Risks for Employers of Wrongly Classifying Employees as Self-Employed

When hiring for the first time in a new territory, particularly if there is no local employing entity, engaging people on a self-employed/independent contractor basis can often feel like the simplest solution. Top talent may be demanding the flexibility that self-employment brings, along with the beneficial tax treatment it often entails. And this has benefits for the employer too, since they can hire with agility and at lower cost.

But is it all too good to be true? Employee classification is a hot button issue in many countries and getting it wrong can come at a high price. Large penalties and legal claims, against employers as well as senior officers, have been highly publicised. The legal and financial risks vary across different countries but can include legal action by misclassified employees for breach of employment rights, significant awards of compensation, fines and even imprisonment. Along with reputational risk, taking a chance on misclassification is perhaps a risk not worth taking.

Employee classification

It is up to employers to determine the employment status of their workforce in accordance with local laws. While employee classification rules vary significantly across different countries, it is often the case that what is stated in the contract is not determinative – a range of factors are often used to make the determination. Hiding behind the contract will not usually be an option if challenged. 

As a general rule, an employment contract is an agreement by which an individual works for a person (natural or legal) under the latter’s subordination, for which they receive remuneration. On the other hand, it is likely that an independent (self-employed) contract applies if the individual is responsible for organising their own workload and occupational activities, without being subject to the ‘authority’ (or ‘control’) of another. The most important distinction tends to revolve around the concept of subordination, where the relationship is characterised by performance of duties under the authority of an employer who has the power to give orders, monitor execution of assigned duties and discipline their subordinate’s breach of duties. 

Other factors include how the individual is paid, whether the individual is free to contract with others, whether they can provide a substitute to carry out the services, as well as the nature of the services, the apportionment of risk, remedies in the event of breach and liability for taxes. 

Legal risks of misclassification 

Getting employee classification wrong can have very significant legal and financial implications for employers, and in some cases also for their senior officers. Although the implications of employee misclassification can vary substantially across different countries, the legal risks for employers can include:

• Large fines and penalties for employers: The size of fines and penalties for misclassification can vary considerably across different countries. While some have relatively low fixed maximum penalties for businesses, others calculate penalties according to the number of individuals impacted by the misclassification. In recent years, there has been considerable publicity around large fines imposed, with the delivery app company Glovo reportedly being fined almost Є79million by Spanish authorities in 2022¹, and again in 2023 when it was reportedly fined close to Є57million.²  It is reported that Glovo disputes the penalties and is appealing. 
• Criminal sanctions against senior officers: In some countries including Australia, France and Germany, misclassification can impact on the business’ directors, board members and other senior officers in a personal capacity. Where they have wilfully or knowingly misclassified employees, they may face criminal prosecution and potentially be liable for significant fines, and in some cases imprisonment.
• Back payment of taxes: Where misclassification occurs, governments don’t receive payroll taxes that are due, and employers will be liable for these unpaid taxes and interest. Depending on the severity of the misclassification, in some countries employers may also face additional penalties and fines. Another consequence for employers is that they may be subjected to increased scrutiny from local tax regulators or other government agencies.
• Legal action – claims by employees: In recent years, employers globally have faced significant class actions by employees who were misclassified as self-employed. These legal claims usually seek compensation for unpaid wages and benefits they were entitled to but didn’t receive (such as holiday pay and health insurance) over a number of years. Very significant sums have been paid in settlement of such claims. In addition, investigating and defending these lawsuits takes up a considerable amount of management time. In the UK, a recent case decided in the Court of Appeal determined that an individual who had been misclassified for 6 years could claim unpaid holiday pay for the whole period.³

Implications for employers

It is crucial that employers understand what the applicable employee classification rules are in each country in which they operate, and follow them correctly, not least because of the legal risks of getting it wrong. There are, however, other potential consequences for employers of misclassifying employees. 

High-profile legal claims and penalties can lead to negative publicity and reputational damage which, among other things, may negatively impact on employee recruitment and retention. In addition to potentially putting a strain on relations with contractors through having to re-classify employment status, employers may even face a ban on hiring independent contractors altogether for a number of years, as is the case in France. 

Given the very significant legal, financial and reputational challenges for employers of wrongly classifying employees as self-employed, employers should obtain local legal advice and take the necessary steps to ensure compliance with local laws. 

^₁Spain fines Delivery Hero's Glovo $78 mln for hiring breaches | Reuters 

²Spain fines Delivery Hero's Glovo a further $62 mln over hiring - source | Reuters  

³Smith v Pimlico Plumbers judgment (judiciary.uk)