How to avoid false self-employment - practical tips

If not handled carefully, false self-employment can become a risk for freelancers and for companies that hire them. The freelancer status is revoked, the contractor is treated like an employee, social security contributions may have to be paid retroactively, and further penalties can follow. Controls of external workers with regard to false self-employment have increased in recent years.

Reason enough to take a close look at the topic of false self-employment. In this blog post, we therefore share our many years of experience and best practices in this area.

Transparency note: The information mentioned has been summarized to the best of our knowledge and belief; no liability is assumed. As the legal situation is constantly changing, status: 24.03.2021.

Summary

What is false self-employment?

Series false self-employment, 1/4: What is false self-employment?!

False self-employment is a working relationship in which a contractor who is formally self-employed is, according to the authorities, a regular employee and should therefore be registered for social security purposes. Failure to comply with the laws on false self-employment can cost both the client and the contractor their livelihood if one of the responsible bodies discovers it.

In a status determination procedure, the actual status of a contractor as self-employed or employed can be assessed by the clearing office of Deutsche Rentenversicherung Bund. This review can be requested by the German Pension Insurance Federation, a court, the tax office, or social security institutions. In principle, either the contractor or the client can also request a review, for example if a contractor wants to enforce protection against dismissal or if a client wants to terminate a contract. Usually, however, both parties are uninvolved and a third party, such as the health insurance provider, requests the review because it wants to reclaim contributions.

Practical example

The problem with the laws on false self-employment is that there is no clear line in the legislation for companies and freelancers - there are no precise rules that say “self-employed or falsely self-employed.” This lack of transparency often leads to problems. A suitable example is a major car manufacturer where two IT specialists who were formally working there under service contracts successfully sued to be treated as employees in the group. In the case at the time, the Baden-Wuerttemberg Regional Labour Court classified the contracts as sham contracts and ruled in favor of the two IT specialists’ claim for a permanent employment relationship with the car manufacturer.

The two IT specialists were not freelancers but temporary workers who were employed through a temporary staffing arrangement by other service providers. However, the effect was similar to that for freelancers - namely, that the end client could save social security contributions through the apparent service contracts. As early as 2013, at the time of the lawsuit, it was clear that consequences could also threaten many other companies and that checks would increase. It is therefore worth taking a closer look at the court ruling of the Regional Labour Court. More on this case later in the article.

Risks for freelancers

Series false self-employment, 2/4: What risks are there for companies and for freelancers?

It can affect any self-employed person who takes on contract work. Freelancers or external employees are particularly affected. The first consequence is the termination of self-employment and the retroactive start of an employment relationship as an employee. On the one hand, this gives a freelancer numerous rights, such as protection against dismissal or entitlement to vacation, but on the other hand they also have to face many negative consequences.

Such a situation can be particularly difficult because most freelancers deliberately chose self-employment. They do not want to be employed and may have structured their retirement provision around self-employment. A forced employment relationship can therefore disrupt all of that.

Both the client and the contractor are legally regarded as joint debtors in the event of false self-employment. The former client can therefore deduct the employee’s share of retroactive social security contributions for the past three months from the future salary of the now employee. In addition, invoices issued by the contractor must be corrected if false self-employment is established. This includes, among other things, the declared VAT, which is rendered invalid. Ultimately, input tax deductions must also not have been claimed - if they have already been taken, the input tax must be repaid to the tax office.

Risks for companies

As soon as false self-employment is established, both the client and the contractor must expect legal and financial consequences. In the case of the client, all liability and payment obligations apply retroactively, just as they would for regular employees. This means that the client must pay social security contributions retroactively for up to four years. In addition, late-payment penalties may apply.

Tax offices can also demand retroactive wage tax payments in the event of false self-employment. Here too, the rule of up to four years retroactively applies. If intentional false self-employment is proven, fines, prison sentences, and repayment claims can apply to the parties involved for up to 30 years. Furthermore, the VAT shown on the invoices of the self-employed person is invalid, which means that the input tax deduction is considered unlawful and the deducted input tax amounts must be corrected and repaid. From the point at which false self-employment is established, the former contractor acquires all rights that employees of the company have.

Reviewing false self-employment

To know what to pay attention to when avoiding false self-employment, it is important to understand the criteria used by the authorities to assess a possible case of false self-employment. The key point is that under the current legal situation and case law there is no black or white. Every case and every review of false self-employment is an individual assessment. That is why there are only helpful criteria and comparisons with other cases that can be used to analyze whether a company or freelancer might be affected by the problem.

Such reviews involve both the examination of the contracts concluded and the actual conditions in everyday working life. Inspectors must, of course, find and prove evidence of false self-employment. The following criteria are among those considered:

• Regular employment of staff who are not subject to social security contributions
• Permanent contracts between both parties
• Dependence of a contractor on only one client - when the vast majority of revenue is generated with a single customer
• Fixed working hours
• Written communication containing work instructions between freelancers and companies
• Low hourly rates that do not cover the costs of freelancers

Practical example

Back to the German car manufacturer: The Regional Labour Court confirmed long-established rulings by the Federal Labour Court on sham contracts. Known factors such as regular and/or exclusive employment of people over a long period of time in the company’s own premises or the use of company-owned equipment played a role. In the car manufacturer’s case, the instructions issued electronically to external employees were among the decisive factors in the court ruling and show that instructions to freelancers should generally be avoided wherever possible.

Other factors were that the two IT specialists often worked at fixed times in the group and were fully integrated into the company, for example by being networked with permanent employees. The specialists working under service contracts therefore carried out assignments with instructions outside the ticket system that the car manufacturer used as a precautionary measure to prevent false self-employment. The two IT specialists’ claim for permanent employment had already failed before the Labour Court in Stuttgart. However, the next higher instance at the Regional Labour Court saw it differently.

“For the legal distinction between a contract for work or services and temporary employment, only the actual performance of the contract is decisive,” says one of the guiding principles of the judgment. The judges thus reaffirm that, legally, it is not decisive what the contracts with external employees look like on paper; what matters is how they are actually lived in practice. Furthermore, the fact that the car manufacturer had never asserted warranty rights in previous years also spoke in favor of the IT specialists being active in the company more as employees than as external staff. In the court’s interpretation, this suggests that what was being purchased tended to be labor input rather than, as is ideally the case with freelancers, a work result.

It is clear - as already mentioned - that the two IT specialists were not freelancers in a situation at the end client. It is equally clear that there are significant differences between temporary employment and freelance experts.

What freelancers and client companies must learn from the car manufacturer’s ruling, however, is which factors and indications help distinguish legally between a valid service or work contract and a temporary employment or employment relationship.

What do we learn from this? With this experience, it is possible to advocate with good reason for the legally compliant use of highly qualified freelance IT specialists in client companies, based on clear guardrails.

Avoiding self-employment: five tips

Series false self-employment, 4/4: 6 hands-on tips for avoiding false self-employment 💡

Ignorance does not protect you from punishment

The important thing is that ignorance does not protect you in the event of a penalty. As a self-employed person, you have a duty to acquire the necessary knowledge about the possibility of false self-employment and how to avoid it. If you are unsure about the legal situation, seek help from consultants or lawyers to clarify open questions and gain legal certainty.

Review all contracts

All of the criteria mentioned above must, of course, be compared with everyday working practice and the contracts. Do contractors have decision-making freedom and do they bear entrepreneurial risk? The contract should include a note that the freelancer is under no obligation to follow instructions. It can also state that the contractor regularly provides evidence of further assignments and self-employed insurance.

Separate hardware, software, and office space

Another step to prevent false self-employment is to ensure that companies and freelancers do not use the same hardware, software, or office space, but remain independent of each other.

Free choice of place of work

The more freedom freelancers have within a company, including the choice of workplace, the lower the risk of false self-employment.

Free choice of working hours

In addition to the place of work, working hours are also one of the most important factors, because freelancers usually work independently of instructions and only owe certain results. When and how they reach those results should be left to them.

How ElevateX prevents false self-employment

Cooperation between companies and freelancers brings major advantages, but aspects such as false self-employment must be taken into account. At ElevateX, we support our clients not only with the best IT experts, but also in avoiding false self-employment. We now have more than 15 years of expertise in freelancing and therefore know how to avoid false self-employment intelligently.

To do this, we work with both the client side and the freelancer side and provide advice, for example on avoiding excessively long assignment periods. We also review the topic separately through our internal processes. We are happy to pass on our knowledge to clients and freelancers so that the cooperation runs smoothly and all parties achieve their goals successfully. Together with experienced lawyers, we handle contract drafting and additional checks, thereby minimizing the risk of false self-employment and maximizing the benefits that freelancers and companies can derive.

Helpful questions - how can I protect myself?

Series false self-employment, 3/4: How do I minimize my risk of false self-employment?!?

Even though there is no crystal-clear legal situation on false self-employment, there are numerous indicators you can use to protect yourself - whether as a company or as a freelancer.

There are some questions you should always ask yourself when signing a contract and in the actual execution of an assignment. If the answers are “wrong,” alarm bells should ring and the planned cooperation should be reconsidered:

• Does the contractor determine their own working hours?
• Are the contractor’s tasks clearly separated from those of permanent employees?
• Is there a relationship of dependence on instructions between contractor and client?
• Does the contractor appear to the outside world as self-employed?
• Is the contractor free from controls by the client, for example with regard to hardware and software?
• Does the contractor have freedom regarding reporting on services?
• The list is not complete - there are more questions that should be considered…

Conclusion

In summary, it is clear that false self-employment should always be avoided and problems in this area prevented. Both sides, meaning both client and contractor, share responsibility for this and should adhere to the rules and measures mentioned here, as well as others, to prevent problems. Then nothing stands in the way of successful and goal-oriented cooperation between companies and freelancers. Even the idea of successful cooperation, which includes avoiding false self-employment, shows how well two parties fit together. We will be happy to advise you on this.