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9 min read

Is Your Contractor Actually an Employee? How to Avoid Legal Trouble

Legal & compliance

Contractor management

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Author

Michał Kowalewski

Last Update

May 07, 2025

Published

June 25, 2024

Table of Contents

What is the difference between contractors and employees?

International contractor considerations

Common misconceptions about worker classification

Official tests to determine worker classification globally

Your options to avoid misclassification

What to do if you suspect you have misclassified a worker

How to convert a contractor into an employee

Hire contractors and employees hassle-free with Deel

Key takeaways
  1. Worker misclassification (labeling employees as contractors) can lead to severe consequences, including payment penalties, class-action lawsuits, and even jail time, whether done intentionally to avoid taxes or unwittingly due to confusion about classification criteria.
  2. There are multiple official tests used to determine proper worker classification, depending on the country in which the contractor resides. These include the IRS 20-Factor Test in the US and IR-35 legislation in the UK. Across the globe, most authorities focus on factors like degree of control, integration into the business, and financial relationship.
  3. To avoid misclassification, you can either redefine the contractor relationship or transition them to employee status. Deel can help with both. Or use Deel Contractor or Contractor of Record service to ensure compliance from the start.

The line between contractor and employee isn’t just an HR formality—it’s a legal risk for many global companies.

Misclassifying workers, whether due to unfamiliar foreign regulations or evolving team needs, can expose your business to severe risks, from staggering fines and back payments to high-stakes lawsuits and even jail time.

As the world’s leading expert in cross-border payroll and compliance, Deel has helped thousands of organizations navigate this complex terrain, confidently interpreting country-specific criteria and spotting red flags before they become legal trouble.

In this guide, you’ll discover clear, actionable tests for proper classification, learn how to identify warning signs, and see how services like Deel Contractor of Record keep you compliant, no matter where your people work.

With Deel, you ensure rigorous compliance and the agility to hire anywhere, knowing that costly misclassification mistakes and compliance headaches are handled by the pros.

What is the difference between contractors and employees?

The distinction between contractors and employees isn’t just a matter of job titles or preference—it’s defined by specific legal criteria that vary across countries. Misunderstanding these differences is often the first step toward costly misclassification issues.

Although the criteria vary between countries, most jurisdictions examine three fundamental aspects of your working relationship:

  • Control: How much direction and supervision do you exercise? Employees typically follow set schedules and procedures, while contractors generally control when and how they complete their work. If you’re dictating working hours, methods, and tools, you might be treating a contractor like an employee
  • Integration: Is the worker performing core business functions or peripheral services? Employees are usually integral to your main operations, while contractors typically provide specialized, project-based support. A “contractor” who handles essential daily operations raises red flags
  • Financial relationship: Employees receive regular wages and benefits, while contractors typically invoice for completed work, cover their own expenses, and have opportunities for profit or loss

International contractor considerations

Hiring international contractors offers access to a wider talent pool and huge opportunities for growth. However, you’ll need to consider these additional complexities:

Complex classification criteria between countries

Different countries have their own regulations and criteria for determining worker classification. What works in the US could get you in hot water in Germany or Brazil. And to make things more complicated, these criteria are constantly changing. The tests we covered earlier are all used by tax authorities to check if you’re playing by the rules. Staying on top of these regulations is a full-time job in itself.

The good news? Deel offers two flexible ways to work with contractors: use Deel Contractor to manage and pay them directly, or rely on Deel Contractor of Record to hire them on your behalf—so you stay compliant while focusing on what matters most.

Tax and reporting obligations

Tax and reporting obligations can be tricky to manage in one country, and even more so when operating in multiple jurisdictions. You might need special forms like the US 1042-S, local tax registrations, or VAT considerations that vary greatly from place to place.

And if you’re not careful, your contractor relationships could create “permanent establishment” risks, potentially subjecting your company to local corporate taxes.

Deel handles all these tax compliance requirements on your behalf, generating the right documentation for each jurisdiction and ensuring you meet all local reporting obligations without building an international tax department.

Currency and payroll challenges

Sending money across borders also comes with its own challenges. Exchange rates fluctuate daily, transfer fees can eat into your budget, and payment methods that work perfectly in one country may not be effective in another.

Deel simplifies contractor payments, giving your contractors the best payment experience possible. Deel is equipped with 15 different payment options, supports 120+ currencies with competitive exchange rates, and has multiple withdrawal options tailored to each country, ensuring your contractors get paid on time, every time.

Case study: How ShopBack used Deel to hire skilled talent in countries without entities

Asia-Pacific shopping platform ShopBack needed to hire contractors in multiple countries without legal entities. Their key challenge was to ensure compliance in each jurisdiction.

Since adopting Deel Contractor, they’re now able to onboard new talent within 24 hours across nine different countries. The platform enables them to hire skilled engineers in new markets efficiently, meeting technical needs without compliance concerns. For ShopBack, Deel transformed complex international contractor hiring into a simple, rapid process while providing responsive customer support.

Deel Contractor
Onboard, manage and pay international contractors compliantly
Hiring talent abroad? Get with the market leader in contractor management. Deel automates HR admin, mitigates misclassification risk, and ensures on-time payments in 150+ countries—all with unrivaled compliance and payment flexibility.

Common misconceptions about worker classification

Distinguishing between contractors and employees can be incredibly challenging, particularly when navigating complex criteria that vary from country to country. Here are some common misconceptions:

Myths Reality
Having a signed independent contractor agreement automatically makes someone a contractor. Legal classification depends on the actual working relationship, not paperwork.
Remote workers can always be classified as contractors. Location doesn’t determine whether a worker is an employee or contractor—the nature of the relationship does.
Classification rules are the same everywhere. Requirements vary significantly between countries and even between states/provinces.

Official tests to determine worker classification globally

The criteria to determine worker classification vary significantly from country to country. These are some of the main tests used across the world to determine proper classification.

United States

  • The IRS 20-Factor Test: Also called the "Right-to-Control" or common law test, this evaluates behavioral control, financial control, and relationship permanency through 20 specific factors
  • Reasonable Basis Test: Examines whether you have legitimate reasons to avoid withholding federal taxes from a worker
  • DOL's Economic Reality Test: The US Department of Labor uses five primary factors to determine a worker’s economic dependence on an employer
  • ABC Test: Used in California and several other states, this classifies a worker as an independent contractor only if they meet three specific criteria
  • Form SS-8: An IRS form you can submit to request an official evaluation of your workers’ status

United Kingdom

  • IR35 Legislation: The UK’s HMRC evaluates whether contractors working through their own limited companies are disguised employees. Key factors include:
    • Right of substitution (can the contractor send someone else to do the work?)
    • Mutuality of obligation (is the company obligated to provide work, and is the contractor obligated to accept it?)
    • Control over when, where, and how the work is completed

European Union

While specific tests vary by member state, the European Court of Justice has established common criteria, including:

  • Subordination (does the worker follow your instructions?)
  • Nature of work (is it integrated into your business?)
  • Remuneration (is payment regular vs. project-based?)

Australia

In Australia, the Australian Taxation Office uses a multi-factor test to determine worker classification. The test investigates:

  • Integration into the company
    • Ability to subcontract/delegate
    • Basis of payment (hourly rate vs. quoted price)
    • Equipment/tools (who provides them?)
    • Commercial risks (who bears responsibility?)
    • Control over work

Canada

Canadian law distinguishes employees, independent contractors, and dependent contractors. The classification criteria investigate:

  • Control over work
  • Ownership of tools
  • Ability to subcontract
  • Financial risk and opportunity
  • Integration into the business
  • Intent of the relationship (though minor weight)

Read more: The Beginner Guide to the Law of Worker Classification in Canada

India

Authorities in India use several tests to determine worker classification. No single test is used exclusively for classifying a worker. Two commonly referenced tests include:

  • The Control Test: Primarily focuses on the degree of supervision and control the employer exercises over the worker’s activities.
  • The Integration Test: Evaluates whether the worker is an integral part of the business.

Singapore

Singapore distinguishes between employee relationships (known as Contract of Service) and contractor relationships (Contract for Service).

While there is no primary test to determine worker classification in Singapore, the Ministry of Manpower considers several factors, including:

  • Control over work processes
  • Ownership of tools and equipment
  • Whether the person operates their own business
  • Whether they can hire helpers

Regardless of the country, most global tests to determine worker classification focus on control (who determines when, where, and how work is performed), integration (how essential the worker is to the business operations), financial relationship (how payment is structured), and exclusivity (whether the worker has multiple clients or one primary source of income).

Global Hiring Toolkit
Misclassification Assessment
Mitigate worker misclassification risks using our combo of AI and award-winning research into employment court cases.

Your options to avoid misclassification

Worker misclassification is a huge risk when working with international contractors. And it can be complex and costly. The easiest way to ensure compliance and avoid misclassification risks is to use Deel Contractor of Record.

Deel handles all those country-specific requirements so that you don’t have to. Our legal experts are based in numerous locations across the globe and have extensive and up-to-date knowledge on local compliance.

Deel Contractor of Record is also quick and easy to use. Everything, including payment, contracts, and tax documents, happens on one platform.

Deel Contractor of Record
Minimize misclassification risk
Guard your business from misclassification risks with 100% protection. Deel Contractor of Record helps you grow your team globally with extra peace of mind.

What to do if you suspect you have misclassified a worker

Suppose you’ve determined that your contractor’s role has shifted to resemble that of an employee. In that case, you have two options to continue your working relationship: redefine the contractor’s scope of work and your level of control, or bring them on as an employee.

Option 1: Redefine the contractor’s scope of work and your degree of control

If you want your worker to retain independent contractor status, revisit your independent contractor agreement and redefine their work conditions.

For example, you can:

  • Reduce the contractor’s workload (or hire additional contractors)
  • Allow the contractor flexible working hours
  • Let the contractor work anywhere they want, not just on your premises
  • Allow the contractor to determine the best method for performing the work
  • Reduce the contractor’s working hours so they can work for other clients
  • Avoid reimbursing the contractor’s expenses

Option 2: Bring the contractor on as an employee

If you want your contractor to continue working under the same conditions but are worried about misclassification risks, you can end your independent contractor relationship with them and hire them as a full-time employee.

This new employer-employee relationship will require a new written contract and new tax documentation. You will have new responsibilities as an employer, such as paying employment taxes or providing sick pay for your employee, that your contractor wasn’t entitled to before.

How to convert a contractor into an employee

If the working relationship genuinely reflects employment, converting your independent contractor into an employee is the safest approach.

Here is the step-by-step conversion process:

1. Make a compelling offer to your contractor

When negotiating an employment contract with the contractor, you should:

  • Include mandatory benefits that contractors typically don’t receive
  • Consider flexible work arrangements to maintain what they value about contracting
  • Use our employee cost calculator to budget for salary, benefits, and payroll taxes

2. Collect necessary documentation

Once your contractor accepts the offer, it’s time to collect the new tax forms you’ll need for an employee. In the US, for example, these include:

3. Conduct proper onboarding

To make your new employee feel welcome, conduct a proper onboarding process:

  • Introduce them to the rest of the team
  • Provide training on internal processes
  • Share company culture and values
  • Send company swag to build belonging

4. Update your payroll systems

  • Add the employee to your payroll software
  • Set up tax withholdings
  • Configure benefits administration

Read more: How to Convert a Contractor to an Employee Fast and Seamlessly

Need to convert your contractor to an employee but lack the legal infrastructure? If you’ve hired a contractor from abroad but don’t have a local entity to employ them legally, Deel’s Employer of Record (EOR) service can help. We’ll hire the worker through our local entity, handling all legal compliance, while you manage their day-to-day work.

Hire contractors and employees hassle-free with Deel

Whether you decide to keep your worker as a contractor or convert them into an employee, Deel can help you hire anyone anywhere in a matter of seconds.

Our all-in-one platform allows you to make mass payments to your whole team in just one click and manage locally compliant contracts for your entire global team. With our customer support team working around the clock to help you with any concerns and a team of legal experts to ensure full compliance, nothing stops you from tapping into the global talent pool.

Want to see Deel in action? Schedule a demo with one of our experts.

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About the author

Michał Kowalewski a writer and content manager with 7+ years of experience in digital marketing. He spent most of his professional career working in startups and tech industry. He's a big proponent of remote work considering it not just a professional preference but a lifestyle that enhances productivity and fosters a flexible work environment. He enjoys tackling topics of venture capital, equity, and startup finance.

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