On Directly Engaging Philippine Contractors from Abroad

Emerico O. De Guzman and Gilyen Ezra Marie L. Li-Nulud, of ACCRALAW, explore the risks for foreign firms of employing Philippine contractors and the ways in which these risks may be mitigated.

Published on 26 September 2022
Emerico O. De Guzman, ACCRALAW, Chambers Expert Focus contributor
Emerico O. De Guzman
Ranked in 1 department in Chambers Asia-Pacific 2022
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Gilyen Ezra Marie L. Li-Nulud, ACCRALAW, Chambers Expert Focus contributor
Gilyen Ezra Marie L. Li-Nulud

With attractive investment opportunities and a plenitude of homegrown talent, it is no surprise that many foreign companies flock to the Philippines to expand their businesses or to simply outsource services to Philippine workers.

Technological advancements and the global shift towards remote working arrangements have likewise made cross-border contracting a feasible, if not always a practical, solution to augmenting the company workforce.

An independent contractor is usually engaged on a non-exclusive basis and is distinguished from an employee based on their unique skills, talent, or expertise

Be that as it may, the challenge lies in curbing permanent establishment risks, as foreign entities that enter into domestic contracts may be construed as doing business in the Philippines, despite the fact that they do not maintain physical offices in the country or that they do not cater to a local market from which they could derive profits. Misclassification risks also arise from the engagement of Philippine contractors by foreign firms, thereby exposing those firms to liabilities associated with local employment, what with the States affirmation of labour as a primary social economic force and its policies for protecting workers rights.

Contractors versus employees

In the Philippines, an employer-employee relationship is determined not by the designation given by the parties to the arrangement, but by the factual circumstances surrounding the same. Such determination is based on a four-fold test, the elements of which are:

  • the selection and engagement of the employee;
  • the payment of wages;
  • the power of dismissal; and
  • the power to control the employee and the means and methods by which the work is accomplished.

The power to control, which is the most critical element, refers to the authority of the employer to control the employee not only as to the result of work to be done but also as to the means and methods by which the work is to be accomplished. Badges of control that would construe a contractor as an employee include imposing a specific schedule on the worker, course corrections, periodic evaluations, training, and furnishing of facilities and materials, among others.

Apart from the extent of control, an independent contractor is usually engaged on a non-exclusive basis and is distinguished from an employee based on their unique skills, talent, or expertise, for which they are specifically selected and engaged by the principal. Moreover, contractors are paid a fixed remuneration or service fee, which amount they themselves have determined, if not negotiated with the principal. They are also not subject to the principals disciplinary process, but rather by the terms of their contract, which may be terminated due to a breach of its stipulations or the expiration of the term stated therein.

This said, misclassification risks are mitigated when the Philippine contractor actually performs work that is free from the control of the principal, and the service contract omits stipulations that allude to the existence of the elements of the four-fold test. However, this is easier said than done as the performance of such services is usually collaborative, especially where the Philippine contractor discharges work that is necessary or directly related to the business of the foreign principal. Work is seldom performed at the discretion of the contractor and the principal is often constrained to provide instructions, training, and guidance to fulfil its objectives and carry out its business purpose. Thus, in the event of litigation, an employer-employee relationship may be found and the foreign principal may be held liable for all the obligations of an employer under the law.

A common trend amongst foreign companies is the use of so-called people employer organisations.

On this score, an employer under Philippine laws is mandated to pay its employees and provide benefits according to minimum labour standards. They must also register with and remit contributions to government agencies, such as the Social Security System (SSS), Philippine Health Insurance Corporation (PhilHealth), and Home Development Mutual Fund (HDMF) for the employees social security and health insurance benefits. The employer is likewise considered a withholding agent by the Bureau of Internal Revenue (BIR) and must therefore register with such government agency for the purpose of filing returns and paying income taxes on behalf of the employee.

A common trend amongst foreign companies is the use of so-called people employer organisations (PEOs) to whom the aforesaid obligations are delegated. While this set-up may appear to provide some convenience to the principals, considering that they will no longer deal with administrative employment matters in the Philippines, it is still fraught with misclassification risks. Here, the PEO is particularly engaged to act as the employer on record and to register with and remit payments to the BIR, SSS, PhilHealth, and HDMF, although the power to control the manner and means by which the employee or contractor performs their work is relinquished to the foreign principal (this is sometimes explicitly stated). Because the PEO does not have the expertise to provide the contracted services, its engagement by the foreign principal can also be easily construed as a circumvention of the law and, in any case, does not preclude permanent establishment risks.

Doing business without a licence and permanent establishment risks

Foreign companies doing business in the Philippines are regulated by and must register with the Securities and Exchange Commission pursuant to the Revised Corporation Code of the Philippines. Under the Foreign Investments Act, doing business includes soliciting orders, service contracts, opening offices, or performing any other acts that imply a continuity of commercial dealings or arrangements within the country for commercial gain or for the purpose and object of the business organisation. By engaging Philippine workers, even on an independent contractor basis, foreign principals may be held liable for doing business without a licence, for which reason they may not intervene or maintain any action in any court or administrative agency of the Philippines, but may be sued or proceeded against on any valid cause of action.

The Supreme Court has held that for the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines.

Relatedly, foreign principals may also be fined or penalised by the BIR for non-payment of proper taxes if they are found to have a permanent establishment in the Philippines. While the conditions therefor are mainly regulated by relevant international tax treaties, the fact that the services are performed in the Philippines may deem the profits derived therefrom as income earned from the Philippines, for which corporate income taxes are due. This is because, in one case, the Supreme Court held that the source of an income is the property, activity, or service that produced the income. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines.

Thus, in light of the above challenges, it is best for foreign principals to consult local employment and tax lawyers first before proceeding to engage individual contractors.

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