What is the ‘Švarc system’ and why is it prohibited by law
The term “Švarc system” is not officially defined in Czech legislation, but its essence falls under the definition of illegal work under the Employment Act. The name comes from the entrepreneur Miroslav Švarc, who introduced this model in the construction industry in the early 1990s. The state banned it as early as 1992, and the ban remains in force to this day.
In short, the Švarc system refers to a situation where a person performs work for a company that has all the characteristics of dependent employment, but not on the basis of an employment relationship; instead, they act as a self-employed person formally presenting themselves as a business partner and invoicing their remuneration. Section 2 of the Labour Code defines dependent work as the personal performance of work by an employee for an employer in accordance with the employer’s instructions, in the employer’s name and under the employer’s responsibility. Such work may be performed exclusively under an employment contract or under an agreement on work performed outside an employment relationship. If these characteristics are met in cooperation with a self-employed person, the work is illegal regardless of the contractual form.
The reason why the state combats the ‘Švarc system’ is clear: self-employed persons pay lower social security and health insurance contributions than employees; moreover, they can claim flat-rate expenses and reduce their tax base. The employer pays no insurance contributions for them at all. The fiscal impact of this model on public finances is significant, and this is precisely why the state systematically combats this practice.
How the ‘Švarc system’ arises and how to recognise it
The Švarc system often does not arise from deliberate circumvention of the law, but rather from a gradual shifting of boundaries. A company awards a single contract to an external supplier; the collaboration proves successful, is extended, and the result is a relationship virtually indistinguishable from an employment relationship. Neither the Labour Inspectorate nor the courts base their assessments on the title of the contract, but on the actual circumstances.
Four key questions will help you get a basic understanding:
- Does the self-employed person work under your supervision and in a subordinate role?
- Do they act on your behalf?
- Do they carry out tasks according to your instructions?
- Do they have to carry out the work in person?
If the answer to all four questions is yes, the relationship demonstrably has the hallmarks of a ‘Švarc’ scheme.
A real-life example
A company hires an external IT specialist for a single project. The collaboration proves successful — the IT specialist is gradually given further tasks, the company lends him a company laptop, sets his working hours, the IT specialist attends internal meetings, has a line manager and invoices the same amount every month. Although this relationship is referred to as external collaboration, legally and in practice it constitutes employment. It is in this indirect way — by gradually pushing the boundaries — that the ‘Schwarz system’ arises.
The five most common indicators in practice
Assessing whether a situation constitutes the ‘Švarc system’ is always a case-by-case matter and depends on the set of circumstances. The following indicators are the most frequently encountered in the practice of regulatory bodies and courts.
- The self-employed person acts as an internal team member. They have a company email address, are not outwardly distinguishable from employees, attend internal meetings and have a clear place in the company hierarchy. From the perspective of third parties and within the company, they act as an employee, not as an independent contractor.
- The work is managed in the same way as for an employee. The self-employed person has a supervisor, receives ongoing instructions regarding how to carry out their work, adheres to working hours, works using company equipment, and must seek approval for any absences. In legitimate external collaboration, the focus should be on the result, not on supervising every step of the work.
- Invoicing resembles a salary. The same invoiced amount every month, bonuses for weekends or public holidays, paid leave or sick pay, invoicing exclusively to a single company resulting in the self-employed person’s complete economic dependence – these are all warning signs. An hourly rate is not in itself unlawful, but it must correspond to the nature of the service and genuine independence.
- A self-employed person cannot refuse or delegate work. If they must accept all tasks, cannot be replaced, and personal performance is effectively required, a key feature of entrepreneurship is missing: the freedom to choose one’s own approach and subcontractors.
- Ongoing cooperation without a clear project. A contract for an indefinite period without a defined outcome, the possibility of immediate termination for any reason, or long-term continuous cooperation without a clear project framework – these are further indicators suggesting a relationship akin to an employment contract.
Key legislative changes: regularity is no longer a requirement
A significant change, which has greatly facilitated the work of supervisory authorities, came into effect on 1 January 2024: the element of regularity has been removed from the legal definition of illegal work. Previously, it was necessary to prove that dependent work had been performed repeatedly and over the long term – this was difficult to substantiate in practice, particularly in the case of short-term or project-based collaborations. Now, it will suffice to prove that dependent work was performed on a one-off basis outside an employment relationship.
The law also expressly stipulates that the duration of the work is not relevant for assessing its illegal nature. This change responds to previous case law and eliminates one of the most common defence strategies during inspections.
New sanctions from 2025: fines, business bans and blacklisting
The amendment to the Employment Act and the Labour Inspection Act, effective from 1 January 2025, expands the range of sanctions to include measures with a significantly greater deterrent effect. A company that permits illegal work to be carried out faces a fine ranging from CZK 50,000 to CZK 10,000,000. A ban on business activities for up to two years may now also be imposed – this measure poses a potential existential threat to companies. The law also carries reputational consequences: decisions on administrative offences will be published on the official notice board of the State Labour Inspection Office for a period of one year. At the same time, publication leads to the company being labelled an unreliable employer, which makes it more difficult to employ foreign nationals and to access subsidies for the employment of people with disabilities.
A key change is the extension of liability for penalties: a fine of up to CZK 100,000 can now also be imposed on the self-employed person themselves who works under the ‘Švarc system’. Until now, penalties had been directed exclusively at the client.
Covert recordings and data sharing: enhanced inspection tools
From 1 January 2025, labour inspectors will be authorised to make audio and video recordings without the knowledge of the persons being inspected in cases where there is no other way to prove an offence. At the same time, inspectorates have gained access to information from the tax authority. Greater data sharing between labour inspectorates and the tax authority means that findings of illegal work are routinely referred for further proceedings – including the assessment of back taxes and contributions, generally covering the previous five years, together with penalties.
Tax and contribution implications upon detection
The detection of the ‘Švarc system’ triggers a chain of proceedings extending beyond the scope of fines imposed by the labour inspectorate. For the company (the client), the most serious consequences are the back-payment of social security and health insurance contributions for the entire period of the arrangement and the back-payment of income tax with penalties.
On the self-employed person’s side, their income may be reclassified from self-employment (Section 7 of the Income Tax Act) to employment (Section 6 of the Income Tax Act) – the self-employed person thus loses the option to claim flat-rate expenses, and their tax liability and insurance contributions increase. The total financial burden of additional assessments over five years can, in the case of repeated cooperation with multiple self-employed persons, reach a sum significantly higher than the labour inspection fine itself.
Legal cooperation with self-employed persons: where is the line?
Cooperation with self-employed persons is not prohibited – provided that it is genuinely of a business nature. The key requirement is that the self-employed person works independently, on their own responsibility, in their own name and without organisational subordination. The following in particular pose an increased risk:
- exclusive or dominant dependence on a single client lasting longer than a year,
- the provision of a company email address, business cards or a work computer,
- mandatory working hours at the client’s premises,
- participation in internal meetings, training sessions or staff appraisals,
- contracts where the self-employed person cannot determine their own approach or appoint subcontractors.
Conclusion
The Švarc system is not merely a historical relic from the 1990s. It is a dynamic compliance area in which the law has become significantly stricter over the past two years – in terms of definitions, sanctions and enforcement tools. The combination of new enforcement tools (business ban, blacklist, fines for self-employed individuals) and the expansion of the inspectorate’s powers clearly signals that the risk is growing across all sectors. Properly structured and regularly reviewed cooperation with self-employed individuals can continue legally – but setting this up requires consistent and systematic legal oversight.
