Tax Law – Covert Employment

Introduction: What is covert employment?

Covert employment, also known as bogus self-employment, is a term that refers to situations in which employers choose to hire workers through a service contract or through a craft instead of concluding a standard employment contract. The goal of such engagement is to save on taxes and contributions, and the worker often performs the same tasks and has obligations that he would have as a regular employee.

Examples from around the world show that some large employers, such as delivery platforms, have been under scrutiny for years for hiring workers as self-employed people to avoid the costs of social security and other work obligations. Workers are registered as craftsmen or freelancers, and employers, who actually control their tasks, thus avoid higher contribution costs.

The tax benefits that such craftsmen enjoy include lower contribution rates and more favorable income taxation. On the other hand, employers use this strategy to reduce their labor costs and increase profitability.

Facts relevant to taxation

The facts relevant to the taxation of an individual taxpayer and employee are considered to be the following data:

• all receipts that are realized per individual source of income in a certain period of time,
• whether the receipts from self-employment are realised in the same period of time with other sources of income,
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• whether there is an established business plan,
• how the market operates,
• what is the usual way of finding business partners and concluding business relationships,
• number of business partners,
• and, depending on the individual case, other facts relevant to taxation.

Criteria for determining clandestine employment

The IRS uses an elaborate set of criteria to determine if there is disguised employment. These criteria look at the relationship between the employer (payer of remuneration) and the employee (executor of work), and include the following:

Behavior control: This criterion examines whether the employer has control over the worker, such as by determining the place of work, giving instructions, supervising the performance of the work, or providing work equipment. For example, if an employer requires a craftsman to perform tasks at the company’s headquarters and supervise its activities, this may indicate covert employment.

The behavioural control criterion includes elements that show whether the employer has the right to direct and control what the employee does and how he performs the work (through instructions, training or other means):

• whether the employer determines the place of work for the employee, regardless of the fact that it can be performed at another place,
• whether the employer gives the employee instructions on how to perform the job,
• whether the employer determines the time, place or manner of performing the work for the employee,
• whether the employer keeps records of working hours for the employee,
• whether the employer supervises the dynamics of work execution or requires reports on the performance of work,
• whether the employee uses the equipment and means of work of the employer,
• whether the employer trains the employee on how to perform the work.

Financial Control: This examines whether the employer has control over the financial aspects of the work. If, for example, the employer bears the costs of the craftsman (such as travel expenses or equipment) or provides monthly payments in the same amounts, this may suggest that it is actually a classic employment relationship.

The financial control criterion includes elements that show whether the employer has the right to direct or control the financial and business aspects of the employee’s work:

• whether it directs and/or contracts, i.e. whether the employer reimburses the employee’s business and travel expenses,
• whether the employer invests in the employee’s equipment, tools and materials,
• whether the employer determines the products and services used by the employee in the performance of work,
• whether the employer controls the manner and scope of providing the employee’s services on the market,
• whether the employer makes payments to the employee in certain periods of time (every month) and/or in approximately similar amounts.

Relationship of the parties: This criterion refers to the contractual relationship between the employer and the employee. If a service or cooperation contract is based on permanent or similar conditions to an employment contract (e.g. holidays are paid or sick leave is paid), then there is reason to suspect disguised employment.

The criterion of the relationship between the parties includes elements that indicate the nature of these relationships:

• whether the employer and the employee conclude a contract that has the characteristics of an employment contract in terms of its essential characteristics,
• whether the employer provides the employee with reimbursement of costs that are typical features of self-employment (annual leave, sick leave benefits or other rights related to self-employment),
• what is the duration of the work and whether this duration of the work is related to the implementation of a specific project or several projects in a row,
• to what extent the work performed by the employee represents the regular business of the employer,
• whether the employee can terminate business with the employer without material and financial consequences,
• whether it is common for business in the activity of the payer of receipts to look for certain jobs in this way on the market.

Exceptions

Depending on the specifics of a particular job, it is allowed to prove the characteristics of self-employment according to criteria that are not specified, and which in a specific relationship may represent a typical feature of self-employment.

Consequences of establishing covert employment

If the characteristics of independent work are determined, the decision will determine the amount of remuneration paid for a specific job, which is considered to be remuneration on the basis of employment. The employer is designated as responsible for the established tax and contribution obligations as a guarantor payer. Depending on the tax status of the taxpayer, certain entries in the business books will be ordered if necessary.

The payment of high fines and potential criminal liability for tax avoidance is not excluded.

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