Employees, independent consultants and tax puzzle

How an organisation engages its workforce is shaped by many factors, with digitisation one of the most crucial. Technology has changed how business is conducted globally such that work can be wholly performed remotely thanks to electronic devices and virtual meetings.

The result is that a person, comfortably ensconced on his or her sofa hundreds of kilometres away, can analyse data sent by email, prepare a detailed analysis and issue a report to the organisation via email or a data sharing site.

This means that a person who has specialist knowledge or skills can utilise that talent to benefit multiple organisations rather than the traditional model where one is exclusively employed by a single organisation on permanent and pensionable terms.

The mode, which allows one worker to serve multiple organisations, carries one major puzzle around the tax treatment — are the workers employees who are subject to PAYE or are they independent consultants who are subject to withholding tax (WHT)?

This question usually boils down to determining whether the individual has entered into a contract for services (relates to an independent consultant) or a contract of service (relates to an employee).

A contract of service according to the Employment Act, 2007 is an agreement to employ or for a person to serve as an employee for a period of time.

The Income Tax Act further extends the definition to an agreement in which “the employer has the power of selection and dismissal of the employee, pays his wages or salary and exercises general or specific control over the work done by him”. Whilst a contract of service is extensively defined in law, a contract for service is not expressly defined.

Lack of clarity between a contract of service and a contract for service has precipitated disputes, both locally and in other jurisdictions. Independent consultants who view themselves as employees have sued their “employers” for termination and other employment related benefits.

The tax authorities on the other hand have demanded PAYE from organisations who considered themselves to be clients of a contractor rather than employers of an employee.

Whilst local laws have largely remained silent on the distinction between these two types of contracts, the courts have not been shy in trying to resolve this stalemate.

One of the tests that the Kenyan courts have extensively considered is the principle of control and supervision. Employees are generally controlled, observed and directed by their employers in the execution of their daily duties.

The courts have held that an employer-employee relationship exists if a person is directed on which tools to use and the manner of executing the task.

For their part, independent consultants are free to determine the means of arriving at the agreed deliverable. In essence therefore, for an independent consultant, a client may dictate the ‘what’ of the deliverable but not the ‘how’ of producing it.

In addition, the Kenyan courts have also weighed the degree of integration of a person into the organisation as a major factor in determining whether an employment relationship exists.

If the person occupies a senior position in the leadership structure or organogram, this may point to someone being an employee. If the organisation has integrated the person into their organisation or office e.g. by allocating designated space, then understandably, the issue of ‘independence’ is thrown into question.

Another pivotal aspect is the economic reality of the agreement. In contracts of service, the economic benefit and risks accrue to the employer as the employee is guaranteed to receive their pay regardless of their output in that particular period.

The risk of financial loss lies with the employer due to poor performance, falling market prices and bad workmanship, etc.

On the other hand, an independent consultant is self-employed in the sense that they can make a financial loss when their revenue is lower than the costs they have incurred to generate that income.

Whilst the methods of engaging workers are quickly changing, our laws and guidelines have not evolved at the same pace. There is therefore a need to find lasting solutions to avoid ambiguity and disputes.

The Kenya Revenue Authority (KRA) commissioner has the power to make a public ruling on any tax issue to express the commissioner’s interpretation of the law in regards to that issue.

A public ruling in relation to the thorny employee vs consultant debate would be a welcome move for many sectors of the economy who are grappling to make a distinction between these two.

Another possible solution is to develop our laws to reflect the dynamism in labour contracting. Since the Income Tax Act is currently being overhauled, this presents a good opportunity to consider enacting provisions that distinguish between contractors and employees once and for all.

Maybe the time has come for us to consider defining a third category of workers — the ‘dependent consultants’. Some of the more developed economies that are heavily dependent on technology such as the UK and the US are already factoring in this third category.

Dependent consultants would be an intermediary category of workers falling between the employee and the independent consultants. They would generally enjoy some benefits which were traditionally considered to be exclusively for employees such as leave days but not terminal benefits.