- August 14, 2024
- Posted by: admin
- Category: Uncategorized
A Consultancy agreement may not necessarily create ‘’a consultancy contract’’ in the eyes of the tax laws(Employment VS Consultancy Test)
With the Finance Act 2023, NSSF Act 2013 and the pending NHIF regulations 2023, payroll costs are expected to significantly increase. Payslips will equally be raided with extra deductions.
Some employers have been considering converting employment contracts into consultancy agreements to avoid employment related statutories. While it is true that independent contractors are not subject to payroll statutories like NSSF, NHIF, NITA, Housing Levy etc, converting an employment contract to a consultancy agreement is not as forthright as it is presumed.
The Courts of law have over the years made landmark rulings that have drawn a clear demarcation between employment and consultancy. The tax authorities on the other hand have demanded PAYE from organizations who considered themselves to be clients of a contractor rather than employers of an employee.
The courts of law go beyond the terminologies in the consultancy agreement. Therefore, the fact that the Agreement is titled a “Consultancy Agreement” does not automatically mean that the parties are not in an employment relationship
Gradually, the courts have recognized that no one test or set of criteria can be conclusive when determining employment status, and so the test adopted by courts for deciding whether a contract is of or for service is the ‘multiple test’. The courts of law have previously applied the below tests to arrive at their decisions with regards to employment Visa Vis consultancy agreements
Control Test– A employee is a person subject to the command of his employer as to the manner in which he shall do his work
In the year 2003,Kapa Oil hired a HR consultant, his roles included taking staff disciplinary measures. He was to work throughout the month from 8am to 5pm like normal employees. He was to be paid as a consultant.
Two years down the line, KRA audited Kapa Oil. It was found out that Kapa had deducted Withholding Tax @ 5% from the consultant pay. KRA found Kapa to be at fault since the said consultant was in the real sense an employee. KRA made a demand for PAYE not paid.
The case ended up at the High Court and later at the Court of Appeal
It was held that:
“From a consideration of the duties and responsibilities of Mr. Ogode, which are set out in the above, referred documents and the fact that he was described as a Human Resource Manager, and an employee of the applicant, earned a regular salary, reported to work like an employee, had a job description etc, I am satisfied that Mr. Ogode was an employee of the applicant. There was total lack of independence in the performance of his dutiesand was totally answerable to the applicant. Section 37(1) of the Income Tax Act requires an employer to deduct PAYE from an employee’s emoluments and account for tax.
Integration Test– When the success or continuation of a business depends to a large degree upon the coordinated performance of workers’ services, the workers must necessarily be subject to a certain amount of control by the owner of the business.
In Christine Adot Lopeyio v Wycliffe Mwathi Pere [2013] eKLR, it was held that:
On the other limb, the claimant was not subjected to any particular rules and procedures of the respondent. In her evidence she stated that she could clean the respondent premises occasionally, but she was not equally prevented from undertaken any other tasks that were personal or of her own choice noting the duties and or services she performed for the respondent.
It is also evident that the claimant was economically not dependent upon the respondent; her services were only party of her economic activities. Though contested, the claimant admitted that there was a water business that her husband peter was running at the premises, there was a kiosk next to her door run by Janet her daughter and that she did run these activities or their activities were run with the knowledge of the respondent for the sole benefit of the claimant. No dues were remitted to the respondent as a principal on whose behalf the water or kiosk business were operated for. The claimant had her independence to operate or run her activities in exclusion of the specific services she rendered to the respondent.
In Everret Aviation Limited V Kenya Revenue Authority (Through The Commissioner of Domestic Taxes) [2013] eKLR, it was held that:
12. There are also various tests to be employed when there is doubt whether a person is an employee. One of those tests is whether the person’s duties are an integral part of the employer’s business. See Beloff vs Preddram Limited [1973] ALL ER 241. The greater the direct control of the employee by the employer, the stronger the ground for holding it to be a contract of service. See Simmons Vs Heath Laudry Company [1910] 1 KB 543, O’ Kelly Vs Trusthouse Forte [1983] 3 ALL ER 456. That test is however not conclusive. The passage cited by the appellant in Halsbury’s Laws of England Vol I 26, 4th edition paragraph 3 is instructive:
“There is no single test for determining whether a person is an employee, the test that used to be considered sufficient, that is to say the control test, can no longer be considered sufficient, especially in the case of the employment of highly skilled individuals, and is now only one of the particular factors which may assist a court or tribunal in deciding the point. The question whether the person was integrated into the enterprise or remained apart from and independent of it has been suggested as an appropriate test, but is likewise only one of the relevant factors, for the modern approach is to balance all of those factors in deciding on the overall classification of the individual. The factors relevant in a particular case may include, in addition to control and integration: the method of payment; any obligation to work only for that employer, stipulations as to hours; overtime, holidays etc; arrangements for payment of income tax and national insurance contribution; how the contract may be terminated; whether the individual may delegate work; who provides tools and equipment; and who, ultimately, bears the risk of loss and the chance of profit. In some cases the nature of the work itself may be an important consideration”.
15. The way I see it, the appellant, for the short duration it hired the services of freelance pilots was substantially in control: It bore the risk of loss and chance of profit. It identified the task, say for example to land the chopper on a ship or to tag a load and return; it determined the pay or emolument; it paid the pilot and released him. True, it did not pay for his licence. It is contested whether the licence in fact was the tool of trade. In this case, the appellant had its fleet of helicopters. It used its own capital. It had special contracts. It was largely in control. I think it would be to expand the boundaries a little too wide to say that it could not dismiss the pilots or force them to fly. The fact is that it employed those pilots, they performed those special tasks, and it paid them. The duration of the contract is not material. Granted the thin line separating a contract of service and a contract for service, the Local Committee was well advised to lean on the side of reason and to adopt an interpretation that led to a fair computation and collection of tax . The freelance resident pilots may not have been on a wage bill but they fell well within section 3 (2) of the Income Tax Act. It is instructive that under that section, it matters not whether the person was resident or not. What is paramount is whether the income was derived from Kenya
Mutuality of obligation Test: The parties make commitments to maintain the employment relationship over a period of time. That a contract of service entails service in return for wages, and, secondly, mutual promises for future performance. The arrangement creates a sense of stability between the parties.
In Kenya Hotels and Allied Workers Union v Alfajiri Villas (Magufa) Ltd (2014) eKLR it was held that
“An independent contractor’s contract, in my view is a contract of work (contract for service) and not a contract of service, or to use the ordinary language a contract of employment. The hallmarks of a true independent contractor are that the contractor will be a registered taxpayer, will work his own hours, runs his own business, will be free to carry out work for more than one employer at the same time, will invoice the employer each month for his/her services and be paid accordingly and will not be subject to usual “employment” matters such as the deduction of PAYE (tax on income), will not get annual leave, sick leave, 13th cheque and so on.”
The intention of the agreement/The substance of the agreement.
If the substance of the contract depicts an employer/employee relationship, the court will overlook the terminology
In Mandela v Workinsights Limited (Cause E578 of 2022) [2023] KEELRC 2023 (KLR), it was held that:
37.Therefore, the fact that the Agreement was titled a “Consultancy Agreement” does not automatically mean that the parties were not in an employment relationship. Rather, their conduct and manner of engagement implied that they were in an employer employee relationship
In Vitalis Oliewo K’omudho v AAR Health Services Ltd [2016] eKLR it was held that
32. The Respondent submit that the service agreement between the parties was clear in that clause 2 was specific that the Claimant was on a consultancy agreement and not on employment with the respondent. The intentions of the parties were clear. It was also agreed that the Claimant would be paid a commission at 1.35% overriding commission which is not a salary and the employee number 808 was simple prudence in accounting for the payment. There was payment of withholding tax and not statutory deduction as required of an employee and the amounts paid were not constant and the commissions differed each month. Termination of the contract is by mutual agreement or where the Claimant was unable to perform and achieve his set targets. In Maurice Oduor Oketch versus Chequered Flag Ltd, Cause No.12 of 2011 the Court held that to determine the intentions of the parties, one has to go beyond terminologies based on pleading and evidence. In this case the parties were clear in their intentions which were put into writing and it was agreed the Claimant was a consultant.
Business Reality Test-An entrepreneur takes the ultimate risk of profit/ loss in the the business
A worker who can realize a profit or who suffers a loss as a result of the worker’s services (different from the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot realize a profit or loss is an employee. There is a common risk to both independent contractors and employees that they may not be paid for their services, but an independent contractor often runs the additional risk of not recouping substantial out-of-pocket expenses (for materials, wages for the contractor’s own employees, etc.).
Tools/Equipment
In Kenneth Kimani Mburu & another vs Kibe Muigai Holdings Limited [2014] eKLR, it was held that
“A Consultant performs work for another person, according to his own processes and methods. A Consultant is not subject to another’s control, except to the extent admitted under the contract. The Court in determining the first question is not bound by the Parties’ respective declarations on the character of these contracts, but should not disregard the Parties’ intention.41. Even with the hybrid wording in the contracts, the intention of the Parties, and the wording in large portions of the two agreements persuade the Court these were employer-employee relationships. A Consultant is paid a fee as confirmed by the Respondent’s Witness Mr. Karabilo, not a salary. A Consultant is not eligible for Company benefits such as health insurance, which was extended by the Respondent to Mburu and three other members of his family. A Consultant would not normally be provided with the tools of work. The Respondent provided Mburu with the laptop, office facilities, and a phone. The Respondent provided the tools of work, and directed the Claimants in the performance of work. There were frequent meetings between the Parties during which Kibe Muigai kept demanding for specific outputs. He was emphatic the Claimants remained accountable to him. A Consultant would have the latitude to discharge his obligation according to his own processes and methods, which would include the ability to subcontract or hire own assistants. The evidence on record suggests all the persons working at the Hotel were engaged by the Respondent, and were paid by the Respondent largely through Debora. He remained in control of the undertaking. There was no evidence that the Claimants paid with-holding tax. Instead, the Respondent paid Mburu a ‘net salary.’ Instead, the Respondent paid Mburu a ‘net salary.’ It is the obligation of an employer to enforce statutory deductions such as P.A.Y.E, N.S.S.F and N.H.I.F contributions. By paying ‘net salary’ the presumption would be that the Respondent had factored in this obligation. The fact that no evidence was presented showing payment of these employee deductions is not an indication that there was no employer-employee relationship.”
https://hisibati-consulting.co.ke/
