The amendments to the Labour Law during 2014 have significantly changed the economic environment and relations between an employer and an employee. The practice which had been developing in Serbia in the years to come was that the employers do not conclude the Contract of employment with the natural persons; rather the natural persons would register as entrepreneurs, and as such would conclude the Contract for the provision of services to the Ordering party (employer).
Legal tax optimization was one of the aims of such a business-legal solution since, in this way, the taxes and contributions are greatly lower (particularly in the case of lump-sum taxation) compared to obligations regarding taxes and contributions on salaries. This business-legal optimization solution is especially widespread in the IT industry.
In December 2019, the National Assembly of the Republic of Serbia adopted the amendments to the Personal Income Tax Law, which introduces, among other things, the entrepreneur independence test. One of the aims of this amendment to the above-mentioned Law is to make a distinction between an “independent“ and “dependent“ entrepreneur, by taxing a “dependent“ entrepreneur’s income from the services he or she performs for an unofficial employer at a greater rate than an “independent“ entrepreneur’s income from their own self-employment activities.
The independence test for the entrepreneur has been applied since March 2020.
The following entities are subject to the independence test:
- Entrepreneurs registered in the Business Registers Agency (Serbian: APR) who keep business records (books) and pay personal income tax according to the actual profit
- Entrepreneurs registered in the APR who pay personal income tax according to the lump-sum rate income (so-called lump-sum tax entrepreneurs).
Legal entities, natural persons, entrepreneurs, lump-sum tax entrepreneurs, that is, anyone who hires another entrepreneur, is considered the Ordering party. This provision of the Article 85 of the Personal Income Tax Law also applies to the related parties – that is, when one entrepreneur is hired by several entities which comprise the related parties. Both domestic and foreign legal entities are considered the Ordering party, as well. This provision also covers those entrepreneurs who provide services to foreign Ordering parties who do not have a registered entity in Serbia.
The entrepreneur independence test is a test comprised of 9 criteria which is used to determine whether the taxable entrepreneur or lump-sum tax entrepreneur is dependent or independent in their work in regard to the other partner (Ordering party). In order to prevent the exploitation of the potential of taxation, the Tax Administration of the Republic of Serbia conducts this test on each contractual connection between the Ordering party and the entrepreneur.
The entrepreneur independence test has nine requirements that must be met. The Tax Administration evaluates the independence of an entrepreneur based on the answers to 9 questions that comprise the independence test.
Therefore, the answer to these 9 questions determines the independence of the entrepreneur, and the questions are as follows:
- Who determines the working hours and vacation?
The Ordering party determines the entrepreneur’s working hours, or the entrepreneur’s vacation and absences depend on the Ordering party’s decision, and the entrepreneur’s compensation is not reduced in proportion to the time spent on vacation.
- Who chooses the place or determines the places where the tasks entrusted by the employer are performed?
The entrepreneur usually uses the premises they provide or performs work in the place designated by the Ordering party for the purposes of performing the work entrusted to him or her.
- Who organizes professional training or development?
The Ordering party conducts or organizes professional training or development of the entrepreneur.
- When and how did the Ordering party hire the lump-sum entrepreneur?
The entrepreneur was employed by the principle after the principal advertised in the media the need to hire natural persons or by employing a third party whose service led to the hiring of that entrepreneur.
- Who provides the basic tools, equipment or other basic tangible or intangible assets needed for the regular work of the entrepreneur; who finances their procurement; who manages the work process??
The Ordering party provides their own basic tools, equipment or other basic tangible or intangible assets needed for the regular work of the entrepreneur or finances their procurement, except for specialized tools, equipment or other specialized tangible or intangible assets that may be necessary in order to perform a specific job or order, or the Ordering party usually manages the work process of the entrepreneur, except for such management which implies giving a basic order in connection with the ordered work and reasonable control of the work results or supervision of the Ordering party, as a good businessman, over the performance of the work he ordered.
Does the lump-sum tax entrepreneur/entrepreneur earn 70% of the income from one Ordering party during the 12-month period?
One Ordering party contributed at least 70% of the entrepreneur’s total income that was achieved over the course of the 12 months that started or ended with the relevant tax year.
- Who bears the risk for the work performed under the Temporary Service Agreement?
Even if the necessary work provided to the Ordering party comes from the Ordering party’s business activities, the Temporary Service Agreement between the Ordering party and the entrepreneur does not contain a clause stating that the entrepreneur would bear the customary risk for the work performed.
- Is the lump-sum tax entrepreneur limited by the Temporary Service Agreement to providing services to other Ordering parties, the so-called non-competition clause?
The Temporary Service Agreement for the entrepreneur either contains a partial or complete prohibition of the entrepreneur to provide services based on contracts with other Ordering parties, with the exception of a partial prohibition that includes the provision of services to a limited number of direct competitors of the Ordering party.
- Does the lump-sum tax entrepreneur / entrepreneur work for one employer for more than 130 days in a 12-month period within a year?
An entrepreneur performs activities for a compensation for the same Ordering party, continuously or with interruptions for 130 or more working days in a 12-month period that begins or ends in the respective tax year, where performing activities in one working day is considered performing activities in any period during that working day between 00:00 and 24:00.
In order for an entrepreneur to be evaluated as dependent in relation to the Ordering party, at least 5 of these 9 criteria must be met.
The fact that the entrepreneur is dependent according to one, two, three or four criteria in relation to one Ordering party does not make him or her dependent in that relationship.
When an entrepreneur “fails“ the independence test, that is, in the scenario of determined dependency of the entrepreneur, the income that such an entrepreneur receives from the Ordering party is taxed as follows:
– Tax on other personal income at a rate of 20%;
– Contributions to pension and disability insurance (Serbian: PIO) at a rate of 25%
The basis for calculating taxes and contributions will be the gross amount of compensation, without deduction for recognized expenses. Both this tax and the PIO contribution are the responsibility of the employer. If the competent tax authority determines that there is dependency of the entrepreneur, it will oblige the Ordering party to pay tax and contribution for PIO, together with interest. Interest is calculated in accordance with Article 75 of the Law on Tax Procedure and Tax Administration.
However, if the entrepreneur receives income from a foreign legal entity and his dependency is determined, the entrepreneur is obliged to determine and pay tax and contribution to PIO based on that income (20% for taxes, 25% for contributions). He or she must also submit a tax return on Form PP OPO.
In order to avoid double taxation, Article 37v of the Law stipulates that taxable income from self-employment shall not include income that is taxed in accordance with Article 85, paragraph 1, point 17) of the Law, and which is earned by a taxpayer on actual income from self-employment.
The employer, after establishing the entrepreneur’s dependency, can continue to hire him or her. The condition is to hire him or her under the Contract of employment, the Temporary Service Agreement, etc.
The independence test for the entrepreneur who works with foreign Ordering parties
In practice, doubts often arise regarding the obligation to conduct the independence test in cases where the entrepreneur is registered in Serbia in the APR, as we have already said, regardless of whether he or she is a lump-sum tax entrepreneur or not, and provides services for compensation to a foreign Ordering party (a non-resident legal entity).
In the scenario when a domestic entrepreneur or a lump-sum tax entrepreneur provides services for compensation to a foreign Ordering party, there is an obligation to conduct the independence test. It does not matter that in such case the Ordering party is a foreign legal entity. The entrepreneur is obliged to conduct the independence test in relation to the foreign Ordering party.
Starting from March 2, 2020, the entrepreneur as a natural person will be required to pay for all fees received on that basis from the foreign Ordering party if, based on the results of the conducted independence test, it is determined that the entrepreneur meets at least five of the nine prescribed criteria in relation to the foreign Ordering party. The entrepreneur will also be required to submit the tax return PP OPO form on the basis of which he will determine and pay the following:
– Tax on other personal income at a rate of 20% (without the right to recognized expenses) and
– Contributions to PIO at a rate of 25%.
If our income were $1,000, for instance, a 20% tax would be $200 and a 25% PIO contribution would be $250, leaving us with €550 after taxes and contributions. The sum of €450 is pretty substantial, and anyone in this circumstance should investigate the profitability of this kind of enterprise. It is also vital to consider the potential liability of the yearly personal income tax.
Possible solutions of the independence test
- When it comes to the relationship between an entrepreneur and a domestic Ordering party, i.e. employer, one of the simplest solutions is the Contract of employment, where there is the possibility of using prescribed tax relief
- When it comes to the relationship between the entrepreneur and the foreign Ordering party, we believe that the most profitable option is the transfer of the entrepreneur to an LTD (Serbian: DOO)
The Creative Finance team is available for any inquiries and helping you find the best solution, no matter what circumstance you are in as an entrepreneur, local Ordering party, or an Ordering party from another country.