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1. Background
In article no. 170, we reported on legislative changes which may affect the tax and social insurance status of certain self-employed individuals, especially those who work primarily for a single client (principal). This legislation represents the German response to what is perceived to be unfair or undesirable avoidance of social insurance obligations by persons who, while nominally self-employed, are in point of fact either dependent employees or similar enough to employees to warrant bringing them within the social insurance system. With minor exceptions, persons who are truly self-employed are not subject to statutory pension, health, or unemployment insurance.
As a result of the criticism which followed enactment of the rules described in our previous article, the government appointed a commission to recommend improvements in the original scheme. This commission, headed by a former president of the Federal Labour Court, recommended a number of modifications, which were enacted in late 1999 (Law for the Promotion of Self-Employment of 20 December 1999 – BGBl I 2000, 2).
This article describes the changes made by the new legislation, which are retroactive to 1 January 1999, the effective date of the law which is being modified. The changes largely eliminate the potentially disastrous effects of retroactive reclassifications of freelancers as employees, at least for employers who take timely action.
2. "Sham" freelancers: determination of social insurance status
The original legislation raised a rebuttable presumption that a nominally independent contractor was in fact an employee for insurance purposes if any two of four specified tests were met. The relevant section of the Social Code (§ 7 (4) SGB IV) has been completely re-written by the new legislation. In addition, new §§ 7a - 7c SGB IV have been added to the Social Code.
2.1 Limitation of presumption to situations involving non-cooperation
The new § 7 (4) establishes a rebuttable presumption similar to that of the old § 7 (4), but more restricted in several important respects.
The new § 7 (4) states that the presumption it provides for can only arise with respect to individuals who fail to comply with their duties of cooperation under § 206 SGB V or § 196 (1) SGV VI. The presumption can therefore not operate against an individual who cooperates fully with an official investigation of his or her social insurance status. The status of persons from whom cooperation is forthcoming would thus continue to be determined solely with respect to the standard criteria for distinguishing between independent contractors and employees (such as right of direction and control, integration, economic dependence, working hours, etc.). Hence, it is these standard criteria which the social insurance authorities must apply as a general rule. A sentence added to § 7 (1) SGB IV provides that subjection to the control or direction of another person and integration into that person's work organisation are criteria indicative of dependent employment as a general matter.
2.2 Revised and expanded list of tests
Furthermore, the presumption under the new § 7 (4) SGB IV depends on five tests (instead of four), three of which must be met by an individual nominally working in a freelance capacity in order for the presumption to arise. The five tests are listed below. The first four are identical or similar to those under the original legislation. Italics identify changes in content and/or wording:
i. Within the scope of the relevant activity, the individual has no regular employees of his or her own who are subject to the public social insurance system and whose wages from this job consistently exceed DM 630 per month. Members of the individual's family are counted for purposes of this test.
ii. The individual works "essentially" for a single principal on a long-term basis. Under the prior law, the social insurance authorities stated that they would regard this test as met if five sixths of the individual's total income was earned from a single principal. Likewise, companies belonging to the same corporate group were to be treated as a single principal for purposes of this test. Whether the social insurance authorities will take different positions under the new law is unclear.
iii. The services in question are of a sort regularly rendered by dependent employees either to the individual's principal or to a comparable firm.
iv. The typical features of independent business activity are not discernible in the work in question.
v. There is a prima facie correspondence between the work in question and the work which the individual used to perform for the same principal in the context of an employment relationship.
2.3 Ruling request procedure
The new legislation also creates a procedure (new § 7a SGB IV) by which freelancers in doubt as to their social insurance status, or their clients, may request a binding ruling from the social insurance authorities. While this procedure is not new as such, it was not previously codified. Furthermore, jurisdiction to issue rulings under this procedure is now vested exclusively in the Federal Social Insurance Institution for Employees (Bundesversicherungsanstalt für Angestellte).
The clarification procedure may be initiated by the "parties" to the nominally independent employment relationship, that is, either by the freelancer or by his or her client (principal).
Where a request for status clarification is filed within one month after commencement of a nominally independent employment activity, any finding by the social insurance authorities that a dependent employment relationship subject to the social insurance laws in fact exists will have effect only from the date of the ruling if the following conditions are met:
• The employee consents, and
• For the period between commencement of the employment activity and the date of the ruling, the employee arranged health and pension insurance coverage equivalent to that under the statutory health and pension insurance schemes.
Otherwise, the standard statute of limitations period of four years applies (§ 65 SGB IV).
2.4 Transition provision
An important transition provision has been added to the law (new § 7c SGB IV). This provides that an adverse ruling pursuant to a ruling request procedure commenced prior to 30 June 2000 will have effect only from the date of the ruling unless either of the following applies:
• A social insurance agency has determined the employee's dependent status or initiated the relevant proceedings prior to the filing of the ruling request, or
• The employer's failure to comply with his obligations under the social insurance law was intentional or grossly negligent.
2.5 Retroactivity in other circumstances
Under new § 7b SGB IV, reclassifications of nominal freelancers as dependent employees other than in a ruling request procedure under § 7a SGB IV will likewise have only ex nunc effect (no retroactivity) if the following conditions are met:
• The employee consents, and
• For the period between commencement of the employment activity and the date of the ruling, the employee arranged health and pension insurance coverage equivalent to that under the statutory health and pension insurance schemes, and
• The improper classification as a freelance relationship was neither intentional nor grossly negligent on the part of either the employer or the employee.
2.6 Deferral of payment pending appeal
The new legislation further provides for deferral of payment of social insurance contributions for the duration of any appeal against an adverse classification ruling issued under the ruling request procedure. The law provides for an administrative appeal followed by judicial review against all adverse classification rulings.
3. Quasi-dependent freelancers
The changes in this area are relatively minor compared with those for so-called "sham" freelancers. Whereas a sham freelancer is in fact a dependent employee, the term "quasi-dependent freelancer" (arbeitnehmerähnlicher Selbständiger, literally, "self-employed person similar to an employee") refers to persons genuinely self-employed who resemble employees in certain respects.
The new legislation (which avoids using the term "quasi-dependent employee" because some found it pejorative) continues to require independent contractors who meet two conditions to pay statutory pension insurance contributions. The obligation to pay such contributions continues to fall entirely on the independent contractor. He or she has no obligation to pay unemployment or health insurance (and hence no benefits).
The two conditions have been modified only slightly (italics):
i. The freelancer has no regular employees of his or her own who are subject to the public social insurance system and whose wages from this job consistently exceed DM 630 per month. Members of the individual's family are counted for purposes of this test.
and
ii. The individual works "essentially" for a single principal on a long-term basis.
The above conditions are also included in the list of the now five tests for presumption of employee status (sec. 2.2 above).
The new legislation excludes independent contractors 58 years of age or over at the time they would otherwise first become liable to pay into the pension insurance system provided they were self-employed prior to this date (generally, 1 January 1999). Individuals starting new freelance businesses are excluded from the law for a period of three years. Finally, the date for opting out of the statutory pension insurance system has been extended for those who are eligible to do so (persons 50 years of age or more on 2 January 1999 and persons with a qualifying private retirement plan in place prior to 10 December 1998). The new deadline is 30 June 2000 or one year from the time of initial liability, whichever is later.
4. Tax status of sham freelancers and quasi-dependent freelancers
The above provisions refer solely to social insurance law. Reclassification of a "sham" freelancer as a dependent employee poses VAT and wage withholding issues for the employer. While the rebuttable presumption of employee status raised under social insurance law would not appear to apply for tax purposes, as a practical matter all persons reclassified as employees for social insurance purposes can expect at least close scrutiny from the tax authorities regarding their status for tax purposes.
It is more difficult to anticipate how the tax authorities will view quasi-dependent freelancers. Since a quasi-dependent freelancer is genuinely self-employed, and since the criteria for distinguishing self-employment from dependent employment for tax purposes resemble those for social insurance purposes (except for the new rebuttable presumption rule), there would appear to be no reason why the tax authorities should react merely because a freelancer is required to pay statutory pension contributions under the new law.
For further information, please send a fax or an e-mail stating your inquiry to KPMG Frankfurt, attn. Christian Looks: Fax +49-(0)69-9587-2262, e-mail cLooks@kpmg.com. You may also send an e-mail to KPMG Germany by clicking the Contact Contributor button on this screen.
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