Tribunal Distinction Between Employee vs. Independent Contractor

Case Study: High Definition Marine Company Limited v Commissioner of Legal Services & Board Coordination (Tax Appeal E572 of 2025) [2026] KETAT 8 (KLR) (16 January 2026) (Judgment)

Case Background

The dispute arose from a KRA audit of High Definition Marine Company Limited for the period May 2022 to December 2023. The tax authority identified a sum of Kshs 25,638,098.41 recorded in the company’s accounts as “management fees.”

The KRA’s Position: The Commissioner treated this entire amount as directors’ remuneration, arguing it constituted a “benefit or facility” provided to directors and was therefore subject to Pay As You Earn (PAYE) under Section 37(1) of the Income Tax Act. Consequently, the KRA issued an additional assessment for Kshs 8,973,334 in unpaid PAYE for 2023.

The Company’s Defense: High Definition Marine contended that the KRA’s classification was fundamentally mistaken. The company broke down the Kshs 25.6 million into three distinct components:

1. Consultancy Fees (Kshs 19,153,702): Payments to an external consultant for advisory services, on which Withholding Tax at the prescribed rate had been duly deducted and remitted.
2. Directors’ Fees (Kshs 3,116,708): Legitimate fees paid to company directors, on which PAYE had already been correctly calculated, withheld, and paid.
3. International Travel Expenses (Kshs 3,367,687): Reimbursements for documented business travel costs incurred by a director, which are not taxable income but legitimate business expenses.

The company provided a comprehensive evidence pack, including the consultancy agreement, invoices, board minutes approving directors’ fees, airline tickets, hotel receipts, and bank payment slips proving tax remittances.

Despite this, the KRA’s objection decision dated 23 April 2025 rejected the company’s arguments, stating it had “failed to discharge the burden of proof.” This prompted the appeal to the Tribunal.

The Tribunal’s Analysis and Findings

1. Dismissal of Technical Preliminary Objection

Before delving into the merits, the Tribunal disposed of a KRA argument that the appeal was invalid. The KRA claimed the company had not paid the “undisputed tax” for 2022 (Kshs 5.7 million) before appealing, as required by Section 52(2) of the Tax Procedures Act (TPA).

The Tribunal’s Finding: The company presented payment receipts showing three installments paid in November and December 2024, completing the payment before filing its Notice of Appeal in May 2025. The Tribunal held this constituted full compliance, rendering the KRA’s preliminary objection “unmerited.” This underscores the importance of taxpayers maintaining clear payment records.

2. Why the KRA’s Assessment Was Flawed

This was the heart of the judgment. The Tribunal systematically dismantled the KRA’s case, making several pivotal findings.

• Failure to Engage with Evidence: The Tribunal noted a critical lapse in the KRA’s process. “What stood out is that the Respondent did not base its arguments on an analysis… of these documents,” the judgment states. The KRA’s statement of facts did not even mention the words “consultancy” or “independent contractor,” indicating it had ignored the company’s core argument from the outset.
• Misapplication of Tax Law – Employee vs. Independent Contractor: The case turned on the legal distinction between a “contract of service” (employment) and a “contract for service” (independent consultancy). PAYE applies to the former; Withholding Tax to the latter.
• The “Shifting Pendulum” of Burden of Proof: This ruling provides crucial clarity on a often-misunderstood principle. While Section 56(1) of the TPA places the initial burden on the taxpayer, the Tribunal affirmed it is not a static burden.
• Risk of Double Taxation and Unfairness: The Tribunal highlighted a glaring injustice in the KRA’s approach. By taxing the entire Kshs 25.6 million as PAYE, the authority was effectively seeking to tax income twice: once as Withholding Tax (already paid on the consultancy) and again as PAYE. “The tax burden was excessive. On this basis alone, the Respondent erred,” the judgment reads.

Final Orders

The Tribunal allowed the appeal in its entirety and issued the following orders:

• The KRA’s objection decision dated 23 April 2025 was set aside.
• The additional PAYE assessment of Kshs 8,973,334 for 2023 was vacated.
• Each party was to bear its own costs.