Deducting 1% TDS on your agency invoice: what Sections 194C and 194J actually require

A founder pays her web development agency ₹4,80,000 for the year and deducts 1% TDS, treating it as a contract. The same founder pays a freelance UI designer ₹45,000 and deducts nothing, because she remembers a ₹30,000 threshold that no longer exists. Both decisions are wrong, and both surface in the same place — the TDS default column of Form 3CD, Clause 34, when the tax auditor reconciles her expense ledger against her Form 26Q returns.

The distinction between a "contract" and "professional services" looks like semantics. It is not. It changes the rate you deduct (1% or 2% versus 10%), the threshold at which liability starts (₹30,000/₹1,00,000 versus ₹50,000), the challan payment code you quote, and — where you get it wrong — whether 30% of the entire expense is disallowed under Section 40(a)(ia) of the Income-tax Act, 1961.

And from 1 April 2026, there is a further wrinkle: the section numbers themselves have changed.

What the law actually requires

The renumbering you cannot ignore in FY 2026-27

The Income-tax Act, 2025 came into force on 1 April 2026 and consolidated the entire non-salary TDS architecture into a single umbrella provision — Section 393. The familiar 194-series sections now appear as rows in the Section 393(1) table, identified by serial numbers and by numeric payment codes running from 1001 upward.

• Contractor payments (formerly Section 194C) now sit at Section 393(1), Table Sl. No. 6(i).D(a) and 6(i).D(b), carrying payment codes 1023 and 1024.
• Fees for professional and technical services (formerly Section 194J) now sit at Section 393(1), Table Sl. No. 6(iii).D(a) and 6(iii).D(b), with separate treatment for director payments.

The rates and thresholds are substantially carried forward. What changed is the reference you quote on the challan and in the return. A contractor payment deposited on, say, 7 May 2026 must carry the Section 393 payment code — not a legacy "194C" reference. The codes are live on the income tax portal, and OLTAS, the banks, and the return-filing utilities have been processing them since April.

Practitioners and most commentary will keep saying "194C" and "194J" for years, because that is how the concepts are known. That is fine in conversation. It is not fine on a challan.

Section 194C / Section 393(1) Sl. 6(i) — contractor payments

Section 194C applies to payment to a resident contractor for carrying out any work in pursuance of a contract. "Work" is defined inclusively and covers advertising, broadcasting and telecasting, carriage of goods and passengers by any mode other than railways, catering, and manufacturing or supplying a product according to the customer's specification using material purchased from that customer.

Rates:

• 1% where the payee is an individual or HUF (payment code 1023)


• 2% where the payee is any other person — a company, LLP, partnership firm, AOP (payment code 1024)

Thresholds — and this is where most founders slip. There are two, and either one triggers liability:

• ₹30,000 for a single payment or credit, or


• ₹1,00,000 in aggregate to the same contractor during the financial year

The aggregate limit was raised from ₹75,000 to ₹1,00,000 by the Finance Act, 2025, effective 1 April 2025. Critically, once the aggregate crosses ₹1,00,000, TDS applies to the entire amount paid during the year, not just the excess. If you paid a vendor ₹40,000 in four instalments of ₹10,000 each, no single payment crossed ₹30,000 — but the moment cumulative payments cross ₹1,00,000 later in the year, you owe TDS on everything from the first rupee.

Transporter exemption: No TDS is required on payment to a goods-transport contractor who owns ten or fewer goods carriages at any time during the year, provided he furnishes a declaration to that effect along with his PAN. The declaration must be obtained — the exemption is not automatic — and the details must still be reported in the quarterly return.

Section 194J / Section 393(1) Sl. 6(iii) — professional and technical services

Section 194J applies to fees for professional services, fees for technical services, royalty, non-compete payments under Section 28(va), and remuneration or fees to a director that is not in the nature of salary.

Rates:

• 2% for fees for technical services (other than professional services), and for call-centre operators


• 2% for royalty in the nature of consideration for the sale, distribution or exhibition of cinematographic films


• 10% for fees for professional services


• 10% for director's fees and other remuneration not chargeable under the head "Salaries"


• 20% where the payee does not furnish a PAN, under Section 206AA

Threshold: ₹50,000 in aggregate during the financial year, raised from ₹30,000 by the Finance Act, 2025 with effect from 1 April 2025. Note that unlike 194C, there is a single aggregate threshold — no separate per-payment trigger. And for director's remuneration, there is no threshold at all. A ₹15,000 sitting fee attracts 10% TDS from the first rupee.

The 2%-versus-10% split inside Section 194J is where the second layer of error occurs. The bifurcation was introduced by the Finance Act, 2020: technical services attract 2%, professional services attract 10%. "Professional services" draws on the Section 44AA definition — legal, medical, engineering, architectural, accountancy, technical consultancy, interior decoration, advertising, and the notified professions including company secretaries, authorised representatives, film artists, and information technology professionals.

Which one applies: the actual test

The distinction is not about who you pay but about what you are buying.

If you are paying for a deliverable produced to your specification — a batch of printed brochures, a catering order, a shipment moved from Chennai to Hyderabad, a facility maintained under an annual contract — that is work under Section 194C.

If you are paying for the application of a person's professional skill or judgment — legal opinion, statutory audit, architectural design, a doctor's consultation, an IT professional's development work — that is fees for professional services under Section 194J.

Three recurring grey zones in startup expense ledgers:

Digital marketing agencies. Pure media buying and advertisement placement is expressly "work" under 194C at 1%/2%. Strategy, creative consulting, and campaign design is professional service at 10%. Most agency invoices bundle both. If the invoice separately identifies the components, deduct separately. If it does not, ask the vendor to re-issue with a break-up — a bundled invoice defaults to the higher characterisation on scrutiny.

Software development. A licensed off-the-shelf product is a purchase, not a service. Custom development by an IT professional or firm is professional services at 10%. A body-shopping arrangement where the vendor supplies manpower to work under your direction has been held to be a contract for work at 2% in several rulings — but the contractual language matters enormously here.

Annual maintenance contracts. A routine AMC for equipment upkeep is 194C. An AMC that involves technical diagnosis and specialist intervention is 194J at 2%. The invoice narration is the first thing an Assessing Officer reads.

Practical implications

Getting this wrong is not a rounding error.

Disallowance under Section 40(a)(ia). Where TDS is deductible but not deducted, or deducted but not deposited before the due date for filing the return under Section 139(1), 30% of the expenditure is disallowed in computing business income. On a ₹20 lakh agency spend, that is ₹6 lakh added back to taxable income — roughly ₹1.5 lakh of additional tax at the 22% concessional rate under Section 115BAA, before interest.

The disallowance is restored in the year the tax is eventually deposited, so it is a timing hit rather than a permanent one. But it lands in the year you can least afford it, and it forces a revised computation.

Short deduction is treated as no deduction — partly. If you deducted 1% where 10% was due, the settled position under the Kotak Securities line of reasoning is that a genuine, bona fide difference of opinion on characterisation attracts interest and Section 201 consequences rather than a full 40(a)(ia) disallowance. That is a defence, not a plan. It requires you to have documented a considered view at the time of deduction.

Interest 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 the date of deduction to the date of deposit. Part months count as full months.

Late filing fee under Section 234E. ₹200 per day for delay in filing the quarterly TDS return (Form 26Q), capped at the amount of TDS. This is a fee, not a penalty — it cannot be waived for reasonable cause.

Penalty under Section 271H. ₹10,000 to ₹1,00,000 for failure to file the TDS return or for filing incorrect particulars, including wrong PANs and wrong section codes.

Clause 34 of Form 3CD. Your tax auditor is required to report, in tabular form, every instance of short deduction, non-deduction, and late deposit. This clause is a standing scrutiny trigger. A clean Clause 34 is one of the cheapest risk reductions available to a growing company.

MCA21 v3 angle. TDS defaults do not surface directly on MCA21, but they surface indirectly. A disallowance under 40(a)(ia) changes your profit figure, which flows into the financial statements filed in AOC-4. Where the AOC-4 figures diverge from the ITR-6 figures for the same year, the data-matching layer in MCA21 v3 flags the inconsistency — and reconciling a mismatch after the fact is considerably harder than getting the deduction right in month one.

Step-by-step: what to do

• Re-map your challan codes for FY 2026-27. Confirm your accounting system, payroll provider, or TDS utility is emitting Section 393 payment codes — 1023 and 1024 for contractors, and the corresponding 6(iii) codes for professional and technical services. If you are still quoting legacy 194-series references on challans deposited after 1 April 2026, fix it before the next quarterly return.
• Build a vendor master with a locked TDS section field. Every vendor gets a section classification, a rate, and a PAN status at onboarding — not at payment time. This is the single highest-leverage control. Payment-time classification is where errors originate.
• Get the invoice break-up before you pay. For any bundled agency, consultancy, or AMC invoice, insist on component-wise values. Add it to your standard vendor terms. A one-line clause saves a Clause 34 entry.
• Run a cumulative threshold report monthly. Flag every vendor approaching ₹1,00,000 aggregate (194C) or ₹50,000 aggregate (194J). Deduct retrospectively on the full year's payments the month the aggregate is crossed — do not wait for year-end.
• Collect transporter declarations in April, not March. Obtain the ten-carriage declaration with PAN from every goods-transport vendor at the start of the year and file it. Report the details in the quarterly return even where no tax is deducted.
• Verify PANs against the portal before the first payment. A wrong or inoperative PAN pushes the rate to 20% under Section 206AA and generates a short-deduction demand on TRACES that you will spend weeks correcting.
• Deposit by the 7th. TDS for any month is due by the 7th of the following month, except March, which is due by 30 April. Missing the 7th costs 1.5% per month immediately.
• File Form 26Q by the quarterly deadline. 31 July for Q1, 31 October for Q2, 31 January for Q3, and 31 May for Q4.
• Reconcile 26AS/TRACES against your expense ledger before the tax audit. Every default your auditor finds in September is one you could have corrected in June at a fraction of the cost.

FAQ

Does a private limited company have to deduct TDS even if it is loss-making or below the audit threshold?
Yes. A company is required to deduct TDS under these provisions irrespective of turnover or profitability. The Section 44AB turnover exemption applies only to individuals and HUFs, not to companies.

What rate applies to a graphic designer who invoices ₹80,000 for the year?
Professional service at 10% under Section 194J. The ₹50,000 aggregate threshold was crossed, so deduct on the full ₹80,000 — not just the ₹30,000 above the threshold.

We paid a contractor ₹95,000 across the year and deducted nothing. Are we safe?
Yes, provided no single payment exceeded ₹30,000 and the aggregate stays below ₹1,00,000 for the full financial year. If a further ₹10,000 is paid in March, TDS becomes due on the entire ₹1,05,000.

Do we deduct TDS on the GST component of an invoice?
No. Where GST is shown separately on the invoice, deduct TDS on the taxable value excluding GST, per CBDT Circular No. 23/2017. If GST is not separately indicated, TDS applies to the gross amount.

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