Difference between an employee and an independent contractor

Gone are the days when white color jobs were glorified. The glamour that was associated with permanent and pensionable jobs is slowly fading away too. Business organizations are now preferring to enter into contracts for very specific engagements, primarily to avoid idle staff capacity during low seasons.

This has ushered a new twist in the distinction between employees and independent contractors as far as taxation is concerned. Employees’ engagement is contract of service while contractors’ engagement is contract for service.  Employees are taxed through the Pay as you Earn (PAYE) regime which graduates upwards to as high as 25%. Independent contractors on the other hand are taxed under the withholding tax regime at three per cent for contractors like fundi’s and five per cent for consultants and professionals. The withholding tax in this case is not a final tax meaning the difference has to be accounted for in the end of year return.

Drawing a demarcation between an employee and a contractor has always been contested in courts, key issue being taxation.  The famous MICE test has always come in handy in drawing the thin line between the two. MICE stands for mutuality, integration, control and economic reality.

Mutuality of obligation is the first test. This refers to the commitment by both parties to maintain the employment relationship over time. The nature of employment relationship is that the employer has obligation to provide work and the employee is obliged to accept that work. Under this test, a contract of service is for essentially services in return for wages, and secondly, mutual promises for future performance.

Integration test is the second stop in checking the status of a worker. A typical employee is subject to rules and policies of the organization which is not the case with independent contractors. An employee is part and parcel of the organization and his or her work is part of the business. The clause “any other duties that may be assigned” whether expressed or implied is quite indicative of integration. In a classic case pitting KAPA oil refineries Vs KRA  http://kenyalaw.org/caselaw/cases/view/183149) , the bone of contention was whether the human resource manager was an employee or a consultant. The jury established, among other issues, that the managing director spelled out the duties of the said officer to include typical human resource roles as well as any other duties assigned from time to time. This clearly showed that the officer was well integrated in the organization and thus an employee.

Control happens to be the most visible distinction. An employee is normally at the beck and call of the employer. The employer controls the employees’ work through instructions, training or requiring approval to be sought before executing a task. Control extends to designing workflow procedures and systems to monitor performance. This creates a distinction between employees and independent contractors on the level of independence enjoyed while undertaking tasks. The most cited case in this distinction is between Everret Aviation Vs KRA (http://kenyalaw.org/caselaw/cases/view/88693). The high court ruled that Everret Aviation had control over freelance pilots, the company identified the task and engaged the pilots. A profound statement providing a clear cut distinction was made in the case between Kenya Hotel and allied workers Vs Alfajiri Villas (http://kenyalaw.org/caselaw/cases/view/95684). In this case, the court held that “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”

Economic reality or business reality comes in as another useful test. If the worker is responsible for the profits or losses, bears the costs and all risks associated with the engagement, then it’s inferred that the worker is an independent contractor. Another way of looking at it is considering equipment. Where the worker uses his or her own tools and equipment, then self-employment is implied. The concept of economic reality is best illustrated in the case of  Ready Mixed Concrete Vs Minister of Pension 1968 (https://liuk.co.uk/ready-mixed-concrete-v-minister-of-pensions/).  The construction company engaged drivers who were required to provide their own lorries. The court in this case decided that because the drivers owned the vehicles themselves, the drivers were self-employed.

Parties engaging each other should therefore be careful in defining whether, at hand is a contract of service or contract for service. The employer who treats an employee as a contractor and goes ahead to withhold tax instead of charging PAYE has to bear the brunt. The consequence is invoking section 37(2) of the Income Tax Act which imposes a penalty of 25% of the PAYE not remitted.