The Dangers of Disguising Employees as Contractors – Part 1

This is the first article in a series of articles relating to Disguising Employees as Contractors.

This is the first article in a series of articles relating to Disguising Employees as Contractors.
This is a follow up to our recent article relating to tax rates (see Legal Insights with Klein Law: 1% Tax Rates for Entrepreneurs and Other Georgian Attractive Tax Rates – Georgia Today).

There are many reasons to disguise employees as contractors, including most importantly savings on Taxes (20+% v. 1%) and ease of hiring and firing.

Georgian employment laws are quite strict and fairly complicated. They follow standards set out by the ILO (International Labor Organization). Typically, in cases where the employer tries to avoid hiring, there is a disproportionate balance of power between the parties, and, as a result, we encounter more vulnerable, unstable forms of employment, a labor force without a labor code and social guarantees. Due to this disproportionate balance of power, employees are very rarely in a position to negotiate on an arms-length basis with employers and are usually happy to have a job offer at all. Further, the attraction of low taxes is a strong incentive for employees to be classified as an independent contractor; perhaps they assume that if proper taxes are paid, that the compensation would be reduced.

If the employee is disguised as a contractor, both employer and potentially the employee could be guilty of criminal tax evasion and the penalties and back taxes.

Employees enjoy many rights that bonified independent contractors do not, namely:
• Pension benefits;
• Ability to benefit from Georgian labor code laws, such as:
• Maternity leave rights;
• Anti-discrimination laws relating to Sex, Gender, Race etc.;
• Laws relating to dismissal, including rights to vacation pay and severance pay;
• Ability to benefit from a company´s internal working rules.

If the facts look and smell like an employee, then it is an employee
In order to understand if a contractor is actually an employee, a number of factors are used to make this determination, including (at least a few of these have to be satisfied in the determination of status):
Does the individual have a boss?
Does the individual perform tasks and is compensated for each task or are they compensated on a weekly basis?
Does the individual use company servers, email addresses, computers and office space?
Is the individual required to attend company video or in-person meetings?
Are there working hours?
Are there company business cards?

The length of the relationship is also a factor.

A wrongly classified employee who is wrongly dismissed can potentially sue their employer and receive compensation for the time the lawsuit takes to process (at times, several years). Since employees are usually unfamiliar with Georgian labor laws, they are often not aware of their rights. Even more important is that a company could be ordered to re-instate a worker as an employee which could be very uncomfortable, especially for estranged contractors (former employees).

In Georgia, there are lot of foreign IT companies that take advantage of laws relating to hiring foreigners. For each foreigner, the IT company has to show over 50K GEL (about 20K USD) of revenues per year to be eligible for big tax incentives. If the revenues are not significant, it becomes a reason for them to want to show a lower headcount. Frequently, foreign IT companies with Georgian subsidiaries have little or no revenues in Georgia, but rather use local staff to create software and the like for head office. This is particularly challenging for foreign IT companies that transfer their staff from other countries, as it makes it less attractive to do so and more attractive to hire locals. If the foreign company is a public company, very strict compliance laws would require subsidiaries to follow local laws very carefully.

Our next article will discuss the issues relating to intellectual property created by contractors who are actually employees, and the highly toxic potential consequences of potential strike suits against IT companies in particular.