Consultant or employee: Which role actually leaves you better off?
Many employees think they would fare better financially as consultants due to tax benefits. How far is this correct? What are the risks of an employee being reclassified as a consultant?
Many employees believe they would be financially better off working as consultants with their employers, rather than being on their payroll. The common assumption is that consultants enjoy significant income tax savings. How far is this correct? What are the risks of an employee being reclassified as a consultant?
It is true that a consultant's payment attracts a flat 10% tax deduction at source (TDS), while for an employee, tax is deducted at source based on the computation of taxable salary. However, the consultant has to file their income tax returns and pay the differential tax on their actual income.
A consultant can opt for presumptive scheme taxation when filing their returns. Under this, income is presumed to be a fixed percentage of gross receipts—50% in the case of specified professions and 6% for others. If the consultant declares income at or above these prescribed thresholds, the tax authorities generally do not question the expenses claimed.
A common misconception is that one needs to offer only the prescribed percentage of the gross fees to the tax. This is incorrect. The sections refer to the prescribed percentage or such higher amount that the taxpayer may earn.
Therefore, one cannot offer 6% of the fees of ₹70 lakh (i.e., ₹4.2 lakh) as taxable income and, at the same time, claim that investments of ₹30 lakh have been made out of such income.
What is taxable is either the actual income earned (generally represented by the amount spent on assets acquired during the year and personal expenditure for the year) or 6% of the gross fees, whichever is higher.
Employee benefits
It is generally true that, as a consultant, your total tax liability may be slightly lower than that of an employee, since employees are entitled to a standard deduction of ₹75,000. However, as an employee, you also get certain tax-free or tax-concessional benefits, which often offset this higher tax liability.
If an employer provides you with a car, the taxable perquisite value is quite small ( ₹2,400 per month) as compared to the monetary benefit that you get.
The employer contributes 12% of your salary to your provident fund account, which is not taxable. On retirement, you are entitled to receive gratuity, which is tax exempt up to ₹20 lakh.
If your employer provides you with residential accommodation, only 15% of your salary is taken as the taxable perquisite value, as opposed to the sizeable monetary benefit that you derive.
Your coverage under a group mediclaim policy of your employer is not a taxable perquisite. As an employee, you also have certain leave entitlements guaranteed by law. Leave encashment on retirement is exempt up to certain limits. Therefore, at times, you may be better off as an employee than as a consultant, if you factor in these benefits.
Tricky situation
The moot question is: do you really have a choice to be taken on the employer’s payroll as an employee, or to be taken on board as a consultant?
At times, the role is such that the person necessarily has to be an employee. For instance, a compliance officer or an executive director of a company is necessarily an employee. Similarly, if you are in a service industry where client requirements of confidentiality prohibit the sharing of client information with persons other than employees, you may necessarily be taken on board as an employee.
The employer might not be comfortable with a consultant filling certain roles. A consultant cannot face disciplinary action for misconduct like an employee can.
There could be certain roles where the employer could choose to hire persons on a retainer basis. Typically, these roles involve flexibility in working arrangements, such as working from home.
There is, however, a risk to the employer when he takes on persons as consultants on a retainership basis, but in substance, they are employees.
It may be penalized under labour laws for not complying wth these laws in respect of incorrectly designated consultants. It may be proceeded against by the tax authorities for deducting tax at source at lower amounts by classifying employees as consultants.
In law, there is a distinguishing factor between an employee and an independent consultant. An employer can direct an employee on how to perform their work, whereas for an independent consultant, the employer merely directs what is to be done, but not how it is to be done.
In other words, an employee is closely monitored by their employer regarding their performance, whereas a consultant is not. An employee normally has fixed working hours—a consultant may not. A consultant may not get various benefits that an employee gets, such as leave. Various court cases have dealt with this distinction.
The roles, responsibilities, and legal liabilities of an employee and a consultant are fundamentally different. The real question isn’t just tax savings, but whether the work can genuinely be outsourced and performed independently.
Gautam Nayak is a partner at CNK & Associates LLP. Views are personal
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