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Employee Service Contract vs. Labor Contract

December 24, 2020 Labor Law Review

Employee Service Contract vs. Labor Contract: Is It Advisable for Business to Sign a Service Contract with an Individual? If So, under What Conditions?

To avoid the obligations of social insurance, health insurance, and unemployment insurance towards their employees and avoid being subject to liability as provided by the labor law, many companies propose that their employees sign contracts to provide services instead of labor contracts. Is the signing of a service contract between a company and an employee (an individual) lawful under Vietnam law?

As will be fully explained below, whether a contract is determined as a service contract or a labor contract will not be based on the title of such contract but by the definition of the contractual relationship between the parties, the legal grounds applicable, and other practical (public policy) issues.  

Specifically, the relevant laws and regulations are as follows:

Labor contract

Article 13.1 of the 2019 Labor Code stipulates: “A ‘labor contract’ is an agreement between an employee and an employer on the remunerated work, wage, working conditions, rights and obligations of each party in the labor relation. An agreement with a title other than ‘labor contract’ is also considered a labor contract if it sets out the remunerated work, wage, as well as the management, administration, and supervision by one party over another.”

Article 3.5 of the 2019 Labor Code stipulates: “‘Labor relations’ shall mean the social relations arising from hiring, using labor, and payment of wages between an employer and an employee, their representative organizations, and competent authorities. Labor relations include individual labor relation and collective labor relation”.

Article 3.1 of the 2019 Labor Code stipulates: “An ‘employee’ shall mean a person who works for an employer under an agreement, is paid a wage and is managed, controlled and supervised by the employer.”

Service contract

Article 513 of the 2015 Civil Code stipulates: “A service contract is an agreement between parties whereby a service provider performs a task for a service user, and the service user must pay a service fee to the service provider.”

Article 3.9 of the 2005 Commercial Law stipulates: “The ‘Provision of services’ means a commercial activity whereby one party (hereinafter referred to as the ‘service provider’) is obliged to provide services to another party and receives payment; and whereby the party using the services (hereinafter referred to as the ‘client’) is obliged to make payment to the service provider and to use the services as agreed.”

From the above regulations, it can be seen that the definitions of “labor contract” and “service contract” are quite similar and difficult to distinguish (i.e., both are an agreement between the parties and the employee/service provider receives a payment). As a result, it is not always a simple matter to determine whether a contract is a service contract or a labor contract.

When a labor dispute occurs, the Court will consider the following legal grounds and practical (public policy) issues to determine whether the contract between the company and the individual is a labor contract or service contract:

The employees are subject to the management, administration, and supervision of the company

One of the most notable and basic difference between the contracts is that employees are always “subject to the management, administration, and supervision of the employers,” which is not necessarily an obligation of a service provider. In some cases, however, the service provider still has an obligation to comply with the service user’s requirements (based upon the contract language and service type). Therefore, it may be difficult to distinguish the service provider’s obligation from the one of “subject to the management, administration, and supervision of the employer” in the employer-employee relationship.

Individuals who do not register their business often have no right to provide services

Article 3.1 of the 2005 Commercial Law stipulates: ‘Commercial activity’ means an activity for a profit-making purpose, including purchase and sale of goods, provision of services, investment, trade, promotion, and other activities for a profit-making purpose”. Thus, the provision of services for a profit-making purpose is a commercial activity that must comply with the 2005 Commercial Law and other relevant laws (Article 4.1, the 2005 Commercial Law).

Under Article 2.3 of the 2005 Commercial Law, individuals (“traders”) who conduct commercial activities have to have their businesses registered, except for “individuals who conduct commercial activities independently and regularly without having to register their business.” These exceptions to business registration are listed explicitly in Decree No.39/2007/ND-CP4. They primarily include small types of services such as “polishing shoes, selling lottery tickets, repairing keys, repairing vehicles, safekeeping vehicles, washing vehicles, hair-cutting, painting, taking photos and other services with or without fixed locations.” The individuals who perform these small types of services are not deemed “traders.”

It should be noted here that, in general terms, companies who are in need of employment do not hire an individual to regularly provide the small types of services listed above but rather will hire individuals to perform activities requiring a certain profession or qualification. With respect to activities requiring a certain profession or qualification, however, the individual must register his or her business to be allowed to have the performance of these activities classified as a commercial activity governed by commercial law instead of an employer-employee relationship governed by the labor law.

The loss of income to the State Budget and the low average wage rate for workers

Social insurance premiums on companies are income sources that relieve the burden on the State Budget and enhance social welfare. Some companies sign service contracts with individuals, instead of labor contracts, to evade paying the premiums on social insurance, health insurance, and unemployment insurance for their employees, which will reduce overall insurance funds. This type of activity seriously affects the State Budget as well as the execution of the State’s social security regime.

Moreover, the wage rate in Vietnam is very low for the average worker. Suppose the insurance regimes are not complied with as provided by the law. In that case, the employees will likely encounter significant financial difficulties when their working capacity declines or is lost. For instance, employees will not receive compensation or allowances from the insurance fund when losing their job, getting sick, taking maternity leave, having labor accidents, or suffering occupational diseases. Other impacts on the worker include, but are not limited to, pensions when reaching retirement age, survivorship allowances, and funeral allowances.

The loss of employee protection and unemployment

If individual workers engage in service contracts instead of labor contracts with a company, such individuals shall not be considered “employees” under the Labor Code.  As a result, they will not be entitled to employees’ fundamental rights and interests such as minimum wage, working time – rest time, overtime wages, and the right to join a trade union. Further, suppose signing service contracts with individuals is allowed without restrictions. In that case, companies may view that the term of a service contract is at their discretion. They shall have the right to unilaterally terminate the contract at any time, without taking any legal responsibility under the labor law. Consequently, the employees’ legitimate rights and interests will not be protected, leading to unemployment without a safety net (such as severance allowances, job-loss allowances, or compensation for being illegally unilaterally terminated). This may result in widespread social evils (such as poverty) caused by unemployment.

There is a misperception that complying with the requirements of personal income tax (PIT) payments means that signing a service contract is acceptable

Many companies incorrectly believe that if they fulfill their obligations under PIT withholding (10% applicable to resident individuals, 20% applicable to non-resident individuals), and the tax agencies accept such taxes, there is no risk in signing service contracts with individuals. They even believe that when the tax agencies accept the service fees paid to the individuals (as deductible expenses to calculate the corporate income tax), they can sign service contracts with individuals instead of labor contracts.

It must be emphasized that if any dispute occurs, the Court is the only jurisdiction which has the competence to determine if the parties are right or wrong. The administrative agencies (such as tax agencies) have no such competence other than giving companies’ opinions or guidance in tax compliance matters. In fact, the current administrative agencies of Vietnam (such as tax, labor, and insurance agencies) cannot overlap the other agencies ’ affairs (i.e., the tax agencies cannot manage the affairs of the insurance or labor agencies and vice versa). Therefore, if an individual or a company wants to pay tax to the State Budget, the tax agencies always welcome them without making any determination as to whether there is any violation of the labor law or not. In general, the tax agencies will not refuse the payment for any reason as it is better than non-collection. Later on, the company’s payments will be inspected or verified later by the tax agencies to see whether there is any violation when determining the type of employment relationship in calculating the correct payment. Even if the company supposes that the tax agencies are wrong in the tax calculation in making its tax arrears decision, such companies still can make complaints or file administrative lawsuits against the tax agencies with the competent State authorities (including the Court).

At present, there are many companies operating in the wrong manner (signing service contracts with individuals not in accordance with the law). Still, their actions have not been inspected or audited by the authorities. This causes companies to believe that the State authorities accept signing service contracts mistakenly, and, consequently, other companies follow such a belief. In addition, as the State authorities are unable to discover or be aware of all violations, they only focus on dealing with cases they can manage conveniently to avoid a backlog and to reach their annual targets (set by the State on them or their sub-units). This does not signify that the agency will ignore the violating companies in the future; it is just that there is not enough time or resources to conduct an investigation at the current time.

We would like to highlight Official Letter, No.1019/TCT-TNCN, dated March 25, 2015 (http://thuvienphapluat.vn/cong-van/Thue-Phi-Le-Phi/Cong-van-1019-TCT-TNCN-2015-giai-dap-chinh-sach-thue-269890.aspx) for your reference. According to this Official Letter, the General Department of Taxation states that the incomes incurred from contracts signed with individuals (without registering their business) will be defined as incomes incurred from a salary/wage. Therefore, the General Department of Taxation (although it does not clarify that [based on the content of the official letter in question] the contracts are labor contracts or service contracts) considers that registration of the individual’s business will be grounds to define the salary/wage as a labor relationship.  In other words, the relation between the companies and the individuals without registering their business will be considered a labor relationship and not a relationship for the provision of services.

Conclusion

Thus, to sign service contracts with individuals, such individuals must register their business as required by the law (primarily complying with the law on enterprises). Suppose a company enters a service contract with an individual without a registered business. In that case, it will most likely be considered a violation of the law’s regulations, as analyzed above.

Another viewpoint (as per our subjective view) is that if the State authorities and Vietnam law recognize the legality of service contracts signed with the individuals without having their business registered as stipulated by the law, there would be no need for the existence of the labor law as well as the regulations on social insurance, health insurance, and unemployment insurance.

The law regulations are clear, and the remaining issue is whether or not the company and the individual wish to comply with the law. If they decide not to obey the law, they should accept the risks when any dispute arises.


[1] Taking effect as of January 01, 2021.


Authors: Employment Team

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