Many companies have come up with innovative business ideas and introduced new forms of work over the past years. Additionally, workers have been demanding more and more freedom in their work settings (such as regarding working hours and places of work).
To balance these needs, an increasing number of companies try to hire workers as so-called “(independent) contractors”, which they believe to be a more flexible setup.
However, relationships with independent contractors (often also called “freelancers”) often constitute employment relationships from a legal perspective in many jurisdictions. This somewhat hidden employee qualification may have substantial consequences for the contracting companies though. Companies may mainly have to (retroactively) observe and fulfill applicable employee rights, but also may be retroactively liable for any potential social security as well as insurance contributions, taxes and insurance coverages. In some jurisdictions they may even be sanctioned for their violation of (employment) laws.
We noticed an increase in this risk during the last few years due to both increased authority activity (inspections) and recent court rulings in various countries, essentially confirming the employee qualifications of independent contractors by different competent bodies in the respective cases.
This article summarizes the distinction between an independent contractor and employee on a general basis and points out potentially associated general risks.
The following general and exemplary criteria may be considered for a distinction between independent contractors and employees in many jurisdictions (e.g. in most EU countries), subject to a case-by-case assessment and local laws:
|Economically independent (several clients)
|Economically dependent (one main client or even exclusivity)
|Is not in a subordination relationship with the principal
|Is in a subordination relationship with the employer
|Is generally not subject to any instructions
|Is subject to instructions by the employer (based on subordination relationship)
|Sets own work organization
|Integration into employer’s work organization
|Determines working hours and working place themselves
|Is subject to working time and place of work rules
|Works with own equipment, material or tools
|Works with equipment, material or tools of employer
|Remunerated for work products (e.g. fixed fee or on a time-spent basis)
|Principally remunerated periodically (e.g. monthly or hourly)
Additionally, in practice the following points may be considered as indicators as well:
- Possession of business cards
- Domain of email account
- Potential working uniforms
- Badge / access cards
- Signature in emails
- Webpage appearance
- Letter heads
In case a believed independent contractor relationship turns out to be an employment relationship, the relationship is typically retroactively governed by all applicable employment-related laws, including social security, insurance and tax laws.
This may principally trigger the following claims / consequences for the hiring company:
- Employment law: retroactive fulfilment of employee claims, e.g. regarding vacation days, overtime, notice periods and sick pay
- Social security: retroactive liability for any social security contributions (employer as well as employee part)
- Taxes: potential liability for any tax-at-source and creation of permanent establishments
- Insurances: potential liability for the non-existence of mandatory insurances (e.g. accident insurance)
Companies are advised to diligently examine all circumstances before engaging independent contractors. A carefully drafted contract is a good aid to define the applicable duties and rights among the parties clearly and to mitigate the mentioned risks.
Additionally, companies often demand the following confirmations before engaging independent contractors in practice, which may further help to mitigate the risk:
- Proof of establishment of an own company
- Confirmation by the competent social security authority regarding e.g. self-employed status (i.e. not as employee)
- Proof of business organization (e.g. business premises, website, marketing channels, etc.)
- Track record as independent contractor (e.g. other customers)
Companies are advised to periodically verify whether their independent contractors still qualify as such, especially if any circumstances change.
Some companies have established procedures for their independent contractors to comply with on an annual basis. Such procedures typically requirespecific documentation and answering of certain questions that are aimed at identifying any employment risks.
Along with the documents above, among the questions to ask are:
- Confirmation that independent contractor employs own employees
- Confirmation that independent contractor uses her/his own equipment, tools or material
- Information on whether independent contractor has another source of income