Co-employment Risk

Co-employment risk refers to the legal and financial liabilities that arise when two companies share employment responsibilities for the same worker.

Different countries impose varying co-employment rules. The U.S., for example, has joint employer standards under the FLSA, while Germany enforces worker reclassification for unlicensed labour hire.

To mitigate risk, businesses should work with reputable workforce solution providers like CXC, define employment responsibilities in contracts, and ensure proper worker classification. Proactively managing co-employment risks helps businesses maintain legal compliance, reduce liability, and create a stable workforce strategy.

Here are some co-employment risks companies should watch out for:

• Pay and benefits claims: Disputes over wages, overtime, or access to company benefits.
• Unemployment claims: A worker may file for unemployment benefits, creating liability questions between the staffing firm and the hiring company.
• Discrimination and harassment claims: Both employers may be held responsible if a worker experiences unlawful treatment.
• Workers’ compensation claims: Liability may be unclear if an employee is injured on the job.

Co-employment allows businesses to share employment responsibilities with a third-party provider, such as a Professional Employer Organisation (PEO) or a staffing agency. While this model can simplify HR processes, payroll, and compliance, it also comes with legal and financial risks.

Failing to manage these risks properly can result in penalties, lawsuits, or reputational damage. Here are some of the most common co-employment risks businesses should be aware of:

Misclassification of workers
One of the biggest co-employment risks is the misclassification of workers—treating employees as independent contractors when they should legally be classified as full-time employees. This can lead to penalties, back taxes, and legal disputes. Companies like Uber and DoorDash have faced high-profile lawsuits due to worker misclassification, resulting in costly settlements and regulatory scrutiny. Misclassification can also impact worker rights, such as access to benefits, overtime pay, and job protections.

Compliance failures
Every country and region has different labour laws that businesses must follow. Regulations set by governing bodies like the IRS, the Department of Labor (DOL), and other international employment authorities require businesses to comply with fair wage practices, workplace protections, and tax obligations. If a co-employment arrangement leads to non-adherence to these regulations, the business can face substantial fines and legal action.

Taxation errors
Tax compliance is a major concern in co-employment arrangements. The failure to withhold the correct amount of payroll taxes or misreporting employee earnings can result in financial penalties and audits from tax authorities. Employers must ensure that income tax, social security contributions, and other statutory deductions are properly calculated and filed on time, even when outsourcing payroll responsibilities.

Legal liabilities
Even if a business outsources HR and payroll functions to a co-employer, it can still be held accountable for violations. For example, if a PEO or staffing firm miscalculates payroll, fails to provide statutory benefits, or breaches employment laws, the client company may share liability. This is why businesses must conduct due diligence before entering a co-employment agreement, ensuring their partner follows legal and ethical employment practices.

Understanding co-employment risks in different countries

Co-employment risks vary significantly across different countries, depending on local labour laws, worker protections, and regulatory enforcement. PEOs and staffing firms offer a valuable way for businesses to expand internationally, companies must be aware of the legal obligations and compliance risks in each market.

Some regions have strict worker misclassification laws, while others regulate the duration of temporary employment or joint liability for worker benefits. Understanding these differences is crucial for businesses that want to avoid legal penalties, protect workers’ rights, and maintain smooth operations globally.

United States
The U.S. has stringent regulations against worker misclassification, with both federal and state laws imposing penalties. Some states have established task forces to deter and prevent misclassification, leading to aggressive prosecution and, in some cases, criminal liability.

Several states have established task forces to deter and prevent misclassification, leading to aggressive prosecution and, in some cases, criminal liability for businesses. Companies using PEOs or staffing firms must ensure they classify workers correctly and clearly outline employer responsibilities to avoid heavy fines and potential lawsuits.

United Kingdom
The UK enforces the Agency Workers Regulations (AWR) 2010, which grant agency workers’ rights to equal treatment concerning pay and working conditions after 12 weeks of continuous employment. This regulation increases compliance risks for companies utilising agency workers.

Australia
Australian labour laws vary by state, with regions like Victoria and Queensland implementing strict licensing laws for staffing agencies. The Fair Work Act also holds companies accountable for sham contracting, emphasising the importance of correct worker classification.

The Fair Work Ombudsman regularly investigates companies suspected of sham contracting, and penalties can be significant. Businesses using PEOs and staffing firms in Australia must ensure their contracts clearly define employment terms and adhere to state and federal employment laws to avoid compliance risks.

Japan
Japan’s Worker Dispatch Law protects dispatch workers (haken rōdōsha), limiting the duration they can work for a client before being offered permanent employment. This law aims to prevent the prolonged use of temporary workers without offering them full employment benefits.

Brazil
Following the Labour Reform of 2017, Brazil allows outsourcing of core activities. However, joint liability for labour obligations can still apply, making compliance and proper contractual agreements crucial to mitigate risks.

Certain industries are more vulnerable to co-employment risks due to their reliance on contingent, temporary, or outsourced workers. These industries often involve high turnover, project-based work, or regulatory complexities, increasing the risk of misclassification, liability disputes, and compliance challenges.

Staffing and recruitment

Staffing agencies play a crucial role in supplying temporary workers across various industries. However, they must carefully navigate joint employer liability, particularly in jurisdictions where both the agency and the client company may be held responsible for wages, benefits, and workplace rights. For example, in the United States, staffing firms and client employers can both be liable under the Fair Labor Standards Act (FLSA) for unpaid wages if proper contracts and compliance measures aren’t in place.

Technology and IT services

Many tech companies rely on contractors, gig workers, and outsourced IT professionals for software development, cybersecurity, and cloud services. This model provides flexibility but also increases the risk of worker misclassification disputes. For instance, companies like Microsoft and Google have faced lawsuits over independent contractors arguing they were effectively treated as employees, triggering claims for benefits, overtime pay, and wrongful termination.

Manufacturing and logistics

Factories, warehouses, and distribution centres frequently hire temporary workers to meet fluctuating demand, often through third-party agencies. However, workers’ compensation claims and wage compliance issues can arise if responsibilities between the employer and the staffing firm aren’t clearly defined. In Germany, for example, companies using temporary workers without a valid Arbeitnehmerüberlassungsgesetz (AÜG) licence risk having those workers legally reclassified as their direct employees, exposing them to unexpected liabilities.

Construction

The construction industry relies heavily on subcontractors and labour hire firms, which can complicate compliance with workplace safety laws and payroll regulations. In countries like Australia and Canada, general contractors can be jointly liable for ensuring that subcontracted workers receive proper wages, superannuation (pension contributions), and safe working conditions. Without clear contracts, companies may unintentionally become the de facto employer, leading to potential legal disputes.

Healthcare

Hospitals and healthcare providers often employ agency nurses, locum doctors, and contract healthcare workers, which can create co-employment risks under labour laws and industry-specific regulations. In the UK, for instance, NHS Trusts must carefully manage agency worker contracts to comply with the Agency Workers Regulations 2010, ensuring equal pay and working conditions after 12 weeks of continuous service. Failure to do so can result in employment tribunal claims.

Retail and hospitality

Retailers, hotels, and restaurants frequently rely on seasonal workers, franchise employees, and third-party staffing solutions. This exposes businesses to wage and hour disputes, joint employer liability, and tax compliance issues. In the United States, companies like McDonald’s have faced lawsuits over whether franchise operators and the parent company share responsibility for employment law violations, such as overtime pay and wrongful termination claims.

Finance and professional services

The finance sector increasingly utilises consultants, legal professionals, and contract accountants, which can blur the lines between independent contractors and employees. In Japan, firms using dispatched workers (haken rōdōsha) must comply with the Worker Dispatch Act, ensuring that long-term temporary workers receive proper employment protections. If a business fails to transition a worker to permanent employment after the legally allowed period, they may face penalties or forced reclassification.

When businesses partner with a PEO or staffing firm, they gain administrative support for payroll, compliance, and HR functions.

However, co-employment risks still exist, meaning both the client company and the PEO may share legal and financial responsibilities for the workforce. To avoid potential legal disputes, tax penalties, or worker misclassification issues, companies must take proactive steps to ensure compliance and clarify employment responsibilities.

Ensure proper worker classification

Misclassifying workers is one of the most significant risks in co-employment. Many businesses mistakenly label full-time employees as independent contractors, exposing themselves to penalties, back taxes, and potential lawsuits. This is especially problematic in jurisdictions with strict labour protections, such as California’s AB5 law or the UK’s IR35 regulations.

To mitigate this risk, businesses should conduct regular worker classification audits and ensure they follow local tax and labour laws. When hiring contractors, companies should verify that they meet legal criteria for independent status, including autonomy over their work schedule, financial independence, and lack of direct supervision.

Engaging legal experts or compliance specialists can also help businesses avoid misclassification errors and protect themselves from regulatory fines.

Clearly define employment responsibilities in contracts

Having a clear and well-structured contract is essential for preventing disputes over employer obligations. Contracts between the client company, the PEO, and the worker should explicitly define responsibilities for:

• Hiring and termination procedures
• Payroll processing and tax withholdings
• Employee benefits administration
• Compliance with local labour laws
• Workplace policies and performance management

Clearly outlining these responsibilities ensures that both the business and the external provider understand their legal and financial obligations. This helps avoid grey areas in co-employment that could lead to unexpected liabilities, wrongful termination claims, or compliance penalties.

By proactively addressing co-employment risks, businesses can take full advantage of workforce solutions while maintaining compliance, reducing legal risks, and ensuring smooth workforce management.

Work with a reputable workforce solution provider

Choosing a trusted workforce solutions provider like CXC is one of the most effective ways to mitigate co-employment risks.

Not all PEOs and staffing agencies operate with the same level of compliance and expertise. A reputable provider like CXC ensures that employment practices align with local and international labour laws, reducing the risk of misclassification, tax issues, and compliance violations.

CXC stays updated with the latest regulatory changes across different markets, helping businesses navigate complex employment laws, tax obligations, and worker protections. Whether hiring in Australia, the United States, or Europe, businesses can reduce their exposure to legal liabilities by partnering with an experienced provider that understands the nuances of global workforce compliance.

Mitigate co-employment risks with an employer of record (EoR)

Co-employment risks arise when two entities share employer responsibilities, potentially leading to legal and financial liabilities. Using an Employer of Record (EoR) is one of the most effective ways for businesses to reduce co-employment risks while expanding globally.

An EoR acts as the legal employer of the worker, handling employment-related responsibilities such as contracts, payroll, tax compliance, benefits administration, and legal obligations. This setup allows the client company to manage the worker’s daily tasks and performance without being legally classified as the employer, minimising the risk of co-employment disputes.

Unlike a PEO, which operates under a co-employment model, an EoR assumes full employer liability. This is particularly beneficial in countries like the United States, the United Kingdom, and Australia, where misclassification penalties and co-employment liabilities can be strict.

An EoR also helps businesses comply with worker classification laws, reducing the risk of disputes over independent contractor misclassification. Additionally, it protects companies from permanent establishment (PE) risks, which can trigger corporate tax liabilities if authorities determine that a company has a taxable presence in a foreign market.