The Serbian government has sent to the National Assembly a bill on the amendments to the personal income tax and social contributions laws. The new rules are supposed to apply as of 1 January 2020. The proposed changes are numerous, but the ones that attracted most attention are changes in the way of taxation of sole entrepreneurs who are engaged on service contracts exclusively with one employer. The new rules introduce the “independent contractor test” to determine cases when an entrepreneur is not genuinely independent from his client. Entrepreneurs who do not pass the test will be subject to higher taxation. The largest effect will be on IT industry. To offset the adverse effects of the new tax hike in the short term, the bill provides for incentives for hiring unemployed people as well as sole entrepreneurs in the period from 2020 and until the end of 2022. Other important changes are in the area of payroll taxation for newly established innovative companies and payroll tax basis cut for specialists who relocate to Serbia.
Independent contractor test
Software developers and other professionals often register as independent sole entrepreneurs and are in the vast majority of cases granted the privileged “lump-sum taxation” status. This means that they do not pay personal income tax and social security contribution on their real income, but on a deemed income which is close to statistical average monthly wage in the area where they live. While Serbia has rather low rate on salary and personal income from registered sole entrepreneurship business (10%), the aggregate rate of social security contributions is significant (35.8%). The benefit of “lump-sum taxation” is therefore obvious. In the IT sector, however, many of those registered as entrepreneurs in fact work exclusively for one IT company. The proposed new rules will, however, apply not only to entrepreneurs who benefit from “lump sum taxation” regime but also to those who keep accounting books and pay income tax on taxable profit, if they do not pass the independent contractor test.
The independent contractor test is run against each individual income stream. Those who fail the test with respect to a particular income stream will be taxed on that income at the rate of 20%, without lump-sum deduction on standardized cost being available, and subject to pension contributions at the rate of 25.5% (subject to the annual cap on the social security contributions of five times the average annual wage in Serbia which is currently RSD 4,100,700 or approx. EUR 34,700). Their other income, which does pass the test, will be taxed under the otherwise applicable regime. This means, for example, that an entrepreneur benefiting from the lump-sum taxation may be required to pay both the lump-sum and special income tax on the income that failed the test.
The independent contractor test will include nine criteria related to the relationship between the entrepreneur-contractor and his client:
- whether working hours or annual/other leave are determined by the client (or the client’s related party) and the fee is the same even when the entrepreneur is on annual/ other leave;
- whether the entrepreneur usually works at the client’s premises or at such other places as directed by the client;
- whether the client organises training for the entrepreneur;
- whether the client engaged the entrepreneur following a recruitment process involving advertising or services of recruitment professionals;
- whether the client provides equipment, tools, other tangible or intangible assets necessary for the entrepreneur’s work or finances acquisition of such assets (except where specialized equipment or tools are necessary for the performance of a specific work), or whether the client habitually organises and leads work process (in excess of basic orders and reasonable supervision of the work process and results);
- whether predominant portion (at least 70%) of total income is earned from one client (including client’s related parties) within any 12-month period;
- whether the entrepreneur carries out the same business activity as the client without bearing usual commercial risk associated with the work product delivered to the client’s client;
- whether the entrepreneur is partly or fully prohibited from providing services to other clients, except where the prohibition relates only to a limited number of client’s direct competitors; and
- whether the period of engagement of the entrepreneur for the client reaches or exceeds 130 business days in any 12-month period (including engagement during any period of time during a business day of 24 hours).
An entrepreneur can pass the independent contractor test only if at least five out of the above nine questions are answered negatively.
The independent contractor test is supposed to start being applicable on 1 March 2020.
Tax breaks for employment during 2020-2022
The bill envisages a significant reduction of tax burden for companies which take on board certain categories of qualified employees under regular employment agreement and register them with the central social security registry in the period from 1 January 2020 and until the end of 2022. Qualified employees are people who will have been unemployed during 2019 and until 30 April 2020, provided that are hired as employees from 1 May until 31 December 2020. Qualified employees are also individuals who will have been self-employed entrepreneurs during 2019, provided that they become employees in the period from 1 January until 30 April 2020. A company which hires qualified employees in the given periods and thus increases its total headcount compared to 31 December 2019, and does not decrease such total headcount number until the end of 2022, will see the payroll tax cost related to those people reduced by 70% and the costs of the pension and disability insurance contributions reduced to zero in 2020. In 2021 the payroll tax for the newly hired qualified employees will be reduced by 65%, while the costs of social security contributions for those people will be slashed by 95%. Finally, for 2022, the payroll tax costs for the newly hired people from the qualified employee category will be cut by 60% and the pension and disability insurance contributions by 85%.
To combat possible abuses, the bill provides that any subsequent decrease in the achieved headcount level will reduce the tax benefit related to the hired qualified employees accordingly. In order not to lose the tax benefit, operating companies which start hiring new qualified employees after 1 January 2020 must keep the achieved headcount level as of 31 December 2019 increased by the number of newly hired qualified employees. For companies that start operating in 2020 or later (until the end of 2022) and start hiring in the first year of operation, the relevant headcount level which should not be reduced will be those as at 31 December of the first year of operation and hiring.
Payroll tax and social security contributions relief for founders of innovative start-ups
Effective from 1 March 2020, a new tax incentive will be available to the founders of innovative start-up companies established between 1 March 2020 until 31 December 2020. Those companies will be fully relieved from paying payroll tax and social security contributions on salaries paid to their founders who hold more than 5% of total share capital., up to the monthly amount of RSD 150,000 or approx. EUR 1,270. This exemption is available for the period of 36 months from the date of incorporation. The shareholder must maintain his shareholder and employee status for the entire 36-month period.
This incentive is available only to companies which are not related to any company within the meaning of the transfer pricing rules of the Corporate Income Tax Act and which generate less than 30% of their total income from trade with parties related to any of their founders. Other anti-abuse measures are built-in in the proposal, preventing multiple use of the tax exemption by more than one company with respect to the same individuals.
Five-year payroll tax basis cut of 70% for specialists who relocate to Serbia
The bill also offer a 5-year long 70% cut in the payroll tax base (gross monthly salary minus allowance of around EUR 135 and social security contributions base (gross monthly salary without allowances) for specialists who relocate to Serbia and (i) enter into an indefinite-term employment agreement with qualified employers in Serbia and (ii) relocate their centre of business and vital interests to Serbia allowing them to become tax residents of Serbia both under the national law and under the relevant double taxation treaty. This particular incentive will be available from 1 March 2020.
A specialist who can benefit from this incentive is an individual who, regardless of his nationality, is a specialist in a field where local experts are lacking. The law distinguishes between two categories of specialists who are eligible for the payroll tax basis cut, as follows:
- specialist who in the period of 24 months prior to the employment agreement with a qualified employer in Serbia, has spent most of their time outside Serbia and whose monthly salary agreed with the qualified employer exceeds RSD 217,656 (approx. EUR 1,840); and
- specialist who has less than 40 years of age at the time of entry into the employment agreement and who, within the 12-month period prior to the employment agreement has spent most of his time studying abroad, and whose monthly salary agreed with the qualified employer exceeds RSD 145,104 (approx. EUR 1,230).
The conditions for the incentive must remain satisfied during the entire 5-year period. However, the benefit is not lost if the specialist terminates employment with one qualified employer and continues employment with another qualified employer.
A qualified employer is a legal person or a self-employed entrepreneur, tax resident in Serbia, unrelated to the specialist’s preceding employer. By way of exception, qualified employer can be related to the former employer of the specialist provided the employee fulfilled the conditions for tax residency in Serbia during at least three consecutive years during the period of 25 years prior to the year when he establishes employment relevant for the incentive.