पाठशाला Pathshala · दल Dal, The team · Lesson 10 · Start

Contractors, interns and employees: who should be what

Every early role can be an employee, a contractor or an intern, and the labour codes in force since November 2025 changed what each costs. How to choose the form from how the work will be done.

Pathshala, The Founder Library · 11 October 2026 · 7 min read

A tailor's hands mark blue fabric with chalk on a cutting table. — Photograph: Ron Lach · Pexels

Every early role in an Indian startup can be filled three ways: an employee on payroll, a contractor on an invoice or an intern on a stipend. Founders usually choose by cost and paperwork, and the choice looks free until a dispute, a diligence call or a departing contractor who owns the code. The right form follows from the work, and the law has recently changed what each form costs.

This lesson sets out what each form promises, what the labour codes in force since November 2025 changed, what each form costs, when a contractor is really an employee, and a decision tree to walk each role through.

Three forms, three different promises

An employee sells the company their working time and accepts its direction. In return the company owes a salary, statutory benefits, an appointment letter and a fair process if the relationship ends. It gets control of how, when and where the work is done, and the person can hold options under the company’s ESOP scheme.

A contractor sells a result. They control the method, usually work for more than one client, invoice the company and charge GST if registered. The company gets flexibility and no long-term obligation. It does not get control of the method, it does not own what the contractor produces unless the agreement assigns it, and a contractor cannot hold options, because Rule 12 limits options to employees and directors.

An intern is learning. The arrangement is time-limited, supervised and educational, paid as a stipend rather than a salary. It is a legitimate form for students and recent graduates when the learning is real. It is not a cheaper way to employ someone.

The labour codes made a fourth form more useful: the fixed-term employee, hired directly for a defined period with full parity in wages and benefits with permanent staff. It suits project work that needs direction, which is exactly where founders most often reach wrongly for a contractor.

What the labour codes changed

The government brought the four labour codes, on wages, industrial relations, social security and occupational safety, into force on 21 November 2025, replacing twenty-nine central labour laws. Four changes matter to a startup choosing between forms.

Appointment letters are now mandatory for all workers, stating job details, wages and social security. Fixed-term employees get the same benefits as permanent ones and become eligible for gratuity after one year of continuous service rather than five. Wages for gratuity and social security are defined uniformly, with anything beyond half of total remuneration added back to wages, so a salary built from a small basic and large allowances no longer shrinks the base for benefits. And gig work, platform work and aggregators are defined for the first time, with social security extended to gig and platform workers. Normal working hours are capped at eight a day and forty-eight a week, with overtime only by consent and at twice the normal rate.

For labour supplied through a contractor, the threshold at which the occupational safety code’s contract-labour provisions apply rose from twenty to fifty contract workers. That matters to operations-heavy companies using staffing agencies. It does not change how the company treats an individual freelancer it engages directly.

What each form actually costs

Take a role worth ₹12 lakh a year to the person doing it. As an employee, the company’s cost is the cost-to-company figure in the offer, which in a well-drafted offer already includes the employer’s provident fund contribution and the gratuity accrual, plus insurance, a laptop and the time to run payroll. The company deducts tax at source on salary each month.

As a contractor at ₹1 lakh a month, the company pays the invoice plus GST if the contractor is registered, which a GST-registered company can usually claim back as input credit, and deducts tax at source. Under section 393 of the Income-tax Act, 2025, as the department’s table stood on 10 October 2026, fees for professional services attract TDS at 10 per cent above ₹50,000, fees for technical services at 2 per cent, and payments to contractors for work at 1 per cent for an individual and 2 per cent for others, above ₹30,000 for a single payment or ₹1 lakh in a year. The [TDS lesson](/library/tds-tax-you-deduct-and-why-it-trips-startups) has the deposit and return calendar.

The cash difference is smaller than founders expect. A good contractor prices in the benefits an employee would get and charges a premium for flexibility. What the contractor form saves is commitment: no notice period, no gratuity, no process at the end. What it costs is control, ownership by default, the ability to grant options and, if the arrangement is really employment, the risk that it is treated as employment when it ends badly.

An intern’s stipend is the cheapest line on the sheet, but supervision is not free. A founder who spends five hours a week supervising an intern is paying in the scarcest currency the company has. Take interns when someone has the time to teach and a defined project to teach on.

When a contractor is really an employee

The label on the agreement is the weakest evidence of what a relationship is. If a contractor works hours the company sets, on the company’s laptop and email, reports to a manager, attends every stand-up, works for no one else and has done so for a year, the relationship looks like employment whatever the contract says. In a dispute over dues, a termination or a claim to benefits, the question will be how the work was actually done.

A construction worker climbs bamboo scaffolding on a building site. — Scaffolding is meant to come down when the building stands. A contractor arrangement that has stood for a year has become part of the structure. Photograph: Rohith Vishaal · Pexels

The rule that follows: a contractor arrangement that has become continuous, directed and exclusive should become employment, fixed-term or permanent, at the next quarterly review. Convert before the person asks, and before an investor’s diligence asks why a third of the engineering team is on invoices. Sam Altman’s advice on hiring is to start strong candidates on a day or two of paid contract work as an audition. That is the right use of the contractor form: a short trial before an offer, not a permanent substitute for one.

Whatever the form, take a written assignment of what the person creates. For contractors it is the only way the work becomes the company’s; for employees it removes any argument about what was made in the course of employment. Every contractor agreement also needs confidentiality and data terms. The [IP assignment lesson](/library/ip-assignment-company-owns-what-you-built) has the wording to check for.

The decision, role by role

Walk each role through the tree. It asks the questions that decide the form: whether the work continues or ends, whether you will direct the method, whether the person is learning, and whether the work touches what the company must own.

Most early teams end up mixed, and that is right. A twelve-person company with nine employees, two contractors on defined projects and one intern on a three-month plan is well structured. One with four employees and eight long-term exclusive contractors has built a liability into its legal position and its culture: the contractors cannot hold options, sit outside the company’s policies and will leave the week a salaried offer arrives.

Choose the form from how the work will be done, not from what is cheapest to paper. The law, the investor and the person doing the work will all look at the substance.

The quarterly review of every non-employee

On the first working day of each quarter, list every contractor and intern and answer four questions for each. Has the work become continuous, directed and exclusive? If so, make an offer of employment this quarter. Is there a signed agreement with IP assignment, confidentiality and data terms? If not, fix it this week. Is TDS being deducted and deposited at the right rate, with the contractor’s PAN and GST status on file? Does each intern have a supervisor, a learning plan and an end date, and has anyone stayed past six months? An intern past six months is usually an underpaid employee.

Then check that every employee has an appointment letter that meets the codes and that every fixed-term contract has an end date someone is watching. The whole review takes an hour for a team of twenty, and it is the hour that turns due diligence into a formality. The [first ten hires](/library/first-ten-hires-who-and-in-what-order) lesson says which roles to fill first; this one says on what terms.

Nothing here is legal, tax or investment advice. The labour codes, their central and state rules and TDS rates change; check the current position on the date you act, with a lawyer and an accountant.