Labor relations under a concluded employment contract are regulated by the Labor Code of the Republic of Lithuania. The employment contract – the agreement between an employee and an employer, according to which the employee undertakes to be subordinated by the employer and to perform work functions for the employer. Meanwhile, the employer undertakes to pay remuneration to the employee. The employment contract establishes all terms and conditions of employment, i.e. job functions, salary, workplace and others.
Individual activity is carried out based on a commercial (civil) contract. The Civil Code of the Republic of Lithuania regulates different kinds of contracts. The Law on Personal Income Tax of the Republic of Lithuania defines individual activity as an independent activity in which a resident seeks to obtain income or other economic benefits during a continuous period.
The difference between labor relations and service relations often seems insignificant. However, the taxation of income from employment and individual activity (self-employment) differs significantly. Therefore, to avoid possible tax consequences, it would be worthwhile to pay attention to the distinguishing features of these relations and to qualify them properly.
Features of labor relations:
- Subordination. The employee must follow the internal rules of the employer, the employee uses the work tools and equipment provided by the employer, working hours are set by the employer, holidays are agreed with the employer, the employee does not bear expenses related to his work, etc.
- The employee receives a fixed salary that does not depend on the work result. Under the employment contract, the parties agree on the performance of work functions, but not on the result.
Features of individual activity:
- Independence. The person himself decides the issues related to the performance of his activities, i.e. what hours to work and when to rest, the person covers his own operating costs, finds clients, etc.
- Continuity and pursuit of economic benefits. Transactions concluded by a person are characterized by continuity, as well as the motive and opportunity to enter future transactions and receive economic benefits from it.
Taxation of income from individual activity vs. employment contract
Individual activity can be carried out according to the business certificate or according to the certificate of individual activity. The business certificate is a document, that confirms the payment of the required fixed amount of income tax for carrying on independent activities and/or lease of property immovable by nature, if these activity types are included in the list of activities that is established by the Government of the Republic of Lithuania.
After acquiring the business certificate, the fixed personal income tax (PIT) is paid in advance, which depends on the type of activity and the period. Compulsory health insurance (CHI) contributions and state social security contributions (SSC) are paid each month when calculating the amount from the minimum monthly salary.
When carrying out individual activity according to the certificate of individual activity, the resident must pay PIT, which is calculated as follows: (income – expenses) x 15 % – credit, CHI payments (6.98%), and SSC payments (from 12.52 % to 15.52%). In addition, the obligation to pay VAT may arise (in case of some circumstances) in accordance with the Law on Value Added Tax of the Republic of Lithuania. All the above-mentioned taxes are calculated and paid by the person.
On the other hand, in the case of labor relations, the employer is responsible for calculating, deducting, and paying PIT, CHI and SSC. There is the following tax rates applied: standard PIT of 20 % (or progressive 32 %) and social security contributions from 19.50 % to 22.50 % (the employee taxes) as well as from 1.77 % to 2.49 % (employer taxes).
After evaluating the tax burden on a person engaged in an individual activity and working under the employment contract, the person providing services under the individual activity has obviously lower taxes. However, please note that if the tax administrator carries out an audit and finds that the relationship under the service contract is in fact an employment relationship, the company may face negative tax consequences due to the difference in the taxation of the income received. Thus, in such a case, not only would the tax difference be paid, but also late interest and fines would be imposed.
In the light of the above, we recommend that companies assess the existence of the characteristics of an employment relationship and the associated tax risks when concluding a service contract with a natural person engaged in an individual activity (“freelancer”).
