The relationship between an employer and an employee differs significantly from that of an employer and an independent contractor, both legally and financially. However, the precise distinction between employees and independent contractors can be unclear, leaving employers at risk of reclassification for tax reasons. The designation attributed to an individual does not ultimately determine their status as an employee or an independent contractor. Understanding the distinction between employees and independent contractors is therefore essential for proper tax compliance.
In Infectious Diseases Institute (“IDI”) v Uganda Revenue Authority (“URA”), the Tax Appeals Tribunal (“TAT”) held that a person receiving a fixed remuneration for more than two months is an employee for tax purposes. However, on appeal, the High Court went beyond the duration of remuneration and considered various additional factors, including control of work, place of work, integration of work, integration, and the nature of the working relationship, to determine whether an individual should be classified as an employee or independent contractor.
The High Court adopted the purposive and harmonious rules of statutory interpretation, and emphasised a more nuanced approach to this distinction, reflecting a broader analysis of the actual working dynamics in the relationship.
IDI v URA
URA contended that certain individuals hired by IDI were employees and that IDI was liable to withhold and remit Pay As You Earn (“PAYE”) at 30% for those individuals.
IDI argued that as part of its activities, it hires individuals to provide support services and withholds 6% from the payments made to these individuals.
TAT Decision
The Tribunal held that an individual who receives income that is constant and certain for more than two months is deemed an employee for purposes of taxation, although other laws, such as the Employment Act may treat such a person as an independent contractor.
The Tribunal stated that the Income Tax Act does not specify a required duration of payment for a relationship to be considered that of employer/employee. Therefore, it is debatable whether a person who receives remuneration for a short period may be considered as one who obtains fixed or ascertainable income. It concluded that a person who receives remuneration for less than two months cannot be considered as receiving fixed or ascertainable income.
IDI dissatisfied with the finding of TAT, appealed to the High Court arguing that TAT misapplied the tests for determining the existence of an employment relationship.
High Court Decision
The High Court disagreed with the Tribunal and held that there is no legal or jurisprudential basis for the assertion that any person who receives a fixed or ascertainable remuneration for a period over two months is to be considered an employee.
Hon. Justice Ocaya, in his judgment, emphasised that determining whether an individual is a consultant, or an employee is a question of fact, which must be guided by the relevant legal principles and provisions of the law, and not a matter for speculation, conjecture, assumption or loose theories.
He ruled that consultancy contracts are by their nature typically deliverables-based, such that nonperformance by the consultant does not entitle them to repayment. Employment relationships are different since the employer must provide work and bad performance by a staff does not, by itself entitle the employer to withhold salary except where there is a contractual or statutory basis for it. In that context, employees occupy “positions” within the structure of the employer and have an “entitlement” to pay which is typically fixed or capable of being ascertained.
The Court outlined several factors to consider when determining whether an individual is an employee or not, which include:
- What work does the person do?
- Who determines the work to be done, how it shall be done, the means to be employed in doing it, the time when, and the place where it shall be done?
- Who provides the tools of work?
- How essential/critical the work is to the mandate of the organisation?
- Whether the person does any work for other entities, including whether their contract precludes them from doing such work.
- What kind of benefits are they entitled to?
- How integrated and embedded in the organisation’s structure is the person?
The High Court then found that the relationship between IDI and the individuals in question was more consistent with a consultancy relationship than an employment relationship.
The High Court's application of both the purposive and harmonious rules of statutory interpretation enabled it to look beyond the literal interpretation of the Income Tax Act which was based on fixed and ascertainable remuneration and considered the objectives of the law and a broader range of factors in determining whether an individual is an employee or independent contractor.
While the Cape Brandy case advocates for a strict textual interpretation of statutes, modern principles of statutory interpretation allow for a more flexible approach, especially when the law's purpose is at stake. The Cape Brandy case does not rule out the purposive approach but emphasises the primacy of the statutory text. However, when a statute is ambiguous or a literal interpretation leads to an absurd or unjust result, the purposive approach provides the necessary flexibility.
Although the High Court's decision presents a more nuanced approach to distinguishing between employees and independent contractors for tax purposes, it may have overlooked the broader legislative intent behind the Income Tax Act's expansive definition of an employee. This definition was designed to prevent tax avoidance schemes where individuals pose as independent contractors to avoid tax liabilities.
It would have been prudent for the High Court to emphasise that independent contractors must possess Tax Identification Numbers registered for business income in accordance with the Act. The additional focus on registration for business income reinforces legislative intent and safeguards against misuse of the independent contractor status, promoting greater tax compliance and fairness.
Lessons from South Africa
The distinction between employees and independent contractors is not unique to Uganda. South Africa and Kenya have also grappled with this issue in their tax laws.
In South Africa, the Income Tax Act provides a comprehensive definition of an employee and includes a range of factors such as remuneration, provision of labour, and labour brokers.
The South African Revenue Service (“SARS”) has also issued guidelines to help distinguish between employees and independent contractors. SARS uses two statutory tests to determine whether one is an employee or an independent contractor. The tests are both conclusive, but the second test overrides the first one.
The First Test
This test has two parts, and it deems a person to be an employee if both parts are met.
First Part: The services or duties must be performed mainly (more than 50%) at the premises of the client. This refers to the premises of either the person paying for the services or the person receiving the services.
Second Part: The worker must be subject to the control or supervision of any other person regarding the manner of performing duties or hours of work or supervision of any other person as to the manner the worker’s duties will be performed.
If both parts of the first test are met, the person is deemed not to be carrying on a trade independently, and the amount paid is considered remuneration subject to employees' tax.
The Second Test
A person is deemed to be carrying on a trade independently if they employ three or more full-time employees who are not connected persons in relation to him or her and are engaged in their business throughout the year of assessment.
If the second test is satisfied, the person is considered an independent contractor, and the amount earned is not subject to employees' tax.
This test takes precedence over the first test even if the requirements of the first test have been satisfied, and over the common law position.
SARS also applies the common law dominant impression indicator to determine whether a worker is an independent contractor or an employee. These include:
- Near conclusive indicators – Control of manner of working, payment regime, the person who must render the service, nature of the obligation to work, the exclusivity of the employer (client) base, risk/profit &loss.
- Persuasive indicators – the extent of instructions/supervision, reports, training, who determines productive time
- Relevant – work tools, office/workshop, integration, hierarchy in an organisation, the threat of termination/breach of contract, employee benefits, the viability of termination, etc.
The list is not exhaustive and depending on the circumstances, some indicators may be irrelevant.
Taking inspiration from South Africa, where the statutory tests and common law principles used to differentiate between the two are properly codified in an interpretation note, Uganda could benefit from further developing and codifying its guidelines to improve clarity and fairness in tax treatment. Overall, a balanced approach that considers both the actual nature of the working relationship and the legislative framework is essential for ensuring compliance and preventing misuse of tax classifications.
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