"Pseudo self employment" - the background

In recent years Germany, like other countries, has seen a move towards the flexibilization of working conditions by employers in an attempt to reduce non-wage labor costs, which at 51% for income tax and employee/employer social security and pension contributions are among the highest in the developed world [1]. Thus a number of publishers, translation services, software developers and many other labor-intensive companies in Germany terminated employees' contracts and then outsourced their previous or similar work to them as independent contractors. In addition, companies coping with peaks and valleys in demand (such as localization providers and software houses in the run up to the Y2K and the conversion to the euro) have engaged considerable numbers of freelance contractors who work in-house, at customer sites, or from their own premises.

In contrast to employees, for whom employers have to pay fixed social security and pension contributions, such freelancers must either arrange for their own cover or try to gain admittance to the "Künstlersozialkasse", a Federal German government insurance program originally designed to help impoverished "artists" (e.g. authors, painters, journalists and editors).

However, as in other developed countries, the current German "pay as you go" pension program [2] is under severe strain as a result of demographic and economic factors, including the large number of aging baby boomers, the tendency of retirees to live longer, and the need to reduce government debt. Against this background and in keeping with its traditional positioning as the champions of the working class and the low-waged, the incoming Social Democratic-Green coalition government pledged to put a stop to practices which were reducing the levels of contributions still further. Its hastily enacted legislation designed to identify quasi employment relationships came into force on January 1, 1999, to howls of protest from many sectors of industry.

"Scheinselbständigkeit" - pseudo self-employment

In brief, the new legislation contained in paragraph 4, section 7 of the Viertes Buch Sozialgesetzbuch - Part 4 of the German Social Security Code - sets up a series of tests to define typical standard employment relationships and then applies them to the self-employed. As a result, a contractor is, by default, considered pseudo self-employed if his/her work situation is characterized by any two of the following criteria:

• He/she has no employees for whom he/she pays social security contributions (family members and casual workers employed on a so-called "DM 630" basis - see below for further details - are not considered employees under this rule).
• He/she works regularly for only one customer and generates 5/6ths of his/her income from that work (the period to be taken as the baseline for measuring this figure does not yet seem to be clear).
• The supplier is subject to the directives and is integrated into the organization of his/her customer in a similar manner to regular employees.
• The supplier has no active marketing policy and does not act as an entrepreneur (e.g., by trying to acquire additional customers).

In practice, the new law provides that the supplier's relevant health insurance organization (to whom all additional wage costs have to be remitted for redistribution to the institutions concerned) has to be notified within two weeks of a supplier starting to work for a customer. It is the supplier's and/or the client's duty to prove that the supplier should not be considered as pseudo self-employed, a reversal of the traditional burden of proof. If such proof cannot be provided or is not accepted by the health insurance organization, both supplier and client have to pay 50 percent each of the supplementary wage costs, as for regular employees. In such cases, the customer may be confronted with having to pay pension and other insurance contributions for the four preceding years or, if abuse is proved, for up to 30 years (cf. http://www.gi-ev.de/beiraete/faqsss.html). In addition, suppliers whose status is re-defined as "pseudo self-employed" may find that their tax filings are reopened. This means that certain types of costs that were deducted from their previous gross income may be considered as ineligible for deduction after the event.

"Arbeitnehmerähnliche Selbständigkeit" - "self-employment with employment characteristics"

To make things even more opaque, new legislation in the Sechstes Buch Sozialgesetzbuch - Part 6 of the German Social Security Code _ creates a second, less severe status: "arbeitnehmerähnliche Selbständigkeit" ("self-employment with employment characteristics"). Also in force since January 1, 1999, this change applies to anyone who fulfils two particular criteria out of the list given in the previous section:

• He/she has no employees for whom social security contributions are being paid (once again, family members are not included)
• He/she works regularly for only one customer and generates 5/6ths of his/her income from that work.

Contractors classified as belonging to this category are considered de jure to be self-employed, but they (although not their customers) nevertheless have to pay pension insurance contributions (DM 860 in West Germany and DM 723 in the former German Democratic Republic, based on an average monthly income of DM 4,410). The reasoning of the authorities is that, even if these people are self-employed, they still need to be saving for their old age. Thus, even if a supplier's status as a self-employed contractor is approved, he/she may well need to bear this additional cost.

A boomerang effect

The effects of the legislation have been far-reaching. For example, the Gesellschaft für Informatik (GI; German Society for Computer Science), a major industry association, estimates that one-third of all German IT contractors must be considered as pseudo self-employed under the new legislation. Ulrich Bode, the spokesman for the Society's Self-Employed Working Group, summarizes results from a survey conducted recently among self-employed GI members as follows: 20 percent have lost a contract due to the law on pseudo self-employment, another 40 percent are afraid they will do so in future.

Ulrich Bode estimates the economic impact of this using the following numbers: There are at least 15,000 self-employed contractors on the German IT market; each job lasts from 6 months to 3 years, and a working hour is priced at an average DM 135. 20 percent of 15,000 suppliers = 3,000 contracts, multiplied by an average contract value of DM 300,000 = DM 900 million assumed potential damage. The minimum actual damage can be presumed to be a delay of two months for suppliers acquiring a new contract, plus acquisition costs, for a total of roughly DM 50,000. Multiply this by 3,000 contracts, and there is a very realistic damage of about DM 150 million caused to IT contractors alone in Germany - a lot of money even before other sectors are included.

More generally, considerable concern has also been voiced about the effect on start-ups (increasingly seen as a solution to the thorny problem of unemployment), since such companies often work for a single client before establishing a broader customer base. Finally, the fact that details of how the Act should be implemented were not available at the time it came into force led to considerable uncertainty.

To sum up: while it is generally recognized that misuse of self-employment has been a problem in some areas, the "solution" was felt to be unnecessarily restrictive, and hence the opposite of what Germany needed given the global trend towards deregulation of the labor market.

Finding solutions

What then, can employers and contractors do to avoid any additional payments? For contractors wishing to avoid being categorized as pseudo self-employed, the following measures have been suggested:

• Contractors should employ staff who are not part of their family. This may be easier for professionals such as technical authors and translators who can easily benefit from secretarial help, for example, than for e.g., programmers, who may not. In the latter case, creating an "IT assistant" education path might help.
• They should also commission professionals to design office stationery, a Web site, etc., and consistently use the materials produced.
• Contractors should not sign any agreements that restrict their ability to work for other customers. However, in practice single-customer relationships over long periods of time are common for IT contractors, technical authors and localization specialists, since the projects they work on are of a considerable size.
• Again, in contracts, contractors should not accept restrictions on where to work from. Nevertheless, integration into workflows will remain a predicament for jobs carried out by certain IT experts and localization staff.
• Contractors should not carry business cards with their name on them issued by their customer(s).
• Contractors should pay all travel expenses themselves and should recoup them by increasing their fixed prices or hourly rates to the customer.
• They may want to make attempts to acquire potential new clients and to document all such activities. This may be a useful procedure even for professionals who find that customers are queuing up to commission them anyhow.
• Contractors should set up their own physical office.
• They should develop and implement their own accounting procedures.
• Last but not least, they can consider switching to working for foreign-domiciled customers, who are not covered by the legislation.

To verify the status of a supplier, clients should:

• Consider asking contractors for a proof-of-status certificate, to be obtained from their health insurance organization.
• Failing this, request contractors to state whether they fulfil the criteria mentioned in the section entitled "Scheinselbständigkeit".
• Switch to foreign-domiciled contractors, who are not covered by the legislation. However, if such contractors perform services in Germany, they are likely to be covered by the 25% withholding charge ruling mentioned below.

Thus one of the unwitting results of the new regulations would seem to be to promote further internationalization, although potentially at the expense of German suppliers.

Casual workers hit by changes to "DM 630 law"

In addition to this, regulations concerning casual workers earning less than DM 630 per month ("geringfügige Beschäftigte"), whose wages are subject to flat-rate deductions as opposed to the progression used for regular work, have been changed. This amendment may be of interest to clients in the language industry who employ e.g., proofreaders, or software checking or support staff on a DM 630 basis.

Firstly, as of April 1, 1999, the DM 630 limit is fixed and unchanging - in previous years, it has been raised successively to reflect changing economic conditions. The former fixed tax rate of 20 percent plus 2 percent "solidarity surcharge" (the supplement levied to finance the rebuilding of Eastern Germany) has been eliminated. However, the employer has to pay 10 percent health insurance and 12 percent pension insurance. The DM 630 limit is absolute, and the favorable flat rates apply only if the earnings of the person concerned do not exceed this monthly amount. If they do, the usual levels of taxation and additional wage costs apply. In other words, people who have a second job are now subject to full rates of tax and social security contributions, in some cases making their work economically unattractive.

25% withholding charge for suppliers not domiciled in Germany

As of April 1, 1999, another change, this time to the application of German tax law [3], has also come into effect. German customers of suppliers domiciled abroad but performing a service in Germany are now required to deduct 25 percent of the net invoice total. The amount has to be remitted without delay to the German tax authorities, which will then issue the customer a certificate. It is as yet unclear whether the customer then has to send the supplier a copy of the invoice or whether the German tax authorities will then contact the supplier directly. The consequence is that suppliers have to register in Germany if they are doing business in Germany and submit a tax return there. They can then claim back any tax due to them at the end of the year, either under their national tax legislation or as a result of double taxation agreements.

The justification for this procedure is that foreign-domiciled companies and individuals performing services in Germany are subject to limited tax liability in Germany. Up to now, though, this rule has been applied only in specific instances (in particular musicians and the construction industry). However, in Germany at least it is now being extended to cover almost everyone.

Modifications announced

The introduction of the new measures led to a hail of protest, including a concerted campaign by newspaper publishers, one of the sectors most affected. As a result, according to the German newspaper "Die Welt" of July 2, Employment Minister Walter Riester is likely to make a number of changes based on the recommendations of an Expert Commission set up by the Federal German government to examine the effects of the legislation. While no final decisions have been made, Thea Dückert (a Green member of the Commission) was quoted as suggesting that the following changes could be made regarding pseudo self-employment status:

• Members of the family may count as employees for self-employed people.
• The "one customer only" rule may vanish.
• Contrary to present practice, customers may be required to pay additional wage costs post-hoc only in those situations in which there is proof of an intention to circumvent the law.

In addition, the deadline for applications for exemption from mandatory pension insurance payments is likely to be been extended until the end of 1999, as opposed to June 30, as previously foreseen. Exemption may be granted to anyone who has taken out life insurance or is on a similar old-age pension scheme.

Thus it would seem at the time of going to press that at least some of the major disadvantages of the new legislation will be removed. Nevertheless, if the main provisions remain in force it will continue to impact the traditional agency model in the language industry. Contractors and customers alike should therefore be aware of the problem and develop answers to it in good time. [i]

Further information

Suppliers and customers may want to consult the following Web sites (a non-comprehensive selection, sites are in German):

Pseudo and dependent self-employment:

• Downloadable legislation on "Scheinselbständigkeit" - www.gi-ev.de/daten/schein.zip
• Explanations - http://www.bfa-berlin.de/vers.2/mrkb.2a/2a_arslb.htm
• most recent additions to the legislation - http://www.bfa-berlin.de/aktuell.9/presse.9a/9a_befr.htm
• the phone hotline of the Bundesversicherungsanstalt für Angestellte - the Federal German Insurance Agency for Salaried Employees - may be reached at +49 (0)800 3331919
• FAQs and reactions - www.gi-ev.de/beiraete/faqsss.html, www.gi-ev.de/beiraete/selbstaendige.html
• www.infoquelle.de/Wirtschaft/Steuern/scheinselbstaendigkeit_arbeitnehmer.htm
• www.bdue.de/schein.html
• www.steuerberaterkammer-nbg.de/mews/scheinselbst.htm
• www.puender.com/d_nl_Scheinselbstaendigkeit_0599.html
• To subscribe to the Gesellschaft für Informatik Newsletter, send mail with "subscribe", first name, last name and e-mail address to selbstaendige@gi-ev.de.

Casual (DM 630) workers

• Explanations, FAQs, and reactions - www.schumacher-meisen.de/mb-630.htm, www.olufs.de/kommentar.html
• www.fdp-luebeck.de/die_neuregelung_und_ihre_folgen.htm

---

[1] OECD data, 1996

[2] i.e. one in which those in work support those who have already retired, as opposed to one funded by reserves.

[3] Section 50a (7) Einkommensteuergesetz _ German Income Tax Act)

[i] This article reflects the situation in early July 1999. The author assumes no liability for the completeness and/or correctness of information given. Companies affected should consult their lawyers for more precise details.

---

Michael Reiter
Senior Project Manager
Fry & Bonthrone Partnerschaft
In der Witz 29
D-55252 Mainz-Kastel
Germany
Tel +49-6134-2046-0
Fax ++49-6134-2046-47
E-mail: michael@fb-partners.com