Employers of Record (EORs) in Germany – What You Need to Know

What Is an EOR?

Many international providers offer services of U.S.-style Employers of Record. An EOR is a third-party company that acts as a local legal employer for another company. The EOR carries the legal and compliance obligations of an employer.

EORs are an attractive option for international companies that want to accomplish a rapid market entry without having an established local legal entity and without having to worry about employer obligations. This way, they can explore the market and reduce their financial risk until the local business has been established. Nevertheless, using EORs in Germany involves some risks due to the particularities of German law.

Contractual Relationships – Tripartite Relationship

Since German law does not recognize co-employments, a company that uses an EOR in Germany establishes a tripartite relationship.

• An employment contract exists between the EOR and the employee. As the legal employer, an EOR is entitled to the employer’s rights regarding termination, performance and misconduct.
• A contract also exists between the EOR and its customer (in many cases a Master Service Agreement). Since the employee is usually integrated into the work organization of the EOR’s customer as the “factual” employer, the EOR’s customer exercises the right of instruction.

Compliance with German Law – EORs Need a License!

• Under German law, the EOR model qualifies as employee leasing (Arbeitnehmerüberlassung), which is regulated by the German Employee Leasing Act (Arbeitnehmerüberlassungsgesetz - “AÜG”). The AÜG sets strict requirements, which entail high risks if not observed.
• Under the AÜG, a company that lends employees to its customers, like an EOR, must obtain an employee-leasing license from the German Labour Agency (Bundesagentur für Arbeit).
• If an EOR does not have the necessary permission, this will be considered illegal employee leasing. This may result in undesirable consequences, not only for the EOR but also for the EOR’s customer.

Risks and Consequences of Noncompliant EOR Models

If the EOR does not have the required license, an employment relationship between the EOR’s customer and the employee arises automatically by operation of law, whether desired or not.

Also, the foreign entity may become taxable under German corporate tax law. Especially if the employee renders certain tasks, such as representing the company or concluding contracts on behalf of the company, this may qualify as a so-called permanent establishment under German law, which triggers tax consequences for the foreign entity.

Both the EOR and the EOR’s customer may face fines of up to €30,000 per violation. It can even lead to criminal prosecution.

Maximum Period of 18 Months

Under the AÜG, an employee may be leased out to a company for up to 18 months. Exceptions are possible in cases of collective bargaining agreements (e.g., in the chemical and automotive industry). After 18 months, a foreign company is generally not allowed to retain a team member through the EOR through which they hired the team member. After a waiting period, the company can redeploy the same employee through the same or another EOR. Again, noncompliance entails significant risks for EORs and their customers, including significant fines.

Confidentiality and Noncompete Issues

Because of the tripartite relationship, confidentiality and noncompete issues are more complex to handle. Regular employment contracts may not sufficiently protect a third party’s interests, which is why the EOR should be required to cover IP/ confidentiality and noncompete issues by agreement with the employee in favor of the customer.

What Other Options Are Available?

Foreign companies do not need a Germany-based legal entity to hire employees in Germany. They can register employees with a German payroll with the assistance of a local payroll provider. The local payroll provider will take care of the deduction of social security contributions and income tax and any other payroll topics.

Also, hiring contractors can be an option, though companies should consider the risk of misclassification. If you’re looking to expand more substantially into the German market, you’ll eventually need to consider registering as a foreign employer or set up an entity in Germany to retain your employees long-term.