In terms of European countries, Germany regularly comes at the top of the list for companies targeting new markets. It’s a highly-developed country, with strong legal protections for companies and employees, its population is well educated, with all the skills you might need from an employee or independent contractor. However, with such a well-developed system of labor laws, how can you pay contractors in Germany without falling foul of compliance issues?
What are the Key Differences Between Independent Contractors and Employees in Germany?
Misclassification is the biggest potential problem that can come from working with independent contractors. This is when a contractor is treated in the same way as an employee yet paid as a contractor. This means that the company employing them does not manage their payroll or make social security contributions on their behalf as part of the payment process.
Employers may feel that hiring contractors is a great way to hire workers without paying for the indirect costs of an employee, however, this is a crime and punishable by fines or even criminal charges because it is effectively depriving the workers of their employee rights and the state of funding.
In Germany, no one piece of regulation defines the exact distinction between contractor and employee. This provides some flexibility in the working relationship. For example, an independent contractor in Germany can choose to work with a single client for as long as they like so long as it is not their only client.
However, if misclassification is suspected, the employer’s relationship with the worker will be examined based on the following criteria:
- Do they determine their own hours and methods of work?
- Do they supply their own equipment and workspace?
- Is their primary form of communication their own email/address/phone number?
- Do they receive compensation for work based on an hourly amount or per project?
- Can they refuse or reject a job or part of a job?
- Can they choose to work with other clients?
- Do they work with multiple clients?
- Do they manage their own tax payments?
- Can they subcontract elements or the entirety of a project to other contractors?
What are Contractor Misclassification Risks in Germany?
Fake self-employment (Scheinselbstständigkeit), or misclassification, is a serious offense in Germany. It is most obvious when a company comes to pay a contractor in Germany and the payments too closely resemble the regularity of an employee’s wage, or the contractors is reliant on a single company as a client. If a worker is found to be misclassified, the employer may be subject to the following:
- Standard fines per breach (around €15,000)
- Payment in full of all the social security contributions that the employer should have made for up to 4 years (or 30 years in the case of intentional misclassification)
- Additional fines for late payment of these contributions (generally around an additional 1%)
- Fines for tax evasion (up to €10,000,000)
- Personal or criminal liability in serious cases (including imprisonment for up to 5 years)
- Restrictions on a company’s future ability to employ workers or manage their payroll
- Additional fines if the company is found to have subcontracted a contractor to another company during the period of misclassification (with fines ranging as high as €500,000)
In this way, a company may have to pay contractors in Germany far more than the initial work agreement suggested. These effects can cause serious damage not only to the reputation of a company but also to the effective rollout of a global growth strategy.
The Employment Laws That Relate to Contractors in Germany
In general, as contractors do not pay social security contributions in the same way as employees, they are mostly free from any kind of relationship with state regulations. This gives contractors a lot of flexibility in how they work, but they then miss out on any employee benefits unless they work with an umbrella company to gain access to payroll services and benefits.
The only areas in which contractors must follow particular labor regulations are those relating to health insurance and qualifications.
Since 2009, all workers in Germany must have health insurance. For employees, social security can cover this, but contractors are obliged to seek their own health insurance solution.
Independent contractors in Germany must also have a degree or diploma-level qualification, otherwise, they must register as a sole trader. If they must do so, they then have to pay an additional municipal tax and are subject to all the restrictions and liabilities of a sole trader in Germany.
How German Taxes and Other Payroll Costs for Independent Contractors Compare to Those of Employees
As previously mentioned, contractors in Germany manage their own tax payments. This is done by registering with their local tax bureau (Finanzamt). Contractors then pay income tax (between 14-45%) trade tax (if applicable), and VAT (for amounts above €22,000 in the first year and €50,000 going forward), but do not pay social security contributions.
As health insurance is mandatory in Germany they will have to arrange this for themselves, but otherwise, they do not enjoy the same benefits as an employee like paid annual or sick leave.
As an employer, it’s a good practice to ensure that all contractors you work with are aware of their responsibilities as contractors in order to avoid unnecessary delays or investigations going forward.
How Do I Convert an Independent Contractor into an Employee in Germany?
You could wish to keep a contractor on as an employee if they demonstrate that they are a valuable asset or that they have special or marketable abilities. You must be able to successfully guide them through the change from contractor to employee in this situation.
1. Persuade the contractor of the advantages of working with your company
When communicating your goals with the contractor, it is your responsibility to make sure that the different types of employee benefits which become available are understood. Contractors may enjoy the freedom and flexibility of self-employment, so you may need to add incentives.
2. Verify if the contractor would qualify as an employee under German law.
The contractor will also need to be made aware of the possibility that the new circumstance could need them to discontinue existing business connections or modify how they deal with other clients.
3. Recognize how the relationship develops and express these changes plainly in an employment contract.
To avoid disputes, all of these changes must be specified in detail in an employment contract that is established in writing.
4. Incorporate the new worker into your payroll system.
Once a wage is agreed upon, you must add the employee to your payroll taxes system and manage the monthly withholding of tax and social insurance from the employee’s gross compensation. Here, you must have a business structure in Germany that can handle payroll and the necessary HR personnel.
To lessen the possibility of difficulties, you might even look for advice from a seasoned payroll provider.
You can even seek the guidance of a professional payroll service to reduce the risk of complications.
An EOR (Employer of Record) services partner is a third-party company that can hire and pay professionals on your behalf. This allows you to work with new employees in countries or regions where you don’t currently have a company organization.
4 Different Ways to Pay Contractors in Germany
1. Direct Deposits
Direct deposits can be used to pay contractors in Germany once or repeatedly depending on your work agreement and payment schedule, even though they are usually used to pay employees.
Be careful to maintain contractor payments apart from other payments made to regular workers when doing this. Additionally, remember that you must not make deductions the same way you would for workers.
Checks used to be the payment method of choice for the majority of contractors, but they are now far less prevalent. Because of their greater rarity and risk of bounce, checks are less reliable. They are slower than electronic payments, take longer to execute, and are more prone to loss.
3. PayPal or Other Online Payment Systems
PayPal has seen major losses in popularity over time due to an increase in companies and organizations that only take electronic payments online and relatively expensive fees. These online payment methods still continue to be quick and simple when paying independent freelancers all around the world.
4. Guaranteed Payroll Company Services
Payroll partners and outside services are created expressly to pay contractors in Germany and other self-employed workers on time and in compliance with the law. These might be a PEO that is legally permitted to run payroll through HR outsourcing services or an umbrella business that manages payroll process administration. Here, the contractor can also receive a better benefits package including retirement benefits.
In Germany, this means working through a third-party company with an AUG (Arbeitnemeruberlassung) license. This license means that a company is allowed to assign contractors to work for clients while also taking care of the contractor’s payroll on their behalf. In this type of relationship, the client receives regular and easily scalable contractor services while the contractor receives the same benefits as contracted employees.