Stories of an IT lawyer. Life outsourcing business. Part 1
# FROM THE AUTHOR
During my career, I met a lot of IT entrepreneurs, helped build a business, and solved problems. Saw ups and downs, success and collapse.
The meaning of this story (and all subsequent ones under the heading “Lawyer's Stories”) is to tell you about the legal aspects and nuances of the life of the domestic IT business.
I will introduce myself. My name is Vyacheslav Ustimenko, I am the founder of a well-known law firm among IT entrepreneurs and a YouTube blogger.
#DISCLAIMER
All characters in the story are fictional, and the situations are simulated, but if you read to the end, you will understand that the story is very close to reality.
#START
In the courtyard of 2012, Sasha held a team lead position in the large outsourcing of My Dream LTD.
His salary reached 4,000 USD per month, the employer is loyal, the projects are interesting.
Sasha spoke directly with customers, was responsible for the implementation of project development and led a small development team.
# CALL
One bell rang. The customer Mike called Skype on Sasha and suggested that he quit the company and work with him “directly”.
Mike said the developer rates in the contract between Mike and My Dream LTD were as follows:
$ 85 - senior developer
65 $ - middle developer
25 $ - QA specialist, junior developer
Sasha knew the real salary of his team, and found that My Dream LTD sells their time at about 3.5 times more expensive.
# OFFER
Mike offered Sasha a long-term contract, the main condition of which was to reduce the rate by 50%. Sasha took the time to discuss with the team, as he understood that under such conditions one could make good money.
After a couple of days, Sasha suggested that the team that worked on Mike's project quit, with a mandatory salary increase of 30%, but within the framework of the new company.
Sasha understood that even in this situation, he “sells” his team at 35% more than it costs.
# CHANGE
Not all team members wanted to quit, and not everyone was motivated only by an increase in salary, but, despite this, the necessary minimum of developers went over to Sasha’s side.
Senior developer Igor, who was the best versed in the architecture of the project, wanted a share of 20% of Sasha’s profit. After several days of negotiations, they agreed on 15%.
# NEW OFFICE
Sasha understood that he needed a room in which his team would work. I rented a small office as an individual. I agreed with the landlord to pay in cash, since Sasha was not registered as an entrepreneur.
*** Sasha didn’t really understand that he was violating the current legislation, did not know that doing business without proper registration is fraught with, for example, a fine in the amount of all illegally earned amounts, but all this was not a priority for him. ***
# FIRST CHALLENGES
It's time to pay a salary to the team, and Sasha only has a personal bank account and a foreign card “Pioneer”. Mike transferred the money there, and with huge losses on converting and withdrawing money at the ATM, the first salary was paid “in an envelope”.
*** Sasha did not think that he and his employees would be obliged to declare the amount received on the account and pay personal income tax from it (personal income tax). ***
# FIRST PROFIT
According to the agreement, Sasha and Igor participated in the distribution of profits, in 85% and 15%, respectively. Each time after paying salaries and deducting expenses for the office and cookies, Sasha gave Igor his share in cash.
# FIRST COMPANY
After a couple of months, one of the developers asked Sasha to help him apply for a visa to Canada, he had to indicate his place of work (here Mike went to a meeting and signed a direct contract between his company and the developer, exclusively for the visa application form). Then another developer wanted to get a loan, but he was denied a bank because there was no official source of income (Sasha and Igor did not know how to help and gave their money on loan against receipt).
It became clear that you need to bring everything to the “white” level, keep track of finances and create legal and financial instruments. So the idea came up to create a company. Without hesitation, the guys found a lawyer on the Internet, registered the company “Pervaya” LLC, re-registered the office rental on it, and opened a bank account.
# PAPER BUREAU
Before the company was registered, the guys did not even have a written contract with the customer. Now, there is such a need. Mike provided them with a contract signed for his part (it was the American company Magic Corp.), the guys gave it to the translator, received a bilingual version, and Sasha (by the way, he was the director of Pervaya LLC) signed the contract.
Within a few weeks, the guys started looking for an accountant on a remote site, and they put CFO and CEO status in Pervaya LLC on their Linkedin.
By the way, this is a common practice in our country to have “directors” in the company more than an employee. If you look at Linkedin, sometimes even Apple or Google has fewer directors than our local companies ... CEO, CBDO, CFO, CTO, CMO, etc.
# FIRST DISAPPOINTMENT
Sasha already knew what invoice and reporting was, went to the bank, if necessary, took paper copies of documents, signed all kinds of “pieces of paper” which the accountant sent from time to time. By the way, the latter, at the request of Sasha, calculated tax losses when paying official salaries to employees. The seen figure upset the guys, and the desire to build a “white” company was gone. But the guys understood that the company could not function without employees, and the legal address of Pervaya LLC (that was the company's office) could be checked at any time and see a dozen unemployed people there.
In our country, they do not like to turn to doctors or lawyers until they press it, because there is the Internet, you can find everything there.
So the guys found a scheme in which the LLC can not employ employees, but register everyone as an individual entrepreneur and pay not as an employee, but as a contractor under a contract.
# FIRST SCHEMES The
financial logistics of the company looked something like this:
The customer pays the amount X to the account of the LLC, and the amount Y to the account of Sasha’s “Pioneer”.
The LLC subcontracts the work to entrepreneurial employees and pays 95% of X, 3% of X goes to pay for office rent, 2% of X settles as a profit for the company.
The sum Y is the net profit of Sasha and, accordingly, Igor.
*** But the guys at that moment did not yet know that there was a judicial practice of recognizing such relations as tax labor, with consequences in the form of serious fines. ***
# FIRST quarrels
It was the middle of 2013. Mike quickly got used to a profitable rate for him and began to become impudent, to delay payments, in the end he said that he did not need part of the work done.
Sasha and Igor went to a lawyer. The lawyer said that the contract does not protect them at all, and the customer can legally manipulate the facts and not pay for the services of LLC Pervaya. What Mike actually did.
It is good that the guys managed to diversify and were in the process of dialogue with several new customers from the USA.
On the same day, they ordered a lawyer a professional contract that can protect their interests.
# PIONEER ALWAYS READY
The story with Mike ended as quickly as it began. The new customer, by the way, it was the company NEWONE LTD, signed a contract with LLC First, but, to the surprise of Sasha and Igor, refused to pay part of the money on the Pioneer card.
*** Payments to “Pioneer” created additional difficulties for the customer’s accounting, he was ready to pay only by bank transfer from his company’s account exclusively according to the invoices issued by LLC “Pervaya”. This makes sense, because the more confusing financial logistics, the more difficult it is to defend oneself in court. ***
NEWONE LTD began to pay monthly the entire amount to the account of LLC “First”. Sasha decided that he would better accept the money with tax losses than delay the start of cooperation with a new customer, because if the customer “disappears”, then you will have to dismiss the developers. And developers are the main asset of the outsourcing company.
Sasha and Igor went to the accountant and asked how they should now receive their money. The accountant said that the legal way is to distribute the company's profits as dividends, but this will create a rather large tax burden on LLC First.
# ON THE SAME RAKE
The guys went back to finding the answer on the Internet. The decision came from the “advisers” from one of the forums. Igor was removed from the founders of LLC “Pervaya”, registered as an individual entrepreneur and made a subcontractor in relation to LLC “Pervaya”.
# NEW DIAGRAMS The
company’s financial logistics looked something like this: the
customer pays the amount (100%) to the LLC account, the
LLC subcontracts the work to entrepreneurial employees (55%), 5% goes to pay for the office lease, 38% goes to the corporate account of the “entrepreneur” ”Igor and is distributed between Sasha and Igor, and 2% settles as the company's profit.
*** But the guys at that moment did not yet know that there was such a thing in the tax code as “market price” and judicial practice on not recognizing a part of the company's expenses. They intentionally exposed LLC Pervaya to the risk of additional taxation of income tax and interest. ***
# KARMA
In the yard in 2015, Pervaya LLC already had three relatively large customers.
LTD HELLO WORLD
NEWONE LTD
SOFTWARE LLC
At the beginning of the month, immediately after the payment of “salary” to employees, Sasha receives a notification from HR in Slack that 7 employees immediately stop working with him.
On the same evening, a notification from the customer of LTD HELLO WORLD on the termination of cooperation came to the mail. Sasha realized that the boomerang was back, and some of his employees “took away” the customer ...
LEGAL DISPUTES
Sasha called the lawyer who created the contract and asked what could be done. The lawyer in the paid consultation mode explained that the customer does not have the right to “lure” employees / contractors, and for this a fine of $ 100,000 is stipulated under the contract and suggested several options:
Do nothing (which counterparties often rely on)
Go to the LCIA London Arbitration ( which was indicated as the place of settlement of disputes)
*** There were high chances in the Arbitration, since the contract was really professionally drawn up, and the server kept an e-mail correspondence of one of the employees, which by law of the UK (Civil Evidence Act 1995) is evidence in court. ***
The company where the lawyer worked was chosen as the main partner.
#ARBITRATION
Mid 2016 LLC First, with the help of a lawyer, won the arbitration and successfully applied the decision of the arbitrators in the USA.
The costs of the entire turnkey procedure amounted to about 25,000 USD:
12,000 for arbitration services,
3,000 for a lawyer in the USA, for work on applying the arbitral award to HELLO WORLD,
10,000 (10% of the amount) - lawyer's fee,
Profit: 75,000 USD
Losses: Large customer and part of the team
. WHAT DO YOU DO?
The end of 2016. One of the programmers was offended by Igor for criticism and unprofessional communication using obscene language and quit. Igor asked Sasha not to pay the last salary to the programmer in order to punish the “wrong person”.
A couple of weeks later the doorbell rang, an ID of the tax officer, an unscheduled inspection. Ground of verification: statement from a third party.
Sasha began to call the lawyer in a panic, because he absolutely did not understand the grounds for a tax audit, did not know how to behave in such procedures, whether it was possible to interrogate the search and seizure of equipment, what could be said and what couldn’t be said. Employees behaved accordingly.
Bottom line: court, fine, recognition of the relationship between LLC “Pervaya” and “employee-entrepreneurs” as labor.
# RESTRUCTURING the
beginning of 2017, despite the problems experienced, LLC “Pervaya” shows good growth. The lawyer proposed the registration of an operating company abroad.
Objectives:
- optimize document flow with customers
- tax planning
- increase company respectability
- secure profit center
- avoid currency conversion losses
- reduce paper bureaucracy
- make direct payments to employees from a foreign company (minimize risks that existed for Pervaya LLC)
Sasha was a resident of the Russian Federation,
Igor was a resident of Ukraine.
The lawyer selected the jurisdiction for the operating company, taking into account the business goals of the company and the requirements of the legislation of the two future founders:
- For the Russian Federation, the Law on Controlled Foreign Companies (CFCs),
- for Ukraine, Cabinet of Ministers and NBU requirements regarding individual licenses.
- Additionally checked double taxation avoidance agreements.
# NEW SCHEMES The
lawyer registered a company abroad under the name ALIG LTD. The
financial logistics of the company looked something like this:
Customers pay the amount (100%) to the ALIG LTD account,
ALIG LTD subcontracts the work to the business employees (25%),
Small part (5%) goes to Pervaya LLC to pay for office rent, salary to the HR department and office manager.
70% remains on the ALIG LTD corporate account, of which 40% Sasha and Igor distribute as dividends, 20% are invested in marketing, and 10% are paid to their personal accounts abroad as contractors of the company under an independent contractor agreement.
One of the first major customers - SOFTWARE LLC wrote an e-mail to Sasha. He wants to buy a 51% stake in ALIG LTD.
To be continued...