Croatian Income Tax Reform Changes Target Freelancers

Law amendments made recently within the fourth Croatian tax reform have targeted the position of freelancers by introducing stricter requirements over the way they set up their business activities to continue to receive favourable tax treatment.

Freelancers usually operate in Croatia by establishing craft businesses or via concluded service contracts for work or service performance. Freelancers benefit from a different amount of personal income tax (PIT) compared with regular employees, whose salaries are considered an income deriving from nonindependent work.

Freelancers who establish craft businesses could choose a particularly favourable option of paying PIT under a flat-rate principle. Such “flat-rate crafts” are suitable for low-cost business operations and annually pay the PIT in the amount of HRK (Croatian kuna) 1,530 to HRK 5,400 (approximately €202 to €713). The tax base for crafters’ contributions calculation is also one of the lowest in Croatia and amounts to HRK 3,496.80 (approximately €462). In order to exploit this setup, many entrepreneurs recognized flat-rate crafts as a way to covertly employ people. Those employees pay lower PITs and contributions by establishing flat-rate crafts acting as service providers for their covert employers.

Croatian legislators have responded by identifying three typical abuses: (1) the organization of nonindependent work in a way that allows lower tax rates; (2) entrepreneurs’ frequently changing their form of organizational business; or (3) using subsidiary companies to lower or evade tax obligations.

The Croatian Tax Administration (TA) has introduced criteria for determining whether the relationship between the client and the freelancer has elements of nonindependent work and, in fact, represents a misclassified employment relationship.

The TA will look for the existence of one of three essential elements that may count towards an employment relationship and which should be taxed accordingly:

1. control over the individual’s conduct; or
2. control over the individual’s financials; or
3. control over the status of the mutual relationship (for example, by drafting the contract between the parties).

The TA will consider the reality of the situation and not just the wording of the contract. This will include analyzing tax records and publicly available information.

When the TA identifies that a relationship has one or more employment characteristics, it will recalculate the PIT based on the employment relationships The TA will then issue a decision obligating the covert employee to pay the amount of unpaid PIT and salary contributions shortfall. The employer will also be liable for the employee’s PIT and contribution obligation as a guarantor-payer.

Although these changes are based on taxation rules, employers may find they are facing legal claims for employment rights from freelancers declared by the TA to have a permanent term employment agreement.

Comment

Craftsmen associations and public experts have criticised the new changes for failing to adequately define the characteristics of employment, which they feel means there will be continued uncertainty in this area.

Written by Boris Dvoršćak at Ilej & Partners in cooperation with Karanovic & Partners and Roger James of Ogletree Deakins

© Ilej & Partners, Karanovic & Partners, and Ogletree, Deakins, Nash, Smoak & Stewart, P.C.