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How to get the best of both worlds

Many employees are opting to be consultants to avoid deductions and reduce taxes. But watch out for the pitfalls before you become one.

Priya Kapoor        Print Edition: September 4, 2008

When Delhi-based graphic designer Ajay Singh switched jobs a few months ago, he was determined to pay as little tax as possible. For years, Singh had been extremely well paid—on paper. What he took home every month was a fraction of his actual cost to company (CTC); taxes and other deductions took care of a large chunk of his pay. However hard he tried, his company’s rigid compensation structure didn’t give any room for avoiding the compulsory deductions or bring down his high tax liability.

So, when Singh was offered a new job, he made sure he was taken in as a consultant. This means he bills the company for services rendered and gets paid a lump-sum amount for those services. He is not on the rolls of the company and is not eligible for any retirement benefits; there are no deductions like provident fund or pension contributions. There is only a 10.3% tax deduction at source. “I knew the implications of working as an employee. In spite of a good package, my take-home salary used to be very low. But as a consultant now, I take home more money,” says Singh.

An increasing number of employees prefer to work as consultants as they believe the compensation structure promises the best of both worlds—a high takehome income with a low income-tax liability. They are attracted by the benefits that consultancy holds out in terms of a lump-sum payment without any deductions and the freedom to deduct everyday expenditure like conveyance and utility bills from the taxable income. Says Lakshika Joshi, a consultant advocate with a leading corporate house: “The best part of being a consultant is more in-hand salary as there are no deductions towards provident fund.”

Lakshika
Lakshika Joshi, 30, Consultant advocate with a leading corporate house in Delhi

 

Inspite of being offered a full-time employment by her current organisation, she opted to work as a consultant. Due to such an arrangement, she claims deduction on all permissible expenses to bring down her tax liability to zero. Had she been a regular salaried employee, she would have paid about Rs 40,000 in income tax in a year.

Surya Bhatia, CA and investment consultant

 

"A person who works as a consultant should be more disciplined about savings as there is no PF deduction"

The tax breaks Like Joshi, Singh is also pleased with the fact that, as a consultant, he is allowed to deduct several expenses from his income while computing his tax liability. Under our tax laws, a consultant’s work is treated as a business and is extended the same benefits as enjoyed by corporate enterprises. So, if Singh buys a computer worth Rs 40,000, he can reduce his taxable income by Rs 24,000 because he gets 60% depreciation on computers. Restaurant bills for dining with a client or even a quick cappuccino with a business associate can be shown as business development expenses. A new car worth Rs 4.5 lakh will reduce his taxable income by Rs 90,000 in the first year. The furniture he uses at home for office work, electricity bills, phone bills, sweeper’s salary—anything and everything that Singh spends while going about his work is permissible expense.

“All expenses—commuting expenses, repair and maintenance, Internet charges, telephone charges, even depreciation on assets—incurred during the course of his work are permissible expenses,” says Vikas Vasal, executive director, KPMG India.

Companies are also happy to take on consultants as it means that they don’t need to have a large workforce and can offer temporary assignments to consultants on a project-to-project basis. Says P Senthil Kumar, director, HR & administration, Cairn India: “Certain roles are time-bound in nature. Hence, companies prefer to engage consultants rather than hiring a full-time employee for the same work.”

The flip side If there are so many advantages to being a consultant, why isn’t every employee opting for it? For one, only people with special skills can be hired as consultants. A company can hire chartered accountants, senior engineers or marketing planners as consultants, but the middle-level clerk, factory in-charge or travelling salesman must be on the company’s rolls as a regular employee.

Says Sudhir Singh, head of HR consultancy firm, Outsmart: “Consultants specialise in a niche area, which may not be the core business of a company.” Moreover, there is a cap—though undefined— on the percentage of consultants working for a company.

A consultant can claim deduction for the following expenses:Apart from this, he can also claim depreciation on the book value of the following assets:
Commuting (for work)Car
Repair and maintenance of office equipmentPortion of building used for work
Internet chargesFurniture
Telephone billsComputer
StationeryOffice equipment
Rent of spaceCell phone
Interest on car loanAC
Interest on house loan 
Car fuel 
Mail and courier service 
Newspaper and journals
 
Books 
Vehicle Insurance 
Salaries to peons, drivers 

If a consultant’s annual income is Rs 10 lakh or more, he has to levy service tax on his income when writing his invoice to bill the company for that. “Depending on the facts and the nature of service, a consultant’s income may fall in the service tax net, which stands at 12.36% on every bill raised. A consultant has to charge this tax on his fee and deposit the same with the government,” adds Vasal. This means more paper work and additional botheration for the consultant.

A consultant also does not get tax exemption for house rent, which a salaried employee does. This is an important head of expenditure and can account for almost 20-25% of a person’s salary. Nor does a consultant get tax-free perks such as medical allowance and leave travel assistance (LTA).

Although people like Joshi are happy about the lack of PF contribution, in the long run, this might not be so good. The provident fund is a convenient way of creating a retirement corpus. The money trickling into your account every month and the interest it earns every year will accumulate into a sizeable nest egg when you retire. But a consultant foregoes this benefit because he is not on a company’s rolls.

If he is not a disciplined investor, he may find himself in trouble later. “Provident fund is a kind of forced saving. In case of a consultant, this deduction doesn’t take place. A person working as a consultant, therefore, has to be more disciplined about his savings,” says Surya Bhatia, chartered accountant and investment consultant.

There are other problems. A consultant has to maintain proper record of all expenses incurred by him during the financial year. The income-tax department can scrutinise the records of up to eight years ago. “Maintaining proper books is a tedious process and any error could result in a notice,” says Bhatia. Also, those who have an annual income of Rs 10 lakh or more are required to get their books audited by a chartered accountant. So, weigh the pros and the cons carefully before opting to be a consultant. You may be trading off less taxes with more hassels.

An employee pays Rs 63,406 tax on Rs 6 lakh income
He gets allowances also but pays more than one month’s salary in taxes every year.
Salary
ActualTaxable
Basic salary24,00024,000
Dearness allowance6,0006,000
HRA12,0009,600
Entertainment reimbursement5,12039,600
PF (employer contribution)2,880 
Total CTC50,000 
Total income per annum6,00,0004,75,200
Less deduction under Section 80C 1,00,000
Net taxable salary 3,75,200
Tax 63,406.8

A consultant with the same income pays Rs 36,642
He benefits by making full use of the permissible expenses allowed as deductions from his taxable income

 MonthlyAnnual
A Remuneration50,00060,000
PERMISSIBLE EXPENSES  
Commuting expenses2,00024,000
Internet expenses2,00024,000
Telephone expenses1,00012,000
Books and periodicals2,50030,000
Stationery1,66720,000
Rent of the space used3,00036,000
Depreciation on car2,50030,000
Depreciation on computer2,50030,000
Seminar5006,000
B. Total expenditure17,6672,12,000
C. Investment under Section 80C 1,00,000
Net taxable income = A-(B+C) 2,88,000
Tax 36,462
Tax already paid as TDS at 10.3%5,15061,800
Tax refund
 25,338

 

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