Tax and Legal Implications of Engaging Freelancers for Businesses in Mongolia

1) What are the tax risks for businesses when hiring freelancers instead of full-time employees?

In Mongolia, an employer hiring a freelancer pays less social insurance contributions than when employing a full-time employee under a labour contract, so no particular tax risk appears to arise. However, if the parties enter into a contract to hire a freelancer for the purpose of reducing the tax burden in a situation that is in fact an employment relationship, such action would constitute a violation of the labour and tax law.

2) How do tax authorities determine whether a freelancer arrangement should be reclassified as employment?

Under the Labor Code of Mongolia, if the total duration of the freelance arrangement, including its extension, is more than 2 /two/ years, the contractual relationship shall be determined as permanent employment. Also, it is important to note that the freelancer does not work under management, instruction, or control of the client at the workplace location designated by the client not to be deemed as employment relations.

3) What are the employer’s withholding or reporting obligations when working with freelancers?

The company or employer is obligated to withhold and remit social insurance contributions and personal income tax from his/her monthly salary. Both the company and freelancer are required to pay their respective portion of social insurance contributions at the applicable rates, and the company must submit the corresponding report to the tax authority within the following month.

4) Are withholding taxes applicable when engaging cross-border freelancers?

Yes. When engaging cross-border freelancers, employers are subject to a 20% withholding tax on payments made to such foreign contractors, unless a double tax agreement applies.

5) How do double taxation treaties impact taxation of payments to foreign freelancers?

Taxation of foreign freelancers depends on their citizenship and whether their country has a double taxation treaty with Mongolia. If a treaty exists and the freelancer provides proof of tax residency, the employer has to pay the withholding tax in Mongolia at the rate specified in the treaty.

6) What compliance documentation should businesses maintain when working with freelancers?

Since freelancers are not regular employees of an organization, the law does not prescribe mandatory record-keeping requirements related to them. However, in practice, to prevent any disputes, it is advisable to conclude the contract in writing and for each party to retain a copy of the contract.

7) What compliance requirements must companies meet when engaging freelancers?

Companies engaging freelancers must ensure correct tax obligations, including withholding and remitting the freelancer’s social insurance contributions and personal income tax from his/her salary. Proper documentation and written contracts are required to demonstrate compliance.

8) What are the legal and contractual best practices for structuring freelancer engagements to minimize tax risks?

It is important to clearly specify the duration of the contract in the agreement. Without a defined timeframe, the contract could potentially be misclassified as an employment contract. Explicitly defining the start and end dates or project milestones may help to reduce tax risk by ensuring both parties have a clear understanding of the contract's timeframe.

Authors: Bolormaa Volodya, Kh. Enkhjin