Which kind of contract to use when contracting team members? An employment contract or a business contract with a freelancer or a company? And how does black labour relate to this? Below you will read the advantages and disadvantages of each alternative.
The golden rule is that even in the garage (pre-seed) phase of a startup, it pays off to contract the entire internal team in writing. There are three options and it is possible to choose a contract that is suitable for anyone.
1. Employment Contract with an Employee
Or another agreement concluded outside employment relationship.
The employment contract is most often concluded with the Office Manager and other back-office workers, sometimes with creatives (Software Developers, Designers).
Advantages
- From the point of view of employees, it offers attractive protection. For example, a guaranteed minimum number of days of leave, more complicated termination of the contract, limited liability for damage caused by employees.
- Automatic application of the work for hire regime, thanks to which the employee’s intellectual property to the work they have created (e.g. software) is transferred to the company without the need to enter into further agreements. Attention: The “work for hire” regime in Slovakia does not apply to agreements concluded outside the employment relationship (e.g. a students’ part time work agreement), and therefore it is necessary to conclude a free license agreement with the employee, on the basis of which the rights to the work they created will be transferred. In the Czech Republic, the employee work regime automatically applies to agreements outside the employment relationship.
- There is no risk of so-called unregistered labour (also known as the schwartz system or illegal labour). More on unregistered labour in our blog HERE.
Disadvantages
- High tax burden approx. 48 % in Slovakia and approx. 45 % in the Czech Republic – you can find a simple calculator of income and taxes, for example, HERE (for Slovakia) or HERE (for the Czech Republic).
- Limited flexibility on the part of the employer in the HR agenda, e.g. with redundancies and firing.
- A number of legal obligations and costs borne by the employer, e.g. for the creation of a healthcare service, complying with obligations within the framework of health and safety protection at work, notifications to the social insurance company and others, non-compliance with which there are various fines.
Although an employment contract can be short, a number of legal provisions apply to the relationship, which strictly regulates the whole relationship and thus complicate it. On the other hand, it brings a certain degree of protection and security to both parties. For some roles, this is the easiest way.
A sample employment agreement can be found at the end of the article.
Watch out: Never conclude an employment agreement with the director of the company to perform the activities of the director.
The director does not need a contract or a contract can be concluded with him to perform the role of a director (director agreement). This agreement must be in writing and must be approved by the general meeting of the company.
The director agreement may stipulate that the director performs the role free of charge. If the role is for remuneration, pay attention to the fact that the same taxes are paid from the remuneration as from a salary on the basis of an employment agreement.
If the director agreement, which stipulates the amount of the director’s remuneration, is not concluded, in the Czech Republic it is possible for the performance of the function to be free. However, in Slovakia, the director would be entitled to remuneration in the amount that is usual at the time of the creation of the role for an activity similar to the activity performed by the director.
2. Contract with a Freelancer
i.e. self-employed person (SZČO in Slovakia or OSVČ in Czechia)
Most often this is a contract for work or a mandate agreement according to the Commercial or Civil Code (in the Slovak Republic) or a mandatory contract or an innominate contract according to the Civil Code (in the Czech Republic) with a freelancer.
It can be suitable for Sales, Software Developers, Designers, or other creative roles, e.g. within marketing.
Advantages
- Tax varies between 19 – 51 % of income in the Slovak Republic and approx. 36 – 43 % of income in the Czech Republic (alternatively, in the Czech Republic from January 2021, there is also the possibility for self-employed persons to register for a flat tax of CZK 6,208 per month (in 2023), which includes contributions). There is a large dispersion in the Slovak Republic, as passive income (i.e. income from e.g. dividends, rent and licensing of the created work) is not covered by social and health contributions. Income tax in the Slovak Republic is 15 % on income up to EUR 100,000. In the Czech Republic, the income tax is 15 % on income up to CZK 1,935,552 (in 2023) and 23 % if the income is above this limit, the rest are contributions. In both countries, it is possible to apply flat-rate expenditures – in the Slovak Republic in the amount of 60 % of income, in the Czech Republic from 30 to 80 % of income (for freelancers it is 60 %, but a maximum of CZK 1,200,000 per year).
- Low administrative costs while establishing a trade and over its duration. It is possible to set a trade up in as little as 1 day, e.g. via Firmáreň (in the Slovak Republic) or zalozfirmu.cz (in the Czech Republic). (After establishing a trade, beware of unfair practices of companies that pretend to be official authorities and offer unnecessary services).
- High flexibility and freedom of the contracting parties.
- Unless otherwise agreed, the freelancer is liable for their liabilities with all their assets (employee only up to four times (in the Slovak Republic) or four and half times (in the Czech Republic) their average monthly earnings).
Disadvantages
- Risk of unregistered labour – it is not possible to conclude this contract with team members who perform “dependent work”. Typical dependent work is back-office or HR, because there is a hierarchical relationship between the employee and the company. More on unregistered labour in our blog here.
- The transfer of intellectual property is not automatic, it needs to be thoroughly adjusted.
- The freelancer is liable with their property, but it is possible to tinker with a limitation of the amount of liability for damage if both parties are willing to do so.
The freelance regime is suitable for creative team roles. However, this is a B2B relationship in which the freelancer is less protected than an employee with an employment contract. The loss of this protection is compensated for by higher net income. It is important to address key aspects such as the transfer of intellectual property, the limitation of liability for damage, and the exclusion of unregistered labour.
Development studios often contract designers, developers and sales as freelancers, while concluding employment contracts with back-office roles (office manager, finance, HR). Directors have contracts for the performance of roles, sometimes combined with a freelance regime, if their role in the company permits it, that means, if, in addition to being a director, they manage to do other activities for the company that are not related to the role of the director.
3. Contract with a Company
Most often it is a contract for work pursuant to the Commercial Code (or in the Czech Republic pursuant to the Civil Code) and a license agreement with a single-person s.r.o. (Slovak and Czech variant of the LLC).
It is typically suitable for a team member with an income of at least EUR 40,000 per year, who has sufficiently high overhead costs.
Advantages
- The owner (shareholder) of the company is liable for the company’s liabilities only exceptionally (e.g. if the company is in crisis).
- Cooperation in this form significantly reduces the risk of unregistered labour.
- When registering as a VAT payer, it is possible to purchase selected goods and services without VAT.
- The obligation to pay contributions does not apply to the income of an s.r.o. (would apply to the payment of the director’s remuneration or their salary). In addition, if an s.r.o. has sufficient costs (office, car, materials, equipment), it can also be interesting from the point of view of reducing the amount of income tax.
Disadvantages
- A complex transfer of intellectual property from the author (a natural person who is a shareholder and managing director) to the company, because the company often does not have a direct contractual relationship with the author himself. This can be dealt with either by a tripartite agreement between the company, s.r.o. and the author or a separate agreement on the gratuitous transfer of intellectual property between the company and the author.
- A personal s.r.o. requires its own accountant and there are many costs associated with it and a relatively large amount of the s.r.o. owner’s time for its successful administration.
- Low flexibility in the use of the company’s finances by its owners.
This regime requires more care and energy, but with a higher income, it can bring many benefits to the owner of the company.
4. Independent Author
If an employment contract has not been concluded with the author and the author has neither a trade nor a company established.
The author’s income is taxed by the client in the amount of 19 % (in the Slovak Republic) or 15 % (in the Czech Republic) in the form of withholding tax (unless otherwise agreed). If the author has no other income and the healthcare contributions are not paid for them by the state (e.g. due to student status), they must pay the minimum healthcare contributions. This regime is not used very often.
