Understanding Employee Misclassification Penalties: What They Are & How to Avoid Them

We’ll cover a general definition and look at some country-specific examples of worker misclassification. Then, we’ll detail the kinds of penalties companies can expect if they break the rules. Finally, we’ll go over how to avoid both employee and independent contractor misclassification penalties.

Understanding Employee Misclassification Penalties: What They Are & How to Avoid Them
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Expanding your workforce is an exciting milestone in any company's story. However, for companies expanding globally, there are numerous complexities.

One of the most familiar complexities for many leadership and HR teams is how to correctly classify certain types of workers.

Specifically, those full-time and part-time employees, contractors or other contingent workers that might be part of your global workforce.

For global businesses, misclassification can lead to severe legal repercussions, substantial financial penalties, and significant reputational damage.

Beyond these risks, misclassification compromises the rights and protections owed to workers. The long-term consequence? You could be pulled into costly disputes that will ultimately hurt long-term worker retention. It’s not a risk worth taking.

That’s why navigating the complex landscape of labour laws is essential if you’re going to safeguard your business's future and ensure compliance.

But misclassification penalties can blindside your company if you’re not prepared.

In this guide, we’ll explain what companies need to know to avoid employee misclassification penalties. We’ll cover a general definition and look at some country-specific examples of worker misclassification. Then, we’ll detail the kinds of penalties companies can expect if they break the rules. Finally, we’ll go over how to avoid both employee and independent contractor misclassification penalties.

What Does Employee Misclassification Mean?

In the simplest terms, employee misclassification occurs when an employer classifies and treats a worker as an independent contractor.

While some employers may intentionally misclassify workers for additional or consistent work without additional costs, it’s also common for misclassification to happen unintentionally. This is why it’s essential to understand what it is, in a technical sense, and the different forms it can take across different countries’ respective labour laws and worker classifications.

Misclassification as Independent Contractors

This is the most common form of misclassification. It typically arises when an employer classes an employee as an independent contractor, usually to avoid obligations that come with an employment relationship, such as providing paid annual leave and sick leave, and giving severance pay upon termination.

Consider the applicable employment laws in the Czech Republic, which include two clear classifications:

  • Employees – These workers are subject to employment contracts; their pay and hours are regular and exclusive, and their employer bears final responsibility for their work.
  • Contractors – These workers are subject to commercial contracts; their pay and hours are self-determined and/or project-based, and they bear responsibility for their work.

Misclassification happens when an employer tries to pass off a consistent, regular, or exclusive employee as a contractor in what is known as the “Švarc system” (or “disguised employment”).

But the Czech Republic is a good example of why correct employee classification varies so much worldwide.

For example, in some countries such as the UK and Ireland, courts have been inconsistent as to whether delivery drivers are classed as independent contractors: the UK classes delivery drivers as contractors, while Ireland does not.

Misclassification as Interns or Trainees

Another important distinction in many countries’ labour laws is between full-time permanent employees and interns or other workers-in-training. Depending on the country, a worker in an intern position may be classified as an employee, with all the rights that come along with that. However, if they’re working as part of an educational opportunity, those protections may be different.

In some scenarios, 'interns' may be classified as employees and enjoy the same rights as employees. However, when certain conditions are met, such as if the employment is part of an apprenticeship or education program, employment standards may be different.

For example, in Canadian labour law, interns are considered employees. They receive all of the same protections under the Canada Labour Code, including a minimum wage. But if the worker is a student intern this is just one of the requirements that may lead to them being considered an employee. One practical implication is that they may not need to be paid in the same ways as other employees (if at all) as part of the conditions of their program.

In fact, the full list of requirements that would lead to a Canadian worker being treated as a student intern would include:

  • They are not an employee
  • They are performing activities for an employer with the primary purpose of gaining knowledge or experience
  • They are enrolled in a valid secondary or post-secondary educational institution, vocational school or equivalent institution outside Canada
  • They are undertaking the internship to fulfill your educational program requirements
  • They provide the employer with required documentation before the start of your internship, supplied by your educational institution. This includes a description of the activities that will fulfill the requirements of the program and contact information for a person responsible for administering the program.

Misclassification as Exempt Employees

This is a relatively niche case related to the Fair Labor Standards Act (FLSA) and workers based in the US. The FLSA guarantees minimum wages and overtime, among other protections, for workers that exceed 40 hours per week. However, certain employees are excluded from these rights as “exempt employees.” A worker’s salary must also meet requirements set by the Department of Labor to be exempt.

It’s worth noting that exemptions are not uniform across the different states. Some states impose additional requirements to qualify for exempt status.

Some of the most commonly used exemptions under the FLSA include:

  • Executive exemptions for employees who manage divisions or two or more reports
  • Administrative exemptions for employees who perform management-related work
  • Professional exemptions for employees whose work requires specialised knowledge

Exempt misclassification occurs when employers incorrectly classify an employee as exempt to avoid paying overtime for hours worked beyond 40 per week. However, the FLSA establishes clear criteria for its exemptions; if a company misclassifies an employee based on false pretences, it could be held legally liable.

The Impact of Misclassification on Businesses and Workers

Worker misclassification is important because it can constitute a violation of workers’ rights. On the workers’ side, this can mean failing to receive direct or indirect compensation they’re due, enduring financial instability and associated psychological strain, or stifling career advancement.

On the business side, inaccurate employee classification may lead to financial and other penalties for contravening labour laws, primarily in the countries where the workers in question reside. There are also reputational costs to consider, as current and potential workers’ opinions of a company may sour if they hear it has a history of these issues.

Fines and Financial Penalties for All Parties

While many companies fall into employee misclassification in an attempt to minimise expenses, it can be far more costly in the long run to misclassify an employee for perceived short-term savings.

The kinds of financial costss companies may be subject to include but are not limited to:

  • Direct fines imposed by a governmental body
  • Civil suits for wages and/or damages (plus interest)
  • Legal fees associated with litigating any charges

To return to the example of misclassification in the Czech Republic, as defined above, engaging in the Švarc system can lead to the company being fined anywhere between 250,000 Kč (~10,000 €) to 10,000,000 Kč (~400,000 €).

Note: An employee could also be fined if they played a part in concealing employment. But this would only happen if the employee does so to avoid tax obligations that come with employees and stringent social security contributions, as well as for flexibility. 

Additional Legal Liabilities for Employers

Beyond fines and other financial penalties, select individuals at companies may also be charged with criminal offences for misclassifying employees. This is a relatively new phenomenon worldwide, but more countries are ramping up legislation against misclassification. The upshot is that deeper and broader consequences can be expected across more national contexts in the future.

For example, employers need to practise extreme caution when sourcing talent from Spain, as the local employment law provides provisions for criminal charges for cases of misclassified worker penalties. When it comes to Spanish employment laws, as of 2022, misclassifying false self-employed Spanish workers (“falsos autónomos”) can carry a criminal charge and sentencing of up to six years in prison—on top of fines up to 10,000 €.

Another European country that’s recently updated its labour laws to include criminal liability for misclassification is Germany. As of 2020, companies that intentionally misclassify their workers as contractors may face criminal charges. Legal scholars consider Germany’s regulatory lens to be strict, as “conditional intent” (i.e., seeing a risk but proceeding regardless) can suffice.

What these laws and the trend toward stricter enforcement show is how critical it is for companies to understand the rules behind misclassifying employees to avoid a penalty.

How to Prevent Misclassification of Workers

Preventing consequences like fines and criminal charges requires diligence and vigilance on the part of companies. Working relationships with current contractors need to be examined to determine if they meet a given country’s criteria for employee status. If needed, companies should prioritise adjustments to minimise the scope of back pay or other financial obligations.

For prospective workers, companies should tailor the terms of engagement to clearly outline responsibilities and ensure the worker’s status aligns with the actual nature of their work. Working with an Employer of Record (EOR) may be required in some contexts.

Even if it isn’t a requirement, partnering with an EOR can help organisations streamline global onboarding and overall management processes, maintaining compliance at scale and across national boundaries as laws continue to evolve. It's crucial to understand each country’s criteria for classification to avoid actions that may be considered misclassification. For example, in some countries, providing equipment to an independent contractor can lead to misclassification; thus, employers should ensure such criteria are not met when classifying workers.

For prospective workers, companies should tailor the terms of engagement to explicitly outline responsibilities in a way that makes a worker’s status clear.

Best Practice: Worker Classification Assessments

Whether working with an EOR or not, companies using global workers should regularly check their working relationships against criteria used to determine status in those workers’ country of employment. To that effect, it can be helpful to create a single point of truth with all criteria to ensure they do not violate any classification regulations.

For example, some criteria common across many countries’ classification laws include:

  • The worker’s control over schedule and when or where work is performed
  • The ownership or provision of materials, tools, and other capital goods
  • The flow of management and reporting to/from a worker and managers
  • The ability to substitute others’ labour and inputs (or the lack thereof)
  • The extent of financial responsibility a worker assumes for the work
  • The ability for the worker to engage or solicit other companies
  • The financial dependence of the worker on the company

Of course, companies should tailor their assessments to the particular national context(s) in which they’re operating and sourcing talent.

Streamline Worker Classification with Omnipresent

Staying abreast of employee misclassification rules is the first step toward preventing the consequences that can come from breaking them. But compliance at scale requires an intentional approach; working with an EOR helps to keep all documentation squared.

Omnipresent helps companies leverage talent pools across the globe while maintaining compliant classifications and protecting workers’ rights. Our all-in-one platform makes navigating different countries’ laws easy so you can focus on finding the best talent.

To learn more about how Omnipresent can help you stay compliant with contactor conversions, contact us today.

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Chloe Ching

A recent law graduate of the University of Hong Kong, Chloe is a Paralegal in the APAC team. Whilst reading law, she had been involved in multiple journalistic projects for international and national media outlets. With a mix of background in journalism and law, she joined the company with hopes to make law accessible for everyone.

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