I. Relevance of the distinction between employees and self-employed individuals
Social security in Germany is closely linked to the existence of an employment relationship. As a rule, the obligation to be insured under the German statutory pension (Rentenversicherung), unemployment (Arbeitslosenversicherung), long-term care (Pflegeversicherung), health (Krankenversicherung) and accident insurance (Unfallversicherung) is associated with the status as an employee. Reporting and contribution obligations of the employer vis-à-vis the competent social security authorities as well as benefit entitlements on the part of the employee thus depend on the correct classification of the legal relationship.
1. Basis of the distinction
Generally speaking, the classification of a person as a self-employed individual or an employee depends on whether or not the person in question is essentially free to organize their activity and determine their place of work and working hours. If so, the person regularly is to be classified as a self-employed individual. If, on the other hand, the person is obligated to perform the contractually agreed services in personal dependence with regard to type, place and time, then they must be considered an employee.
The status determination cannot be based solely on the written agreements between the parties. Rather, the actual implementation of the legal relationship must be taken into account. If the practical handling deviates from the contractual regulations, the practice trumps the content of the contract.
2. Consequences of incorrect classification
The incorrect classification of an employed person as a self-employed individual (so-called bogus self-employment – Scheinselbständigkeit) may have far-reaching consequences under employment, tax and social security law and can cause significant costs for the principal. In serious cases, regulatory or criminal consequences are possible, too.
a. Employment law
A person incorrectly classified as a self-employed individual can invoke all employee protection rights retroactively (e.g. continued payment of remuneration in the event of illness, vacation entitlements, compensation for overtime, minimum wage). In the event of a termination of the employment relationship (subject to its other conditions for application being met), the person may claim protection against dismissal under the German Dismissal Protection Act and, if necessary, claim re-instatement in legal proceedings in the labor court.
b. Tax law
The tax authorities may order the principal to pay unpaid wage tax (incl. substantial late payment surcharges – Säumniszuschläge) for the person incorrectly classified as a self-employed individual. In an employment relationship, it is usually the employer's responsibility to withhold the wage tax due on the employee's remuneration and to forward it to the tax authorities. If the payment is not made, the employer can be held liable.
c. Social security law
The principal may be obliged to pay outstanding social security contributions to the social security authorities. In the case of bogus self-employment, the employer is liable for both the employer’s and employee’s share of social security contributions.
Corresponding claims can generally be asserted by the authorities for the last four years. In the case of intentional acts, recourse is even possible for thirty years. In addition, substantial late payment surcharges may be charged.
There is only a very limited possibility of recourse against the employee since such claim can only be asserted through deduction from the employee’s remuneration and for the following three payments only.
d. Criminal law / administrative offenses
There is a risk of criminal prosecution under the German Tax Code because of tax evasion due to unpaid wage tax. In the event of a conviction, the Tax Code provides for a prison sentence of up to five years or for a fine, in particularly serious cases for a prison sentence of six months to ten years. A negligent (leichtfertig) violation of the employer’s obligation to pay wage tax may be punished with a fine of up to EUR 50,000.
Furthermore, there is a risk of criminal prosecution under the German Criminal Code because of withholding and embezzlement of social security contributions. In the event of a conviction, the Criminal Code allows for a prison sentence of up to five years or for a fine, in particularly serious cases for a prison sentence of six months to ten years. The intentional or negligent violation of social security related reporting obligations is punishable with a fine of up to EUR 25,000.
II. Status determination procedure
The status determination procedure is an administrative procedure of the German Pension Insurance (Deutsche Rentenversicherung) to clarify whether the activity of an individual is subject to social security contributions. Both parties of the contractual relationship (i.e. the principal/employer and the self-employed individual/employee) may request the implementation of the procedure.
It can be expected that a status determination procedure takes approximately eight to twelve weeks until the decision of the German Pension Insurance is made. On the basis of the current legislation, a decision is made only with regard to the individual participating in the status determination procedure. However, a decision in an individual procedure may create a precedence for any subsequent status determination procedures of comparable individuals.
III. New regulations from 1 April 2022
The legislator introduced the following changes to the status determination procedure that will take effect on 1 April 2022. The new regulations are intended to create legal certainty in a simpler and faster way for both parties of the legal relationship.
1. Decision on employment status
According to the case law of the Federal Social Court (Bundessozialgericht), the German Pension Insurance was not able to decide on the existence of employment as such, but only on the obligation to subject a legal relationship to contributions in the individual branches of the social security system. In the future, the status determination procedure will serve to assess whether self-employment or an employment relationship has been established between the parties.
2. Clarification of triangular relationships
Up until now, only bilateral legal relationships have been determined in a status determination procedure, but not triangular legal relationships (e.g. between the principal, the self-employed individual and a third party requesting the principal’s services). Where necessary, two status determination procedures have had to be carried out. Now, third parties can be included in the status determination procedure: (i) if the activity agreed between the principal and the self-employed individual is performed for a third party and (ii) there are indications that the self-employed individual is integrated into the third party's work organization and (iii) is subject to the third party's instructions, the German Pension Insurance may also determine whether there is an employment relationship between the self-employed individual and the third party.
3. Request for a prognosis decision
In the past, the parties of a legal relationship regularly applied for a status determination procedure after the start of the self-employed individual’s activity. This is because the status determination is based on the actual implementation of the legal relationship. According to the new regulation, either party can gain legal certainty about the status of the legal relationship earlier by obtaining a so-called prognosis decision before the self-employed individual starts their activity for the principal.
4. Introduction of a group determination
In order to reduce bureaucracy and to create the earliest possible and most comprehensive certainty about the status, a so-called group determination will be introduced. This enables the principal to obtain an expert opinion for similar contractual relationships with various self-employed individuals, i.e. whenever several contractual relationships are carried out on the basis of uniform agreements. A self-employed individual may request an expert opinion in the case of similar contractual relationships with the same principal. However, the expert opinion is not equivalent to a binding decision which is issued at the end of the status determination procedure.
5. Temporal limitation of individual measures
The regulations mentioned above on the clarification of triangular relationships, the request for a prognosis decision and the introduction of a group determination are initially limited until 30 June 2027. In addition, the German Pension Insurance is required to evaluate the changes and submit a corresponding report to the Federal Ministry of Labor and Social Affairs (Bundesministerium für Arbeit und Soziales) by 31 December 2025.
IV. Conclusion
In reforming the status determination procedure, the legislator did not address the crucial issue in connection with the distinction between employees and self-employed individuals: the weighing of the criteria that are decisive for the distinction. The law does provide a certain direction through fundamental statements in Section 611a of the German Civil Code (Bürgerliches Gesetzbuch) and in Section 84 (1) of the German Commercial Code (Handelsgesetzbuch). In addition, the case law of the labor and social courts has developed numerous criteria for the status of an employee or a self-employed individual. Ultimately, however, a clear-cut case is rarely found in practice. In the future, the grey area will continue to be determined primarily on a case-by-case basis, which makes it almost impossible to make a reliable forecast about the outcome of status determination proceedings.
The coalition agreement (Koalitionsvertrag) of the new Federal Government maintains the previous government's changes to the status determination procedure. In addition, there are plans to provide self-employed individuals with further, unbureaucratic legal certainty regarding the determination of their own status. It remains to be seen if, and how, the legislator will implement the necessary tools to provide such legal certainty.
In view of the changes to the status determination procedure, companies that use freelancers or other self-employed individuals should pay even closer attention to avoid creating an employment relationship when exercising the legal relationship in practice. In this context, our check on bogus-self-employment can serve as an initial orientation.
Written by: Paul Single.
