Employees vs. Independent Contractors, Qhala Limited PAYE Case

Case Study: Qhala Limited v Commissioner of Domestic Taxes (Tax AppealE112 of 2024) [2025] KETAT 41 (KLR) (24 January 2025) (Judgment)

Background of the Dispute

• Qhala Limited, is a company that provides digital business solutions.
• KRA conducted a tax audit on Qhala.
• KRA concluded that Qhala had incorrectly classified 43 individuals as “independent contractors” instead of “employees.”
• As a result, KRA issued a demand notice for unpaid Pay As You Earn (PAYE) taxes amounting to Kshs 25,280,079 for the period from January 2020 to July 2023.
• Qhala objected to this decision, but the objection was rejected by KRA, leading Qhala to appeal to the Tax Appeal Tribunal.

The Core Legal Issue

The central question for the Tribunal was:

Did the Respondent err by reclassifying Qhala’s service providers as employees (subject to PAYE) instead of independent contractors (subject to Withholding Tax)?

Qhala’s Arguments :

• Contractual Terms: The agreements were clearly titled “Consultancy Agreements” and stated the relationship was not one of employer-employee.
• Lack of Control: The consultants used their own tools, worked at their own time and place, and were not integrated into Qhala’s daily operations.
• Payment Structure: Consultants were paid based on invoices submitted for specific projects, not a fixed salary. Qhala correctly withheld a 5% Withholding Tax on these professional fees.
• No Employee Benefits: The consultants were not entitled to benefits like paid leave, sick pay, or pensions, which are standard for employees under the Employment Act.
• MICE Tests: Qhala argued that applying established legal tests (Control Test, Integration Test, Economic Reality Test, Mutuality of Obligation) confirmed the individuals were independent contractors.

Kenya Revenue Authority’s Arguments :

• Substance Over Form: The actual relationship, not just the contract title, indicated an employment relationship.
• Elements of Control: The contracts specified how services were to be performed, reporting lines, and required the Appellant’s permission for subcontracting.
• Continuous Relationship: The consultants submitted invoices consistently every month, suggesting a continuous relationship akin to employment.
• Integration: The services provided by the consultants were integral to Qhala’s core business.

Tribunal’s Analysis & Decision

The Tribunal analyzed the contracts and applied the MICE tests to determine the true nature of the relationship.

Key Findings in Favor of Qhala:

• The Contracts Lacked Essential Features of Employment: The agreements did not include key employment particulars required by the Employment Act (e.g., hours of work, leave entitlements, sick pay, notice periods).
• Invoicing is a Hallmark of Independent Contractors: The requirement for consultants to submit invoices for payment is a strong indicator of a contract for services, not a contract of service.
• Own Tools and Insurance: The consultants provided their own tools and were required to have their own insurance, demonstrating financial independence and risk-bearing.
• Explicit Contractual Intent: A clause in the agreements explicitly stated that nothing in the agreement should be construed as creating an employer-employee relationship.
• MICE Tests Supported Contractor Status: The Tribunal found that Qhala exercised insufficient control over the consultants’ daily work to establish an employer-employee relationship. The consultants were not integrated into Qhala’s organization but were engaged for specific projects.

Final Judgment

The Tribunal allowed the appeal in favor of Qhala Limited. It held that the 43 individuals were rightfully classified as independent consultants.

You Can Book Consultation with me through

https://cal.com/hisibati/consulting-session