Bogus self-employment: Reclaiming fees and VAT

The issue of bogus self-employment is a perennial issue in employment law and social insurance law, as well as a tricky issue for the solo self-employed.

As is well known, in such cases, clients often face the threat of having to make additional payments of fairly hefty social insurance contributions and correcting their input tax deductions. However, the Federal Labour Court (Bundesarbeitsgericht – BAG) had some welcome news for a change for honest clients in its recently published decision of 4 December 2024: they can indeed reclaim fees and VAT from their contractors (case number 5 AZR 272/23).

Facts and core issues

The judgment was based on a case in which the German state pension authority (Deutsche Rentenversicherung) determined retroactively in the course of a tax audit that employment on which social security contributions are payable existed for the years 2015 to 2018. The defendant, who provided its services to the claimant as an allegedly independent contractor, disputed her status as an employee and invoked protection of legitimate expectations. The lower courts dismissed the claim for repayment of excessive fees without taking further evidence, so the claimant appealed. The Federal Labour Court thus had to clarify whether and on what conditions an employer can reclaim fees and VAT in the event of a contractor later being classified as an employee. However, the Federal Labour Court was unable to make a final assessment of the case: it is the task of the lower courts to clarify the facts of the case and to make a final assessment.

Federal Labour Court’s decision and grounds

The Federal Labour Court clarified that reclaiming overpaid fees is possible in principle but is not always enforceable. What is decisive is whether there is employment within the meaning of section 611a of the German Civil Code (Bürgerliches Gesetzbuch – BGB) which does not automatically follow from the social insurance classification as dependent employment. It is crucial to independently assess the contractual relationship and especially the circumstances of how the relationship arose from an employment law perspective.

To reclaim fees, the higher remuneration must have been based directly on the supposedly freelance work, in other words especially to cover risks such as lack of sick pay or paid holiday. If there is no such causal link, there is no basis for a claim of unjust enrichment.

In particular, the employer must explain what remuneration comparable employees would have received (section 612(1) of the Civil Code). It should be noted that the difference compared to the actual remuneration must be corrected by the amount of the employer’s social insurance contributions. The Federal Labour Court emphasised that the question of whether overpaid fees can be reclaimed depends on whether the employee enjoys protection of legitimate expectations. This is usually the case if the employer has actively worked to prevent the employment being classified as dependent employment. In such a situation, it would be contradictory to demand repayment after previously claiming the opposite.

With regard to reclaiming VAT, the Federal Labour Court referred to the procedure under the law on unjust enrichment “around the corner” in accordance with section 14c(2) of the German VAT Act (Umsatzsteuergesetz – UStG). If the repeat assessment under employment law shows that an employment relationship actually exists, the excess VAT paid can initially be reclaimed by the employee from the tax office, in order to be reclaimed by the employer in accordance with the principles of the law on unjust enrichment. Reclaiming directly from the employee is only possible if the employee has not already spent the VAT collected. If the money is paid to the tax office, but the tax office does not repay the money for whatever reason, the employee can raise the defence of loss of enrichment.

Practical relevant and distribution of risk

The Federal Labour Court's decision makes it clear once again that companies take considerable financial risks when commissioning supposedly freelance employees. In addition to the risk of having to make additional payments of social security contributions, they may also be left with excessive fees and taxes paid if the freelancer enjoys protection of legitimate expectations or if there has been loss of enrichment. The economic risk of incorrect classification thus lies (almost) solely with the client, while the freelancer is usually only affected in exceptional cases.

Companies should therefore take measures at an early stage to minimise risks. These include careful documentation of the decision-making processes for structuring remuneration, in order to be able to prove in the event of a dispute that the higher remuneration was due to the entrepreneurial risk of the freelance work.

Agreeing on freelance work without documentation? Not a good idea. The risk is that in the specific case the client will be left with the costs. Whether comprehensive documentation, especially written specification of the contractual basis, would have helped in the present case can only be said after further findings by the lower court, which has now been asked to rule on the matter again.

This much can be said: the freelancer acts as a businessperson in legal transactions. This allows for a more flexible use of clauses in standard terms and conditions. It is possible, under strict conditions, to prevent contractors from raising the defence of loss of enrichment. Likewise, protection of legitimate expectations can be made harder to access by smart contract drafting, such as reserving the right to reclaim sums paid.

While this may not help in the context of social insurance law, at least the civil-law risks can be positively influenced in one’s own favour.

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Do you have any questions on this topic? Speak to us for expert and customised advice. We are a market leader in employment law and company pension schemes, with over 40 professionals specialising in the field.

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Our legal tech solution, Noerr Contractor Compliance Check, helps companies to comply with the law when engaging and deploying external staff. The tool integrates all the necessary processes for purchasing the services of external personnel efficient and in a way that is legally compliant. For further information, go to our website.

Further resources on the topic of deploying external staff

The latest information on the topic of deploying external staff is available

• in our quarterly webinar series, Quarterly Update on Contractor Deployment (available in German only)
• and our podcast on this topic (Noerr_podcast: Employee status, employee data protection and algorithm transparency in the platform economy) (available in German only)

 

Authors: Daniel Happ und Pasquale Bender