Real or pseudo self-employment? A key component of compliance

Pseudo self-employed persons who are in fact “illegal” employees are frequently the focus of audits by the social security or customs authorities as well as criminal investigations. Similarly, interest from the media associated with the accusation of compliance failures is not uncommon in cases of this kind, especially where prominent companies are involved. However, depending on the specific form chosen, it is not always easy to come to a correct legal assessment of an assignment. It is important to avoid the suspicion from the outset that a person who is supposedly freelance is in fact employed. Not only the contract documents used but also the internal processes have to be adapted to take this into account.

Prevention is better than cure

If freelancers/self-employed contractors work in the company under service contracts or contracts for specific work and are to be paid on the basis of invoices, it is essential to carry out checks before they start work – and when they are actually working – to determine whether it is necessary to integrate the person into the company’s operating processes in such a way that classification as a dependent employee is triggered under social security and tax law. This is because incorrect assessments will have significant (and above all expensive) consequences for the company and its management.

Why prevention?

If a freelancer is found to have been classified incorrectly during an external audit, then demands for back-payment of social security contributions and relatively high penalty surcharges will be an issue. The customs authorities and public prosecutor’s office will also launch investigations against the responsible people at the company on account of misappropriation of social security contributions under section 266a of the German Criminal Code and tax evasion. Apart from this, there is often a risk of considerable damage to the company’s reputation that will be difficult to repair. Companies who are known from the daily press can, in particular, expect to receive negative attention from the media.

What is prevention?

Which preventative measures make sense will depend on the specific case because above all the way the company is organised dictates the degree to which it is necessary to “integrate” freelancers. However, as a rule the following measures are especially helpful:

• Analysis of duties and assessment: Not all tasks may be carried out by contractors. The question to ask here is whether it is sufficiently possible to avoid integrating the person into the principal’s work organisation under “real conditions”? Besides drafting the underlying contracts in an appropriate way, what measures can be taken to avoid the person being gradually integrated into the company, simply for reasons of convenience, where this is unnecessary?
• Control and documentation: A best possible initial assessment is useless if it is not put into practice. Thus companies have to carry out sufficient checks to ensure that the agreed mechanisms are being complied with and document this.
• Status procedure: If, despite safeguards being in place, the principal/employer is not sure whether a freelance relationship or employer-employee relationship exists, this can be clarified by the competent social security authorities, for example in the context of a procedure to determine the person’s status. Whatever the case, companies who discuss uncertainties openly with the competent authorities, provided they do so early, will not expose themselves to the accusation that they have attempted to cover up the situation or that they are not willing to adhere to compliance rules. The important thing is to react early enough.
• Correcting erroneous assessments: By checking and documenting the situation, assessments that are initially incorrect can be identified more quickly. Apart from limiting damage relating to the past (by reporting and making back-payments of social security contributions and notifying the tax authorities), the aim must be to correct the problem in the future by amending the relevant arrangements. It is particularly important to provide sensitive advice, also taking into consideration how errors are perceived in the media.

Instructing a GmbH or UG in order to safeguard against incorrect assessments?

Contrary to the assessment frequently found in practice, setting up a one-person company (limited liability company (GmbH) or entrepreneurial company (UG)) whose managing director-shareholder is the (former) freelancer and engaging the freelancer via this company is only a limited help. Although the limited liability company/entrepreneurial company itself cannot be regarded as a form of “pseudo self-employment”, the same does not necessarily apply to the managing director of the company/entrepreneurial company who is working for the principal if he or she is deployed by the principal in the same way as a dependent employee. Hence, this structure should be combined with the risk minimisation strategies referred to above in order to then serve as an additional component.

Does it help to have several principals?

If a freelancer has been engaged by other principals as well, this may help him or her not to be categorised as a “quasi freelancer”, i.e. a freelancer comparable to an employee. However, this is only a limited help for the company concerned: although working for different principals would indicate that the person is carrying on an entrepreneurial activity, this is not definite because, after all, several jobs involving dependent employment can exist alongside one another. On the other hand, it can be helpful if several assignments for different principals are combined with the risk minimisation strategies referred to above.

Conclusion

In the end, prevention is still better than cure – not only in connection with the drafting of contracts but also in connection with the assignment as it is actually carried out. Any corrections required should be made as quickly as possible. If incorrect assessments made in the past are ascertained, the company should act quickly and carefully to perform the necessary notifications and corrections in an effective manner. In this way, and by communicating sensitively with those involved, it is possible to reduce the disadvantages for the company and its employees.