Consultant or employee?

20 April 20265 min readPeople

Why founders reach for consultancy agreements

Usually for good reasons: flexibility, simpler paperwork, no payroll to run, and the sense that statutory obligations are avoided. The first three are genuine. The fourth is where the difficulty starts, because the obligations attach to the relationship as it actually is, not as it is described.

How the distinction is actually drawn

Indian courts have approached this through a series of overlapping tests rather than one bright line. The older approach asked simply whether the employer controlled not just what was done but how it was done. The modern approach is broader, looking at the whole picture of the relationship — integration into the organisation, who bears the commercial risk, who provides the tools, whether the person can profit from managing the work well, and whether they are in business on their own account.

In practice the following factors do most of the work:

No single factor decides it, and a relationship will usually show some of each. The question is where the weight of the picture falls. A useful self-test: if you would be upset that a "consultant" took another client, or took a Tuesday off without telling you, you are describing an employee.

What follows from getting it wrong

Statutory benefits

Provident fund, employees' state insurance and gratuity attach to employment and are triggered by thresholds relating to the establishment and the employee's wages. Where a person engaged as a consultant is found to have been an employee, contributions can be claimed for the period concerned, and the liability sits with the company rather than with the individual.

Tax deduction at source

Salary attracts deduction under Section 192 of the Income Tax Act, 1961 at the employee's applicable slab rate, spread across the year. Fees for professional or technical services attract deduction under Section 194J at a flat rate on payment. Applying the second where the first is correct misstates the position for both sides, and it is a mismatch that is straightforward to spot.

GST

Services by an employee to the employer in the course of employment are outside the scope of GST. A genuine independent consultant, once past the registration threshold, charges GST on their fees. A consultant who invoices with GST while working as an employee in substance creates a problem in both directions.

Termination

A consultancy agreement can usually be ended in accordance with its notice clause. Ending an employment relationship engages a different framework — notice, dues, and in some cases statutory procedure depending on the category of employee and the applicable state legislation. A company that believes it can terminate on a week's notice, and turns out to have been employing the person for three years, has a materially different problem.

Intellectual property

This is the one founders most often miss, and it is the one with the longest tail. Copyright in work created by an employee in the course of employment ordinarily vests in the employer. Copyright in work created by an independent contractor generally stays with the contractor unless it is assigned in writing. Paying an invoice does not transfer it.

A company can pay a contractor for two years and discover at diligence that it does not own its own product.

Every consultancy agreement should contain an express assignment of intellectual property created under it, together with a waiver of moral rights so far as the law permits, and a covenant to execute any further documents needed to perfect the assignment.

Engaging consultants properly

Independent contracting is entirely legitimate and often the right arrangement. To keep it what it says it is:

• Define a scope, deliverables and milestones rather than a job.
• Pay against invoices for work delivered, not a fixed monthly salary in all events.
• Do not impose fixed hours, leave approval or a reporting line into the hierarchy.
• Leave them free to work for others, and do not require exclusivity.
• Have them use their own equipment where that is practical.
• Deduct tax under the head that matches the relationship.
• Include express intellectual property assignment and confidentiality.
• Include indemnity and limitation of liability provisions appropriate to the work.
• Review long-running engagements: a six-month project that has quietly run for three years, full-time and exclusively, is no longer what the contract describes.

The middle cases

Some engagements genuinely sit between the two. Part-time senior people, fractional executives and advisors on retainer are common in early-stage companies and do not always fall neatly on one side. Where the position is unclear, the sensible course is to document what the relationship actually is, keep the practice consistent with the document, and revisit it when the facts change — rather than choosing the label that is convenient and hoping the facts follow.