Undeclared Earnings and Illegal Employment

Factually, these are different types of illegal employment. Particularly common are so-called cash-in-hand agreements or partial cash-in-hand agreements and pseudo-self-employment.The proceedings are often quite "messy", because different authorities are involved. These include the public prosecutor's office, the police, the Tax Authority, the Tax Investigation Unit, the Office of Fines and Criminal Matters of the Tax Authority, the Customs Inspection, the German Statutory Pension Insurance Scheme (Deutsche Rentenversicherung - DRV) and the health insurance funds and employment agencies.They all issue various assessment notices, such as social security contribution assessments, payroll tax liability assessments, and not infrequently, freezing injunctions in criminal proceedings.

Payroll tax fraud

Payroll tax fraud has been committed, if the employer deliberately fails to duly notify the Tax Authority of any payroll tax that is to be withheld (not merely the amount that has in fact been withheld) no later than by the 10th day of the month following the declaration period. For the offence of tax fraud under § 370 AO, it is irrelevant whether the payroll tax has been paid in full and in due time to the Tax Authority.  The mere non-payment of payroll tax after a proper declaration has been submitted is only a misdemeanour (subjecting withholding taxes to risk, as set out in § 380 AO) and is therefore not a criminal offence.

The declarable payroll tax is exclusively determined by the actual amount of wages paid to the employee in the previous month. The contractually owed wages are therefore not applicable. In tax law, the so-called accrual principle applies in accordance with §§ 11, Sec 1 and 38a Sec 1 EStG.

Employers are liable for payroll tax plus penalty interest. It is irrelevant, whether the employee is the ultimate debtor of payroll tax. 

Withholding of social security contributions

Gross wages are applicable for calculating the contributions of employees subject to compulsory insurance. This also includes the statutory deductions to be withheld by the employer, such as payroll tax and the employee's share of social security contributions.  Contrary to tax law, the so-called principle of origin is applicable in social security law. In accordance with § 14 SGB IV, the contractually owed wages rather than the actually paid wages are relevant. It follows, that so-called phantom wages (contractually owed, but unpaid wages) are also subjected to social security contributions. The actually paid wages will only become relevant, if the contractually owed wages have been exceeded.  

Remember: The assessment bases for payroll tax fraud and withholding of social security contributions are not always identical. 

In respect of the legal situation applicable to the withholding and misappropriation of wages, the following needs to be distinguished:

A. Employee contributions to social security: § 266a, Sec 1 StGB
Unlike payroll tax fraud - see above - the employer’s failure to pay by the due date constitutes an offence as stipulated in § 266a, Sec 1 StGB. Under § 23 Sec 1 S. 2 SGB IV, a criminal offence has in such a case been committed on the third-last bank business day of a month. In the case of employee contributions, the timely payment of the correct amount of contributions does not suffice to avoid criminal prosecution.The employer must also pay his share of contributions. 

The employer is liable to the health insurance funds (or their collection agencies) for the employee’s share (50%) of the total social security contributions (§§ 28 e, h, i SGB IV). The contributions must be paid in full by the employer (including the employee’s share and any late fees). The employer can only reclaim these from the employee for the preceding three months and only if the employment is ongoing (§ 28g S. 3 SGB IV). 

Tax-trap payroll tax: The actual payment of the employee’s share of social security contributions by the employer is in turn liable for payroll tax, which may result in a further offence of payroll tax fraud being committed. Previously, the Federal Fiscal Court (Bundesfinanzhof) interpreted this waiver (so-called advance waiver of repayment) as an economic benefit for the employee, and therefore deemed it a payment of wages. It was irrelevant to the Federal Fiscal Court, that the employer - as explained above - was prevented by law from reclaiming the employee’s share of social security contributions due to the short time allowed for a recovery as stipulated in § 28g P. 3 SGB IV.   Although the Federal Fiscal Court has given up this interpretation, many Tax Authorities continue to apply it in complete misjudgement of the legal situation. Since 2007, the Federal Fiscal Court applies a different justification approach with a fairly similar result. It no longer argues, that the employer must indemnify the employee from paying a liability, but rather that the employee is granted a separate legal entitlement to social security benefits by making retrospective contribution payments. He is therefore put in the same legal situation as if the contributions were properly paid at the outset. This presupposes, however, that employees are individually identified, which differs from the way many collective assessment notices are prepared.If this is not the case, respective demands for the retrospective payment of payroll tax can be successfully contested on these grounds. 

B. Employers' share of social security contributions: § 266a para 2 StGB
In respect of the employer’s share of social security contributions, even the mere non-remittance constitutes a criminal offence. However, as with tax fraud as set out in §370 AO, a fraud-like conduct by the employer in respect of significant facts relating social security is required (§§ 28a, f SGB IV).

A quantification of the damages, which forms the basis for assessing a fine, stands at the end of all investigation proceedings by the Tax Inspection Unit or the Illegal Employment Task-Force (Customs Inspections). The respective penalty is assessed on the basis of the payroll tax and associated social security contributions withheld. The assessment base for determining the social security contributions withheld is, in accordance with § 14 para 1 P. 1 SGB IV, the amount of wages paid once or continuously. The designation of the wage and the payment method are irrelevant. The assessment base is the gross wage. If employers and workers entered into a net pay arrangement, then the (gross) wage is considered, in accordance with §14 Abs. 2 S. 1 SGB IV, to be the net wage plus any applicable taxes and social security contributions. This statutory provision relating to net pay arrangements is to the detriment of the person concerned. The fictive gross wages which would form the base of the net wages are applicable in net pay agreements.

Previously, uniform assessment bases applied to the affected areas of law (tax law and social security law) in respect of the investigative proceedings by the Tax Inspection Unit and the Illegal Employment Task-Force (Customs Inspection). This has changed since the Federal Supreme Court handed down its judgement on 2.12.2008 (File No. 1 StR 416/08). Nowadays, the actually paid wages for illegal work are extrapolated to form a gross wage amount in cases where social security contributions have been withheld, including cases where only a part of the wages was paid illegally (Federal Court of Justice of October 7, 2009, File No. 1 StR 320/09). When determining payroll taxes withheld, the actually paid illegal earnings serve as assessment base (Federal Fiscal Court of 21.2.1992, File No. VI R 41/88).

Partial illegal wage payments and casual employment (mini-jobs):

Particular conditions apply for the quantification of damages and determination of the assessment base in cases of partial illegal wage payments and casual employment (mini-jobs):

In terms of partial illegal wage payments, the Supreme Court has decided, that the above regulations on net pay agreements, as set forth in §14 Sec. 2 lit 2 SGB IV are applicable in principle . When calculating the amount, the addition of taxes and social security contributions is restricted to the illegal portion of the wages paid while the declared portion is excluded from the calculation. It must further be considered in cases of partial illegal wage payment, that the employer will have been in possession of the employee’s wage tax card. For this reason, the calculation of payroll tax must not be carried out assuming payroll tax bracket VI for the entire amount, but must focus on the individual income tax bracket of the individual employee, in accordance with the jurisprudence of the Federal High Court.

In the case of casual employment (mini job), the following distinction needs to be made. In calculating the damage caused by the offence, the “net wage standard” in §14, Sec 2, lit 2, SGB IV is not applicable, if the requirements for casual workers (mini jobs) have been satisfied in accordance with § 8 Sec. 1 No. 1 SBG IV. In these cases, the employer would in fact only have paid the lump-sum payroll tax and social security contributions, even in the event of a proper registration of casual employment (mini-jobs). Hence damage is limited to these. The situation is different, if the thresholds applicable to casual employment (mini-jobs) were exceeded. In these cases, the Federal High Court applies the net wage regulation of §14, Sec 2, lit 2 SGB IV, so that not only the “undeclared" disbursed portion of attributable payroll taxes and social security contributions are taken into account, but the general principles for net wage agreements apply. This means, that payroll tax and social security contributions are calculated and added to the paid wages (net pay), whereby the payroll tax in these cases is regularly calculated in accordance with tax bracket VI, due to lacking wage tax cards.

Tax investigation officers and the Illegal Employment Task-Force (customs inspection) are frequently unable to determine the actually paid (gross or net) wages. The periods concerned by the inspection measures frequently lie many years in the past, or records no longer exist, which means that the individual calculation bases (wage payment, taxation characteristics of the employee, applicable health insurance fund contribution rate) are unknown. Arbitrary assessments are therefore made in these cases, which is permissible on these grounds (Supreme Court of 13.06.2001 File No. 3 StR 126/01). The known assessment bases should initially be used in these cases.

If information, e.g. the extent of undeclared wage payments, is missing, the Federal High Court considers the investigative approach to be the invoices issued by the company (BGH of 10.11.2009 - 1 StR 283/09). On the basis of these invoices, an expert should be able to determine the workload required for these orders. So-called cover invoices could be another source of information, which are used to disguise undeclared wage payments in the company accounts. In this context, there is a further risk of an allegation of document forgery. If there is a lack of the aforementioned investigation possibilities, arbitrary assessments can also be made on the basis of industry awards for comparable revenues.

All arbitrary assessment methods are inherently inaccurate to a certain degree, because the results are neither based on facts nor on the individual circumstances of the affected company. There is frequently room to exercise discretion, including to the benefit of the company. The task of an experienced attorney/ tax law specialist / tax adviser representing the person concerned as an attorney for criminal law, is to query the arbitrary assessments and raise reasonable doubts in respect of their (arbitrarily assessed) calculation bases, in order to mitigate the ramifications for contributions, taxes and criminal prosecution.

The criminal defence lawyer should therefore scrutinise the arbitrary assessments made and the conclusions drawn and contest them. The general principle of "in dubio pro reo" (the accused enjoys the benefit of the doubt) is to be observed, so that the result of the social security proceedings must not be assumed congruently in the criminal proceedings. In order to achieve the required degree of probability for an arbitrary assessment, discounts need to be applied to the arbitrarily assessed contributions and taxes. Last but not least, commercial aspects, such as being disqualified from holding office in a company, must be considered. To secure the livelihood of a company owner, prohibition orders in respect of holding offices in companies should be contested by an attorney.

For criminal convictions in the event of undeclared wage payments or illegal work, the Federal High Court requires, that all necessary assessment bases have been calculated and disclosed. Determinations in respect of the workforce, the gross wages, the work hours and the contribution rates must be made at the time of each individual payment date. There must further be a separation of contributions by the employee and contributions by the employer. Calculations by social security authorities may not simply be adopted. In particular, so-called full-scale arbitrary assessments must not be adopted hastily. All sources of information and investigative opportunities must be utilised to determine and calculate the actual wages. The Federal High Court (Bundesgerichtshof) has derived an insight into undeclared wages, for example, from so-called cover invoices. For the labour-intensive construction industry, an average wage rate of two-thirds of net revenues is considered appropriate in many cases. Defence attorneys should scrutinise each individual case on whether this reflects the reality and which particular factors could impact on the wage ratio.

The limitation periods applicable to the withholding and misappropriation of wages with regard to social security contributions are usually much longer than the limitation periods in proceedings for payroll tax fraud by illegal employment. 

The limitation periods applicable for the purposes of § 266a Sec. 1 and 2 StGB begin, as set out in § 78a StGB, with the criminal deed being completed, as is the case for tax fraud (§ 370 AO). In the case of so-called true omission offences, as those contained in § 266a StGB, the deed is completed once the duty to take action, meaning the duty to report and pay contributions, expires. Except for the case of a later payment of the contributions, this is generally only the case if the contribution liability itself is time-barred, which takes a long time to come into play: wilfully withheld contributions become time-barred after 30 years from the end of the calendar year in which they were due for remittance, pursuant to § 25 Sec 1 lit 2 SGB IV The time until the offence is time-barred can be up to 36 years, if the five-year limitation periods prescribed in § 78 Abs. 3 Nr. 4 StGB are included in the calculation.  

Advice by the tax attorney: Defence attorneys dealing with undeclared employment should carefully consider the possibility of knock-on effects of settlements in criminal tax proceedings, because they may entail further criminal prosecution for withholding and embezzlement of wages. This is particularly significant against the background, that the fiscal authorities are obligated to report the circumstances to the responsible other authorities under § 31a Sec. 1 No. 1a AO and tax confidentiality will thereby be breached. 

The Managing Director of a limited liability company (GmbH) faces a quandary when the employer (the company) finds itself in an economic crisis. In accordance with § 266a StGB and § 823, Sec 2 BGB, the Managing Director is liable if he does not comply with the obligation of remitting the employee contributions. He will also be liable for criminal prosecution. If the company becomes insolvent (bankruptcy or excessive indebtedness), the Managing Director is obligated to file for insolvency without delay and within no more than three weeks. To safeguard the company's assets, payments to third parties are strictly prohibited during this period (§ 64 GmbHG). 

Jurisprudence has established, that the obligation to remit social security contributions is a priority, as it would be unreasonable to expect a managing director to expose himself to criminal prosecution for the purpose of complying with other statutory obligations. 

Advice by the tax attorney:To avoid personal liability, managing directors of limited liability companies should, even if the company is insolvent, always remit the employee’s share of social security contributions, but not the employer’s contribution.The remittances to the social security institutions should be designated with an appropriate reference ("payment should be used primarily for employee shares").