Tax treatment of a consultant differs from that of an employee

Written by Hiten Shah | Updated: Nov 30 2011, 06:26am hrs
Today, an employer often gives flexibility to a person to be employed as an employee or a consultant. Such a situation may arise due to the type of the profession, the persons age and the extent of reporting and supervision.

Currently, employer is not defined in the Income Tax Act, but it is defined in the proposed Direct Taxes Code (DTC) as, a person who controls an individual under an express or implied contract of employment and is obliged to compensate him by way of salary.

Before entering into a contract with a person joining the organisation as a consultant, the employer should be careful in wording down the contract, as it should not imply that the relationship is more of an employer and an employee, rather than of a principle/employer and a consultant to avoid any issue from the tax authorities.

If a person enters into a contract as a consultant, he/she can claim certain legitimate business expenses like travelling, printing and stationary, telephone, depreciation as deductions against the income for the work done.

But the consultant will not be eligible for certain retirement benefits and social security, which otherwise is available to an employee. As per IT Act, the income earned by the consultant is regarded as income from profession, while income earned by the employee is classified as income from salary.

The consultant is required to maintain books of account, income and expenditure account, and balance sheet, unlike in the case of an employee where the latter has only income from salary and other sources like interest from savings account and fixed deposit.

Also, the consultant is required to comply with service tax laws. Further, if the gross income of the consultant is more than R15 lakh per annum, then he has to maintain books of account under Section 44AB of the Income Tax Act, unlike an employee. Being a consultant, the individual will need to file his tax return in form ITR 4 as against ITR 1 or 2 in case of an employee.

In absence of any specific guidelines, the employer can rely on the guiding principles laid down by a Supreme Court in the ruling of Ram Prashad vs commissioner of income-tax, where it says that the employer has the right to control the method of doing the work, the employee is subject to the supervision and control of the employer, the employee will not normally be allowed to pursue another employment or profession during her/his current job with a company and the employer is responsible for the payment of salary or other remuneration. There is no straight-jacket formula to decide which option is better, but can be decided based on the actual facts of each case.

*The writer is senior tax professional, Ernst & Young