Section 194C TDS on Contractor Payments — FY 2025-26 Rates, Thresholds, and Section 206AB Removal

Why Section 194C matters for Indian SMEs

For most Indian SMEs, Section 194C is the most frequently invoked provision in the entire TDS framework. Whether the business is paying a printing vendor for branded brochures, a logistics company for freight, a contract manufacturer for job work, or a caterer for office lunches — almost every such transaction sits inside the “works contract” envelope and triggers Section 194C.

The rates are low (1% or 2%), but the volume of transactions is high. Mis-classifying a payment under the wrong section (most commonly 194C vs 194J), missing the single-payment trigger, deducting on the GST component, or applying repealed Section 206AB rules in FY 2025-26 — these errors create mismatched ledgers, vendor cash-flow friction, and interest under Section 201(1A).

For FY 2025-26, the operational burden of Section 194C has reduced meaningfully because the Finance Act 2025 has repealed Section 206AB (the higher-rate-for-non-filers section that previously required a compliance-status check on every contractor before deduction). This is a good moment for SME finance teams to recalibrate ERP TDS rules. For the broader withholding-tax context, see the TDS in India overview.

What Section 194C covers — the definition of “work”

Section 194C does not apply to every contract. It specifically targets “works contracts” and “supply of labour.”

Per Explanation (iv) to Section 194C, “work” includes:

1. Advertising — production and placement of advertisements (the creative-consultancy component, where separately contracted, may fall under 194J)
2. Broadcasting and telecasting — including programme production
3. Carriage of goods or passengers — by any mode other than railways
4. Catering
5. Manufacturing or supplying goods to specification using customer-supplied material — where the customer supplies raw material and the vendor manufactures to the customer’s specification, the consideration paid for the manufacturing labour and overheads is “work.” Where the vendor sources its own raw material and sells a finished product, it is a sale of goods and falls outside Section 194C.

Section 194C does NOT apply to:

• Pure professional / technical services — doctors, lawyers, chartered accountants, IT consultants, architects, engineers (these fall under Section 194J)
• Commission or brokerage — agency arrangements where the payee acts on the payer’s behalf (Section 194H)
• Sale of standard off-the-shelf goods — no TDS under 194C (Section 194Q may apply where the buyer’s turnover exceeds ₹10 crore and the aggregate purchase from a single seller exceeds ₹50 lakh in the FY)
• Payments to non-resident contractors — Section 194C is for residents; payments to non-resident contractors fall under Section 195

When the deduction kicks in — thresholds and triggers (FY 2025-26)

The law specifies two monetary thresholds. If either is breached, the 194C deduction obligation triggers:

1. Single-payment threshold — any single payment or credit to a contractor exceeding ₹30,000
2. Aggregate annual threshold — total payments and credits to the same contractor exceeding ₹1,00,000 in the FY

The aggregate trap (worked example):

An SME pays a catering vendor ₹25,000 in April, ₹25,000 in July, ₹25,000 in October, and ₹30,000 in January.

• None of the first three crosses the ₹30,000 single-payment threshold individually.
• The January payment brings the FY aggregate to ₹1,05,000 — crossing the ₹1,00,000 aggregate threshold.
• The SME must now deduct TDS on the January payment AND must catch up on the previously undeducted ₹75,000. The catch-up is typically effected by deducting against the current payment so the total deduction equals 1% (or 2%) of ₹1,05,000.

Persistence rule: once either threshold has been crossed for a vendor in the FY, TDS applies to all subsequent payments to that vendor for the remainder of the FY, regardless of individual ticket size.

194C rates FY 2025-26

The 194C rate depends on the legal status of the payee, not on the nature of the work:

• 1% rate — payee is an Individual or HUF
• 2% rate — payee is any other entity (partnership firm, LLP, private limited company, AOP, BOI, trust, etc.)
• 0% rate (transporter exemption, Section 194C(6)) — payee is a goods transport contractor who owns 10 or fewer goods carriages at any time during the FY AND has furnished a formal declaration to that effect along with a valid PAN. Without the declaration + PAN on file, the standard 1% / 2% rate applies.

Surcharge and Health & Education Cess are not added to the 194C rate for resident contractors. For the complete cross-section TDS rate reference, see the TDS Rate Chart for FY 2025-26.

Who is liable to deduct — and who is not

Always liable to deduct (regardless of turnover): Companies, partnership firms, LLPs, trusts, co-operative societies, and local authorities.

Conditionally liable (Individuals and HUFs): An Individual or HUF carrying on a business or profession is required to deduct 194C TDS only if their accounts were subject to tax audit under Section 44AB in the immediately preceding financial year — i.e., for FY 2025-26 deductions, the relevant test is whether the audit applied to FY 2024-25 (business turnover above ₹1 crore — extended to ₹10 crore where ≥95% of receipts + payments are in non-cash mode; profession receipts above ₹50 lakh).

Personal-use exemption: Even where an Individual or HUF is otherwise required to deduct under 194C, payments made exclusively for personal use (e.g., a contractor building the individual’s personal residence, a caterer for a family wedding) are exempt from Section 194C. If the personal-use contract aggregate exceeds ₹50 lakh in the FY, a different section — Section 194M — triggers at 5%.

Section 194C vs 194J vs 194Q — the SME confusion matrix

Mis-classification across these three sections is one of the most common 194C-side errors. Quick comparison:

Section	Covers	Rate	Threshold
194C	Works contracts + supply of labour	1% (Ind/HUF) or 2% (others)	₹30k single / ₹1L aggregate FY
194J	Professional / technical services	10% professional / 2% technical, royalty, non-compete (specified)	₹30k per nature of payment per FY
194H	Commission / brokerage	2% (cut from 5% by Finance Act 2024)	₹15k aggregate FY
194Q	Purchase of goods	0.1%	₹50L aggregate FY; applies only where buyer’s PY turnover > ₹10 crore

Worked scenarios:

1. Graphic designer — SME pays a freelance graphic designer ₹50,000 to design a company logo. Specialised intellectual work. Section 194J @ 10%.
2. Printer (custom) — SME gives the designed logo to a printing press and pays ₹50,000 to print 10,000 brochures from press-supplied paper, to the SME’s specification. Manufacturing to specification using vendor-sourced material is outside 194C — it is a sale of goods (194Q may apply for very large buyers).
3. Printer (custom, customer-supplied material) — SME supplies paper to the press and pays for the print run only. Manufacturing to specification using customer-supplied material is squarely Section 194C @ 1% / 2%.
4. Off-the-shelf goods — SME buys 50 standard, blank notebooks. Pure sale of goods. No TDS under 194C. Section 194Q may apply if the buyer’s preceding-year turnover exceeded ₹10 crore and aggregate purchase from the seller exceeds ₹50 lakh in the FY.
5. Logistics — SME pays a transport contractor ₹2 lakh in the FY for moving finished goods. Carriage of goods is Section 194C — 1% / 2% normally, but 0% if the transporter is a “small operator” with ≤10 goods carriages and has furnished the Section 194C(6) declaration + PAN.

Section 206AB removal — what changed in FY 2025-26

Until FY 2024-25, before applying the 1% / 2% 194C rate, the deductor had to check the Income Tax department’s “Compliance Check” portal to verify whether the payee had filed Income Tax Returns for the prior FY. Where the payee was a “specified person” (broadly: had not filed ITR for the relevant preceding year AND had aggregate TDS/TCS of ≥ ₹50,000 in that year), Section 206AB required deduction at the higher of (twice the normal rate, 5%).

The Finance Act 2025 has omitted Section 206AB with effect from 1 April 2025. For FY 2025-26 onwards:

• No “compliance check” portal lookup is required before applying the 194C rate.
• The standard 1% / 2% (or 0% for qualifying transporters) applies regardless of the payee’s ITR-filing history.
• Section 206AA continues to apply — where the payee does not furnish a valid PAN, TDS is deducted at the higher of the normal rate or 20%. A missing PAN still overrides the standard 194C rate.

ERP / accounts-payable systems that were configured for the 206AB compliance check should be updated to remove that workflow step for FY 2025-26.

Compliance mechanics — depositing and reporting 194C TDS

Once deducted, the tax must be deposited with the government and reported in the quarterly TDS return:

1. Deposit (Challan ITNS 281) — TDS deducted in any month is deposited by the 7th of the following month (April deduction → deposit by 7 May). Exception: TDS deducted in March is depositable by 30 April.
2. Quarterly TDS return (Form 26Q) — 194C deductions are reported in Form 26Q, the non-salary TDS return. Due dates: Q1 — 31 July, Q2 — 31 October, Q3 — 31 January, Q4 — 31 May.
3. TDS certificate (Form 16A) — issued to the payee after Form 26Q filing. Downloadable from the TRACES portal; due within 15 days of the Form 26Q due date. For the certificate landscape across forms, see Form 16 vs Form 16A vs 16B/16C/16D/27D.

GST exclusion rule: Per CBDT Circular No. 23/2017 dated 19 July 2017, where GST is indicated separately on the invoice, TDS under Section 194C is calculated on the value excluding GST. For an invoice with a base value of ₹1,00,000 + GST of ₹18,000 + invoice total of ₹1,18,000, the 194C TDS base is ₹1,00,000 — so 1% TDS would be ₹1,000 (not ₹1,180). Vendor invoices that don’t separately indicate GST default to the inclusive total as the TDS base — review supplier invoicing against the ITC rules guide for the GST-side compliance.

Common 194C mistakes

Frequently observed errors in SME 194C compliance:

1. Treating works contracts as professional / technical — applying Section 194J at 10% on what is a Section 194C transaction. The payee can claim refund of the excess in their ITR, but the cash-flow drag and the vendor-relationship friction are real-time costs.
2. Missing the single-payment trigger — assuming TDS isn’t required because the ₹1 lakh aggregate hasn’t been crossed, even where an individual payment exceeds ₹30,000. The single-payment trigger operates independently of the aggregate.
3. Deducting on the GST-inclusive total — failing to configure the ERP to strip GST from the TDS base, leading to over-deduction.
4. Applying repealed Section 206AB rules in FY 2025-26 — continuing to check the compliance-check portal and apply 5% on “non-filers” after the section has been omitted by the Finance Act 2025.
5. Missing transporter declarations — applying 0% transporter exemption without collecting the Section 194C(6) declaration and PAN, which is the documentary precondition. Without the documents on file, the standard 1% / 2% rate applies.
6. Wrong section for non-resident contractors — applying Section 194C on payments to non-resident contractors. Section 194C is residents-only; non-resident contractors fall under Section 195, which has different rates + treaty considerations.
7. Aggregate cross-checking missed at year-end — vendors who individually look small but cumulatively cross ₹1 lakh by Q4 trigger retrospective deduction on past payments; year-end vendor-aggregate review catches these.

For the cross-section context (including the new partner-remuneration TDS introduced by Finance Act 2025), see the Section 194T spoke. For quarterly TDS return preparation, Form 26Q filing, and TRACES reconciliation, see the TDS Return Filing service.