Is it worth paying social contributions?

As part of our services, we also help clients reduce their tax and levy obligations. But we try to explain to them that tax optimization is not just “about Excel”. You cannot set up a company in Bulgaria or Malta and invoice your Slovak company for fancy services. It does fit in excel (the tax rate in Bulgaria and Malta is significantly lower than in Slovakia), but it’s not exactly legal. Tax optimization needs to be addressed in its full complexity. Not only does it have to fit the calculation, it also has to be legally defensible (or at least have the potential to be defensible), legitimate and not unduly administratively burdensome. And even the social insurance element is not a negligible aspect in terms of tax optimisation for a critical part of entrepreneurs.

Some time ago, when we implemented the conversion of some employees to sole traders at a client (we talked more about this topic at our conference: http://reklama-a-dane.sk/), we identified in one of the older employees with approximately average wages in the economy that not paying social contributions for only 1.5 years meant a lower pension of 19 EUR/month. If he nets €200 more during that 1.5 year period (his gross wage equals his invoiced amount), he will “earn” €3,600. Taking into account the average life expectancy in Slovakia and the retirement age, the total loss of such a conversion for this employee at retirement pension is EUR 4 104. Thus, although this particular employee will have a net increase of EUR 3 600, his total pension will be reduced by EUR 4 104. Of course, these numbers may change over time to one side or the other (e.g., lower labor costs, different lump-sum expenditures, higher current pension value), but for the purposes of this article, such a static comparison is sufficient.

Tax optimisation

The topic of tax and levy optimization in connection with the above example is therefore not just about “excel”, in principle everyone can calculate it. Nor is it just about adding a lawyer who has studied judicial and administrative practice and can thus effectively protect employers and employees from the risks of illegal work. Comprehensive advice must also include an assessment of the impact of such measures on social insurance benefits and transfer pricing regulation (e.g.: can I pay myself the minimum wage in my own company?). Sale speech on: “Here you have it all under one roof. And you can add accounting to that”, sales speech off.

The subject of social levies is shrouded in the cloak of informational secrecy. The law not only has a great many paragraphs, but also a great many incomprehensible paragraphs. Demographics and today’s pension populism encourage us not to rely on the state. Threemy’s information, in turn, motivates us to “dump” the state. Since current practice allows to combine the payment of social contributions with a voluntary decision of an individual (legally, such as voluntary insurance of a self-employed person, but also semi-legally or even illegally, such as paying an inappropriately low wage in one’s own company or “self-employment”), the question of whether it is worthwhile to pay social contributions is quite topical.

What are the basic social insurance benefits?

The most basic social insurance benefits, apart from the old-age pension, include maternity, nursing, unemployment and sickness benefits.

1. Starobný dôchodok

If the second Fico government had not introduced a minimum pension, we could probably argue that the social system in Slovakia, at least to the extent of the amount of the old-age pension, is based on the principle of merit (the more I contribute during my lifetime, the higher my pension). This year’s political corset from the SNS (i.e. linking the minimum pension to the average wage) clearly confirms the principle of solidarity as the key principle on which the payment of old-age pensions in Slovakia is based. There is nothing wrong with this in itself, both principles (i.e. merit and solidarity) are legitimate and neither is more correct. The problem with the Slovak minimum pension and its ‘tweaking’ by SNS MPs is that it comes in a not very coherent and neutral environment. In such an environment, an entrepreneur need only pay a gross monthly salary of around EUR 250 for 30 years and is entitled to a minimum pension of EUR 334.3. A self-employed entrepreneur who will pay the minimum social contributions for 30 years is entitled to the same. The amount of pension for such “contributors” will be the same as for an employee who has paid full contributions for 30 years (which is several times more) on a salary close to the current average wage. Unless the tax authorities start to control the “marketability” of wages and remuneration of entrepreneurs in their own companies and push for the elimination of the grey economy, not only the high levy in Slovakia, but also the minimum pension and others (as mentioned below) will not motivate these contributors to pay higher wages and remuneration at all.

2. Materské

Although one cannot deny the efforts of the drafter of the Social Insurance Act to set the amount of maternity allowance in accordance with the principle of merit, in practice it is relatively easy to prepare for maternity allowance in such a way that the amount of maternity allowance exceeds the social insurance payments by several times. And since the social insurance office does not have the legal and economic capacity to effectively address the abuse of the right of the insured, this is now a widespread practice.

3. Ošetrovné

Since the need to care for a sick child cannot be planned (unlike maternity benefits, where the insured person knows several months in advance), the possibilities for creative abuse of this benefit are naturally limited. At this dose, the presence of the principle of merit is very strong. The higher the amount of social contributions the insured person pays, the higher the benefit. The amount of the benefit is 55% of the daily assessment base for the reference period. The reference period varies depending on the type of insured person. For example, an employee with an average salary is entitled to a sickness benefit of 55% of his/her salary per month, divided into days. A self-employed worker who pays the minimum contributions is entitled to a nursing allowance of around €8-9 per day in 2019. The period of payment is a maximum of 10 calendar days.

4. Dávka z poistenia v nezamestnanosti

Since the unemployment insurance benefit can be obtained regardless of the form in which the employment relationship of the insured ended (i.e. it could also have ended by agreement), it is perhaps more appropriate to refer to this benefit in the context of the current economic situation in Slovakia as the “sabatikal benefit”. The insured person is entitled to it if he/she has paid unemployment insurance for more than 730 days in the last 4 years. Please note that self-employed persons do not have unemployment insurance as part of their basic insurance package and have to supplement it. The rate is 2% of the assessment base.

The amount of this benefit is 50% of the daily assessment base, which is calculated on the average of the insured person’s assessment bases for the last two years or less. Given that the length of such a state-paid sabbatical is 6 months, and given the relatively flexible arrangement in the law, it is also possible to creatively abuse this benefit and its payment. For an average wage earner, this benefit can amount to €550/month for 6 months.

5. Nemocenské

As with sick pay, the sickness benefit is based on the principle of merit, and the creative abuse of the payment of this benefit is itself limited. The amount of the benefit is 25% of the daily assessment base for the reference period for 1. – 3. day of sick leave and 55% for 4th and subsequent days of sickness absence. The decisive period varies depending on the type of insured person. For example, an employee with an average wage is entitled to sick pay of about EUR 9 per day and 4. day of approx. EUR 18 per day. A self-employed person who pays the minimum contributions is entitled to sick pay of approx. EUR 4 per day in 2019 and the 4th. This will increase to approx. EUR 8 per day on the 4th day.

So what is the result?

If the insured person has the legal or practical flexibility to determine whether or how much to pay in social contributions, while the answer options are narrowed down to yes or no, the answer is no. It doesn’t. The primary motivation may not even be that the insured person is able to obtain the desired social insurance benefits in many cases without contributing adequately to the system. An important reason, in my view, is that the attractiveness of benefits that cannot be creatively abused and are based on the principle of merit is very low. And it is also low because these negative externalities (abuse of the social system in order to obtain higher benefits) increase the cost of social insurance, which makes it impossible to increase the overall attractiveness of social insurance benefits.

In general, this is not even a problem of bad intent on the part of standard lawmakers; the problem is with purely political proposals that not only may not have the state budget in mind, but more importantly are inconsistent and passed without the lawmakers thinking about the bigger picture. Such unconceptual proposals undermine the already fragile neutrality of the legal order and thus motivate entrepreneurs in particular to abuse the law. Another proposal from the SNS MPs – a 15% tax – is also unconceptual. More about this at our next conference entitled: “Does Danko’s 15% tax bring new opportunities for tax optimization?”

For more information on legal and legitimate tax or levy optimization, please contact us at info@hg.amcef.com.