A service contract: an alternative to an employment agreement?

man-875702_1920Authors: Vilius Martišius, associated partner, attorney-at-law at METIDA and court mediator; Valdemaras Kovalevskis, junior lawyer and attorney assistant at METIDA

So far the most popular way to start work has been by signing an employment contract. Of course, it is not the only form of agreement to provide others services that involve activity and creative process. In Lithuania, a service contract is also possible in this situation. In fact, employment and service contracts can exist simultaneously, i.e. a person can do both: work for another company under the employment contract and provide additional services. What is more, in some cases (for example, if you are an attorney-at-law, an attorney assistant or a notary) the service contract may be the only option to ensure your right to work. However, it is not always possible to opt for the service agreement.

It appears that some employers and employees seek to be exempted from taxes and therefore, aim for service contracts that are, in fact, identical to employment agreements. If appropriate institutions administering assessment and payment of taxes inspected one of these companies and figured out that someone worked under the service agreement, but were treated as employees, sanctions could be applied to both parties, i.e. employers and employees. Thus, before going for the service agreement, you should know the difference between the employment contract and the service agreement.

The subject of the agreement and the type of work

The main purpose of the employment contract is to ensure that job functions are performed. In other words, a person who signed this contract performs work without any particular results in mind, and does not need to accomplish any specific tasks (although sometimes they have a concrete job to do). According to Lithuanian case law, the employees are expected to perform specifically defined duties, namely they are usually professionals, specialists and qualified workers or have a certain position in the company.

As for the service agreement, it helps to ensure the provision of services that are intangible in nature (intellectual or similar). In other words, the services in this case should not be related to the creation of a tangible object. Hence, work under this agreement cannot lead to a physical result, although the result may have certain specifications.  The service contract is formed not to guarantee the completion of the tasks, but to ensure the provision of services. Thus, the result of the services cannot be a separate object that needs to be received by a client, despite the fact that in some cases the result is clearly defined, e.g. a consultation on a specific matter that would help solve a concrete problem.

The duration of legal relationship

Work relationship is based on stability and continuity. But the relationship built upon the service contract is characterised by an occasional and infrequent act of work. That the work has continuity or not, is determined in each case differently depending on all key circumstances. Even the work of sporadic nature can be served as an evidence to prove the continuity of the legal relationship. For example, the Supreme Administrative Court of Lithuania in one of the cases stated that a work relationship in question showed continuity, as the company regularly (i.e. every month) formed copyright agreements with their employees. Therefore, the agreement of this kind cannot be considered as temporary if it is valid for one month, but is renewed regularly.

A more independent service provider

The employment agreement obliges the employee to follow employer’s orders and work procedures, i.e. subordination is a key characteristic of their relationship. To be more specific, the employees cannot take the full control of their actions, as they receive orders from their employers. For example, the employees should follow the requirements related to task organising, working hours, work discipline and etc. This is due the specifics of work relationship, i.e. it would be difficult to effectively organise work unless the employees are obliged to act in favour of their employers. Parties that work under the service contract are more independent and are not under each other’s control.

Payments

Both employment and service contracts belong to the category of reimbursable agreements. In the service contract scenario, the payment for the services is closely related to the length of the legal relationship and is transacted only after the provision of services. As for the employment contract, the salary is received periodically (every month, half month and etc.).

Of course, this list is not exhaustive. There are other differences between employment and service contracts, namely parties of the agreement, forms, risk management, termination of the contract and guarantees.

Lower tax rates

Employment contracts are also less attractive due to a larger financial burden. Under the service agreement the income tax is 15% of the earned money, except in cases where the service is provided under the sole trader certificate (then the income tax would be 5% of your earnings). Yet, this does not apply to attorneys-at-law, bailiffs, architects, accountants, engineers, psychologists, real estate agents, and other freelance workers.

Under the employment contract, both the employers and the employees should pay national insurance and healthcare insurance contributions (39.98% of all the income minus the income exempt from taxation if a person is eligible for this exemption). Under the service contract, the national insurance and healthcare contribution reaches 37.5%. Such contribution is calculated from the ½ of the taxable income (when a person works under the sole trader certificate). A person who provides temporary services without such certificate, does not need to pay national insurance or healthcare insurance contributions.

Why should you opt for the service contract?

Apart from the financial benefits, the service contract can attract companies (employers) due to other reasons too, for instance, the service contract can be terminated at any time following the set out procedures. The person working under this type of contract is not entitled to employee’s privileges defined in the Labour Code of Lithuania (work and free time balance, holidays, redundancy benefits and etc.). The service providers in this case do not have any financial liability, take their own risk and are fully responsible for the quality of their services.

To conclude, the service contract cannot be treated as an alternative to the employment contract for all the employees, but it could work with some of the professions. The service contract is viable if the provision of services meets the above mentioned criteria. The most important one is that the service should be of intangible nature. Hence, this type of contract is not suitable for industry, agriculture workers or any other similar occupations. However, the service contract would be perfect for IT, marketing, advertising specialists, creatives and other similar professionals.

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