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EATLP Congress, Cambridge 2008
Taxation of Workers in Europe
Part 1: Taxation of Employment Income in the EU Member States
General Report
Sandra Eden/Carlos Palao
Preliminary remark
This report is based solely on the national reports that have been presented to the Working Group. These concern the following [CPT1]14[CPT2][CPT3]countries: Belgium, Denmark, Finland, Germany, Greece, Luxembourg, The Netherlands, Norway, Poland, Portugal, Spain,Sweden, Switzerland and the UK. Not all the details have been reproduced in this report; for further information the national reports should be consulted.
- Basic framework
Regarding income taxation the tax systems can broadly be divided into two groups: (1) countries that include all kinds of income in a single base to which common rates are applied (the synthetic system) and (2) countries that separate income from capital or investment and income from employment or self-employment (the latter two referred to here as labour income). The latter is generally called the “dual system” and is characteristic of the Scandinavian countries (Finland, Norway and Sweden). Spain has joined this group in 2007. In this system basically capital income is subject to a flat rate, whereas employment and self-employment income are subject to progressive rates[1].
Under both systems, employment income is taxed at the same rate as self-employment income[2] although in Poland, the self-employed can choose between being taxed according to the general rules at a progressive rate (to which employment income is subject) or at a flat rate of 19% on gross income. However, there is some evidence that employment income is given certain preferences over self-employed income in some jurisdictions – for example Greece and the Netherlands give a higher personal exemption in relation to employment income and Sweden gives “job tax relief”. The lump sum reduction from employment income granted by Spanish law (see infra, 5,B) has a similar function. In Switzerland, capital paid by an insurance institution to an employee in connection with employment is taxed at a rate one fifth of the normal one.
- Definition of employment income
a)What tests are used to distinguish employment income from independent activities such as a profession?
It is evident from all the reports that employment income is treated as a separate category, with the possible exception of Denmark. Even countries which tax labour income separately from capital income still distinguish between employment income and income from being self employed.
The reasons for this are obvious in some cases, for example the specific reliefs
for employment income noted in section 1. Other reasons include the differential rate of social security contributions on employment income, different rules for the deduction of expenses as between employment income and business income and so on. But one of the most compelling reasons for distinguishing them is administrative – the payer’s obligation to collect tax at source from employment income.
Employment income must obviously proceed from an employment relationship or labour contract, not necessarily in the formal legal sense (Portugal). Thus, the Swiss report points out that the characterization of the relationship under private law is only a sign of employment income for tax purposes. Any income connected with such relationship is considered employment income. The connection can be quite loose. The reports mention various characteristics that point towards the existence of an employment contract(rather than a contract for services) which are remarkably consistent: the dependent nature of the employee’s activity, that is, the degree of control exercised by the employer. Another characteristic that is mentioned in the reports is the absence of the economic risk inherent to entrepreneurial or professional activities. Doubtful cases must be decided taking into account the specific circumstances. The Swiss report describes some cases that illustrate a vis attractiva of the qualification as employment income.
b)Can income from a partnership be taxed as employment income?
This question is unanimously answered in the negative by the national reports. Partnerships (or the equivalent Civil law figures) are usually subject to a fiscal transparency regime, according to which the income of the partnership retains its nature in the hands of the partners. This excludes it from being treated as employment income. The Greek report mentions the exception of certain retainer payments to members of law firms (partnerships), which constitute employment income.
c)Outside the normal definition of employment income, are other forms of income deemed to be employment income for tax purposes, either on the grounds of consistency or anti-avoidance?
For example, can company income ever be attributed to an employee of the company, or vice versa?
Are there any special rules for agency workers, so that a person who would normally regarded as providing services in an independent capacity is treated as an employee for tax purposes?
Can royalties be taxed as labour income where for example they are effectively disguised employment income paid as royalties for the use of rights assigned to a company?
The combat against the various forms of avoidance that affect employment income can of course be fought with the general anti-abuse provisions, such as lifting the corporate veil, or other legal doctrines, as some reports indicate. Other reports mention the necessity to look for the correct characterisation of income, in other words, the way in which the parties dress the income up is not necessarily the end of the story: it is the reality of the situation which determines the correct characterisation (for example Norway).
Several countries also have specific rules designed to prevent the conversion of employment income into another kind of income less heavily taxed (a case of tax avoidance). In Sweden there are rules [CPT4]against the transformation of employment income into dividends. There are other rules against other specific varieties of avoidance: in Belgium rental payments for a building rented by a company from a director can be reclassified as director’s fees. Other rules can also work in the opposite direction, that is against the transformation of capital income into salary. This is the case of a provision in The Netherlands according to which payments for services performed for a company by persons who possess a substantial interest (5%) in it may not deviate substantially (30%) from what is usual in a normal business environment.
The reports that have addressed the question about agency workers on the whole deny the existence of specific provisions on this matter. Under the general definition of employment income they either be treated as employees, or be considered self-employed according to whether their relationship with the person to whom they render their services is dependent or independent. However, the UK has a set of special rules which operates under certain circumstances to treat the income of an intermediary as the income of the worker. Where a service provider (which can be a company) is interposed between the worker and the end-user of the services (“the client”) and the relationship between the worker and the client demonstrates the characteristics of an employer-employee relationship, the income of the service provider is taxed as the employment income of the worker. In the Netherlands, under certain conditions agency workers can be treated as it they have en aemployment contract. Similarly, Poland treats the income of those who provide services as a manager as employment income.
No national report, with the exception of the UK and the rules relating to service providers, noted earlier, has answered affirmatively the question about the possibility of company income being attributed to an employee; some of them expressly deny such possibility.
Only the Spanish report mentions the existence of specific rules destined to combat the avoidance scheme consisting in paying salary in the form of royalties for the use of the right of image. This scheme was frequently used by sportsmen, in particular football players. The anti-abuse provision establishes that the amount paid as a royalty is imputed to the sportsperson unless the amount paid on the ground of the employment contract is at least 85% of the total payment. Income thus imputed is not considered employment income but belonging to a separate category of income, which is however added up with employment income and consequently taxed the in the same way as this.
The Dutch report refers to a case in which royalties from a copyright received by an employee (a producer of music recordings) alongside his salary was considered by the courts to be a wage, on the grounds that the income would not have been realized in the absence of an employment relationship. The Swedish report states that as a deviation from the rule that royalties constitute business income, they can be considered employment income when the royalty payment is derived from employment, an assignment or temporary activity. Under Spanish tax law, income from copyright the exploitation of which has been assigned is considered employment income unless the author or artiste has a business organization. If the owner of the copyright is not the author or artist herself (e.g. an heir) the royalty is considered income from capital.
- Attribution of employment income
Are there any situations in which employment income can be attributed for tax purposes to another person (eg from one spouse to another by virtue of civil marriage arrangements)?
The question arises when in the case of marriage each spouse is taxed separately either because this is the mandatory method of taxation or because it is optional and the spouses have chosen it. If joint taxation is compulsory, as in Luxembourg and Portugal, the problem does not arise.
In nearly all the Member States for which reports were presented, the answer to the question is negative. In some countries the law attributes part of other kinds of income to the other spouse or divides the income between them. This happens sometimes in the case of self-employment income, as in Denmark, when both spouses run a business together, and in Norway. In this situation income is earned actually by both spouses, not attributed (so to speak indirectly) to the spouse who has not obtained it. The latter seems to be the situation contemplated in the Belgian rule according to which if only one of the spouses earns business income 30% of it is taxed in the hand of the other spouse with a maximum of € 8,800. If both spouses obtain business incomeand the business income of one of the spouses amounts to less than 30% of the aggregate business income of the couple, income is redistributed between them so that this minimum proportion is reached.The aim of this provisions is to alleviate the effect of progressive rates; hence they are not the effect of a right on the income established by civil law. Consequently, they can be described as a partial splitting system. Similar rules apply in Switzerland, where if both spouses work half of the income of the spouse that earns less is deductible within certain limits.
In The Netherlands, income from substantial interest and from living property (not investment property) can be attributed to the spouse. But this attribution is always excluded in the case of employment income. In Spain, although in the case of the community property marriage arrangement most of the income is attributed by half to each of the spouses for civil law purposes, for tax law purposes employment income is attributed exclusively to the spouse who has earned it.
The question refers to attribution caused by the law itself, ope legis, not to transfer of income by an act or contract of the earner. This is of course not admissible for income tax purposes, as some reports point out (Germany, Sweden); furthermore, it might constitute a taxable gift. With greater reason (simulated) payment to the spouse or children for the purpose of avoiding tax is not acceptable (as the Finnish report points out).
- Timing aspects
a)Cash vs. accrual basis
There are broadly three methods of allocating payments to a particular period for tax purposes: the cash basis (the payment is taxed when it is actually paid), the accruals basis (the payment is allocated to the period over which it accrues) and the entitlement basis (the payment is allocated to the period in which the employee became entitled to call upon payment).
The majority of countries adopt the cash basis method as the normal rule, although there are some specialties within these systems. Danish law, however, establishes a limit of six months after the “day of payment” (scil., the day when payment is due). This brings Danish law closer to the minority of countries in which employment income is taxed when it can be claimed (the entitlement basis). In the Netherlands, where wages aretaxed when paid or when they could be claimed, there is an anti-avoidance rule, which operates when the payment is delayed or brought forward for tax purposes, in which case it is taxed at the “usual time”, ie the time when it would normally have been paid. However, “when a salary is not paid due to the fact that the company has cash flow problems, this is not regarded as not paying, or say delaying, the salary due to tax purposes.” This comment raises a different question: the effect of insolvency on the employee’s claims on their wages and how it reflects on taxation. Finland exempts payment made more than five years after the year of assessment in which the duties were performed.
Belgium and Luxembourgoperate on an accruals basis.
[CPT5]Greece, Spain and Switzerlandadopt the entitlement basis, with some special rules; e.g. when income is the object of litigation it is not taxable until a final judgement is issued in Spain.
b)Averaging
Most countries have no averaging rules for employment income. Consequently, they do not take into account the effect of progression on income produced by an activity performed during a time that exceeds a tax period, a decision that can be explained with the consideration that this is probably an infrequent situation with regard to employment income as compared with business or professional income. There are some exceptions, for example the Swedish ruleunder which a Swedish taxpayer may make a claim to have certain payments, for example pension contributions, attributable to a more than two years of service, divided between the years of service.Also in Norway there are special rules for the averaging of bonuses to military personnel. In Spain a 40% deduction is granted if the income has accrued over a period exceeding two years and it is not obtained in a periodical or recurrent manner. The same deduction is applicable to a list of irregular payments which includes basically indemnities of different kinds. There is a special rule concerning the application of this 40% deduction to income from the exercise of stock options.
c)Might a payment made to a person before he becomes an employee (for example a payment to induce him to take up employment) be taxable, and if so, taxable as employment income?
All national reports that have answered this question indicate that the payment would be considered employment income, since it is connected with the employment, irrespective of the fact that the relationship has not yet come into existence. In the opinion of the author of the German report, this would not be the case if the person does not in fact take up the employment but nevertheless may retain the money, in which case the payment would be taxed as “other income”. The author of the Spanish report suggests that in Spain the income would still be treated as employment income. In Switzerland, payment made before entering the employment relationship would not be considered employment income. According to the Portuguese report inducement payments must be examined on a case by case basis. There have been a few cases in the UK where the payment was exempt from tax on the basis that it was properly analysed as a payment to compensate for the loss of something as a result of leaving the former situation.
- Tax base
A) Taxation of income other than salary
i)Money payments
a)Can income from third parties be treated as employment income, for example tips?
All reports agree (with the possible exception of Poland) that payments from third parties can be treated as employment income as long as they fulfil the elements of the concept, essentially that the cause of the payment is the service provided by the employee.
Concerning tips, certain nuances can be observed. In The Netherlands the answer depends on whether the employer pays a reduced salary on the basis of anticipated tips – if so, the tips are treated as employment income. If a full salary is paid, tips appear to be tax free.In Norway there are special rules regarding the assessment and reporting of tips, according to which only part of them are reported and taxed. In Poland the tips are only taxed as employment income if they are pooled by the employer and subsequently divided among the employees, whereas tips paid directly to and kept by the employee are taxed as “income from other sources”. In the view of the author of the Polish report, “this approach suggests that payments made by a third party and not directly referring to employment but to services performed by the employee to the third party may not be taxed as labour income.” The question refers again to the connection of the payment to employment. Under Greek law, tips paid directly to waiters are tax-free. In the UK, tips paid through the employer must have tax deducted at source.