Employee vs. Contractor: How to Classify Workers in Germany (Quiz included) [2024]
Germany is well known for its complex bureaucratic system. Although it welcomes new businesses—both foreign and domestic—there are many hoops to jump through to get started.
One of these is worker classification. When hiring workers in Germany, it’s crucial to classify them correctly. This nation has some of the strictest laws and penalties for those employers who misclassify independent contractors as employees. Otherwise, you risk being on the receiving end of significant fines and penalties.
Learn how to classify workers correctly and stay compliant with German labor laws with our guide.
Classifying workers in Germany
Germany differs from other countries when it comes to misclassification. Here’s a quick list of things to be aware of:
- The German authorities actively look for and audit employers to make sure they’re not misclassifying their workers. Their approach tends to be, in a word, aggressive.
- You should expect that Social Security authorities will make sure you are deducting the correct amount for all of your employees and aren’t trying to game the system.
- Termination disputes between workers and employers often come to German authorities’ attention, and they’ll look for issues like misclassification during these cases with a close eye. And, since German labor laws favor workers, even compliant employers might find themselves facing legal penalties.
While this list is nerve-wracking, don’t let it stop you from hiring employees and independent contractors. The German legal system has some very clear guidance for differentiating between the two, plenty of businesses are extremely successful in the nation, and this guide will help you understand what you need to do.
Now, you’re well aware that Germany categorizes employees and contractors differently. To keep your business running smoothly, it’s crucial to understand how to classify these workers correctly. Let’s get started by defining what an employee is in the eyes of the German authorities.
What is an employee in Germany?
Germany has no single definition for what constitutes an employee (unlike other European nations, such as France and the UK). However, generally, an employee performs regular or “dependent” work for an employer.
Employees are also entitled to numerous protections and statutory benefits under German labor laws. These include:
- Belonging to the statutory social security system, which both they and the employer contribute to
- Health insurance
- Long-term care insurance
- Unemployment insurance
- State pension scheme
- Statutory paid vacation days
- Paid sick leave
- Paid statutory holidays
- Maternity/parental leave
Workers classified as employees are also protected against unfair dismissal, including being terminated for no reason. And, their taxes and social security contributions are deducted from their paychecks by their employer.
What is a contractor in Germany?
The definition of an independent contractor in Germany is pretty simple: It’s a self-employed individual (or freelancer) who is contracted by an employer to provide services. Independent contractors do not receive any benefits and are responsible for deducting taxes, social security payments, and more from their own paychecks. Importantly, they can also be let go by the employer without the latter having to give any reason for their dismissal.
Worker classification overview: Employees vs contractors in Germany
Contractors
Employees
- High level of worker control.
Contractors are generally given more autonomy to determine how to complete the work and when to do it. - Equipment and tools are owned by the worker.
- Less integrated. Contractors tend to be independent, they’re more likely to work remotely, and they use their own tools and equipment.
- No entitlement to benefits. Contractors are not entitled to the same benefits and protections as employees, and they are responsible for paying their own taxes.
- No protection against dismissal. Contractors may be terminated at any point in time without notice or a reason from their employer.
- Time-bound engagement. Contractors are typically engaged for a specific project or period of time.
- Risk of loss. Contractors may assume more risk and liability for the work they perform.
- Non-exclusive services. Contractors cannot be contractually bound to a single company; they can provide their services to more than one organization.
- More direction from the employer. Employees are generally subject to more control and direction from their employer, who will provide guidance on how to perform the work and may set specific hours of work.
- Equipment and tools are typically provided by the company.
- Highly integrated. Employees are typically more integrated into the employer's organization, for example, they may work at the employer's premises.
- Entitled to benefits. Employees are entitled to certain employment benefits and protections, such as minimum wage, overtime pay, and vacation pay. They may also be entitled to benefits like health insurance, retirement plans, and paid sick leave.
- Protection against dismissal. Employees are protected against sudden termination without a reason or a notice period.
- Indefinite engagement. Employees are generally hired for an indefinite period of time.
- No risk of loss. Employees are generally protected from liability for work-related issues.
- Exclusive services. Employees can be contractually bound to provide services to just one company.
Tests to classify workers in Germany
To further assist employers in classifying workers correctly—especially considering that several different legal authorities can make decisions about what constitutes misclassification and the rules are rather vague (surprising, considering all the labor laws the country has put forth!)—the German government has designed a series of “tests.”
These tests will help define the nature of the employment relationship—and whether it's an employer-employee relationship or an employer-independent contractor relationship.
Keep in mind that in a dispute, German courts and tax and social security authorities look at all aspects of the working relationship, and no single test should be considered conclusive for classifying a worker.
There are nine criteria—here’s a quick list:
- Mutuality of obligation
- Personal service
- Control
- Other activities
- Pay and benefits
- Integration
- Facilities and equipment
- Financial risk
- Taxation
Here's a deeper dive into the nine-criteria test of classification:
Mutuality of obligation
This refers to whether there is a binding commitment on the company to offer work and on the individual to accept it. Employees must be provided work and accept it. The employer has no obligation to provide work to an independent contractor, and the contractor has the freedom to turn down projects.
Personal service
An employee is required to provide their services personally, and if there is a right to appoint a substitute, this will typically be qualified at the employer’s discretion. An independent contractor generally can subcontract their work and use a substitute to complete some tasks.
Control
This refers to the degree of control which the employing entity has over a worker’s hours and place of work. An employee is supervised by a company manager and generally told when and where they can work. An independent contractor is not supervised and has more freedom to decide when and where they can get their tasks done.
Other activities
Whether the worker can undertake other work outside of the employing entity and if so, to what extent. An independent contractor is permitted to provide the same services to multiple employers at once. The same does not apply to employees.
Pay and benefits
An employee will be paid a fixed amount on a regular payment date according to their hours worked, irrespective of performance targets or project completion. An independent contractor must invoice their employer to be paid, and they will only be paid when they complete their project.
Integration
How involved a worker is in the company and its management and how they are perceived by third parties. An employee is considered to be essential to the workings of the company and integrated into the team, while the independent contractor is not.
Facilities and equipment
An independent contractor will usually provide their own equipment and materials (like laptops, desks, etc.) in order to perform the services, while an employee will rely on the employer to provide the equipment necessary to do their jobs.
Financial risk
Which party has liability for any losses arising from the agreement? An employee will be paid even where there is insufficient work to keep them occupied and will assume no financial risk in working for the employer. The same is not true for an independent contractor.
Taxation
Which party bears the liability for tax arising from the engagement? A self-employed person (AKA the independent contractor) will be responsible for the payment of their own income tax and social security contributions, whereas the employer will account for these in the case of employees.
Penalties for misclassifying workers in Germany
As mentioned earlier, employers who misclassify workers in Germany will face extremely harsh penalties. These include:
- Retroactively paying the social security contributions they should have been paying if the worker was classified correctly as an employee (Note: Employers are responsible for paying the entire amount on their own in this case, whereas normally, the employee would contribute part. Employers are not allowed to deduct social security contributions from the employee for anywhere between four and 30 years.)
- Late payment fines of up to 1% per month
- An inability to be reimbursed by the employee for any of these costs
The managing director of the company runs the risk of being held personally liable for such misclassification instances, depending on the case. They may be fined, criminally charged, spend up to five years in jail, and/or have to pay all the retroactive social security contributions out of their own pocket.
And these are just the financial risks. Businesses can also be banned from hiring independent contractors, face legal action from employees, and suffer reputational damage that makes it difficult to keep or hire employees.
Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.
