Salaried vs consultant: What's a better option for high earners in India?

If your business expenses are a significant portion of your income (more than 50%), being a consultant and claiming those expenses can be beneficial

Union Budget 2023 introduced changes for people with an annual income of Rs 60 lakh or more. These changes could affect your decision of whether to be a salaried person or a consultant. The new tax regime offers lower tax rates but restricts deductions and exemptions. Professionals can benefit from presumptive taxation under Section 44ADA, which taxes 50% of gross receipts as income.

Understanding Tax Regimes in India

Before diving into the consultant vs salaried debate, let's get familiar with the two main tax regimes in India:

Old Tax Regime: This traditional regime allows you to claim various deductions and exemptions while filing your taxes. These deductions can significantly reduce your taxable income, potentially lowering your tax burden. Common deductions include travel allowances, medical expenses, interest on home loan, and investments under sections like 80C and 80D of the Income Tax Act.

New Tax Regime: Introduced a few years ago, this regime offers lower tax rates compared to the old regime. However, the flip side is that most deductions and exemptions are unavailable here. This can be beneficial if your expenses are minimal.

Salaried employees get standard deductions and other benefits but cannot claim business-related expenses. Consultants can claim business-related expenses but must file more complex tax forms. The best option for you will depend on your individual circumstances. If you have a lot of business expenses, you may be better off as a consultant. But if you prefer a simpler tax filing process, you may be better off as a salaried employee.

Presumptive taxation is a way for certain professionals to pay taxes in India. It's simpler than the regular way of filing taxes. Normally, you have to track all your income and expenses and then subtract your expenses from your income to get your taxable income. But under presumptive taxation, you don't have to do that. The government assumes that your profit is 50% of your gross receipts (income). So, you just pay tax on that 50%. This can save you time and hassle.

Here's who can benefit from presumptive taxation under Section 44ADA of the Income Tax Act:

Medical professionals (like doctors)

Legal professionals (like lawyers)

Accounting professionals (like chartered accountants)

Film artists

Engineers

Technical consultants

Architects

Interior decorators

Company secretaries

There are some things to keep in mind though. If you choose presumptive taxation, you can't claim any other deductions or exemptions under sections 30 to 38 of the Income Tax Act. So, it might not be the best option for everyone.

Moreover, Budget 2023 also proposed to increase the limit for presumptive taxation from Rs 50 lakh to Rs 75 lakh. But there's a condition. Cash receipts during the financial year cannot be more than 5% of your total gross receipts. If it is more than 5%, you won't get the benefit of the higher limit of Rs 75 lakh.

"Salaried employees don’t have tools to save taxes apart for the conventional tax saving investments. For the deductions claimed they are expected to show the proofs when asked by the employer.  Thus, they end up paying a major portion of their hard earned money towards taxes. On the other hand, the Income earned out of business is eligible for various expenses and the remaining profit is charged to taxes after applicable tax saving deductions. Further, there’s a provision of declaration of Business Income under Presumptive tax system under section 44ADA (applicable for the services and professionals). Wherein, the 50% of deduction can be claimed from the Gross receipts and balance is declared and taxable income on which further tax saving deductions can be claimed under section 80C, 80D and so on," said Alay Razvi, Partner, Accord Juris LLP

Razvi explains how a salaried employee can ask his employer to hire him/her as a business consultant and can save taxes as explained below:

Choosing Between Salaried and Consultant Status: A Balancing Act

"Switching to consultant work can offer tax breaks, but the exact amount depends on your income, expenses, and tax bracket. The key benefit is claiming business expenses that reduce your taxable income. Though its not possible to directly quantify the tax benefits , however one can get an approximate idea through this example. Let's say you earn Rs 15 lakh annually as a salaried employee and fall under the 30% tax bracket. By becoming a consultant and incurring say around Rs 1,50,000 in business expenses towards travel, office supplies, internet, professional fees etc, you could potentially reduce your taxable income to Rs 13,50,000. In this simplified scenario, that translates to tax savings of Rs. 45,000 (30% of deducted expenses).

Therefore, though this can offer tax advantages through expense deductions, the actual amount saved depends on your individual circumstances. Remember, this might come with the responsibility of managing your own taxes and the loss of employee benefits," said Ritika Nayyar, Partner, Singhania & Co.

Now comes the big question: salaried employee or consultant? Here's a breakdown of the pros and cons of each option to help you decide:

Salaried Employee:

Pros:

Standard Deduction: You get a fixed deduction (up to Rs. 50,000) without needing proof of expense.

Simpler Tax Filing: Your employer deducts TDS (Tax Deducted at Source) throughout the year, and you receive a Form 16 with all tax details, simplifying filing.

Employer Benefits: You might be eligible for social security benefits like health insurance and provident fund contributions.

Cons:

Limited Deductions: Compared to consultants, you have fewer options to claim deductions for work-related expenses.

Consultant:

Pros:

Expense Deductions: You can claim deductions for actual business expenses incurred while working, like travel, internet, professional fees, and office rent. This can significantly reduce your taxable income if your expenses are high.

Loss Carry Forward: If you have business losses in a year, you can offset them against your income from other sources or even carry them forward to future years, potentially lowering your tax burden in those years

.

Cons:

No Standard Deduction: Unlike salaried individuals, consultants don't get the automatic Rs. 50,000 deduction. You need to maintain records and claim deductions for actual expenses.

Advance Tax Payments: As a consultant, you're responsible for paying advance taxes throughout the year to avoid interest penalties. This requires proper tax planning and discipline.

"If your salary is a high amount more than Rs 20 or 30 lakh per annum, you should ask your employer to treat you a consultant rather than an employee. The upside of this is that you would be receiving a consulting fee instead of a salary. This is beneficial because the Tax Deducted at Source (TDS) will not be either 20 or 30% according to the Income Tax slab rate, instead your TDS will only be 10% under Section 194J of the Income Tax Act since you are a consultant earning a fee your services," said Adithya Reddy, International Tax Lawyer

Example: Let’s say Adithya is a consultant receiving a consulting fee of Rs 35 lakh per annum.

Gross Income: Rs 35,00,000

Presumptive income at 50% of gross income under Section 44ADA: 50% of 35,00,000 = Rs 17,50,000

Taxable Income: Rs. 17,50,000 (TDS @ 10%)

However, let’s say Adithya is a salaried employee earning Rs 35 lakh per annum.

Gross Income: Rs 35,00,000

Expenses: Rs 10,00,000

Taxable Income: Rs 35,00,000 – Rs 10,00,000 = Rs 25,00,000 (TDS @ 30%) - Standard Deduction under Section 16 of Income Tax Act of Rs. 50,000

Therefore, if your taxable income is Rs 17,50,000 under Section 44ADA, the difference in the taxable income is Rs 7,50,000 between consultant and salaried professional.