DRV takes a closer look at one-man shops

The correct classification of legal relationships as employment relationships or self-employed activities regularly occupies both business practice and jurisdiction. For years, the correct classification of legal relationships between customers and freelancers has been a particularly important issue in the corporate landscape. It is not uncommon for freelancers who were hired as self-employed workers to turn out to be employees after years of cooperation. Only recently, for example, the Federal Labor Court (BAG) issued a landmark ruling on the employment of crowd workers (Ref.: 9 AZR 102/20).

With the reform of the Temporary Agency Work Act (AÜG), the focus of the German Pension Insurance (DRV) shifted towards checking three-person relationships for misclassified self-employment. In particular, it examined in more detail legal structures where companies used subcontractors of a service provider as regular workforce and did not declare the relationship properly as agency work. As result, if the subcontractor was treated as an employee, a misclassified employment relationship between the subcontractor and the customer came into effect. The fact that the subcontractors were not considered employees by the service provider was irrelevant, as since April 1, 2017, it is sufficient for the establishment of an employment relationship pursuant to Sections 9 (1) no. 1 a, 10 (1) AÜG that the deployment of a temporary worker is not properly documented. Such a misclassification may even have consequences for the customer under criminal law.

However, this legal consequence did not apply to managing directors who are sole shareholders of the service provider. The Federal Labor Court decided (BAG of 17.1.2017 - 9 AZR 76/16) that the managing director of a subcontractor or a service provider cannot hire himself out as a temporary agency worker. Those who assumed that the establishment of a one-man shop could eliminate any risk with respect to misclassification were now proven wrong by the Federal Social Court.

Federal Social Court: Criteria for classifying employees subject to social security also apply to service contracts with a one-man shop

The Federal Social Court has now ruled in all three cases that the legal relationship with a one-man shop is to be classified as an employment relationship subject to social security contributions between the customer and the managing director and sole shareholder of the service provider/subcontractor, even though there is no legal relationship between the managing director and the customer. Specifically, two of those cases involved care services in a hospital and another case related to a consultancy service. In each instance, the services were provided solely by the managing director of the respective company who was – at the same time – the sole shareholder of the company.

The reasons of the decision have not yet been published, but only a press release. It seems, however, that the Federal Social Court did scrutinize the factual circumstances and relationship between the managing director and the customer, although an explicit agreement between these parties has never been concluded and was also not established by operation of law. The Federal Social Court made clear that the criteria for classifying employees subject to social security also apply to service contracts concluded only between a customer and a one-man shop. This means that the actual performance of the legal relationship is decisive for the classification of the activity as an employment relationship. Whether the contractual relationships with the one-man shops constitute an unlawful circumvention of the law, as the lower courts have ruled in some cases, is not yet known.

Therefore, it seems that the following usual criteria for the classification of contractual relationships as employment relationships also apply to the assessment of contracts with one-man shops. Criteria which might indicate that an employment relationship exists, are inter alia: 

• Low complexity tasks
• Integration of the managing director into the business unit of the customer
  • Close collaboration with employees of the business unit
  • Working together as team members of the employee
• Working on-site
• Using/working with operating resources of the customer
• Remuneration per time and not per product
• Giving instructions to or receiving instructions from employees of the customer
• Performing work which is usually done by the customer's employees
• Involvement in daily business tasks
• Managing director is engaged because of capacity bottlenecks (such as seasonal demand, employees on sick or parental leave, interim position)
• Work product of the managing director cannot be distinguished from work product of the customer and/or its employees

What are the consequences of a misclassification?

If the managing director of a subcontractor/service provider is reclassified to be an employee of the customer and provided that the case law of the fiscal courts follows the view of the Federal Social Court, the customer/employer will be liable for:

• Wage tax which was not paid
• Input tax deductions which should not have been made and must be reimbursed
• Social security contributions. In contrast to taxes, the employer can usually not take recourse against the employee and to bear both, the employee's and the employer's portion to social security contributions which can amount to 40% of the gross amount be paid. Furthermore, the employer can be liable for late payment fine of 1% per month.
• Depending on the circumstances at hand, even criminal liability of the managing directors of the customer/employer

How to deal with the risks of misclassification?

Prior to engaging a service provider the customer has the possibility to ask the competent authority to assess the relationship with the service provider. Alternatively, the customer can establish its own system for the correct classification of legal relationships. With regard to one-man shops, the reasons for the decision of the Federal Social Court must first be awaited and analyzed to determine which concrete measures are necessary. However, customers should already apply the general test criteria for the classification of employees to contracts with one-man shops, if they rely on their own compliance system.

If the customer does not use its own compliance system or the status assessment procedure, the customer runs the risk, on the other hand, of even being accused of "conditional intent" with regard to misclassification and thus a criminal offense.

Click here to access the German version.