Section 194C of the Income Tax Act: TDS on Payment to Contractor

Section 194C of the Income Tax Act focuses on the mandatory deduction of TDS from payments made to resident sub-contractors and contractors. A 'person' making such payments to the concerned payee is responsible for deducting TDS. This Section bears essential provisions which contain vital information. Hence, interested individuals can keep scrolling to know more about it!

As per Section 194C (1) of the Income Tax Act, a person denotes an entity that has a contract with a contractor who will work in exchange for payment. Here are the following entities identified as 'person':

• Trust
• Local authority
• Central or State Governments
• Firm or company
• Cooperative Society 
• Registered society under Society Registration Act, 1980 or any corresponding law of the Act
• Deemed university or established university
• Corporation instituted under Provisional, State or Central Act.
• An authority that deals with fulfilling the requirement for housing accommodation or engaged in planning, improvement or development of towns, cities and villages or focuses on  both
• Individual or HUF, if sales or gross receipt exceed Rs 1 crore in case of business or 50 Lakhs in case of profession during immediately preceding financial year.

According to Section 194C (1) of the Income Tax Act, the terminology of 'work' connotes to any of the following:

• Advertising and catering
• Telecasting and broadcasting covering production programmes required for telecasting or broadcasting
• Carrying passengers and goods by any transportation mode, except railways
• Producing or supplying a product as per the specifications and needs of customers by utilising materials bought from those customers. However, it does not cover the production and supply of products to meet the specifications and needs of customers by utilising materials bought from a 'person' other than those customers.

As per the Section 194C of the Income Tax Act, a contractor is a person who bears a contract with the following entities to carry out work, which also includes supplying labour to carry out such work -

• State or Central Government
• Local authority
• Corporation instituted under or by a Provisional, Central or State Act
• Any company or cooperative society 

A sub-contractor denotes a person who has a contract with a contractor for the following purposes –

• Carrying out work wholly or partly which a contractor has undertaken as per the contract
• Supplying labour for conducting a whole or part of the work as agreed by the contractor in the contract 

Section 194C of the Income Tax Act is applicable for labour contracts and work contracts. However, it is not applicable for a contract that focuses on the sale or supply of goods.

TDS deduction on payments made to contractors is applicable when the following conditions of Section 194C(1) are fulfilled:

• The contractor (payee) must be a resident as per Section 6 of the IT Act.

• Payment must be completed by the 'person' as stated under Section 194C

• A person should make payment in exchange for work, including supplying labour and the stipulation agreed between the payee and payer in an oral or written contract.

• The maximum payment limit for TDS to get deducted under Section 194C must be above ₹ 30,000

• If the total amount paid or to be paid to a contractor in a fiscal year is above ₹ 1,00,000, the payer must deduct TDS.

• In the case of advance payment, a payer must deduct TDS if the aggregate payment is above ₹ 30,000.

• If it appears that the total payment may not be above ₹ 30,000, however, later it is estimated that it will be more than ₹ 30,000, a payer must also deduct TDS on previous payments made.

TDS deduction on payments made to sub-contractors is applicable when the following conditions of Section 194C(2) are fulfilled:

• Sub-contractor must be an Indian resident as per Section 6 
• A resident contractor must pay the sub-contractor to work or supply labour for carrying out such work
• The amount to be paid to a sub-contractor as agreed in a contract should not be below ₹ 30,000
• A resident contractor paid or credited this amount after 31st May 1972
• A contractor should pay the total amount agreed in a contract with specified bodies

Payers do not require to deduct TDS in the following circumstances as per Section 194C:

• Hindu Undivided Families and individuals shall not deduct TDS if the payment is transferred to a contractor for meeting their personal purpose.

• When the amount is paid before the first day of June 1972. Or else, the amount payable is transferred to the payee's account before the 1st day of June 1973 related to the contract agreed between a cooperative society and a contractor. Alternatively, it can be a contract between a sub-contractor and contractor for completing work for a cooperative society.

• A payer shall not deduct TDS from payments made or to be made during a previous financial year to a contractor conducting business in hiring goods carriage, owned ten or less goods carriage at any time during the financial year, provided the contractor provides their PAN to the payer.

A person making payment to a sub-contractor or contractor must deduct TDS  in the following times as per the Section 194C:

• A person credits payment to the payee's bank account and 
• Payment is made via cash, cheque, or other modes 
• Payer transfers an amount aimed for the payee to a 'Suspense Account' or other accounts

Here are some exceptions to TDS while making payments to contractors as per Section 194C:

• TDS Deduction for Composite Contract 

If the Government supplies materials, the decision to deduct TDS while making payments to a contractor rests on the contract and conduct of the parties involved.

When a constructor agrees to develop a dam or building, and the specified person or the Government supplies materials at agreed prices to carry out such work, the concerned payer will deduct TDS on gross payments without adjustments related to material cost.

When a contractor agrees to offer labour to carry to work on a project, and the Government or specified person will supply materials for work, the payable amount to the contractor will be based on services or labour provided and will not cover the material cost.

Therefore, a payer will deduct TDS from payments made to a contractor is 2% or 1% on gross or net payments based on the contract. The TDS rate is 0.75% and 1.5% for payments made from 4th May 2020 to 31st March 2021.

• TDS Deduction In Case a Party Provide Materials to Contractor

In this, no deduction of tax at source is applicable. However, a payer will deduct TDS if he or she pays in kind or cash to a sub-contractor or contractor. 

Non-compliance to Section 194C of the Income Tax Act attracts a substantial interest on the payment paid and also disallows a taxpayer to claim a tax deduction on such expenditures. Therefore knowing about this Section is essential to remain tax compliant and avoid increasing tax liabilities.