Sometimes, I would give my eyeteeth to be paid double-time for Wednesday, which is a day-off in our company. Sometimes, I wish we had a labor disputes commission and free milk at work (Ukraine’s Labor Codes requires employers to provide free milk for certain categories of employees doing stressful or hazardous jobs). However, I do this daydreaming only on rare occasions. The rest of the time, I am really happy that we have no staff handbook and that I cannot be suspended for being drunk at work. If this works for you as well, then employment agreement is definitely not your thing.
Ukraine’s labor law is good enough only for the real fans of shabby antiques, and here is why.
Labor law: nothing for employers, everything for employees
Labor turned apes into humans (no offense, dear opponents of Darwinism). So, apes learned how to hold a pen and wrote a number of Ukrainian laws. For example, it’s been almost half a century that we have been using our Labor Code (it has been in force since 1971). This law is a legacy of the soviet era. Its preamble still says that its aim is to “raise the standards of living and culture for working people, strengthen workplace discipline and gradually turn labor for the good of society into the major need of all able-bodied people”.
If you have started a company and want to establish relations with your new employees in the most transparent way possible, this article of the Labor Code is really meaningless. However, your would-be employee agrees to work with you only with an employment agreement. Your employee believes in labor guarantees just like he believes in Santa: someone told him about labor protection, minimum wage, compensation for business trips, the right to strike, and even the involuntary servitude ban. Well, it’s no good for you. Paying him 10 dollars and forcing him to go on business trips without compensation is exactly what you were about to do, didn’t you?
To explain the meaning of Ukraine’s labor law, I am going to put it in plain English: there will be a lot of paperwork, a lot of third persons in employer-employee relations and certainly, a lot of taxes. You will have to deal with vacation leaves, business trips, hiring and termination of employment. Quite possibly, you will have to create a staff handbook and make every employee read and sign it. Obviously, there are certain pros (for example, you will have a perfect reputation in case you want to attract investors or go for M&A). However, you are definitely not going to benefit from a statutory ban on non-competition clauses in employment agreements and a complicated procedure for finalizing the documents that would protect your trade secrets.
Obviously, there is a lack of balance between the obligations of employers and employees. Besides, there is a complicated procedure for legalizing employer-employee relations, especially when you are only beginning to develop your business. Many people deal with these issues by using civil law contracts. Civil law means freedom of contract and gives carte blanche to employers who want to make an honest living by running a business. By freedom rubs some people the wrong way, especially people in government.
Employment agreement is for the honest (meaning ‘foolish’ or ‘rich’, depending on the context)
This thesis does mean something to those who know how much employers pay in taxes. One day, someone really smart started using civil law contracts with individual contractors instead of employment agreements. A contract with an individual contractor is a wonderful civil law tool. Employment agreements require employers to pay taxes for their employees. Under civil law contracts, individual contractors who provide services or perform works are responsible for paying their self-employment tax. That is, if you pay an individual contractor a bit more, you will cover your contractor’s tax obligations, but you will still spend much less than you’d spend with an employment agreement. Therefore, this convenient tax system is affordable even for new businesses. To see how it really works, let’s do some math.
When employers hire new employees under employment agreements, there are at least two ways how they can pay them.
- The first option is for those who are extremely honest: an employer indicates his employee’s real wage in an employment agreement and instructs an accountant to assess all payroll taxes. If the basic wage is, let us say, 10 000 UAH (+/-370 USD), then this employer is required to pay 22%, which is 2200 UAH (+/-82 USD), of unified social tax, withhold 1,5%, which is 150 UAH (+/-5.5 UDS)of war tax (war tax is due since the beginning of the anti-terrorist operation in the eastern Ukraine), and 18%, which is 1800 UAH (+/-67 USD) of income tax. In the end, the employee gets 8 050 UAH (a little less than 300 USD) of take-home pay.
- The second option is for those who are cheaters to a certain extent: an employer indicates a minimum wage rate (currently, it is 3200 UAH(+/- 121 USD) in Ukraine) in an employment agreement. This employer has to pay 22%, which is 704 UAH (+/-27 USD) of unified social tax, withhold 1, 5%, which is 48 UAH (+/- 2 USD), of war tax, and 18%, which is 576 UAH (+/- 22USD) of income tax. The rest is a backdoor salary.
What to do if you don’t think that honesty is the best policy?
Just joking! Civil law contracts with individual contractors are transparent enough. These contracts are provided by law, but some old-school businesses consider it ‘gray’ and sketchy, when it comes to their reputation. Why? Let us do some math once again.
Under a civil law contract, an individual contractor has earned 30 000 UAH (+/-1130 USD) in three months, where 26 388 UAH (+/-995 USD) is his take-home pay, and 3 612 UAH (+/-137 USD) is self-employment tax plus unified social tax (5% self-employment tax plus unified social tax, which is 704 UAH, or +/- 27 USD monthly). There are at least two ways how to deal with civil law contracts:
- The first option is for noobs: contracting parties agree that the order value is calculated based on an hourly rate and the assets. In the acceptance certificate, the parties indicate the amount that includes self-employment tax and unified social tax due for an individual contractor. The individual contractor does the tax reporting and pays taxes.
- The second option is for advanced users: the parties indicate the same conditions in their contract, and the ordering party hires an accountant for individual contractors. The parties make a coworking agreement that contains the accounting services clause. As a result, individual contractors do not have to deal with tax reporting. Instead, all they have to do is provide accountants with the information they need.
It looks like they call these schemes ‘gray’ for a reason. In the developed countries, simplified tax systems were established not because governments wanted to help IT people who earned ten times more than average employees. Initially, it was intended to encourage businesses that needed some incentives, or businesses that governments wanted to support in order gain benefit. In Ukraine, nearly any Tom, Dick and Harry can use this tax system.
However, let us get a new angle on the whole situation. In some countries, pathways most frequently used by people get covered with asphalt. That is, at first they watch how something should work, and then they do it. If Ukrainian IT companies opt for the simplified tax system, it does not necessarily mean that they want to avoid taxes.
Most certainly, there are many startuppers who want to do the right thing. Still, can they do it with our labor law? It’s highly unlikely. Ukraine’s labor law is so ancient that it stands in the way of freelancers’ freedom. Freelancers choose to work as individual contractors because they are the people who evolved from apes and took stones to till the land. So, maybe it’s time to get this pathway covered with asphalt?
This client from a startup is a reckless guy, isn’t he?
While labor law remains the same and taxes continue increasing, we take risks. People in government really like reckless guys. They think that those who take risks should pay fines ranging from 8 500 UAH (+/-320 UDS) to 17 000 UAH (+/-640 USD) (Article 41, Administrative Offenses Code of Ukraine) and 96 000 UAH (+/-3620 USD) (Article 265, Labor Code of Ukraine) for failure to execute employment agreements (by the way, this includes agreements with interns as well). Those who take risks working for reckless guys (brave individual contractors working under civil law contracts) pay fines ranging from 17 000 (+/-640 USD) to 34 000 UAH (+/- 1280 USD) (Labor Code of Ukraine) for doing business without registration.
However, those who are not only brave but as well smart, go a lawyer to check whether there is any risk that relations under their civil law contracts may be defined as employee-employer relations. After that, they delete all workplace, equipment and working hours clauses, add acceptance certificates, avoid scheduling and employment guarantees, add more freedom, confidentiality, and an awkward non-competition clause, which is at least provided for by civil law. Finally, individual contractors settle down in coworking spaces and hire accountants to avoid the adrenaline rush during inspections. Now they are not reckless anymore. Instead, they are smart and well-versed.
When taking risks, do use your head. Being involved in hidden employer-employee relations is no picnic. Unlike us, people in government have no sense of humor.