Tax liabilities for consultants don’t end at TDS

The actual tax liability has to be computed while filing the income tax return
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First Published: Wed, Oct 24 2012. 07 38 PM IST
Shyamal Banerjee/Mint
Shyamal Banerjee/Mint
On account of the economic slowdown, many companies have opted to reduce their fixed costs, by firing some of their employees, many of them being high-paid ones. Many of these employees are still quite productive and far away from their retirement age. Employers would like to retain the services of such employees, while at the same time reduce the cost to the company of such employees. One option which many companies offer employees is that of continuing as consultants to their former employers, drawing either a fixed retainer or a fee linked to the time that the consultant spends on the job. Does this have any tax implication so far as the consultant is concerned?
Many people feel that consultancy is preferable to employment from a tax perspective, as the tax deducted at source (TDS) from the fees paid to them is only 10%, while the tax being deducted earlier from their salaries was almost 30%. This is a very narrow view. What needs to be kept in mind is that TDS is only an interim measure, and that the actual tax liability has to be computed while filing the income tax return. While all the taxes payable by an employee in respect of his employment are deducted at source by his employer, in case of a consultant, this is not so. In most cases, the actual tax liability is much higher than TDS, and often needs to be paid by way of advance tax in three instalments. Non-payment or late payment of such taxes attracts a liability to pay interest.
So far as a consultant is concerned, it is true that while computing his taxable income, he gets a deduction for various expenses from the fees received by him, while an employee does not get any such deductions other than for professional tax deducted by his employer. However, an employee can get certain tax-free allowances from his employer, such as house rent allowance, conveyance allowance, medical reimbursement which is not the case with consultants. All amounts received by the consultant are taxable.
What is deductible as an expenditure for the consultant is only expenditure incurred solely and exclusively for the purposes of his consultancy activity, and not each and every expenditure. The consultant will have to maintain books of accounts, such as a cash book and ledger, and prepare a balance sheet and an income and expenditure account showing details of his income and such expenditure, maintain evidence of such expenditure in the form of vouchers, and may be asked to prove that all expenditure that he is claiming as a deduction is genuinely for the purpose of his consultancy activity. In the absence of such vouchers or proper explanation, such expenditure may not be accepted by tax authorities.
Examples of expenditure which can be claimed as a deduction would include motor car expenses (including driver’s salary and insurance) or conveyance expenditure, telephone expenses, entertainment expenditure, and expenditure on attending seminars relating to the consultancy.
Unlike in the case of an employee whose salary income is taxable as and when receivable, the consultant has the option of accounting for and paying taxes on the fees receivable by him only on actual receipt (by following cash system of accounting). However, in such a case the expenses also have to be accounted for as and when actually paid, and cannot be claimed on the basis of the fact that the liability to incur such expenditure has been incurred.
In case you feel that it is much more attractive being a consultant rather than an employee, you need to keep in mind that there are other commercial aspects. As a consultant, you are not entitled to any bonus, gratuity, provident fund or pension. The services of a consultant can be terminated overnight, unlike in the case of an employee who has to be given notice. Further, any benefit that you receive as a consultant is taxable at its fair market value, and there are no rules for concessional valuation for tax purposes, as in the case of perquisites received by employees.
There is also the tax risk that if you are really an employee disguised as a consultant, the tax authorities can treat you as if you are an employee and not a consultant, and deny you deduction for any expenses that you claim. Some of the factors that would be considered for determining whether you are an employee or a consultant are: whether you are required to attend office every day regularly at specified hours, whether you are entitled to take paid leave, whether you have the designation of an employee, and basically whether for all practical purposes, you are subjected to the same discipline and enjoy the same benefits as an employee, or really have the freedom of a consultant. Consider all these aspects, before you conclude that being a consultant is preferable to being an employee.
Gautam Nayak is a chartered accountant.
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First Published: Wed, Oct 24 2012. 07 38 PM IST
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