Reports of the death of service contracts with workers are exaggerated | In Principle

In the early years of my legal career, I came across a tax interpretation requested by a library wishing to determine the tax consequences of forgiving fines for overdue books. That was when I heard for the first time the advocacy rule of avoiding “the question too far.”

In 2015, a municipal library in Poland asked the director of the National Revenue Administration in Katowice about the tax consequences of charging readers a fine for failing to return books on time, and then, as the readers’ request, waiving the fine. The library wanted to find out whether the readers had obtained imputed income from debt forgiveness which would require the library to issue an income statement (PIT-8C) to the readers for their forgiven fines.

The tax authority ruled that, indeed, a reader whose fine is forgiven obtains a taxable benefit, and the library must issue a PIT-8C statement to the reader.

Some libraries in Poland celebrate Librarian’s Day (May 8) by forgiving fines for readers who return overdue books on that date. So footfall tends to be higher on that day than during the rest of the year. And librarians familiar with the tax interpretation had to accept that their holiday would turn into a day for issuing PIT-8C statements.

Happily, this interpretation has become a distant memory. Nonetheless, at that time I grasped a principle that has stayed with me, known as “the question too far.” In other words, don’t ask a question if you suspect you know the answer and it is not the answer you want to hear.

This principle came back to me in full force when I read a ruling by the head of the National Revenue Administration refusing to issue a safe-harbour opinion on conclusion of service agreements with former employees (interpretation of 12 June 2024, no. DKP3.8082.10.2023).

What the tax authority said

A company employing a group of people under employment contracts asked the head of the National Revenue Administration whether it would constitute tax avoidance to (i) create a subsidiary, (ii) terminate the employment contracts, and then (iii) have the former employees enter into service contracts with the new subsidiary.

This change would generate a tax benefit because it would obviate the need for the employer to withhold PIT advances and would also give the workers greater flexibility in choosing how to be taxed.

In the ruling, the tax authority pointed out that the service providers would be permanently and structurally involved in the subsidiary’s work, and their duties would essentially be the same as before, performed using the same infrastructure. Awkwardly, the applicant also stated explicitly that its intention was to change the form of employment.

The tax authority found that in these circumstances, the applicant’s intent was to obtain a tax benefit, and the applicant was not interested in actual conduct of business by the service providers.

The ruling cites numerous arguments by the applicant pointing to an economic rationale for the planned change. While the tax authority logically dissects many of these claims, its reasoning is not always persuasive. Leaving aside the details, I would pose the broader questions:

• Could the tax authority have ruled differently? No. Condoning the applicant’s plan could trigger an avalanche of similar reorganisations in many sectors, not just those where “self-employment” is common practice. This would weaken worker protections, reduce tax receipts, and increase the cost of audits seeking to uncover artificial tax arrangements.
• Does the tax authority’s position hurt industries that rely on service contracts? No. The request put the tax authority in a bind. On one hand, the authority must counter aggressive tax optimisation, but on the other hand, must state its position in a way that will not disrupt sectors like IT, where such arrangements are common. In selecting the arguments to include in the ruling, the tax authority leaves enough room not to cause unnecessary harm.

In the ruling, the tax authority points to a number of circumstances distinguishing the situation outlined in the taxpayer’s request, which was denied, from the actual situation of many service providers, for example:

• The facts stated by the applicant concern the transition from an employment relationship to a civil relationship with a company whose establishment was driven by tax considerations
• There is no obstacle to an employer entering into a service contract with individuals conducting their own business activity who did not previously work for the company under an employment contract
• The tax authority took a dim view of the fact that the service providers would have the same scope of responsibilities as they did when they were employees, and would not be using their own infrastructure
• In principle, an employment contract and a service contract set different liability rules for non-performance or improper performance of the work or services in question.

Is it as bad as the internet makes it out to be?

In response to this ruling by the head of the National Revenue Administration, the internet in Poland exploded with headlines and articles striking a doomsday tone, as if the taxman were about to take an axe to self-employment, and turn the delivery of contract-based services into a nightmare for all parties.

In reality, the applicant here was the main culprit behind the online frenzy. Before this ruling was issued, bogus self-employment was already an area of interest for the tax administration, in its inspection policy and at the legislative level. This state of affairs continues, and the views expressed by the head of the National Revenue Administration in the recent ruling should not have surprised anyone.

Sometimes it’s better not to ask.

Wojciech Marszałkowski, adwokat, Tax practice, Wardyński & Partners