Author: Abhishek Sanjay & Vishesh Prakhar are 2nd Year Students at NALSAR University of Law Hyderabad.

The paper aims to highlight the extent of the labour misclassification issue in India and the relevancy of such a discussion in the present scenario. The authors analyse the present legal framework in India, its lacunae and ambiguities and the jurisprudential evolution on the subject of misclassification. In order to compare with a cross-jurisdictional perspective, the authors carry out a comparative analysis of foreign legislations, identifying the factors that such legislations implement in order to have a watertight labour framework. The authors ultimately propose a novel, systemic solution attuned to India’s current socio-economic landscape by advocating the implementation of a labour card system linked with Aadhaar. This mechanism aims to establish a comprehensive social security framework, comparable to those in nations like the United States, thereby ensuring robust protection and accurate classification within the labour sector. In doing so, the authors also engage with the idea of the criminalisation of misclassification as a white-collar crime and attempt to answer the core question of whether it is truly the way forward in India.

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Introduction

Labour law in India, as a beneficent legislation, primarily aims to protect workers by ensuring fair treatment, equitable remuneration, and adequate social security. However, the misclassification of workers poses a significant challenge to these objectives, as it often leads to the denial of legal protections that labour laws intend to provide. Worker classification forms the bedrock of labour law, determining the scope of rights and protections available to individuals within the workforce.

Traditionally, workers in India are categorised as employees or independent contractors, with substantial implications for their access to social security benefits, wage entitlements, and job security. However, the advent of the gig economy and non-traditional employment arrangements has blurred these classifications, leading to widespread instances of misclassification and the resultant deprivation of workers’ rights. The Indian legal framework has evolved through various judicial tests to ascertain the employer-employee relationship, including the control test, integration test, and multifactor test. These tests often fall short in addressing the intricacies of modern employment relationships, particularly in the context of temporary contract workers. The multifactor test, for instance, assesses control, integration, mode of remuneration, and economic dependency, yet it may not fully capture the complexities inherent in gig work, including flexibility of control and inconsistent engagement of work.

The authors, through this paper, aim to highlight the legal lacunae and the multiple ambiguities in the Indian legislative framework regarding the protection of workers from misclassification. By doing so, the authors also bring forward the relevancy and extent of the misclassification problem in India and further posits a novel and systemic solution through a comparative analysis.

The Extent of the Issue: Statistical Analysis

The plight of labourers in India is dire, as is evident by the stark statistics that reveal the grim realities they face. More than half of the nation’s economic output is derived from the unorganised sector, which contributes 90% to the employment generated within this segment. Employers frequently engage in misclassification to reduce costs, often utilising contractual labour through contractors to whom they are not obligated to provide any form of social security. This practice is prevalent across labour-intensive industries such as mining, quarrying, and construction, where the growth in unorganised and contractual work has surpassed the pace of formal employment since the 1990s.

Employers achieve significant cost savings through these practices, as evidenced by studies in the hospitality and restaurant industries, where nearly 98% of individuals are not permanently employed despite the consistent nature of business in these sectors. Despite long-term employment in their industries and skill development over time, often with the same employer, these workers are only paid statutory minimum wages.

Moreover, due to the absence of fixed-term contracts in various parts of the country, particularly in the construction and smaller manufacturing units, as well as certain public sector companies, contractors often withhold a portion of the worker’s wages as token money for job continuity. Further studies have shown that contract workers are subjected to longer working hours, which may or may not be paid. By enforcing working hours of no less than 12 hours, contractors manage to hire fewer workers at a lower cost.

In order to provide social security coverage to contract workers and other non-formalised workers, the government, under the PM-SYM scheme, launched the Labor Card enrollment nationwide. However, to date, it suffers from arduously minuscule coverage, covering a meagre 1% of the country’s existing labour force, as presented by government statistics.

Additionally, studies reveal that contract workers predominantly reside in slums or rented accommodations. These rented accommodations are scarcely better than the slums, with studies showing that over 60% of workers live in unhygienic environments lacking adequate water facilities or basic amenities such as toilets and proper electricity. The average earnings of a contract worker are insufficient to afford better living conditions, leaving little surplus after meeting basic needs. Consequently, instances of child labour are rampant, as children work to support economically struggling households.

Legislative Perspective in India

Under the existing legal framework, social security is provided to all members of Indian society as a social responsibility, irrespective of their productive capacity. This principle has led to the enactment of various social security measures over time, culminating in the Social Security Code 2020, which defines the social security regime for the working populace. Two primary schemes that cover workers, excluding government servants, are the Employees’ Provident Fund and the Employees State Insurance schemes. These schemes offer a range of benefits, including pensions, maternity benefits, free or subsidised healthcare, and high-interest savings, in exchange for contributions from both employees and employers. However, these schemes primarily cover regular employees at private enterprises, thereby excluding a significant proportion of the workforce. Contractual workers are governed by the Contract Labour (Regulation and Abolition) Act (C.L.R.A.), which provides similar but less extensive benefits and places the employer’s liability on the contractor. As shown in the above section, the majority of the Indian workforce comprises contractual workers who are employed through contractors and, consequently, do not directly receive these benefits.

Judicial interventions have sought to expand the scope of social security coverage in India. The Hon’ble Supreme Court, in the case of C.E.S.C. Ltd. v. Subash Chandra Bose, recognised social justice, including social security, as a fundamental right, further enshrined in the Constitution as a Directive Principle of State Policy. Moreover, the Court, in Olga Tellis v. Bombay Municipal Corporation, expanded the ambit of social security by including it as part of the Right to Life. The Madras High Court, in Employees State Insurance Corporation v. S.M. Sriramulu Naidu, further broadened the interpretation of “employee” to include contract workers and other labourers employed through agents.

Additionally, the Occupational Safety, Health and Working Conditions (O.S.H.) Code 2020 imposes strict regulations, including periodic inspections of working conditions, notification requirements before layoffs, termination of contracts for contract workers, paid leave, and gratuity. However, in practice, the application of these regulations has been significantly narrowed. These regulations only apply to enterprises that regularly employ more than 10 people, exempting smaller establishments from these provisions. According to a report by the Ministry of Micro, Small, and Medium Enterprises (M.S.M.E.s), out of 63.35 million enterprises in India, 63.02 million falls under the micro categorisation, thus exempting them from such regulations.

The protections under the C.L.R.A. Act only apply to contractors and agencies with more than 20 employees, an arbitrary threshold that has been increased to 50 in several “business-friendly” states. A study by the University of Boston reveals that the median size of an Indian firm is nine employees, thereby exempting such firms from social security obligations for both contract and regular workers. Employers, faced with higher workloads, often opt to employ more contractual workers, thereby circumventing social security provisions. Additionally, other regulations, such as the Factories Act, apply only to units with more than 10 employees. Studies indicate that implementing social security increases employee costs for employers by up to 35% and leads to inspections by factory inspectors. Consequently, employers frequently resort to misclassification to reduce firm size, subjecting workers to substandard working conditions and artificially low real compensation.

Therefore, in both legal fiction and financial reality, there are incentives to classify workers as temporary and employ them on a contractual basis, even for long-term projects. This leads to a structural problem, as a result of which 94% of the Indian workforce is unable to avail of any social security benefits despite the robust measures on paper.

Cross-Jurisdictional Perspective

The Dutch framework for worker classification is often lauded as it comprises several legislative measures aimed at ensuring the correct classification of workers. The Deregulation of Labour Relations Act (D.B.A.) requires principals and contractors to jointly assess their relationship to determine if it constitutes employment, and to provide certainty in ambiguous cases, parties may use a model agreement. The Balanced Employment Market Act (W.A.B.), implemented in January 2021, set a moratorium on enforcement, fines and penalties, after which the employers are held liable for any misclassification. Additionally, to assist in compliance, the Dutch government even introduced a pilot web tool. However, for a country such as India, which is heavily reliant on the gig economy, adopting the Dutch framework in the present scenario not only poses the issue of a lack of grassroot implementation but also runs the risk of over-regulation, leading to economic deceleration. Instead of a seemingly utopian solution, the U.S. legal framework, wherein worker misclassification is a white-collar crime, can be considered as a primary step.

In the United States, The Fair Labor Standards Act (F.L.S.A.) and the Internal Revenue Code (I.R.C.) are two primary federal statutes governing worker classification. On March 11, 2024, the Department of Labor’s final rule, “Employee or Independent Contractor Classification Under the F.L.S.A.,” became effective. The I.R.C. and F.L.S.A. determine worker classification on broadly similar factors. It uses six economic factors to determine worker status: the opportunity for profit or loss based on managerial skill, degree of permanence of the work relationship, nature and degree of control by the employer, control over economic aspects including control over prices, rates for services, and marketing, with no single factor having predetermined weight under the final rule. The penalties for violation by an employer are generally payroll and taxation fines; however, if established to have fraudulent intent, repeat offenders can be held criminally liable under California’s Labor Code Section 226.8.

Labour laws in the United States primarily revolve around the doctrine of “employment-at-will“, which means that both employers and employees have the right to end their work relationship at any time, with or without cause. However, there exist three exceptions to this, including public policy, implied contracts and covenant of good faith.

For fixed-term contracts, the exception of implied contracts is pertinent as employees can claim the ‘reasonable expectation of renewal of contracts’ to claim permanency. Having recognised labour law as a beneficial legislation, American courts, through case laws such as Toussaint v. Blue Cross & Blue Shield of Michigan, recognised this concept and allowed employees contracted for long periods of time to receive benefits as permanent employees.

The Way Forward

As has been identified in the previous sections, the issue of misclassification of workers in India is not limited to the legislative lacunae in the present framework. Instead, the problem extends to the very basis of the labour structure in India and the systemic implementation of various beneficial policies. Though the current Indian regime offers robust social security standards on paper, the classification of firms on the basis of the number of employees they employ serves as an arbitrary standard wherein the Indian workers only stand to lose. This arbitrary classification disregards industry-specific nuances and heavily disincentivises the most labour-intensive industries, as has been shown in the previous sections. Furthermore, even if an employer endeavours to follow such arbitrary standards, the labour regulations of the country have been stuck in the past, causing employers to follow arcane obligations and making compliance arduous and burdensome.

Instead of relying on archaic arbitrary standards, existing frameworks and infrastructure can be modified and improved to provide social security under the current framework. Widespread adoption of the labour card, akin to the Aadhar system, could yield comprehensive insights into the socio-economic conditions and demographic composition of the workforce in real-time. Furthermore, integrating the labour card with the Aadhar system and the Employees’ Provident Fund Organisation (E.P.F.O.) could facilitate the development of an Indian counterpart to the American social security system. This objective could be efficiently realised by leveraging the existing digital infrastructure provided by the National Public Digital Stack, thereby enabling the formulation of a social security scheme based on individual contributions.

Moreover, international models of labour legislation must be considered. The criminalisation of willful misclassification of workers, as is the case in American legislation, must be adopted, and moratorium periods must be provided to employers so as to ensure gradual implementation. While the Dutch model of labour rights and protections may seem utopian in the present Indian context, it offers valuable lessons for substantial systemic change. Once the legislative changes are implemented, adopting the Dutch framework in gradual stages poses a feasible solution for accountability and compliance.

Much caution, however, must be taken so as not to over-regulate the country’s gig economy. Excessive regulatory burdens often result in increased operational costs for businesses, as they must allocate substantial resources to ensure compliance with complex and often cumbersome legal requirements. This heightened cost structure can render certain business models unviable, particularly in labour-intensive industries where profit margins are already thin. As a consequence, businesses may face economic pressures that lead them to downsize their workforce or, in extreme cases, cease operations entirely. Such outcomes not only precipitate mass unemployment but also diminish overall economic productivity and growth.

Based on the current legal position of misclassification and the realities and implications associated therewith, one thing is clear – we cannot afford to kick the can down the road. The instant paper is only an attempt to advocate for substantial change in the status quo.