Section 194C of Income Tax Act

Section 194C applies when any individual pays a contractor for the work done, such as labour supply. The payer is to deduct TDS while crediting the amount or making payment, whichever occurs first. This Income tax section aims to introduce transparency and accountability in dealing with contractors

Companies usually hire contractors for construction, transportation, and other specialised work. Under this Section, a portion of the payment must be deducted and paid to the government as TDS.

Certain major provisions determine the scope and applicability of this Section. First, TDS deductibility is the responsibility of the payer. Second, the contractor can be an individual, Hindu Undivided Family (HUF), partnership firm, company, or association. Third, TDS only needs to be deducted when the payment is above certain thresholds, thus avoiding unnecessary compliance for minor payments.

The TDS rate is different according to the payee category. The said provisions help ensure that only large contractor payments are brought covered, and the load on minor-scale payments is minimised.

The term "work" is generic under this Section and encompasses a range of activities. It entails advertising, broadcasting, carriage of cargo and passengers, catering, and manufacturing or producing goods to customer order based on materials provided by the customer.

It also entails repair, rebuilding, or construction work but if one sells goods without customisation, it is not "work" under this Section. The definition is framed to apply to all services based on contract where labour or expertise is employed. Understanding what constitutes work is crucial for appropriately applying the TDS provisions.

A contractor, in most situations, may not undertake the work himself and can delegate a part of it to someone else. The individual who has been assigned to this work is referred to as a subcontractor. The amounts paid by the contractor to the sub-contractor are also included under Section 194C of the Income Tax Act.

For instance, if a building firm hires a smaller firm to carry out electrical work on a project, the smaller firm is a subcontractor. The same rules on TDS are applicable to such payments too. This makes sure that tax is recovered equally on all levels of the chain of contractors and avoids leakage of revenue.

Agreements under this Section may be of different forms based on the type of work. Most prevalent are:

• Work contracts such as construction, repair, and installation.
• Service contracts, like catering and transportation.
• Manufacturing contracts in which products are produced according to customer specifications from the customer's materials.

Every type of contract carries the same TDS requirement, but in practice, the suitability rests on whether the payment crosses the threshold and whether the contract qualifies under the meaning of "work." This categorisation enables companies to understand under which of their contracts TDS deduction is applicable under Section 194C.

There are specific conditions that need to be fulfilled before the deduction of TDS pertaining to the payer and nature of contact etc. Let’s quickly understand them:

• First, the payer should be a named person, i.e., the government, company, firm, cooperative society, or any individual or HUF who are required to get their accounts audited in the last financial year.
• Second, the payment must be related to a contract for performing work, such as providing labor or services. Third, the sum should exceed the threshold limits notified under the statute. If these requirements are met, the payer is not left with any option but to deduct TDS prior to making the payment.

This structure only allows for actual contractual payments of a minimum amount to be covered and excludes deductions on small-scale work, as it is not required.

TDS under this Section must be deducted while crediting the amount to the account of the contractor or while making the payment, whichever is earlier. Whether the payment is made in cheque, cash, draft, or any other method, it does not matter.

For example, if an expense is accounted for by a company to be paid to a contractor, the TDS liability is incurred at that time, even if payment is made subsequently. The idea is that taxes should not be delayed and revenue should be protected at the earliest opportunity.

Not all payments to contractors are subject to TDS. The law allows definite exemptions in order to minimise the compliance burden. Payment to small contractors where the amount does not exceed the threshold limit is exempt.

Likewise, some contracts, like payment to transporters who have fewer than 10 goods carriages, are exempted if they provide their PAN. Individual or HUF payers who are not under tax audit provisions are also excluded from the scope of this Section. These exemptions make the system more convenient and simpler to adhere to for small taxpayers.

There are certain common cases where TDS is not required to be deducted:

• Payment made to contractors by individuals or HUFs is not subject to audit.
• Payment for contracts where the single payment is below the threshold limit.
• Payments to transporters who have 10 or fewer vehicles are liable to submit PAN.
• Payments are purely for the acquisition of goods without customisation.

These carve-outs prevent TDS rules from becoming a hindrance in day-to-day small-scale transactions.

The law has prescribed threshold limits to prevent unnecessary TDS deduction. The thresholds are as follows:

If the payment is above these thresholds, TDS is required. This prevents TDS deduction on small contracts for small contractors, while ensuring cover for larger transactions.

The TDS rate varies based on the recipient of the payment.

If the contractor does not provide PAN, TDS must be deducted at a higher rate of 20%. This differential rate system ensures fairness and compliance.

The calculation of Section 194C TDS is simple once the rate and threshold are known. The steps include:

Step 1: Input Basic Details

Enter the financial year, the resident status of the payee, and the type of recipient (individual, firm, etc.) into the TDS calculator or worksheet.

Step 2: Determine the Applicable TDS Rate

Identify the correct TDS rate based on the contractor or recipient category as prescribed under Section 194C.

Step 3: Calculate the Taxable Amount

Calculate the contract payment value, excluding GST if it is separately reported, since TDS is not deducted on GST.

Step 4: Compute TDS Amount

Apply the identified TDS rate on the taxable contract value to find the TDS amount to be deducted.

Step 5: Deduct TDS at Payment Time

Deduct the calculated TDS amount when making the payment to the contractor.

Step 6: Deposit TDS with the Government

Ensure the deducted TDS is deposited with the government within the prescribed due dates to avoid penalties.

For instance, if a company makes a payment of ₹5,00,000 to a firm for construction work, TDS at 2% (₹10,000) has to be deducted and paid.

At times, contractors feel the rate of TDS prescribed is more than their actual tax liability. In that case, they can make an application to the Assessing Officer (AO) for a lower or nil deduction certificate. The application is filed in Form 13 under Section 197 of the Income Tax Act. When this is granted, the payer can make the TDS deduction at the lower or nil rate specified in the certificate.

This is beneficial to contractors with thin margins or those already taxed under the tax reliefs. But in the absence of this certificate, the payer has to deduct TDS at standard rates to avoid penalties.

After deducting TDS, the payer has to issue a TDS certificate in Form 16A to the contractor. This certificate acts as proof that tax has been deducted and deposited with the government on behalf of the contractor. It contains details such as the amount paid, TDS deducted, and the challan identification number.

Contractors can use this certificate while filing their income tax returns to claim credit for the TDS deducted. Non-issuance of Form 16A can cause inconvenience to contractors, as they may not be able to claim the tax credit. Therefore, the timely issuance of this certificate is crucial for smooth compliance.

The TDS deducted should be paid to the government within certain time limits. For deductors other than the government, the due date is the 7th of the immediately succeeding month in which the TDS is deducted.

In the case of March, however, the due date is up to 30th April of the next financial year. Government deductors, however, must remit TDS on the same date. Without the use of challans, or within 7 days if challans are utilised. These tight time frames ensure that the taxes collected at source are paid to the government in a timely manner and assist in the effective collection of revenues.

If TDS is not deposited within the specified time, it incurs penalties and interest that is certainly the last thing any person wants.

The deductor has to pay interest of 1% per month from the date of deduction to the date of actual deposit. Further, such expenses on which TDS is not deducted or paid may be disallowed for arriving at taxable income, and consequently, increased tax liability.

The Income Tax Department can also impose a penalty and prosecute in serious cases. Therefore, it is always better to make TDS deposits on time to escape unnecessary expenses and legal issues.

While deducting TDS, certain documents are mandatory to provide proper compliance. Let’s check the items below:

• Copy of the agreement or contract with the contractor
• PAN details of the contractor
• An invoice or bill issued by the contractor
• Evidence of deposit of TDS (challan details)
• Details of payment to the contractor

Keeping these records is necessary not just for compliance but for audits or disputes in the future as well. Correct record-keeping provides transparency regarding how TDS was deducted and makes assessment processing smooth.

All deductors are required to file quarterly returns of TDS, reporting details of deductions. These returns are submitted in Form 26Q in case of non-salary payments. Due dates are:

• 30th June quarter: 31st July
• 30th September quarter: 31st October
• 31st December quarter: 31st January
• 31st March quarter: 31st May

Deductor needs to file correct TDS returns as the details appear in the contractor's Form 26AS. Any discrepancy will cause concern to both the deductor and the payee. Hence, timely and accurate submission is vital for Section 194C TDS compliance.

Non-compliance is liable to penalties as well as interest. Some of the most important consequences are:

Interest on Late Deduction and Deposit

If the deductor delays the deduction of TDS, interest at the rate of 1% per month (or part thereof) is levied from the due date of deduction until the actual deduction. Similarly, if the TDS is deducted but not deposited with the government on time, an even steeper interest rate of 1.5% per month applies from the date of deduction to the date of deposit. This dual-interest mechanism ensures timely compliance.

Heavy Penalties for Non-Deduction or Non-Deposit

In addition to interest, the law imposes a penalty equal to the amount of TDS that was either not deducted or not deposited. This means the deductor may have to pay double the tax amount, once as the actual TDS liability and once as a penalty, significantly increasing the financial burden.

Disallowance of Expenses for Tax Purposes

To discourage willful non-compliance, the Income Tax Act mandates that 30% of the expenses on which TDS was not deducted can be disallowed while computing taxable income. This effectively raises the taxable income and, consequently, the tax payable by the deductor.

Risk of Prosecution and Imprisonment

For serious or repeated defaults, criminal prosecution can be initiated against the defaulter. This may lead to stringent penalties including imprisonment for a term that can extend up to 7 years along with a substantial fine, damaging both personal freedom and professional reputation.

Why This Matters:

These strict provisions underline the government’s intent to ensure that deductors follow the TDS compliance rigorously. Failure to comply not only results in hefty financial penalties and interest but also risks business reputation and legal trouble. Timely and accurate TDS deduction and deposit safeguard against these consequences.

Sometimes, contractors might end up paying more tax because of TDS deduction. On such occasions, they can claim a refund when they file their income tax return. Refund is issued by the Income Tax Department after checking the details of the expenses, income, and taxes paid.

Contractors need to check whether their TDS details are reflected accurately in Form 26AS, which is submitted along with their PAN. Excess tax payment, if detected, is credited directly to the bank account of the contractor. This requires contractors to get Form 16A certificates from the payers and cross-match them with Form 26AS.