Limits of tax sanctions for Švarc system
In recent years the Supreme Administrative Court has repeatedly ruled in favour of a stricter tax treatment of income from activities carried out by self-employed persons within a Švarc system. However, in its decision of February 2018 the court halted the trend of some regional courts viewing any longer-term business cooperation with elements of exclusivity as concealed employment.
In the case in question, the Supreme Administrative Court dealt with the characteristic features of dependent activity in the construction industry. The taxpayer, a construction work provider, cooperated with the same subcontractors over a long time, while the cooperation was the sole source of income for most of them. The subcontractors, mostly small sole traders, bricklayers or unskilled labourers, carried out work based on oral contracts for work. Their remuneration was based primarily on the amount of work done, to a certain extent also taking into account the profitability of the project.
In agreement with the financial administration, the regional court held that this type of cooperation concealed its actual status (i.e. employment), and confirmed the assessment of additional tax on income from employment that the taxpayer should have paid on behalf of the individuals. The SAC disagreed with this conclusion, emphasising that while the tax treatment of the situation is to be based on the actual content of legal relations, when assessing contractual arrangements where there are no doubts as to the free will of both parties, deference is appropriate. Therefore, if the nature of the activity allows for various contractual arrangements in the realms of private law (in this case a contract for work as well as an employment contract), the tax administration should primarily respect the type of cooperation chosen by the contractual parties, while the choice of the contractual arrangement may also take into account its tax implications.
The decision implies that when reclassifying a business relationship to employment, it must be proved that the situation involves either a concealed (dissimulated) legal status or abuse of right. This was not the case here, as the substantial characteristics of dependent activity were missing. When ascertaining the actual situation (also with respect to oral contracts having been concluded), the SAC took as its basis mostly the questioning of the persons involved. The SAC also emphasised the necessity of assessing the circumstances on a case-by-case basis, refusing the blanket statement that all relationships lasting longer than six months must be viewed as long-term. The SAC further held that the financial dependence of one contractual partner on the other is common in business relationships and does not in itself make the relationship a dependent activity. In the case in question, the cooperation did not significantly deviate from a reasonable arrangement of relationships. The SAC hence did not establish an abuse of right.
The SAC decision confirms the importance of arranging one’s contractual relationships appropriately, taking into account both the legal and tax implications of the cooperation. Mutual understanding between the contractual parties regarding the substance of the relationship is also of crucial importance, because when assessing witness statements the courts often also consider how the cooperation and dependence is perceived by the contractors.