TALKING TAX: Independent self-employed or agents as employees?

  • 2007-12-19
  • By Uve Zosars [Sorainen]
From Jan. 1, 2008 in Latvia the personal income tax payable by individuals on income earned through trading activities or the provision of services as a registered independent self-employed person will be reduced from 25 to 15 percent.
In order to prevent a possible mass conversion of current employees to independent self-employed persons and to clarify what income will be eligible for the 15 percent tax rate, Latvia's personal income tax law has been amended to list six specific criteria to determine whether the income earned by an individual will be subject to "wages tax" of 25 percent and social security contributions (33.09 percent) instead of the 15 percent income tax.

Where an individual provides personal services under an employment agreement the employer must also pay a significant social security contribution for the employee.
However, if the same individual provides personal services under an independent contractor or agent agreement there is no "employer"social security contribution liability for the contracted individual.
These differences in employer liabilities have led to some worker arrangements being structured as independent contractor or agent agreements and not employment agreements. Notwithstanding, there is often not much to distinguish them from the terms and conditions and physical circumstances of an employment relationship.

The changes to Latvia's personal income tax law will now allow the Latvian State Revenue Service (SRS), where one of the six "wages tax" criteria is established, to easily reclassify personal services arrangements that are presently structured as independent contractor or agent arrangements as employment arrangements.
Accordingly, we strongly recommend that if your company has existing contracts with independent self-employed individuals or agents that a review of these arrangements is carried out to ensure that none of the six criteria can be applied to the arrangement. If you intend to enter into independent contractor or agent agreements with existing employees or other individuals, you will also need to ensure that none of the six criteria are applicable in this agreement since this would allow the State Revenue Service to reclassify it as an employment arrangement.

Should a reclassification occur, this could result in a higher tax payable, taxation penalties, as well as penalties for non-registration of the individual as an employee and beginning an employment arrangement without an agreement and other acts of administrative non-compliance. It is still an open issue whether the criteria can be also extended to single-person limited liability companies entering into the same arrangements as the above-described self-employed persons.

Uve Zosars is a senior associate at Sorainen in Riga