Independence test of the entrepreuner
Income taxation of the sole traders (entrepreuner) has been changed in the Individual Income Tax Law of the Republic of Serbia, by defining the so-called independence test in Article 85. Stated changes impact the relationship between sole traders and their clients, both local and foreign, and therefore influence the business.
The independence test of the sole trader is tied to the entrepreneurship. This form of business organization is, besides LLC, most common in Serbia.
Before the analysis of these changes, it is relevant to state who the sole trader is and what taxation options lie before him.
Who is the sole trader?
According to the Company Law, a sole trader is a legally capable natural person who conducts an activity in order to gain profit and who has been registered as such pursuant to the registration act.
Individual farmer is not a sole trader in terms of this Act unless otherwise provided by a separate statute.
Taxation of the sole trader
According to the Individual Income Tax Law (IITL), the sole trader is a VAT taxpayer, and therefore can choose between two options:
- lump-sum taxation
- without personal payment
- with personal payment
- filing a report to the Tax Administration
- fulfilling conditions specified in Article 40 of the IITL
- Tax Administration determines the tax and contributions amount, based on the average income in the area of the trader’s business.
- The amount does not depend on the results of the trader’s business
- The sole trader does not have to run books (besides those on total turnover) or write down expenditures, which is beneficial.
Self-taxation without personal payment
If the sole trader decides on this taxation model, it means next :
- The taxes and contributions are calculated based on the net income. If the net income is less than a minimum contribution base, the contributions are calculated according to the contribution base and not the net income
- Expenditures depend on the business results
- The tax rate is 10%
Self-taxation with personal payment
- Taxes and contributions are paid based on the personal income, determined by the sole trader
- If the personal income is smaller than the minimum contribution base, the contributions are calculated based on the minimum base and not the personal income of the trader
- the rest of the income is paid as VAT with the tax rate 10%
- the contributions are paid only based on the personal income (net income is not relevant)
- Expenditures follow the business results
- The tax rate is 10%
This all refers to the trader that is independent according to Article 85 of the IITL, that is to say, if he/she “has not failed” the independence test.
What is the independence test?
In Serbia, like in many other countries, many people work on a service contract instead of an employment contract, even though they work as employees. To clarify – a local/foreign legal person needs a natural person who possesses certain skills and knowledge, such as IT expert, consultant, and similar. The legal person has two options:
- hiring the natural person on the service contract/agreement
– a legal person becomes a client and the hired natural person will offer services as a sole trader. As a sole trader, he/she has at disposition above-mentioned taxation forms and the wage received is taxed according to the chosen form.
- concluding an employment contract with the natural person
– a legal person becomes an employer, and the natural person the employee, so the wage for the job done is a salary, and is treated in that way in tax offices.
In the first case, the amount of taxes and contributions is significantly smaller than the same amount in the second case. That is why the natural persons are hired as sole traders and not as employees since the taxes are lower. In this way, the true nature of the relationship between the client and the sole trader is hidden.
All mentioned is applicable in situations when the degree of independence is higher, which has to be determined from case to case. That is how the independence test was built, formed of nine criteria that determine the true connection between the sole trader and the client.
By introducing the independence test in the Serbian legal system, Article 9 from the Law on Tax Procedure and Tax Administration is concretized. In Article 9, it is stated that the Tax facts are established in accordance with their economic nature. So, if the sole trade is actually tied to the client, the tax treatment must be corrected. We will focus on this further in the text.
Who does the independence test concern?
Note: The independence test is applicable from March 1st, 2020. According to the IITL, everything paid before March 1st, 2020 will be considered as a personal income, regardless of the nature of the relationship with the client.
We should highlight that the subject of investigation, here, is the relationship between a client and a sole trader. If it turns out that the sole trader is not independent of the client, the nature of the relationship is changed, i.e. the way of paying wage is changed. The sole trader stays the sole trader and the client stays the client.
The control concerns following individuals:
- sole traders (lump-sum taxpayers and or those who are in the self-taxation system, whether they pay personal income or not)
- local or foreign legal person – client
- a person who is considered connected to the client according to the Law on VAT
- a sole trader who has directly or indirectly hired another sole trader
The independence test does not concern the following individuals :
- a local/foreign legal person, as well as a sole trader who directly deposits the wage to other soler traders, as long as the wage is paid for mediator/agent jobs and he does not demand anything more than usual agent/mediator fee.
- a sole trader who performs such jobs that do not require employment contract with the client (e.g. lawyers, according to the Legal Profession Act)
Criteria of the sole trader’s dependence
Note: further in the text, the term client describes the client and the connected person.
The independence test examines the relationship between the specific sole trader and the specific client. If it turns out that five out of nine criteria have been met, the sole trader is independent. That does not mean that their cooperation is forbidden, but it should be taxed differently.
- The client determines the working hours of the sole trader, or vacation and leaves depend on the client while the wage is not comparatively smaller to the time spent on vacation.
- The sole trader usually uses the premises determined by the client to do jobs that were entrusted to him/her.
- The client holds or organizes vocational training or specializations for the sole traders
- The client hired the sole trader via job adverts or by hiring a third person who normally does the headhunting.
- The client provides his own tools or other material and non-material means needed for everyday work of the sole trader, finances their supply unless the tools and means are specialized for that particular job. The client usually manages the work process of the sole trader, unless the managing implies giving directions connected to the requested job and sensible control of the results or supervising.
- Within 12 months, at least 70% of the sole trader’s total income that starts or ends in one tax year is attained from one client.
- The sole trader does the work from the client’s area of expertise and for these jobs, his hiring contract does not contain the clause under which the sole trader bears the business risk for the job delivered to the client’s customer if there is a customer.
- The contract for sole trader contains a partial or total ban on offering services to other clients, except a partial ban that includes offering services to a limited number of client’s competitors.
- The sole trader fulfills activities for the same client, consecutively or with pauses 130 or more working days within 12 months that start or end in one tax year. By fulfilling activities is meant the work done in any period during the day from 00 to 24 hours.
Note: One should bear in mind that some of the mentioned criteria are set alternatively. So, if we look at criteria 4, it will be met if the client has not published the job advert, but has hired the third person who does headhunting and later hired that sole trader.
Also, in criteria 5 and 8, one should take care of the exceptions, where the Law states what situations are excluded by using words “unless” and “except”.
The consequences of not meeting the independence criteria
The examination of the relationship between the sole trader and the client is done by a tax inspector. He/she examines the contract, current situation, and other public facts.
If it transpires that the sole trader is not independent of the client, the income attained will be considered as additional income, according to the IITL. Therefore, the gross income of the sole trader will be taxed without diminishing normative expenditures, with a tax rate of 20%.
Depending on the client, the question of who pays taxes and contributions is determined:
- The client is a local – taxes and contributions are paid by the client
- The client is a foreigner – taxes and contributions are paid by the sole trader (PP OPO form)