Taxation Perspective – Employee VS Independent Consultant

Some people have the facility to work as an employee or independent consultant (also known as a contractor or freelancer) when taking a new job. If properly planned consultants have less tax for the same CTC (Cost to Company). With Budget 2016 introducing conceptual taxation for some professionals like legal, medical accountancy, architects, IT consultancy, etc. it makes even more sense.

Employees vs. consultants: How Income Tax Treat Them?

Income tax earns income from a different method/source.

In the case of employees, salary is classified as “income from salary”, while income for a consultant is classified as “income from business or profession”. This is important because all classifications are based on this classification.

Why a consultant is better than an employee?

• Low TDS rate – Tax on salary is deducted based on tax slab while in the case of consultants the tax is deducted at 10%. However, consultants have to take care of their advance taxes so that there is no interest in the tax.

• Optimize tax outgo – Employees have to depend on their employers to make their salary. Many companies do not offer a tax-efficient salary structure. The main reason for this is laziness or fear of compliance with the tax authorities. In the case of consultants, they can balance their income and expenditure in such a way that their total value is minimized.

• Easily availing benefits – Employees are not able to avail of all tax benefits- (even after the company offers) due to some constraints. For example, many employers offer car plans where you can save a lot in taxes if you buy a car through company policy. But these are given to employees after a certain position and / or tenure. Also, there is a time limit to buy the car back. With frequent job changes, employees do not opt ​​for such schemes. There is no such obligation for contractors. Consultants can easily deduct interest on car loans, insurance, petrol, parking and driver as business expenses.

• Not dependent on employers to avail tax deduction- In January / February you need to present all your investment proofs, rent receipts, etc. to your employer to claim tax benefits. There are times to play safe when employers do not accept evidence even though it is legal. The advisor does not do this issue. They are responsible for their tax deduction.

• Presumptive taxation – Professionals who come under the presumptive tax regime can reduce their tax to a great extent as they are required to receive 50% of their gross receipts as income. However, they cannot deduct any other business expenses.

Here are the rules of presumed taxation:

  1. Presumptive taxation for professionals was introduced in the Budget 2016 under a separate section 44ADA.
  2. Income under this scheme is considered as 50% of the total receipts. So for a CTC of Rs 100, the taxable income for the consultant is only Rs 50.
  3. Gross Receipts (CTC) should be less than Rs 50 lakhs.
  1. The following professionals are covered
  • Legal
  • Medical
  • Engineering
  • Architecture
  • Accounts
  • Technical Consultation
  • Interior Decoration
  • Film Artist
  • Information Technology Professionals
  • You can avail of all Chapters VIA Deductions which include Sections 80C, 80D, etc., along with home loan interest deduction, etc.

Drawbacks for Consultants:

1. Tax benefits for salaried people – There are some tax benefits like house rent allowance; Traveling Allowance, Convention Allowance and Uniform Allowance which are available only to employees. However, consultants may deduct all eligible business expenses incurred in providing consulting services along with depreciation on assets used to provide services such as AC, furniture, computers, phones and other business assets.

2. Employer subsidized benefits – Employees have certain benefits such as group life, disability and health insurance that are subsidized by employers that are not available to consultants.

3. Retirement benefits – Retirement benefits like gratuity, PF, leave encashment, etc. are available only to employees. Consultants have to feel for themselves.

4. Additional Compliance-Consultants have to comply with additional requirements such as service tax, an audit of accounts by Chartered Accountant, payment of advance tax, etc. which are not required by the employees.

Employee vs. consultant: who pays more?

We take an example where a lawyer has the option of working as an employee or an independent consultant. He has been offered Rs 15 lakhs as CTC. What should he choose to work?

Below is the salary structure, which is pretty tax efficient!

Salary Components Annual Monthly Tax Status
Basic Salary 8,00,000 66,667 Taxable
House Rent Allowance (HRA) 4,00,000 33,333 Partially Taxable
Transport Allowance 19,200 1,600 Tax Free
Meal Coupons 26,400 2,200 Tax Free
Special Allowance 89,400 7,450 Taxable
EPF (Employer Contribution) 96,000 Tax Free
Mobile Phone/ Internet Bill Reimbursement 24,000 Tax Free
Medical Reimbursement 15,000 Tax Free
LTA (Leave Travel Allowance) 30,000 Tax Free
Total Cost to Company 15,00,000

Assuming he pays Rs 40,000 monthly rent, he would get 100% HRA exempted from tax too. So as an employee the taxable amount would be Rs 8,89,400 (Basic Salary + Special Allowance).

As an independent consultant he can take benefit of Presumptive Taxation u/s 44ADA and his taxable amount would come to Rs 7,50,000 (50% of 15,00,000).

Income Tax Calculation As Employee As Consultant
Cost to Company 15,00,000 15,00,000
Taxable Income 8,89,400 7,50,000
Standard Deduction 50,000 0
Section 80C Exemption (-) 1,50,000 1,50,000
NPS (Sec 80CCD(1B)) Exemption (-) 50,000 50,000
Taxable Income after deduction 6,39,400 5,50,000
Income Tax 40,380 22,500
Education Cess 1,615 900
Total Tax Payable 41,995 23,400

If our lawyer wishes to work as a friendly consultant, he can easily save Rs 18,595 in taxes that he pays as an employee which is almost half!

In most cases, consultants/freelancers have more tax-efficient incomes than employees!

Employer or consultant: what should you choose?

We said above; in the case of tax outgo consultants have an upper hand than employees. However, it carries the risk of job loss and increased compliance. Think and choose.

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