Guideline for Application of the Independence Test for Entrepreneurs
Author: Attorney-at-law Goran M. Ćiraković, the Law Firm “VUK Tax Attorneys”
Date: 27th February 2020
Public announcement of guidelines regarding application of certain legal provisions is not something that the Tax Administration usually does. However, the Tax Administration recently issued the Guideline for Application of the Independence Test for Entrepreneurs (hereinafter: the “Guidelines”), which elaborates in more detail application of the Article 85, Paragraph 1, Point 17 of the Law on Personal Income Tax (hereinafter: the “Law”). In this particular case, for the first time a very detailed and extensive guidelines of 90 pages is published for interpretation and application of only several provisions within one article of the Law.
Having in mind that existing increase of registered entrepreneurs in certain sectors (information technology, construction sector, advisory and administrative services), constitutes main reason for enacting amendments to the Law for the purpose to introduce the Independence Test, the very essence and aims of the Guidelines seem to be justified. Namely, the Guidelines, beside clarifying nine (9) criteria that assess independence of an entrepreneur in a business relationship with a client, also contains specific examples in that regard, on which basis it would be possible to assess whether particular entrepreneur can pass the Independence Test in the event of tax audit.
It is also important that the Guidelines elaborate application of the “Substance over Form” Principle, which is prescribed by the Article 9 of the Law on Tax Procedure and Tax Administration. This Principle authorizes competent tax body to discretionally determine tax facts according to their economic substance in each transaction and business relationship. In the case at hand, following adoption of amendments to the Law, there was justified concern that tax inspectors will often apply “Substance over Form” Principle in regard to the Independence Test, when assessing relationship between entrepreneur and its client, in order to reach conclusion whether engagement of an entrepreneur by its client constitutes fictive employment.
However, the Guidelines clearly stipulate that referencing to the “Substance over Form” Principle cannot change or extend application of the Independence Test by adding new criteria, modifying or neglecting existing criteria, etc., but only that fulfilment of nine (9) explicitly prescribed criteria can be demonstrated. For example, if the form and substance of particular business cooperation between entrepreneur and its client does not provide sufficient proofs to demonstrate fulfilment of at least five (5) out of nine (9) explicitly prescribed criteria, the existence of entrepreneur’s dependency cannot be claimed by applying the “Substance over Form” Principle, thereby justifying taxation by withholding of the fee paid to entrepreneur.
In addition, prior to enacting of the Guidelines, there was uncertainty as to whether the criteria of the Independence Test would be differently assessed by various tax authorities. The Guidelines unequivocally define that nine (9) prescribed criteria have no hierarchical relationship, difference in legal force or priority, and that there is no difference in their contribution to interpretation and application of the Independence Test. Therefore, exclusively by fulfilling of at least any five (5) out of nine (9) criteria, it can be concluded that there is no independence in relationship between entrepreneur and its client.
Additionally, in most cases the burden of proving the existence of unreported tax liability will rest with the Tax Administration, in accordance with the Law on Tax Procedure and Tax Administration. Namely, the Guidelines provide that burden of proof is borne by a person who seeks to apply special taxation regime that results from fulfilment of at least five (5) out of nine (9) determined criteria of the Independence Test, which will be the Tax Administration in most cases.
Finally, we emphasize that certain evasion-aimed actions of entrepreneurs and their clients in order to avoid tax liability are specifically elaborated by the Guidelines, and we especially point-out to the situation when engagement of entrepreneurs is shifted from domestic to foreign client – related party. If it is determined that domestic client, who previously hired entrepreneurs that continue to work for foreign client – related party in the sense of the Law on Corporate Income Tax, tax inspector may determine within the audit partial or complete transfer of business between related parties (from domestic to foreign client), as well as to determine (independently or based on expertise) value of transfer of such business based on “arm’s length” principle, and to make correction of domestic client's income in controlled period in accordance with transfer pricing rules. In this way, tax liability for corporate income tax would be imposed to domestic client.