Difference between a freelancer, self-employed and employee

WHO IS CONSIDERED A FREELANCER?

Generally speaking, when we talk about a freelancer we usually do not mean a person who is going to build a typical company and have a permanent office. In case you’re self-employed, then you own a "sole proprietorship." You have a possibility to hire employees when you’re self-employed. Person, who is self-employed (sole proprietor) has the possibility to hire employees, if they manage to afford it. Freelancers don’t have a specific industry so it doesn't matter if you work as a consultant, web designer or IT programmer. Typically, the costs of a freelancer's business are small, as are the financial risks. A freelancer's income is "honorar" in Danish. The word stands for income different than a salary or sales that appear in a sole proprietorship. You could say that honorar is something in between, however, for ease of reference we will refer to it as "income" later in this article.

FREELANCER RECEIVES INCOME B

If we take a tax perspective, a freelancer's income is called B-income (just as for a sole proprietor). The tax paid by a freelancer is called B-tax (just as for a sole proprietor). However, a true freelancer is definitely not self-employed, even if both, the income and tax, are labeled "B". It just informs the IRS that the income is not earned from a regular job ( A income). Working as a freelancer might make it complicated to put you in the right box with regard to what kind of tax you pay and your accounting and VAT obligations you have. You probably think you are a freelancer only because of the contract that you signed with the client, but in Denmark it is impossible to refuse being an employee, despite the signed freelance contract stating otherwise. 

WHAT IS THE DIFFERENCE AMONG BEING AN EMPLOYEE, FREELANCER AND SELF-EMPLOYED?

Typically, we have to be ready for 3 possible scenarios

FREELANCER WHO IS CONSIDERED AN EMPLOYEE

If a freelancer meets even part of the following criteria, they are considered an employee under the law:

  1. You have only one employer or one main client(employer);
  2. The contract between you and client(employer) is in progress and does not have a specific deadline for completion;
  3. The client(employer) gives you instructions on the work you are to do;
  4. The client(employer) controls the work that you do;
  5. The client(employer) chooses exactly which equipment and programs you should use;
  6. You cannot employ other people to do the work;
  7. You bear no financial risk - whatever happens, you still get paid;
  8. You don't incur any costs associated with doing the work;
  9. You use your client;s (employer’s) company brand name on the entire documentation;
  10. Hours of your work and vacations are agreed upon or set by the client(employer);
  11. The contract is concluded without specifying,
  12. The contract provides for a notice period;
  13. You are paid on an hourly, weekly, monthly basis;
  14. The client(employer) covers the costs associated with the work performed;
  15. Vacation, employee insurance etc. are paid.

Instead of invoicing their services, employees receive a pay stub 

When you are hired as an employee, you will receive a normal pay stub. You shouldn't therefore submit invoices for your services, if your client appears as your employer. Income you get when you are an employee is referred to as A-income, while the tax that you pay when you are an employee is referred to as A-tax. Your employer/client collects the A-tax and pays it to the IRS. In addition, you have the usual benefits of working as an employee, such as vacation rights, etc.

Employees are not allowed to deduct expenses in personal income

However, costs you incur by being an employee are not deductible as they would be in a company, but instead they will be recognized as typical costs of employment. The amount of the tax deduction is lower than in the case of a company, because the costs can only be deducted in taxable income, not in personal income. Costs must also be related to income received from the employer. Declaring related expenses is done in the employee expenses field No. 58 on your tax return. You declare your income using the normal field No.11 for salaries. In this situation, the fields for sole proprietors are not used by you. No matter how much income you have, as an employee you are not obliged with VAT payment. You also don't have to deal with bookkeeping.

A FREELANCER WHO IS NOT AN EMPLOYEE AND NOT SELF-EMPLOYED

In this case there’s a "true freelancer" who is somewhere in between being hired as an employee and self-employed. As we look at these factors here - and keep in mind that there is a bigger picture you need to look at - no single factor will be fully sufficient to specify your situation.

Factors that signal that in fact you may not be an employee - and also not self-employed - but a true freelancer

  1. There's more than just 1 client;
  2. You have a certain level of financial risk;
  3. You want to be yourself and don’t plan on running a big company;
  4. You contract on a variety of terms depending on a client;
  5. Your projects are short-termed and defined;
  6. There’s a limited time frame in your work;
  7. It’s your decision how to do your work;
  8. Working hours are up to you;
  9. Choice of equipment and programs to use is yours;
  10. Your client cannot give you instructions on how you manage your work;
  11. Your client cannot control your work;
  12. You receive payment once the project is delivered;
  13. You are using your very own "company" brand name all over the work and documentation that you are delivering to your client;
  14. You are responsible for covering the costs of the office, computer, office supplies, phone, etc;
  15. You may also work for different clients;
  16. You can hire employees;
  17. You create advertisements to receive new projects;
  18. You may face civil liability when you make a mistake;
  19. You have to be registered as a VAT payer;
  20. You are not subject to the privilege of paid vacation, and you are not paid in case of illness;
  21. It’s your decision when it’s time for vacation;
  22. The contract is terminable with no notice ( naturally, most contracts have a notice period, but its wording shall not be as in the case of an employment contract).

What deductions are possible in the case of a freelancer?

A freelancer can deduct their expenses from their income. These expenses cannot exceed their income, so the year cannot be ended with a deficit as a sole proprietor can. The company that pays “honorar” has to declare the income in box 12 on their tax return. When the company did not declare freelancer’s fee in box 12, they must enter the amount in box 15.

Freelancer’s cost must be declared in box 29 on their tax return. They must be able to document all details of their costs.

Freelancers often have to pay VAT

When a freelancer's income (also known as revenue or sales) exceeds DKK 50,000 in a 12-month period, then the whole income will be subject to VAT. In this case, they must comply with VAT regulations. In addition, sales they had before reaching DKK 50,000 in sales will be subject to VAT in this case. This will give them a VAT of 20% (20% of DKK 50,000 in sales equals 25% of DKK 40,000 - the VAT rate in Denmark is a 25% charge without VAT), which they must pay later on for all previous sales. Note that not everyone has to pay VAT even if sales exceed DKK 50,000 for 12 months. These may include actors, musicians, artists, journalists, bloggers, speakers, writers and translators.

SELF-EMPLOYED FREELANCER

So what distinguishes being an employee, a true freelancer, and self-employed? Situation, when a freelancer appears self-employed is when their activity starts looking more like a serious business and the financial risk increases. Perhaps your idea is to employ staff and have your own office. Pretty much the same conditions would apply here just as in the case of the freelancer from example 2 above, only everything is more advanced.

What a PMV is?

In Denmark it’s possible to run a small sole proprietorship that doesn't have to pay VAT. This is possible if your sales are less than DKK 50,000 in a period of 12-months. However, you still have to register a business, resulting in a small version of a sole proprietorship called PMV ("Privat Mindre Virksomhed"), which you can use when you go to register a business but don't expect your sales to be more than DKK 50,000 in a 12-month period. If you think your sales may reach DKK 50,000 or more, it's better to register as a VAT payer right from the start. If your PMV exceeds DKK 50,000 in sales for 12 months, then the sales you already had before reaching DKK 50,000 will be subject to VAT in this case. This will give you a VAT of 20%, which you will later pay on all previous sales. The PMV gets a CVR number as well, only there’s no VAT registration. Later you can convert the PMV in a sole proprietorship and the CVR number stays the same when registering as a VAT payer.

In short, a PMV is basically a smaller version of a sole proprietorship that has a CVR number, but no VAT registration. Sales shouldn’t ever exceed DKK 50,000 for 12 months. A sole proprietorship should exceed DKK 50,000 for 12 months. A sole proprietorship owns a CVR number and is also registered for VAT.

What is a sole proprietorship?

The terms "self-employed" and "sole proprietorship” are equal. A sole proprietorship must register the company as a VAT payer if the company's sales are expected to exceed DKK 50,000 in a 12-month period. Generally, a sole proprietorship is run to generate a profit and see what the typical costs of running a business are, such as marketing employees, office rent, computers, machinery, etc. One-person business owners have more financial risk with clients than a freelancer. There’s no set amount that can be used to determine financial risk.

Factors indicating that you are a sole proprietorship

  1. You work for more than one customer;
  2. You enter into contracts with variety of terms;
  3. Your projects are short-term and defined;
  4. You work with a limited time frame;
  5. It’s up to you how to do your work;
  6. Your working hours are up to you;
  7. It’s your decision what equipment and programs to use;
  8. You’re not instructed by the client on how to do your work;
  9. The customer does not control your work;
  10. You receive payment once the project or milestones are delivered;
  11. You place your "company" name on work and documents that are delivered to the customer;
  12. You are responsible for covering the costs of the office, computer, office supplies, telephone, etc.;
  13. You may also work for other clients;
  14. You can hire employees if you wish;
  15. There is a financial risk if, for example, you make mistakes and/or being late with project’s deliver;
  16. You create ads to receive new projects;
  17. There may be civil liability when you make a mistake;
  18. You are a VAT payer;
  19. You are not subject to the privilege of paid vacation, and you are not paid in case of illness;
  20. It’s up to you when to go on vacation;
  21. It;s possible to terminate a contract without notice.

Freelancers who run one-person businesses must comply with standards of accounting. We recommend using e-conomic for your accounting. Running a sole proprietorship results in declaration on the tax return (on SKAT Borger) using the following field numbers:

Profit: 111;

Deficit: 112;

Income, interest: 114;

Expenses, interest: 117.

WHAT IF I'M UNSURE IF I'M AN EMPLOYEE, FREELANCER OR SOLE PROPRIETOR?

Based on the above factors, are you able to determine with 100% certainty whether you are an employee, freelancer or sole proprietor? Of course not. However, sometimes it’s quite clear that everything points to a sole proprietorship, but sometimes it may be obvious that you are an employee, however, more often than not, it might be difficult to determine. Once you're not sure, you can ask the tax office. Tax office can always provide you with written confirmation of what kind of freelancer you actually are. It costs about DKK 400.

WHAT ARE THE RISKS FOR YOU AND THE CLIENT IF YOU ARE FOUND TO BE AN EMPLOYEE RATHER THAN A FREELANCER OR SOLE PROPRIETOR?

Firstly, your client may face both a tax bill (because they were supposed to withhold personal income tax from you) and penalties for non-compliance (e.g., failure to provide a proper employment contract, violation of the Danish Holiday Act, notice periods, etc.). A lot of these claims might be caused by you, e.g. for wrongful termination, lack of an employment contract, failure to receive vacation, etc. Secondly, in the case where you have deducted costs in your personal income as a sole proprietorship, these expenses will be deducted according to different tax rules that will reduce the amount of the tax deduction. In addition, if in the past you have declared a deficit, this will instead be changed to zero income, which means you will get a tax bill.

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