TDS on Contractor Payments explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
1. What Are Contractor Payments Under Section 398?
Section 398 of the Income Tax Act, 2025 covers TDS on payments to contractors and sub-contractors for carrying out any work or providing labour for such work. This is one of the most broadly applicable TDS provisions — covering construction, catering, advertising, transportation, manufacturing, and any other work contract.
2. Who Must Deduct TDS?
The following must deduct TDS under Section 398:
- Central/State Government and local authorities
- Companies (public and private)
- Firms, LLPs, and co-operative societies
- Trusts and artificial juridical persons
- Individuals/HUFs subject to tax audit
3. TDS Rates
| Type of Contract | Rate (Resident) |
|---|---|
| Any work under contract (general) | 1% |
| Works contract (composite supply of goods and services — construction, civil, electrical) | 2% |
| Payment to HUF/individual for contract | 1% |
| Payment to others (company, firm, LLP) | 2% |
4. Threshold
TDS under Section 398 applies when:
- A single payment to a contractor in a transaction exceeds Rs 30,000; OR
- The aggregate payments to the same contractor in a Tax Year exceed Rs 1,00,000
Once either threshold is crossed, TDS applies to all payments — including those already made before the threshold was hit.
5. What Qualifies as a "Contract"?
The definition of "work" under Section 398 is very broad:
- Advertising (printing, broadcasting, hoarding, digital)
- Broadcasting and telecasting
- Catering (including hotel banquets)
- Carriage of goods and passengers by any mode except railways
- Manufacturing or supplying a product per buyer specification (job work)
- Civil construction, electrical installation, interior fit-outs
- Security services, cleaning services, maintenance contracts
6. Transporter Exception
Payments to transporters for carriage of goods are covered under Section 398. However, if the transporter provides their PAN and declares they are not owning more than 10 goods carriages, the payer is not required to deduct TDS. The transporter must give a declaration to this effect. This exception was introduced to ease compliance for small transport operators.
7. Sub-contractors
If the main contractor engages sub-contractors, the main contractor must also deduct TDS on payments to sub-contractors under Section 398 — at the same rates (1% individuals/HUF, 2% others). The chain of TDS compliance continues down to the sub-contractor level. The TDS deducted at each level appears in the respective Form 26AS.
8. Practical Example
Illustrative only. XYZ Ltd gets its office renovation done by a construction firm for Rs 12 lakh. Payment schedule: Rs 4L on contract signing, Rs 4L mid-project, Rs 4L on completion. This is a works contract — TDS at 2%. Total TDS: Rs 12L × 2% = Rs 24,000. XYZ deducts Rs 24,000 across the three payments (Rs 8,000 each) and deposits by 7th of following month. Form 26Q filed quarterly.
9. Why TaxClue
Section 398 applies to almost every business that engages contractors — civil, IT, catering, advertising, security. Incorrect rates or missed thresholds create significant compliance risk. TaxClue provides complete TDS compliance advisory and return filing. Contact us under ITA 2025.
Key Facts About TDS on Contractor Payments
- Applies in: All states across India, under the relevant central law.
- Mode: Mostly online via the official government portal.
- Typical timeline: Ranges from a few days to a few weeks depending on the case.
- Non-compliance: May attract penalties, interest or late fees.
- Expert help: TaxClue completes the entire process end to end for you.
What is TDS on contractor payments?
Under Section 398 of ITA 2025, TDS must be deducted on payments to contractors for carrying out any work. The rate is 1% for individuals and HUFs and 2% for companies, firms, and LLPs (or 2% for works contracts). The threshold is Rs 30,000 per single payment or Rs 1,00,000 aggregate in a Tax Year — whichever is crossed first triggers TDS on all payments including those already made.
What is a works contract for TDS purposes?
A works contract is a composite contract involving both supply of goods and provision of services — such as civil construction, electrical installation, interior fit-outs, equipment erection and commissioning. For works contracts, TDS is at 2% regardless of whether the contractor is an individual or company. Pure service contracts (no goods supplied) are not works contracts — they are general contracts taxed at 1%/2% based on contractor type.
Over 90% of compliance penalties in India arise from missed due dates — timely handling can save businesses thousands of rupees each year.
TDS on Contractor Payments: a key compliance topic in Indian tax and corporate law that businesses and individuals must understand to remain compliant.