Ep 16 | PEO Employees & Equity Rewards with Marlene Zobayan & Jon F. Doyle

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This is Own Up, the Global Shares podcast about employee ownership and equity compensation. Answering questions and sharing with industry experts, here are your hosts, Chris Dohrmann and John Bagdonas.

Chris Dohrmann 00:21

Welcome back to Own Up. In today’s episode, we’re going to be talking about PEO employees and equity rewards. And I’m joined by two experts in the field. One is Marlene Zobayan, who is a global stock plan expert and a Partner at Rutland associates. Welcome, Marlene!

Marlene Zobayan  00:37

Thank you. Thank you for having us!

Chris Dohrmann 00:40

I’m also joined by Jon F. Doyle, who is the Managing Shareholder for International Law Solutions. Welcome Jon!

Jon F. Doyle  00:47

Thank you, Chris!

Chris Dohrmann 00:50

I introduced this as PEO employees. So I’m already starting what were we in the industry are always accused of…we love our abbreviations. And we love our jargon. So I’m just going to you a little definition and say PEO stands for professional employment organization. And the focus of today’s episode is going to be on – is it right for your organization? And then we’ll talk about a couple of issues that may be the right way to get started or help you evaluate whether professional employment organizations are right for you!

So I’m going to start by asking John, because I think you receive the most questions about this. It’s an emerging topic and emerging trend. You know, how does it the conversation usually start?

Jon F. Doyle  01:30

Well, Chris, as a as a law firm, we advise clients on the tax and regulatory issues of offering equity, you know, around the world. So you know, we really get involved in this. And typically what happens is, a client will contact us and say, hey, we want to offer equity to someone new or in certain countries. And that’s where the discussion starts. And the first couple of things that we want to understand are well, what are they offering? What type of equity? Is it options? RSUs ESPP?  What countries are they offering in?

And then the next question, which really leads right into our topic today is – what type of workers are getting the awards? Are they employees of the subsidiary or affiliate? Are they contractors? Or are they folks with a third party such as a professional employer organization? And that’s really kind of how we start this. And it’s important to literally defy from the beginning what type of arrangement it is, because as Marlene and I explain today, that’s going to make a big difference on the taxes and some of the regulatory issues. So that’s a very critical thing that we have to figure out.

In terms of professional employer organization, the question is, what is it? And that’s an ongoing debate in terms of what it is. And in all candor, it really depends!  It depends on the country. And it depends on the specific arrangement. But generally speaking, it’s a third party that provides payroll and other HR services to a company – and the issuer company’s employees. So the issuer can use the PEO to help with engaging people in other countries.

Chris Dohrmann 03:21

So when I refer to it as a solution or a vendor solution or a partner solution for companies that are looking to address what amounts to the global labor shortage, and it’s one way to make sure that they can start to engage with the labor market in a way that may be easier for them in certain situations. Would I be wrong in clarifying it like that?

Jon F. Doyle 03:47

No you’re absolutely right, Chris. And, you know, these have become really popular for a lot of reasons. But one of the reasons is just as you explained, you know, we get calls a lot from clients that are like we have, we’ve managed to find someone, an engineer or someone in a country, that the client doesn’t have any connection with otherwise. And they don’t necessarily want to establish a subsidiary or anything like that, or they, maybe can’t do it fast enough.

You know, in a lot of countries it takes time to get these subsidiaries up and running. So a PEO can really be a good quick way to get things going. And you know, one thing I should mention, Chris is, you know, as I said earlier, there’s different variations of a PEO, but the most basic one is, you know, it’s really a kind of a co-employment relationship where the PEO is providing certain HR and payroll functions, and then the issuer company is also the employer. But there’s another variation of this that gets used a lot and it’s called employer at record. And a lot of times they’re lumped together but that’s where the third party is actually the employer and the only employer. And it does everything – it employs first person, it does all the payroll and everything. And then they simply have the individual worker provide the services back to the company client or the issuer company if you will.

Chris Dohrmann 05:08

You already mentioned a couple of things that when Marlene joins the conversation in a moment, and when I guess we can wrap it around, there are really common themes here. One is, you mentioned specific countries. So we’re going to come back to the country relationship here. And the other is the fact that my background has always been in servicing employees. Then you also have other some quasi employment relationships, like board members, and sometimes contract. In this case, you’re really bringing up the differences, and highlighting the differences between employees, and what are non-employees.

Jon F. Doyle 05:44

That’s right. And to kind of back up for a second here, you know, in terms of getting those qualified workers… companies are really, they have a number of different ways they can go. They could decide that they’re going to employ the people directly, or through a sub, they could decide to engage them as contractors, or they could decide to use some variation of a PEO.

Whether it’s a co-employment arrangement, where they’re technically still employed with the company, and also employed, if you will, by the PEO, or a full on EOR, where all the employment is with the third party. And so the big thing for the client is to figure out, you know, what makes the most sense. And one of the reasons that the PEO arrangement has become so popular is the different countries around the world really, are skeptical or don’t like contract arrangements. And so frequently, clients will come to us, and they’ll want to use a contractor, but the issue becomes tax, if the individual doesn’t pay the taxes, then there’s a risk to the company. And so for this reason, a lot of folks use these PEO arrangements, because then they can be sure the taxes are getting paid in. And that’s really a very, very critical point here is to make sure they’re paid it, but yet they get the person they’re looking for to provide services to them.

Chris Dohrmann 07:11

So just to summarize, it sounds like this is an emerging solution to continuing, you know, problems situation where companies need to find qualified expert employees, and navigate the restrictions for global issues as far as whether it be country specific or be tax specific, or labor law specific, and bring those folks on. What our focus here is going to be…assume they’ve been brought on through this mechanism – is equity granted to these folks? Or can it be granted to these folks? Because obviously, you have the same retention, reward, you know, discussions, can it be granted in the same way as employees?

Jon F. Doyle  07:54

Basically, it can, and I think in most places, you know, this is a workable approach. You know, you do have to be careful, though, some of the tax considerations and as well as some of the regulatory stuff. So for instance, if you’re dealing with a country where you got to get an approval or something, it may make a difference whether or not the individual is actually somehow employed with the issuer, either directly or its subsidiary as opposed to a third party. So that can play a role. But generally speaking, Chris, it is perfectly workable, to make these grants to folks working for a third party or a PEO.

Chris Dohrmann  08:32

I don’t want to put you on the spot, Marlene, but I mean, it’s sounds like the solution for labor and to actually start to procure them. My concern, and I think we’ve had, you know, brief discussions about this. It sounds like the labor laws are catching up, or at least being proactive. Have the tax laws caught up to this arrangement?

Marlene Zobayan  08:56

No, not at all. It takes a very long time for tax authorities to ask. And quite honestly, in the last three years, when we’ve seen, in my opinion, we’ve seen the largest amount of PEO employee growth, the tax authorities have been dealing with remote workers and what to do when people are stuck in a location during the COVID pandemic. They really haven’t had a chance to even get their arms around this. And maybe I’m being a bit generous when I say that. I am a little bit jealous of John, he says that he gets the calls when companies are thinking of making the grant. I tend to be the one that gets the calls when a company says we have a PEO employee that we’ve given equity to and now he wants to exercise his stock options, how do we withhold? And now you’re trying to unravel a situation that they went into and, you know, it’s too late.

So there are lots of tax issues that come up when you’re granting to employees of this nature. The first one is, is there a withholding and reporting liability for payroll compliance? And that really depends on the country. It depends, firstly, on the country whether there is a payroll reporting withholding compliance requirement. And secondly, who has that requirement? Is it the PEO? Or is it a company? In some situations like the UK, anything an employee gets by reason of being an employee is the employers responsibility to withhold and report even if the employer is not the one providing the benefit. And there’s a lot of case law about this in the UK, primarily with Call Center employees that were given benefits by the vendor that they were making the cold call for, but they were employed by the call center. And the call center is still liable to do the withholding and the reporting. There are other countries like Canada that says, well, the issuer is the one liable even if they’re not a resident company. But if the issuer, i.e. the company in our discussion, is the one that’s liable, and they don’t have a presence, that requirement can usually be met by the PEO, who has a presence in that country whose payroll registered in that company. The issue is, will the PEO want to do that withholding and reporting? And very often they do not.

And that’s why it’s really critical in advance of making any grants to PEO employees that a company has that conversation with a PEO because it doesn’t just end with withholding and reporting. There could be other compliance requirements like John alluded to. There’s also other equity statements that might be required to be made, such as in the UK, in Australia, there’s the ESS statement that has to be done every year. And there’s a question as to who’s responsible for doing this? And who will do it? And that’s really key.

Chris Dohrmann  12:08

I don’t want to be, you know, trite, but it sounds like what you’re both bringing up is that failure to plan, you know, is going to generate, you know, a failure point at some point here. And I think you’re being both very informative about that process. It sounds like a solution more and more folks are adopting, but as long as they ask the right questions going into it, then you know forearmed is the best way to approach it.

Jon F. Doyle  12:33

We’ve definitely seen progress what Marlene is talking about where the clients aren’t clear what the PEO is going to do. And oftentimes, as Marlene was explaining, they’re like we can’t do the withholding reporting on equity. We’re seeing a little bit of a change in that, some of the companies now are getting more open to doing this. But it has really presented a lot of problems for our clients. Because, you know, just as Marlene said, they’ll show up and they’ve got an exercise or vest coming up. And they have no idea who’s going to do the withholding and reporting. And that’s an issue.

So we’ve tried when we start working with people, if they haven’t already gone too far down the road, to let them know, hey, this is going to be an issue, we recommend you first talk to the PEO, and see whether they are willing to do the withholding and reporting. If they’re not, then we can look at you know, potentially other ways to approach this. And honestly, sometimes the problem solves itself, because a lot of times the client is already in the process of trying to set up a more formal arrangement, you know, subsidiary or local entity where they’re going to eventually employ the people. And they maybe haven’t done it yet. But by the time there’s an actual taxable event, they may be able to themselves do the withholding and reporting. And, but it just depends on a number of factors. But this is the primary issue that we see is that there’s often times no assistance with those tax obligation.

Chris Dohrmann  14:06

You both mentioned something that I want to, at least highlight, or put a flag on because we can come back to it maybe at the end or in the conversations. Marlene, you talked about the trend of, you know, actually almost all employees now have had at least a discussion about whether or not they’re going to be hybrid in some way, shape or form, whether it be home or work, or whether it be from a site that’s other than their home or work. And that would probably happen in the same case for PEO employees. So the transition from PEO to mobile employees or introducing the complexity of having that happen is one thing. The other thing that you just mentioned, John is the fact that some of these PEO employees are likely to migrate to de facto employees at some point too. So it’s a good question to ask of the PEO, or at least ask of your other stakeholders when you’re in administrator in this, to make sure that those possibilities have been addressed.

Marlene Zobayan  15:05

I want to go one step back and say you’ve got to have policies when it comes to mobility. One of the reasons I think that PEOs came up isn’t just the global talent shortage. It’s also because we now have a system of working remotely or a prevalence of working remotely, where you might have had an employee that say, worked in the US, got incentive stock options, which are tax favorable in the US, and now wants to work in Peru.

And if your policy is while you can work from anywhere, and you’ll get to keep that employee, you might hire a PEO in Peru, to accommodate that employee, as opposed to letting them work directly from Peru. And there are tax issues about letting them work directly from Peru, which I’ll address in just a minute. And so now you’re sort of, the rugs been pulled under you, you already have an employee with equity that’s now in Peru that you have to deal with. And I just make Peru up, it’s actually not that difficult a country to deal with, but it could be anywhere in the world that could be more problematic from a tax and regulatory perspective. And so I think the remote working that we are looking at right now in the in the professional community is also what’s driving PEO prevalence. You also have, in that particular example, you not only have mobility, you also have an issue of this person has a qualifying stock plan that is tax qualified in the US. But it only applies to employees and PEO employees typically cannot get the tax benefits of the tax qualifying plan such as an ISO in the US. And the same is true in Israel and France. And most countries that I’ve looked at there have tax qualifying plans do not allow PEO employees to participate. When it comes to mobility, you really have to do a double research. And that’s why I always tell companies to have a policy in mind, so at least somebody doesn’t think they can just move from A to B without pre approval, without giving the company a chance to at least do their due diligence about it. Because some countries will tax non-employee stock options. And these PEO employees are not your employees at the time of grant. So you could have an individual that’s been taxed at the time of grant on their equity award and is now moving to a country that was going to tax them at the time of exercise. And they’re going to be double taxed in a way. So it is happening. It’s also happening this transition from PEO employee to full employee across the border. Those things unfortunately, require individual attention. And the answers do vary by country. I hate to keep saying that. But it’s true!

Chris Dohrmann  18:00

Well I was just going to come back to that because we were all sitting in various points of one of the countries that is the most aggressive as far as taxation and the most complicated. But you have both mentioned this. And I just wanted to say, as far as a PEO arrangement, are there some jurisdictions, some countries, some states, some provinces, that are a little bit more challenging than others? So folks can take away and say, look, at least we know that it’s going to be a little bit more difficult going in if we have to work there?

Marlene Zobayan  18:29

Chris, there are actually some countries where PEO arrangements are not allowed and PEOs do operate there. And they are under the radar. So as a corporation, it may or may not bother you. But places such as France and Spain have pulled very strict parameters around what PEOs can and can’t do and the types of roles they can fill. And sometimes, you know, the length of time that those employees can be there as opposed to an indefinite employee. So that’s definitely something I consider challenging. Having said that, I know a number of corporations that have hired PEOs in that location.

Jon F. Doyle  19:09

No, that’s a great point, Marlene, and we’ve seen that too. And I think this is where we have to get down in the weeds a bit in terms of what really is the function of the PEO. You know, are they a co-employer, you know, assisting with payroll and HR, or are they really what we would call an employer of record, a true third party, and that those factors can make a real difference. And certainly, you know, we have plenty of clients that want to offer equity in places like China. Well in China in order to be able to have people acquire equity the company has to have a local subsidiary and has to have a SAFE approval and has to be a public company.

So if the individuals are working for a third party, it’s not likely that you’re ever going to be able to get approval because they have to work for your wholly owned foreign enterprise and a third party. So there definitely are places like that. And another one that comes up occasionally where there’s some uncertainty is the Philippines. Philippines has securities rules that require you to either qualify for small exemption or to register a certain amount of shares. But our sense is that those rules would really only work if you had folks working for your local subsidiary not a third party. So there are a lot of places where there’s a bit of uncertainty. But you know, most of it can be dealt with.

And I think one of the things we probably should talk about is, because the grants are coming from the issuer, the client company, if you will, to people that work somewhere else, you oftentimes need to clarify that in some type of a side letter. And we want to be careful, because if we’re trying to have the individuals actually employed by the PEO more like an EOR arrangement, we’ve got to be careful what we’re saying and how we’re saying it.

So oftentimes, we’ll put together side letters that’ll just memorialize the fact that the individual is getting a grant from the client company, but the client company is not their employer, and it’s for services that are being provided to the third party company. And so that helps, you know, we’re always trying to ride this line. We don’t want them necessarily to be an employee of us, we’d rather they be the employee of the PEO or the EOR. And so there’s this balance that you have to strike. And then there are things like intellectual property, you know, does the PEO have sufficient agreement with the individual and make sure that they’re not going to run off the IP. So there are things like this, you have to look at, they go a little bit out of the equity, but it always seems to come up one way or another.

Chris Dohrmann 21:58

There are just a couple of final things that I wanted to address here. I recognize these from a while back from working with companies that are basically in the financial world, or primarily in the technical world, or even on the biopharmaceutical, but I can see this happening across the board in ecommerce in anything where that you may want to get specific talents from places around the world where you’re may not be able to get it in your home country. Should the arrangement with the PEO be done out of HQ? Or should these companies investigate the possibility of having at least a subsidiary or an office in the country, you know, negotiate a contract with these firms?

Jon F. Doyle  22:44

Well, in our experience, it’s typically done at the parent company level, because usually the parent company is the one that’s kind of deciding where they’re going to hire. And most of the time, there is no one local, you know, this is oftentimes the first hire for a lot of these clients. So they are like, oh, we found a software engineer, and they happen to be in Nepal, you know, or they happen to be in Bulgaria, we have nothing else there. So typically, in my experience, unless it’s a much larger company, it’s typically run by the headquarters, the headquarters decides kind of how they want to do it. And, you know, I think, to that point, Chris, you know, these are a really good tool, in a lot of cases to initially get people on board. And you know, we see this a lot where client will call, and they’ll say, you know what, we’ve got the perfect person, we got to move fast on this. And you know, moving fast, if you have to set up a subsidiary is not fast, and you’ll likely lose person. So that’s where these really are helpful.

And we see them best used, frankly, when they are kind of an initial onboarding, a way to onboard people. And then, at some point, you know, if the client gets sufficient people in the country or the region, then a lot of times, we’ll help them set up a local subsidiary. And for instance, we worked with a biotech company that long ago that was using these arrangements in probably six or seven countries in Europe, and they finally got to a point where they’re like, we have enough people now that it makes sense for us to employ them, us to manage this. And so we helped them set up a Dutch entity, and then it employed the people in the various regions. So I look at these in their best use as a way to quickly get folks on board. But at the same time, we do have other clients. We have one client that’s in like 50 countries and the vast majority of countries they only have one or two people. So you know, you have to kind of balance that in terms of what’s going to make the most sense, but there’s plenty of folks that start with a PEO that eventually set up their own their own arrangements.

Marlene Zobayan  24:47

I will say I have come across situations where a US company might have say a European headquarters, and that European headquarters might engage a PEO in one or two countries where it’s not physically present in. So for example, the client case I had it was a UK employer, it was a US company with a UK subsidiary. And then the UK subsidiary was using a PEO in the couple of other European countries that all rolled into that UK subsidiary. So we have seen that sort of arrangement too. I think the world is, it’s very vast and varied in terms of what companies are doing. So there’s no one size fits all.

But to answer that, to go back to your original point, Chris, I think if you are incorporating in a country, and then hiring a PEO in that country, you’ll really very much I think, more at risk by jurisdictional limitations, especially if there is something that goes wrong in that country in terms of non-compliance or withholding and reporting. You’d have an entity right there, and the tax authorities can easily point to you and say you’ve had a presence, why didn’t you do this?

Chris Dohrmann  26:01

And the deeper pockets would be the concern there. Okay. So I just wanted to say thank you very much, because I do appreciate your expertise, both of you, and I wanted to open this up, and maybe address a couple of questions that are coming in from the audience! The first one is, if the PEO is refusing to do the reporting, what can the issuing company do?

Marlene Zobayan  26:25

I think there’s a couple of different things they can do. I’ve had clients who, if they are about to incorporate in that particular country, they’ll go ahead and you know, finish that off, and then do the reporting themselves. Because they’re about your payroll register and transfer these employees over. They can encourage the employees to make sure that those individuals report the income themselves, and that mitigate some of the risks, or they can cash out. Often I’ve been told by PEOs that they cannot report non cash income so they can cash out the awards, and have those paid as a bonus through the PEO. But really, at that late stage, your hands are pretty much tied by the rules of what the country requires and what the PEO is willing to do.

I will agree with what John says, I have seen in the last few months, more and more PEOs, more willing to do the withholding and reporting, but it’s definitely not all of them at this point. Um, John, did you have any other creative solutions that you’ve dealt with on this?

Jon F. Doyle  27:28

Yeah, I think Marlene you’ve hit the main ones, you know, the last resort is obviously the cash out which everybody hates. But you know, that’s a way if you got to get the money to people, you could run it through the PEO they treat it like a bonus, they do all the tax withholding. The first one you mentioned, we see more, which is if we get in touch the client early enough, and they are contemplating an entity, that problem can solve itself, because by the time there’s a taxable event will have their own entity to do the withholding and reporting.

And then the second one you mentioned, I think which is basically you just let the individual take care of the tax obligations, you know, that’s basically treating them like a contractor, if you will, for purposes of equity award only, which again, we’d all love that, because that’s why we got a PEO in the first place. But at the end of the day, if the taxes have to get in, they have to get in. The only the risk we see there obviously is like I was talking before with contractors is, you know, the governments can say, no they’re not really a contractor, they’re really an employee, and you should be withholding and reporting.

And again, if the individual pays their taxes in, it’s probably a moot point, unless, of course, there’s employer social taxes or something like that, that they wouldn’t have paid. And that’s where we had, as you said, Marlene, we look at each individual country and in a lot of places it may not be a problem. But there will be some where there are those pretty steep employer taxes. And so there’s always that risk that you know, even though the, quote contractor paid in their taxes, if they’re reclassified that could bring in employer taxes, and then you would be on the hook. But I always argue with clients or are explained to the PEOs, you know, you guys are the ones actually sitting in country, technically engaging these folks. And I would expect the regulators are more likely to look at them. But then again, they may look at the deep pocket. So it really just depends on circumstances.

Chris Dohrmann 29:25

There was one other question that I think we addressed because it came in earlier in the conversation, which is – do you need to set up a subsidiary and we talked about that. So maybe I can close with my own question to you both. Just because you can do this, because it is seems like a very good solution to very real problem, should you?

Jon F. Doyle  29:45

Well, spoken like a true lawyer, I’ll tell you it just depends. You know it can be great in some circumstances. I like it best when it’s used as kind of an interim measure, if you will. But you know, as Marlene has carefully explained here, the taxes are super important. And if there’s not a clear understanding how those are going to be dealt with, there can be a real problem. So I think if you know on the front end, kind of, what you’re dealing with, these can be a great tool. Obviously, there’s some places they don’t work, you know, and that’s why it’s important to really check things out.

Marlene Zobayan  30:22

I completely agree with John, I have nothing more to add, on this point. Do your homework before you grant, it’s the best advice I can give to any company.

Jon F. Doyle  30:31

You know, to Marlene’s point, there’s still a lot of uncertainty, you know, the regulators and the different countries are still looking at these things, trying to figure them out. And you know, I fully expect there will be even more countries that are going to maybe take a look at these and say we don’t like it, you know, but they’re still, you know, they’re still kind of looking at it. In my view, where the countries have the biggest problems is, they just want to make sure the tax money is coming in, if the tax money is coming in, they probably have a lot less trouble with it, then, you know, let’s say a contractor arrangement.

Marlene Zobayan  31:05

So I’ve been talking a lot about the taxes, but there are significant securities, foreign exchange, labor law issues, and I want to hand over to John to maybe talk about those.

Jon F. Doyle  31:17

Yeah let’s start with the securities. You know, as I mentioned a little bit ago, you know, like the Philippines, if you have to qualify for securities exemption there, it may not apply, when you have a non-employee arrangement or a non-contract arrangement. In other words, it’s a third party. And so in every country, when you’re offering equity, there’s technically a securities offering. So what we basically got to do is make sure we fit within an exemption, or we have to get, you know, a filing or approval done. And in a lot of cases, you can’t necessarily do that, unless the individuals working for your company or one of your subsidiaries. So that’s an important thing to know right off the bat. In the vast majority of places I think you can do this, because the issuer will just have to make sure that it’s exempt, and a lot of times it will, because it will be a service provider at one form or another. But you kind of have to look at the details.

Marlene Zobayan  32:16

I was just going to say, and usually there’s a small number of individuals in that particular location, which is why you have a PEO and not a subsidiary, so you might fall under a small filing exemption.

Jon F. Doyle  32:27

That’s right, yeah! But they don’t always apply, though, for certain categories. In other words, if it’s an employee or employee of a sub, then it may work. In some cases, it won’t. So but by and large, you know, security shouldn’t be a showstopper here. You know, on the data privacy side, that’s interesting, because if the person is technically working for a PEO, then the PEO is going to be responsible for how it handles the data. And if it’s then giving the data to, you know, the client company, it needs to make sure the client company then is following the privacy rules and handling it. So it’s a bit of a chain in terms of who has the information. So again, it’s not insurmountable, but it’s something people need to be aware of.

Chris Dohrmann 33:17

Thank you very much for your time today. I always learn something when I’m speaking to both of you. Thank you, and I appreciate it!

Marlene Zobayan  33:20

Thank you!

Jon F. Doyle  33:24

Thank you, Chris and Marlene, pleasure. Thank you!

Chris Dohrmann  33:28

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