Section 194 of the Income Tax Act: TDS on Contracts
Understand the process for TDS on contracts under Section 194, from identifying liability and rates to meeting all final compliance requirements.
Tax Deducted at Source (TDS) is a method of collecting income tax in India where the entity making a payment deducts a percentage as tax before releasing funds to the recipient. This system ensures tax is collected at the point of income generation. The Income Tax Act, 1961, contains provisions under Section 194 that mandate TDS on different types of payments. This article examines the rules for deducting tax on payments made to contractors and sub-contractors for carrying out work.
Applicability to the Payer
Any person who makes a payment to a resident contractor for services under a contract must deduct tax before making the payment. This group includes a wide range of entities such as central or state governments, local authorities, corporations established by law, companies, cooperative societies, trusts, and universities. Any firm is also included in this list of specified payers.
A distinction applies to individuals and Hindu Undivided Families (HUFs). These payers are only required to deduct tax if their total sales, gross receipts, or turnover from their business or profession exceeded certain monetary limits during the financial year immediately preceding the one in which the payment is made. Specifically, the threshold is ₹1 crore for a business or ₹50 lakhs for a profession.
Scope of Work and Payments
The term “work” under Section 194C is defined broadly and encompasses a variety of services. The provision applies to payments made for carrying out any work, which includes the supply of labor. The contract for such work can be either oral or written, meaning a formal written agreement is not a prerequisite for the TDS obligation to apply.
The scope of work covers several categories of services:
- Advertising, broadcasting, and telecasting, which also covers the production of programs for such broadcasts.
- Carriage of goods or passengers by any mode of transport other than railways.
- Catering services.
- Manufacturing or supplying a product according to a customer’s requirement or specification, but only when the material for it is purchased from that customer.
The provision does not apply to contracts that are purely for the sale of goods, where no element of “work” is involved. If a manufacturer produces a product using materials purchased from someone other than the customer, it is considered a sale. Payments made by an individual or a member of an HUF for work done exclusively for personal purposes are exempt from this TDS requirement.
Tax Deduction Rates and Thresholds
A deduction is not necessary if a single payment to a contractor does not exceed ₹30,000. Even if individual payments are below this amount, a separate threshold applies to the total payments made during a financial year. If the aggregate amount of all payments made or likely to be made to a single contractor in a financial year does not exceed ₹1,00,000, no tax needs to be deducted.
For payments made to contractors who are individuals or Hindu Undivided Families (HUFs), the TDS rate is 1%. For payments made to any other type of resident contractor, such as a company or a firm, the applicable rate is 2%. These rates are applied to the invoice value of the work performed.
The recipient of the payment, the contractor, must provide their Permanent Account Number (PAN) to the payer. If the contractor fails to furnish their PAN, the payer is obligated to deduct tax at a much higher rate of 20%.
Compliance Procedures for Deducted Tax
After deducting the tax, the payer has specific compliance responsibilities. The deducted tax must be deposited with the government by the 7th day of the month following the month in which the tax was deducted. For tax deducted in the month of March, the due date is extended to April 30th.
Following the deposit, the payer must file a quarterly TDS statement, known as a TDS return. For deductions on payments to contractors, the relevant form is Form 26Q. This statement provides a summary of all contractor payments and the corresponding tax deducted and deposited during that quarter, and filing these returns electronically is mandatory for most deductors.
Finally, the payer must issue a TDS certificate to the payee, which is the contractor. This certificate, Form 16A, serves as proof for the contractor that tax has been deducted and paid on their behalf. The certificate must be issued within 15 days from the due date for filing the quarterly TDS return.