The biggest fear of any German HR department: Having covert salary employees among their workforce
German labour law is strictly regulated and employees are well protected against dismissal if the employer’s workforce exceeeds 10 full time employees (details here). Furthermore, German wage tax (Lohnsteuer), health insurance, social security and state pension contributions are rather hefty (for more see here: Statutory Pension Insurance in Germany). Therefore, to try to avoid these labour costs, some employers but also employees are tempted to make it look as if the employee was a freelancer. They enter into a “consulting” or “freelance” agreement. But in reality the employer still expects the so called “freelancer” to be there at certain hours and the “freelancer” does not have any other clients. This is extremely risky:
German law has a special name for this constellation: “Scheinselbstständigkeit”, which may be translated as “fake self-employment” or “fictitious self-employment” or “covert salary employment”. Many founders of their own one man micro-enterprise are in reality quasi employed, because they only work for one main contractor.
This is, however, rather dangerous for both parties because if this is found out – maybe even years later – the “freelance agreement is being treated by German social security athorities (welfare funds) as an employment agreement. This means that taxes and contributions of a salried employee are due for the fake entrepreneur. He/she must pay half of the contributions towards German pension, health insurance, long-term care and unemployment insurance. The other half must be paid by the (main) contractor. For more details see here
From a labour law perspective the main contractor may even have to give the worker a permanent salary job. This is the reason why some employers are almost a bit paranoid and ask the freelance contractor very intensively, how many clients he/she has. They want to make sure that the person working for them is not “fictitiously self-employed”.
What are the criteria to determine whether someone is a real entrepreneur?
German tax authorities, welfare funds and courts use an overall view approach, i.e. they do not look at one single factor but rather do assess the big picture. The main cirteria are:
- Freelancer does not have any employees of his/her own
- Freelancer is essentially only working for one (main) client / contractor (the courts have developed a rule of thumb according to which someone is considered “scheinselbständig”, if he/she generates 5/6th or more of the total turnover from one client
- Level of integration into the organization of the employer (Eingliederung in den Betrieb des Auftraggebers); i.e. does the employee attend organisational staff meetings, company outings etc.
- Employer also has salary employees (regular staff) doing the same kind of work as the freelancer does
Again, the big picture is important. But if a few of the above criteria apply, there is a high risk that tax authorities and welfare funds will present a huge bill years later for unpaid contributions.
The law firm Graf & Partners (Germany) assists entrepreneurs and businesses with their international expansion to Germany since 2003. Also, we have a network of professionals in the areas tax, IT, marketing and business consulting. Do not hesitate to contact us by calling solicitor Bernhard Schmeilzl at +49 941 463 7070 or send an email to: mail [at] grafpartner.com