The LEC “tax scandal” and the distinction between employees and contractors.

Recently a YouTube video by Richard Wells, founder of H2K gaming, talking about a LEC “Tax Scandal” has been making the rounds:

The video opens up with some ominous music and allegations that this would be “the biggest shitstorm of all shitstorms to hit League of Legends,” so I got my popcorn ready expecting to hear hear some shady, shady stuff. Unfortunately, I was a little disappointed. The TL:DR of the video is this:

Back in 2013, when the LEC was just getting off the ground, Riot provided teams joining the league with a template player contract they could elect to use. The template stated the players were independent contractors, not employees. All the teams in the LEC used the template, and thus may have misclassified their players as independent contractors for a few years. As a result, they may now be liable for failing to remit taxes on what they paid the players to the German government.

To understand why this is an issue we need to go into some basics on the distinction between employees and independent contractors. The general idea is that independent contractors are more like ‘outside hired help’ and a company has fewer obligations towards them than they do to their employees. A few of the key differences between the two in most jurisdictions are:

  • Employees are subject to employment standards legislation (covering things like minimum wages, overtime, sick leave, occupational health and safety, etc.). Contractors are not.
  • Employees are generally entitled to participate in any benefit plan the company offers. Contractors are not.
  • Employees are (in some jurisdictions) entitled to severance if they are let go by the company. Contractors are not.

And, most important for our purposes:

  • Companies generally withhold employees’ taxes on each paycheque and remit the taxes (as well as deductions for things like employment insurance, contributions to programs like social security, etc.) directly to the government. With contractors they do not. Companies pay contractors a lump sum for their services, without any deductions, then it’s on the contractor to pay their own taxes and other remittances.

As you might expect, generally companies prefer to hire workers as contractors instead of employees, as doing so places fewer obligations on them. Of course, this is not as simple as just drafting up an agreement that calls someone a contractor (if it was, no one would be an employee). Regardless of what a legal agreement may say, the authorities will generally look at the nature of the actual relationship between a company and a worker to determine if a worker is contractor or an employee. The factors they look at vary from jurisdiction to jurisdiction, but they include things like:

  • how much control the company has over the worker’s activities, and how integrated they are in the company’s operations;
  • whether the worker is financially dependent on the company (i.e. is this their only income source or one of many sources);
  • does the work they perform fall within the scope of work generally performed by the company; and
  • does the worker provide their own equipment or have their own independent chance of profit/risk of loss;

The distinction is not always easy to make. If a company hires a SEO consultant to do a few hours of work a week on their site they’re probably a contractor. If they hire them full-time as the company’s head of marketing, they’re probably an employee.  But what if they hire them to work from home for 20/h a week and they continue to work with other clients on their own time? The answer in situations like these gets a bit murkier. That’s why a lot of the time the issue of whether someone is an employee or a contractor is not clear-cut, and needs to be determined on a case-by-case basis.

So what’s a company to do if it doesn’t know whether a worker should be classified as a contractor or employee? Well, in theory, they should look at the case law and the details of the specific relationship with that worker and try their best to make sure the classification for that worker is correct. In practice, they often err on the side of calling them contractors. After all, there’s no real way to know for sure until the tax authorities come knocking, and often the authorities don’t in fact come knocking in any event, so they take the risk.

What happens if a company is wrong, and classifies a worker as a contractor when they should have been an employee? The laws vary but in many jurisdictions they have to go back and remit everything they failed to pay, including back-taxes, contributions to things like employment insurance, national pension plans like social security, etc, as well as pay some kind of penalty.  It looks like the LEC teams may have, knowingly or unknowingly, taken that risk here, and if the German tax authorities come calling and determine their players were employees they could potentially be looking at some liability in line with the above (though I can’t really give specific info on German law).

With that context out of the way, I had a look at the video and there’s a few points I think are worth making.

1. This kind of thing happens all the time.

As discussed above, companies classifying workers as contractors even though they’re not actually sure they are is not anything new, either in esports or in other fields. Indeed, most esports player contracts I’ve seen classify players as contractors. The obligations associated with hiring someone as an employee are often too onerous, especially for new orgs, and in many cases the relationship between the company and player is defensible as an independent contractor relationship. The issue of whether esports athletes are independent contractors is actually still something that’s being discussed among lawyer-types. The Esports Bar Association even wrote about it in their inaugural journal.

The fact that something is common practice doesn’t make it right, of course, but it’s not like anyone in the LEC was fixing matches, doctoring financial records or sneaking into offices after-hours shredding incriminating documents. Yes, if the teams were wrong about classifying players as contractors they may be looking at some penalties from the German tax authorities, but to me this doesn’t really qualify as some deep, dark secret that would be “talked about only in hushed tones, behind closed doors” as the video states. To be honest with you, I would have been much more surprised if the LEC’s players weren’t classified as independent contractors, at least in the league’s early days.

2. The players’ status is not as clear-cut as the video claims.

The video states pretty unequivocally that if someone works in Germany for 6 months and 30+ hours a week they are considered an employee under German law. While I’m obviously not a German lawyer, that’s not correct as far as I understand. As set out by a memo Richard had his own lawyer put together, the courts in Germany, like the courts in most jurisdictions, take a more holistic approach to determining whether someone is a contractor, looking at a wide number of factors in keeping with the discussion above. It looks like 6 months/30+ hours per week criteria applies to whether someone is a German resident for tax purposes and needs to file taxes in Germany, but this isn’t relevant to whether they’re an employee or a contractor.

This isn’t to say that the LEC players aren’t employees – there’s a good case to be made that they are – but no German government body has made a decision on the issue. Richard has provided a lawyer’s opinion that states that they are, but an opinion is just that – an opinion. I’m sure Riot’s lawyers would be happy to provide an opinion that states the opposite. Until there’s an actual decision on this by a court or administrative body, no one really knows for sure. Thus, the video is overstating things just a weeeeee tiny bit when it states that it’s been “confirmed that the contracts are completely illegal.”

3. Some of the blame for this falls on Riot.

Riot put together the template contract that caused this whole problem, and it appears from the video that when providing it to the teams they didn’t advise them about the finer points of the employer/independent contractor distinction, and the risks associated with designating someone as a contractor.

Of course, the teams could have gotten their own legal advice, but anytime you’re preparing a legal document for someone else to potentially use, even if the document is just for “informational purposes,” that’s a bit of a touchy situation. If the German tax authorities come after the LEC teams for this, I wouldn’t hold it against them if they turn towards Riot and ask them why they’re in this mess because of their contract template. If they do, I don’t know how credible it’s going to be for Riot to say “well, we never meant for you to actually use the things.”

Whether Riot could actually be legally liable to the teams over this I don’t know, but this is certainly not a good look on them. They were the proverbial ‘adults in the room’ when the league was starting up, and had legal resources that dwarfed those of the LEC teams.  If there’s anyone who should have made sure this issue was handled at that time, it’s them.

TL:DR

So is this a big deal? Well it’s potentially a deal – we’ll see if this gets any media attention and if the German tax authorities investigate further as a result. However, it wouldn’t surprise me if this was something they already looked at. Remember, all the players would (or should) be filing individual tax returns with the German government as independent contractors, so it’s not like this is some secret no one but the teams knew about until now.

However, while this may be a problem for the LEC, is it a massive scandal and a “Nuke dropped on the LEC/Riot’s head” as Rich tweeted recently? In my opinion at least, probably not.

 

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