A hot topic in both the tax and IT industries in Serbia is the announcement that the amendments to the Personal Income Tax Act will be adopted. Amendments to the law will change the tax treatment of hiring entrepreneurs instead of employees - this will be considered to be income outside of employment, which is less favorable. For employers who hire qualified new employees (including entrepreneurs who were not employed during 2019), tax incentives will be introduced for a transitional period of three years (starting from 1 January 2020).
With these changes, the Ministry of Finance plans to end a widespread practice, especially in the IT industry, of hiring freelancers paying lump-sum taxes instead of employees. Instead of hiring employees and paying taxes and contributions at an average consolidated rate of 65% on a net earnings, part of IT companies hire freelancers who pay a fixed monthly lump-sum of taxes and contributions, which is on average circa 250 EUR, regardless of the actual monthly income (up to an annual limit of 6,000,000.00 RSD or about 51,000 EUR). Also, these freelancers are not subject to an annual income tax unless they earn significant income from other sources, while employees with earnings above three times the average annual salary in Serbia are.
This model of engaging freelancers paying lump-sum taxes has reduced the cost of hiring IT professionals in Serbia, thereby contributing to the strengthening of part of the IT industry and retaining highly qualified personnel in Serbia. The other part of IT industry that hired employees pointed to the disproportionate tax burden and the costs of labour law compliance that they were bearing, putting them at a disadvantage in the market. As a result, for some time, there were rumours of ending the practice of hiring freelancers as a substitute for employment by the state.
According to the draft amendments, the institute of independence test will be introduced for all freelancers (both lump-sum taxpayers and freelancers who keep business books). This independence test should check whether engaging freelancer is factual employment. If a freelancer does not pass the independence test, its income will be taxed as other income according to the Art. 85 of the Law on Personal Income Tax – at the tax rate of 20%, where the basis will be the total gross income (without prescribed costs of 20%). In addition, pension contributions will be paid at a rate of 26% (while health insurance contributions at a rate of 10.3% will not be paid since these persons already have health insurance contributions paid as freelancers).
For example, if the lump-sum freelancer had paid a lump sum tax of 300 EUR per month on a monthly income of 2,000 EUR (15% of net earnings), if he had not passed the independence test, the monthly taxes and contributions on net income of 2,000 EUR would be 1,704 EUR or 85.18% of net earnings.
Independence test has 9 criteria which are used to check whether a freelancer is independent from principal or related party of principal. If the freelancer meets at least 5 criteria, he/she will not be independent. The criteria are as follows:
- The principal determines the working hours of the freelancer OR vacation of freelancer and his/her absence depend on the decision of the principal and during the absence his/her remuneration is not reduced
- The freelancer uses the premises of the principal OR the principal provides equipment for work of the freelancer
- The principal performs professional training of the freelancer OR normally manages the process of work of the freelancer
- The principal has hired the freelancer after advertising in the media a need to engage individuals
- The freelancer performs his duties by frequently working in a team with other freelancers or employees with the principal
- At least 70% of the total freelancer revenue in 12 months came from the same principal
- His/her contract with the principal does not contain a clause whereby the freelancer bears the usual business risk for the job delivered to the client of the principal
- His/her contract with the principal contains a non-compete clause
- The freelancer performs business for the same principal continuously or with interruptions 130 or more working days for a period of 12 months.
The principal is considered to be a domestic or foreign legal entity, as well as an entrepreneur.
According to the currently available draft of amendments to the tax laws, tax incentives for the next 3 years will be prescribed for employers who hire freelancers. Personal income tax on earnings will be decreased by the following percentages:
- in 2020 - 70% deduction
- in 2021 - 65% deduction
- in 2022 - 60% deduction
Pension contributions will be decreased by the following percentages:
- in 2020 - 100% deduction
- in 2021 - 95% deduction
- in 2022 - 85% deduction.
No tax incentives are prescribed for health insurance and unemployment insurance.
The following table shows the costs of taxes and contributions for the monthly net income of 1,000 EUR, 2,000 EUR and 4,000 EUR, in the following scenarios:
- Lump sum taxation of freelancers (where the estimated lump sum monthly amount for taxes and contributions is 200-300 EUR),
- Application of Art. 85 of the Personal Income Tax Law (as other income, with tax of 20% and SSC for pension at rate of 26%),
- Salary (if case freelancer is engaged under employment agreement from 01.01.2020), with tax incentives for the period 2020 - 2022,
- Salary, without tax incentives from 1 January 2023, or if freelancer is not qualified for tax incentives.
Revenues marked in grey are additionally taxed with the annual personal income tax. In the calculation, the current maximal monthly base for SSC is used (for earnings ever this basis).
This model undoubtedly means higher tax and contribution costs for employers hiring highly qualified and experienced IT professionals, while even some savings are possible if beginners are hired in the period 2020-2022. Also, an additional cost will be labour-law compliance, as employment carries greater risks in case of termination and other labor disputes. For lump-sum freelancers transitioning into employment, the question arises of the net earnings they will receive, ie. whether during negotiations with the employer part of the costs of taxes and contributions will also be transferred to them.