First hires: employee on payroll or contractor — TDS and records

You are about to bring someone in for the first time. Do they go on your payroll, or do you pay them an invoice every month as a contractor or freelancer? Before the legal and HR questions, there is a tax question you cannot skip: what do you deduct before you pay, and what must you keep on file?

This article covers only the income-tax side, called TDS (tax deducted at source). It does not tell you whether a particular person is an employee or a contractor in law. That is a question of facts and of other laws, for you and your adviser. Here we explain what the Income-tax Act says once you have decided how you pay.

Which Act applies to you

Payments you make in tax year 2026-27 (1 April 2026 to 31 March 2027) fall under the Income-tax Act, 2025, as amended by the Finance Act, 2026. Its TDS rules sit in Chapter XIX-B: section 392 for salary and section 393 for contractors, professionals and most other payments.

If you read older articles or ask someone who learnt TDS under the Income-tax Act, 1961, the same ground was called section 192 (salary), section 194C (contractors) and section 194J (professional and technical fees). The official mapping table between the two Acts links section 192 to section 392, sections 194C and 194J to section 393, section 201 to section 398 and section 203 to section 395. This article uses the 2025 Act numbers throughout.

The short version

The big difference: for salary you estimate the year's tax and spread it across the months. For contractors and professionals, you apply a fixed percentage to what you pay.

Employee on payroll: section 392

The Act says any person responsible for paying income under the head "Salaries" "shall deduct income-tax on the amount payable", at the time of payment, "at the average rate of income-tax computed on the basis of the rates in force for the tax year in which the payment is made, on the estimated income of the assessee under this head for such year" (s.392(1), Income-tax Act 2025).

In plain words: work out the employee's likely salary for the year, work out the tax on it at that year's rates, and deduct a share each month.

Points for a first-time employer, all from section 392:

• The employee can give you particulars that increase or decrease the deduction: salary from another employer, a loss under house property, income under other heads, and tax already deducted or collected elsewhere in the year. You take these into account if furnished in the prescribed form and verified in the prescribed manner (s.392(4)(a)).
• The tax you deduct cannot be reduced except for a house-property loss and for tax deducted or collected under other provisions of the Chapter (s.392(4)(b)).
• You must obtain from the employee the evidence or proof of the prescribed claims they make, including set-off of losses (s.392(5)(b)).
• If you give non-monetary perquisites, you must furnish a statement of their value (s.392(5)(a)). You may choose to pay the tax on such a perquisite yourself without deducting it from the employee (s.392(2)).
• An eligible start-up that allots shares or sweat equity to an employee must deduct or pay tax on that income at the time set by s.392(3). If you plan equity for early hires, read it with your adviser.

Contractor: section 393, Sl. No. 6(i)

Row 6(i) covers "any sum for carrying out any work (including supply of labour for carrying out any work) in pursuance of a contract" between the contractor and a "designated person" (s.393(1), Table Sl. No. 6(i), Income-tax Act 2025).

Rate:

• 1% if the contractor is an individual or a Hindu undivided family.


• 2% if the contractor is any other person.

Threshold, for both rates:

• ₹30,000 for any such sum, and


• ₹1,00,000 for the aggregate of such sums.

Who is a "designated person"? Section 402(11) lists them. It includes the Government, local authorities, any company, any co-operative society, any registered society, any trust and any firm. An individual, Hindu undivided family, association of persons or body of individuals falls in only if its total sales, gross receipts or turnover in the previous tax year exceeded ₹1 crore for a business, or ₹50 lakh for a profession (s.402(11)(l)).

So if your new business is a company or a firm, you are a designated person from day one. If you are an individual proprietor below those turnover levels, row 6(i) does not apply to you; row 6(ii), described below, does.

Three more points on "work":

• A contract includes a sub-contract (s.402(10)).
• "Work" is defined in section 402(47) to include advertising, broadcasting and telecasting, carriage of goods or passengers by transport other than railways, and catering. The Finance Act, 2026 added a further item: supply of manpower to a person to work under that person's supervision, control or direction (s.402(47)(f), inserted by s.90 of the Finance Act 2026). If you take people from a staffing agency, read this carefully.
• Where the work is manufacturing or supplying a product to the customer's specification using material bought from the customer or its associate (s.402(47)(e)), tax is deducted on the invoice value without the material if the material is shown separately on the invoice, and on the whole invoice value if it is not (Note to Sl. No. 6(i)).

Individuals and HUFs below the turnover levels: Sl. No. 6(ii)

An individual or Hindu undivided family who is not required to deduct under rows 6(i) or 6(iii) (or row 1(ii)) deducts 2% on a sum paid for contract work, for professional services, or as commission or brokerage. The threshold in the table is "fifty lakh rupees" (s.393(1), Table Sl. No. 6(ii), Income-tax Act 2025).

Professional or technical fees: section 393, Sl. No. 6(iii)

Row 6(iii) covers fees for professional services, fees for technical services, remuneration or fees or commission to a director of a company (other than what is salary under section 392), and royalty, paid by a "specified person" (s.393(1), Table Sl. No. 6(iii)).

A "specified person" is any person other than an individual or Hindu undivided family, or an individual or Hindu undivided family whose turnover in the previous tax year exceeded ₹1 crore (business) or ₹50 lakh (profession) (s.402(37)).

Rate:

• 2% for fees for technical services that are not professional services, for royalty on sale, distribution or exhibition of cinematograph films, and where the payee is engaged only in running a call centre.


• 10% in all other cases.

Threshold: ₹50,000 for professional fees, technical fees and royalty. For director remuneration, fees or commission the threshold is nil.

"Professional services" means services in the course of a legal, medical, engineering or architectural profession, or the profession of accountancy, technical consultancy, interior decoration or advertising, or another profession the Board notifies (s.402(28)). A freelance lawyer, architect or consultant is likely to fall here rather than in the contractor row. The label on the invoice does not decide it; the nature of the service does.

Before you deduct: the account number and PAN

Every person deducting or collecting tax must apply for a tax deduction and collection account number (TAN), within the time prescribed, if not already allotted one (s.397(1)(a), Income-tax Act 2025). You then quote it on challans, statements and certificates (s.397(1)(b)).

There is an exception that suits the smallest payers. The requirement does not apply to a person whose only deduction is under row 6(ii), that is, an individual or HUF below the turnover levels paying contractors or professionals (s.397(1)(c), as amended by the Finance Act 2026 with effect from 1 October 2026). If you also have an employee, section 392 applies to you and the exception does not help.

Ask each payee for a valid PAN. If the payee does not furnish one, tax is deducted at the higher of the rate in the relevant provision, the rate in force, and 20% (s.397(2)(b)(i), Income-tax Act 2025).

What if you do not deduct, or deduct and do not pay

A person who must deduct tax and does not, or deducts and does not pay it, is "deemed to be an assessee in default" (s.398(1)). On top of that, simple interest is charged at:

• 1% for every month or part of a month from the date the tax was deductible to the date it is deducted; and
• 1.5% for every month or part of a month from the date it was deducted to the date it is actually paid (s.398(3)(a)).

There is a relief for failure to deduct. If the payee furnished their return, took the amount into account, and paid the tax due on it, and you obtain a certificate to that effect from an accountant in the prescribed form, you are not deemed an assessee in default for that failure (s.398(2)). Interest from the date the tax was deductible to the date the payee filed the return still runs (s.398(3)(c)).

The late-filing fee for a TDS statement under the Act, as substituted by the Finance Act 2026, is ₹200 for every day the delay continues, capped at the tax deductible, and payable before the statement is filed (s.427(1) and (2), Income-tax Act 2025).

Certificates and returns

Every person deducting tax must issue the payee a certificate stating the tax deducted, the rate and other prescribed particulars, within the period prescribed (s.395(4)(a), Income-tax Act 2025; earlier section 203). Keep the date you issue each one.

You must also deliver the statement of deduction required by section 397(3)(b), within the time prescribed under it.

Records to keep from the first payment

Keep these in one folder per person:

• The engagement paper: offer letter or contract, with start date, pay and the work to be done.
• Each person's PAN and, for employees, the declarations and proofs they give you for claims under section 392.
• For each payment: date, gross amount, tax deducted, net paid, and the invoice or payslip.
• For each deduction: the date you paid it to the government and the challan details.
• Copies of the certificates you issued, with dates.
• For contractors and professionals: the invoice showing the nature of the service, and material shown separately where relevant.

What to do now

• Decide, with your adviser, whether the person is employed or engaged as a contractor. The TDS follows from that, not the other way round.
• Apply for a TAN if you will deduct under section 392 or rows 6(i) or 6(iii) and have none (s.397(1)(a), Income-tax Act 2025).
• For an employee: estimate salary for the year, deduct at the average rate each month, collect proofs (s.392(1), (4) and (5)).
• For a contractor or professional: identify the row (contract work, or professional or technical fees), check the payer test and the payee, and deduct at the rate once the threshold is crossed (s.393(1), Table Sl. No. 6).
• Deduct at the time of payment or credit. Interest runs from the date tax was deductible (s.398(3)(a)).

Have a CA review your facts before you act or file.

FAQs

Do I deduct TDS on a freelancer's first invoice of ₹20,000?
For professional or technical fees the threshold is ₹50,000 (s.393(1), Table Sl. No. 6(iii)). The table does not spell out how sums to one person are added up, so also check what else you have paid that person in the year. Director remuneration or fees have a nil threshold.

I am a sole proprietor. Do these sections apply to me?
Row 6(i) and row 6(iii) reach an individual only if turnover in the previous year exceeded ₹1 crore (business) or ₹50 lakh (profession) (s.402(11)(l) and (37)). Below that, row 6(ii) applies at 2% with a ₹50 lakh threshold. If you employ anyone on salary, section 392 applies to you regardless.

Does calling someone a "consultant" mean 10% TDS?
No. The rate follows the nature of the service. Professional services as defined in section 402(28) attract the 10% or 2% split in row 6(iii); contract work falls under row 6(i) or 6(ii).

What if I paid a contractor without deducting?
You may be treated as an assessee in default, and interest runs at 1% and then 1.5% a month (s.398(1) and (3)(a), Income-tax Act 2025). The accountant-certificate relief in section 398(2) may apply if the payee has paid the tax. Speak to a CA before you file anything.

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See Also

• Hiring your first employees in Hyderabad: Telangana professional tax registration and deduction