Understanding TDS on Contractors: A Simple Guide to Section 194C

TDS, or Tax Deducted at Source, is a way for the government to collect income taxes directly from income sources to reduce tax evasion. Instead of waiting until later, income taxes are taken out when payments are made.

TDS applies when businesses pay contractors and subcontractors for work, including labour. This is outlined in Section 194C of tax law, which is important for businesses that hire contractors to understand. Following these rules helps avoid penalties and keeps finances in good shape.

Section 194C covers many types of work, especially contracts where work is done, like construction or manufacturing, rather than just selling goods. Knowing what counts as work under Section 194C is important for compliance.

If a contractor hires another subcontractor, the main contractor must also deduct TDS from payments made to that subcontractor.

Types of Work Covered by Section 194C for Tax Deductions

Section 194C of the Income Tax Act outlines the types of work for which tax can be deducted at the source when paying contractors and subcontractors. 

Here’s a simple list of what’s included:

• Building Construction: This includes residential, commercial, and industrial buildings.
• Infrastructure Projects: Projects like roads, bridges, and dams.
• Production of Goods: When contractors provide labour to make products.
• Services: Any work done by contractors, like maintenance and installation.
• Consulting Work: If the contractor is doing actual work, not just giving advice.
• Labor Supply: Payments for contractors supplying labour in different sectors.
• Subcontractor Payments: Payments made by a main contractor to subcontractors for any covered work.
• Transportation Services: Payments for moving goods physically.
• Project-Specific Work: Includes civil, electrical, or mechanical work related to a specific project.
• Broadcasters and Telecasters: Payments made by broadcasters or telecasters to production houses for creating content will attract TDS only if two conditions are met: the content must be produced according to the broadcaster’s specifications, and the copyright of the content must be transferred to the broadcaster or telecaster.
• Sponsorship Payments: For sponsoring events like debates or seminars, where the agreement is essentially for advertising.
• Advertisement Costs: For advertisements included in souvenirs published by organisations.
• Printed Material Supply: For supplying printed materials according to specific guidelines.

However, payments just for goods without any associated work do not fall under Section 194C.

Also, salaries paid to employees are not covered here; they fall under Section 192.

TDS Rates for Contractors under section 194C

According to Section 194C of the Income Tax Act, the TDS rates for payments to contractors are:

Note: If the contractor does not provide their PAN, the TDS rate will be 20%.

Threshold Limit under section 194C

Under Section 194C of the Income Tax Act, the threshold limits for TDS on payments to contractors are as follows:

Example calculation

For example, Company A engages Contractor B for a construction project. Here’s how the TDS provisions apply:

Payment Details:

• Payment 1: ₹25,000 (for initial work)
• Payment 2: ₹50,000 (for additional work)
• Payment 3: ₹20,000 (for finishing touches)

Total payments made to Contractor B is ₹25,000 + ₹50,000 + ₹30,000 = ₹1,05,000

Since the total exceeds ₹1,00,000 in the financial year, TDS must be deducted from the entire amount.

Assuming the contractor is not an individual or HUF, TDS at the rate of 2% of ₹1,05,000 = ₹2,100

When to Deduct TDS under section 194C

According to Section 194C, any person responsible for paying a sum to a resident contractor for work under a contract must deduct income tax at whichever event occurs first:

• When the payment is actually made.
• When the amount is credited to the contractor’s account.

This means, tax should be deducted at the time when the payment is made to the contractor. This applies whether the payment is made in cash, by cheque, or by any other means. If the payment is credited to the contractor’s account (in books of accounts) but not yet paid, tax should be deducted at that time.

Example

If Company A pays Contractor B ₹50,000 on April 1, TDS under section 194C should be deducted at that time. If Company A credits ₹60,000 to Contractor B’s account on April 15 but pays him later, TDS should still be deducted under section 194C at the time of crediting the account.

TDS Compliance for Contractor Payments

To comply with TDS rules for contractor payments under Section 194C, here are the key steps to follow:

• Collect PAN: Always get the contractor’s Permanent Account Number (PAN). If they don’t provide it, a higher TDS rate of 20% will apply.
• Deduct TDS: Deduct tax under section 194C at the rates of 1% for individuals or Hindu Undivided Families (HUF) and 2% for others, if the payment exceeds ₹30,000 in one transaction or ₹1,00,000 in a financial year.
• Timing of Deduction: Deduct TDS under section 194C when the payment is made or when the amount is credited to the contractor’s account, whichever happens first.
• Deposit TDS: Pay the deducted tax to the government by the 7th of the following month.
• File Returns: Submit quarterly TDS returns (Form 24Q) to report the tax deducted during that quarter, including details of all contractors.
• Provide TDS Certificate: After deducting tax under section 194C, give the contractor a TDS certificate (Form 16A) showing the amount deducted. This is important for their tax filings.
• Keep Records: Maintain proper records of all payments made to contractors, the tax deducted, and any certificates issued. This documentation is essential for compliance and audits.
• Check Form 26AS: Ensure that the deducted amount appears in Form 26AS, which shows the tax deducted and deposited against the contractor’s PAN.

Following these steps is important for both the payer and the contractor to avoid penalties and ensure everything runs smoothly.

Exemptions from TDS under Section 194C

You don’t need to deduct TDS under section 194C in the following cases:

• Payment Thresholds: If a single payment is less than ₹30,000 or if total payments to the same contractor in a financial year are under ₹1,00,000.
• Deductor is not subjected to tax audit U/S 44AB(a) or 44AB(b): If the contractor’s total income is below the limits set by the Income Tax Act (currently ₹1 crore for businesses or ₹50 lakh for professionals) and they have no taxable income, TDS may not apply.
• Goods Only: Payments made just for the supply of goods, without any work involved, are not covered under Section 194C, so TDS isn’t needed.
• Transport Agencies: When payments are made to a  transport agency engaged in business of plying, hiring or leasing of goods carriage, where such contractor owns not more than 10 goods carriage at any time during the previous years for transporting goods, and the contractor provides their Permanent Account Number (PAN).
• Certain Entities: Payments to specific organizations, like government bodies or certain exempt groups, may also be exempt from TDS.
• Other Tax Sections: Payments that are covered by other sections of the Income Tax Act (like salaries under Section 192) don’t require TDS under Section 194C.

Consequences of not following TDS rules

If you don’t comply with TDS rules under Section 194C, you may face several serious consequences:

• Interest Charges: If TDS isn’t deducted or paid on time, you’ll owe 1% interest per month on the unpaid amount.
• Penalties: If you fail to deduct TDS when required under section 194C, you can be penalized. The penalty can be equal to the amount of TDS you should have deducted.
• Disallowed Expenses: If TDS isn’t deducted under section 194C, the tax authorities may disallow the expenses you claimed in your profit and loss statement, resulting in higher taxable income.
• Late Filing Penalties: If you file TDS returns late, you may face a penalty of ₹200 for each day of delay.
• Higher TDS Rate: If the contractor doesn’t provide their PAN, you may have to deduct TDS at a higher rate of 20%, which can be a financial burden.
• Legal Action: Continuous non-compliance may lead to legal action from tax authorities, including possible prosecution in serious cases.
• Reputation Damage: Not following TDS rules can harm your business’s reputation, making it harder to work with contractors and other partners.
• Increased Audits: Non-compliance raises the chances of being audited by tax authorities, leading to more scrutiny of your financial records.

Always check for updates from the Income Tax Department about changes to TDS rates or rules. It’s essential to comply with TDS rules to avoid these severe consequences. 

Regular training and consulting with tax professionals can help you stay compliant and reduce risks.

Frequently Asked Questions (FAQs)

What is Section 194C?

Section 194C is a part of Indian tax law that explains how to deduct tax (TDS) when making payments to contractors who do work for certain organizations, like government bodies or companies.

When is TDS under section 194C applicable to contractors?

If you pay a contractor up to ₹30,000, you don’t need to deduct any tax. However, if you pay that contractor more than ₹1,00,000 over the course of the financial year, you must deduct TDS on those payments.

What is the TDS rate under Section 194C?

As per section 194C, the TDS rate varies based on who you are paying:

• If the payment is to an individual or a Hindu Undivided Family (HUF), you deduct 1%.
• If the payment is to a business or another type of entity, you deduct 2%.

When is tax deducted (TDS) under Section 194C?

You need to deduct tax either when you add the payment to the contractor’s account (like when you record it) or when you actually make the payment (like giving cash or writing a cheque)—whichever happens first.

Do you need a written contract to deduct TDS under Section 194C?

No written contract is necessary. Even if you and the contractor have just a verbal agreement, you still need to deduct TDS.

When is TDS not deducted under Section 194C?

You don’t need to deduct TDS under section 194C in these situations:

• If the payment is up to ₹30,000.
• If the total payments to the contractor in a financial year are under ₹1,00,000.
• If an individual or HUF pays the contractor for personal use (not business-related).
• If the payment is for transporting goods, and the contractor provides their Permanent Account Number (PAN).

Does Section 194C cover payments for manpower supply?

Yes, payments made to labour supply agencies for providing workers are included under Section 194C since these agencies supply labour. 

However, payments made to recruitment agencies, which help hire staff, fall under a different section (194J) that applies to service payments.

What is a sub-contractor according to Section 194C?

A sub-contractor is someone who has a contract with a main contractor to do part of the work or provide labour for that work. 

Essentially, they help the main contractor fulfill their obligations under their contract with the client.