer of Record Solutions?
Like any approach to HR or employment, EOR solutions, if implemented incorrectly, can be to the disadvantage of client companies. Some potential disadvantages include:
- Potential time limits
- In some countries, it is not possible for staff to be permanently employed via an EOR solution. For example, in Germany, the local equivalent of an EOR solution (Arbeitnehmerüberlassung – AÜG), requires that an individual not be hired for more than 18 months consecutively.
- In these situations, client companies interested in permanent team members should consult a global PEO about establishing a local entity or subsidiary to directly hire local employees.
- Limitations on powers of client company
- While employees work under the day-to-day supervision of the client company, formal disciplinary action must be carried out by the EOR. This means that many HR steps require the co-operation of the EOR. This means a possible delay in implementation, as well as the risk that the EOR does not comply with client company directions.
- Any disadvantage here is mitigated by the terms of the contract between the EOR and the client company: This will specify that the EOR must act on the directions of the client company.
- For additional assurance, it is possible in some jurisdictions for the EOR, the client company and the employee to enter into a tri-partite agreement, clearly setting out the rights and obligations of each party.
- Some activities require local incorporation
- When expanding globally, some organizations wish to do more than simply hire local staff: For example, they may wish to enter into supply contracts under local law, or apply for government subsidies that require a business to be incorporated in that country.
- In that case, an enterprise will need to establish themselves locally, rather than simply relying on an EOR solution.
- Co-employment or ‘joint employment’ risk
- The test for who counts as an employer differs by country. However, it is worth pointing out that, irrespective of what the contract between the client company and EOR says, the test for who counts as the employer is set by law.
- In the United States, it was recognized by the Supreme Court in Boire v. Greyhound Corp., 376 U.S. 473 (1964) that, in some cases, two companies can be recognized as joint employers under the National Labor Relations Act (the law setting out key entitlements such as minimum wage and collective bargaining rules).
- A responsible EOR manages their relationship with client companies and employees to minimise these risks.
Frequently asked questions
Employer of Record services are usually charged either as a percentage of the total cost of the employee to the enterprise, or on a set per month basis.
International EOR services usually start from USD$200 per month.
In general, yes. In some countries, such as Germany, there are restrictions on how long an employee may be engaged by an EOR before they have to move onto the payroll of the client company (see discussion above).
Note also that there is a ‘co-employment’ or ‘joint employment’ risk, where both an EOR and a client company may be found to be the employer for certain purposes. See discussion of this risk, and how to mitigate it, above.
An Employer of Record is the legal employer of a workforce. By contrast, an Agent of Record is an individual or entity that represents an insured person or entity with the insurer.
Any industry could potentially benefit from the use of EOR solutions.
Originally, EOR services were popular in the US for administrative, temporary and janitorial and cleaning staff, but they are now popular across all industries.
Engage an Employer of Record to Hire Anywhere in the World
Using an Employer of Record solution ensures that payroll and employment is in full compliance with withholding and tax rules. It is more cost-effective, and allows for a quicker hire, than setting up a local entity or subsidiary.
To find out how our Employer of Record solution can hire and onboard your international team in as little as 48 hours, contact Horizons.
Footnotes
1. The professional recruiter’s handbook: Delivering excellence in recruitment practice. 2nd edn, Kogan Page Limited, Walnut Street, Philadelphia, USA.
2. Metters, R. and Verma, R. (2008). “History of offshoring knowledge services”. Journal of Operations Management, 26: 141-147. https://doi.org/10.1016/j.jom.2007.02.012
3. Day, J.S., (1988). “Employee Leasing”. Flexible Workstyles: A Look at Contingent Labor. Conference Summary. Women’s Bureau (DOL), Washington, DC. https://files.eric.ed.gov/fulltext/ED305471.pdf.
4. Submission of Marvin R Selter. Certain pension access and simplification issues: hearings before the Subcommittee on Select Revenue Measures of the Committee on Ways and Means, House of Representatives, One Hundred Second Congress, first session, July 25 and September 16, 1991.
Washington : U.S. G.P.O. : 1992. Volume 4, p345.
5. Nerney, T., & Shumway, D. L. (1996). Beyond managed care: Self-determination for people with disabilities. Durham, NH: Institute on Disability, University of New Hampshire. https://mn.gov/mnddc/past/pdf/90s/96/96-BMC-TND.pdf
6. Juravich, T., and Ormiston, R. (2021). “The Social and Economic Costs of Illegal Misclassification, Wage Theft and Tax Fraud in Residential Construction in Massachusetts”. Institute for Construction Economic Research. UMass Amherst Labor Center. https://www.umass.edu/lrrc/sites/default/files/juravich%20NASRCC%203%20%28002%29.pdf
