As companies grow, their workforce rarely stays neatly full-time. There are permanent employees, fixed-term employees on defined contracts, consultants and contractors billing through invoices, and workers engaged through staffing agencies. Each of these is treated differently for payroll and statutory purposes, and getting the classification and the treatment right is both a compliance matter and a cost matter. The Labour Codes have also changed the picture meaningfully, particularly for fixed-term employees.
This guide walks through how payroll differs across these categories and where the risks lie.
The main categories
It helps to be precise about the categories, because the differences in treatment flow from them.
A full-time permanent employee is on the company's rolls with no fixed end date, fully covered by the statutory framework — PF, ESI, gratuity, bonus, and the rest, subject to the applicable thresholds. A fixed-term employee is on the rolls but engaged for a defined period under a fixed-term contract; they are employees, not contractors, but their engagement has an end date. A contractor or consultant is not an employee at all — they provide services and bill the company, typically through invoices, and are governed by a service contract rather than employment. A contract worker engaged through a staffing or manpower agency is technically employed by the agency, which handles their payroll and statutory compliance, while they work at the company's premises.
The crucial distinction running through all of this is employee versus non-employee. Employees — whether permanent or fixed-term — attract the statutory payroll obligations. Genuine contractors and consultants do not, because they are not on the payroll; they are paid against invoices with a different tax treatment.
Full-time and fixed-term — the statutory treatment
For employees on the rolls, payroll runs through the full statutory machinery. Salary is structured into basic, allowances, and benefits. PF and ESI apply subject to the thresholds. TDS on salary is deducted under the income-tax framework. Gratuity, bonus, and leave encashment accrue per the applicable rules. In short, a fixed-term employee's payroll looks much like a permanent employee's payroll while their contract runs — the difference is the defined end date, not the statutory treatment during employment.
The big Labour Codes change for fixed-term employees
This is the development that matters most in this category. Under the Labour Codes, effective from 21 November 2025, fixed-term employees gain important parity with permanent employees. Most significantly, fixed-term employees become eligible for gratuity after completing just one year of service, rather than the usual five-year threshold. This is a substantial shift — historically, fixed-term workers rarely qualified for gratuity because their contracts ended before five years, but the one-year rule changes that entirely.
The Codes also reinforce that fixed-term employees should receive benefits and conditions on par with permanent employees doing similar work. For employers, this means fixed-term engagements now carry statutory cost implications — particularly the one-year gratuity eligibility — that need to be built into cost planning and into the full and final settlement when a fixed-term contract ends.
Contractors and consultants — a different framework entirely
A genuine contractor or consultant is outside the salary-payroll framework. They are not employees, so PF, ESI, and gratuity do not apply to their engagement, and they are not part of the salary TDS framework. Instead, they bill the company for their services, and the company's obligation is to deduct TDS on those payments under the relevant provisions for professional or contractual payments — a different TDS mechanism, at different rates, from salary TDS. The contractor handles their own tax affairs and typically their own GST where applicable.
The appeal of engaging contractors is clear — lower statutory overhead and flexibility. But this is exactly where the misclassification risk lives, and it is a serious one.
The misclassification risk
The single biggest danger in this area is treating someone as a contractor when, in substance, they are an employee. If a person works exclusively for the company, under its control and direction, on its premises, on fixed hours, integrated into its teams, drawing a regular monthly amount — calling them a "consultant" and paying them against invoices does not change the underlying reality. Authorities and courts look at the substance of the relationship, not the label on the contract.
If a relationship that is genuinely employment is dressed up as a contractor arrangement to avoid PF, ESI, gratuity, and salary TDS, the company is exposed to back-dated statutory dues, interest, penalties, and the reclassification of the relationship as employment. This is not a hypothetical risk; misclassification is an area of active scrutiny. The safe approach is to classify based on the true nature of the relationship — genuine, independent service providers can be contractors; people who are employees in all but name should be on the payroll.
TDS — the two different mechanisms
It is worth being explicit about the tax-deduction difference, because it is a frequent point of confusion.
For employees (permanent and fixed-term), TDS is deducted on salary under the salary-income framework — the employer estimates annual tax liability across the regimes and deducts monthly, as covered in our TDS on salary guide. For contractors and consultants, TDS is deducted on the payments made to them under the provisions for contractual or professional payments, at the applicable rate for that category, with the contractor accounting for their own income tax. These are genuinely different mechanisms, and applying the wrong one — salary TDS to a contractor, or contractor TDS to an employee — is both incorrect and a sign of possible misclassification.
Common mistakes
The recurring errors in this area are consequential.
Misclassifying employees as contractors to reduce statutory cost, exposing the company to back-dated dues and penalties.
Overlooking the new one-year gratuity eligibility for fixed-term employees under the Labour Codes, and under-providing for it.
Applying salary TDS to genuine contractors or contractor TDS to actual employees.
Forgetting that fixed-term employees attract the full statutory treatment during their engagement, not a reduced version.
Assuming agency-supplied contract workers carry no compliance responsibility for the principal employer, when in fact there are obligations around contract labour that the principal employer must heed.
Why classification and payroll belong in one system
The complexity here comes from the fact that different worker categories carry different statutory treatments, different TDS mechanisms, and now different benefit eligibilities under the Labour Codes — and the cost of getting the classification or the treatment wrong is significant. When worker type, payroll treatment, and statutory calculations live in disconnected systems, it is easy for a fixed-term employee's one-year gratuity eligibility to be missed, or for the wrong TDS mechanism to be applied.
When the workforce record, payroll, and statutory engine sit on a single database, each worker's category drives their payroll and statutory treatment automatically — a fixed-term employee gets the full statutory machinery including the one-year gratuity rule, a permanent employee the standard treatment, and the system applies the correct framework consistently. The classification is captured once and flows through to every calculation. This is part of how Helion handles a mixed workforce — because the worker's type and their payroll are the same record, the right statutory treatment follows from the classification rather than depending on someone remembering the rules for each category. For a growing company with permanent staff, fixed-term hires, and contractors all in the mix, that consistency is what keeps the compliance exposure contained.
This guide describes the general framework for full-time, fixed-term, and contract engagement in India as of 2026, including the four Labour Codes effective from 21 November 2025 and the fixed-term gratuity change. Classification, statutory coverage, gratuity eligibility, and TDS treatment are governed by the applicable statutes and continue to settle in detail, and misclassification carries real legal risk. This is general information for employers, not a substitute for advice from a qualified professional on your specific workforce arrangements.