Is It Legal for Employers to Skip EPF and ESI by Hiring on Direct Contracts?

Dear All,

It has been noticed that to avoid a high rate of service charge and service tax paid to the manpower vendor, the Principal employer is recruiting employees on a direct contract basis and giving them a consolidated salary without providing EPF & ESI.

Is this legally correct?

Dear Nikhil Kujur,

You need to provide PF and ESI through direct contract if your organization is covered under the PF and ESI Act.

Regards,
Hekarthik

Direct Recruitment vs. Recruitment Agencies

What is wrong with recruiting directly by the company when there is an HR person employed mainly to do this activity? In such cases, why should we engage any recruitment agency and pay them service charges? There is no need to delegate this function of finding candidates to someone else when we have an HR person to do this.

Outsourcing and Direct Employment

If your query is about outsourcing, I would also say that there is no need to engage people through a contractor (manpower agency). We can directly employ people and save on service charges.

Consolidated Pay and Legal Considerations

Regarding consolidated pay, nowhere in the law is it stated that you should not pay a lump sum amount as remuneration. However, your total remuneration should contain components like basic salary, HRA, conveyance, etc. There can be an exception when we fix minimum wages, which may include a component called variable dearness allowance (VDA). The purpose of this component in the salary is to adjust wages according to the cost of living indices. Without this element, we would be refixing the salary only after, say, 12 months. However, if you have DA as a component, you will be able to increase wages periodically (in some states, it is done every 6 months, whereas in Kerala, it is done every month) based on an increase in consumer prices. At the same time, if the total of basic and VDA is equal to the sum paid as a consolidated salary, there will be no illegality.

Implications of Not Providing PF and ESI

Not providing PF and ESI is a different story. If, in order to avoid ESI and PF, the employer fixes the salary above Rs 15,000, say, Rs 15,100, then you cannot question it because legally the employer is correct. However, the amount of gratuity, which is normally calculated based on basic and DA components of salary, would be available to the employee on a higher amount, Rs 15,100, i.e., the consolidated sum. Similarly, the employee will receive leave encashment and other terminal benefits based on the consolidated sum.

Suppose the PF and ESI increase the salary ceiling from the present Rs 15,000 to Rs 16,000 or Rs 25,000, then what will the employer do? Will they increase the salary and make it above Rs 16,000 or Rs 25,000? We cannot predict what amendments might happen to the law tomorrow.

Regards,
Madhu.T.K

Mr. Madhu has explained the matter well in terms of company cost optimization and employee benefits, duly stating the legal terms. So far, I'm getting your point. The company is recruiting on a "Contract Basis" because they want to avoid statutory benefits like PF, ESI, Bonus, Gratuity, Leave Encashment, etc.

Important Points to Consider

1. If they recruit on a contract basis, there should be some agreement in which the service period, nature of the job, fixed remuneration, payment terms, etc., must be given and acknowledged by both parties. Moreover, such recruitment falls under the category of "Professional Services." The candidate ("Employee" in general terms) is supposed to raise an invoice for the professional services which the company has to pay after making TDS deduction @ 10% (10% TDS rate for Professional Services).

2. The above scenario is from the company's point of view (to save statutory & other benefits) which can be useful for the short term. However, if we consider the legal implications in the long term, it can be more costly.

The company allows such professionals to receive other regular benefits (Phone allowance, Conveyance, flexi working hours, W/off, Holidays, Leaves, etc.). If after working for approximately 10 years, any "Professional" lodges a complaint in the Labour Office and claims all regular employee benefits, the company could be in trouble and might have to pay more claims. All savings would then be reversed, and paying benefits from the past period would lead to higher costs. In an earlier post, Mr. Madhu has stated all related laws and court judgments.

Merely signing any contract or following false procedures can't avoid any statutory liability.

Although I have provided a detailed summary against your short query, this information will also be useful for other fellow members as well.

Regards