Disguised Subcontracting — How to Check Whether Your Contract Qualifies

This section explains what disguised subcontracting is and gives concrete examples of the situations in which freelancers are at risk.

A Typical Case of Disguised Subcontracting

Consider the case of Engineer A, who works as a freelance engineer for a software development company. The contract is titled "Software Development Service Agreement" and is structured as a contract for work at a monthly fee of 600,000 yen. But the reality is:

• A shows up at the office every day at 9:00 a.m. and works until 6:00 p.m.
• A receives specific daily work instructions from a project manager
• A is required to be constantly reachable on the company's internal chat tool
• At month end, A reports working hours, and compensation is adjusted accordingly

This situation has a high probability of qualifying as disguised subcontracting — an illegal arrangement that takes the form of a service contract but contains a relationship of command and control equivalent to a labor dispatch or employment arrangement.

Patterns Specific to Freelancers

Consider also the case of Freelance Designer B, who works at a design firm under a "Website Design Service Contract," but whose actual situation includes:

• Required to follow working hours in line with the company's work rules
• Receives detailed instructions on the number of design revisions and design direction
• Attendance at internal meetings is effectively compulsory
• Sits at the same desk and does the same work as full-time designer employees

What these cases have in common is that regardless of the contract's label or form, the actual working style is no different from that of an employed worker. Whether a freelancer's contract qualifies as disguised subcontracting is determined by the substance, not the wording of the contract.

Understanding the corporate staffing strategies and institutional factors that give rise to disguised subcontracting clarifies why the problem exists.

Corporate Motives and the Reality of Labor Cost Reduction

Behind the disguised subcontracting practices of many companies is the desire to avoid the costs and responsibilities of regular employment. When hiring full-time employees, companies bear the following:

• Employer's share of social insurance premiums (approximately 15% of salary)
• Obligation to provide paid leave
• Job security obligations under employment protection rules
• Obligation to pay overtime

Under a service contract, none of these obligations arise. By using a service contract in form while having workers perform the same tasks as employees, companies can sometimes reduce labor costs by 30 to 40 percent.

The IT industry in particular has many project-based operations. There is a natural alignment between companies wanting to avoid the risk of hiring full-time staff and engineers or designers who want to work as freelancers. However, this structure is a breeding ground for disguised subcontracting.

The Complexity of Labor Law and the Difficulty of Judgment

The Labor Standards Act identifies "labor under direction and supervision" and "compensation as consideration for work" as the primary factors in determining worker status. However, in the IT and creative industries, this determination is often extremely difficult.

For example, the line between "technical guidance to meet quality standards" in software development and "instructions to an employee" is blurry. Also, with remote work now normalized, the constraint of work location is not always as clear a criterion as it once was.

This difficulty in making the determination raises the risk of disguised subcontracting for both companies and freelancers.

Here is a practical method for checking whether your contract qualifies as disguised subcontracting, based on the criteria used by labor offices and courts.

Key Criteria and Specific Checkpoints

The following five factors are important criteria for identifying disguised subcontracting. Specific checkpoints are provided for each.

1. Presence of a Command-and-Control Relationship

The more "yes" answers to the questions below, the closer the relationship is to employment.

• Do you receive specific instructions about day-to-day tasks?
• Do you have little discretion over how work is carried out?
• Does a superior-subordinate type relationship exist?
• Are you told when to start and finish work?

2. Constraints on Work Location and Hours

• Are you required to work in a specific location?
• Are your working hours strictly defined?
• Do you need approval for being late or leaving early?
• Even when working remotely, are you under constant monitoring through online meetings etc.?

3. Compensation as Consideration for Time

• Is your compensation structured on an hourly or daily basis?
• Is payment based on hours worked regardless of the quality of the deliverable?
• Is there additional payment for overtime or weekend work?

4. Exclusivity and Replaceability

• Are you restricted from working on other projects in parallel?
• Can the work not be delegated to someone else?
• Are you restricted from working with competing clients?

5. Equipment and Expense Burden

• Are you supplied with equipment and software needed for the work?
• Are expenses such as transportation or communication costs covered?
• Are business cards or an email address provided by the client?

Practical Self-Check Procedure

To conduct an effective self-check, regularly review your contract using the following process.

Monthly Check (at end of each month)

1. Review the month's working style and record any facts that correspond to the five criteria above
2. Check whether the contract terms and the actual working style are consistent
3. Record the instructions received from the client and evaluate whether they exceed the scope of technical advice

Quarterly Check (every 3 months)

1. At contract renewal time, propose a review of contract terms
2. Exchange information with other freelancers and industry peers to check whether your contract is appropriate by market standards
3. Negotiate adjustments to contract language or work scope as needed

Here are the risks freelancers face if classified as disguised subcontracting, and specific remedies.

Freelancer-Side Risks and Financial Impact

If disguised subcontracting is discovered, freelancers face the following risks.

Tax Risks

• Possibility of retroactive taxation as employment income
• Back taxes assessed for amounts not withheld at source
• Obligation to return consumption tax if the freelancer was a tax-exempt business

In actual cases, a freelance engineer whose three years of disguised subcontracting was discovered ended up paying approximately 1.8 million yen in back taxes including late fees.

Social Insurance Risks

• Possibility of being retroactively treated as a welfare pension and health insurance enrollee
• Obligation to return national health insurance premiums
• Potential impact on future pension amounts

Impact on Contract Continuation

• Possibility that the client terminates the contract
• Risk that other clients form similar suspicions
• Loss of reputation within the industry

Specific Remedies and Negotiation Strategy

Here are step-by-step remedies for cases where disguised subcontracting is suspected.

Stage 1: Early Detection and Prevention

When signs of disguised subcontracting appear, take the following actions.

1. Review and propose revisions to the contract

   • Clarify deliverables
   • Specify in writing the discretion over how work is carried out
   • Review the compensation structure

2. Improve the actual working arrangement

   • Propose more flexible working hours
   • Increase the proportion of remote work
   • Work on multiple projects in parallel

Stage 2: Negotiation with the Client

If the working arrangement has the substance of disguised subcontracting, constructive negotiation with the client is necessary.

1. Share the problem and propose solutions

   • Have both parties acknowledge the disguised subcontracting risk together
   • Present a transition plan to a genuine service contract
   • Agree on a phased improvement schedule

2. Renegotiate contract terms

   • Change the compensation structure (from hourly rate to results-based)
   • Clarify the scope of work
   • Reorganize the chain of command

Stage 3: Consultation with Specialists

If the problem cannot be resolved independently, consult a specialist early.

1. Consult a lawyer familiar with labor issues
2. Have a tax accountant assess the tax risk
3. Have a social insurance labor consultant organize the social insurance situation

Here are daily management methods and negotiation tips for avoiding disguised subcontracting and sustaining a genuine contractor relationship.

Key Points for Drafting and Revising Contracts

To maintain a genuine service contract, the following must be clearly stated in the contract.

Defining Deliverables

• Specific deliverables and their specifications
• Quality standards and acceptance conditions
• Deadline and method of delivery

Example: "Production and delivery of a corporate website using WordPress (5 pages, responsive design). Acceptance criteria per the attached specifications."

Preserving Discretion Over How Work Is Carried Out

• Freedom of working hours and location
• Discretion over how the work progresses
• Possibility of delegating to a third party

Example: "The contractor may determine working hours and location at their own discretion in performing this work. However, weekly progress reports will be provided."

Appropriate Compensation Structure

• Clearly state that compensation is in exchange for a deliverable
• Compensation not based on time
• Clear payment terms

Tips for Day-to-Day Work Management

Pay attention to the following in day-to-day work management to avoid disguised subcontracting.

Documenting Communications

Record all interactions with the client and periodically check whether any instructions qualify as direction and control.

• Save emails and chat contents
• Prepare meeting minutes
• Distinguish between work instructions and technical advice

Working on Multiple Projects in Parallel

To avoid exclusivity, work on as many projects in parallel as possible.

• Confirm that the contract contains no exclusivity clause
• Clarify the scope of any non-compete obligation
• Maintain independence in schedule management

A Results-Oriented Work Style

Maintain a working style focused on deliverables rather than time.

• Regularly present deliverables
• Implement intermediate deliveries
• Agree on quality standards in advance

Long-Term Relationship Building and Contract Renewal Strategy

Take the following strategies to maintain a good relationship with clients while avoiding disguised subcontracting.

Building a Value-Providing Relationship

Establish a position as a partner with specialized knowledge rather than simply a task executor.

• Actively make technical proposals
• Present ideas for work improvement
• Provide information in areas of expertise

Gradual Improvement of Contract Terms

Rather than seeking large changes all at once, improve contract terms incrementally.

• Minor reviews of terms every 3 months
• Improvement of compensation structure based on track record
• Clarification and expansion of scope of work

As a freelancer, staying consistently aware of the disguised subcontracting risk and maintaining a genuine contractor relationship leads to long-term success. Regular self-checks and proper contract management allow you to avoid legal risk while sustaining stable business operations.

Review your contract now using the checkpoints above, and consider discussing a review of contract terms with your client as needed.

References

Labor Standards Act (e-Gov Law Database) (2024)

Standards for Determining Worker Status (2024)

Overview of the Act on Proper Transactions with Specified Consignees (2024)

Guidelines for Creating an Environment Where Freelancers Can Work with Peace of Mind (2021)