A draft bill from the German Federal Ministry of Labour and Social Affairs (BMAS) that has recently come to light aims to simplify the determination of self-employment status and to make it dependent on the parties’ intentions and formal criteria.
The draft bill has recently been the subject of heated debate and is facing considerable opposition – in its current form, it is unlikely to be passed. Nevertheless, it has reignited the debate on the distinction between self-employment and dependent employment. The following article provides an overview of the status quo, outlines the key elements of the draft and contextualises the discussion to date.
Current situation: Determining bogus self-employment through a comprehensive assessment
Anyone who engages a self-employed person as a contractor always bears the risk of bogus self-employment. This occurs when a person contractually designated as self-employed actually works like an employee. The two main criteria for classification are the obligation to follow instructions and integration into the principal’s work organisation (see Section 7(1) of Book IV of the German Social Code). In addition, there are a number of further criteria and indicators (own entrepreneurial risk, own business premises, freedom to organise working hours, use of own capital, etc.) which must be taken into account as part of an overall assessment.
The consequences of bogus self-employment are significant: if the German Pension Insurance Fund subsequently determines, as part of an audit or a status determination procedure, that the work constitutes dependent employment, the principal must pay social security contributions retroactively for up to five years, plus late payment penalties. Furthermore, the contractor may take legal action to establish their employee status and assert all claims under employment law. In cases of intent, the principal also faces criminal consequences.
When conducting an assessment, the German Pension Insurance Fund and/or the German Social Court always take into account the overall circumstances of the individual case. It is not a question of whether there is a greater number of indicators for or against dependent employment (bogus self-employment) – rather, what matters is the weighting of all circumstances in the specific individual case. Where the actual practice deviates from the contractual arrangement, it takes precedence.
The risk for principals also lies in the fact that clear legal rules for distinguishing between the two have so far been lacking under German law. The classification is largely shaped by German case law and legal literature – with the result that the boundary between self-employment and dependent employment is often blurred in practice.
BMAS’s proposed solution: “new self-employment”
The BMAS has responded with a draft bill. The key point is the introduction of a further form of self-employment, which is intended to offer greater legal certainty through predictable, clearly defined criteria – at the expense of a mandatory statutory pension insurance obligation and with the principal being involved in the registration and contribution procedures. The existing system (overall assessment under Section 7(1) of SGB IV) will remain in place in its entirety alongside the new framework.
Clear requirements instead of complex assessment
The “new self-employment” provided for in the draft bill sets out four cumulative requirements:
- Firstly, both contracting parties must agree at the time of concluding the contract that the activity constitutes self-employment.
- Secondly, the activity must exhibit typical characteristics of entrepreneurial activity. This necessarily presupposes the contractor’s right to appoint a representative and also requires the presence of at least two of the following four characteristics:
- Risks of loss and prospects of profit
- Work for several clients
- Expenses typical of an entrepreneur
- Promotional market presence
- Thirdly, the principal must not have reported the termination of the contractor’s employment within at least six months prior to the commencement of this activity.
- Fourthly, the principal must report the start of the work within six weeks.
If these conditions are met, the work would then be regarded as self-employment. Subordination to instructions and integration into the work organisation would be disregarded, as would the previous overall assessment of all the circumstances of the individual case.
Exception: According to the draft, the new self-employment would not be established in the economic sectors or branches of industry specified in Section 2a(1) of the SchwarzArbG (German Act to Combat Undeclared Work and Illegal Employment), where there is an increased risk of undeclared work and illegal employment (e.g. the construction and hospitality industries).
The price of simplification: compulsory pension insurance
According to the draft, principals and contractors would then be free to choose in future whether to follow the “new” or the traditional route to self-employment (overall assessment under Section 7(1) of SGB IV).
However, the “new self-employment” would come at a price: the draft bill provides for the new self-employed to be subject to compulsory insurance under the German statutory pension scheme. The basis for calculating pension contributions is not – as is the case for traditionally self-employed persons subject to compulsory insurance – earned income, but rather the remuneration received from the respective contractual relationship, from which only a flat-rate deduction of 10 per cent is made for business expenses.
In practice, this is likely to result in a noticeably higher contribution burden for the self-employed. The contributions are to be borne solely by the self-employed person, whilst the principal is responsible for registration and payment.
The debate: Legal certainty at a price?
The draft bill has sparked a wide-ranging and, in some cases, heated debate. The criticism levelled against it can essentially be traced back to the following lines of argument:
There are doubts as to whether the proposed “optional model” will actually guarantee freedom of choice in practice. As principals are likely to push for the “new self-employment” in order to minimise their own liability risks, the model threatens to become, in effect, a compulsory model for many self-employed persons.
Critics argue that the regulations place a disproportionate burden on solo self-employed persons: the exclusive burden of bearing contributions, coupled with the corresponding relief for principals, significantly increases the financial pressure, particularly for self-employed persons on low incomes.
Furthermore, there are constitutional concerns regarding the creation of two parallel “legal worlds” in which the same activity can be classified differently under social security law and employment law – especially as the draft explicitly states that the determination of status under employment law is to remain unaffected. The blurring of the hitherto strictly separate areas of “bogus self-employment” and “pension insurance obligations for the self-employed” is viewed by some as contrary to the system.
In addition, it is criticised that the status of self-employment must ultimately be “purchased” through a willingness to pay pension insurance contributions – with the result that the question of status is determined less by the actual circumstances than by the readiness to bear contribution obligations.
Finally, individual criteria are criticised as impractical: for instance, the mandatory requirement to be able to provide a substitute is simply unworkable in numerous fields of activity. Moreover, the increased administrative burden for principals – who are to be responsible for registering and paying the contributions, even though these are to be borne solely by the self-employed person – is a further point of contention.
The result is that, whilst the draft bill addresses a real problem – the lack of legal certainty in distinguishing between self-employment and dependent employment – the chosen solution meets with resistance on key points. The criticism is directed less at the aim of establishing clearer distinguishing criteria than at the specific design of the proposed framework: the linking of status clarity with a contribution obligation, the one-sided burden on the self-employed, and the creation of parallel legal worlds are regarded as fundamental design flaws.
Outlook
The draft bill is unlikely to be implemented in its current form. The coalition parties – the CDU and SPD – have reportedly signalled in parliament that the German Federal Government will shortly present a separate draft bill. Whether, and if so in what form, the concept of “new self-employment” will be retained remains to be seen.
Clearer legal criteria for distinguishing between self-employment and dependent employment are fundamentally desirable, as the existing risk of principals unwittingly engaging in arrangements constituting bogus self-employment is considerable given the uncertain legal situation in Germany. It will be crucial, however, that any such reform bases the status determination on actual circumstances and does not place the burden solely on the self-employed. It remains to be seen whether the German Federal Government’s announced draft bill will meet these requirements.
For further information, please contact:
Cara-Marlene Fuchs, Bird & Bird
cara-marlene.fuchs@twobirds.com
