Employment Contract, Service Agreement or Sole Proprietor: How to Hire a Contractor in 2026 and Avoid Reclassification

The author of the article: Denis Korablyov

Modified date: 10 August 2026

When a business needs to engage an employee, contractor or sole proprietor, the question arises of how to formalise the relationship correctly. This affects not only the tax burden but also the risk of reclassification as an employment relationship, penalties and additional tax assessments. A contractor can be engaged in at least four ways: an employment contract, a civil law contract, cooperation with a sole proprietor or a gig contract.

The greatest risk is reclassification: when the tax authorities or the State Labour Service determine that an agreement with a sole proprietor or a civil law contract actually conceals an employment relationship. This may result in significant additional tax assessments and penalties, which in some cases can reach UAH 86,470 for each employee. We will explain how these arrangements differ and how to choose the right one without unnecessary risk.

Four ways to engage a contractor

Here is a brief overview of each option, followed by a detailed explanation:

The key difference between these arrangements is who pays taxes on the remuneration and what guarantees and risks arise.

Employment contract: guarantees and cost

An employment contract is the traditional way to hire an employee under the Labour Code of Ukraine. The employer acts as the tax agent and:

• withholds 18% personal income tax and a 5% military levy from the accrued salary;
• charges a 22% unified social contribution on top of the salary at its own expense.

For example, from a minimum monthly salary of UAH 8,647, the employee will receive approximately UAH 6,660 after tax, while the total monthly cost to the employer will be approximately UAH 10,549 – the salary plus a unified social contribution of UAH 1,902.34.

In return, the employee receives a full package of employment guarantees: paid annual leave, sick pay, regulated working hours and protection upon dismissal. This is the most expensive and heavily regulated arrangement, but it is the only appropriate option when a person works permanently and under the employer’s direction.

Employing staff also involves regular reporting and payroll processing, which are often outsourced to avoid employing a separate HR specialist and accountant.

Civil law contract

A civil law contract, such as a contract for work or services under the Civil Code, is used when a specific result is required rather than ongoing work: developing a website, completing repairs or preparing a project. The contractor is not part of the staff, organises their work independently, and receives payment for the result, which is documented by an acceptance certificate.

A common misconception is that a civil law contract is cheaper than an employment contract because it saves on the unified social contribution. This is not true. When remuneration is paid to an individual under a civil law contract, the customer must also withhold 18% personal income tax and a 5% military levy and charge a 22% unified social contribution. The tax burden is the same as under an employment contract – the only saving relates to employment guarantees, which do not apply under a civil law contract.

A civil law contract is therefore appropriate specifically for one-off and project-based assignments. If a person attends work every day according to a set schedule, this is an indication of an employment relationship rather than a civil law arrangement. The subject of such a contract must be the result of the work, not the process of performing it.

Cooperation with a sole proprietor: taxes and reclassification risk

The most common arrangement in small businesses and the IT sector is to work with a contractor registered as a sole proprietor under the simplified taxation system. In this case, the customer is not a tax agent: it does not withhold anything from the remuneration, while the sole proprietor independently pays the single tax and the unified social contribution. For the customer, this is generally one of the least expensive forms of cooperation.

However, this is also where the main risk arises – reclassification as an employment relationship. If a sole proprietor effectively works as a salaried employee, with one customer, a designated workplace, a fixed schedule and managerial supervision, the tax authorities may recognise the relationship as employment, with all the resulting consequences. This may be regarded as a form of business fragmentation, which regulatory authorities are monitoring increasingly closely.

Gig contracts for Diia.City residents

A gig contract is a special arrangement available only to Diia.City residents, primarily IT companies. 

A gig specialist is neither an employee nor a sole proprietor but has a separate legal status. Their remuneration is subject to 5% personal income tax and a 5% military levy, while the unified social contribution is charged at no less than 22% of the minimum salary.

This arrangement has the lowest tax burden among the official forms of engagement, but it is available only to companies that meet the Diia.City eligibility criteria. For companies already operating under Diia.City, it often provides a compromise between an employment contract and cooperation with a sole proprietor. Read more in our articles comparing a gig contract and a sole proprietor and explaining taxation under Diia.City.

Comparison of engagement arrangements: table

Here is a summary table to make the choice easier:

The least expensive model is not always the safest – the final choice depends on how the contractor actually performs the work.

Reclassification of employment relationships: indicators and penalties

The main point to understand is that regulatory authorities consider not the title of the contract but the actual nature of the relationship. If cooperation with a sole proprietor or under a civil law contract has the characteristics of employment, it may be reclassified regardless of what the contract says.

There is currently no exhaustive statutory list of criteria. Eight indicators of disguised employment relationships are included in the draft new Labour Code, but they are not yet legally binding. In practice, however, the State Labour Service, tax authorities and courts consider the following indicators:

• the work is ongoing rather than one-off;
• the contractor follows internal workplace rules and a set schedule;
• the customer provides the workplace, equipment and materials;
• payment is made regularly, like a salary, rather than for a final result;
• the work is performed personally, and the contractor is integrated into the company’s structure;
• for a sole proprietor – a significant share of income comes from one customer within the customer’s core business activities. This is a risk factor, not an automatic prohibition.

None of these indicators alone results in automatic reclassification – the regulatory authorities assess all the circumstances of the particular working relationship.

The more of these indicators are present, the higher the risk. Consequences of reclassification include additional assessments of 18% personal income tax, a 5% military levy and a 22% unified social contribution for the entire period, late-payment interest and a penalty for an undeclared employee.

Penalties for undeclared employment under Article 265 of the Labour Code of Ukraine: allowing an employee to start work without an employment contract or without notifying the tax authorities results in a penalty of 10 minimum salaries = UAH 86,470 for each employee. A repeated violation within two years is subject to a penalty of 30 minimum salaries, or UAH 259,410. Single-tax payers in Groups 1-3 receive a warning for the first violation. A mitigation rule applies during martial law: if the employer complies fully and on time with an order to remedy the violation, the penalty may not be imposed. Such violations may be identified, in particular, during State Labour Service inspections.

Learn more about the 7 signs of disguised employment, how a fine can be imposed even without an inspection, what the sole proprietor risks losing, and how to safely draft a contractor agreement in the article “Sole Proprietor Instead of an Employee: 7 Signs of Reclassification.”

How to engage a contractor correctly

There is no universal contract: first, you must determine the actual nature of the cooperation and only then choose the appropriate legal arrangement. The key requirement is that it must reflect the true nature of the relationship:

• Employment contract – issue an employment order and submit the mandatory notification to the tax authorities before the employee starts work, using the form approved by Resolution No. 413 of the Cabinet of Ministers of Ukraine. Allowing the employee to start work without this notification is already a violation.
• Civil law contract – specify the exact result, deadline and payment for the completed result, and document completion with an acceptance certificate. Avoid provisions concerning working hours and subordination.
• Cooperation with a sole proprietor – make sure the contractor is genuinely independent: they have several clients, their own equipment, an appropriate KVED activity code, and the contract describes a service rather than a job position.

If you are planning to hire your first employee, see the step-by-step procedure in our article explaining how a sole proprietor can hire an employee.