Tax implications are different for employees, consultants
Tax Partner, EY
In the current competitive economic environment, to obtain a specialized service, it is not necessary to employ a person having specialized knowledge; rather he may be appointed as a consultant for a specified fee for a specified duration.
Sanjeev Sethi, my next-door neighbour, was recently approached by a big company with the option to join it either as an employee or a consultant. Confused, Sethi came to me asking the obvious question weighing on his mind-whether he should join the company as an employee or provide advisory services as an independent consultant? He did have some background knowledge about the difference between the two options-a consultant would be able to earn a higher net take-home pay due to lower tax withholding rate and would be able to deduct his expenses from consultancy income for tax purposes.
I cautioned him that in both the options the gross compensation remains the same, but other aspects need to be considered very carefully to avoid problems during the course of tax assessment at a later stage. The difference between a consultant and an employee is not only the difference in the tax withholding rate; there are other factors too.
Nature of income
The income received from consultancy is classified as income from profits and gains of business or profession, whereas in case of employment, it is considered as salary income.
As an employee, one cannot claim deduction of any expenditure incurred by him for employment purposes while calculating the taxable income. A salaried employee is eligible to claim tax exemption on certain components of the salary, such as house rent allowance and leave travel allowance. However, all the eligible business expenses incurred in providing consultancy services are deductible from the consultancy income for tax purposes-even the value of depreciation of the business assets can be deducted.
Books of accounts:
In case of specified professions such as lawyers, doctors, engineers, architects and other professions, where the income or the gross receipts exceed the specified amount, maintenance of books of accounts by the consultant is mandatory. If the gross receipts from consultancy exceed Rs. 15 lakh, books of accounts are to be audited by a chartered accountant. These special requirements of maintaining the books of accounts and getting the accounts audited are not applicable to salaried employees.
Setting off loss
Consultants are allowed to set off the losses of another business or profession from consultancy income and further carry forward unabsorbed losses for eight succeeding years. However, an employee can set off only his house property loss from his employment income.
In case of employment, tax is withheld by the employer every month at an average rate of tax applicable to the employee. An employee is not required to pay advance tax if he has no income other than salary. But in case of a consultancy, the payer deducts the tax at a flat rate of 10% from the consultancy fee at the time of payment, if the consultancy fee exceeds the amount specified under the tax laws. Since taxes are withheld at a lower rate from the consultancy fee, there may be a higher net take -home pay, but there may be a need for a consultant to pay the balance tax in three instalments as advance tax if the tax withheld is not sufficient to cover the total tax.
Sethi was a bit surprised after hearing the above tax implications and wanted to know if there were any other issues he must be mindful of. I smiled at him and said that he also needed to know that in addition to the income-tax implications, there is separate regulation under which certain services are subject to service tax. If the services provided are covered under the notified services, such as management and business consultancy, legal consultancy and consulting engineers and so on, there is a need to obtain a service tax registration and comply with service tax regulations.
After hearing me conscientiously, Sethi was ready with his decision.
Sonu Iyer is tax partner, EY.