What happens if you are considered an employee and not a freelancer or sole proprietor?

What happens if you are considered an employee and not a freelancer or sole proprietor?

This blog discusses what happens if you are considered an employee and not a freelancer or sole proprietor in Denmark.

We based the blog on our experiences following tax rulings made for some of our clients, following the case of Wolt vs the Danish Tax Agency.

The Wolt case serves as a relevant and current example of how the Danish Tax Agency treats situations concerning the reclassification of income from freelancers or businesses as salary from employment.

The case between Wolt and the Danish Tax Agency, which was “won” by the Danish Tax Agency, resulted in the reclassification of income as salary for many individuals working as Wolt couriers, who previously had reported their income as a freelance or business income.

We have not seen any fines or other penalties applied to our clients, but we strongly recommend that you check if your income is classified correctly as salary from employment, freelance, or business income.

This is especially relevant if you claim tax deductions for business expenses or apply the business tax scheme since this could result in having underpaid your personal income tax, and with that, comes a potential tax liability, as well as potential criminal liability for tax evasion if the underpaid tax is a substantial amount.

In addition to the tax consequences, we also discuss changes made to VAT due to this case.

Generally, as we have discussed previously in this blog, it can be pretty difficult to precisely determine whether someone is an employee, freelancer, or a sole proprietor.

Proper income classification is essential for complying with Danish labour laws and tax and VAT regulations.

It also ensures that employees receive the appropriate benefits and protection as employers fulfil their responsibilities.

If you classify yourself incorrectly, you may face tax and VAT liability consequences.

Misclassifying income may result in loss of unemployment benefits, loss of pension contributions, create tax and VAT liabilities, start disputes over entitlements to other benefits such as holiday pay, termination periods, and maternal leave, and also can result in penalties.

Income types in Denmark

In Denmark, it is important to understand the distinctions between being an employee, a freelancer, or a sole proprietor from an income classification point of view.

Each status has its own set of rights, responsibilities, and implications.

Below is a brief discussion on each status:

Employee

An employee generally works under an employment contract with one employer. The employer controls the employee’s tasks, work hours and workplace. Typically, the employer carries the responsibility for the work delivered to clients. Income tax (A-tax and AM-contribution) is automatically withheld from salary by the employer and forwarded to the Danish Tax Agency. Employees are covered by Danish labour laws and entitled to benefits like holidays, maternal leave, etc. Employees are not responsible for paying self-employment taxes and cannot deduct business expenses from their taxable income. Employees often have a fixed salary and work 40 hours per week for the same employer.

Freelancer

A freelancer is an independent contractor; any single company does not legally employ them. Freelancers can decide on working hours, projects, clients, etc. They are responsible for calculating, reporting, and paying all income taxes (B-tax and AM-contribution). Freelancers are not covered by the same labour laws, protections, and employee benefits. However, they can deduct legitimate freelance expenses from their taxable income above a certain threshold. Freelancers may need to charge and pay VAT depending on their annual revenue. The VAT requirement is relevant if the revenue is 50.000 DKK or more during any 12-month period. Often, freelancers work on a project basis for multiple clients. A freelancer also has some level of risk for work performed. A freelancer will need to register in the same way as a sole proprietor and obtain a CVR-number. The main difference between a freelancer and a sole proprietor from a tax perspective is how the income is reported on the personal income tax return and what tax deduction can be claimed by the freelancer. Generally, the freelancer has fewer tax deductions available compared to a sole proprietor.

Sole proprietor

A sole proprietor is a registered self-employed business owner with a CVR-number. In Denmark, we call this registration “Enkeltmandsvirksomhed” or, in English, a “sole proprietorship”. The registration comes with an obligation to collect and pay VAT for most industries. A miniature version of the sole proprietorship called “PMV” or a “small private business” also exists, which is not required to collect and pay VAT, but this only applies to businesses with revenues below 50.000 DKK during any 12-month period. A business operated as a sole proprietorship has no legal separation from the owner personally. Sole proprietors report all business revenues and expenses on their personal income tax returns as a profit or loss. They are responsible for paying their income tax (B-tax and AM-contribution) and VAT if applicable. While sole proprietors can hire employees, they still operate as self-employed individuals. Sole proprietors are personally liable for all the debts and obligations of their business. They can deduct legitimate business expenses and depreciation of assets from their taxable income. A sole proprietor generally will have more risk than a freelancer. Also, a sole proprietor would present him- or herself as a real business with a website, have marketing activities, maybe have an office, serve multiple clients, and can have a more complex setup than the freelancer.

Simply put, employees benefit from more formal protections but less flexibility. At the same time, freelancers, especially sole proprietors, have more autonomy but greater responsibility for taxes, accounting, and legal compliance while carrying more risk.

Criteria for Employee vs. Freelancer or Sole Proprietor Classification

To determine employee, freelancer or sole proprietor classification in Denmark, the Danish Tax Agency considers various factors, such as the level of control exercised by the employer or client, integration into the business, and the opportunity for profit or loss.

1: Control over work

In general, employees work under an employer’s direction and control by following specific instructions and sticking to company policies. Freelancers and sole proprietors, on the other hand, have more independence over their work arrangements and decision-making processes.

2: Integration into the business

Employees are often integrated into the business’s daily operations, working alongside other employees and using company resources. Meanwhile, freelancers and sole proprietors maintain a separate business identity and may work remotely or from their premises.

3: Opportunity for profit or loss

Employees receive a fixed or hourly wage regardless of the business’s viability. While freelancers and sole proprietors can generate profits from their work, they also bear the risk of financial losses.

Other factors that can influence income classification include the duration and permanence of the working relationship, the provision of tools and equipment, risk assumed, termination period, benefits, and the wording of contractual agreements outlining the terms of engagement.

VAT Implications of reclassification of income to salary

VAT corrections

VAT corrections are needed after reclassifying freelance or business income to salary from employment.

When a reclassification occurs, the declared VAT is typically adjusted to zero, necessitating corrective measures.

Sales VAT and purchase VAT

Generally, any VAT you have previously declared will be changed to zero.

Since you have most likely already declared VAT, this will create some challenges.

To correct this situation, the Danish Tax Agency will generally consider the amount of sales VAT you have paid and the amount of purchase VAT you have already been reimbursed.

The purchase VAT you have already been reimbursed will be added to your taxable income until you settle this with your client.

The VAT you have paid to the Danish Tax Agency will generally be transferred back to you, so you can also transfer this to your client.

However, the Danish Tax Agency can decide to transfer the amount to your client directly, who paid the sales VAT to you, if they believe there is a chance that your client will make unreasonable efforts to claim the VAT from you.

The difference in VAT is a claim that your client will have against you.

When you later pay the difference in VAT to the client, you can ask that your taxable income be lowered accordingly.

Tax Implications of reclassification of income to salary

Profit or Loss Adjustments

Generally, any income you have previously declared as freelance or business income will be changed to zero.

This adjustment invalidates any reported profit or loss affecting the tax obligations.

A-Income Declaration

When profit or loss is adjusted to zero, the freelance or business sales are acknowledged as salary instead.

We also call “salary” for “A-income”.

The A-income after reclassification will include the total sales excluding VAT, along with any purchase VAT that has already been reimbursed to you.

Deductible Expenses

In addition to reclassifying the income to A-income, you can often deduct certain expenses from the taxable income.

One such deductible expense is employee costs that exceed 7.000 DKK (2024).

These costs should be declared appropriately, allowing you to lessen your taxable income.

Example of Reclassification

If you issued a sales invoice for 10.000 DKK + 25% VAT to a client, you would have received 12.500 DKK.

If you purchased equipment during the same period for 1.000 DKK + 25% VAT, which was deducted as a cost in your business, you would have paid the supplier 1.250 DKK.

On the VAT return for this period, you would pay 2.500 DKK in sales VAT and get reimbursed 250 DKK in purchase VAT.

This means you would settle 2.250 DKK with the Danish Tax Agency as a freelancer or sole proprietor.

When the Danish Tax Agency reclassifies the income to employment, they start by zeroing the VAT.

So, the Danish Tax Agency will either repay you the settled VAT (2.250 DKK) or transfer this amount directly to your customer.

In this example, we let the Danish Tax Agency transfer the settled VAT directly to the customer.

Since the Danish Tax Agency regards VAT and costs as not applicable, it will look at income, which should be classified as salary.

In this example, it would be the 10.000 DKK, excluding VAT, which you first issued on a sales invoice.

However, since your customer already paid you, including VAT, you received more than 10.000 DKK.

In total, you have received:

10.000 DKK + 2.500 DKK in sales VAT = 12.500 DKK

And you paid:

1.000 DKK in purchase of equipment + 250 DKK in purchase VAT = 1.250 DKK

Since the VAT is considered zero after the reclassification, the Danish Tax Agency will transfer 2.250 DKK to your client (2.500 DKK – 250 DKK).

The Danish Tax Agency will consider the 250 DKK purchase VAT you already received reimbursed as an extra salary.

The 1.000 DKK in purchase of equipment they will consider as a private cost in this example.

It means you will be taxed on 10.000 DKK + 250 DKK = 10.250 DKK.

Your client will receive 2.250 DKK from the Danish Tax Agency.

If the client wants to claim the 250 DKK difference and asks you to repay this amount, you can apply to the Danish Tax Agency to lower your income to 10.000 DKK after you have paid the 250 DKK to your client.

That way, you get paid and taxed only on the 10.000 DKK.

And your client ends up paying only 10.000 DKK.

Your tax deduction loss for the 1.000 DKK in equipment purchase is most notable.

Under certain limitations, an employee can deduct costs directly related to the employment.

But the annual cost must exceed 7.000 DKK (2024).

One specific example pertains to Wolt couriers in Denmark:

The Danish Tax Agency seems to allow for a deduction of transportation costs, typically based on 10% of the courier’s income from Wolt.

Various industries in Denmark may have other unique tax implications.

Fines and Criminal Liability

Incorrectly classifying income may lead to fines, penalties, and reputational damage.

Understanding the potential consequences of misclassification is essential to avoid costly mistakes and legal repercussions.

Tax evasion or postponement tactics are illegal practices in Denmark that can result in criminal liability for businesses and individuals.

Our recommendations

Based on what we have discussed in this blog, our recommendation is always to familiarise yourself with the criteria used by the Danish Tax Agency to determine income classification.

Also, we recommend everyone to apply for a binding ruling to get a 100% clear situation.

Applying for a binding ruling from the Danish Tax Agency can help you mitigate the risks associated with misclassification and safeguard your financial interests.

This is the best way to avoid surprises later.

(This blog was updated: 4.6.2024)

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