How TDS on vendor payments works in practice
Follow what actually happens when tax is deducted from a vendor payment in India, who carries the liability and where the credit usually goes missing.
What you are being asked to do
A vendor sends an invoice and your accountant says tax has to be deducted before paying it. The vendor objects because they want the full amount. Somewhere between those two positions sits a process that most small businesses run badly and discover only when a notice arrives.
Tax deducted at source is a collection mechanism rather than a tax of its own. You hold back a part of the vendor's money, deposit it with the government against the vendor's permanent account number, report it, and give the vendor a certificate. The vendor then sets that amount against their own tax liability. Nobody pays more in total. The money simply reaches the government earlier and through you.
What the obligation does not settle and what it costs
Deducting does not settle your vendor's tax position and it does not end your own exposure. If you deduct less than required the shortfall remains your liability even where the vendor has paid their own tax in full. The obligation sits on the payer and it is not transferable by agreement.
The costs are administrative. A tax deduction account number is required before you can deduct at all. Quarterly statements have to be filed and most firms pay for software or a professional to do it. That professional fee attracts GST at 18%. There is also a relationship cost that nobody records. A vendor receiving less than the invoice value for the first time will ask questions and somebody has to explain the mechanism patiently. A qualified chartered accountant should confirm which payments your business is required to deduct on.
Who has to deduct and who should not try
Companies, partnerships and limited liability partnerships are generally within the deduction framework for the categories of payment the Act specifies. Individuals and Hindu undivided families are brought in only above prescribed turnover levels, with a few specific provisions that apply to them regardless.
A small proprietor below those levels should not deduct voluntarily to feel safe. Depositing tax you were never required to deduct does not earn goodwill from the department. It creates a credit against a vendor who was not expecting it, a statement you now have to file every quarter, and a short payment the vendor may chase you for. The instinct to be cautious produces more work and more risk than doing nothing. Equally a firm that crosses a turnover trigger and keeps paying vendors in full is accumulating a liability quietly. Both errors come from not knowing which side of the line you are on and that is a question with a definite answer.
How the sequence actually runs
Deduction happens at the earlier of two events. Credit of the amount in your books or actual payment. Many firms assume the duty arises when payment leaves the bank. It can arise when the bill is booked.
The rate depends on the nature of the payment and each category has its own threshold below which no deduction arises. Professional and technical fees, contract work, rent, commission and brokerage are treated separately. Where the vendor has not furnished a valid permanent account number a higher rate applies. The amount deducted is deposited by a due date with a challan referencing your deduction account. A quarterly statement then reports each deduction against each vendor and only after that statement is processed does the credit appear in the vendor's own tax records. You issue the vendor a certificate for the quarter. Whether the deduction is computed on the invoice value including or excluding GST depends on how the invoice presents the tax and on departmental clarifications so have that confirmed rather than assumed.
Judging whether the process is sound
The flattering statement is that you deduct on everything. Over-deduction is not compliance and it irritates vendors without protecting you.
The honest measure is a three way reconciliation each quarter. Amount deducted in your books against amount deposited by challan against amount reported in the statement. Those three figures should be identical and in many small businesses they are not. Alongside it count the vendors who asked why their credit has not appeared. Every such query is a reporting error you have not yet found.
The common mistake
The expensive error is deducting correctly and reporting carelessly. A wrong permanent account number, a wrong section, a wrong assessment year or a wrong quarter in the statement means the money has reached the government and the credit has not reached the vendor.
That position is worse than not deducting. The vendor cannot claim what does not appear in their records so they come back to you for the shortfall. You have already paid it out. Recovering it requires a correction statement and the vendor waits in the meantime. Where the error is a missing or invalid permanent account number the higher rate may apply to the whole payment and the difference is yours to fund. Verifying the vendor's details once at onboarding costs a minute and removes almost all of this.
A note on figures
Rates, thresholds, due dates and the sections that apply to particular payments are amended regularly. No rate or deadline is stated here for that reason. A qualified chartered accountant should confirm the current position for your own payments.
This guide explains how something works. It is not legal, tax or financial advice, and rules change. Confirm anything regulatory with a qualified professional before you act on it.