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At times an opportunity may exist for a person to choose to serve an organisation as an employee or as a consultant. With the increasing opportunities for flexible working hours and working from home, the traditional way of attending an office regularly is done away; at least for some categories of services in Media, IT and ITES industries.
Do you know what issues need to be considered in deciding whether to serve an organisation as an employee or as a consultant? What are the tax implications to be considered in taking such a decision?
Employees are rule bound
The major issue to be considered is the existence of employer-employee relationship. As an employee, one is bound by the rules of the organisation concerning employment, such as leave, attendance and working conditions.
The employee may be liable to be transferred across departments, divisions and locations. The employee may grow within the organisation hierarchically. The organisation will be bound to comply with labour laws related to an employee's PF, Gratuity and other terminal benefits on retirement or resignation.
However, the employee will not normally be allowed to pursue another employment or profession during her/his current job with a company.
Consultants are like free birds?
On the other hand, a person is not bound by the rules of the organisation concerning rules of employment, if s/he is working as a consultant. There will be no PF, Gratuity and other terminal benefits. The consultant will not have any restriction in taking up assignments with any other organisation, excepting perhaps competing organisations, in few rare cases.
A consultant is normally a professional offering services as per the scope of her/his assignment. A consultant may render services as an individual or as a firm or even as a corporate entity.
Employee vs consultant: Tax issues
From taxation point of view, an employee gets paid salary as per the terms of employment. The income from salary will be worked out under the head 'Income from salary' as per the Income Tax Act and Rules, by considering some exemptions and deductions.
Some of the exemptions available are House Rent Allowance (HRA), Leave Travel Allowance (LTA), Medical Reimbursements, Gratuity and Contribution to Provident Fund and Super Annuation by the employer.
Again from taxation point of view, a consultant gets paid her/his remuneration, which may be in the form of a lump sum payment on assignment to assignment basis or on a retainer basis. The retainer fees may be paid on a monthly basis but still it is not in the nature of salary so long as there is no employer-employee relationship between the consultant and the employer.
The fees or remuneration received from an organisation is in the nature of professional income and is assessable to Income Tax under the Head 'Income from profession' as per the Income Tax Act and Rules.
The expenses incurred by the consultant in her/his profession and relatable to her/his profession are allowed as expenditure and the remuneration net of such expenditure is assessed as income from profession.
Some examples of such business expenditure allowed is salaries paid by the consultant to her/his staff, including servants who are used to clean her/his office premises, repairs and maintenance, vehicle maintenance, travelling and conveyance, interest on loans taken by the consultant on term loans for setting up her/his office and purchase of capital equipments and working capital limits availed from any bank or even on secured and unsecured loans taken from others.
The major criterion is that the expenditure shall be relatable to her/his business or profession. Further the consultant can claim depreciation as expenditure in respect of capital assets, such as office building, plant and machinery, including computers and vehicles, which are put to use in her/his business, at the rates as prescribed in the Income Tax Rules.
The other major issues relating to taxation
~ The tax will be deducted at source by the employer by computing the tax liability of the employee and the employee can just file her/his return of income by including the particulars as given in the Form 16 issued by the employer.
~ However, if the employee has any other sources of income, s/he may declare it to her/his employer, who will consider such income while deducting tax at source. Alternatively, s/he may declare such income in her/his Income Tax Return separately and pay self assessment tax, if required, while filing his return.
~ In the case of a consultant, the tax will be deducted at the rates prescribed under the Income Tax Act for professionals, depending upon her/his constitution and residential status. While filing his return of income, s/he has to prepare her/his profit and loss account and arrive at her/his taxable income. The consultant may be required to pay advance tax if the TDS is not sufficient to cover her/his tax liability.
~ An employee needs not maintain books of account. On the other hand, a consultant needs to maintain books of accounts if her/his turnover exceeds the limits specified in the Income Tax Act (normally Rs 1,20,000) in one financial year. S/he has to maintain her/his books of accounts for a period of 8 years and produce them before the Income Tax authorities, if called for. If her/his professional income exceeds Rs 10 lakhs, her/his accounts need to be audited and a tax audit report needs to be filed along with his return of income.
~ An employee need not pay any service tax but a consultant is liable to pay service tax if the nature of service rendered by her/him is covered under the Service Tax.
~ An employee need not deduct source if s/he makes payments, otherwise liable for deduction of tax at source in respect of payments to contractors. On the other hand, a consultant, even if s/he is an individual, needs to deduct tax at source in respect of such payments, if s/he is covered under tax audit. If the consultant is rendering services as a firm or a corporate, tax needs to be deducted at source in respect of various payments like interest, commission, professional charges and rent.
~ A consultant, rendering services in the form of a firm or a corporate, will be liable to pay Fringe Benefit Tax if s/he has even one employee. An employee is not liable to pay Fringe Benefit Tax.
It is reported that the Income Tax Department has recently decided to scrutinise the payments made by the organisations to the so called consultants, which are actually salary payments made in the guise of professional contract payments and avoiding TDS on salaries, as applicable to them.
One may ponder over seriously the nature of relationship with the organisation before deciding upon the nature of payment. The actual tax liability depends upon the salary structure in the case of employment and nature of association and expenses that can be reasonably attributed to professional activities, in the case of appointment as a consultant.
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