At the end of 2019, the National Assembly of the Republic of Serbia adopted the Law amending the Law on Personal Income Tax (“LPIT”), which entered into force on 14 December 2019, however the application of certain provisions was delayed until 1 March 2020, notably those referring to the so-called independence test. Contractors, despite paying income taxes from independent activity, will have to prove how independent they are in performing their activity.

What does independence test actually mean?

The purpose of test application is to determine the independence of a contractor in relation to his principal. If it is established that a contractor meets five out of nine prescribed criteria, he will not be considered “independent” and the salary earned from such principal will be additionally taxed as other income at 20% rate, including an additional obligation to pay contributions for pension and disability insurance. Therefore, payment of such taxes does not exclude the obligation to pay taxes on income from independent activity and relevant contributions on such basis, hence the overall tax obligation can exceed the amount of taxes that would have been paid if a contractor were employed by the principal.

It should also be noted that, although a taxpayer is contractor who earned this ¬– other income, the principal as income payer will be obliged to calculate, suspend and pay taxes and relevant contributions, considering that this is a withholding tax.

These rules will not apply to income earned by the contractor until 1 March 2020 i.e. such income will not be subject to additional taxation.

Tax relief for contractor employment

The amendments to the LPIT also envisage certain tax reliefs for employers who employ persons who had been unemployed in 2019 and thus increase the total number of employees. The above stated is an incentive for employers to start employment with the contractors who rendered them services in the preceding period and who do not pass or who will most likely not pass the independence test.

Tax collection – the first and only goal

By introducing independence test, the state intends to discourage this form of working engagement so that it would not be only a formal substitute for employment and a legal basis for reduction of taxes and contributions. There are somewhat similar mechanisms in other jurisdictions (e.g. Germany, Austria, Slovenia, Hungary etc.). What can be noted is that domestic legislator considered the public law aspect of relationship between the contractor and principal, whereas the private law i.e. labour law aspects of such engagement have not been considered at all. The new legal solution does not provide contractors with any rights relating to protection specific for employment relationship, alike certain foreign laws (e.g. in Austria).

(Un)clear scope of prescribed criteria

Considering that certain criteria are not defined clearly enough, immediately upon publication of the draft amendments to the law there have been many uncertainties and questions in public regarding practical application of the test and they remained even after the law adoption. That is why, only a few days before the start of application of the new legal regime, the Tax Administration published comprehensive instructions for application of independence test.

The instructions clarified that the independence test is a concretization of facticity principle, which is one of fundamental principles of tax procedure. This means that the consequence of independence test application should be the establishment of tax obligation according to the factual situation that is considered closer to economic essence and not according to formally presented factual situation. Also, given that the form of taxation that can result from application of this test is an exception from the general regime of contractors’ taxation, the provisions on independence test should be interpreted narrowly.

It was also confirmed that the prescribed criteria do not have a hierarchal relation, they do not differ in legal force and priority and there is no difference in their contribution to independence test. In addition, when one of the criteria can be fulfilled by meeting one of several prescribed facts, the existence of more facts will not influence the significance of thus fulfilled criterion i.e. it will not make it more significant for application of independence test.

With regard to manners of establishing the decisive facts, the instructions contain many examples that can be used by tax inspectors as a guidance for tax control. It is most notable that the establishment of fulfilment of six criteria can be done, among other, by insight into communication between contractor and principal in any form, including e-mail.

Do we need instructions for application of instruction on independence test?

It should also be noted that, if a tax inspector establishes during control that a contractor is not independent from a principal, a related tax control of the principal will be initiated, considering that the latter was obliged to calculate and pay relevant taxes according to the LPIT.

However, what is moot here is the fact that the principal did not participate in control of the contractor and therefore could not suggest evidence or give statement on his relationship with the contractor, whereas it is not clear from the LPIT and the instructions for independence test application whether the inspector would, during the control of the principal, enable the re-establishment of facts that were already “established” during the control of the contractor or the control would only apply to calculation and payment of taxes and contributions. In the latter case, principals’ rights could be infringed, considering that the tax decision would be based on facts established in another procedure where principal was not a party. In the appeal procedure or at least in administrative dispute this would have to be sanctioned to the benefit of the principal.

Anyhow, the contractors who plan to maintain such status after 1 March and the companies engaging them should analyse their service contracts and verify the compliance of business operation with the new requirements.

This article is to be considered as exclusively informative, with no intention to provide legal advice.
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