The difference between being an independent contractor or an employee can have an impact on your income tax, particularly if you think you're a contractor but the Revenue authority decides that you're not after you've already filed several tax returns.
Specific criteria may be used to determine your status and you can take steps to protect your status as an independent contractor if you understand them and how to implement them.
Advantageous tax deductions
The biggest tax advantage for an independent contractor is the potential for tax deductions that aren't available to employees. A self-employed person can generally deduct all reasonable business expenses.
Less paper work for employers
Employers Love to hire Independent Contractors from a business's perspective, hiring a contractor is much preferred to hiring an employee because means a lot less paperwork and responsibility.
Lower statutory deductions
Contractors don’t receive benefits packages or pensions. They must pay their own NSSF and NHIF contributions. Businesses don't have to provide them with
- health insurance,
- life insurance, and
- other common employee benefits.
Lower overhead cost
A company that uses an independent contractor doesn't have to do payroll, which involves PAYE and paying pension or gratuity.
Lower training cost
It's assumed that a contractor is proficient at the service being provided and therefore doesn't require paid training.
A business hiring a contractor who is later determined to be an employee can lose big financially. The employer will have to remit unpaid taxes and might even be subject to penalties and interest
As for the contractor, business expense deductions claimed in previous years will have to be repaid. This can have catastrophic where the individual has claimed deductions through several prior years that were all ultimately disallowed by the KRA.
The FOUR point test is based on the following key elements however additional elements are known to exist. The acronym MICE is commonly used in some literature.
POINT 1: Mutuality of obligation - M
The test for mutuality of obligation has two key elements that must be present:
An employer is obliged to offer work to an individual, and that individual is obliged to do the work offered.
Essentially, for a contract of employment to exist, these reciprocal obligations must exist. Without the necessary obligations entered into by both parties, ie; that work will be provided and that this work will be undertaken, a contract cannot be a contract of service.
Where both elements are present, this provides a clear indication that the contract could be one of employment, whereas absent one or both of these elements, this is a strong indication that the worker is instead self-employed.
The essential elements within the mutuality of obligation concept that makes it possible for a contract to be classed as a contract of service is the reciprocal agreement to provide and undertake work, whether this be on a one-off basis or long-term. However, if a worker has a number of one-off contracts with different clients, it is less likely that they will be deemed to be contracts of service than where there is a succession of one-off contracts with the same client.
POINT 2: Integration - I
An employee's job is an integral part of their employer's business. Conversely, tasks performed by a self-employed individual are less likely to be integrated into the payer's business.
One obvious way of “proving” integration to your own commercial activities is to have multiple clients. The contractor who only has one client makes it too easy for others to perceive his relationship with that client as employer/employee
POINT 3: Control - C
An employer retains the right to hire or fire an employee, to determine the wage or salary the employee is paid, and to decide on the time, plac
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, and manner in which the work is done.;
"Control is the ability, authority, or right of a payer to exercise control over a worker concerning the manner in which the work is done and what work will be done."
On the other hand, a contractor in a business relationship decides how the work will be performed, so it's important that you maintain the right to decide
- when, and
the work is done if you want to be considered an independent contractor.
You’ll have a much better chance of being deemed a contractor if you can show that you were the individual responsible for planning the work to be done, choosing the hours of work, and deciding the standards to be met.
POINT 4: Ownership of Tools - E
It might seem obvious that contractors supply their own tools, but it's also customary for employees to supply them in some trades. Think of painters and garage mechanics.
The cost of using the tools is a much better indication of this test. According to the Revenue Authority: "Self-employed individuals often supply the tools and equipment required for a contract. As a result, the ownership of tools and equipment by a worker is more commonly associated with a business relationship.”
Another example would be an IT worker who uses their own desktop/laptop computer and mobile devices. This would be indicative of self-employment.
POINT 5: Chance of Profit or Risk of Loss
Your financial involvement also determines whether you’re involved in an employer/employee relationship or a business relationship.
You're a contractor if you have opportunity to make a profit and run the risk of incurring losses due to bad debts, damage to equipment, materials, or delays. You're not an employee if you cover the operating costs.
INCORPORATION & CONTRACTOR STATUS?
Some employers seem to view incorporation as “proof” of independent contractor status—to the point where they will only do business with incorporated contractors. Being incorporated could conceivably be one point of evidence showing an arm’s length relationship between a contractor and employer, but it isn’t proof of a business relationship, at least not by itself.
This is particularly the case if you're performing activities that an employee would normally perform.
PROTECT YOUR TAX ADVANTAGE
Always enshrine your relationship with each employer in a contract, focusing on the first three points of this four-point test.
“Having a carefully-crafted written agreement setting out the intentions of the parties may offer some protection if one of the parties subsequently changes his or her mind and argues that the relationship is not what it was purported to be.
Discuss the issue with your adviser or contact the relevant tax authority if you've taken measures but are still uncertain about whether you’re actually an employee or an independent contractor.
The Kenya Revenue Authority has turned its guns on hundreds of Container Freight Stations (CFSs) on
This article focuses on what independent contractors must do so as to differentiate their work from the employees. This saves the contracting business the headache of Employee taxes among other employee-related issues.