Businesses in Germany can take several approaches when drawing up contracts with external service providers and employees. Two of the most common options are service contracts and contracts for work. This article explains the differences between these two contract types, including invoicing and taxation.

What’s in this article?

• Legal bases for service contracts and contracts for work
  
• What does German law say about accepting completed work?
  
• Service contracts vs. contracts for work: Differences in invoicing
  
• Tax implications of service contracts and contracts for work
  

Legal bases for service contracts and contracts for work

Service contracts and contracts for work are based on different statutes. This directly impacts the rights and duties of the two contracting parties.

Service contracts

In Germany, service contracts are governed by the German Civil Code (BGB) starting with Section 611. A service contract is a contractual agreement where one party provides a specific service, and the other party uses this service for a fee. Any service can be governed by a service contract. Typically, the contractor in a service contract only provides the agreed upon service. They are not required to achieve a specific outcome. This means, within the framework of a service contract, “success” means the full and correct performance of the agreed upon service, rather than a measurable result.

In a service contract, parties often establish the nature, scope, and timing of the service, in addition to its place of performance. They can also agree on deadlines for completion or fulfillment. The parties usually negotiate a specific fee for each contract, establishing an hourly rate, flat fee, or any other billing model. In addition to the amount itself, a service contract can also include terms and conditions for payment. The contract ends at an agreed upon time, when it is terminated by one of the contracting parties, or when it is canceled by mutual agreement.

Often, businesses use the term “service contract” synonymously with “employment contract.” While the two share attributes, they are not identical legally. Contractors subject to a service contract are not under the same obligations as workers under an employment contract. Contractors don’t have to follow the same instructions and take more personal responsibility than workers in traditional employment.

The following minimum legal standards must be included in a service contract, according to the BGB:

• Typical contractual duties of each contracting party (Section 611)
  
• Rights and duties in the case of a transfer of business (Section 613a)
  
• Duty of medical care (Section 617)
  
• Regulations for the end of the service relationship (Section 620)
  
• Periods of notice for service relationships (Section 621)
  
• Tacit extension of the contract (Section 625)
  
• Duty to provide a reference (Section 630)
  

Contracts for work

A contract to produce completed work is focused on achieving a specific, testable outcome, rather than simply rendering a service. According to Section 631 of the BGB, contractors produce the agreed upon work, while the client is obligated to pay for the work. The subject of a contract for work can be a production, modification, or outcome achieved through work or service. This is one of the key differences between a contract for work and a service contract, which does not mandate a specific result.

According to the BGB, a contract for work provides details about the work, production period, and quality standards. Compensation is generally set at a fixed rate that is only payable upon successful completion and acceptance of the work. Some contracts can also stipulate progress invoicing for individual project milestones.

The contract to produce completed work usually ends once the work is accepted. The contract can be terminated by either party. Clients can do this at any time. However, contractors can only terminate contracts if they include unreasonable expectations or the client fails to fulfill their duties to cooperate in a reasonable amount of time. When this happens, the work done so far must be properly documented and provided to the client.

According to the BGB, a contract to produce completed work must include the following legal minimum standards:

• Typical contractual duties of each contracting party (Section 631)
  
• Compensation agreements (Section 632)
  
• Claims for rectification and liability for defects (starting with Section 633)
  
• Acceptance of the work and rights in case of defects (Section 640)
  

What does German law say about accepting completed work?

Accepting completed work means that the client inspects the finished work and acknowledges that it fulfills the contract. The relevant provisions are set out in Section 640 of the BGB. Among other things, this section states that clients are, in principle, obligated to accept completed work, unless the nature of the work does not permit acceptance. This only applies if the work demonstrates substantial defects in breach of the contractual agreements. According to Section 640.1 of the BGB, acceptance cannot be refused if the work exhibits only trivial defects.

Completed work is also considered accepted if the client fails to accept it by a reasonable deadline after completion. It is also considered accepted if the client fails to declare any concrete defects. If a private individual commissions work, they must be informed in writing of the consequences of not accepting the work or not reporting any defects.

If clients accept completed work with known defects, they can only bring claims at a later date if they have explicitly reserved these rights when accepting the work.

Service contracts vs. contracts for work: Differences in invoicing

One of the main differences between a service contract and a contract for work is the way they are invoiced. Service contracts are generally invoiced according to actual time spent. For example, a contractor invoices a company based on the number of hours or working days spent on the service. Usually, the agreed upon hourly or day rate is multiplied by the actual time spent. Invoicing is performed on a rolling basis until a set deadline or until the service contract ends.

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Contracts for work are, for the most part, billed as a flat fee. The price is usually set ahead of time for the entire work or defined partial deliveries. In the case of the latter, contractors issue progress invoices. For example, the contractor issues invoices when reaching certain milestones and provides a final invoice upon completion of the entire work. Commonly, payment is not due until the work is accepted. In the event that the work does not fulfill the agreed upon requirements or exhibits defects, the client has the right to rectification or a reduction in compensation.

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Tax implications of service contracts and contracts for work

Service contracts and contracts for work have many tax implications that both parties should assess carefully. Here is an overview of the most important implications.

Value-added tax (VAT)

As a general rule, invoices issued under both contract types are subject to VAT. In both cases, VAT is charged on the work fulfilled and must be remitted to the tax office. Service contracts are billed based on the agreed upon compensation, while contracts for work use the price of the work.

Under Section 19 of the German VAT Act (UStG), small-scale entrepreneurs can be exempt from VAT. To qualify for this exemption, their annual revenue must be below €22,000 the previous year and must be forecast not to exceed €50,000 in the current financial year.

Social security

Businesses in Germany should make sure they know when they are—and are not—obligated to remit social security contributions when contracting workers. The key criterion is whether the worker is employed or contracted as a freelancer. Under service contracts, contractors are generally regarded as employees subject to social security requirements because this type of contract resembles an employment relationship. In this case, the contracting business must remit social security contributions for the employee(s).

On the other hand, with contracts for work, contractors typically pay their own social security contributions. This means businesses are not required to remit social security contributions when working with independent service providers.

Tax deductibility

Generally speaking, clients can claim costs for services and completed work as business expenditures to reduce their taxable profit. This requires that expenditures are business-related and properly documented. Contractors can also deduct work-related costs as business expenses if they are directly related to the work fulfilled. In both cases, it is a good idea to get individual tax advice to avoid errors and get the most out of potential tax savings.