Until recently the case-law regarding the issue of whether tax authorities may declare that a civil contract conceals an employment relationship when conducting an inspection was very controversial.
Some court panels accepted that only the control bodies of the Labour Inspectorate have the power to declare the existence of employment relationships, concealed with fictitious civil contracts and thus infringement of Bulgarian labour law. Other courts sustained the opposite opinion - stating that revenue authorities also have the power to incidentally declare the existence of employment relationships in the course of tax inspections.
In a new interpretative judgement № 6/27.10.2022 the Supreme Administrative Code (SAC), SAC decided the issue by declaring that ‘When establishing tax and insurance obligations of employers in inspection procedure under the Tax and Social-Security Procedure Code the revenue authorities do not have the power to incidentally declare (ascertain) the existence of employment relationships, covered by fictitious civil contracts under the Labor Code, when labour is provided in violation of Art. 1, para. 2 of the Labour Code, since only the control bodies of the Labour Inspectorate have such competence ‘
According to the LC the control bodies of the Labour Inspectorate are vested with competence to declare the existence of employment relationships. Since no other public authority is vested with comparable rights, it seems that the revenue authorities are not authorised to exercise such rights either.
What is the procedure for declaring the existence of employment relationships?
The procedure for declaring the existence of an employment relationship is regulated in the LC. When the control bodies of the Labour Inspectorate determine that labour is being provided in violation of the LC, the existence of an employment relationship is declared by a ruling, issued by them. The ruling should, among others, set a specific starting date of the employment relationship which may be determined retroactively.
Where no date is determined in the ruling, the employment contract is concluded from the date of issuance of the ruling. The employer may appeal against the ruling. However, such appeal does not suspend enforcement. Thus, employees will have to be employed for the duration of the potential dispute between the employer and the Labour Inspectorate at least until a final decision is issued. If the court renders the ruling of the Labour Inspectorate invalid, the employer may terminate the employment contract unilaterally and without notice. However, in cases where rulings are issued in violation of the law, the employer would be in the position where he/she shall be obliged to appoint the party that was supposed to be a service provider as an employee during the period between the entry into force of the ruling and its cancellation and shall be obliged to pay additional social security contributions, which would inevitably lead to higher costs for the employer. In addition to that, the total amount of the costs may increase significantly depending on the starting date of the employment relationship determined in the ruling (i.e. depending on how long back in time it has been set). This raises the question what is the earliest starting date of the employment relationship that can be determined by the authorities.
In case of similar breaches against labor law the employer may be subject to fines of between BGN 1,500 and BGN 15,000. Higher sanctions are provided for repeated violations.
What options remain for the revenue authorities during inspection
The revenue authorities have two options when determining the nature of the legal relationship between the party that is being inspected and the third party (employee or service provider):
- To consider the formal will of the parties and accept that the legal relationship is a civil one, as per the contract presented by the parties during the inspection, and then to proceed to establish the due tax and social security obligations.
- In cases where the revenue authorities consider that an employment relationship is being concealed, they need to refer the issue to the control bodies of the Labour Inspectorate, as only they have the powers to assess whether the civil contract conceals an employment relationship.
Changes in the existing practice. What should employers look out for?
It is expected that in similar cases in future, when there is an indication that a service contract is signed in violation of Bulgaria labour law, the revenue authorities shall refer the matter to the competent control bodies of the Labour Inspectorate and shall suspend the inspection until the administrative procedure before the Labour Inspectorate is completed. It is possible that this may lead to an overall delay of the inspection, as both administrative procedures will have to be completed. Only after the existence of a ‘disguised' legal relationship is confirmed by the competent authorities by a final decision, the revenue authorities may proceed to establish the due tax and social security obligations as for an employment relation.
In such cases eventually the employer may become subject to sanctions by two different authorities – the Labour Inspectorate for breach of Bulgarian labour law and by the tax authorities for improper payment of tax and social security contributions.
Several questions remain open and will have to be resolved by market practice:
- How far back in time can the Labour Inspectorate determine the starting date of the employment relationship?
- For what period of time may the employer owe the payment of social security contributions and how should the prescription periods be determined?
- Will the control bodies of the Labour Inspectorate take into assessment the amount of the social security contribution when determining the fine and how shall they act in cases where the amount of the social security contribution is significantly higher or lower than the amount of the fine?
The SAC judgment is certainly well-founded from a legal perspective, and it resolves fairly the issues regarding the distribution of powers between the different control bodies. This shall also ensure a fair and more competent evaluation made by the control bodies in their final decision. Nevertheless, it appears that the financial burden of the employer may increase because the employer may become subject to two separate inspections by independent institutions, as well as the deadlines for the completion of the inspection of the NRA shall be extended until the successful completion of the incidental inspection by the Labour Inspectorate.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.