Executive summary

With the increase in remote working and some workers' preference to be independent consultants, employers should consider a key decision by the Kenya Tax Appeals Tribunal (TAT or Tribunal). The Tribunal determined in Qhala Limited v. Commissioner (Tax Appeal E112 of 2024) [2025] KETAT 41 (KLR) (24 January 2025) that for tax purposes, Qhala Limited's service providers who are engaged as consultants were correctly categorized as independent contractors and not employees. The Tribunal ruled that the consultancy arrangements lacked features of employment contracts and that payments to the consultants were subject to withholding tax (WHT) and not the Pay As You Earn (PAYE) system.

As a result, the Tribunal set aside the Kenya Revenue Authority's (KRA's) PAYE assessment, concluding that the consultants' fees should be subject to WHT in accordance with the law.

Background

Qhala Limited (Appellant) is a private limited company registered in Kenya, primarily engaged in providing business solutions and digital consultancy services. The KRA (Respondent) conducted an audit of the taxpayers' records and identified discrepancies in the classification of 43 individuals engaged by the company as consultants.

The KRA deemed that the individuals should have been classified as employees for tax purposes and proceeded to issue a PAYE demand notice. The Appellant objected to the assessment, maintaining that the consultants were independent contractors whose payments were subject to WHT and not PAYE.

Appellant's arguments

The Appellant argued that based on its business model, the individuals engaged as consultants were not employees and therefore not subject to PAYE. The Appellant maintained that its principal business involves providing digital solutions and consultancy services, with consultants engaged on a project-by-project basis and not as regular employees.

The Appellant emphasized that the consultants exercised control over their work, used their own tools, bore the risks associated with their engagements and did not include employee benefits such as annual leave or sick pay. The consultancy agreements specified that payments to consultants were subject to a 5% withholding tax and not PAYE. The Appellant asserted that the nature of the consultancy arrangements, including invoicing for services and the absence of mutual obligations, supported their classification as independent contractors under the law.

Respondent's arguments

The KRA argued that the individuals engaged by the Appellant were not independent contractors but employees, and that the payments made to them constituted taxable income subject to PAYE. According to the KRA, the Appellant's principal business involved providing labor and supervisory services, and the nature of the engagement with the service providers reflected an employer-employee relationship.

The KRA maintained that the consultancy agreements and supporting documentation demonstrated control over the service providers, including fixed remuneration, reporting lines and integration into the company's operations. The KRA further contended that the contracts included features typical of employment, such as monthly invoicing and ongoing engagement, and that the Appellant had assumed contractual obligations as an employer. On this basis, the KRA asserted that the payments made to the service providers should subject to PAYE and not WHT.

Issues for determination

The Tribunal considered the facts of the case and framed the following issue for determination: whether the KRA erred in treating the Appellant's service providers as employees instead of independent contractors for tax purposes and issuing an additional assessment for PAYE.

Analysis and determination

The Tribunal analyzed the relevant provisions of the Income Tax Act and Employment Act, which define the characteristics of a contract of service (employment) versus a contract for service (consultancy). The Tribunal considered factors such as control, integration, economic reality and mutuality of obligation in assessing the nature of the relationship between the taxpayer and its service providers.

The Tribunal further examined the consultancy agreements and supporting documentation, noting that the contracts lacked features typical of employment relationships, such as fixed working hours, employee benefits and pay slips. Instead, the agreements specified that consultants used their own tools, invoiced for services rendered and were subject to a 5% withholding tax. The contracts expressly stated that no employer-employee relationship existed.

Based on this analysis, the Tribunal determined that the service providers were engaged as independent contractors, not employees. As such, payments made to the consultants were subject to WHT and not PAYE. The Tribunal set aside the KRA's PAYE assessment and allowed the appeal.

Implications

The Tribunal's decision provides guidance on how to distinguish between an employment relationship and an independent contractor arrangement for tax purposes. Businesses engaging consultants or service providers should carefully review the substance of their contractual relationships and ensure that agreements clearly reflect the intended classification.