In order to avoid paying 20% tax as well as the additional required contributions for social security, an entrepreneur (i.e. the owner of the sole proprietorship) needs to take appropriate steps to harmonize his business with the relentless hand of the tax administration of the Republic of Serbia. Amendments to the Law on Personal Income Tax of Serbia prescribe criteria for the independence test based on which the tax administration could determine whether an entrepreneur will be obliged to pay taxes and contributions, similar to the situation in which the entrepreneur is employed by his largest client or principal. It should be noted that the term independence test is a colloquial term. The law does not call it the test of independence, but in practice, this is the test of independence, so that name has become usual. The independence test attracted a lot of attention from freelancers and other entrepreneurs in 2020, when it was introduced in Serbia, but also in 2021. Thus, the independence test is a relatively new institute in the Serbian tax system. The goal of the state, when introducing the independence test, is to prevent the reduction of taxes and contributions of persons who are in practice employed by one client and work on paper as entrepreneurs with one client, so they could pay taxes and contributions much less than the employer (largest client) would pay if that person was employed by the largest client.
What is the independence test?
The test of independence of entrepreneurs, in general, is a set of the criteria prescribed by law, based on which the tax administration, in case of control, will determine whether the entrepreneur is in fact independent or his business depends on the largest client. Therefore, the tax administration applies the independence test to determine whether the entrepreneur is independent and the criteria of the independence test are prescribed by law and known in advance. The independence test is a special danger for entrepreneurs because it can make their business practically unprofitable.
When does the independence test apply?
The independence test applies exclusively to entrepreneurs, i.e. owners of the sole proprietorship in Serbia. If you are concerned about the independence test of a legal entity, e.g. LLC, you can immediately stop worrying since the independence test only applies to the entrepreneur. One of the ways to definitely pass the independence test is the re-registration as a one-person LLC instead of a sole proprietorship. However, the corporate income tax for LLCs is higher than the tax on income from the self-employment of entrepreneurs, i.e. sole proprietors. In addition, transferring money is incomparably more difficult from the bank account of a limited liability company than from the account of an entrepreneur, who in some cases does not keep books, so he has additional savings on bookkeeping. How entrepreneurs operate is particularly attractive, due to the small administrative burden and the fixed and predictable amount of tax. However, the sole proprietorship and its benefits have become less attractive to many because this new test of independence has been introduced. Therefore, entrepreneurs view the test of independence with suspicion. However, nothing revolutionary is prescribed, you just need to dedicate yourself to the topic and seek adequate legal advice. Therefore, in this text, we will focus on how to pass the test of independence as an entrepreneur.
In this text, we will skip the burdensome citation of the provision of the Law where the criteria of the independence test are prescribed. You can find a specific provision by searching the Law on Personal Income Tax, Article 85, paragraph 1, subparagraph 17. This text presents instructions on how to pass the independence test, in practical terms, for a layman.
What are the criteria for the independence test?
The criteria refer to the entrepreneur's relationship with the largest client. There are a total of 9 criteria, and an entrepreneur must pass a minimum of 5 criteria in order to be considered independent, and not be obliged to pay additional taxes. The criteria of the independence test apply equally to the entrepreneur who keeps books as well as to the entrepreneur that does not.
Now the key. Signing an appropriate written contract with the largest client and its application allows you to pass the independence test.
If an entrepreneur gets over 70% of his income from one client and if the entrepreneur works for that one client for over 130 days a year, the entrepreneur would think that he or she would surely fail the test of independence. This is not true. These two circumstances are only 2 of the 9 criteria of the entrepreneurial independence test.
The written contract prescribes the articles that indicate that the entrepreneur is independent, through the following 6 key contract clauses:
- The client does not assign working hours, absences, or vacations to the entrepreneur. So, if the biggest client determines working hours for you, as an entrepreneur, that indicates to the tax administration that you depend on him a lot.
- The client does not provide the entrepreneur with premises for work, nor does he impose a place of work, i.e. specific city.
- The client does not perform or organize professional training, courses, or other education for the entrepreneur.
- The entrepreneur on his own provides his basic tools and equipment for regular work and finances the purchase of work equipment (eg computer, internet, etc.), and the client does not regularly manage the work of the entrepreneur. An entrepreneur may use certain specialized tools and equipment of the client (i.e. specific software or API) that may be necessary to perform a specific job. Also, the client can issue general, basic, orders related to the ordered work and can perform reasonable quality control.
- In case the entrepreneur performs the same activity as the client (e.g. both are engaged in computer programming), the entrepreneur must bear the usual business risk for the delivered work to the client or end customer. If the entrepreneur's liability is excluded by the contract or limited below the usual liability, it indicates to the tax administration that the entrepreneur is protected by his client towards the end customer and that the client bears all responsibility for the delivered work, which resembles the employer-employee relationship where the employer is liable for errors in the work of its employees.
- The entrepreneur must be allowed to cooperate with other clients, and only a partial ban on the entrepreneur is allowed, which includes the provision of limiting cooperation with a few direct competitors of the client.
The contract of cooperation or engagement between the entrepreneur and the largest client must precisely regulate these circumstances. This is the ultimate guide to the independence test that needs to be followed. If these 6 provisions are defined by the contract and applied in practice, the entrepreneur has passed at least 6 criteria of the independence test. To pass the independence test, you need to pass only 5 criteria. If this is done precisely, the entrepreneur should pass the independence test.
It is important to point out that there is no single form for the independence test, nor a standard contract. However, monitoring whether all the above clauses have been complied with is to some extent a model for the independence test, i.e. for its passing. There are no special consultants for the independence test or a specific forum for the independence test where all the answers to the questions could be obtained. The tax administration interpreted the criteria of the independence test within their instructions, however many questions remained unanswered. The formulation of specific provisions, including the contract as a whole, and the risk assessment for the entrepreneur concerning the independence test can be compiled by lawyers who deal with this matter. As can be seen from the presented key clauses, entrepreneurs whose biggest client is from abroad have an excellent chance of passing the independence test.
It remains to be seen how the tax administration applies the independence test, because, due to lack of capacity and resources, very few entrepreneurs have passed through the control of the tax administration, so the independence test does not necessarily imply certain experiences of entrepreneurs. Entrepreneurs should responsibly approach this problem and hire an expert to regulate the relationship with the client with the aim to pass the independence test.
This blog is for informational purposes only and does not constitute legal service, as each situation requires a commitment to the specific circumstances of an individual case, which may be different from others.
For legal assistance, tailored to your needs, contact the Law Office Pekić at: firstname.lastname@example.org
Author: attorney at law Stefan Pekić, law office Pekic