On 26 February 2020, the director of the Serbian Tax Administration revealed a detailed instruction (“Instruction“) on the application of the “independent contractor test”. The test was introduced by the recent amendments to the Personal Income Tax Act and it applies as of 1 March 2020.
The Instruction is addressed to tax inspectors. The independent contractor test checks the relationship between an employer and a contractor registered as self-employed entrepreneur by application of nine criteria. If at least five out of those nine criteria are met, the contractor “fails” the test, is regarded as not independent from the employer and his remuneration is subjected to a higher taxation.
The Instruction makes it clear that the independent contractor test will be performed in the course of tax audits only for the periods after 1 March 2020, and offers “amnesty” from review to practices implemented prior to that date.
Rules of interpretation
When performing the independent contractor test, tax inspectors are bound to stick to nine criteria and are not allowed to widen the scope of the review by applying general “substance-over-the form” rule found in Article 9 of the Tax Procedure and Administration Act (“GAAR“). When the tax inspector cannot prove that at least five out of nine criteria are met, he is not allowed to invoke the GAAR as support for the conclusion that the contractor has failed the test.
With respect to the nine independence criteria, the Instruction reiterates that they should be interpreted in accordance with their wording and normal meaning assigned to such wording. In particular, words “working hours”, “annual leave” or any “leave” and similar should be given the meaning assigned to those terms in the relevant legislation (the Employment Act).
All nine criteria should be assigned equal weight, despite the fact that a number of criteria are composed of different alternatives or a cumulative set of facts. For example, the criterion no. 1 consist of two alternative elements: (i) the employer determines the working hours of the contractor, or (ii) holidays and leaves of the contractor depend on the decision of the employer and the contractor’s fees are not reduced pro rata in the periods while he is on a leave. In order to prove that the contractor fails the criteria no. 1, it is sufficient to determine either that the employer sets the contractor’s working hours or that the employer decides on the timing of the contractor’s leave and pays him a remuneration while on leave. If both subcriterion (i) and subcriterion (ii) are met, that does not attach more relative importance to the criterion no. 1 in the overall assessment.
The Instruction adds that the independence test and the corresponding rule on heaver taxation in case the test is failed must be interpreted narrowly.
Burden of proof
The burden of proof that a contractor is not independent from a particular employer clearly lies with the Tax Administration. However, the Instruction imposes on all other persons involved a duty to provide any required information or document asked by the inspector. Failure by a taxpayer to provide requested information/documents may have adverse consequences on the test results.
Who will be audited?
Both contractors and their direct or hidden but genuine resident employers could be subject to an independence audit. Non-resident employers cannot be audited as they are not subject to the withholding obligations or to the obligation to file tax returns.
If the audited person does not have or is unable to provide all required information/documents, tax inspectors may request the same from any other person, including a foreign one. Tax inspectors are encouraged to make use of mutual administrative assistance provisions of the applicable multilateral and bilateral treaties, including the OECD Convention on Mutual Administrative Assistance in Tax Matters which Serbia joined last year. Examples of cases when tax inspector should seek relevant information from foreign tax authorities are: determination whether Serbian employer has related parties abroad, whether payments are made to the contractors on their offshore accounts or through online payment systems.
Virtual platforms
The Instruction discusses the use of virtual platforms as intermediaries between the employers and the contractors. Intermediaries are entities who are not employers themselves but pay for the contractors’ work on behalf of the real employers. While in most cases virtual platforms are true intermediaries and therefore should not be subject to the test (i.e. their relationship with the contractors should not be tested), the Instruction draws attention to the possible use of virtual platforms as something more than just an intermediary. An example is when a virtual platform is engaged in providing services to a client, e.g. creating teams for the client, negotiating on behalf of the client, assuming the risk for supplying services to the client, integrating the teams into the client’s organisation etc. If a virtual platform is not an intermediary, but is essentially an employer, the independence test should be applied to the relationship between the virtual platform and the contractor.
The independent contractor test and tax evasion
The Instruction warns the inspectors of several typical forms of tax evasion in connection with the independence test.
Use of foreign conduit companies:
One form of evasion is when a domestic employer sets up a company abroad and shifts payments to the contractors to such foreign company. Another form is when payments to the contractors are redirected to their foreign bank accounts or performed via online payment platforms. In order to combat such abusive structures, the Instruction recommends to the inspectors to consider taking novel measures, such as characterization of the transaction as transfer of a business between related parties (domestic employer and a foreign company) subject to transfer pricing (“TP“) rules and adjustment of the transferor’s income.
With respect to foreign companies assuming payment obligation to the contractors, inspectors are advised to check whether such foreign companies are related to domestic employers, by requesting information from domestic banks, the Central Register of Ultimate Beneficial Owners and foreign tax authorities.
One interesting advice given to inspectors is to consider whether foreign conduit companies can actually be regarded as domestic tax residents due to the fact that, although registered abroad, they might have their principal place of management and control in Serbia. Although the criterion of principal place of management and control is an old concept, the Tax Administration has not used it so far to recharacterize tax residency of a corporation registered abroad. If regarded as tax resident of Serbia, the foreign company becomes subject to Serbia’s unlimited taxing right with respect to its worldwide income.
If a foreign company is not declared tax resident in Serbia, inspectors may examine whether it may be said to have a permanent establishment (“PE“) in Serbia due to the fact that it acts through a dependent agents (i.e. contractor who is not independent). If so, Serbia can tax a portion of the profits attributable to the PE activity (or the entire profits if the foreign company is a mere conduit).
If it turns out that a foreign company is beneficially owned by a Serbian resident, the inspectors are advised to refer the matter to the Ministry of Finance or the National Bank of Serbia for check whether the reporting requirements of the foreign exchange regulations have been complied with (residents are required to report on their outbound investments in other countries).
Use of resident companies
Multiple resident companies may be interposed between a true employer and a contractor to simulate the existence of contractor’s multiple clients. Such companies may be unrelated to the employer. The Instruction states that the inspectors should check whether the work product is delivered to the intermediary company or whether such intermediary has any business substance, operations, employees. GAAR can be relied upon to disregard the existence of the interposed intermediaries and apply the test to the relationship between the contractor and the true employer.
Use of hubs
The Instruction explains the notions of hubs, co-working or meet-up spaces that are widely used in the IT industry and explains how they can be abused for tax evasion. For example, an employer can finance a hub, which provides its space, equipment and training to the contractors. Possible abusive structures also include a scenario where the contractors pay membership fees or contributions to the hub for the right to use its infrastructure, while their employer reimburses that cost through the increased fee.
Hubs should not normally be subject to tax audits, but may be requested to provide information and documents to the Tax Administration as any other third party. In case of a suspicion that a hub is used to facilitate the passing of the independence test, the tax audit could formally be extended to the hub itself.
