What’s in a name? that which we call a rose
By any other name would smell as sweet;
– William Shakespeare in Romeo and Juliet
While it is perfectly legitimate for organizations to hire consultants (along with hiring full-time employees) during the course of business, it is important that the underlying statutory requirements are fully adhered to. We find many organizations not calculating salary-related statutory deductions such as income tax, PF and ESI for personnel they classify as consultant. Just because the title of consultant is used does not automatically make a person non-employee. Authorities, in a variety of cases, have gone beyond mere titles given to work personnel to examine whether the underlying relationship between an individual and the organization is that of employee and employer.
TDS – Under section 194J or 192 of the Income Tax Act?
In a case (ITA No. 747/2009) involving a health care organization and the Income Tax Department, The High Court of Karnataka has provided guidelines for ascertaining the nature of relationship between an individual and his employer. In the said case, the assessee (health care organization) deducted TDS for payments made to consultant doctors under Section 194J (TDS on fee for technical services). The Income Tax Department argued that the TDS should have been deducted under Section 192 (TDS on salary) since the nature of relationship between the consultant doctors and the assessee organization was that of employee and employer.
The Honourable Judges, in their verdict, said:
13. To decide the relationship of employer and employee we have to examine whether the contract entered into between the parties is a ‘contract for service’ or a ‘contract of service’. There are multi-factor tests to decide this question. Independence test, control test, intention test are some of the tests normally adopted to distinguish between ‘contract for service’ and ‘contract of service’. Finally, it depends on the provisions of the contract. Intention also plays a role in deciding the factor of contract. The intention of the parties can also determine or alter a contract from its original shape and status if both parties have mutual agreement. In the instant case, the terms of contract ipso facto proves that the contract between the assessee-Company and the doctors is of ‘contract for service’ not a ‘contract of service’.
The courts of India, including the Supreme Court, have gone into the issue of whether the relationship between an individual and his employer can be said to be that of employee and employer in several cases. The key factors considered by courts in this regard are as follows.
Does the employer exercise significant or absolute control over the day to day functioning of the individual? For example, does the individual have any flexibility in work timings? Does the individual work on the basis of specific tasks (such as those in a short-term project) or does the individual have to commit a certain period of time to the employer irrespective of the actual work done? Does the individual work under the complete supervision of managers in the employer organization or can the individual work independently to achieve work objectives?
The more the control exercised by an employer on an individual’s daily work routine, the more the individual’s role can be characterized as that of an employee’s.
b. Payment of remuneration
Does the individual receive a fixed remuneration on the basis of hours spent or a variable remuneration on the basis of certain work outcomes? An individual can be characterized as an employee if the remuneration has a significant fixed component.
c. Applicability of services rules
If the contract with consultants contain terms which resemble the service rules which govern employees, the statutory authorities could well argue that the consultants are in fact employees.
d. Independence to work for other employers
Organizations typically require employees to sign an exclusivity agreement that bars them from working for other employers while in service. Consultants, in most cases, are independent to pursue multiple work opportunities across employers at the same time.
e. Service duration
An individual who is employed for short periods of time on a sporadic basis is more likely to be a consultant than an employee (who is more likely to be hired on a permanent basis).
In a recent ruling (Appeal No. Income Tax 572/Bang-2014), a Bangalore bench of the Income Tax Apellate Tribunal, said that the assessee incorrectly deducted TDS under Section 194J instead of Section 192 on account of the assessee misclassifying employees as consultants. The Tribunal Bench, after going through the terms of the contract between the assessee and the individuals hired as consultants said, “All these conditions go to prove that it is a case of contract of service.” The term Contract of Service, as you would appreciate, refers to employer-employee relationship.
The Bench in the above case also stated that mere title (such as Consultant) does not change the nature of the relationship. To quote from the ruling,
All these circumstances go to prove that the assessee is only making an attempt to camouflage real nature of the transaction by using clever phraseology. It is not the form but the substance of the transaction that matters. The nomenclature used may not be decisive or conclusive to determine the nature of transaction. The intention of the parties is to be ascertained with reference to terms of conditions contained in the agreement.
Hire consultants, but..
If your business requires hiring consultants, do so by all means. However, do not create a category of work personnel called consultants with the sole objective of avoiding statutory deductions such as PF and ESI. The PF and ESI authorities can and do examine whether exclusion of any of the work personnel is on valid legal grounds.
The Supreme Court of India (in Royal Western India Turf Club Ltd. Vs. E.S.I. Corporation), while commenting on exclusion of certain types of personnel from ESI, said:
The definition of “employee” is very wide. A person who is employed for wages in the factory or establishment on any work of, or incidental or preliminary to or connected with the work is covered. The definition brings various types of employees within its ken. The Act is a welfare legislation and is required to be interpreted so as to ensure extension of benefits to the employees and not to deprive them of the same which are available under the Act.
In other words, please be clear about the legal basis when you keep a person out of statutory deductions such as PF and ESI.
Finally, please make sure that your organization’s agreements with consultants contain terms which, beyond any doubt, denote that the relationship is one of “contract for service” and not “contract of service”.