Deducting TDS on Contractor Payments Under Section 194C

TDS on Payments to Contractors: Section 194C / Section 393 Guide for FY 2026-27

If your business pays a contractor, a sub-contractor, a transporter, a caterer, or an advertising agency, you are almost certainly required to deduct TDS before releasing the payment. Section 194C of the Income Tax Act 1961 (now consolidated into Section 393 of the Income Tax Act 2025) governs this obligation. Getting it wrong does not just create a compliance notice. It disallows 30% of the entire payment as a business expense.

This guide covers the rates, thresholds, exemptions, and filing requirements as they apply from FY 2026-27 onward.

When Must TDS Be Deducted on Contractor Payments? Deduct TDS if a single payment exceeds Rs 30,000 or annual payments exceed Rs 1,00,000. Rates: 1% (individual), 2% (entity), 20% (no PAN). Transport contractors exempt if they own 10 vehicles or fewer and provide PAN.

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Who Must Deduct TDS Under Section 194C

Any of the following persons making a payment to a resident contractor or sub-contractor must deduct TDS:

• Central Government or State Government (or any local authority)
• Any body established under a Central or State Act, or any Government-owned or controlled company
• Any company (private or public)
• Any partnership firm (including LLPs)
• Any co-operative society
• Any trust, university, or educational institution
• Any individual or HUF whose total sales, gross receipts, or turnover exceeded Rs 1 crore (business) or Rs 50 lakh (profession) in the immediately preceding financial year

The last point is critical for SME owners. If your business turnover crossed Rs 1 crore in FY 2025-26, you are obligated to deduct TDS on contractor payments starting FY 2026-27. If your turnover was at or below these limits, the obligation does not apply to you for that year. An individual or HUF paying a contractor purely for personal purposes is also not required to deduct TDS under Section 194C.

What Qualifies as "Work" Under Section 194C

The section defines "work" broadly. It covers:

The definition specifically excludes manufacturing or supplying a product according to the requirement of the customer where the contractor uses their own materials. If a contractor buys raw materials themselves and delivers a finished product, the payment is for a purchase (sale of goods), not "work" under 194C.

This distinction matters. If you order 1,000 printed cartons and the printer uses your paper stock, TDS applies at 194C rates. If the printer sources their own paper, it is a purchase and 194C does not apply.

TDS Rates

Tax Rate Chart

Section 194C / Section 393 TDS Rates on Contractor Payments

Rates apply to gross payment amount (inclusive of GST unless separately itemised)

Individual / HUF Contractor

Applies to contractors who are individuals (including sole proprietors) or Hindu Undivided Families

1%

Company, Firm, LLP, AOP, Co-operative, Trust

All entities other than individuals and HUFs

2%

No PAN Furnished (Section 206AA)

Mandatory higher rate if contractor fails to provide PAN : overrides the normal 1% / 2% rate

20%

Source: Section 194C, Income Tax Act 1961 / Section 393, Income Tax Act 2025

These rates apply to the amount credited or paid. Where the contract or invoice shows the GST component separately, TDS is deducted on the amount excluding GST (CBDT Circular 23/2017); otherwise it applies to the full amount.

If the contractor has not furnished their PAN, the deductor must withhold TDS at 20% under Section 206AA, regardless of the nature of payment or the applicable rate.

For a simple case, a Rs 50,000 payment to an individual contractor attracts TDS of Rs 500 (1%), while the same payment to a company or firm attracts Rs 1,000 (2%). The only way to deduct at a lower rate, or not at all, is when the contractor gives you a lower or nil deduction certificate issued under Section 197. In that case, deduct at the rate and up to the amount stated in the certificate.

Quick Comparison: Section 194C vs Section 194J

Contractors often ask: "Is my payment under 194C or 194J?" Use this table:

Key distinction: If you pay for work/labor (contractor does the work), use 194C. If you pay for expertise/advice (professional/technical knowledge), use 194J.

Threshold Limits: When TDS Is Not Required

TDS is not required if:

• The single payment does not exceed Rs 30,000, AND
• The total of all payments to that contractor during the financial year does not exceed Rs 1,00,000.

Once the aggregate crosses Rs 1,00,000, TDS must be deducted on the entire aggregate paid or credited during the year, including earlier payments on which no TDS was deducted, and on every later payment to that contractor in the year, even if it is below Rs 30,000.

Worked Example

Your business makes the following payments to a contractor during FY 2026-27:

If the contractor is an individual, TDS at 1% on the August payment would be Rs 350.

Example 2: Single Payment Exceeding Rs 30K Threshold

Scenario: Your company engages an individual contractor for packing and dispatch work. First invoice: Rs 25,000. No prior payments in FY 2026-27.

TDS Applies? NO. The single payment (Rs 25,000) is below Rs 30,000 and the aggregate is below Rs 1,00,000.

Later: The same contractor submits another invoice for Rs 8,000 in the same FY. Aggregate now Rs 33,000.

TDS Applies? NO. The Rs 30,000 single-payment limit is tested on each payment separately, and neither payment exceeds it. The aggregate (Rs 33,000) is also below Rs 1,00,000.

Third invoice: Rs 70,000. This single payment exceeds Rs 30,000, and the aggregate becomes Rs 1,03,000, which exceeds Rs 1,00,000.

TDS due: Because the aggregate limit is crossed, TDS applies to the whole Rs 1,03,000, including the first two invoices: 1% × Rs 1,03,000 = Rs 1,030, deducted from the Rs 70,000 payment.

Example 3: Aggregate Crossing Rs 1,00,000 Mid-Year

Scenario: Manufacturing unit pays a labor contractor monthly for factory work.

• April 2026: Rs 15,000 (no TDS, below Rs 30K)
• May 2026: Rs 15,000 (aggregate Rs 30K, no TDS yet)
• June 2026: Rs 20,000 (aggregate Rs 50K, no TDS)
• July 2026: Rs 25,000 (aggregate Rs 75K, no TDS)
• August 2026: Rs 30,000 (aggregate Rs 1,05,000, EXCEEDS Rs 1,00,000)

TDS Applied? YES. The August payment itself does not exceed Rs 30,000, but the aggregate now exceeds Rs 1,00,000, so TDS applies to the whole Rs 1,05,000: 1% (individual contractor) = Rs 1,050, deducted from the August payment.

September onwards: TDS must be deducted on ALL subsequent payments to this contractor in FY 2026-27, even if individual invoices are <Rs 30,000.

Example 4: Sub-Contractor TDS Cascade

Scenario: You (company) hire Contractor A (individual) for Rs 2,00,000 to build scaffolding. Contractor A engages Sub-Contractor B (individual) for Rs 1,00,000 to do half the work.

Your obligation: Deduct TDS on Rs 2,00,000 payment to Contractor A at 1% (individual) = Rs 2,000.

Contractor A's obligation: If Contractor A's turnover exceeded Rs 1 crore in the preceding financial year, A must deduct TDS on the Rs 1,00,000 payment to Sub-Contractor B at 1% = Rs 1,000. If A's turnover was within that limit, A has no TDS obligation on this payment.

TDS does NOT cascade back to you: Sub-Contractor B's TDS is Contractor A's responsibility, not yours.

Example 5: Transport Contractor - With vs Without PAN

Scenario 1 (Exempt): You hire a transporter for Rs 50,000 per month. Transporter owns 8 goods carriages and furnishes their PAN.

TDS Applies? NO. Transporter is exempt (≤10 vehicles + PAN).

Scenario 2 (NOT Exempt): Same transporter owns 12 goods carriages.

TDS Applies? YES. Despite PAN, exceeding the 10-vehicle limit triggers TDS at 1% = Rs 500 per month if the transporter is an individual or HUF (2% = Rs 1,000 if it is a firm or company).

Scenario 3 (Higher Rate): Transporter owns ≤10 vehicles but refuses to provide PAN.

TDS Applies? YES, at 20% (Section 206AA) = Rs 10,000 per month (even though they would be exempt with PAN).

Transport Contractor Exemption

A specific exemption exists for payments to transport contractors. No TDS is required on payments made to a contractor engaged in the business of plying, hiring, or leasing goods carriages if:

1. The contractor furnishes their PAN to the deductor, AND
2. The contractor does not own more than 10 goods carriages at any time during the previous year.

If the transporter owns 11 or more goods carriages, TDS at the normal rate (1% for individual/HUF, 2% for others) applies regardless of PAN. The deductor should obtain a declaration from the transporter regarding the number of goods carriages owned.

GST Treatment in TDS Calculation

A common mistake: deducting TDS on the full invoice amount including GST. The correct approach depends on invoice format:

GST Separately Shown (Invoice Shows Rs 1,00,000 + Rs 18,000 GST = Rs 1,18,000 Total)

TDS applies on: Rs 1,00,000 (excluding GST)

TDS amount: 1% × Rs 1,00,000 = Rs 1,000 (if individual contractor)

Payment to contractor: Rs 1,18,000 - Rs 1,000 TDS = Rs 1,17,000 (the GST is still paid to the contractor; only the TDS base excludes it)

GST Embedded (Invoice Shows Single Amount Rs 1,18,000 with GST included but not itemized)

TDS applies on: Rs 1,18,000 (full amount)

TDS amount: 1% × Rs 1,18,000 = Rs 1,180

Payment to contractor: Rs 1,18,000 - Rs 1,180 = Rs 1,16,820

To avoid confusion: Ask contractors to use GST-itemized invoices (base + GST separate), so that TDS is not deducted on the GST amount.

Sub-Contractor Coverage

Section 194C covers both direct contracts and sub-contracts. If your business hires a contractor, and that contractor engages a sub-contractor to carry out part of the work, the contractor must deduct TDS when paying the sub-contractor. The TDS obligation flows down every level of the contracting chain.

As the principal payer, your TDS obligation is on the payment to your direct contractor. You do not need to track or deduct TDS on the sub-contractor's payments. That is the contractor's responsibility.

Timing of Deduction and Deposit

TDS must be deducted at the earlier of:

• The date of credit of the amount to the contractor's account (including a "suspense account" or any name given), or
• The date of actual payment.

After deduction, the TDS must be deposited with the government by:

Late deposit attracts interest at 1.5% per month (or part of a month) from the date of deduction to the date of actual deposit.

Section 393 Under the Income Tax Act 2025: What Changed

From April 1, 2026, the Income Tax Act 2025 is in force. The old scattered TDS sections (192 to 196D, the entire 194-series) are now consolidated into a table-driven structure under Section 393 (for non-salary TDS) and Section 392 (for salary TDS).

For contractor payments, the practical impact is:

For payments made on or after April 1, 2026, the return must use the new Section 393 payment code. If your accounting software or TDS utility has not been updated, update it before filing the Q1 FY 2026-27 return.

For the full section-by-section mapping, see our Income Tax Act 2025 section mapping guide.

Consequences of Non-Deduction or Non-Deposit

Getting Section 194C wrong has real financial consequences:

30% Disallowance Under Section 40(a)(ia)

If TDS is not deducted on a payment where it was required, 30% of the expenditure is disallowed while computing business income. For a Rs 10,00,000 payment to a contractor where TDS was skipped, Rs 3,00,000 is added back to your taxable income. For a domestic company taxed under Section 115BAA (25.168% including surcharge and cess), that is about Rs 75,500 in additional tax on a payment where the TDS itself would have been Rs 10,000 (1%) to Rs 20,000 (2%).

The disallowance applies if:

• TDS was not deducted at all, or
• TDS was deducted but not deposited with the government before the due date of filing the income tax return under Section 139(1).

Interest on Late Deduction/Deposit

Interest is calculated per month, and a part of a month is counted as a full month.

Penalty Under Section 271C

The Assessing Officer can impose a penalty equal to the amount of TDS that should have been deducted. If TDS of Rs 20,000 should have been deducted, the penalty can be up to Rs 20,000 on top of the TDS amount, interest, and disallowance.

Filing Requirements

Quarterly Due Dates for Form 140

After filing Form 140, the deductor must issue Form 131 (TDS certificate, formerly Form 16A) to each contractor within 15 days of the due date for filing the quarterly return. For deductions up to FY 2025-26, Form 26Q and Form 16A continue to apply.

Common Mistakes to Avoid

1. Confusing 194C with 194J. Payments for professional or technical services (legal, accounting, engineering, consultancy) fall under Section 194J (now Section 393 with a different payment code), not 194C. TDS under 194J is 2% for technical services and 10% for professional services. Using the wrong code triggers notices.

2. Not tracking aggregate payments. Many businesses deduct TDS only when a single invoice crosses Rs 30,000. They miss the Rs 1,00,000 aggregate rule. If you pay a contractor Rs 20,000 per month for 6 months (Rs 1,20,000 aggregate), the sixth payment takes the total past Rs 1,00,000, and TDS is then due on the whole Rs 1,20,000, not just the sixth payment.

3. Deducting TDS on GST component. If the invoice separately shows the base amount and the GST charged on it, TDS is deducted on the base amount only. If the invoice shows a single lump-sum amount without separating GST, TDS is on the full invoice value. Ask contractors to issue invoices with GST breakup clearly shown.

4. Not obtaining PAN from transporters. The transport exemption requires the transporter to furnish their PAN. If they do not, TDS at 20% under Section 206AA applies. Collect PAN and a declaration about the number of goods carriages before making the first payment.

5. Missing the "credit" trigger. TDS is due at the earlier of payment or credit. If your accountant books the contractor's bill in March but payment goes out in April, TDS is due in March (when the credit entry was made).

Practical Checklist for SME Owners

• Confirm whether your FY 2025-26 turnover exceeds Rs 1 crore (business) or Rs 50 lakh (profession). If yes, you must deduct TDS on contractor payments in FY 2026-27.
• Maintain a contractor-wise payment register to track aggregates against the Rs 1,00,000 annual threshold.
• Collect PAN from every contractor before the first payment. For transporters, also collect a declaration on the number of goods carriages.
• Update your TDS software to use Section 393 payment codes for Q1 FY 2026-27 filings.
• Deposit TDS by the 7th of the following month. Set a recurring calendar reminder.
• File Form 140 quarterly and issue Form 131 (formerly Form 16A) within the prescribed timelines.
• Reconcile Form 26AS / AIS of your contractors periodically to confirm deposits are reflecting.

Tax Garden Handles Your TDS Compliance

Tax Garden's TDS compliance plans track every contractor payment, apply the correct TDS rate and threshold, deposit TDS before the monthly deadline, and file Form 140 on time every quarter. No disallowances, no interest, no penalty notices.

For related topics, see our guides on TDS rate chart for FY 2026-27, TDS on interest under Section 194A, TDS return filing with Form 24Q and 140, TDS/TCS changes for FY 2026-27, new TDS payment codes under the Income Tax Act 2025, TDS on property purchase (Section 194-IA), and the Section 393 mapping under the new Act.

Frequently Asked Questions

What is the difference between TDS under Section 194C and Section 194H?

Section 194C covers payments for carrying out work, such as labour, repairs, transport, catering or job work, at 1% for individual or HUF contractors and 2% for others. Section 194H covers commission and brokerage, at 2% (reduced from 5% from 1 October 2024) once payments cross Rs 20,000 in a year. Decide by the nature of the payment, not by what the invoice calls it.

Do I need to deduct TDS on the GST amount in a contractor invoice?

If the invoice shows GST separately from the value of the work, TDS is deducted only on the value excluding GST, as clarified by CBDT Circular 23/2017. If the invoice shows one lump-sum amount without a GST breakup, TDS applies to the full amount. Ask contractors for invoices that show the base value and GST separately.

What happens if I deduct TDS on a contractor payment but deposit it late?

Interest applies under Section 201(1A): 1% per month from the date TDS was deductible to the date it was actually deducted, and 1.5% per month from deduction to deposit, with part of a month counted as a full month. If the TDS is still not deposited by the ITR due date, 30% of the contractor expense is also disallowed under Section 40(a)(ia).

Are transport contractors automatically exempt from TDS under Section 194C?

No. The exemption applies only if the transporter is in the business of plying, hiring or leasing goods carriages, owns 10 or fewer goods carriages at any time in the year, and gives you a declaration with PAN. If the transporter owns more than 10 vehicles, TDS applies at 1% or 2%. If no PAN is furnished, TDS is 20% under Section 206AA.

Can a contractor ask me to deduct TDS at a lower rate or not at all?

Only if the contractor gives you a lower or nil deduction certificate issued by the Assessing Officer under Section 197. You then deduct at the rate and up to the amount stated in the certificate, for the period it covers. Without a valid certificate, you must deduct the normal 1% or 2%, or 20% if PAN is not furnished.

Can the 30% disallowance for missed contractor TDS be reversed?

Yes. If TDS is deducted late or deposited after the ITR due date, the 30% disallowed under Section 40(a)(ia) is allowed as a deduction in the year in which the TDS is actually paid. Paying the TDS with interest quickly therefore limits the damage, although interest and any penalty are not recovered.

Sources

This guide is verified against Section 194C of the Income Tax Act, 1961 (TDS on contractor payments), Section 393 of the Income Tax Act, 2025 (consolidated non-salary TDS table effective April 1, 2026), Section 40(a)(ia) (30% disallowance for non-deduction), Section 206AA (TDS at 20% for no PAN), Section 201(1A) (interest on late deduction/deposit), and Section 271C (penalty for failure to deduct). Threshold limits of Rs 30,000 (single payment) and Rs 1,00,000 (aggregate) confirmed from CBDT circulars and ClearTax, Tax2win, TaxGuru, and BajajFinserv reference materials as of May 2026. Transport exemption provisions verified against Section 194C(6) and Explanation (iv) to Section 194C. Section 393 consolidation and payment code structure confirmed from ClearTax and TaxGuru coverage of the Income Tax Act 2025. All rates and thresholds should be verified against incometax.gov.in/iec/foportal/ before applying to specific deductions.