Sham freelance

For the principal, i.e. the employing company, freelance contracts offer many advantages at first sight. There is no legal dismissal protection for the freelancer as he or she is not part of the operating unit in terms of employment law. The freelancer has no entitlement to paid sick leave or to paid holiday or vacation. The maternity protection law and other regulations which protect employees are not applicable to freelancers, neither are collective agreements or in-house company practices. In addition to these advantages regarding employment law, the principal saves the expensive contributions to social security and is entitled to the VAT pre-tax deduction.

These advantages for the principal are not favourable to the government, which, in view of the precarious financial situation of the social security system, strives to obtain contributions by as many people as possible. The principals, of course, are interested in saving these contributions and working as economically as possible. Besides, working with freelancers offers the advantage that the principal can react flexibly to production points because the law of dismissal protection is not applicable. Examination of a freelancer’s actual independence for questions of social security is exclusively incumbent on the social security administration, and the requirements to satisfy the conditions to be classed as a freelancer are quite stringent.

Most legal judgments go back to the concept of the employee. The problems of determining whether someone is a freelancer or an employee are not confined to employment law. There are also problems in tax law and social security law. This means that three different courts deal with the topic of sham freelance. Although every court makes its own judgment, the jurisdiction of the Federal Labour Court (Bundesarbeitsgericht) on an employee’s status is the basis for all courts. In particular cases, there are different judgments possible, because each court pursues its own goals and their specific characteristics can require another verdict.

Freelancing does not constitute employment. The contracting parties want to avoid this. Unlike the employer-employee relationship, freelance is an independent business activity on a service or work contract basis. A written agreement should always be concluded. However, a freelance contract does not prevent the courts from considering it to be an employer-employee relationship that is liable to the social security system. It does not depend on the nature of the contract, but on the actual execution of the contractual relationship.

The courts will proceed on the assumption of an employer-employee relationship, if the freelancer is personally and financially dependent on the contract, as financial dependence can at least serve as an indicator. Whether the freelancer is integrated into an organization would also be of central relevance.

Criteria of sham freelance

For the evaluation of a concrete contractual relationship as independent business activity or as a personal dependent activity and therefore as an employee, different criteria are used. Only the case in hand is relevant, other former or simultaneous activities and their assessment do not play a part in the assessment of the case in question. The following are some of the criteria that should be considered when drafting a freelance contract.

Criteria indicating an independent activity

  • Own entrepreneurial risk
  • Own cost calculation
  • Own employees
  • Own time management
  • The right to obtain other contracts
  • Free choice of principals
  • Several principals
  • Reimbursement is sacrificed during down-times
  • Business occurrence outward
  • Free choice of the place of activity, unless the content and type of the activity demand otherwise

Criteria indicating a personal dependence and therefore an employee status

  • Treatment equal to employees
  • Integration into the flow chart
  • Necessary cooperation with other employees
  • No absorption of the costs
  • Obligation personally to carry out the work
  • Prohibited to hire own employees
  • Prohibited to set prices
  • Obligation to accept all orders
  • Obligation of comprehensive reports
  • Subject to directives with regard to technical instructions and to the contents of the work
  • Exclusive use of external working material
  • Dependence on technical facilities of the principal
  • Permanent presence in the enterprise
  • Temporal and local connection (admission into the roster)
  • Included in the personnel roster
  • Obligation to notification of sickness
  • Holiday allowance and payment
  • Subject to working control procedures

How we can help you

In essence, it is very difficult to provide generally accepted criteria. Hence, it is difficult to predict how a court will classify a contractual relationship. Judicial variations are inevitable and only a minimization of risk can be achieved.

The arguments are considered by the court, which then examines whether there is more in favour of an independent business activity or a dependent employment. The criteria do not have any universal validity. Even the incorporation of a limited company or the registration of a business are not indications for an independent activity. The principal should therefore adhere as much as possible to the criteria laid down by the court.

Risks that may occur for the principal, if a freelance situation is considered an employment due to an official audit

  • Very high financial risks
  • Liability for the employer’s and the employee's share of social security contributions
  • First-line liability for the employee’s income tax
  • Reversal of VAT payment and pre-tax deduction
  • Criminal Law: e. g. Tax fraud
  • Possible consequences with regard to employment law

Counselhouse can help you to minimize the risks of your contractual situation. For more information please do not hesitate to contact us.

René Udwari

Attorney-at-Law
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Copyright Counselhouse 2017
*Copyright Counselhouse 2017. Counselhouse is a legal service provider. All legal advisory services offered on this website are provided by René Udwari & her team. René Udwari is a registered business lawyer in Germany.