Section 194M – TDS on Payment to Resident Contractors and Professionals

Section 194M of the Income Tax Act, 1961 is a provision that deals with Tax Deducted at Source (TDS) on payments made to resident contractors and professionals. It was introduced as a part of the 2019 Budget with the intention of ensuring tax compliance by deducting TDS on specific payments made to individuals and Hindu undivided families (HUFs) who are exempt from having their books of accounts audited.

The section is applicable if a resident person receives more than Rs. 50, 00,000 in a financial year for performing any contractual work or rendering professional services. A resident contractor or professional will receive 1% of the total payment as TDS under Section 194M. In contrast, the TDS rate would be 2% if the payee was running a call centre. 

Aiming to improve tax compliance, especially in situations where payments were previously evading TDS because of specific exemptions, TDS Section 194M was introduced to broaden the scope of TDS. The government aims to bring more payments made to resident contractors and professionals under the tax net by deducting TDS at the rates set forth in this section. This reduces the possibility of tax evasion and fosters financial transaction transparency.

Section 194M of the Income Tax Act, 1961 mandates that individuals and HUFs withhold TDS from payments made to resident contractors and professionals when the total payment exceeds Rs. 50,00,000 in a financial year at a rate of 1% (or 2% for payees engaged in the call centre business). This clause was added to help with tax compliance and stop tax evasion on large payments for professional and contractual services.

What were the Compliances Prior to Section 194M?

Prior to the introduction of the 194M TDS Section, neither individuals nor HUFs were required to deduct TDS from payments made for either personal or business-related purposes. Only individuals or HUFs are required to do an audit of their books of accounts under section 44AB of the Income Tax Act, 1961 (Gross turnover from business exceeding Rs. 1 Cr or gross receipts exceeding Rs. 50 lakhs from the profession) are covered under Section 194C and 194J.  As a result, there was room for tax evasion because a sizable portion of payments made for professional services and contract work were not subject to TDS. In order to resolve this problem, TDS 194M Section was introduced to make sure that TDS is taken out at a predetermined rate on payments that exceed the established threshold.

It is important to note that individuals and HUFs do not need to deduct tax at source under Section 194M if they are already doing so under Section 194C (TDS on payment to a contractor) and Section 194J (TDS on payment of professional fees).

Why Section 194M Is Introduced?

When services are rendered to a resident contractor for personal use, Section 194M of the Finance Bill of 2019 allows for the tax to be deducted at source from any payments made by an individual or HUF to the resident contractor. Therefore, both personal and business-related payments are covered by this section.

Even when payments were made for business or professional purposes, individuals or HUFs operating a business or profession (who were not subject to an audit) did not deduct any tax at the source. Due to this exemption, a significant portion of payments made for professional services and contractual work were exempt from TDS, opening the door for tax evasion.

Meaning of Certain Terms Like “Work”, “Contract” and “Professional Services” in Section 194M

Work

The term "work" in this section would refer to the following:

• Advertising
• Production of shows for such broadcasting or telecasting is included in broadcasting and telecasting.
• Transportation methods other than railways are used to transport both passengers and cargo.
• Catering.
• Creating or delivering a product in accordance with a customer's requirements or specifications using raw materials bought from that customer. 
• However, it excludes producing or supplying a product using raw materials bought from someone other than the customer in question in accordance with their needs or specifications.

Professional Services

In this section, the following would be considered professional services:

• Professional fees
• Fees for technical services
• Salary-free compensation given to directors (such as attendance fees at board meetings)
• Royalty
• Payments in the form of non-compete fees (i.e., fees paid to refrain from engaging in any profession or business for a predetermined period of time and within specific geographic restrictions) or fees paid to refrain from disclosing any technical information or know-how.

Contract

• It shall be interpreted in accordance with clause (iii) of the Explanation to Section 194C.

Who Will Deduct TDS Under Section 194M?

According to the Union Budget 2019, on or after September 1, 2019, if anyone paying a resident more than Rs 50,00,000 annually for any work (including the supply of labour) must deduct TDS at a rate of 5%, under any contract or by way of fees for professional services rendered during the financial year.

If an individual or HUF needs to pay a resident for work on a contract they completed or any professional services they rendered, they must withhold tax at the source in accordance with section 194M.

When TDS Under Section 194M Is Required to Deduct?

TDS must be withheld at the time of crediting the amount or at the time of payment (whether the amount is paid in cash, when a cheque or draft is issued, or when it is paid using any other method), whichever is earlier basis.

Exemption From Section 194M

• Individuals and/or HUFs that are required to deduct TDS under Sections 194C (TDS on payments to contractors) and 194J (TDS on payments for professional fees) are exempt from Section 194M's source tax withholding requirement. TDS deduction is applicable in accordance with Sections 194C and 194J if they are required to have their books of accounts audited.
• Also, when the total payment made to a resident person during a financial year for professional services rendered or contractual work performed does not exceed Rs 50, 00,000, Section 194M does not apply.
• The scope of this section does not apply to payments made to non-residents.

Rate of TDS Under Section 194M

• If the total amount paid to a resident in a given financial year exceeds Rupees fifty lakhs, TDS at 5% will be deducted under section 194M.
• However, 20% TDS will be deducted if the deductee's PAN is not readily available.

Threshold Limit of TDS under Section 194M

TDS must only be withheld when a single sum, or in aggregate, exceeds fifty lakh rupees per year. However, it is suggested that these individuals or HUFs deposit the tax deducted using their PAN and not be required to obtain a TAN in order to compliance section 194M.

Other Considerations Need to Know for TDS Under Section 194M

Due Date of Deposit of TDS Under Section 194M

When payment is made by or on behalf of the Government

TDS is required to be deducted and paid to the department on the same day of making the payment.

When payment is made other than by or on behalf of the Government

Issue of TDS Certificate

The person who has deducted tax under Section 194M, will be required to issue a TDS certificate to the deductee in Form 16D within 15 days from the due date of furnishing the challan cum statement in Form 26QD for TDS under Section 194 M.

The deductee may claim a TDS credit in their income tax return. Additionally, Form 26AS on the income tax department website contains information about the tax deducted in accordance with section 194M.

Filing of TDS Return

The person who has deducted tax under Section 194M, is required to submit TDS reports in accordance with Section 194M of the Income Tax Act. As a result, they must file a Challan- cum statement in Form 26QD within 30 days from the last day of the month in which TDS was deducted.

Points to Remember Under Section 194M

• Obtaining a tax deduction account number (TAN) is not required to take advantage of TDS deductions, individuals or HUFs that must withhold taxes may pay them to the government by simply providing their PAN. 
• The scope of this section does not apply to payments made to non-residents.
• Even if the contract was in place prior to the applicability date, if a payment is made after that date that exceeds Rs 50,00,000, TDS will be deducted.

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