Revisiting Employer–Employee Relationships: Supreme Court’s Clarification and Its Implications under Direct Taxes and GST Law

Revisiting Employer–Employee Relationships: Supreme Court’s Clarification and Its Implications under Direct Taxes and GST Law

1. Introduction

In a landmark judgment delivered on 11^th September 2025, the Hon’ble Supreme Court in General Manager, U.P. Co-operative Bank Ltd. v. Achchey Lal & Another (Civil Appeal No. 2974 of 2016) revisited the foundational principles for determining the existence of an employer–employee relationship. This decision not only settles a long-standing dispute but also carries significant implications for direct tax and GST compliance, especially for organizations engaging workers through intermediaries or affiliated societies.

2. Background: The Allahabad High Court Decision

The case originated from a dispute over the employment status of canteen workers at the U.P. Co-operative Bank. The Allahabad High Court, in its judgment dated 17 February 2015 in Writ Petition No. 2586 (SS) of 2005 – Achchey Lal & Others v. General Manager, U.P. Co-operative Bank Ltd., had held that the canteen workers were deemed employees of the Bank. The High Court relied on the fact that the Bank provided infrastructure and financial support to the canteen and inferred an implied employer–employee relationship.

This decision was challenged before the Supreme Court, which ultimately reversed the High Court’s ruling.

3. Supreme Court’s Analysis

The apex court emphasized that determining an employer–employee relationship is a mixed question of fact and law, requiring a multi-factorial assessment. The Court reaffirmed and refined the following tests:

A. The Control Test

This is the oldest and most basic test.

It asks: Does the employer have the right to tell the worker not only what to do but also how to do it?

If the employer can decide the manner, timing, and method of the work — and can also discipline or dismiss the worker — then there’s a strong indication of an employer-employee relationship.

However, if the employer only tells what result to achieve but not how to achieve it (for example, in a contractor or consultant setup), the relationship is less likely to be that of employment.

B. The Integration (or Organisation) Test

Under this test, the court looks at whether the worker is part and parcel of the organisation’s main business.
If the person’s work is integral to the business (for instance, a bank clerk working in the daily operations of the bank), that points towards an employment relationship.
But if the person provides external or supporting services (for example, a plumber called to fix a leak in the bank’s office), then it suggests independence rather than employment.
So, the more the worker’s role is woven into the regular structure of the business, the stronger the case for being treated as an employee.

C. The Multifactor (or Composite) Test

The Court recognised that no single test — neither “control” nor “integration” — is decisive in modern workplaces.
Therefore, one must look at all relevant surrounding facts together.
These include:

• • Who pays the wages?
  • Who provides the tools and place of work?
  • Who bears the risk of profit or loss?
  • How much control or supervision is there?
  • Is the person economically dependent on the organisation?
  • Can the employer dismiss the person at will?

When seen collectively, these factors reveal the real nature of the relationship — whether it is truly one of employment or an independent contract.

D. The Refined (Contextual) Test

Finally, the Supreme Court said that the above tests cannot be applied mechanically.

They have to be refined and adapted to the specific facts of each case.

Different industries — banking, manufacturing, education, gig economy, etc. — may call for different weightage to each factor.

What matters is the economic reality and the substance of the relationship, not the label used in the contract.

If the arrangement functions like employment, it should be treated as such even if the agreement calls it something else.

Hence, the Court concluded that no employer–employee relationship existed between the Bank and the canteen workers.

4. Related Supreme Court Decisions

Joint Secretary, CBSE & Anr. v. Raj Kumar Mishra & Ors. [SLP (C) No. 19648 of 2023,; 14 February 2025 (primary judgment date); hearings and orders also noted on 17 March 2025]

• The case involved outsourced staff (including Raj Kumar Mishra) working at CBSE offices through third-party manpower agencies.
• The Supreme Court held that mere supervision or control over day-to-day work does not establish an employer–employee relationship.
• The Court ruled that such workers were not entitled to regularization or employment benefits from CBSE.
• The judgment reaffirmed the legal principle that outsourced workers cannot claim direct employment unless the principal employer exercises deep and direct control over hiring, firing, and remuneration — the core elements of the “control and supervision” test.

The following Table Amy be usefully referred to:

5. Implications Under Direct Tax Law

A. TDS Classification

– Employees: TDS under Section 192 (salary).

– Contractors/Service Providers: TDS under Section 194C or 194J.

B. Misclassification Risks:

– Incorrect TDS deduction

– Disallowance of expenses under Section 40(a)(ia)

– Exposure to interest and penalties

C. Payroll and Compliance

– Accurate classification is essential for:

– Issuance of Form 16

– PF/ESI obligations

– Income tax return disclosures

6. GST Areas Impacted by the SC Ruling on Employer–Employee Relationship

a) Scope of Supply [Section 7 of CGST Act, 2017]

• • Employer–employee services are excluded from GST under Schedule III (neither supply of goods nor services).
  • The SC ruling helps determine when a person is not an employee, and thus the services become taxable under GST.
  • If a person is hired through a third-party agency and not under deep control of the principal employer, the service is taxable as manpower supply.

b) Manpower Supply Services

• • GST applies to manpower supply services under SAC 99851.
  • The ruling clarifies that mere supervision by the principal employer does not convert a contractor’s worker into an employee.
  • Hence, CBSE-like arrangements with manpower agencies are taxable supplies, and GST is applicable.

c) Reverse Charge Mechanism (RCM) [Section 9(3) & 9(4)]

• • If the manpower agency is unregistered and the recipient is a registered entity (like CBSE), RCM may apply.
  • The judgment helps determine who is the supplier and who is the recipient — critical for RCM applicability.

d) Input Tax Credit (ITC) Eligibility

• • If the service is not an employer–employee relationship, GST paid on manpower supply is eligible for ITC, subject to conditions under Section 16.
  • The ruling supports ITC claims by clarifying that such workers are not employees.

e) Contract Labour in Government and PSU Audits

• • In GST audits of government bodies and PSUs, this judgment can be cited to:
    • Justify GST liability on outsourced staff.
    • Deny exemption claims based on alleged employment relationships.

f) Litigation on Employee Classification

• • The ruling will influence GST disputes where businesses claim that certain individuals are employees to avoid GST.
  • It reinforces that control over work alone is insufficient — hiring, firing, and remuneration control are key.

g) Compliance Risks:

• • Wrong GST treatment
  • Denial of Input Tax Credit (ITC)
  • Potential interest and penalties for incorrect classification

7. Practical Guidance for Organizations

• Document relationships clearly: contracts, payment terms, supervision structure.
• Apply the Refined Multifactor Test to assess employment status.
• Align HR, legal, and finance teams to ensure consistent classification.
• For MSMEs and religious societies, avoid informal arrangements that blur employment lines.

8. Concluding remarks

The Supreme Court’s evolving jurisprudence provides much-needed clarity on a complex and often litigated issue. By emphasizing a composite, fact-based approach, the Court has empowered organizations to make informed decisions while also cautioning against superficial or proxy arrangements. For stakeholders in sectors like hospitality, religious trusts, and MSMEs, this is a timely reminder to review existing contracts and compliance practices to avoid unintended tax and legal consequences. Where one entity exercises supervision and control over the activities outsourced to another, it might make the former engaged in a manufacturing activity; the former could be treated as manufacturer, but the same will not create any employer-employee relationship.

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Author Details:  CA R. Raghunathan, LL.B., FCA, ACMA, DISA | Senior Partner: M/s R. Sridharan & Co | Email: ca.raghu.he@gmail.com