How to Convert Contractors to Employees in the Philippines

Introduction

The Philippines has strict labor laws governing the conversion of contractors to employees. This guide outlines the process, whether or not you have a local entity.

Contractor vs. Employee: Legal Overview in the Philippines

One of the most significant challenges businesses face when converting contractors to employees in the Philippines is ensuring the proper classification of workers. Misclassification can result in severe penalties, including back taxes, fines, and legal disputes. The Department of Labor and Employment (DOLE) has stringent rules concerning the definition of contractors versus employees, which businesses must adhere to when making the transition.

Classification Differences

In the Philippines, the distinction between contractors and employees is primarily based on control and the nature of work performed. Contractors typically operate as independent entities, managing their own working hours and outcomes, while employees are subject to the company's rules and oversight.

Key differences include:

• Control and Supervision:
  Employees work under the direct supervision of the employer, with set work hours, while contractors have greater freedom to determine how, when, and where they perform their work.
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• Tax and Social Security Obligations:
  Employers are responsible for withholding taxes and making contributions to the Social Security System (SSS), PhilHealth, and the Home Development Mutual Fund (Pag-IBIG) for employees. Contractors, in contrast, are generally responsible for handling their own taxes and contributions.
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• Benefits and Entitlements:
  Employees in the Philippines are entitled to benefits such as paid leave, 13th-month pay, and access to government-mandated benefits like health insurance and retirement contributions. Contractors do not receive these benefits unless specified in their contract.

Legal Implications of Misclassification

Misclassifying employees as contractors can lead to significant repercussions. Businesses may be subject to penalties, including back payments for unpaid taxes, benefits, and wages. Furthermore, contractors who believe they have been misclassified can file claims with DOLE or the National Labor Relations Commission (NLRC), potentially leading to legal action against the company.

Steps for Converting Contractors to Employees in the Philippines

Once you’ve determined that a contractor should be converted into an employee, there are several steps that need to be followed to ensure a smooth and compliant transition.

1. Review the Contractor Agreement

The first step in the conversion process is to review the existing contractor agreement to determine if it reflects the contractor’s current role. If the contractor is working under the same conditions as an employee, it may be time to formalize the employment relationship.

Indicators that a contractor may need to be converted into an employee:

• The contractor works under the company’s supervision and direction.
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• The contractor’s work is integral to the company’s operations.
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• The contractor uses company-provided tools or resources to perform their tasks.
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• The contractor works for the company long-term, rather than on a project-by-project basis.

2. Draft a New Employment Contract

Once you’ve identified that a contractor should be transitioned into an employee, it’s essential to draft a new employment contract that complies with the Labor Code of the Philippines. The employment contract should include:

• Job Title and Description:
  Clearly define the employee’s role and responsibilities within the organization.
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• Salary and Benefits:
  Detail the employee’s salary, benefits, including 13th-month pay, and any additional compensation packages.
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• Work Hours and Expectations:
  Outline the employee’s expected work hours, including overtime policies in accordance with local labor laws.
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• Leave Entitlements:
  Specify the employee’s entitlement to paid leave, sick leave, and maternity or paternity leave as applicable.
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• Termination Terms:
  Define the notice period, termination conditions, and severance pay in line with the Philippine Labor Code.

3. Ensure Compliance with Social Security and Benefits Contributions

When transitioning a contractor to employee status, the company becomes responsible for registering the employee with government agencies, including SSS, PhilHealth, and Pag-IBIG. Contributions to these programs must be made regularly, and failure to do so can result in fines and penalties.

• SSS Contributions:
  Employers must contribute to the employee’s social security fund, providing benefits in case of disability, retirement, or death.
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• PhilHealth Contributions:
  Employers must also contribute to the national health insurance program, ensuring employees have access to healthcare benefits.
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• Pag-IBIG Contributions:
  This mandatory savings program helps employees save for housing and other long-term needs.

4. Provide Statutory Benefits

In addition to social security contributions, employers are required to provide employees with several statutory benefits, including:

• 13th Month Pay:
  A mandatory bonus that equals one-twelfth of the employee’s total basic salary for the year.
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• Paid Leave:
  Employees are entitled to a minimum of five days of service incentive leave after one year of service.
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• Rest Days and Overtime:
  The Labor Code of the Philippines mandates a rest period of at least 24 consecutive hours per week, usually on Sundays, with overtime pay for work performed beyond eight hours a day or on rest days.

Without a Local Entity: Using an Employer of Record (EoR)

If your business does not have a legal entity in the Philippines, converting contractors to employees can seem like a complex and time-consuming task. This is where an Employer of Record (EoR) comes in as an ideal solution for businesses looking to expand without establishing a local entity.

How an Employer of Record Works

An Employer of Record acts as the legal employer for your workers in the Philippines, managing payroll, taxes, social security contributions, and compliance with local labor laws on your behalf. While the EoR handles these administrative tasks, your company maintains full control over the day-to-day operations and responsibilities of the employees.

Benefits of Using an EoR in the Philippines

1. Faster Onboarding:
   An EoR can help your business convert contractors to employees quickly, eliminating the need to navigate the lengthy process of setting up a local entity.
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2. Compliance with Local Laws:
   The EoR ensures that all employees are fully compliant with Philippine labor laws, including payroll, taxes, and benefits.
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3. Reduced Administrative Burden:
   By outsourcing employment management to an EoR, your business can focus on core operations without the hassle of managing payroll and benefits compliance.
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4. Risk Mitigation:
   Using an EoR reduces the legal and financial risks associated with employee misclassification, ensuring that your business complies with all local regulations.
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For companies without a presence in the Philippines, partnering with an EoR offers a practical and compliant way to convert contractors into full-time employees, allowing for seamless business expansion.

How AYP Can Help

AYP’s Employer of Record (EoR) services in the Philippines provide businesses with a comprehensive and compliant solution for converting contractors to employees. Our EoR services include:

• Managing payroll and taxes in accordance with Philippine labor laws
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• Handling social security contributions (SSS, PhilHealth, and Pag-IBIG)
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• Ensuring that employees receive all statutory benefits, including paid leave and 13th-month pay
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• Mitigating the risk of employee misclassification by ensuring full compliance with local employment regulations

Whether you have an existing local entity or are looking to expand your operations without one, AYP’s EoR services help you streamline the process of converting contractors to employees, enabling you to focus on growing your business in the Philippines.