External personnel are temporary workers, freelancers or other kinds of third-party employee who are not directly employed by a company. In essence, they are individuals who perform activities under service or work contracts. Further, unlike direct employees, external personnel are not typically entitled to the benefits granted by German labour law, such as statutory protection against dismissal, continued payment of wages in the event of illness and paid leave.
There is a considerable need for external personnel – partly due to the current labour market's limited supply of highly qualified specialists willing to work as employees in some areas and partly due to the increasing demand for flexibility. Engaging external personnel is also a popular choice for companies because it:
- frees them from certain labour law requirements;
- reduces the costs associated with hiring and terminating direct employees; and
- reduces the need for personnel management.
While engaging external personnel allows companies to concentrate on their core competencies (thereby improving efficiency) and provides easier access to external know-how, it also carries considerable legal and economic risks if handled improperly. For example, a company's representatives and decision makers may be subject to both civil and criminal liability and the company may be required to back pay social security contributions and taxes and face steep fines.
The legislature views the engagement of external personnel by companies as fit for abuse. Therefore, since 1 April 2017, companies have been prohibited from engaging temporary workers in such a way that they appear to be self-employed or leased when in fact they are direct employees. This prohibition – and the potential consequences of violating it – hovers like a sword of Damocles over companies that engage external personnel.
Considerable legal hurdles have been formulated to prevent the engagement of external personnel in ways that in fact amount to pseudo self-employment or concealed personnel leasing. The consequence of non-compliance is that the contractual relationship will be considered direct employment under Section 611a of the Civil Code, even if the parties involved acted otherwise. Therefore, instead of assessing an employment relationship according to definitions provided by the parties involved, the German labour courts examine the execution and implementation of contractual relationships in practice (party definitions are considered one indication among many). For example, a direct employment relationship may be indicated by an individual's:
- high level of operational integration within their host company;
- obligation to follow instructions; and
- claim to employee protection rights.
If a court finds that the engagement of external personnel represents the temporary leasing of a worker from one company to another, the Personnel Leasing Act applies. Exceptions are limited to a small number of situations (eg, providing temporary staff in group companies). Without a valid personnel leasing permit and proper personnel leasing agreement, providing temporary staff invalidates the concluded contract. However, a direct employment contract with the company engaging the worker is implied by law. Consequently, companies which engage such workers must pay social security contributions and withhold and pay income tax from the beginning of the employment relationship.
Social security contributions must be paid not only for future employment, but also retroactively (up to four years in case of negligence and up to 30 years in case of wilful non-payment). For earlier periods, a default surcharge of 1% of the outstanding amount must be paid for each unpaid month. In 2017 the revised employment law regulations introduced a statutory maximum duration of 18 months for leasing an individual employee. Exceeding this period by even one day is a punishable violation.
Depending on the number of misclassified employees, outstanding social security contributions and taxes can threaten a company's existence. Social security contributions represent approximately 40% of an employee's gross salary (up to a certain assessment ceiling) and, in principle, must be borne equally by the employer and the employee. However, the law severely limits an employer's options to reclaim a misclassified individual's share if its company is held liable for unpaid social security contributions.
Companies can be held liable for any unpaid income tax for up to five years in case of negligence and up to 10 years in case of wilful non-payment. In addition, companies that engage external personnel often overestimate value added tax (VAT) in their pre-tax deductions because the VAT is considered illegally invoiced and ultimately illegally paid.
Before the law was amended in 2017, temporary personnel leasing permits could be obtained on a purely provisional basis. This allowed companies to use personnel leasing as a default option, even if a work or service contract was deliberately misrepresented or if a company was uncertain as to whether a particular employment relationship would be considered personnel leasing. As a result, the use of specious contracts for work and services was largely unproblematic and carried no consequences. However, in 2017 the legislature declared that it aimed to end such business models by ensuring that a person who can present a personnel leasing permit is no longer in a better position than a person who openly leases staff without permission. The legislature strove for a higher degree of legal certainty in this matter.
Besides potential civil liability, representatives acting on behalf of a company are faced with a considerable risk of criminal prosecution. The misclassification of employees can lead to criminal liability for withholding social security contributions (Section 266a of the Criminal Code) and for tax evasion (Section 370(4) of the Tax Code). These offences are subject to monetary fines and imprisonment for up to five years (10 years in particularly serious cases).
Statutory provision violations
In order to detect violations of the now stricter rules regarding the engagement of external personnel, the practice is more closely monitored by the regulatory and supervisory authorities. In addition, this procedure has become an essential component of corporate compliance management.
For example, in the voluntary social security status determination proceedings conducted in 2017, the Pension Insurance Association found that in 40.3% of reviewed cases, the contractual relationship was in fact considered an employment relationship and subject to statutory social security contributions. In 2007 this was true in only 21.2% of cases. At the same time, the number of company audits conducted by the Customs' monitoring authority for illegal employment, the Financial Control of Undeclared Work (FKS), increased significantly: the FKS conducted 52,209 company audits in 2017 (compared with 40,374 in 2016).
In addition to the abovementioned consequences (eg, the obligation to pay social security contributions, income tax and misestimated VAT, in each case potentially with late payment fines), substantial administrative fines of up to €10 million may be imposed on companies. Board members and managing directors may personally face administrative fines of up to €1 million. This is in addition to the risk of criminal prosecution and penalties. Steep fines and criminal penalties have already been imposed. For example, the FKS initiated 107,903 investigative proceedings for criminal offences in 2017 (compared with 104,494 in 2016).
The abovementioned risks have encouraged many companies to strengthen their focus on contractor compliance, particularly as some companies now rely exclusively on personnel leasing. However, this approach is not always feasible in light of (for example) the 18-month statutory maximum hire term and the fact that many freelancers and highly qualified specialists are unwilling to enter into an employment relationship.
A comprehensive compliance plan is necessary to minimise the risks associated with service and work contracts. Such plans aim to establish structures that prevent external staff from receiving orders from and being operationally integrated within their host company (receiving and being subject to instructions and operational integration are the main indicators of pseudo self-employment and concealed personnel leasing).
An effective compliance plan includes precautionary measures aimed at preventing illegal external staff engagement before it occurs – for example:
- establishing binding rules for external staff engagement;
- training responsible employees; and
- implementing measures that prevent external staff from becoming operationally integrated within their host company.
Important elements in this context are the physical separation of internal and external staff, as well as the introduction of clear communication channels and job descriptions that preclude shared responsibilities and collaboration between internal staff and contractors. In some cases, entire projects must be outsourced. In addition, staff who procure external personnel must know exactly which agencies are reliable and suitable.
As well as preventive measures, effective compliance plans must also include damage management for legal violations that have already been committed. This includes suitable solutions for uncovering legal violations and remedying non-compliant behaviour under social security and tax laws by working with the tax authorities and the relevant public prosecutor's office.
An earlier version of this article was first published in Labor Law Magazine.
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