In 2018 the Regional Court in Hradec Králové has rendered a judgment that has drawn the attention of the community of experts and may bring about a shift in perceiving the offshore structures of remunerating employees in terms of social security implications.
The court has taken decision concerning a claim of a major manufacturing company against the Czech Social Security Administration. The claim related to ten employees of a sister company based on Jersey who worked as top managers with the Czech company (some of them simultaneously being the claimant's directors). The fee for their activities was regularly invoiced to the Czech company under a contract for the provision of services and its amount was fixed on the basis of a cost plus method. The Czech company did not pay social security premium for the managers pointing out that they were foreign employees for whom social insurance involvement was only voluntary.
The Czech Social Security Administration opposed the status of the mentioned employees in relation to the Czech company maintaining that the case did not involve foreign employees but so-called contract employees and, therefore, the Czech company was obliged to pay social security premium for such managers in the Czech Republic. The company brought a lawsuit against such Czech Social Security Administration's decision before the Regional Court but was not successful.
Let us briefly summarize the fundamental difference between a foreign and a contract employee which pervades the entire judgment and was also used as argument by the claimant and, subsequently, in the court's decision.
In Section 3, the Sickness Insurance Act defines as contract employee as an employee of an employer based on the territory of a country with which the Czech Republic has not concluded an international treaty on social security (hereinafter referred to as the “foreign employer”), if he/she is active in the Czech Republic with a contract employer.
Under the Sickness Insurance Act, a contract employer is deemed to be a legal entity or an individual with the registered office on the territory of the Czech Republic where employees of a foreign employer are active in the Czech Republic being deemed to be contract employees in the Czech Republic if the earnings of the contract employees are paid to them by the contract employer or are paid to the foreign employer by the contract employer under a contract made with the foreign employer.
Finally, under the identical Act, a foreign employee is deemed to be an employee of a foreign employer if he/she is active in the Czech Republic in favour of a foreign employer.
As the Sickness Insurance Act definitions make it clear, the borders between both types of employees are not too distinct despite the correct specification of the nature of the relationship between the Czech company and the employee being of key significance for the assessment of the involvement in the sickness insurance and, therefore, the obligation to pay social security premium in the Czech Republic. Under the Sickness Insurance Act, foreign employees may participate in the sickness insurance voluntarily but contract employees are subject to such insurance mandatorily.
In its statement of claim, the company relied on the interpretation of two major models of cross-border employment included in the professional literature and on the concept applicable to the income tax sector. In general, there are the following two models:
HIRING OUT WORKFORCE – generally, this model can be invoked if employees are provided by their legal employer to perform work for another entity (economic employer) being managed, organized and controlled by such economic employer. Simply speaking, their foreign legal employer hires out the employees to another company to manage them and bear the fruit of their work.
PROVISION OF SERVICES – unlike the previous model, the foreign legal employer does not provide employees as such but provides a service to the counterparty. To perform the services, it will use its employees and second them to another company but the employees will remain under the full control of their foreign legal employer who manages them and bears full responsibility for the results of their work.
As part of the proceedings, the Czech company argued that the relevant managers were managed by the foreign company (their legal employer) and that the model of service provision was involved saying that as part of that model the definition sign of contract employee had not been accomplished. The foreign employer had concluded a contract for the provision of management services with the company and the services were provided through its employees who, in the claimant's opinion, were not in any relationship in law or fact with the Czech company. The Czech company also pointed out that it did not have any information regarding the fee amounts of the specific managers that were necessary for the settlement of the social insurance obligations.
The main argument of the opposite party, i.e. the Czech Social Security Administration, was that the employees in question were and have been in the top management of the Czech company on a long-term basis which conceptually excluded management by the foreign company. The Czech Social Security Administration did not agree to the application of the strict dividing line between the hiring out of workforce and providing services as opposing terms that would exclude each other, arguing that each case would rather be assessed individually. Moreover, during the proceedings, it also transpired that the relevant managers had been employed by the Czech company in the past and commencing from the specific date they became the employees of the foreign company without their roles being changed in any manner whatsoever. Subsequently, from 2016 they again became the employees of the Czech company. With the exception of one of them, the managers were the citizens of the Czech Republic, lived in the Czech Republic and the contracts made with the foreign employer were executed pursuant to Czech Labour Code, with the place of work performance being in the Czech Republic.
In the opinion of the Czech Social Security Administration, all the above facts indicate that contract employees are involved being active with a contract employer and that employment of such managers abroad was only formal.
The Regional Court did not allow the claimant's request and dismissed the legal action. The court emphasized that in each specific case one must rely on the particular actual situation and the real performance of the activities of the affected employees and not only on the contractual relationships and the content of the text of the contract concluded. In agreement with the Czech Social Security Administration, the court concluded that the Czech company met all the three requirements for the definition of the contract employee pursuant to Section 3 of the Sickness Insurance Act, i.e. the company's registered office being on the territory of the Czech Republic, the employees' activities being performed with the company and payment of employees' earnings being made to the foreign employer (the payment of the fee for the management services comprising the seconded managers' wages as a calculation item can, in the court's view, be understood as such). The managers were, therefore, found to be contract employees in terms of the Sickness Insurance Act and additional premium assessment imposed on the Czech company was not contested by the court.
The company filed an appeal in cassation against the Regional Court's judgment. Therefore, the case is still to be resolved by the Supreme Administrative Court. It will be of interest to see whether the interpretation of the Czech Social Security Administration will be upheld in the highest instance or whether the Supreme Administrative Court will correct the Regional Court's opinion.
What lesson can be taken from the judgment? The case sued was specific but it, nevertheless, indicates a very narrow borderline between the two models of cross-border employment and a certain risk related to the application of any similar offshore structures. One must always consider each situation individually and take account of all circumstances in question. The correct setting will not only impact on the sickness insurance participation and, therefore, on the involvement in social and, frequently, in health insurance but has also some income tax implications and is vital for the use of the right taxpayer's procedure.
Should you handle any similar setting of employment with cross-border elements, we would be glad to give you assistance and advice.
Jana Pytelková Svobodová
Head of Tax Team