To hire employees or to engage independent contractors? That is the question!
The decision regarding which type of worker is right for your business is regularly on the minds of business owners and managers in the Philippines.
Sometimes, the answer might actually lie between a combination of both employees and contractors depending on the needs of the business!
When making this decision, however, owners and founders must always consider the financial implications associated with bringing on employees, contractors or any other form of worker or service provider.
So, in this article, we outline some key financial matters to consider when deciding if your PH company should hire an employee or engage an independent contractor and what impact this might have on your company’s finances!
1. Labor Protections
Let’s start with a well known and clear distinction that often arises early within the employee v independent contractor debate – the status and protections of workers under local Philippine laws.
In summary, the primary protections that an individual has as an “employee” will be under Philippine labor laws and under the terms of their employment contract (sometimes, these two might overlap).
An independent contractor’s primary protection, however, will generally only be under the terms of their service agreement.
If you hire employees to work for your business in the Philippines, they will be entitled to receive the full suite of protections afforded to them by the Department of Labor and Enterprise, or DOLE, and specifically, under The Labor Code of the Philippines.
Both DOLE and the Labor Code set out the rules and guidelines that employers in the Philippines must comply with in order to ensure protection and support for the employer-employee relationship.
Importantly, The Labor Code provides for various finance-related protections for employees. For example, minimum wage rates, form and timing of compensation payments, prohibitions on wage deductions, mandatory compensation payments for regular or special holidays, overtime payments and 13th Month Pay (see No. 4 below), to name just a few.
If an employee has an issue or complaint against their employer company, they can enforce their labor law protections by making a claim to DOLE.
So, when seeking to hire employees in the Philippines, business owners should make themselves fully aware of the protections afforded to employees and the obligations imposed on employers under Philippine labor laws and how this can potentially impact the finances of the business.
When engaging an independent contractor, the company and the contractor have a lot more flexibility to negotiate the terms of the engagement without fearing a breach of local Philippine labor laws.
Why? The purpose of The Labor Code is to provide financial protections for employees – not for independent contractors!
As such, the primary protection that an independent contractor would have when working with a company would be any protections that he or she negotiates under the specific terms of his or her service agreement or contractor agreement with that company.
In order to enforce any such protections, an independent contractor would have to take action through the formal courts, usually in the form of a breach of contract.
2. Taxation on Compensation
Business owners must also be aware of the key taxation implications that might arise depending on if the company hires employees or engages independent contractors.
There are significant differences!
Withholding Tax on Compensation is effectively a tax on the income of employees in the Philippines.
It is a payroll-related tax, mandated by government, on the gross value (i.e. the salary prior to any payroll deductions) of each employee’s salary.
Under the Withholding Tax on Compensation framework, employers must deduct and hold on to a certain percentage of an employee’s salary and then pay the deducted amount to the BIR.
Withholding Tax on Compensation is reported by employers to the BIR every month through the filing of BIR Form 1601C. Withholding taxes are then paid by the employer to the BIR the following month.
How is Withholding Tax on Compensation computed? It is based on graduated withholding tax rates ranging from 0% to 35% on net taxable compensation.
For the relevant rates, you can check out the Withholding Tax Table on the BIR website.
Here is some additional information on the Withholding Tax on Compensation Framework in the Philippines.
As mentioned above, Withholding Tax on Compensation will apply where there is an employer-employee relationship.
In the case of a company in the Philippines engaging an independent contractor, withholding tax is payable by the company – however, it is a different type of withholding tax and computed differently.
In the Philippines, withholding tax is required to be deducted from payments to independent contractors, consultants or service providers. Note: While there is a distinction, many companies will use the terms “contractors” and “consultants” interchangeably.
The rate of withholding tax that must be deducted and remitted to the BIR for payments to contractors and consultants will differ depending on a number of criteria. For example, the rate of withholding tax can differ depending on if the company is paying a professional consultant, a contractor or an outsourced service provider company. The personal circumstances of the contractor or consultant may also be relevant, including in particular the level of gross income generated by that contractor or consultant within the relevant financial year.
In general, however, and depending on the particular circumstances, companies can expect to have to deduct and remit between 0% and 10% withholding tax on payments to independent contractors/consultants/service providers.
Contractors and consultants will generally try to negotiate with the engaging company to ensure that their fees are negotiated net of withholding tax, to avoid a reduction in the level of fees they receive for their service.
So, for companies, make sure to consult your accountant or bookkeeper in advance when paying a professional consultant, contractor or other service provider to fully understand what the withholding tax implications are in relation to that payment!
3. Government Contributions
In addition to the payment of taxes in the Philippines, there are a number of additional contributions that a business may have to pay depending on the status of the workers engaged by the company.
In the Philippines, companies that hire employees are mandated to contribute to various national social and health schemes on behalf of their employees.
While both employer and employee might contribute to such payments (through add-ons and deductions to their wages), the onus is on the employer company to ensure that these contributions are properly processed.
There are three primary social and health insurance schemes to which employers in the Philippines are required to register for and contribute, as follows:
- SSS. The Social Security System is the government-mandated program for employees that work for private establishments. This social insurance scheme provides for various benefits during the lifetime of each SSS member.
- Pag-IBIG. This is also commonly referred to as the Home Development Mutual Fund (HDMF) and it is a national savings program that provides support for affordable home financing for workers across the Philippines.
- PhilHealth. This provides for affordable health insurance coverage for working Filipinos. The government mandates for all employees to be insured through the PhilHealth system.
Employers must be aware that the above social security scheme contributions will be an additional cost to the employer above an employee’s standard salary. While the employee’s % contribution will be deducted from the employee’s salary and remitted to the relevant agency, the employer’s % contribution will be a cost to the employer in addition to the regular wages paid for each payroll period.
So, when business owners are preparing budgets or financial models and computing the cost of employee wages, it is important to include the actual cost to the business of hiring an employee – which should include additional mandatory payments such as social security contributions!
The position when engaging contractors is quite different.
A company is not mandated to make contributions to the various social security schemes on behalf of a contractor. This would not, in fact, be standard practice.
If an independent contractor wishes to contribute to any or all of the social security schemes in the Philippines, it will be the contractor’s responsibility to process and pay for the contributions itself – it is not the company’s responsibility!
While this can make it a little easier for a company from an operational and administrative perspective, it is not necessarily a “cost saving” for a company. An independent contractor may wish to contribute to these social security schemes and as part of his/her own pricing model, they might build the cost of their social security and health contributions into their service fees, therefore increasing the level of fees.
However, the contribution payments will still remain a responsibility of the independent contractor and not the company.
4. 13th Month Pay
While the matter of 13th Month Pay is a protection, or indeed a benefit, afforded to employees under PH labor laws (see No.1 above), it is such an important financial consideration for employers in the Philippines, that we decided to give it its own section in this article!
See here for a more detailed analysis of 13th Month Pay in the Philippines.
13th Month Pay is a government mandated benefit payable to rank-and-file employees in the Philippines each year. Employees that have at least one month of employment service are entitled to receive a payment, in addition to their regular wages to the equivalent of one twelfth (1/12) of their basic salary for the relevant calendar year.
Employers in the Philippines are required to disburse 13th Month Pay to all covered employees on or before the 24th of December every year.
Business owners and managers need to consider this mandatory requirement to pay 13th Month Pay at all times during the year – not just in December – and in particular, when hiring new employees.
The key here is for owners and managers to understand the true cost to the business of hiring an employee and not just base their employee costs on gross wages!
In short, independent contractors do not have any entitlement under PH law to receive 13th Month Pay.
The total compensation will be negotiated by the company and the independent contractor at the beginning of the engagement and it would be quite unusual for such a negotiation to specifically include any provision for a 13th month pay.
Again, however, similarly to the social security contributions (see above), an independent contractor might opt to build the cost of a 13th Month Pay into their pricing model and service fees when negotiating with companies seeking their services. This would be, however, a matter for each individual contractor.
5. Associated Costs
Business owners and managers must remember that the costs associated with hiring an employee or engaging an independent contractor are not limited solely to the compensation paid to them on a weekly, bi-monthly, monthly or project basis.
There are usually additional costs and expenses associated with such engagements that a business owner or manager will need to account for in their business plans, financial projections and budgets.
Employees must be paid each month at the various intervals agreed with their employer. In the Philippines, it is common for salary intervals to be bi-monthly.
However, employees will also require the necessary equipment and tools to be able to perform their work to the level expected by their employer. For example, employees may need laptops, computers, key cards, company uniforms, access to cloud platforms, travel expenses, office facilities, machinery or building tools, safety equipment, furniture, etc.
There are also costs associated with onboarding an employee. Usually, a HR Manager or HR Team will be needed to oversee the process – which is another cost to the business.
Employees are also likely to require training and upskilling. Employers may see this as a way of helping employees to grow for their own benefit and for the company’s benefit and may pay for more advance qualifications, diplomas, seminars and other forms of training courses.
The list of associated employee costs can be quite long depending on the business model and industry! However, the key point is that usually it will be the employer who pays for such costs as part of the employer-employee relationship.
In the case of contractors, associated costs or expenses and who will pay for those costs will generally be included in the terms of the service agreement negotiated between the company and the contractor.
It is, however, standard practice that an independent contractor will be responsible for providing his or her own tools or equipment needed to perform the services. For example, independent contractors will generally use their own laptops, subscribe themselves to tools or solutions that they need, work offsite or at home, provide their own machinery or building tools, etc.
It would also be quite unusual for a company to pay for the training or upskilling of an independent contractor. In fact, in many cases, the reason that a company will hire a contractor is because the contractor already has a very niche or specialised set of skills that the company requires for a specific project.
Sounds great, right? Companies don’t have to pay for any of these add-on costs like they do for employees?
Not quite, unfortunately! An independent contractor, who understands his or her offering and their worth, is likely to build any associated costs into their service price, thus increasing the cost to the company! Again, this will be for the company and the contractor to negotiate freely!
CloudCfo – Finance Management Services for Startups and SMEs in the Philippines
The CloudCfo Team supports a large number of startups, small businesses and SMEs across a wide range of industries within the Philippines.
We have significant experience working with companies that have a large number of employees and for who we provide our Payroll Services.
We also work with many companies that prefer to outsource and engage contractors for the majority of the work to be performed. Our team are experts are advising on specific compliance requirements of engaging contractors or services through our Tax Services.
Contact Our Team Today and let’s discuss how we help your business scale here in the Philippines – whether it is with employees, contractors or both!