Important Changes to German Legislation

Information has been passed to us, which has been circularised to various agents, concerning new German withholding tax and social security legislation, which after consulting with our German accountants and lawyers has proved to be grossly misleading.

We are aware that information like this and other rumours have caused great consternation amongst agencies and contractors and we trust the following will set the matter straight.

A. Social Law
It is very common in Germany to pay contractors as freelancers. The reasons for this include not only reductions in social security but also to conform with labour leasing laws and avoid enforced offers of permanent positions by the client to the contractor. Nothing has changed in this regard and indeed to attempt to convert any existing contractors to employee status will result in substantial social security liabilities on your German client for previous years.

There are in fact four criteria, which have to be met in part, to be defined as self-employed.

These are:

1. The contractor illustrates that they are available to the market i.e. Market themselves.

2. They are not integrated within the client and not under the direct control of a boss.

3. They have their own employee (under certain criteria).

4. They receive less than 5/6th of their total income from one client.

Where an individual complies with any three of the above criteria they will be treated as "full" self-employed.

Where they comply with simply the first two criteria, with which in the main the vast majority of contractors should be able to comply, they will be considered a freelance "similar to employee". This last status still deems the contractor as a freelance but paying a relatively small amount of social security.

This new legislation has not been directed at the typical contractor but to other workers such as shop and office workers, taxi drivers and many other individuals registering as freelancers who have followed a trend in Germany over many years. In reality they are full-time employees, perhaps working for a company over 10 years or more, who have attempted to use the legislation to avoid paying social security. It is these so called freelancers in Germany who have had their contracts terminated and been re-employed as employees or set-up Germany companies and it was never intended for the type of contractors that you as an agent place at clients to be affected by this legislation.

To summarise it is advisable to consider the following:

1. New Contractors

Must be paid as freelancers but wherever possible using a properly managed compliance system. Consideration must be made to the wording of the contract and the practices of the client to ensure criteria two is fulfilled. This will obviously be of benefit to the client as well as the agent as any deemed employee many carry with it an illegal labour leasing situation or confer rights on the contractor that the client would want to avoid. This would also enable the best contractors to be made available as their overall package would be enhanced. It many also be appropriate to obtain a self-employed E101 wherever possible to guarantee no liability to German social security.
These procedures will of course avoid the need for agencies to reduce their margins or deal with administration

2. Current Contractors

It is, as described, particularly dangerous to attempt to change the status of contractors who are on current contracts or who have already been working in Germany for your client from freelance to employee status. This, as mentioned, will render a liability on the client for back social security the result of which could lead to bankruptcy for the German company. It is obviously preferable to protect this position by ensuring the contractor fulfils the criteria as freelancer/freelancer "similar to employee". This will require the review of your client contracts and client practices to ensure the contractor meets criteria two i.e. not under direct control or supervision. If this is the case then there will be no exposure to tax or social security. This, of course, avoids the need for you to lose any goodwill with your client or halt the services you were previously providing to your clients.

Where the individual contractor can qualify as "full" self-employed then there will be no social security liability and where he qualifies as self-employed "similar to employee" the contractor will have a relatively minor liability backdated to the 1 January 1999. We stress that in this event no liability will be incurred by the contractor or agent.

3. Other labour leasing problems

Even where an agent attempts to use an interim/managment compnay with a labour leasing license to take on fully employees, this does not prevent the need for the agent itself to require its own labour leasing license. Additionally by using employees under labour leasing, a contractor cannot legally be provided to the same client for more than 12 months (attempts to get around this legislation by changing the address of the client etc. would still be regarded as non-conform labour leasing). Any contravention of these requirements would be regarded as illegal and would lead to very heavy fines.

Other problems apart from enforced employment on the clients would include enforced rights and conditions e.g. if a contractor became pregnant they would be entitled to full maternity pay under Germany employee legislation etc etc.

So to finalise, what should you now be doing?

1. Ensure the contractors can be self-employed and in particular check the client contracts and practices do not contravene direct control or supervision concepts.

2. Utilise a compliance system, such as Project Service Beta, to ensure local compliance with tax and social security.

In so doing, overall this should not require an alteration in contractors or agency or client rates and will provide the most appropriate, legal & competitive structure for Germany contracts.

Yours, Michael Marks BSc(Econ), FAC, MO1
International Tax Solutions.