1. Legal Framework Differentiating Employees from Independent Contractors
In Germany, the distinction between an employee and an independent contractor is not regulated by one specific regulation. There is a strict assessment under various criteria, which generate partly from German law regulations, but mostly from rulings of the German labor courts and the German administrative courts. Both courts use slightly different criteria for their assessment of whether a person is an employee or an independent contractor, which may lead to different rulings regarding their status. However, mostly, the assessment with both kinds of criteria will lead to the same results.
a. Factors that Determine Who is an Employee and Who is an Independent Contractor
In Germany, the decision whether a person is an employee or an independent contractor, depends on numerous criteria.
German law indicates in the Commercial Code (Handelsgesetzbuch – HGB) that an independent contractor has the distinction of being able to freely determine his/her performance as well as his/her working time. In contrast, an employee is someone who may not determine his/her work performance free from instructions by the principal/ employer and is bound by specific working times.
However, as these criteria are rather vague, especially with regard to flextime wage accounts and highly specified jobs, and no other statutory regulation exists, the German Federal Labor Court (Bundesarbeitsgericht) specifies the distinction between a “dependent” employee and an independent contractor by the grade of personal dependence.
Therefore, the main criterion for the Federal Labor Court is whether a contractor is personally dependent on the principal. This will be assessed based on the scope of instructions, which the principal may give: If the principal may decide on the content of the performance, the kind of performance, the time, duration and place of performance, and if the contractor is strictly bound by these instructions, then the contractor will most likely be regarded as an employee. Therefore, as a guideline it may be said:
The more the principal may determine the work performance of the contractor, the more likely the contractor is an employee.
Labor courts will therefore decide on the legal status of a contractor by an overall assessment of various criteria such as:
- how sophisticated are the working tasks given to the contractor (i.e. how to perform the assigned tasks)?
- how is the working time determined?
- how is the workplace determined?
- to what extent does the contractor’s work depend on the principals ? business organization (e.g. use of equipment and resources, team work with other employees)?
- in a valuing reflection, which of the two parties gains more directly from the performed services?
As these criteria are still vague and in border cases hard to assess, the social security authorities have developed several criteria, which may be taken into account when determining the status of an employee. These criteria are:
- does the contractor have to provide his services in person or may he engage an employee / subcontractor himself?
- who bears the economic risk of no performance or poor performance?
- is the contractor integrated into the business organization of the principal? • is the contractor named in duty rosters?
- who provides the equipment for the work performance?
- does the contractor have a regular workplace at the principal’s location? Does he have an e-mail address or a telephone number? Is he registered in the principal’s telephone book? Does he have branded business cards of the principal?
- does the contractor anend internal team meetings? Does he anend training sessions? Does he anend internal events like Christmas parties?
- is the contractor obliged to notify about holidays or other leave?
- does the contractor receive a fixed monthly remuneration or is he paid only for the services he actually provided?
- does he have to write invoices?
- is he covered for sick leave or for holiday?
- is there a fixed monthly payment?
- does the contractor have his own trade license / registered business?
- does the contractor announce / advertise his services in the market?
- does he work for other principals or is he at least free to choose other principals?
- how much payment does he receive overall by only one principal (more than 5/6 of his overall income)?
- how much time does he work for one principal?
The decision whether a contractor is to be qualified as an employee or an independent contractor, depends on an overall consideration of these criteria. In their considerations, labor courts tend to focus more on the degree of personal dependency, whereas the social security authorities rely more on the economic dependence of a contractor.
Finally, it should be noted that it is not relevant how the parties determine their contractual relationship. Especially, it is not relevant how the parties have designed their contractual relationship in the contractual documents, but how the contractual relationship is exercised in the day-to-day business. Thus, even if both parties involved are convinced that their contractual relationship is a service agreement, it may still be assessed as an employment relationship by German courts or authorities and vice versa.
b. General Differences in Tax Treatment
The differentiation between an employee and an independent contractor has several consequences for the parties involved. Especially with regard to social security law and tax treatment, there are significant differences between an employee and an independent contractor.
Social security law
In Germany, a comprehensive statutory social security system is established. The system includes health insurance, long term care insurance, unemployment insurance and a state pension scheme. The system is funded by social security contributions of generally all workers that have the status of an employee. Both employer and employee pay these contributions, which are calculated on the basis of the employee’s monthly gross salary. The employee’s contributions are withheld from the salary and paid by the employer along with its own contributions as an aggregate amount.
In 2017, the contribution rates are as follows:
Health insurance 14.60 % ( 7.3 % employee; 7.3 % employer)
Long term care insurance 2.55 % (1.275 % employee; 1.275 % employer)
Unemployment insurance 3.0 % (1.5 % employee; 1.5 % employer)
Pension scheme 18.7 % ( 9.35 % employee; 9.35 % employer)
Exceptions are made for marginal employment, short term employment and student employees. Here, the social contributions may be paid as a lump sum and borne in their entirety by the employer or may not accrue at all.
As a general rule, independent contractors do not participate in the German statutory social security system. They need to arrange for their social security on their own accord, e.g. by means of private health insurance and private pension funds. Therefore, they usually receive a higher (gross) remuneration than comparable employees.
However, with regard to the statutory pension scheme and for specific professions, there are exceptions to this general rule. Independent contractors, who do not employ any employees themselves and are mainly engaged by one principal only, must participate in the German statutory pension scheme and make contributions to it. In contrast to employees, they must, however, bear the total contributions themselves.
There are also differences between employees and independent contractors regarding tax treatment:
An employee’s remuneration is subject to wage tax, which is a withholding tax and is deducted by the employer from the employee’s monthly gross salary.
The services of an independent contractor are generally subject to VAT (Umsatzsteuer). Certain professions are excluded from the taxation, such as specific professional medical services. Furthermore, an independent contractor is exempt from such VAT taxation, as a petty trader, for annual revenue up to EUR 17,500, if the expected profit of the following year amounts, at most, to EUR 50,000. The independent contractor is responsible for transferring the incurred VAT and his personal income tax.
c. Differences in Benefit Entitlement
By virtue of statutory law, an employee is entitled to some particular benefits, each constituting a mandatory minimum level. Thus, employers may grant more, but never less than what is stipulated in statutory law. An independent contractor by contrast is not entitled to such benefits by virtue of statutory law. In fact, where a contractor is granted these particular benefits by his principal, this may imply a disguised employment. These particular benefits include:
Paid holiday leave
Employees must be granted at least 20 days of paid holiday leave, based on a five-day week. However, it is more common in Germany to grant employees 25 to 28 days of paid holiday. In addition, employees are entitled to receive their regular remuneration on statutory holidays (approx. 10 – 13 days per year), while they are generally not obliged to work.
Independent contractors on the other hand are, in general, not granted any paid holiday leave. This is only natural as independent contractors by definition do not have a specific working time and are therefore free to take days off at their own discretion. However, they are typically not granted any compensation for such time off, as they only get paid for services effectively rendered.
Paid sick leave
In case of incapacity to work due to illness, employees remain entitled to receive their
remuneration from the employer for a term of up to six weeks pursuant to the German Act on Continued Remuneration (Entgeltfortzahlungsgesetz – EFZG). This covers both
fixed remuneration as well as any variable remuneration such as bonuses. Under certain conditions, this entitlement applies several times per year, e.g. if the employee was healthy to work for a period of at least six months in between two instances of illness.
The German Act on Continued Remuneration does not cover independent contractors. However, with regard to § 616 German Civil Code (Bürgerliches Gesetzbuch – BGB) an independent contractor may claim compensation in case of incapacity to render his services for personal reasons, e.g. illness. However, this provision covers only a short period of time, generally less than a week, and its application may be excluded by the parties. As a general practice in Germany, independent contractors are not granted any compensation for sick leave at all.
Many employers in Germany grant additional benefits to their employees that are not mandatory, e.g. holiday allowance, Christmas allowance or surcharges for overtime work or work rendered on Sundays or statutory holidays.
Independent contractors, on the other hand, typically do not receive any such special allowances. Their remuneration usually exceeds the average salary of a comparable employee and no additional benefits are granted.
d. Differences in Protection from Termination
The difference regarding the termination of an independent contractor and an employee is extensive. Whereas an employee in general may only be terminated for a valid reason, an independent contractor may be terminated without cause, observing a contractual notice period.
Employees’ protection against dismissal is divided into general and special protection. Special protection is provided to employees who generally face greater detriments in case of a dismissal, such as handicapped or pregnant employees. In such cases, the permission of relevant government authorities is required prior to issuing a termination. Also, employees who act as employee representatives, such as a member of a works council or data privacy officers, enjoy special protection against dismissal.
As to the general protection, the freedom of the employer to dismiss an employee is substantially restricted by the German Act on Protection Against Unfair Dismissal (Kündigungsschutzgesetz – KSchG). The act applies if:
- a business establishment generally employs more than ten employees and
- if the employee has worked in the same company or business establishment for six months without interruption.
Under the Act on Protection Against Unfair Dismissal, a termination of employment by the employer is only legally effective if it is reasonably justified. Generally, a termination is only justified if it is based on grounds related to the person (e.g. impairments, lengthy or frequent illnesses) or the conduct (breach of contract) of the employee, or where compelling operational reasons, which preclude the continued employment of the employee in the business, exist.
Termination of an employee is generally subject to a notice period. Its term is governed by statutory law and ranges from two weeks to seven months on a sliding scale, contingent upon the duration of the employment relationship. The parties may agree to a prolonged term of the otherwise applicable statutory notice period.
In contrast, the contractual relationship with an independent contractor may generally be terminated for virtually any reason or no reason, except if the termination violates the principle of good faith. Parties may agree on specific reasons that need to be on hand to effectively terminate the contractor.
Termination of an independent contractor is generally subject to a notice period. In the absence of a provision in the contract, the term of the applicable notice period is based on the applied reference period for the payment of the agreed remuneration and varies between one day and six weeks to the end of a quarter. However, it is common to agree on a notice period of one month to the end of a calendar month in the contract.
Both employment relationships and relationships with independent contractors may, in case of severe breach of contract, be terminated for cause with immediate effect by the affected party.
e. Local Limitations on Use of Independent Contractors
There are no limitations on the use of independent contractors in Germany.
f. Other Ramifications of Classification
Other ramifications of the distinction between employees and independent contractors mainly relate to their scope of protection during the contractual relationship.
For example, most of the safety regulations, e.g. regarding the prevention of accidents at work, are only applicable to employees. Also, employers must abide by working time regulations for their employees, which do not apply to independent contractors.
Furthermore, employees enjoy limited liability regarding their work performance in case of normal negligence, while an independent contractor is generally fully liable in relation to his services.
Finally, the legitimate interests of employees are represented by a works council, who is not competent for the interests of independent contractors as they are not part of the workforce in its strict sense.
g. Leased or Seconded Employees
Under German law, it is possible to lease employees to another employer. In order to legally operate, the lessor (temporary employment agency) must hold an administrative permission, and the deployment of temporary agency workers must always comply with the requirements set forth in the German Act on Employee Leasing (Arbeitnehmerüberlassungsgesetz – AÜG) and other applicable law. Where a lessor does not hold said permission, any temporary agency worker deployed by him may claim full employment with the corresponding lessee.
As a general rule, the lessor is obligated to grant his employees (the temporary agency workers) the same fundamental conditions of employment that apply to comparable regular employees at the lessee’s. This fundamental principle of German and EU legislation can be deviated from if the lessor applies a collective bargaining agreement for his employees. In the vast majority of cases, such collective bargaining agreements apply.
The main advantage of employee leasing is flexibility: temporary agency workers are not considered regular employees of the lessee/principal. As such they are not subject to dismissal protection, and therefore the principal can react quickly to a reduction of the work load and without further redundancy costs applicable in case of a restructuring process by cutting temporary agency workers. Vice versa, in case of an increased work load or in case specialized personnel are needed, employee leasing can be a useful option to increase the workforce without significant hiring costs.
Of late, costs have become more an issue than an advantage, as employee leasing is subject to a statutory minimum wage and the tariff-level is on the rise. Highly qualified temporary agency workers are usually more expensive than one’s own regular employees anyway.
Strictly to be distinguished from employee leasing is the use of a contracting firm to fulfill certain services within the principal’s business operation, e.g. facility management, cleaning services, operation of catering or canteen services, etc. The contracting firm will usually employ its own employees to perform the agreed services. When engaging a contracting firm, the principal must refrain from acting as the actual employer of the contracting firm’s (i.e. external) employees. Otherwise, such use of a contracting firm may be considered as disguised employee leasing; its employees may then claim full employment with the principal. In order to assess whether a principal acts as the actual employer, the criteria to determine a contractor as an employee apply mutatis mutandis.
The distinction between employee leasing and use of a contracting firm is currently a very hot topic in Germany, and often principals are not aware of this issue. However, risks are major as imprudent principals may end up employing regular employees they never wanted on their payroll.
In April 2017, certain sections of the German Act on Employee Leasing will be amended. One of the main consequences of the amendment is the limitation on employee leasing: leased employees may only be employed by the same employer for 18 months. However, after a waiting period of three months, the employer is entitled to lease the employee again for another 18 months. This is likely to further affect the practice of employee leasing.
h. Regulations of the Different Categories of Contracts
Under German law, both contracts with independent contractors and contracts with employees are in substance service agreements. Therefore, both types of contracts do have the same roots and resemble each other. Both are subject to German civil law, mainly set forth in the German Civil Code.
However, as employees are historically regarded as more vulnerable, there are many special legal regulations that protect employees’ rights and do not apply to independent contractors. Many of these protective regulations constitute a mandatory minimum and cannot be replaced by the parties to an employment contract. However, the terms and conditions of employment contracts, especially remuneration and benefits, are widely set and governed by collective bargaining agreements rather than by legal regulations.
As for independent contractors, there are scarcely binding rules regarding terms and conditions of their engagement.