Independent Contractor Misclassification in Europe: What You Need to Know
Independent contractor misclassification presents serious risks for companies. Treating individuals as independent contractors while they perform the function of a full-time employee is an illegal business practice that many governments are beginning to recognize and penalize companies that make this misstep.
Eurofound conducted a research report on fraudulent work contracting in 28 EU member states, including Norway. According to the report, 79 percent of the national correspondents reported a ‘significant’ fraudulent use of self-employment. Understanding independent contractor misclassification and constantly changing government reforms is key to avoid significant penalties.
IR35: the UK government’s solution to independent contractor misclassification
The UK government introduced the tax legislation IR35 in the year 2000. This tax legislation aimed to address how contractors were leaving employee roles and forming limited companies, also called Personal Service Companies (PSCs). This was mainly done because working via a PSC enabled contractors to be taxed with all the advantages of a business, rather than as employees.
As per the latest announcement by the UK government, the changes to IR35 have come into effect as of April 2021. From then on, workers who don’t meet the criteria for being self-employed will fall inside IR35 rules. And it’s the responsibility of the company to ensure their contractors aren’t misclassified, or face missing taxes, interest and related penalties.
The gig economy and employee misclassification
In recent years, the gig economy has thrown the subject of independent contractor misclassification into the news — and into the courts. As more and more people turn to contract workers for their rides, housecleaning, dog walking, meal and grocery deliveries, and other services, questions of how to treat those workers legally become more pressing.
Like other European countries, the UK has seen new laws that require employee classification for certain workers. For example, a new law requires Uber to classify its UK drivers as employees rather than self-employed contractors.
UK Uber drivers must now receive at least minimum wage for their hours worked. They are entitled to holiday pay as well as social security benefits through employer payroll contributions. Uber has also had to set aside millions of pounds to resolve back pay claims for its misclassified drivers.
In its ruling, the UK’s Supreme Court considered a few different factors related to driver autonomy and subordination:
- Predetermined fares and contract terms: Uber set all ride prices, dictating how much drivers could earn for their work. Uber also set 100 percent of its contract terms, giving drivers no input into them.
- Discipline and penalties: Uber could penalize drivers for canceling too many rides, giving drivers no option but to accept all rides assigned to them if they wanted to maintain good scores.
- Oversight and termination: Uber regularly monitored its drivers through the star rating system passengers used. It had the authority to give drivers warnings and fire them if performance did not improve.
The Supreme Court determined that these circumstances gave Uber too much autonomy over drivers for them to be considered self-employed. This notion provided the basis for the ruling that Uber must treat its drivers as employees rather than contractors.
Other European countries have ruled likewise, requiring employee classification for certain gig workers like delivery riders and Uber drivers. In general, companies employing full-time contractual workers may need to assess and update their hiring models to ensure compliance with the law.
Tightening contractor laws across Eastern Europe
What other European countries are revising their independent contractor misclassification laws?
1. Serbia: The independent contractor test
At the National Assembly, the Serbian government proposed numerous changes to the personal income tax and social contribution laws, which took effect in January 2020. Of the many changes proposed, “the taxation of entrepreneurs engaging in service contracts with one employer” gathered the most attention. It led to the introduction of a new independent contractor test. Entrepreneurs who fail to pass the test will be subject to higher taxation.
Many software professionals and entrepreneurs are granted the lump-sum taxation status in Serbia. This ensures that income tax and social security contributions are not paid based on real income, but on a statistical average monthly wage. The proposed new independent contractor test will apply to working professionals and entrepreneurs who benefit from the lump-sum taxation scheme as well.
If they do not pass the independent contractor test, they would be subjected to higher taxation. The test will be applicable to each individual income stream. Workers benefiting from the lump-sum taxation would be required to pay both the lump-sum tax and special income tax on the income that failed the test. This reform is set to affect the Serbian IT industry — by far the largest economy in the western Balkans.
2. Poland: Crackdown by the national labour inspectorate
Almost 19 percent of people in the Polish economy are self-employed. Poland also ranks fifth among the European Union member states in terms of self-employment share in the total workforce numbers. Workers who provide a high level of skill and expertise while operating in a freelance capacity are also widespread.
In recent years, the National Labour Inspectorate has sought to re-establish the relationship contractors have with companies. The inspectorate has been given the right to ask control questions to employers who post their workers to Poland, and also to Polish companies posting their workers to other EU countries. If no convincing answer is sought, the company is liable to a fine of up to PLN 30,000 by the National Labour Inspectorate.
3. Hungary: The burdensome contractor relationship
The employment relationship is becoming increasingly burdensome — both administratively and financially — for companies in Hungary. Employers might be tempted to disguise employment relationships as independent contractors — a move which can result in severe financial penalties by courts.
Hungarian courts use several primary and secondary factors to determine whether the relationship is that of employment, or independent contractors. The major primary factors include personal working obligations, regular employee availability, and hierarchy between the parties. Severe financial sanctions may be applied if employees have been disguised as independent contractors.
Tax authorities, labour authorities, and Hungarian courts have the power to re-classify independent contractor contracts as employment contracts. However, the independent contractor and principal would have to pay all contributions and taxes, along with default interests and penalties.
4. Romania: Notorious tax legislations
The Romanian fiscal code has laid down dependent and independent activities to clearly differentiate employment income from independent contractors. Since 2003, Romanian IT workers have enjoyed zero income tax — a move to boost the IT sector throughout the country. This led to a decrease in independent contractors within the IT industry. However, as of January 2020, the Romanian government said that the IT industry’s zero income tax could soon come to a halt — which could again lead to an increase in the number of independent contractors.
In addition, the Romanian tax system is known to be notoriously complicated. The combination of a complex legal system and more serious penalties for individuals who evade taxes makes compliance even more crucial while contracting in Romania.
The differences in legal status between workers having an employee status versus independent contractors could lead to situations wherein companies use different contracts to suit their own needs, without properly protecting their workers.
5. Spain: New protections for delivery workers
In considering whether workers are employees or independent contractors, Spain generally uses criteria like individual autonomy and contractual documentation. Workers who have the freedom to choose when, where, and for whom they work are typically contractors, while those who do not are generally employees. Workers generally have formal employment contracts, while contractors do not.
Workers classified as independent contractors must pay social security fees to receive benefits like public pension or unemployment subsidies. They are also responsible for their entire tax burden because employers do not withhold anything in payroll taxes. These requirements can cause financial hardship for contractors.
As in the UK, one recent change to Spanish law involves the classification of gig workers such as delivery drivers. In 2021, the government implemented a landmark law to combat employee misclassification by requiring delivery platforms to hire the workers currently working for them on a contract basis.
Under the new law, companies must draft and sign employment contracts with these workers and treat them as employees. They must pay payroll taxes, so the employees will receive social security benefits and will not be responsible for their entire tax burden every year.
The new law resulted from negotiations between industry associations and Spain’s major workers’ unions. Currently, it applies only to delivery drivers and riders and not to other gig economy workers, such as personal care attendants and housecleaners. However, other companies employing contractual workers will need to keep an eye on legal changes that may apply to them.
The new law also requires increased transparency surrounding the artificial intelligence (AI) these platforms use to manage their workforces. All platforms must now provide workers’ legal representatives with details about how AI processing systems and algorithms assign jobs to workers and evaluate their performance. Ideally, this requirement will result in more equitable employment practices.
6. The Netherlands: Employee status for delivery riders and Uber drivers
The Netherlands has recently implemented a law designed to minimize misclassification of employees by classifying Uber drivers as employees.
Previously, Uber drivers in the Netherlands were independent contractors, or self-employed. The Uber platform did not withhold taxes or pay into social security funds on the drivers’ behalves. Now, an Amsterdam court has ruled otherwise, paving the way for drivers to see more benefits and lower their tax burden.
The new ruling means the provisions of collective labour agreements, including wage requirements and certain benefits, now apply to Uber drivers. In some cases, Uber may also have to pay back wages to the drivers it previously misclassified as contractors.
The Netherlands has also ruled that delivery riders with the platform Deliveroo cannot be classified as contractors. The delivery riders are now payroll employees, entitled to employee wages and certain benefits.
In making its determination in the case of Uber drivers, the court considered three main elements — wages, work, and authority. Specifically, it evaluated the driver ranking system and the use of algorithms in assigning the drivers work and determining the price for each ride. The drivers had no say in their routes or the fares charged for them.
The court found this relationship gave the Uber platform significant authority over the drivers. The drivers were, therefore, employees, rather than contractors working for themselves.
Beyond fines and penalties: Additional benefits of providing full-time employment
In a world where highly qualified talent is hard to find, companies should focus on providing stability for their employees. The consequences of misclassifying contractors are not limited to the realm of employment law, but more about protecting a crucial organizational asset in the longer run — your workforce.
Some additional benefits of providing employment instead of contractor work include:
- Lower turnover: Misclassified workers may soon leave a company to gain more favorable compensation and benefits. Employees with benefits, competitive salaries, and job security, on the other hand, are more likely to stay for the long term. When you hire more employees or convert existing contractors into employees, your company will likely see higher retention rates.
- Improved skill building: Workers who stay with your company as permanent employees have much more opportunity to learn new skills and hone existing ones. They’ll develop their talents in the areas that will most directly benefit your business, and they will learn to use their skills to boost your company’s growth and profits over time.
- Improved workforce unity: Independent contractors or self-employed workers often receive less company training and guidance than employees. They may not have enough sense of your company culture or know other workers well enough to function optimally on teams. Long-term employees get to know your company and their colleagues well enough to help you develop a cohesive company culture.
- Valuable project continuity: With contractors, you may have one team working on one part of a project and an entirely different team working on another. Or you might have one team working on an initial project and then another working on an upgrade two years later. With permanent employees, you are more likely to have holdovers from one project to the next who can provide valuable insights and ensure consistency.
- Boosted workforce morale and productivity: Because they often work over shorter periods and receive fewer benefits, contractors may feel less engaged in your company than employees do. Employees, on the other hand, are likely to feel appreciated by and invested in your company. These positive perceptions can quickly translate into more productive work. Studies by Gallup in the U.S. show that highly engaged teams generate 21 percent more profitability than others.
How Globalization Partners can help solve contractor misclassification troubles
If your company needs to retain a contractor across the European Union, but you’re overwhelmed by the intricacies surrounding labour laws, you can get in touch with Globalization Partners. We have a physical, on-the-ground presence around the world and can act as your Employer of Record (EOR) in more than 187 countries.
We can help you establish a capable, legally compliant infrastructure for accounting, legal counsel, HR, and IT. Our comprehensive solution allows you to handle administrative processes in one easy-to-use interface.
If you’re worried whether your contactors are classified properly or not, download our quick guide The Cost of Contractor Misclassification to learn more.
Get in touch with Globalization Partners if you want to retain employees compliantly or have plans to expand internationally.
