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overview
Employees are often mistakenly classified as independent contractors. Misclassification can sometimes be an innocent mistake by everyone involved or a conscious decision by an employer to avoid certain responsibilities and costs required by law by the Income Tax Act or other regulatory agency. In any case, the penalty for wrong distinction can result in a significant tax burden for businesses.
Pursuant to Section 108 of the Income Tax Act, “employment” includes any public or other employment or position for which remuneration for tax purposes is payable. One person who is employed should be distinguished from another person who is self-employed.
This article highlights the difference between an employee and an independent contractor, the factors to consider as a guide for businesses to consider when classifying an individual as an employee and an independent contractor, and how the difference affects tax obligations.
Differentiation between employee and self-employed contractor
An employee is a person who regularly works for the employer for what is known as a “salary”. The working conditions are described in a contract called an “employment contract”. An employee gives up control and independence elements and is entitled to certain services and works in the context of a workplace.
An independent contractor, on the other hand, is a self-employed person, that is, a consultant, lawyer, accountant, engineer or any other person who provides services to other organizations for a fee. Common law principles also define the status of an independent contractor through a payment method. Clearly, when an individual is on an employer’s payroll and receives a fixed salary, the individual is an employee and not an independent contractor.
An independent contractor is free from any control or influence of the company, as he is responsible for the manner in which the task is carried out at his own discretion and regardless of the outcome of the task.
How to tell if a person is an employee or an independent contractor
- Service contract – employment contract
Under Nigerian law, the relationship between an employer and an employee could be compared to that of a master-servant relationship, so a service contract is entered into at the beginning of this relationship. This is because the employer directly controls the work-related activities of the employee. For example, the working hours, the tools and equipment used for the work, when and where the work should be done, and how the work should be done.
- Service contract / independence contract
This is an agreement between an independent contractor and a customer to carry out a specific project or assignment for a fee. In this case, the independent contractor, who is considered an expert for the service commissioned by him, has direct control over the execution of the work and provides the work tools required for the work.
Key differences between an employee and an independent contractor
It can sometimes be difficult to properly see the differences between an employee and an independent contractor. Therefore, a classification process is needed to use guidelines as a guide in determining the tax treatment of income from services provided, such as:
- Direct control of your work & provision of work tools and equipment
Independent contractors control their work, the way and time of their work, and the tools and equipment used to do their work. Unlike salaried employees, independent contractors are not controlled by their customers and their work is carried out without or without supervision.
In addition, they typically provide their own work tools and equipment, while workers use the work tools and equipment provided by their employers. Unlike independent contractors, employees may also be required to work in offices provided by employers. - Usually run your own business and market their services openly
Independent contractors typically act as sole traders, partners and companies; while employees only act as individuals It is not uncommon for independent contractors to have a company name and work for multiple clients.
They also openly market their services because they have direct control over their business. Conversely, many employees are not allowed to work for other employers because they are restricted by a non-competition clause or other provisions that may restrict or prevent them from other paid employment. - Experts in their industries
While the employees receive training for their job, independent contracts bring their special know-how to their work. As a result, independent contractors may not need specific training to do their jobs.
- Responsible for their own taxes and generally controlling their payment
Whereas employers withhold and pay taxes on behalf of their employees, independent contractors file their personal income tax returns annually and remit their taxes directly to the government.
In contrast to employees who receive a certain salary for a certain period of time, self-employed contractors are usually remunerated for services provided directly by the recipient of the service. They can have a standard billing rate for their service, which is usually paid after an invoice is issued to the customer. - Employees usually work for an indefinite period
In contrast to independent contractors, employees usually work for an indefinite period. While independent contractors are usually hired for a specific project for a shorter period of time.
- Independent contractors can subcontract or delegate their work
In general, independent contractors can use subcontractors to do their work because they have control over how their work is done. Employees, on the other hand, are obliged to do their work themselves, unless a supervisor or department head can delegate the work to members of their team who are also employees of the employer.
Tax implications
While the independent contractor is sometimes subject to withholding tax (WHT) on their income, the employee is taxed under the Pay-As-You-Earn (PAYE) system.
This practical distinction is somewhat confused by Section 3 (3) (d) of PITA, which defines employment as “any service rendered by a person in return for profit or gain”. While the definition includes independent contractors, in practice they are never taxed as employees. They demand deductible expenses, capital allowances and, if necessary, loss compensation before they declare an eligible profit. In contrast, employees are only partially entitled to tax-free personal allowances and reimbursements.
The above analysis shows that the word “employment”; as used in the context of Nigerian tax law has a less broad meaning than the ordinary meaning of the word. For example, a person can “employ” the profession of lawyer himself, but is not necessarily a tax employee of his client. Auditors who work as auditors for several companies have a profession and cannot be treated as employees of the companies. But an accountant who is appointed a company’s internal auditor has an office under him. He is an employee of the company. An employment relationship exists when a person holds an office or receives wages or salaries from an employer for the activities performed. As mentioned earlier, this is often referred to as a “service contract”.
If an employee works for more than one employer, it cannot make sense to count each of his wages as a separate earned income. Rather, his commissioning can involve services from contracts that are provided in the context of a professional or professional activity. The income from all sources could then be aggregated and taxed as profits or profits of a business or profession.
Persons who hold offices or appointments for a fee or who provide services for any profit or gain are therefore employed in the sense of the PITA. Profits or profits from occupations, however, are distinguished from employment … “The dividing line between an occupation and an occupation may be narrow and may not be easy to determine”.
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It is critical that business owners properly determine whether the individuals providing the services are employees or independent contractors.
The classification of an employee as an employee or a self-employed contractor has a significant impact on the tax treatment of the payments made for the services provided. Therefore, organizations need to pay close attention to worker classification issues to ensure compliance with Nigerian tax regulations.
Employers should also carefully consider entering into long-term or permanent relationships with independent contractors. You should consult a competent tax advisor to conduct regular audits of all positions and review the requirements for an employee against an independent contractor to avoid unexpected consequences and penalties.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.