Independence test and comparative practice of tax authorities in other countries

Amendments to the Personal Income Tax Law and the introduction of an “independence test” for entrepreneurs have caused strong controversy, while opinions on the new changes have been divided. While everyone is slowly becoming more familiar with the criteria outlined in the “independence test”, the next step is eagerly anticipated, ie in which direction the tax authorities will apply and interpret the criteria outlined in the “independence test”.

Until now, tax inspectors have had fairly wide discretion in interpreting and applying tax laws. By introducing as many as nine criteria under the “independence test”, their rationale as much as the announced rulebook that will further define the “independence test” is an attempt to alleviate uncertainty about future controls by tax authorities.

However, no one can say with certainty what the future actions of the tax authorities will be, or how the criteria described in the “independence test” will be interpreted. In order to try to figure out to some extent what we can expect from the tax authorities in the future, we will show examples of comparative practices of tax authorities in some of the countries where similar rules exist:

Slovenia

In the Republic of Slovenia, there is a similar mechanism for verifying whether the relationship between the entrepreneur and the principal can be considered as independent or not. Namely, during the control, the tax authorities first check all elements of the contractual relationship, which includes, among other things, whether (and to what extent) the process of providing the service is organized by the principle, whether the entrepreneur provides services in the business premises of the principle, whether working the time specified by the principle, whether the entrepreneur continuously provides services to only one the principle for a long period of time, etc.

It is interesting to note that tax inspectors in Slovenia also pay attention to the dynamics of entrepreneur payments, ie whether the entrepreneur is paid on a monthly basis or only after the service has been provided (eg after the product for which the entrepreneur is engaged). Namely, when the compensation to the entrepreneur is paid on a monthly basis, it can be an indicator that the entrepreneur is not independent in relation to the principal.

In practice, one of the more important criteria (and often crucial in determining independence) is the one concerning the percentage of income that the entrepreneur earns from the principal. Namely, if an entrepreneur earns more than 80% of his annual income from just one principle, this will be a strong indicator that he is not independent.

Netherlands

From the point of view of the legislation of the Netherlands, there are three key elements that characterize a work engagement: 1) the employer has the right to give an order to the employee as to how a particular work assignment will be carried out, 2) that work assignment must be performed solely by the employee, and 3) the employee receives an appropriate remuneration for the work he conducts for the employer.

In this regard, the three criteria mentioned above are most often taken into account when determining whether a contractual relationship can actually be considered as an employment relationship. In addition, the following criteria may also be taken into account when determining whether a contractual relationship actually constitutes a covert employment relationship:

Freedom regarding the organization of how the task will be performed (the entrepreneur should have freedom regarding the organization of the way he will provide the service, in terms of the choice of working hours and the day when he will provide services),

The extent to which the entrepreneur bears the risk of the service provided, etc.

It is important to highlight the significant advisory role that the tax authorities of the Netherlands provide to tax payers in that country with regard to clarifying the concerns raised in practice regarding the application of these rules.

Hungary

Our northern neighbors have a recognized practice in establishing entrepreneurial independence. Namely, the courts in that country have already made decisions where the relationship between the entrepreneur and the principal is characterized as being a work relationship.

In Hungary, the independence of the entrepreneur in relation to the principal is determined on the basis of two groups of factors. The following are key factors that can be used to determine entrepreneur independence:

  • If the contract between the entrepreneur and the principal contains a detailed description of the work activities that the entrepreneur must perform on a regular basis during the provision of the service, this can be a strong indicator of the entrepreneur’s independence.
  • In a traditional employment relationship, employees do not have the opportunity to hire subcontractors to complete their work tasks, but the employee is personally engaged in the performance of work tasks and, in the absence, cannot entrust his work to another person (this is a decision that may be made by the employer ). On the other hand, a sole proprietorship has the ability to engage subcontractors when providing the service.
  • If the principal has determined that the entrepreneur is obliged to provide his services in a clearly defined place and within a certain time, this can be a strong indicator of the entrepreneur’s independence.
  • The existence of a clearly defined hierarchy between the entrepreneur and the principal can be a clear indicator of independence. The hierarchy is generally considered to be the fact that an individual performs his / activities under the direct control of a supervisor, and that he  has a clearly defined place in the organizational structure of the principal (with the existence of the subordinate or subordinate person). Alternatively, independet entrepreneur may receive basic guidance regarding the realization of a particular project, but in essence they have the right to decide for themselves how to accomplish a particular task. In addition, there is no hierarchy in the relationship between the independet entrepreneur and the principal, that is, the entrepreneur should not be part of the organizational structure of the principal.

In addition to the (key) factors listed above, there are a number of other supporting factors that may be helpful in determining an entrepreneur’s independence (such as whether the entrepreneur is using the principal’s assets, etc.)

Germany

In Germany there is not only one specific regulation dealing with this subject. Namely, courts and other state institution often apply a number of criteria when determining the independence of entrepreneurs.

For example, the decision as to whether a person can be considered a independet entrepreneur can be made primarily by taking into account the criteria that determine the degree of dependence between the entrepreneur and the principal (whether the principal determines the entrepreneur’s working hours, the place where the entrepreneur will provide his services, as well as project timeline, etc.).

On the other hand, the following criteria can also be used to determine the entrepreneur’s independence:

  • Whether the entrepreneur has to provide services personally or can hire a subcontractor;
  • Whether the entrepreneur or the principal bear the economic risk when providing the service;
  • Is the entrepreneur part of the organizational structure of the principal;
  • What are the basic assets an entrepreneur uses when providing a service;
  • • Does the entrepreneur have a normal place of work on the premises of the principal;
  • Whether the entrepreneur has an e-mail address or a telephone number belonging to the principal;
  • Does the entrepreneur attend internal meetings, trainings and other internal activities with the principal (New Year’s celebration, team building, etc.);
  • Whether the entrepreneur receives a monthly fee for the services provided or is paid after the service has been provided;
  • Does the entrepreneur generate more than 80% of the total revenue from a single principal;
  • Does the entrepreneur advertise his services in the market, etc.

Czech Republic

Practice in the Czech Republic has highlighted difficulties in determining whether a particular contract with an entrepreneur can be characterized as a covered work engagement.

Generally speaking, if the relationship between the entrepreneur and the employer does not meet certain criteria that are generally transcribed by the employee (eg that the work is done personally by the employee, in accordance with the instructions given by the employer), the relationship between the entrepreneur and the employer can be considered independent.

Conclusion

As can be seen from the preceding examples of comparative practice, the issue of entrepreneurial independence and covert employment is an issue of great importance in many countries that has received considerable attention from tax authorities. The tax authorities’ actions alone vary from country to country, although it can be observed that there are similarities between countries in applying individual independence criteria.

As for the practice in Serbia, it remains to be seen how the tax authorities will interpret and apply the criteria of the “independence test”. In any case, taxv payers would have to do an “independence test” as soon as possible, using all available information, so that they could make a timely and correct decision based on the results of that test with regard to further steps in their business.