GST on Contract Employee Remuneration: Applicability, Rates, ITC, and Compliance

In India, staffing services and contract employees are essential for industries ranging from information & technology (IT) to manufacturing and logistics. For foreign investors and compliance managers, however, the goods and services tax (GST) treatment of contract employee remuneration often raises questions. 

Unlike salaries paid to permanent employees, which are exempt from goods and services tax (GST), remuneration for contract employees – whether supplied directly or through staffing agencies – falls under the GST regime. The distinction is critical because it directly affects costs, eligibility for input tax credit (ITC), and overall compliance obligations.

India Briefing explains how GST applies to contract employee remuneration, outlines applicable rates, highlights ITC considerations, and explores compliance issues businesses must keep in mind.

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India’s GST Council has refined rules on work contracts and manpower supply. According to the central government guidance, manpower supply or staffing services are treated as a taxable supply of services under GST, as described by the GST Council Flyer on Work Contracts. 

Salaries and wages paid to regular employees are not liable for GST in India. However, services provided through manpower recruitment or supply agencies, where employees are on the payroll of a third-party agency, are fully taxable. This includes IT consultants, contractual engineers, warehouse staff, and other temporary personnel engaged via a service contract.

This regulatory framework means companies need to distinguish clearly between direct employment relationships and third-party contract arrangements to assess their GST liability correctly.

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Applicability of GST on contract employees

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The key question businesses face is, when does GST apply to remuneration?

• Permanent employees: Salaries, allowances, and wages paid to regular employees under an employer-employee relationship are outside GST’s scope. This is because such services are not considered a “supply” under Section 7 of the CGST Act.
• Contract employees engaged directly: If a company hires an individual on a fixed-term contract as its employee (with tax deducted at source, or TDS, under income tax and covered by employment laws), then GST does not apply.
• Contract employees via staffing agencies: Where workers are supplied by a manpower agency or staffing firm, GST applies. The agency invoices the company, charging GST on the remuneration plus services fee.

For example, if an IT company engages 50 software developers through a staffing agency, the invoice raised by the agency will include remuneration plus 18 percent GST. The company can generally claim ITC, subject to compliance conditions.

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Applicable GST rates

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GST on manpower supply and staffing services is levied at 18 percent under SAC code 998513 (contract staffing services) and related categories.

This rate applies uniformly across industries, whether the workers are engaged in IT, healthcare, construction, or logistics. Unlike some exempted services in education or healthcare, manpower supply services attract full GST.

Some nuances to keep in mind:

• Reverse charge mechanism (RCM): In certain cases, if manpower services are provided by an unregistered vendor to a registered company, GST liability may fall under RCM.
• Work contacts vs manpower supply: A work contract, such as construction of an immovable property, is taxed differently from mere manpower supply. It is crucial not to conflate the two categories.

CLICK HERE TO KNOW MORE: How India’s New HSN and SAC Code Structure Transforms Tax Compliance for Businesses

Input tax credit considerations

One of the most important aspects for businesses is whether GST paid on contract employee remuneration is eligible for ITC.

• General rule: GST paid on manpower supply services is eligible for ITC, provided the cost is incurred in the course of business and the company holds valid tax invoices.
• Restrictions under Section 17(5) of the CGST Act: ITC is blocked on certain personal or non-business expenses, such as staff welfare or canteen services. However, manpower supply for core operations (e.g., contract engineers, IT staff, logistics workers) usually qualifies.
• Documentation: To claim ITC, businesses must ensure that staffing agencies are GST-registered, invoices carry valid GSTINs, and payments are made via traceable banking channels.

Example: A logistics company engages a staffing agency for 100 warehouse workers. The agency raises an invoice for INR 5,000,000 (US$60,000 approx.) plus GST at 18 percent (INR 900,000/US$10,800). The logistics company can claim ITC of INR 900,000 (US$10,800), reducing its effective tax burden, provided compliance conditions are met.

Compliance requirements

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Companies engaging contract employees must pay attention to compliance on several fronts:

• Vendor due diligence: Ensure staffing agencies are properly registered under GST, and verify their GSTIN on the government portal.
• Invoice matching: Reconcile invoices uploaded by staffing agencies with the company’s GSTR-2B to avoid ITC mismatches.
• Contract structuring: Draft contracts to clearly specify that the arrangement is manpower supply, with applicable GST charges, to avoid future disputes.
• Reverse charge scenarios: Be alert to RCM obligations if services are sourced from unregistered vendors.
• TDS and labor laws: Distinguish GST liability from obligations under income tax and employment laws. For instance, companies must still comply with TDS deduction on salaries where applicable, separate from GST on manpower supply.

Failure to adhere can result in disputes during GST audits, leading to penalties, denial of ITC, or demands for interest on delayed payments.

Common challenges and risks areas

Despite clear rules, companies often face practical challenges:

• Blurred distinction between employees and contractors: Authorities scrutinize whether an arrangement is truly a supply of service or an employer-employee relationship. Poorly drafted contracts may invite litigation.
• Double taxation risks: In some cases, companies fear overlap between GST on manpower supply and TDS obligations under income tax, though these operate under separate frameworks.
• Cash flow impact: GST at 18 percent can create a significant upfront cash outflow for companies, especially small & micro enterprises (SMEs), even if ITC is eventually available.
• Multi-state compliance: Large companies engaging staffing agencies across multiple states must ensure GST compliance in each jurisdiction, as staffing services are taxed based on place of supply rules.

Opportunities for businesses

While GST adds a tax layer to contract employee remuneration, it also brings some benefits when managed well:

• Transparency: Invoicing and ITC mechanisms create a transparent trail for staffing costs.
• Cost rationalization: Businesses that claim ITC effectively neutralize the GST burden, making manpower supply services tax-efficient.
• Professionalization of staffing: GST has encouraged staffing agencies to formalize operations, register under GST, and provide compliant invoices, improving reliability for corporations.
• Flexibility: Contract employees continue to offer scalability for businesses, and GST compliance ensures that such arrangements remain cost-competitive compared to permanent hiring.

Conclusion

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As contract staffing grows in sectors like IT, e-commerce, and logistics, companies must be proactive in managing their GST exposure. For foreign companies and MNC compliance teams, understanding these distinctions is critical not only to avoid tax disputes in India but also to unlock potential cost savings through ITC.

The evolving GST regime underlines the importance of treating contract staffing as a taxable supply while still leveraging its flexibility as a workforce solution. By combining tax efficiency with compliance discipline, companies can continue to rely on contract employees as an integral part of India’s labor ecosystem.

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