Employee or independent contractor? – Guidance for payers
In force until further notice
Work can be compensated in the form of wages or salaries paid to employees or as fees billed by independent contractors. This document looks at the differences between employment income and trade income from a tax perspective. *
It is important to distinguish between these two concepts because the obligations of employers are different from those of businesses paying for services from external providers, independent contractors or self-employed individuals. If your business has an employment relationship with individuals doing work for it, you must withhold tax and social security contributions on their behalf; if there is no employment relationship, no social security needs to be paid. If your business makes payments to individuals who are not on the Prepayment Register at the date of payment, you must withhold tax. The register can be checked online at www.ytj.fi/english/.
Payment is held to be trade income (in Finnish: työkorvaus; in Swedish: arbetsersättning) only if it is clearly shown not to be in the nature of employment income.
Definition of employment income
For work performed under an employment contract, a salary or wages are paid through the payroll system to the employee or worker. The employer can be a public or private organization or an individual. The Prepayment Act of 20 Dec 1996 (1118/1996) lists a number of payment types that should always be classified as wages, even if no employment contract exists.
In order to determine whether or not the worker is an employee or an independent contractor, and consequently, whether payments should be treated as employment income or trade income there is a number of factors to consider.
Who has the right to direct and control the performance of work?
Employers can usually to a large degree direct and control the work of their employees. They can give orders and detailed instructions as to what work must be performed. They can also control how the work is done.
In contrast, a business in the role of a client is usually paying for delivery of the completed work from an external service provider, independent contractor or self-employed individual. However, even in this case, the business has some control over how the services are being performed and can also give instructions to make sure that the end results are satisfactory. If the completed work differs significantly from what has been ordered, the business has the right to demand rectification of the errors or monetary compensation.
Social security contributions
Under Finnish law, all employers are required to provide for the social security of their employees. This takes the form of a variety of insurance contributions, including pension insurance. Employers also pay wages during days off and sick leave.
However, in the case of independent contractors, payment is based solely on invoices — with no extras added on. The independent contractor’s fee can be based on an agreed total amount or on hours worked.
Social security — such as pension contributions, other insurances, holiday pay, and sick leave — are the responsibility of the contractor, not the business purchasing the services.
It is common for employers to offer their employees in-kind or fringe benefits, which are given in addition to monetary compensation. Typical of these are telephones, meals and company cars. The employer can further choose to make arrangements for free or subsidized medical care, recreation and sports.
However, in the case of independent contractors, payment is entirely based on the invoice, reflecting the value of the work. The arrangement does not involve any benefits in addition to the amount invoiced.
Responsibility and guarantee
Generally there is an employee/employer relationship when the person for whom services are performed carries responsibility for the work. In this way, if a third party were to suffer harm or injury arising as a result of the work, they would direct their demands for damages to this person – the employer – not to the employee or worker.
However, independent contractors are fully responsible for the quality of the work they perform. They may offer the client a guarantee period – during which time they promise to rectify any problems free of charge.
Tools, equipment and materials
Generally there is held to be an employee/employer relationship when the necessary tools and materials have been purchased by the person for whom services are performed. Nevertheless, there are lines of work in which it is standard practice for workers to have their own hand tools (for example in carpentry, where they typically bring their own, privately owned tools even though they work for an employer under an employment contract).
Independent contractors tend to own the tools they use, and also buy at least some of the materials themselves. There is an economic risk associated with the ownership of machinery and equipment. Independent contractors typically bear this risk themselves; employees do not.
Time and place
Independent contractors may have their own premises. Nevertheless, in many industries, it is not possible for independent contractors to carry out work other than at the client’s premises — housing construction and shipbuilding being two examples. Other lines of work require that contractors be part-time at client premises — for example, software programming, IT services, and data security services. Sometimes employees can work from home. Today’s flexiwork arrangements between employers and employees make it possible for ordinary employees to carry out their work away from their employees’ premises.
For these reasons, the place of work alone is not sufficient to determine whether or not the worker is an employee or an independent contractor. However, the fact that a worker regularly comes to company premises to work - even if there is no obvious reason to perform the work there – tends to support the view that a normal employer/employee relationship exists.
Rules on specific payments
The following types of payment are always considered employment income:
- Payments for attending conferences
- Honorary fees for giving speeches or lectures
- Payments for membership of a board of directors,
- Payments paid to managing directors
- Payments from general or limited partnership companies, i.e. monies withdrawn by shareholders
- Payments for appointment to positions of trust.
The above are considered compensation for employment even if none of the other characteristics of an employer/employee relationship exist.
*Royalty-type payments (käyttökorvaus; bruksavgift in Finnish and Swedish) arise less frequently, and are associated with authors’ rights to finished works. However, except for a different classification in the Employer Payroll Report, monies paid out as royalties are treated in a similar way to other trade income.