Digital transformation has gained traction in recent years and affects employment relationships more than ever. The emergence of the so-called platform economy is certainly the epitome of this development. However, new technologies and methods of collaboration also need to comply with legal requirements.
At the end of 2020, the Federal Labour Court (FLC) likely turned the platform business model upside down, when the judges decided that a crowdworker using a platform’s app on a freelance basis was actually an employee. The case is known as the “Crowdworker Case” and attracted a lot of attention, especially because the lower instance courts had previously declined the status of the crowdworker as an employee. The FLC’s decision has the potential to radically change business models of platform service providers in Germany.
This article describes the relevant criteria to determine the status of a worker in Germany and outlines the facts of the Crowdworker Case as well as how the FLC’s approach might change status assessment in the future. It also describes the potential legal consequences of the misclassification of a contract. Apart from the establishment of an employment relationship, a company could face substantial payment obligations from a social security and tax law perspective if a freelancer is misclassified as an employee. Furthermore, without a robust compliance system, companies run the risk of being criminally liable for intentional misclassification.
Classification of employees and freelancers in Germany
The methodology of classifying employees/freelancers in Germany is similar to those in other countries. Whether the use of external staff results in a misclassification depends on the individual case. Unfortunately, it is often difficult to reliably assess the correct classification. According to case law in Germany, whether an occupation is carried out on an employed or self-employed/freelancer basis is decided within the framework of an overall assessment. The contractual arrangement and description of the activities in the contract is one important piece of classifying the contractual relationship, but not the decisive element. Rather, what is decisive is how the contractual relationship is implemented in practice.
In order to evaluate the relationship in practice, courts have developed — over recent decades — certain criteria which are relevant for assessing the status. The following example criteria indicate the existence of an employment relationship:
- complexity of the work;
- being integrated into the business unit of the company:
- close collaboration with employees of the business unit;
- working together as team members of the employee;
- working on-site;
- using/working with operating material of the company;
- being remunerated according to time and not per product;
- giving or receiving instructions to/from employees of the company;
- doing work which is usually done by the company’s employees;
- doing daily business work;
- being engaged because of capacity bottlenecks (such as seasonal demand, employees on sick or parental leave, interim position);
- producing a work product that cannot be distinguished from the work product of the company and/or its employees.
However, in the Crowdworker Case, although the Defendant tried to stick to the relevant criteria to lawfully engage the crowdworker as a freelancer, the FLC considered other criteria more important and came to the conclusion that the crowdworker was actually an employee.
The decision of the Federal Labour Court (01.12.2020 – 9 AZR 102/20)
Facts of the case
In the decided case, the Defendant provided services for product placement checks in retail stores and at gas stations. The Defendant used an online platform to perform these services. Customer requests were split up into micro tasks (“Micro Jobs”) and published on an online platform as individual job offers. Crowdworkers can register on this platform and accept these offers in return for payment.
The Plaintiff was such a crowdworker. After being given notice from the Defendant, the Plaintiff filed a complaint of unfair dismissal before the labour court. He was of the opinion that the underlying contractual relationship was not a freelance contract, but an employment relationship.
The contractual relationship between the Plaintiff and Defendant was regulated by a framework agreement which stated, amongst other things, the following:
- The contractual relationship between Plaintiff and Defendant is not an employment relationship.
- The Plaintiff is not bound by any instructions by the Defendant.
- The Plaintiff can freely decide to accept or decline offers.
- The Defendant can, but is not obliged to, offer Micro Jobs.
The Micro Jobs were published on the Defendant’s app. The app showed available Micro Jobs within a radius of 50 km of the current location of the Plaintiff. Even after acceptance, the Plaintiff was able to cancel the order without being exposed to any sanctions. If the Plaintiff accepted an order, he was obliged to complete the order within two to four hours. If the deadline lapsed, the order was cancelled and republished in the app. The remuneration for each Micro Job was rather low. However, the crowdworker was able to receive a higher salary by completing more jobs over time. Similar to a video game, the crowdworker was able to achieve higher levels and, by doing so, receive a higher salary. This concept of incentivizing crowdworkers to accept as many orders as possible was described as a “gamification piece” of the app by the Defendant.
Within eleven months the Plaintiff completed 2,978 orders. The orders mainly consisted of checks by acting as an ordinary customer at gas stations and taking pictures. The orders specifically stated the steps to take to complete the order.
Legal assessment of the FLC
In contrast to the previous instances, the FLC held that the service agreement was actually an employment agreement. Although the Plaintiff was not obliged to accept orders and was not bound by a set schedule of the employer, the FLC was of the opinion that the Plaintiff was personally dependent because of the low complexity of the Micro Jobs and the incentive system of the Defendant which encouraged its users to accept as many orders as possible.
The Micro Jobs were not complex, as the Plaintiff merely had to take photos of products and act like a customer. The Micro Jobs had a specific step plan on how the Plaintiff had to complete the job, so there was not much leeway on the Plaintiff’s side to complete the job. Even though the Plaintiff was able to accept, reject or cancel Micro Jobs, the FLC assumed there was a personal dependency between the Plaintiff and the Defendant due to the fact that it only made sense economically for the Plaintiff to accept jobs if the Plaintiff was able to achieve higher levels by accepting as many jobs as possible.
The FLC’s decision is noteworthy for two reasons. Firstly, the assessment that an employment relationship had been established was based on two criteria only. Secondly, the FLC introduced a new criterion which had not existed before: the incentive system.
Although the FLC decided on a very unique case, which cannot be used as precedent for all crowdsourcing platforms, the reasoning of the FLC certainly does not make compliant use of freelancers in the gig economy easier. The consequences of misclassification can be significant, from a financial and criminal law perspective.
Consequences of misclassification
A labour court deciding that a freelancer is actually an employee does not lead to the status as an employee from a social security or tax law perspective by operation of law. However, as the criteria for assessing a contract as an employment relationship are virtually the same from employment, social security and tax law perspectives, the assessment in one legal area that will most likely result in the same assessment in the other legal areas.
Although an employment relationship from a civil law perspective certainly increases financial liability (e.g. vacation entitlements, sick pay, etc.) and can also make it more difficult for the company to terminate the contract, far greater consequences result from social security and tax law.
Liability for social security contributions
If the freelancer is actually an employee of the company, the company has likely not paid social security contributions, so the employer is obliged to pay social security contributions. In most cases, the employer cannot take recourse against the employee with respect to social security contributions and this applies to both the employee’s and the employer’s portion of the social security contribution.
The social security contributions amount to roughly 40% of the salary amount (20% employee’s portion and 20% employer’s portion). In the case of intentional misclassification, the basis for calculating the social contributions usually doubles because the agreed salary is deemed to be a net amount by operation of law. Furthermore, the employer has to pay 1% of the monthly social security contributions as a late payment fine each month. It is not uncommon for the late payment fines to put affected companies at risk of insolvency.
Liability for wage tax
If the freelancer has been classified as an employee of the company, the company has likely not withheld wage tax from the remuneration paid to the freelancer. In such case, it is likely that the company as the employer will be held liable for wage tax due. Generally, the company can take recourse against the employee; however, it is often difficult to assert this claim in practice. If the company will not be able to take recourse against the employee, the wage tax paid by the company is treated as additional taxable benefit in kind subject to wage tax. Thus, the taxable amount has to be grossed up so that the company faces higher wage tax liability. In addition, the calculation of the wage tax amount due is typically made based on the most unfavourable tax class IV, which increases the wage tax liability even further.
The following example should illustrate the consequences:
- An intentionally misclassified freelancer was hired for a full calendar year and received EUR 19,608.00 in total. This amounts to EUR 1,634.00 gross per month.
- In the case of intentional misclassification, this amount will be considered as net payment, which needs to be grossed up adding applicable income tax. A monthly net amount of EUR 1,634.00 results in a gross extrapolated amount of EUR 3,703.77 per month based on tax class VI.
- This amount will be the basis for calculating the social security contributions, which are approx. 40% of the gross amount, i.e. about EUR 1,481.51 per month or EUR 17,778.12 for the entire calendar year. Again, if the freelancer were hired as an employee from the beginning of his/her activity on for a salary of EUR 1,634.00 gross per month, the company would only have been obliged to pay its portion of EUR 326.80 (= EUR 3,921.60 per year).
- In addition, the social security contribution amount of EUR 1,481.51 will be subject to a late payment fine of 1% per month, i.e. EUR 14.82 for each month per salary. After one year, the late payment surcharge is approximately EUR 1,155.00.
- The wage tax amount due will be EUR 2,069.77 per month or EUR 24,837.24 for the entire calendar year.
- In total, the company has to pay the originally agreed amount of EUR 19,608.00, social security contributions in the amount of EUR 17,778.12, late payment penalties in the amount of EUR 1,155.00 and wage tax in the amount of EUR 24,837.24, so almost five times more than if the company had hired the freelancer as an employee and processed the payments correctly. Again, the company cannot take recourse against the employee with respect to the social security contributions and late payment penalties, but only with respect to wage tax.
Repayment of input VAT
If freelancers are misclassified, VAT invoiced by them is not deductible, although the misclassified employees will owe the VAT. Thus, the employer must refund the wrongly claimed VAT (including interest) to the tax office. However, a recourse against the misclassified freelancer might be possible, but often difficult to implement in practice.
In addition to the financial risks, intentional misclassification is a criminal offence in Germany. The threshold for intent is quite low as so-called “conditional intent” suffices. Such conditional intent is fulfilled if the employer might have realized the possibility of a misclassification risk, but has nonetheless entered into the contractual relationship on a freelance basis. The authorities are very strict in this respect, as social security laws provide for a so-called status assessment procedure. The company may — prior to engaging a freelancer — ask the authority to assess the status of the freelancer. Therefore, courts argue that the company has had the chance to verify the status before entering into a contractual relationship. If the company has not used this possibility and has not implemented a compliance system which is as robust as the status assessment procedure, the authorities might argue that the company and its representatives acted with conditional intent.
Following the decision of the Federal Labour Court, platform providers and other companies that typically work with freelancers face increasing uncertainty in Germany. The classification criteria developed by the case law over recent decades might not apply in the same manner as before. It remains to be seen how this new case law will be developed further. For now, we recommend reviewing and, if necessary, adjusting the current business model, including the standard terms and conditions applicable to freelancers, to reduce the risk of misclassification.
Furthermore, contingent workforce and flexible working continue to be a dominant issue in the current employment landscape not only in Germany, but around the globe. The laws in this area are still evolving, as governments adapt to modern workforce models, which companies are increasingly engaging with in order to help ‘future proof’ their businesses.
Recognizing this issue, our multi-practice team of industry experts have come together to provide resources that guide organizations through the essential considerations and risks that come with these flexible working models and less traditional forms of worker engagement. We have created a multijurisdictional, interactive map and comparison tool that highlights the various areas of risk that companies should be considering when engaging contingent workers, covering employment, tax, social security and pensions. Click HERE and, with just a few clicks, find out answers to your questions, such as those regarding the main risks involved or the availability of a safe harbour for contingent workers from different perspectives in various countries in the EU.