RUS
А+ | А-
Home | Insights | What threats can be faced by businesses engaging freelancers
25.07.2021

What threats can be faced by businesses engaging freelancers

Maintaining engagement of self-employed persons (aka freelancers) may help businesses to reduce their tax burden. However one should be aware - Marina Abramova (Andrey Gorodissky & Partners) warns – that if the company fails to ensure appropriate formal documentation for such relationship, it will have to pay fines

It makes good sense for businesses to engage self-employed persons as they themselves are responsible for all profit tax issues, being VAT exempt, and payments to them are recognized as expenses of the company who engages them. There are however some nuances which employers should be aware of.

Who are self-employed and where they can work

The term “self-employed” does not appear in the Federal Law “On experimental introduction of the special self-employment tax regime” dd. November 27, 2018, No. 422-FZ (“Law”). Still, the term is widely used by tax authorities and in the subordinate legislation to identify individuals who have shifted to payment of the self-employment tax and got recorded themselves as payers of such tax.

This status is economically attractive as its holders are eligible for lower tax rates (4% on income received from individuals and 6% on income received from legal entities and individual entrepreneurs) and they are not required to provide reporting documentation or use cash register machines.

However, not everyone can be eligible for the self-employment tax. According to Article 4(2) of the Law, registration of self-employed status and, accordingly, engagement or hiring by a company or individual entrepreneur of a self-employed person subject to tax benefits are not allowed for the following types of business:

  • Sale of alcohol, tobacco products, cars, motorcycles, petrol and all other goods subject to excise tax (listed in Article 181 of the Russian Tax Code), as well as perfumes, leather garments, outer garments, footwear, certain food products and all other goods requiring identification marks (as per the list approved by the Order of the RF Government dd. April 28, 2018, No. 792-р);
  • Wholesale, retail, i.e. re-sale of goods or property rights;
  • Production, sale of mineral resources;
  • Entrepreneurial activities to the benefit of another person under a commercial mandate agreement or commission agreement or agency agreement.

The Law allows self-employed persons to provide courier services to others, provided that they should have a formal sales receipt or a cash register machine dully recorded by the seller.

Individuals who apply any other tax regime or are engaged in entrepreneurial business subject to individual profit tax are not eligible for the self-employment tax. Furthermore, an individual forfeits the right to apply the self-employment tax if and when his income subject to such tax reaches RUB 2.4 mln during a calendar year.

The Law however allows an individual to work under an employment agreement and at the same time be engaged and receive income as a self-employed person. His income under the employment agreement is subject to the individual profit tax and insurance contributions which are generally applicable, and is otherwise eligible for the self-employment tax.

Nuances for companies

Companies engaging self-employed persons should take into consideration all the above-mentioned reservations. Apart from that, they should also be aware that their relationship with freelancers is purely civil-law relationship (not employment relationship). So, such relationship should be formalized in an agreement subject to requirements of civil legislation for relevant types of agreement and the written form requirements for transactions.

Substitution of a civil-law agreement for employment relationship is not permitted, and if controlling authorities find hat the existing relationship between a company and a self-employed person is in fact an employment relationship, the company would face adverse financial implications, such as additional insurance contributions, penalties and fines, including those for the failure to withhold the individual profit tax. Furthermore, the company would face the risk of being held administratively liable for violation of the employment legislation, which may lead up to an administrative order to suspend its business operations.

A very important distinction between an employment relationship and a civil-law relationship is that an employee should perform a job function, i.e. work in a certain job position under the employer’s control, get on-boarded with the company’s organization and receive scheduled salaries. Thus, while an employment relationship is more process-oriented, it is typical for a civil-law relationship to be aimed at a certain performance result, such as work done.

In practice, for tax authorities and labor inspectors, the fact that a self-employed person provides services just to one organization and nobody else can be regarded as an element of an existing employment relationship. A distinctive feature of a civil-law agreement is that the contractor receives under it piecework remuneration based on the result of work done and not scheduled recurrent payments such as salary payments.

When taking a decision to enter into a civil-law agreement instead of an employment agreement with an individual, the company should clearly see what result it expects from the cooperation with such self-employed person and make sure that the activity concerned does not conflict with applicable legislation and the individual has the status of self-employed. For this purpose it is necessary to ask him to present a self-employed registration certificate and check his details on the website of the Federal Tax Service.

Important: If a company replaces an employment agreement with a civil law-agreement with an individual, during two subsequent years the company’s payments to such individual under the civil-law agreement will not be eligible for the above-mentioned tax benefits. Obviously, this legal provision is aimed at keeping employers from encouraging their employees on payroll to get themselves registered as self-employed.

Finally, it is important of an employer to get a payment receipt from a self-employed person. Otherwise, the remuneration paid to him will not be recognized as expense for the purposes of the company’s income tax base. Similarly, payments to a self-employed person will only be exempt from insurance contributions if the company can submit relevant payment receipts issued by the self-employed person.