Recently, a considerable number of our clients who are entrepreneurs have contacted us after receiving a call from the Tax Administration to provide certain documentation and information to assess the compliance of their business with various legal obligations, including the so-called Independent Contractor Test.
We have previously written about the Independent Contractor Test, and as we approach the end of the first five years since its implementation began, it is not surprising that the relevant authorities are starting to conduct checks on its proper application and sanctioning any identified violations.
When discussing these provisions of the Law on Personal Income Tax, which apply to all entrepreneurs, it is essential to remember the various other obligations that come with running a business, and which are often lost sight of in the speed and busy schedule of every entrepreneur.
Such oversights can lead to severe consequences.
For example, if a business relationship between an entrepreneur and a company from Serbia fails the Independent Contractor Test, the consequences will be manifold. If the test determines the lack of independence of the entrepreneur in relation to a specific client, the income achieved will be taxed as other income at a rate of 20%, with the payment of pension and disability insurance contributions at a rate of 24%. This obligation will burden the domestic payer as the income disburser, but if the entrepreneur works for a foreign client, the entrepreneur itself will be required to pay these amounts. Not only that but if the entrepreneur fails the test, it will also be required to revise the business relationship with the specific client to ensure compliance with tax regulations.
Therefore, this time we present a brief reminder of the obligations of entrepreneurs (including entrepreneurs operating under a lump-sum tax regime) and provide several practical tips for comprehensive alignment of your business with the relevant regulations.
1. Contract with the Client as a Key Element of Compliance with the Independent Contractor Test
The conclusion of a properly formulated contract between the entrepreneur and the client is the first step toward establishing a successful collaboration, but it is often much more than that.
Namely, certain formulations in the contract may be decisive for the (non)fulfillment of several criteria in the Independent Contractor Test:
- from correctly specifying the services provided under the contract,
- to defining the rights that the entrepreneur does or does not have, which significantly affect its independence,
- up to and including certain provisions that are mandatory from the perspective of the test, and whose absence directly leads to the failure of specific criteria.
Furthermore, regardless of the Independent Contractor Test, there are numerous provisions that may restrict the entrepreneur’s independence, which are routinely incorporated into clients’ standard contracts. For example, provisions on non-solicitation (prohibiting the poaching of employees or clients) or non-compete clauses sometimes go unnoticed because they may not seem very important at the time of contract conclusion. However, they become significant when the entrepreneur wishes to change their business model or expand their business.
Regardless of whether the contract complies with the mentioned rules, it is certainly advisable to be thoroughly familiar with its contents to avoid unpleasant surprises in the event of a tax audit.
2. Be Mindful of the Language Versions of the Contracts
Regulations do not stipulate a mandatory language for a contract between client and entrepreneur, so it is possible to conclude a contract solely in a foreign language, which is often the case with entrepreneurs working with foreign clients. However, in the event of a tax audit, the tax inspector will not analyze the contract in a foreign language. Instead, he may:
- require the entrepreneur to provide a translation of the contract into Serbian, or,
- independently arrange for the translation into Serbian at the entrepreneur’s expense.
The practice has shown that when the tax inspection arranges the translation, it often leads to errors in translation or misunderstandings of the translated text, which directly increases the risk for the entrepreneur, as certain provisions might be interpreted unfavorably and lead to the failure of some criteria in the Independent Contractor Test.
Such situations can be prevented by concluding bilingual contracts from the start, which include both a foreign language version and a Serbian language version. This ensures that your contract fully reflects the agreement between you and the client, regardless of the language, and that you can provide it upon request by the tax inspector without delay or additional costs.
3. Pay Attention to Business Correspondence with Clients in Light of the Independent Contractor Test
Generally, the contract is the most critical element of the business relationship between the entrepreneur and the client and is likely to be the first item requested during an audit. Therefore, it is always advisable to have a detailed written contract with each client – the absence of a written contract can significantly weaken the entrepreneur’s position, as the contract itself provides answers to numerous questions that the inspector will likely pose, while its absence can lead to suspicion and a need for more in-depth and detailed inspection.
However, it is important to understand that the subject of a tax audit is not only the contract but the entire business relationship between the parties involved. Therefore, also pay attention to other factors that might indicate the nature of your collaboration with clients and your (non)independence, as the tax inspector may review each of these elements.
For example:
- ensure that your email correspondence with clients does not include information that might cause you to fail some of the criteria, such as an agreement concerning payment for professional training or the procurement of equipment by the client.
In addition to the aforementioned points, numerous practical tips can reduce the likelihood of failing the Independent Contractor Test. Therefore, it is crucial to stay adequately informed and take all necessary preventive measures on time, so you are well-prepared for a tax audit and can ensure that it does not conclude unfavorably for you.
4. Ensure You Have All Required Documentation for a Tax Audit
As previously mentioned, during an audit, the relevant inspectors may request a variety of documents to determine the compliance of the entrepreneur’s business with applicable regulations. Depending on the case, the list of requested documentation can vary and, in many cases, is provided to the subject of the audit before the audit itself begins. However, if this is not the case, it is advisable to request from the inspector a written list of the documentation required prior to the audit, so that the entrepreneur can be adequately prepared, and the process can be faster and more efficient.
Specifically, inspectors commonly review the following during an audit:
- business books and other financial documentation,
- records maintained by the entrepreneur,
- other documents and evidence deemed relevant by the tax inspector for establishing the facts.
5. Regularly Monitor Your Finances
The threshold of six million dinars in annual revenue is a well-known figure for lump-sum taxpayers and is crucial for the operations of many entrepreneurs. This upper limit for lump-sum taxation must be monitored throughout the calendar year, as exceeding this amount results in a significant change in obligations and legal status, shifting the entrepreneur from lump-sum taxation to the dual-entry bookkeeping system.
A valuable piece of advice for every entrepreneur: regularly track the status of your transaction book and be well-informed about the consequences of “breaching” the six-million-dinar limit, as well as the available business options once this occurs.
Although operating as a lump-sum taxpayer is often the most favorable business model, there are ways to legally optimize tax and contribution costs even after losing the right to lump-sum taxation, using the available options provided by tax regulations. These options are particularly interesting for those who anticipate revenue exceeding six million dinars within the calendar year.
In addition to the six-million-dinar threshold, it is important to note the eight-million-dinar revenue amount, upon exceeding which the entrepreneur, by operation of law, becomes a VAT taxpayer. This additional obligation does not necessarily mean a significant extra burden, considering that this threshold primarily encompasses revenue from Serbia, but not from abroad. It is crucial to note that the eight-million-dinar threshold is not monitored within a calendar year as with the six-million dinars threshold but over any 12 months. Therefore, the assessment concerning this threshold is based on the 12 months preceding the time of inspection. In other words, the relevant periods for these two thresholds differ, so particular attention should be given to monitoring each individually.
Additionally, maintaining accurate records is significant from the perspective of the previously mentioned Independent Contractor Test. If most of the entrepreneur’s income comes from a single client, the likelihood of failing one of the test’s criteria significantly increases. Therefore, it is important to also monitor the structure of annual revenues, that is the percentage of total income derived from a single client.
6. Before a Pause, Don’t Forget to “Freeze” Your Agency
Another issue many entrepreneurs are currently facing is a situation where the Tax Administration has initiated enforcement procedures to collect taxes and contributions that became due during a period when the entrepreneur was not actively conducting business but failed to place its business in a state of inactivity. In other words: tax obligations continued to accrue even though the entrepreneur was not operating, leading to significant tax debt.
Notification of the cessation of business activities or, colloquially, “freezing” of the entrepreneurial agency, is implemented whenever an entrepreneur wishes to cease operations, whether due to a lack of work, vacation, or other personal reasons. The main reason why cessation of business activities is advisable (though not mandatory) is that during the registered period of inactivity of the entrepreneurial agency, tax and contribution obligations also “pause,” so the entrepreneur incurs no costs typically associated with active business operations.
However, many entrepreneurs forget this step, inadvertently putting themselves at risk of accumulating state obligations even though they are not actively operating, which often leads to tax warnings and, ultimately, enforcement actions to settle the accrued debts.
For example, the described situation often occurs when an entrepreneur moves abroad but remains registered as an entrepreneur in Serbia, assuming that the entity will automatically dissolve after some time or that tax and contribution obligations will cease due to the lack of income in the business account. We have bad news – such conduct is incorrect. Not only that, but it is also directly contradictory to the fundamental principle of lump-sum taxation: the lump-sum amount of taxes and contributions determined by the tax decision is payable regardless of the level of income, and this obligation exists as long as the entrepreneur remains active.
7. Ensure That the Software You Use Is Legal
Another example of business errors that are frequently discovered during audits by the relevant authorities is the use of unlicensed software, specifically “pirated” versions of software or unauthorized copies of legitimate software.
Although software licenses are not cheap and can represent a significant expense, especially for entrepreneurs at the start of their business, the consequences can be far more severe if it is discovered during an inspection that you have installed a computer program on your computer or your employees’ computers that was not legally acquired. Such action constitutes a violation of intellectual property rights and is punishable by substantial fines, which can reach up to 500.000 dinars, according to the Law on Copyright and Related Rights.
Fortunately, there is a way to prepare for a software legality inspection. The Checklist outlines the requirements for the lawful use of licensed software that you need to meet to ensure compliance with regulations. This list allows businesses to conduct a self-assessment of their operations proactively and adequately prepare for potential audits. This list enables business entities to conduct a self-audit of their operations and adequately prepare for potential inspections.
Of course, the list of obligations for entrepreneurs does not end there, but this time we have highlighted a few specific ones that are always relevant, and which have particularly been subject to frequent audits by the relevant authorities recently.
Now that you have refreshed your memory, we hope you are ready to face new business challenges.
