What Is Tax Deducted at Source (TDS)? Understanding India's Most Important Tax Mechanism

Description: Master TDS (Tax Deducted at Source) in India. Learn how it works, when it applies, rates, exemptions, how to claim refunds, and avoid penalties with this complete guide.

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I overpaid ₹42,000 in taxes over two years because I didn't understand how TDS works—and never claimed the refunds I was owed.

It was 2017. I'd just started freelancing alongside my full-time job, earning an additional ₹3-4 lakhs annually from freelance projects. Clients were deducting TDS from my payments—I noticed the deductions but didn't understand what they meant.

I assumed: "They're deducting tax, so I don't need to worry about it. Tax is paid."

That assumption cost me ₹42,000.

What I didn't know:

• Clients were deducting TDS at 10% on entire payment (without considering my tax-exempt income limit or deductions)
• My actual tax liability after all deductions was much lower
• The difference between TDS deducted and actual tax owed was REFUNDABLE
• But only if I filed income tax returns claiming the refund
• I wasn't filing returns because I thought "tax already paid via TDS"

For two years, I left ₹42,000 with the government—money that was rightfully mine, that I'd already overpaid, sitting unclaimed because I didn't understand the system.

A CA friend finally asked: "You're freelancing and earning side income—you're filing returns and claiming TDS refunds, right?"

"TDS refunds? What do you mean?"

His face said it all: "Oh no, how much have you lost?"

He explained how TDS actually works—not as your final tax payment, but as advance tax collection. The government takes tax upfront (TDS), then when you file returns, calculates your actual liability, and refunds the difference if you overpaid.

I'd never filed returns. Never claimed refunds. Just let the government keep my excess payments.

Once I understood the system:

• Filed returns for previous two years (still within time limit)
• Claimed ₹42,000 in total refunds
• Received refunds within 3 months
• Learned to file returns every year going forward
• Started using tax-saving instruments to reduce liability legally

The knowledge didn't just get me ₹42,000 back—it transformed my understanding of how India's tax system actually works, enabling better financial planning and preventing future losses.

Today, I'm explaining TDS in the clearest possible terms—not with confusing tax jargon, but with practical examples showing exactly how it works, when it applies, how to claim refunds, and how to avoid penalties.

Because here's the uncomfortable truth: millions of Indians have TDS deducted from their income without understanding what it is, how it works, or that they might be owed refunds—leaving thousands unclaimed with the government.

Let's master TDS permanently.

What Is TDS? (The Foundation)

TDS (Tax Deducted at Source): A mechanism where the person making payment deducts tax before paying you, and deposits that tax to the government on your behalf.

The Basic Concept

Traditional tax payment:

1. You earn income throughout year
2. Calculate tax owed at year-end
3. Pay entire tax liability in lump sum
4. Risk: People might not pay, government doesn't get revenue

TDS system:

1. You earn income
2. Payer deducts tax immediately before paying you
3. Payer deposits tax to government
4. You receive income minus tax already deducted
5. Benefit: Government gets revenue throughout year, collection rate higher

Simple example:

Freelance payment without TDS:

• Client owes you ₹1,00,000
• Client pays you ₹1,00,000
• You're supposed to pay tax later (might not happen)

Freelance payment with TDS:

• Client owes you ₹1,00,000
• Client deducts TDS @ 10% = ₹10,000
• Client pays you ₹90,000
• Client deposits ₹10,000 to government
• Tax already collected, government secured

Why TDS Exists

Government's perspective:

• Ensures steady revenue throughout year
• Reduces tax evasion (hard to evade when deducted at source)
• Distributes tax collection across multiple parties
• Provides audit trail (tracks income sources)

Your perspective:

• Tax paid in installments throughout year (easier than lump sum)
• Forces you to pay taxes (can't evade)
• Creates refund opportunity (if TDS exceeds actual liability)

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How TDS Actually Works (Step-by-Step)

Let's walk through the complete TDS lifecycle.

Step 1: Income Transaction Occurs

You provide service or earn income where TDS applies.

Example: You freelance and complete a project for ₹1,00,000.

Step 2: Payer Deducts TDS

Before paying you, the payer:

• Calculates applicable TDS rate (based on income type)
• Deducts tax amount
• Pays you the remaining amount

Example continued:

• Applicable rate: 10% (Section 194J for professional services)
• TDS amount: ₹1,00,000 × 10% = ₹10,000
• You receive: ₹90,000

Step 3: Payer Deposits TDS to Government

The payer must:

• Deposit ₹10,000 to government within specified deadline
• File TDS return (Form 26Q for non-salary, Form 24Q for salary)
• Mention your PAN details

Timeline: Usually by 7th of following month

Step 4: TDS Certificate Issued to You

The payer provides you with TDS certificate:

Form 16: For salary (annual certificate)

Form 16A: For non-salary payments (quarterly certificate)

Contains:

• Payer details
• Your PAN
• Amount paid to you
• TDS deducted
• TDS deposited (challan details)

This certificate is your PROOF that tax was deducted and deposited on your behalf.

Step 5: You File Income Tax Return

At year-end, you:

• Calculate total income from all sources
• Calculate actual tax liability (after deductions, exemptions)
• Show total TDS already deducted (from Form 16/16A)
• Compare: TDS paid vs. actual tax owed

Step 6: Refund or Additional Payment

Three scenarios:

Scenario A: TDS > Actual Tax (You get refund)

• TDS deducted: ₹50,000
• Actual tax after deductions: ₹30,000
• Refund owed: ₹20,000
• Government refunds ₹20,000 to your bank account

Scenario B: TDS = Actual Tax (No refund, no payment)

• TDS deducted: ₹50,000
• Actual tax: ₹50,000
• Balanced—no further action needed

Scenario C: TDS < Actual Tax (You owe more)

• TDS deducted: ₹50,000
• Actual tax: ₹70,000
• You pay remaining ₹20,000 when filing return

The key insight: TDS is ADVANCE tax, not FINAL tax. Final calculation happens when you file returns.

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When Does TDS Apply? (Common Scenarios)

TDS applies to many income types—here are the most common.

1. Salary Income (Section 192)

Who deducts: Your employer

Rate: Based on your projected annual income and tax slab

How it works:

• Employer calculates expected annual salary
• Considers your declared investments (80C, 80D, HRA, etc.)
• Deducts tax monthly based on calculation
• Adjusts in March if actual income/deductions differ

Example:

• Annual salary: ₹8,00,000
• Declared 80C investments: ₹1,50,000
• Taxable income: ₹6,00,000 (after standard deduction ₹50,000)
• Tax liability: Calculated per slab
• TDS deducted monthly: Total annual tax ÷ 12

Certificate: Form 16 (issued annually by employer)

2. Professional/Technical Services (Section 194J)

Who deducts: Client/company paying for your services

When it applies:

• Freelancing
• Consulting
• Professional services (CA, lawyer, doctor)
• Technical services

Rate: 10% (2% if payee is individual/HUF and payment for technical services)

Threshold: Applies if payment exceeds ₹30,000 in a financial year

Example:

• Freelance project payment: ₹1,00,000
• TDS @ 10%: ₹10,000
• You receive: ₹90,000

3. Commission/Brokerage (Section 194H)

Who deducts: Company paying commission

When it applies:

• Sales commissions
• Insurance agent commissions
• Brokerage payments

Rate: 5%

Threshold: Applies if payment exceeds ₹15,000 in a financial year

4. Rent (Section 194-IB and 194-I)

Two categories:

Residential rent by individuals (194-IB):

• When it applies: If you pay rent exceeding ₹50,000 per month
• Rate: 5%
• Who deducts: You (the tenant), if not liable for tax audit

Rent by businesses (194-I):

• When it applies: Any rent paid by business
• Rate: 10% (land/building), 2% (machinery/equipment)
• Threshold: ₹2,40,000 per year

Example:

• Monthly rent: ₹60,000
• Annual rent: ₹7,20,000
• TDS @ 5%: ₹36,000 annually
• Landlord receives: ₹6,84,000

5. Fixed Deposit Interest (Section 194A)

Who deducts: Bank

When it applies: If total FD interest from one bank exceeds ₹40,000 in a year (₹50,000 for senior citizens)

Rate: 10%

Example:

• FD interest earned: ₹60,000
• Threshold: ₹40,000
• TDS @ 10% on entire ₹60,000: ₹6,000
• Interest credited: ₹54,000

Special note: You can submit Form 15G/15H to prevent TDS if your total income is below taxable limit.

6. Lottery/Game Show Winnings (Section 194B)

Who deducts: Lottery company/game show organizer

When it applies: Winnings exceed ₹10,000

Rate: 30% (highest rate—no threshold consideration)

Example:

• Game show prize: ₹5,00,000
• TDS @ 30%: ₹1,50,000
• You receive: ₹3,50,000

7. Contractor Payments (Section 194C)

Who deducts: Company/business hiring contractor

Rate:

• Individual/HUF: 1%
• Others: 2%

Threshold: ₹30,000 per transaction or ₹1,00,000 per year

Applies to: Construction contracts, supply contracts, advertising contracts

8. Purchase of Property (Section 194-IA)

Who deducts: Buyer of property

When it applies: Property value exceeds ₹50 lakhs

Rate: 1%

Example:

• Property sale price: ₹80,00,000
• TDS @ 1%: ₹80,000
• Seller receives: ₹79,20,000
• Buyer must deposit ₹80,000 to government

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TDS Rates Summary Table

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PAN and TDS: The Critical Connection

Your PAN (Permanent Account Number) is essential for TDS.

Why PAN Matters

When you provide PAN:

• TDS deducted at specified rate (10%, 5%, etc.)
• TDS credited to your account
• You can claim credit when filing returns

When you DON'T provide PAN:

• TDS deducted at MAXIMUM rate (20% or rate in section, whichever is higher)
• You still get credit, but higher deduction impacts cash flow
• Payer faces compliance issues

Example comparison:

Freelance payment: ₹1,00,000

With PAN provided:

• TDS @ 10%: ₹10,000
• You receive: ₹90,000

Without PAN:

• TDS @ 20%: ₹20,000
• You receive: ₹80,000
• (You can claim ₹20,000 when filing return, but cash flow impact immediate)

Lesson: ALWAYS provide PAN to payers to avoid higher TDS deduction.

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Form 15G/15H: Preventing TDS When Not Required

If your total income is below taxable limit, you can prevent TDS deduction.

Form 15G

Who can use: Individuals/HUFs below 60 years with no tax liability

When to use:

• FD interest will exceed threshold (₹40,000)
• But total income below ₹2.5 lakhs (no tax owed)
• Submit to bank to prevent TDS

Example:

• Senior citizen with only pension income of ₹2 lakhs annually
• FD interest: ₹50,000
• Without Form 15G: Bank deducts TDS ₹5,000
• With Form 15G: No TDS deducted (since total income ₹2.5L below taxable limit)

Form 15H

Who can use: Senior citizens (60+ years) with no tax liability

Same concept as 15G, specific to senior citizens

Note: These forms are self-declarations—you're certifying your income is below taxable limit. False declarations can lead to penalties.

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How to Claim TDS Refund (Step-by-Step)

This is where most people leave money on the table.

Step 1: Collect TDS Certificates

Throughout the year, collect:

• Form 16 from employer
• Form 16A from all sources deducting TDS (clients, banks, etc.)

Check certificates contain:

• Correct PAN
• Correct amounts
• TAN of deductor
• Challan details (proof tax deposited)

Step 2: Verify TDS in Form 26AS

Form 26AS: Your consolidated tax statement

Access via:

• Income Tax e-filing website
• Using PAN and password

Shows:

• All TDS deducted on your PAN
• Advance tax paid
• Self-assessment tax paid
• Refunds received

Verify: TDS shown in certificates matches Form 26AS (proves tax actually deposited to government)

Step 3: Calculate Actual Tax Liability

Prepare calculation:

• Total income from all sources
• Less: Deductions (80C, 80D, HRA, home loan interest, etc.)
• Taxable income
• Tax as per slab
• Less: Rebates (87A if applicable)
• Final tax liability

Step 4: File Income Tax Return

Use appropriate ITR form:

• Salaried: ITR-1 (Sahaj) or ITR-2
• Freelance/Business: ITR-3 or ITR-4

In the return:

• Show all income
• Claim all deductions
• Enter TDS details (auto-populated from Form 26AS)
• Calculate tax liability
• System calculates refund if TDS > tax liability

Step 5: E-verify Return

Critical step:

• E-verify immediately (Aadhaar OTP, net banking, etc.)
• Without verification, return not processed
• Refund won't be issued

Step 6: Receive Refund

Timeline:

• Usually 2-4 weeks after e-verification
• Direct deposit to bank account linked to PAN
• Check status on IT portal

My experience: Filed return on July 10th, e-verified immediately, refund of ₹23,000 received August 2nd (23 days).

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Common TDS Mistakes and How to Avoid Them

Mistake 1: Not Filing Returns Because "TDS Already Paid"

The problem: Assuming TDS = final tax, no return needed

Reality: TDS is advance payment; return mandatory to claim refunds

Loss: Thousands left unclaimed with government

Solution: File returns every year, even if no tax owed

Mistake 2: Not Providing PAN to Deductors

The problem: Higher TDS deducted (20% instead of 10%)

Impact: Severe cash flow hit

Solution: Always provide PAN to clients, banks, anyone making payments

Mistake 3: Not Verifying TDS in Form 26AS

The problem: Certificate shows TDS deducted, but not in 26AS (means not deposited)

Impact: Can't claim credit for TDS not deposited

Solution: Always verify 26AS before filing return, raise disputes for mismatches

Mistake 4: Missing TDS Credit

The problem: Not claiming all TDS in return (forgetting sources)

Impact: Leaving money unclaimed

Solution: Comprehensive record-keeping, check all Form 16A certificates

Mistake 5: Not Submitting Form 15G/15H

The problem: Unnecessary TDS deduction when income below taxable limit

Impact: Money blocked with government until refund processed

Solution: Submit forms to banks/sources if income below threshold

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TDS for Businesses: Compliance Requirements

If you're paying others and TDS applies, you have obligations.

When You Must Deduct TDS

If you're:

• Company/business making specified payments
• Individual/HUF (in certain cases like rent >₹50,000/month)

You must:

• Deduct TDS at applicable rate
• Deposit to government by 7th of next month
• File quarterly TDS returns
• Issue TDS certificates to payees

Penalties for Non-Compliance

Failure to deduct TDS:

• Interest @ 1% per month
• Disallowance of expense (can't claim in your business)

Failure to deposit TDS:

• Interest @ 1.5% per month
• Penalty up to TDS amount

Late filing of TDS returns:

• Late fee: ₹200 per day (max ₹20,000 for small entities)

The lesson: TDS compliance is serious—non-compliance expensive.

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The Bottom Line

Those ₹42,000 I left unclaimed for two years taught me the most expensive lesson: TDS isn't your final tax—it's advance collection, and understanding the system determines whether you overpay or get rightful refunds.

My mistaken assumption—"TDS deducted means tax paid, nothing more needed"—cost me ₹42,000 and would have cost more if I hadn't finally learned how it works.

The truth about TDS:

• It's advance tax collection, not final settlement
• The difference between TDS paid and actual tax owed is REFUNDABLE
• But only if you file returns and claim it
• Millions leave refunds unclaimed through ignorance
• The system favors those who understand it

Understanding TDS transformed my relationship with taxes:

• Filed returns consistently every year going forward
• Claimed ₹42,000 in back refunds (within time limit)
• Used Form 15G to prevent unnecessary deductions
• Planned investments to reduce tax liability legally
• Helped family and friends claim thousands in unclaimed refunds

You now understand:

• What TDS is (advance tax collection mechanism)
• How it works (step-by-step lifecycle from deduction to refund)
• When it applies (common scenarios and rates)
• How to claim refunds (filing returns and verification)
• How to avoid mistakes (PAN, Form 26AS, Form 15G/15H)

TDS knowledge isn't optional—it's the difference between keeping your money and gifting it to the government.

Check your Form 26AS today. How much TDS was deducted this year? Have you filed returns claiming it? If not, you're leaving money on the table.

This tax season, file your return. Claim every rupee of TDS. Get your rightful refund. The government won't remind you—they're happy to keep unclaimed money.

Your ₹20,000, ₹40,000, or more in refunds is waiting. The only question: will you claim it, or leave it like I did for two years?

The system is complex by design. But once understood, it works for you instead of against you.

File your return. Claim your money. Stop overpaying through ignorance.