Manav Pamnani & Huzaifa Kapadia
Abstract: This paper discusses the recent Assistant Commissioner of Income Tax v. Paul Dhinakaran decision, which held that a mere existence of managerial authority or designation is insufficient to negate the presence of an employment relationship, particularly when other factors, such as a contract of service, fixed remuneration, and documentary evidence, indicate the same. It explores the current legal position pertaining to the determining tests that have been judicially evolved to establish an employment relationship and argues that these tests fail to account for the intricate nature of employment relationships today, with their practical application remaining fragmented. Therefore, it ultimately proposes a single, integrated test to account for and resolve the identified discrepancies.
Introduction
Recently, through a judgment delivered on October 31, 2025, in Assistant Commissioner of Income Tax v. Paul Dhinakaran (‘Dhinakaran case’), the Income Tax Appellate Tribunal, Chennai (‘ITAT’), ruled that the mere title of managing director does not preclude a person from being classified as an employee[¶8.4]. This case involved a dispute under Section 6 of the Income Tax Act, 1961 (‘IT Act’), wherein Mr. Dhinakaran’s global income was taxed in India, in spite of him being a non-resident Indian. The principal issue was whether Mr. Dhinakaran, the assessee, could be regarded as an “employee”, in accordance with the established tests, for the purposes of determining the residential status under Explanation 1(a) to Section 6(1) of the IT Act [¶8]. This Explanation provides that a person who leaves India in any previous year for the purposes of employment outside India shall not be treated as a resident unless he stays in India for over one-hundred and eighty-two days during that year. The Revenue argued that the assessee’s senior managerial position and the control they exercised over the organisation were inconsistent with the fundamentals of the employer-employee relationship [¶6]. On the contrary, the assessee contended that they were working under a contractual employment arrangement and receiving remuneration that was treated as salary in the United States [¶¶7, 8.2]. The ITAT ultimately rejected the Revenue’s position and held that the existence of managerial authority or designation did not negate employment, emphasising upon the presence of a contractual relationship of service, fixed remuneration, and documentary evidence of employment [¶8.4].
However, the judgment does not clearly articulate the doctrinal framework through which the conclusion was reached. The reasoning appears to implicitly draw from elements of the substance over form approach by refusing to accept the assessee’s mere designation as determinative of the issue. However, the Tribunal has invoked multiple overlapping considerations without following a coherent analytical hierarchy, consequently failing to clarify how the traditional tests or existing factors should be applied in the context of senior executives or individuals exercising significant operational autonomy. It is this doctrinal uncertainty that motivates and guides this paper’s attempt to re-examine the existing tests and propose a consolidated analytical framework that is capable of addressing modern employment structures. The paper, therefore, explores the current legal position pertaining to the determining tests that have been judicially evolved to establish an employment relationship. It argues that these tests fail to account for the intricate nature of employment relationships today with their practical application remaining fragmented, and ultimately proposes a single, integrated test to account for and resolve the identified discrepancies.
Existing Judicial Framework for Determining Employment Relationships
There are various tests developed through jurisprudence in India which aid in the determination of the employer-employee relationship. One of the most important tests developed, is the “Control and Supervision” test. It follows that the greater the degree of control exercised over the manner in which work is performed, the stronger the inference of employment. Importantly, control should not be limited to micromanagement and even senior employees may remain subject to the ultimate authority of a governing body, such as a board of directors. In the landmark case of Commissioner of Income Tax v. B.P. Dalmia(‘B.P. Dalmia case’), the assessee was a director of a company and characterised his remuneration received as salary and claimed standard deduction under Section 16(i) of the IT Act but the taxing authority, on account of the wide power and control over the affairs of the company exercised by the assessee, did not treat him as an employee for the purpose of taxation [¶2]. Ultimately on appeal, it was held by the High Court of Calcutta that on a perusal of the Articles of Association, it was clear that such a managing director was to discharge his duties and powers subject to the direct control and supervision of the Board of Directors, and hence, there existed an employer-employee relationship [¶6]. Indian courts have repeatedly clarified that managerial authority does not negate employment if such authority is exercised within the limits set by the employer. An explicit reference to the control and supervision test would have underscored why the Revenue’s reliance on “control” was conceptually flawed rather than merely unsupported by evidence in the Dhinakaran case.[A1] [K2] In the Dhinakaran case, the Revenue had argued that because the assessee was the President of the organisation and exercised managerial authority, they could not be an employee [¶6]. The flaw in this reasoning is that the control and supervision test does not require day-to-day supervision [Ram Pershad v. Commissioner of Income Tax, ¶14] and even senior executives with operational autonomy may be employees if their authority is delegated and ultimately subjected to the employer’s institutional authority, such as a board or governing body [Ram Pershad v. Commissioner of Income Tax, ¶14], as is evident from the B.P. Dalmia case discussion above.
Closely allied to the Control and Supervision test is the “Hire and Fire” test, which examines whether an employer/payer has the contractual right to terminate the engagement. While not conclusive by itself, the power of termination has traditionally been treated as a strong indicator of employment. However, Indian jurisprudence has also cautioned that this power must be understood contextually, as even agents and independent contractors may be terminated for cause. In the case of Ram Pershad v. Commissioner of Income Tax, the issue was whether commission received by a Managing Director was salary or business income [¶4]. The Supreme Court held that since the director could be removed for non-performance or acting against the company’s interest, the relationship was one of employment and the commission constituted salary income [¶¶14, 15]. In Stya Paul v. Commissioner of Income Tax (‘Stya Paul case’), where the assessee was Managing Director of two companies under their articles of association, without a separate employment contract [¶¶2,3,4], the Calcutta High Court held that in company ‘S’, where the assessee had powers to appoint and remove directors, he could not be treated as an employee [¶¶13, 34]. In contrast, in company ‘A’, where he was required to act under the board’s directions and could be removed by the company through an overriding article, the relationship amounted to employment [¶¶33, 34]. Hence, it would not be wrong to say that engaging with the hire and fire test would have allowed the Tribunal to clarify, in the Dhinakaran case that the mere improbability of termination due to seniority or influence does not erase the existence of a contractual power to terminate.
Lastly, and perhaps the most compelling framework, is that of the “substance over form” test, which Indian courts have increasingly favoured when clever phraseology has camouflaged the real nature of the engagement. The test clearly states that even if an engagement has all the requisites of a quintessential of a contract of service, namely fixed remuneration, predetermined work hours, gratuity, leave salary, and so on, the totality of the contract would be looked into. A landmark case in this regard is that of Hosmat Hospital P. Ltd v. Assistant Commissioner of Income Tax, where consultant doctors were engaged on fixed remuneration with defined working hours, long tenure, a non-compete clause, and were subject to the hospital’s control [¶2]. The Tribunal in this case held that the substance of the arrangement, not its nomenclature, determines its nature, and the intention of the parties must be gathered from the contractual terms [¶7]. Another case worth engaging in this regard is that of Red Chillies Entertainment (P) Limited v. Deputy Commissioner of Income Tax, wherein a film production company had personnel engaged under retainer agreements, who received fixed remuneration, performed assigned duties, were entitled to leave, and were provided company facilities [¶¶4, 9, 10]. The Tribunal held that despite the absence of some employment benefits, the overall arrangement evidenced an employer–employee relationship [¶¶12, 13, 14].
Problems with the Existing Framework
The current framework as examined above, although extensive and settled, posits the problems of fragmentation and doctrinal incoherence. Indian courts in practice, apply multiple tests without articulating a clear hierarchy or unified framework. The selective application of different tests to identical fact situations often results in contradictory conclusions. For instance, in disputes involving managing directors or senior executives, some courts emphasise control by the board, while others prioritise the individual’s operational autonomy. In Commissioner of Income Tax v. M.S.P. Rajes, the Karnataka High Court held that the very existence of power of control and superintendence in the board of directors would render the relationship as an employer-employee one [¶18]. On the contrary, in the Commissioner of Income Tax v. Balabhai Nanavati Hospital case, the Bombay High Court held that since the appointed doctors were free to practice independently in other hospitals, were not bound by any fixed schedule, and were not subject to the hospital exercising real supervisory control over them, they could not be considered as employees [¶14]. Therefore, evidently, the doctor’s operational autonomy was the decisive factor here. Further, as examined above, in the Stya Paul case, the Court in the context of one company held that since the Managing Director had the power to appoint and remove directors, they could not be considered an employee [¶¶13, 34]. This reasoning is flawed because it fails to consider that irrespective of the power of appointment or termination, even the managing director is subject to the control of the Board, has to carry out functions within the overarching policy structure of the Company, and can be removed by passing a resolution to that effect. Therefore, a single situation could potentially lead to different conclusions because of the complex nature of employment relations today. This often results in doctrinal inconsistency and fragmentation, consequently preventing the emergence of a stable legal principle. Therefore, to prevent transforming adjudication into a fact-sensitive exercise with limited precedential value, this paper subsequently introduces a single, integrated test.
Further, the traditional “control and supervision” test is conceptually outdated because it often equates employment with visible, day-to-day supervision, except a few instances, as seen in the B.P. Dalmia case above, wherein institutional control was emphasised [¶6]. For example, in the Shivnandan Sharma v. Punjab National Bank case, it was held that the difference between a servant and an independent contractor is that in the case of a servant, the master controls not only what is to be done but also the manner in which the work has to be performed [¶¶15, 16]. Further, the Court laid emphasis upon the fact that the bank exercised direct day-to-day control over the treasurer’s assistants and the cash department and ultimately concluded that the relationship was that of employment [¶¶17, 24]. Subsequently, in Dharangadhara Chemical Works Limited v. State of Saurashtra, the Supreme Court adopted a similar line of reasoning and stated that the distinction between a contract for and of services is that in a contract of service, the master can not only order what is to be done but also how it should be executed [¶9]. This implicitly indicates a day-to-day supervision because the manner of performance is itself being controlled. In modern corporate and professional settings, especially involving senior management or specialised professionals, control is often exercised institutionally rather than operationally. Although managing directors and other heads of department may enjoy wide discretion in execution, they remain subject to removal and policy constraints of the institution or entity they function within. The presence of autonomy or influence is frequently misconstrued as evidence of independence, even though such attributes may coexist with deep organisational subordination. This leads to unintended outcomes where junior employees are easily classified as employees, while senior executives, despite their economic dependence and institutional subordination, are considered independent. The existing test therefore fails to capture this distinction between delegated authority and independent autonomy.
Additionally, despite repeated judicial affirmations that substance must prevail over form, courts and tax authorities continue to place disproportionate weight on contractual labels such as “consultant,” “retainer,” or “professional fees.” The epitome of this is the recent Deputy Commissioner of Income Tax v. Agilus Diagnostics Limited case wherein the Respondent had engaged specialised doctors as full-time and part-time consultants [¶2]. The ITAT affirmed the decision of the Commissioner of Income Tax (Appeals) and placed decisive weight on the contractual label of consultancy, consequently concluding that the requirements of an employment relationship were not fulfilled [¶¶3,4]. Additionally, even if such precedents are not considered, in the absence of an integrated test, courts and tribunals retain their discretion to place undue emphasis on mere contractual labels. This incentivises strategic drafting by employers to disguise employment relationships through carefully worded agreements. The current tests also fail to account for considerations such as economic dependence and risk allocation and are often applied in a checklist-like manner with ultimate decisions often solely depending on the presence or absence of certain factors. Such mechanical application ignores the complex nature of employment relationships. Ultimately, these scattered tests and interpretations without standardisation have resulted in increased litigation, consequently raising costs and uncertainties. The test proposed in the section below aims to resolve these identified discrepancies.
The Integrated Economic-Functional Subordination Test: A Unified Proposal
This paper proposes the Integrated Economic-Functional Subordination Test (‘IEFST’) as the single integrated test to determine questions about employment relationships. It intends the IEFST to be used as a reference point for both future legislative amendments as well as judicial determinations. The IEFST establishes that an employer–employee relationship exists where, notwithstanding contractual form, seniority, or professional autonomy, the individual’s work identity is economically dependent upon and functionally subordinated to the institutional framework of the employer, such that the employer exercises ultimate authority over the manner in which the individual’s labour is integrated, deployed, and represented within its organisational structure. For the purposes of this stipulation, “economic dependence” would refer to the individual’s primary or substantial livelihood being sustained by a single institutional payer, with the individual not bearing entrepreneurial risk, lacking market-facing autonomy, and being exposed to structural economic vulnerability upon disengagement from the payer. This would be assessed not by absolute exclusivity but by the absence of an independent role or separate profit-making capacity and the continuity and predictability of remuneration received by the assessee. Further, “functional subordination” would denote a structural relationship wherein the individual’s work and functions would be organised under and constrained by the governance framework, policies, and strategic objectives of the institution, irrespective of the presence of any discretion in operation. An individual might exercise wide latitude and power in execution and decision-making but will still remain functionally subordinated if their authority is delegated, revocable, and exercised under the institution’s overarching chain of command instead of a purely independent professional capacity. The inquiry must not focus on episodic supervision or the presence of mechanical control. It should instead examine whether the individual operates within the employer’s governance ecosystem, subject to its board, policies, and strategic direction and whether they are performing functions that are integral or recurring to the enterprise rather than episodic, temporary, or project-specific. Additionally, this assessment rests on the allocation of economic risk and continuity. Where remuneration is fixed or assured, entrepreneurial risk is absent, and the individual’s livelihood exhibits sustained dependence on a single principal, the relationship tilts decisively toward employment.
Thus, for instance, a managing director or chief executive who exercises wide operational discretion but remains answerable to the board, removable by shareholder resolution, and bound by the company’s articles of association continues to operate under delegated authority rather than sovereign independence, indicating employment despite the absence of day-to-day supervision. Similarly, a senior consultant doctor engaged on a “retainer” basis by a hospital, who works exclusively for that institution, follows its clinical protocols, uses its infrastructure, and receives fixed monthly remuneration irrespective of patient inflow, is functionally integrated into the hospital’s core operations and bears no entrepreneurial risk, thereby satisfying economic dependence even though the contract disclaims an employment relationship. Conversely, an external specialist engaged for a discrete project, remunerated per assignment, free to serve multiple clients, and bearing the risk of non-engagement or market failure, would ordinarily fall outside the employment fold because their economic identity remains independent of any single payer.
No single factor is determinative, and the relationship must be assessed holistically to uncover the true structural reality of the engagement. This involves considering factors such as the weight of institutional authority, functional integration, and economic dependence together. The adoption of the IEFST is justified and significant because it consolidates fragmented judicial approaches into a single coherent framework, enhances predictability in tax and employment classification, neutralises strategic contractual drafting designed to disguise employment, accommodates the conception of modern professional and executive work arrangements, and aligns legal analysis with contemporary economic realities rather than outdated formalistic indicators.
It is important to flag the apparent resemblance that exists between the concept of dependent agency permanent establishment (‘PE’) in international taxation and IEFST as proposed above. Dependent agency PE arises when an agent, lacking entrepreneurial risk, acts predominantly for a single principal and represents the enterprise in a sustained and institutionally embedded manner. The agent is consequently treated as an extension of the foreign enterprise despite legal separateness and gives taxing rights to the domestic country over the profits earned through operation. However, despite the structural similarity, the two inquiries operate in fundamentally different domains for two major reasons. First, the dependent agency PE concerns itself with allocating taxing rights between jurisdictions and the attribution of profit in international taxation, whereas the IEFST is applied to determine the existence of employer-employee relationships in the domestic realm to compute the amount liable to be taxed as salary income. Second, dependent agency PE focuses on the authority of an agent to conclude contracts, the habitual exercise of that authority, and the representation of the enterprise externally, contrary to IEFST, which applies to the individual’s internal and continuous relationship with the institution.
Conclusion
This paper has conducted an analysis of the existing jurisprudential tests that have evolved to determine the existence of employment relationships. It has demonstrated how these tests often experience a staggered application and have failed to keep up with the dynamic nature of employment relationships today. It has ultimately proposed the IEFST as a single integrated framework to guide law-making and judicial determinations in the future. Moving forward, considering the burgeoning corporate sector of India, incorporating this test directly into the IT Act would be the correct approach, rather than leaving it entirely to the judiciary, consequently opening the possibility of interpretative ambiguities. A clear definition of an “employee” is required with detailed accompanying explanations, aligning with the IEFST that this paper has proposed. This would foster clarity and certainty, and align with India’s ambition of cementing its position as a global tax-friendly jurisdiction in the years to come.
Manav Pamnani is a fourth-year B.A. LL.B. (Hons.) student at the NALSAR University of Law, Hyderabad, a securities law enthusiast, an author of two books, and a qualified company secretary.
Huzaifa Kapadia is a third-year B.A. LL.B. (Hons.) student at the NALSAR University of Law, Hyderabad. He is passionate about corporate governance frameworks, securities law, and legal history.