Who is More Tax Efficient – a Salaried employee or a Consultant?

Tax implication of switching from being a salaried employee and a consultant and vice-versa.
Often people consider changing status from salaried employee to a consultant status to reduce tax liability. Following are the queries:
1)What are the advantages and disadvantages of shifting from a salaried status to a consultant?
a)Rate of TDS is lower for professional on higher income: The tax deduction ratio (TDS) is lower for consultants as compare to salaried person earning more than one lakh per month. Because the tax on salary income is deducted as per tax slab whereas professional consultants has fix 10% deduction.B Hence, higher salary person can take benefit of lower deduction by working as consultants. However, interest on tax would be payable if there is any additional tax payable at the time of filing return.
b)Consultants have more flexibility in income and expenses for tax optimization: The CTC structures in corporate are not tax efficient and flexible because of administration difficulties.B In spite of ample opportunities in the tax laws for tax optimization and technical innovation to manage these changes in volume.B One more reason to play safe for corporate is the fear of IT department notice to the company for clarification/proof submission later. Government employees has even lesser flexible CTC as compare to private employees.
c)Not able to take benefit of tax efficient option in CTC because of short term employment: It has been noticed that many corporate specially IT sector has tax efficient CTC but employees do not utilize fully. For example car lease being 3 year kind of commitment and job change is always in mind. Hence, loose major tax benefit which can be easily availed as consultant by claiming interest on car loan, insurance, petrol and driver as business expense. ESOP is good option for deferment of tax and diversification of assets portfolio but fewer employees take interest. Rather happy to take the risk of their own by becoming consultant/businessman.
d)Consultants have more flexibility in working time, projects and clients: In case of salaried employee the working time and projects are almost fixed. Whereas, consultants has flexibility which helps in taking risk in other projects for faster growth thus more income. In case of loss the project loss can be adjusted with another project income.
e)Salaried people are dependent on employer for major deduction i.e. NPS: NPS deduction on employer contribution is not available till employer implement in the company. Similarly, HRA, LTA, medical reimbursement, gratuity, superannuation, leave encashment, term cover, food coupon car lease, driver, phone bill, ESOP etc are tax optimization components for salaried but corporate has to provide as part of CTC. Otherwise employee can not avail tax benefits through these options. Moreover, the window of availing these benefits is very limited during the year or career. Once or twice in a year is generally allowed to select the option, further restricted by employee level.B Whereas consultants can invest 20% of their income in NPS to save tax without any approval from clients.
2) Under what circumstances such a shift is advisable and when not?
a)Switch if growth in job seems lower: One should work and get the income to the extent of his/her potential. However, salaried person has limitation to work within corporate growth plans/ideas.
b)Switch if you can take the financial risk: Consultants income is not as regular or assured as salaried person. Hence, one should take the stock of available funds/assets and expected expenses for next few years.
c)Switch if you can manage accounts and tax compliance record: There are many tax compliance requirements as a consultant i.e. service tax, TDS, tax audit, labor laws regarding staff EPF, ESI etc.
d)Switch if you have sales and marketing skill or network: Consultants also need to have sales skill for generating new business. Whereas, salaried gets support from other team members.
3) What are the things that should be kept in mind when deciding on such as shift?
a)Do check the tax implication on dues before switch: there are many incidents when employees leave the job for new job or starting own without considering the avoidable taxes. For example withdrawal from PF before 5 years continued job makes it taxable, notice pay deduction from salary payable but not in tax computation, leave encashment and gratuity also dependent on service period. Hence, one should see the hard earned money is not wasted in haste.
b)Do check your insurance covers for financial security: Many corporate provide insurance life and medical to employees as well as family. Hence, switching leads to more financial risk hence get it before hand and take experts help for right insurance covers at right cost.
c)Do check the emergency funds are available for delay in fees: There are cases when consultant fees get delayed for months. Whereas expenses are regular i.e house hold and EMI etc. hence minimum cash should be ensured for 6 months.
4)Are there other tax compliance requirements (such as service tax) in case of shift?
a) Yes, service tax is applicable for fee above 10Lakh during the F Y. Even TDS, PF, ESI etc also applicable after certain limits.
5) What to keep in mind if one again wants to shift to a salaried status from a consultant?
a) Ensure all tax compliance done for consulting : do surrender the registrations after compliance done otherwise it would lead to default.
b) Do check your insurance and surrender the policies, if not required or make them paid.
c) Do check your tax saving investment and realign with CTC structure. Save tax beyond 80C, Optimize Tax Now!
d) Do sell your consulting goodwill, if possible and make some money. The tax experts can also help you to plan taxes in sale of consulting business as well as planning CTC.
 
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