Income Tax on Contract based Employee/Consultant

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Many companies have now started hiring employees on contract basis. Such employees although work in the company premises and work as a normal employee but their legal status is not the same as an employee and they are not entitled to get the same benefits as an employee.

Such employees working on contract basis/consultant basis only get a fixed amount as remuneration and they are not entitled to any other benefits and allowances like House Rent Allowance, Leave Travel Allowance, Leave Encashment, Pension Income etc.

ITR Form for Contract Employee/ Consultant

As the status of this type of workforce is not the same as that of an employee, the manner of computation of tax of such employees also differs. As there is no employer-employee relationship in this case, their income won’t be taxed under head Income from Salaries and they therefore cannot file ITR 1/ ITR 2 Form while furnishing their Income Tax Returns.

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Such type of contract based employees are required to disclose their income under head Income from Business or Profession and shall file their Income Tax Returns in ITR Form 4/ ITR Form 4S

Moreover, as the TDS deducted on the amount paid to such contract employees also won’t be deducted under Section 192 but would be deducted under other sections. In many cases, companies are deducting TDS on amount paid to such contract employees either under Section 194J or Section 194H or Section 194D. TDS in such cases is normally being deducted at a flat rate of 10%.

Such workforce won’t be issued the Form 16 as well because Form 16 is only issued to regular employees. Such type of contract employees would be issued Form 16A. The TDS so deducted by the company can be verified easily by the recipient through the Form 26AS which can be downloaded online as well

Manner of Computation of Taxable Income of Contract Employee/ Consultant

As such type of contract employees would be required to show their income under head “Income from Business/ Profession”, they would also be eligible to deduct some expenses from the total amount received. There total taxable income would be computed in the following manner:-

Total Amount Received xxx
(Less) Total Expenses incurred for the purpose of earning this Income (xxx)
(=) Total Taxable Income xxx

All expenses incurred for the purpose of earning this income can be claimed as an expense. Some examples include Commuting Expense, Telephone Expense etc. It is important to note here that only those expenses which have been incurred for the purpose of earning this income are allowed to be claimed as an expense. Personal Expenses are not allowed to be claimed as an expense.

After computing the Total Taxable Income, the Income Tax would be levied as per the existing Income Tax Slab Rates.

Income Tax would only be levied on the Total Taxable Income computed after deducting the expenses from the total amount received.

Alternate way to compute and Save Tax – Applicable from 2016 onwards

As Contract Employees are not treated as normal employees, there Income is taxed as Income from Business/Profession and such employees are also required to maintain a record of all their expenses and maintain their Profit & Loss A/c and Balance Sheet.

However, it gets very difficult for a contract employee to keep a record of all the expenses and maintain their Balance Sheet. Therefore, to simplify the manner of computation of taxes for all Professionals, the Govt introduced the Presumptive Scheme of Taxation in Budget 2016 which is applicable from Financial Year 2016-17 onwards.

According to this Scheme of Presumptive Taxation under Section 44ADA, neither is the professional required to maintain the list of all his expense and nor is he required to keep a copy of all the invoices. He can simply disclose his Income as 50% of the amount received. As he can show his income as 50% of the total amount received, Income Tax in such a case would only be levied on 50% of the amount and not on the Total Amount.

As Income Tax is only levied on half the amount and not on the total amount, it reduces the tax liability of the employee to half of what it would have been earlier. This scheme of taxation has been recently introduced and is applicable from Financial Year 2016-17 onwards. As this scheme is newly introduced, very few professionals are aware of this scheme.

However, this new scheme of Presumptive Taxation under Section 44ADA is very useful for Contract Employees as they can directly reduce their tax burden to 50%. This scheme of Presumptive Taxation has been explained in detail in this e-book which can be purchased for Rs. 49 from this link – e-book on Presumptive Taxation for Contract Employees.

Karan is CA by Qualification with the rare distinction of being awarded All India Rank 22. He is also the founder of this website and loves to help people with their Tax Queries.