Contract employee is hired by business entities on a principal-to-principal basis. He is not ‘employee’ per se, but third party persons who are paid to conduct a specific task/project.
However, certain salaried employees can provide services which are covered in the contract of employment and can also provide additional services that are outside the ambit of their employment. Their consideration would include salary and also fees provided on a principal-to-principal basis for the additional services.
Applicability of GST on remuneration to contract employee
Supply under GST is defined as below:
All forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease, or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
Going by this definition alone, one may reason that an employee provides a service to an employer in exchange for consideration (salary) and hence could satisfy the definition of ‘supply’ in the GST law.
However, Schedule III of the CGST Act, 2017 contains a list of supplies that will not be taxable under GST. Para 1 of Schedule III states services as ‘Services by an employee to the employer in the course of or in relation to his employment.’
Thus, it can be concluded that services rendered by an employee to the employer in accordance with the contract of employment would not be chargeable to GST. Therefore, any services provided by contract employee or part-time workers or freelancers will be subject to GST.
Further, if the employee provides any service to the employer that is outside the ambit of his employment, on a principal-to-principal basis, then the same would be chargeable to GST. Let us analyse this principle with the help of a few examples:
(1) Notice pay: Most employment contracts have a clause to compensate the employee in case of premature termination or termination without providing the adequate notice period. This type of payment is called notice pay and is within the ambit of employment since it is part of the offer letter/employment agreement. Thus, notice pay would not be liable to GST.
(2) Directors’ sitting fees: The fees paid to the director for attending board meetings are called directors’ sitting fees. Such service is not part of the employment terms and is provided by the director in his professional capacity. Such services provided by the employee on a principal-to-principal basis would be liable to GST.
(3) Non-compete fees: The service of forbearance to act – in this case, the act of joining another company is deemed to be a service by virtue of Para 5(e) of Schedule II of the CGST Act, 2017. Thus, the same would be liable to GST. The employee is given a separate consideration for not joining the employment of another organisation.
(4) Service by an employee to associate company: The employee of the company is bound to provide certain services to the company as stated in the contract of employment. However, the provision of similar services, to an associate company, by the employee, would be outside the contract of employment and hence chargeable to GST.
Value of Supply and GST Rate
The value of supply depends upon the type of consideration paid. If the price is the sole consideration and the supply is made to an unrelated person, GST shall be calculated on the transaction value.
The employer-employee relationship is covered as ‘related persons’ under GST, Accordingly, the open market value of the supply will have to be taken in place of the transaction value.
The GST rate would depend on the nature of services and the corresponding SAC code. You can check out the relevant HSN code for a particular item of goods or services using ClearTax’s GST rate & HSN Code finder.
Who is liable to pay GST with tax authority?
The person who is liable to pay tax, in this regard, would again depend on the nature of services provided. The applicability of GST provisions on reverse charge mechanism (RCM) will need to be checked in this regard – whether the supply is notified under these sections or not.
If the value of a supply does not exceed the maximum threshold limit for registration, then the applicability of RCM for purchases from unregistered persons will have to be checked. In such a case, the liability to pay tax falls on the company under reverse charge. On the other hand, certain services notified for RCM like directors’ sitting fees, would also make the company liable to pay tax under reverse charge.
In any other case not covered above, the contract employee would be liable to pay the tax under the normal charge.