Germany: 170. Tax and Social Insurance Status of "Sham" and "Quasi-Dependent" Freelancers

Last Updated: 2 June 1999
KPMG Germany Webpage
Click on the above link to visit the KPMG Germany webpage on the Mondaq website

For disclaimer and copyright see end of this article.

With effect from 1 January 1999, the new government of Social Democrats and Greens has enacted legislation which threatens to have considerable negative impact on certain self-employed individuals, especially those who work for a single principle client (Law for Correction of the Social Insurance System and the Protection of Employee Rights of 19 December 1998). Like the changes made in the field of low-paying jobs, the new rules have encountered stiff opposition from industry and the affected individuals.

In considering the new rules, it is important to bear in mind that Germany has no provisions equivalent to the "self-employment tax" in the United States and, with minor exceptions, does not require self-employed individuals to pay into any statutory pension plan.

The new rules will not apply to individuals covered by the social security system of a foreign country with which Germany has a social insurance treaty or to individuals who are subject to the social security jurisdiction of another EU member state by the terms of EU Ordinance 1408/71.

1. Rebuttable presumption of dependent employment of nominal freelancers

A provision in the laws governing the social insurance system (sec. 7 (4) SGB IV) has been changed to raise a rebuttable presumption that individuals nominally working on a freelance basis for a client are in fact the latter's dependent employees if any two of the following four tests are met:

  • The individual does not have any dependent employees of his or her own who are subject to the public social insurance system. Members of the individual's extended family are disregarded for purposes of this test.
  • The individual works "regularly and essentially" (regelmässig und im wesentlichen) for a single client. This requirement is met if five sixths of the individual's total income is earned from a single client. Companies belonging to the same corporate group are treated as a single client for purposes of this test.
  • The work performed is of the sort typically performed by dependent employees.
  • The individual does not offer his or her services on the general market as would an independent entrepreneur.

The above rules do not apply to commercial representatives (Handelsvertreter as defined in sec. 84 HGB) who organise their own activities independently for the most part and are able to fix their own working hours.

No change has been made in the underlying substantive legal distinction between a dependent employee and a freelancer. Instead, by raising a rebuttable presumption, the law shifts the burden of proof on this issue to the individual (and his or her clients) under the circumstances set forth above. While it is still possible in theory to rebut the presumption by presenting evidence of all relevant facts and circumstances, the expectation is that the presumption will be difficult to rebut in practice wherever it arises.

Persons nominally working as freelancers who are in fact dependent employees are commonly referred to as "sham freelancers" (Scheinselbständige).

2. Social insurance consequences of reclassification as a dependent employee

The consequences of reclassification of a nominal freelancer as a dependent employee are highly disadvantageous for the person who, by reason of the reclassification, is regarded as the individual's employer for social insurance purposes. In situations in which the individual has worked for a single client, this client is the person who risks being treated as the individual's employer. If the nominal freelancer has worked for several clients, but nevertheless is reclassified as a dependent employee, he or she would appear to be the dependent employee of several employers at the same time. Hence, the negative consequences would be suffered by several employers.

Essentially, a client found in retrospect to have been the employer of an individual improperly treated as a freelancer is required to pay social insurance contributions on the individual's behalf not only in the future, but for the past as well. The obligation can extend backwards in time for several years and applies not only to the contributions which the employer would have owed had the relationship been treated properly from its inception, but also to the contributions owed by the employee, i.e. half of total contributions. Since total contributions currently exceed 40 % of an employee's wages, the back payments can be very substantial indeed.

Even if the employment relationship still continues, the employer's ability to pass half of this cost along to the employee is limited by law, generally to what can be deducted from the employee's salary in the three months following recognition of the misclassification. If the employment relationship has already terminated, the employer has no recourse whatsoever and can, in particular, not sue the employee for reimbursement of half of the social insurance arrearages paid by the employer.

Typically the employer bears virtually the full cost in such situations. The employee enjoys a windfall benefit at least with regard to the pension insurance payments made on his or her behalf, as these lead to accrual of pension insurance claims.

3. Tax consequences of reclassification as a dependent employee

The distinction between dependent and independent employment is significant for tax purposes as well. A freelancer is generally required to remit VAT with regard to sums invoiced to his or her clients. Clients are generally entitled to an input tax credit for this VAT, if separately invoiced, which is almost invariably the case. If the individual is discovered to have been a dependent employee, the input tax credit is forfeited retroactively by the client, who is now seen as an employer. The individual remains obligated to remit to the tax authorities all VAT separately invoiced. The net result is that the employer loses the input tax credit and hence has additional cost in this amount, whereas the employee is probably no worse off than before.

While there is no legal prohibition on seeking to recover the VAT amount from the employee, the legal grounds of such an action are unclear. No claim for unjust enrichment would appear to lie as long as the employee has paid the VAT invoiced to the tax authorities, because in this case there is no net enrichment of the employee. In any event, recourse against the employee is often impossible as a practical matter.

A case is currently pending before the European Court of Justice posing the issue of whether forfeiture of the input tax credit in this and other situations is compatible with EU law.

Besides the negative VAT consequences, the client/employer may also be liable for failure to withhold income tax (wage tax) from the sums paid to the sham freelance employee. This liability is relevant whenever the employee has not paid the income tax owing on such amounts. Once again, the employer's exposure is potentially considerable.

4. Relation of the rebuttable presumption under social insurance law to tax law

It is not clear whether the rebuttable presumption raised for social insurance law purposes also applies for tax purposes. Since distinct bodies of law involved, this would not appear to be the case. The tax risk as a practical matter remains high, however, since reclassification for social insurance purposes seems likely to prompt close scrutiny for tax purposes as well.

It is not clear whether the tax and social insurance authorities will exchange information with each other in this regard.

5. Entry into force of the rebuttable presumption under social insurance law

It is not clear whether the rebuttable presumption raised under the new law first applies to periods from 1999 onwards or to prior years as well. Since the change is procedural in nature, not substantive, the reversal of the burden of proof may well apply to years prior to 1999.

6. Defence strategies

Before assigning work to small freelancers, especially those who have no dependent employees of their own and are likely to fulfil two or more of the tests set forth above, clients should consider their chances of rebutting a presumption of a sham freelance arrangement. Even if these appear good, it is important to document the factors indicative of a genuine freelance arrangement from the start. For instance, information on the extent to which a freelancer works for other clients and is visible on the general market should be gathered prior to issuance of a contract. Non-competition clauses should probably not be included in contracts with small freelancers.

A procedure also exists whereby freelancers who have doubts as to their status may request a ruling from the appropriate social insurance authorities. Clients may wish to consider requiring certain of their freelancers to obtain such a ruling.

7. Political outlook

A reasonable chance appears to exist that changes will be made in the social insurance legislation in response to the considerable political protest. Certain industries, e.g. the software programming industry, have argued that the effects of the law in its present form will be devastating for their businesses. The government has indicated willingness to correct its legislation if undesired consequences become evident.

It is still too soon, however, to speculate as to what revisions might be made.

8. Quasi-dependent freelancers

The term "quasi-dependent freelancer" must be distinguished from that of "sham freelancer". "Quasi-dependent freelancer" (arbeitnehmerähnlicher Selbständiger) refers to individuals working in an independent (self-employed) capacity who meet both of the following tests:

  • They have no dependent employees of their own who are subject to the public social insurance system, except for family members; and
  • They work regularly and essentially for a single client.

It should be noted that individuals who meet the above two tests will also be presumed to be dependent employees under the rules set forth in sec. 1 above. Hence, the classification as "quasi-dependent freelancer" can only occur in cases in which the presumption has been rebutted, since otherwise the basic requirement of working in an independent capacity would not be met.

9. Consequences of classification as a quasi-dependent freelancer

The consequences of classification as a quasi-dependent freelancer differ greatly from those of classification as a sham freelancer. Quasi-dependent freelancers are required to pay into the statutory pension insurance system at the standard rate, currently 19.5 % of annual income up to an income ceiling which is adjusted each year (currently DM 102,000 / DM 86,400 per year in the old and new German states respectively).

The clients of quasi-dependent freelancers are not treated as employers. They have no withholding obligations. The pension insurance contributions are owed solely by the freelancer.

The new law contains opt-out provisions for freelancers who were in business prior to 1 January 1999. Freelancers 50 years of age and older on 2 January 1999 may opt out of the new rules unconditionally.

Freelancers under this age are permitted to opt out provided they had contractual pension insurance (such as whole life insurance) with a public or private insurance carrier on 10 December 1998. If such insurance is not equivalent to public pension insurance, additional insurance must be taken out by 30 June 1999. Equivalence is determined in part with respect to the cost of this contractual pension insurance, which must be at least equal to the payments which would be required under the public pension insurance system.

The election to opt out must be exercised in both cases by 30 June 1999 by application to the public pension insurance authorities.

10. Perspective

The statutory changes discussed in this article are regarded by some as stopgap measures constituting a poor substitute for the lack of a statutory self-employment tax or compulsory membership of all self-employed individuals in the general public pension insurance system. However, there is no apparent willingness to take such a radical step at this time.

The new legislation is harshly criticised and may be revised in certain respects in the foreseeable future. It may also be challenged on constitutional grounds.

Disclaimer and Copyright

This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions