Identification of the shvarc system

In the past we have analysed in detail the history and advantages or disadvantages associated with the shvarc system, which you can read about in our article The Schwartz System: Do you want to work as a freelancer or employ freelancers? Be careful not to get knocked on the door by Cobra or the CID.

The issue of the shvarc system is often perceived as a hunt for a fictitious sole trader (but also a one-person SRO), i.e. a self-employed person (self-employed person) without own employees who does not meet at least two of the following criteria:

• autonomy – has more than one client for whom he works,
• subcontracting – it has the possibility to employ staff if necessary,
• Decision-making power – it is capable of important decisions regarding its planning.

Although this definition is vague and neglects many variables, the state tries to identify and punish such tradesmen because they are “robbing” the public finances, failing to pay pension contributions and other compulsory contributions.

Let’s look at this issue from a different angle. Why is the shvarcsystem so controversial? And what are its real advantages and disadvantages for sole traders and employers? These questions open the way for an interesting debate and bring new perspectives to old problems.

Read more to find out how you can safely navigate the world of the shvarcsystem without unnecessary risks.

Motivation for the use of tradesmen

In Slovakia, the number of sole traders is constantly growing, which brings us to the question: what motivates people to become sole traders?

One of the main reasons for this is the significant disproportion between the tax and levy obligations of sole traders and employees. This imbalance in the tax system creates more financially favourable conditions for sole traders, which naturally attracts many who are looking for ways to optimise their income. However, the state is looking at this phenomenon critically and intervening to prevent abuse of the system. It should be noted that if there is such a disparity in the law between the different regimes, the intervention of the state is legitimate.

At the conference, Peter Varga addressed this topic from a different perspective. He stressed that if the tax system were more neutral, the decision of individuals to become a sole trader or an employee would not be considered fraudulent. It would not be an attempt to avoid tax, but a free choice of the legal form that best suited individual needs. In situations where the individual expects social insurance benefits (mainly a pension), the optics are more neutral for a change. Be that as it may, it is the knowledge of the complex perspective of taxes, levies and social insurance benefits that is a prerequisite for a greater likelihood of defending a business relationship with a contractor. In other words, it can be argued from the case law that legal analysis alone is not sufficient and that legal analysis must reflect the existence or non-existence of a financial disproportion in the adjustment of the relationship. These are also the conclusions of our conference.

In the absence of a disproportion, we would be on a level that would allow a freer choice of the appropriate legal form for a particular natural person. Within the relevant legal models, employment, single-person LLCs, trades, but also IP relationships and other forms of cooperation, such as silent partnerships, were presented in more detail. Watch the video recording of the conference to learn more about why working as a sole trader is so attractive and what advantages and disadvantages it brings for both employers and sole traders. A deeper look at the motivations for using sole traders and the contractual freedom in choosing the legal form is presented by Peter Varga in the video from the Švarc system conference : “Employing freelancers” – where is the limit?

Comparison of tax and levy obligations

The motivation of market participants on the part of employees is to seek other forms in order to increase their income. For better clarification, we also provide a summary of the tax rates, the basic models that frame the issue

Effective levy rate: Who pays less?

At the conference, we made a detailed comparison of levy rates for different working regimes based on an income of €1,000 gross salary for an employee and €1,000 on an invoice for a sole trader (other alternatives were also discussed).

The results clearly show that the effective tax and deduction rate for an employee is 42%, while a sole trader who uses the deduction holiday pays only a tiny 10%. When compared to a managing director with. r. o. we can see that this scheme is not so advantageous, since with the executive remuneration of the minimum subsistence level, i.e. j. 269 € per month, which is the most efficient in terms of minimum health levies, and we assume that it pays 15% corporation tax, so the effective levy rate is 28%. From the above, we can seem to understand why the incidence of sole traders in Slovakia is so high. To clarify, we provide a brief summary.

Peter Varga at the conference explained in detail the individual items and evaluated the changes in the effective tax-tax rate with increasing wages/remuneration, the obligation of a sole trader to pay social contributions , including the possibilities for SROs to reduce the tax burden through the standard ways in practice for small SROs to optimize (legal/illegal) taxes (e.g. purchase of a car, etc.) and thus reduce the % of the effective tax rate in this table.

You can subscribe to the full video recording of the conference here:

Legal and regulatory challenges

At the conference, we also highlighted the legal risks associated with the shvarc system. This issue of illegal employment and dependent work is under scrutiny and falls under the jurisdiction of not only the tax authorities, but also the Labour Inspectorate, the Social Insurance Institution and, until recently, the Social Welfare and Family Labour Office. Employers who resort to this employment model risk heavy fines and even criminal prosecution. In order to define some kind of boundary, it is also necessary to analyse the different legal concepts that we may encounter in this issue.

In the case of the Labour Inspectorate and illegal employment, as a concept that is regulated by law č. 82/2005 Coll. on undeclared work and illegal employment, which defines several types of undeclared work, but primarily prohibits the classic shvarcsystem. It is understood by law as dependent work performed by an individual for an entrepreneur without an employment relationship or a state employment relationship existing between them. The performance of work by a self-employed person for an entrepreneur cannot in all circumstances be subsumed under the definition of a shvarcsystem. The essence is that the cumulative fulfilment of the features of dependent work found in Art. 2 of the Labour Code, under which it is the work performed:

• In the relationship of superiority of the employer and subordination of the employee;
• The employee performs it personally for the employer;
• As instructed by the employer;
• On behalf of the employer; and
• The employee performs work at the time specified by the employer.

In the case of tax administration and tax authorities, the issue is that of dependent activities, which is regulated in Section 5 of the Income Tax Act. Simply put, a dependent activity is a situation where a person is obliged to follow the instructions or orders of the payer of the income. A mechanical interpretation of dependent activity could lead to the erroneous conclusion that any instruction or direction given to someone is a dependent activity. Such an interpretation would not only be totally illogical, but more importantly, it would not reflect the state of affairs and the purpose which the legislature sought to achieve by the above formulation.

It is important to understand that the concept of dependent activity is broader than the concept of dependent work. This means that all dependent work is dependent activity, but not all dependent activity is dependent work. This distinction is key in controlling and sanctioning the shvarcsystem.

Controls and penalties: what can you expect in the scarcity system?

The Shvarcsystem is under the strict supervision of a number of supervisory authorities. The main institutions carrying out controls are:

• The Labour Inspectorate, which controls illegal employment under Art. on illegal employment;
• The tax authority controlling the dependent activity pursuant to Art. on income tax;
• Social Insurance Institution, which refers to the Income Tax Act.

Each of these authorities has the authority to carry out separate inspection activities, but we know from decision-making practice and findings that inspections are often initiated by the Labour Inspectorate. If it finds a breach of duty and determines that an offence has been committed, it issues a report and informs the Social Insurance Institution.

Employers who violate their obligations face heavy fines not only from the Labour Inspectorate but also from the Social Insurance Institution. The Labour Inspectorate can impose a fine of between EUR 2 000 and EUR 200 000 under the law. The Social Insurance Institution may impose a fine of up to EUR 16 600 and may also impose a penalty of 0.05% for each day of non-payment of insurance premiums, which amounts to 18% per year.

The penalties imposed by the tax office are different and this is related to the fact that the tax office has the power to carry out an audit even several periods back, which makes it impossible to determine the maximum amount and could therefore lead to liquidation consequences for the company. During the conference, Peter Varga spoke about the possibilities of how to avoid such liquidating sanctions from the tax office.

The law also defines non-monetary sanctions such as:

• Inability to obtain subsidies from the state budget;
• Inability to participate in public procurement;
• Inclusion in a public list of persons fined for illegal employment;
• And others.

Professor of criminal law Tomáš Strémy in a discussion with Petr Varga at the conference also spoke about the criminal aspect of the shvarcsystem. In extreme cases, a prison sentence of up to 12 years can be imposed. More about the criminal aspect of the shvarcsystem can be found in the video from the conference Shvarc system: “Employing freelancers” – where is the line?

Legal vs. factual: What does reality say?

In law, the principle is that the state of the law must correspond to the state of the facts. Simply put, the contract must reflect the actual situation. You cannot have a contract to do job A if the employee is actually doing job B. This is often referred to as a legal sham. For a better understanding and preparation of employment contracts, here are some of the indicators that should, or should not, be included in contracts. For example, such indicators are:

• Instructions: clear instructions regarding the work to be done.
• Representability: the ability of an employee to be represented.
• Project: work on specific projects.
• Holidays: rules on holidays and time off.
• Penalties: possible penalties for non-compliance.

These indicators can serve as an aid in assessing and proving the true nature of the contractual relationship in a dispute with the tax authorities or the Labour Inspectorate. When setting up relationships for clients, we focus on several details that neither an entrepreneur nor an attorney who does not deal with taxes and levies in detail will notice at first glance. If you would like to If you are interested or would like to assess/set up relationships at your company, let us know.

The shvarcsystem may seem at first glance to be an attractive employment model, but it hides a number of risks and potential negative consequences. At our conference, we offered an in-depth look at this issue, highlighted the importance of complying with laws and regulations, provided advice on how sanctions can be avoided, and opened a discussion on the opportunities and challenges associated with this model.

If you have any questions or need professional assistance in this area, please do not hesitate to contact us. We are here to help you find the best solutions for your business.

Článok The Schwarz system: Don’t you face up to 12 years for “employing” freelancers? je zobrazený ako prvý na Highgate.

In addition, Highgate Law & Tax is also celebrating its win in the “Capital Markets” category, proving itself to be a comprehensive law firm with an extensive portfolio of expertise and the ability to successfully navigate diverse legal challenges.

The awards gala evening, which was organized by the media and educational group EPRAVO Group and the weekly TREND, was held at the Double Tree by Hilton hotel in Bratislava. For Highgate Law & Tax it was not only an opportunity to celebrate its success, but also to thank its clients and partners for their trust and support, without which this milestone would not have been possible.

This double triumph confirms Highgate Law & Tax’s excellent reputation for legal and tax services and reinforces its position as a leading player in the legal services market in Slovakia.

Článok Highgate Law & Tax and its double triumph in the prestigious Law Firm of the Year competition je zobrazený ako prvý na Highgate.

Článok Hello world! je zobrazený ako prvý na Highgate.

The amendment introduces the so-called minimum employee health levy. The previous legislation did not provide for such a thing . Do účinnosti tejto novely the employee paid the insurance premiums on the gross salary or remuneration earned in the relevant month. On that basis, he was provided with general health insurance, often literally “for a few euros”. For example, under the old system, if an employee earned a gross salary of EUR 100 in a given month, he also paid a total of EUR 14,00 in insurance premiums on that amount, namely EUR 4 for the employee and EUR 10 for the employer.

The same was true for managing directors, if the managing director had a monthly remuneration of EUR 10, EUR 1.40 per month was paid to the health insurance company for him, while he was fully covered by public health insurance. This fact often led in practice to the conclusion of many speculative employment contracts. This was because if a person was registered as voluntarily unemployed, he or she would be obliged to pay insurance premiums at the level of the minimum levy, which for 2022 was EUR 79,31 (currently already EUR 84,77 for 2023). After all, it was precisely the desire to prevent speculative remuneration, speculative employment and the avoidance of levy obligations that led the legislator to adopt the aforementioned amendment.

Who will be most affected by the amendment?

At first gl ance, it may seem that the amendment will affect only employees or persons who receive remuneration from dependent activities with income below the minimum subsistence level, which is EUR 234.42 as of 01.01.2023. However, it will also affect employees with a monthly income higher than EUR 234.42, up to EUR 328.00 per month if they claim a deductible in health insurance. As we have already indirectly outlined, this will also affect members of statutory bodies (e.g. managing directors who are also owners of the company) whose remuneration is below the current minimum subsistence level, i.e. j. less than EUR 234,42.

Amount of minimum health levies

According to the amendment, the insurance premiums together with the advance payment for insurance premiums must be at least the amount that the employee would pay together with the employer if the employee’s salary were equal to the minimum subsistence level for a single natural person, i.e. j. the aforementioned EUR 234,42.

The Health Insurance Act, in turn, provides that the premium rate for the employee is 4% of the assessment base and for the employer 10% of the employee’s assessment base.

Taking into account the condition that the minimum health levy, as we have mentioned above, is calculated on a minimum of EUR 234.42, a simple calculation leads to the conclusion that the minimum health levy is EUR 32.81 per month.

However, the employee’s minimum advance shall be reduced by the proportionate part attributable to the number of calendar days during which the employee has been employed:

• at the same time a self-employed person;
• at the same time insured by the state (e.g. student, pensioner, person receiving sickness benefit, maternity benefit,…);
• a person with a disability;
• declared a missing person;
• the insured person was not considered an employee.

Example:

The person was registered as an employee with the health insurance company during January 2023, but at the same time, between 01.01.2023 and 25.01.2023, the person was incapable of work and received income compensation from the employer and sickness benefit from the Social Insurance Institution. As a result, the person was not also insured by the State for 5 days. Therefore, the calculation will be as follows:

• EUR 32,81 x (5/31) = EUR 5,29

In this case, the employee’s minimum advance payment will be EUR 5.29 for the month of January.

What if a person’s monthly wage/remuneration is less than the living wage?

These are cases where the calculated health levy would not reach the required minimum amount and therefore the difference would have to be made up. Once the employee’s health levy comes out below EUR 32,81, the employee is obliged to make up the levy up to that amount. This also implies that the employer’s levy burden does not change and any additional payment up to the amount of the minimum advance payment is paid in full by the employee.

For the sake of simplicity, let us give the following examples (for the purposes of the calculations, we assume that the employees do not use any deduction):

1. An employee with a monthly salary of EUR 200.00 was obliged to pay a health insurance premium of EUR 30.00 (EUR 8.00 for the employee and EUR 22.00 for the employer), which is less than the minimum health levy under the amendment, and therefore the difference of EUR 2.81 will have to be paid by the employee, i.e. from 2023 it is EUR 32.81 (EUR 10.81 for the employee and EUR 22.00 for the employer).
2. An employee with a monthly salary of EUR 10.00 was obliged to pay a health insurance premium of EUR 1.40 (EUR 0.40 for the employee and EUR 1.00 for the employer), now it is EUR 32.81 (EUR 31.81 for the employee and EUR 1.00 for the employer).
   

Minimum health levies for managing directors

As we have already mentioned, the amendment will also affect directors with a symbolic remuneration, below the minimum subsistence level. This is mainly because the managing director of a company who pays himself remuneration is also considered an employee, as this is a dependent activity.

Despite the introduction of minimum health levies, such income optimisation will still be to some extent advantageous for statutory bodies. However, it may also not be the most efficient solution because of the various tax-insurance benefits, which include social insurance benefits or tax bonuses. If executives continue to pay themselves less than the living wage despite legislative changes, they could “overpay” on health insurance prepayments .

In order to avoid only “topping up” health levies, one solution could be to increase the executive’ s remuneration to the subsistence level, or even a little higher. As a consequence, although directors would have higher tax and social security contributions, they would also benefit from the social security system in the long run.

Managing directors who decide to increase their remuneration to the living wage level can save approximately EUR 40.00 per year on their regular remuneration by doing so.

If the directors increase their remuneration to, for example, EUR 400.00 per month, they would pay an extra EUR 200.00 per year to the health insurance company. Although the amount of their income would also affect the amount of their social security contributions, they would also be entitled to a minimum pension if other conditions were met. The amount of social contributions calculated on the basis of income is, among other things, also responsible for a higher tax bonus, affects sickness benefits and other benefits paid under social insurance.

Another possible alternative is for the managing directors to consider moving to an employment relationship with a monthly salary of EUR 329.00. In this case, they would be able to save approximately EUR 36,00 per year.

More of our comments on the issue can also be found in interviews for Trend(From the new year, health levies must be paid also by statutory officers with a symbolic salary), Hospodárske noviny (From the new year, even statutory employees with a token salary have to pay health levies. At least approximately 30 euros ), or .week(Even LLCs and low-wage employees must already pay minimum health insurance premiums).

Who is not covered by the minimum health levy?

The employee’s minimum advance does not apply to an employee who is:

• at the same time a self-employed person;
• at the same time insured by the state (e.g. student, pensioner, person receiving sickness benefit, maternity benefit,…);
• a person with a disability;
• declared a missing person.

In short, this means that if the employee was also insured by the state during the whole month, the minimum employee health insurance contribution does not apply.

However, if the employee was also insured by the State for only part of the month, as we have already mentioned earlier in this article, the amount of the minimum advance payment will be reduced by an aliquot amount.

In addition to the above, minimum health contributions do not apply to persons who do not receive any wages or remuneration, such as a contract worker who has no wages in a particular month.

If you are interested in this topic, please do not hesitate to contact us.

Článok Minimum health levies 2023 je zobrazený ako prvý na Highgate.

We are thus relatively intimately familiar with the related realities of this segment. Whether it is the topic of tax optimization, “employing sole traders”, investor entry, setting up a holding company, automated accounting, ESOPs, the legal, practical and tax pitfalls of scaling a business abroad, or operating with cryptos, these are all topics that we encounter in practice.

For this reason, we perceived that this conference can help many entrepreneurs to navigate through the complex tangle of more complex Slovak and foreign tax and legal issues. It was also intended to help to better understand the perspective of an investor or potential buyer in a company exit.

Sale of the company or entry of an investor :

• What are the basic situations and types of investor entry into companies?
• What are the key motivations and areas of interest for the investor and the company owner?
• What should an IT firm focus on to maximize the benefits of the investment for the firm and the business owner?
• Structured transactions and relevant tax implications from an income tax perspective (e.g. tax burden through a Slovak vs. a foreign holding company);
• Transaction Experience;

Relevant financial ratios when a company is sold or an investor enters :

• What is of interest to the investor or the buyer in accounting?
• Risks associated with incorrect accounting;
• Capitalization of the company;
• Transaction Experience;

Foreign IT contractors and work “from Bali” :

• Withholding taxes on payments to foreign contractors;
• Working from “Bali” – tax and levy implications;
• Setting up contract documentation;

ESOP – Best practice :

• What forms of shares and options can Slovak companies offer to their employees?
• Legal and practical context;
• Tax and levy context;
• Cross-border structure and practical experience;

Functioning in the crypt :

• Receiving retribution and paying contractors in the crypt;
• Types of crypto projects (token issuance, management, consulting, community token,…) and regulatory and tax aspects;
• Accounting and tax pitfalls in Slovakia and best practice when leaving Slovakia;
• Experience;

Scaling the IT business abroad :

• Do I need to have a company abroad in different business situations?
• Establishment of a permanent establishment, VAT regimes, withholding taxes;
• A company in an offshore jurisdiction from a legal, tax and practical perspective;
• Holding abroad – advantages and disadvantages;
• Investor requirements for foreign structure;
• Protection of the owner’s private property in the context of the political situation in Slovakia;
• Transfer pricing;

Software contracts :

• Framework or one-off contracts;
• Waterfall vs. agile SW development;
• Licensing Terms;
• Warranties and liability for defects in the SW;
• Problematic provisions – experience from practice;

Structuring business to the US :

• How best to enter the US market;
• Where can I get some help/information/grants?
• What is the tax and administrative burden?
• How to choose the right lawyer and accountant?
• How to get into the investors/funds horizon?
• In which state are the best conditions to enter the US market?

Tax optimization for digital and IT companies :

• Holding structure – owner protection;
• Patent Box and Supercomputing – how some IT companies do not have to pay income tax in Slovakia;
• Other tax and levy types and practical experience;
• When is tax optimisation already a criminal offence;

Schwarz system :

• Tax-tax implications and calculations;
• Impact on employees’ social insurance benefits (maternity, pension, sick leave,…);
• What impact does the change to a sole trader’s trade have on a sole trader’s pension?
• Analysis of court decisions that have dealt with the topic;
• Practice of tax administrations and labour inspectorates;
• Criminal liability;
• Setting up contracts with contractors;

Relevant financial ratios when a company is sold or an investor enters :

• What is of interest to the investor or the buyer in accounting?
• Risks associated with incorrect accounting;
• Capitalization of the company;
• Transaction Experience;

Many topics and many questions from conference participants. Companies were particularly interested in topics around ESOPs, tax optimizations or company sales. However, many attendees stayed until the end to hear the current practice in connection with the so-called In the meantime, there was a lot of interest in the practice of the shvarc system (i.e. the employment of freelancers).

We received a lot of positive feedback on the content and organisation of the conference. We are therefore very pleased that after the conference on setting up investment funds, this conference was also a success.

If you are interested in this topic, please do not hesitate to contact us.

Článok Conference on legal and tax optimization for technology companies je zobrazený ako prvý na Highgate.

In his 4-hour lecture, Peter Varga focused mainly on the issues of effective payout of owners from the company , not only from the tax and taxation point of view, but also from the legal point of view. This is because some, at first glance effective, solutions may bring with them the legal inconvenience of a natural person being liable for all of his or her assets. This may arise in particular in situations where the disbursement of funds to the holder in question has not been made in accordance with the relevant commercial law standards. In addition, if the paying company is in a more difficult financial situation, it is also possible to talk about the criminal consequences of improper payments from the company.

In addition, the topics were mainly the possibilities of setting up and operating companies abroad in the context of legal defensibility and other tax-legal pitfalls as well as the relevant administration. Establishing not only offshore companies, but any foreign companies is a very complex topic in the context of today’s legislation, partly the practice of tax authorities and administrative pitfalls. Gone are the days when it was possible to set up and run a foreign company with ease and extract profits simply by moving them into a low tax bracket. Peter Varga has been working on this topic for a long time and has also discussed it at our recent conferences on setting up investment funds and tax optimization for IT companies.

In addition to the above topics, he also discussed other commoditizable tax optimization techniques. However, many optimization opportunities arise only in the context of the dynamics of specific companies. Thus, a number of specific opportunities can only be applied to specific situations, making the range of possibilities very wide in today’s relatively complex world of tax law contexts. Either way, tax optimisation is a lively topic and we have been working on it for a long time.

If you are interested in this topic, please do not hesitate to contact us.

Článok Lecture by Peter Varga on tax optimization options je zobrazený ako prvý na Highgate.

What is the content of the training?

• the different options for remuneration of statutory officers in companies (for simplicity, the statutory officer is hereafter referred to as the managing director);
• Different tax differences between different types of executive remuneration in companies;
• is it possible to be employed as a managing director in my own company?
• Are the various sub-minimum remuneration schemes (e.g. 1/5th time, €1 executive remuneration) legally OK?
• whether such wages/remuneration are in line with transfer pricing and do they constitute tax and insurance evasion, which is a criminal offence?
• taxation of profit shares for directors and employees;
• tax burden on irregular executive remuneration;
• Impacts on individuals’ pensions, Pensions, sick leave or disability (also in the light of the current COVID situation);
• the effect of director’s remuneration or status as a statutory officer and status as an employee on travel allowances;
• the alternative options offered by our legal system for getting out of the company.

Specifics of the levy obligation for executive remuneration

In principle, there are three different levy obligations for executive remuneration. If you have a small company where you are both the owner and the director and you decide whether or not to give yourself remuneration or an employee’s salary, you should be aware that if you are not employed but only receive director’s remuneration, you do not pay guarantee insurance. Guarantee insurance is generally a type of insurance designed to protect an employee if the employer gets into financial difficulties. However, an employee does not pay guarantee insurance if he or she is also a director of the company and owns more than 50% of the company. Furthermore, you do not pay accident insurance when you are paid as a managing director and even sickness and unemployment insurance if you set up an irregular remuneration as a managing director.

Deductions of a managing director – can a managing director be employed in his/her own company?

As the decision of the Supreme Court of the Slovak Republic indicates, a managing director may be an employee in a company where he acts as a managing director: ‘It is not excluded that one natural person acts as a managing director of a limited liability company and is also an employee of that company’. (Supreme Administrative Court of the Slovak Republic 1 Sža 27/2015). This decision to some extent negates a decision that was issued several years before. Indeed, the original decision did not envisage that a managing director could perform certain functions for the company from a position other than that of managing director. Such a view of the Supreme Court is certainly contrary to the standard set-up of small companies in Slovakia, where the managing director provides his services as a sole trader to his own company.

You can see the whole topic with the presentation here:

Článok Managing director’s levies vs. minimum wage je zobrazený ako prvý na Highgate.