Payment clauses decide whether a service agreement actually pays. Paying parties routinely draft themselves broad comfort: rights to set off "any amounts due", to withhold invoices pending disputes, or to approve payment "in their sole discretion". Indian law supports far less of this than the drafting suggests: the Contract Act fixes how payments must be applied, courts refuse to bless withholding of undisputed sums, the MSMED Act 2006 attaches interest that no contract can waive, and the tax statutes assign obligations that cannot be shifted. This piece maps where the lines fall, and how a service provider can draft to hold them.
Set-Off Starts with Section 59 of the Contract Act
Where a debtor owes several distinct debts to one creditor, Section 59 of the Indian Contract Act 1872 dictates how a payment is applied:
"Where a debtor, owing several distinct debts to one person, makes a payment to him, either with express intimation, or under circumstances implying, that the payment is to be applied to the discharge of some particular debt, the payment, if accepted, must be applied accordingly."
The statute's own illustration makes the point: A owes B, among other debts, ₹1,000 on a promissory note falling due on 1 June, and owes B no other debt of that amount; when A pays B ₹1,000 on 1 June, the payment discharges the promissory note. The rule is mandatory. A creditor cannot accept a payment and then re-apply it to debts of its own choosing in disregard of the debtor's expressed or implied designation; acceptance of the payment is agreement to that designation.
Parties can contractually expand set-off beyond this statutory baseline, but two limits persist. First, clauses that purport to strip a party of its right to have a payment applied to a particular debt may be unenforceable as contrary to Section 59. Second, set-off needs a legal or equitable footing, not mere preference: courts do not uphold clauses that operate as naked rights to withhold payment or to apply credits at the payor's unilateral discretion.
Three protections follow for the party against whom set-off is asserted. The cross-claim must be liquidated and undisputed: a genuinely contested or unquantified claim cannot be netted against an undisputed debt, and the burden of proving entitlement rests on the party exercising the set-off. Set-off is generally confined to debts of the same nature or arising from the same contract; claims from different contracts or of a different character may not be set off at all. And an improper set-off can simply be rejected, with payment of the undisputed amount demanded.
In drafting terms, a service provider should confine any contractual set-off to amounts that are undisputed and liquidated, arise directly from the same service contract, and are claimed in writing with supporting documentation a defined period (say 30 days) before the set-off is exercised, with an express right to challenge the claimed amount within a further window. General claims, such as unquantified "damages for failure to perform", should not be nettable against fees for services rendered unless specifically documented and agreed.
Undisputed Amounts Cannot Simply Be Withheld
Indian law confers no automatic right on a paying party to withhold undisputed sums while a separate dispute plays out. Amounts that have been invoiced without any genuine challenge to quantum or performance, or that relate to services accepted (or deemed accepted after the agreed objection period), fall due on their contractual date. Withholding them pending resolution of other items is treated by Indian courts as a breach of contract unless the agreement explicitly authorises the withholding and defines the conditions for exercising it. What a payor may legitimately hold back is the genuinely disputed portion: contested or incomplete performance, disputed quality or quantity, or a documented counterclaim arising from the same transaction.
The courts have not upheld blanket clauses that leave payment to the payor's will. In Shanti Conductors (P) Ltd. v. Assam State Electricity Board (Supreme Court, 31 August 2016), in the context of delayed payments to small-scale suppliers, the Court observed that "buyers, if required under law to pay interest, would refrain from withholding payments to small-scale and ancillary industrial undertakings" — a recognition that unrestricted withholding discourages timely payment and distorts contractual balance. Withholding is a tool that must be justified, not a free-standing right: a payor that withholds must be prepared to prove a genuine dispute, contractual or legal authority for the withholding, and proportionality between the amount held and the counterclaim asserted.
The protective drafting pattern is a dispute-notice regime: the paying party must give written notice within a short window (seven days of invoice is workable) identifying the disputed portion and its basis; it may withhold only that portion; it must pay the undisputed balance by the due date; and if no notice issues within the window, the whole invoice is deemed undisputed.
Interest on Delay: Not Automatic, Except Where Statute Steps In
General contract law gives no automatic right to interest on late payment. Interest is owed only if the contract provides for it, a statute imposes it, or actual loss is proved. The Supreme Court has recently confirmed the corollary in Kerala Water Authority v. T.I. Raju (reported in 2026): a clause expressly barring interest on delayed payment is enforceable even where payment is substantially delayed, and courts will not use statutory discretion to override it. The Interest Act adds little here: it creates no independent right to interest, and merely enables courts to award it in defined circumstances where the contract is silent.
The decisive exception is the Micro, Small and Medium Enterprises Development Act 2006. Where the service provider qualifies as an MSME supplier, interest is statutory and cannot be waived by contract. Section 15 requires the buyer to pay by the agreed date, which cannot stretch the credit period beyond 45 days, or within 15 days where there is no written agreement. Default triggers compound interest under Section 16 at three times the bank rate notified by the Reserve Bank of India, compounded monthly, running from the agreed due date or, absent agreement, from the "appointed day" — the day after expiry of 15 days from acceptance or deemed acceptance of the services. A supplier invoicing on 1 March under a contract with the maximum 45-day credit period must accordingly be paid by mid-April; from then on, statutory interest accrues automatically.
For an MSME provider, the agreement should say so expressly, keep the payment timeline within 45 days, and acknowledge the MSMED interest consequence rather than attempt to exclude it. For a non-MSME provider, the lesson is to write the interest clause: a defined rate (a stated percentage per annum, or a spread over an RBI reference rate) accruing on undisputed amounts from the due date. Silence, or a contractual bar, will be enforced as written.
TDS: The Deduction Is the Payor's Obligation, Not a Bargaining Chip
Tax deduction at source on service payments runs under two provisions of the Income Tax Act 1961, and which one applies turns on the character of the services. Section 194C covers payments to contractors for carrying out work or supplying labour or materials, at 1 per cent for individuals and HUFs and 2 per cent for others, once payments cross ₹30,000 on a single invoice (or ₹1,00,000 in a financial year). Section 194J covers fees for professional or technical services — consultancy, software development, engineering design, professional advice — at 10 per cent for professional fees, with differing rates for certain categories, above prescribed monetary thresholds. Physical work and supply point to Section 194C; professional or technical expertise points to Section 194J.
The obligation sits with the payor and cannot be contractually shifted to the service provider. Deduction happens at the earlier of the amount being credited in the payor's books or actual payment. Deposit with the government falls due within seven days of the end of the month of deduction (30 April for March deductions). Quarterly TDS statements are filed in Form 26Q, and the payor must then issue Form 16A, the TDS certificate, to the service provider within 15 days of the due date for the quarterly statement. Form 16A must carry the provider's PAN, the payor's TAN, the challan identification number and the receipt number of the TDS statement; the provider needs it to claim credit for the deducted tax. One transition note: for payments made on or after 1 April 2026 the Income Tax Act 2025 applies in place of the 1961 Act, with the rates and timelines remaining substantively the same.
What the contract can usefully do is police performance of the statutory duty: identify the applicable section and rate; confirm that fees are payable gross less TDS; require challan evidence of deposit within a few days of the statutory deadline; fix the Form 16A timeline in the clause; and indemnify the service provider against any tax demand, interest or penalty flowing from the payor's failure to deposit or certify the tax it deducted.
GST: The Supplier's Filing Failure Becomes the Payor's Credit Problem
Input tax credit runs in the opposite direction: the compliance burden is the supplier's, and the financial risk the recipient's. Under Section 16 of the CGST Act 2017, the recipient's credit is conditional on the supplier reporting the invoice. Section 16(2)(aa) provides that no registered person is entitled to input tax credit unless
"the details of the invoice or debit note… ha[ve] been furnished by the supplier in the statement of outward supplies and such details have been communicated to the recipient of such invoice or debit note in the manner specified under section 37."
The mechanics: the supplier files Form GSTR-1 by the 11th of the following month with complete invoice details; those details populate the recipient's Form GSTR-2B in the next tax period; and the recipient claims the credit in Form GSTR-3B on that basis. Section 16(4) imposes an outer limit: credit must be claimed by 30 November following the end of the financial year to which the invoice relates, or the filing of the relevant annual return, whichever is earlier. An invoice the supplier never reports therefore does not generate usable credit — the CGST Rules leave only marginal room to claim credit on invoices missing from the supplier's returns — and a supplier who files late enough can time-bar the recipient's credit entirely.
Notably, the CGST Act gives the recipient no direct statutory claim against the supplier for the lost credit. Protection has to be contractual: an obligation on the supplier to maintain GST registration and file GSTR-1 by the due date with complete invoice details; evidence of filing within a defined period; a right for the payor to withhold an amount equal to the estimated credit loss until filing is evidenced; and an indemnity for credit actually lost, with associated interest or penalties, through the supplier's non-filing. A service provider should accept these as legitimate asks — this is the one context in which a withholding right is commercially defensible — while insisting that the right is bounded: capped at the estimated credit at stake, and released on proof of filing. If the provider is unregistered, the analysis changes altogether, since the payor may then be liable under reverse charge.
Books of Accounts: No Blanket Right of Access
No statute gives one contracting party general access to the other's books of accounts. Access arises only where a statute specifically grants it (auditor rights under the Companies Act, for example), the contract provides for it, a court orders discovery in litigation, or a tax authority demands it in an audit. Clauses granting one party unrestricted access to the other's records are vulnerable to challenge on three fronts: as unconscionably one-sided, as inconsistent with the privacy protection read into Article 21 of the Constitution, and as compelled disclosure of trade secrets.
A bounded audit clause, by contrast, is enforceable: access limited to records tied to the engagement (invoices, timesheets, cost statements, expense vouchers), for a defined purpose such as verifying billing accuracy, on reasonable notice (ten days), at limited frequency (not more than twice a calendar year), under strict confidentiality, and with express exclusions for financial statements and profitability data unrelated to the engagement, information about other clients or vendors, tax returns, privileged documents and anything the provider reasonably treats as a trade secret.
"Sole Discretion" Clauses Have Judicial Limits
Clauses conferring "sole discretion" are prima facie valid as an exercise of freedom of contract, but Indian courts read them against an implied obligation of good faith and reasonableness. Discretion must serve the contract's legitimate purpose; it cannot be exercised arbitrarily, capriciously or in bad faith, and it cannot be used to nullify the other party's rights. So a clause letting the payor approve invoices in its sole discretion survives, subject to a duty to review reasonably and not withhold approval arbitrarily; a sole discretion to judge whether services meet quality standards survives if exercised on a reasonable and consistent basis. By contrast, a right to unilaterally rewrite the payment schedule is likely unenforceable because it destroys the bargained-for exchange, and a promise to pay fees "in its sole discretion" is likely unenforceable because it renders the agreement illusory. A party that truly wants an arbitrary right, such as termination "for any reason or no reason", must say so in explicit and unambiguous words; courts will not infer it from general language. Discretion anchored to standards, on the other hand, is not void for uncertainty: in X Corp v. Union of India (24 September 2025), the court held that terms giving guidance or indicia for the exercise of discretion are not vague. Source
The drafting answer is bounded discretion. Approval or a dispute notice within five business days of invoice, failing which the invoice is deemed approved; rejection of services only against quality standards set out in a schedule, on written notice within three days of delivery and with a five-day cure period; and defined criteria wherever a judgment call is unavoidable.
Practical Takeaways
For a service provider negotiating or redrafting a payment clause, the protections group naturally:
- Timeline and deemed approval: undisputed invoices payable within a fixed period (30 days is common); invoices deemed approved and undisputed absent a written dispute notice within 5–7 days identifying the disputed portion and its basis.
- Split-invoice discipline: the payor segregates and withholds only the disputed portion, pays the undisputed balance on the due date, and pays any disputed amount later found due with interest for the delay period.
- Set-off confined: only undisputed, liquidated amounts arising directly from the same contract, claimed in writing with supporting documentation on 30 days' advance notice and subject to a contest window; no netting of unquantified damages claims against fees for services rendered.
- MSME status declared: if the provider is a registered MSME, the agreement should say so, keep the credit period within 45 days, and acknowledge Section 16 MSMED interest (three times the RBI bank rate, compounded monthly) — which applies regardless of what the contract says.
- Interest written in for non-MSMEs: a stated rate on undisputed amounts from the due date; contractual silence forfeits it.
- TDS mechanics fixed: the applicable section and rate identified; deposit evidence (challan) shared promptly; Form 16A within 15 days of the return due date; an indemnity covering demands caused by the payor's default.
- GST evidence and a capped withholding: GSTR-1 filing by the due date with proof to follow; any payor withholding limited to the estimated input-credit loss and released on evidence of filing; indemnity for credit actually lost through the provider's non-filing.
- Audit access bounded: engagement-specific records only, ten days' notice, at most twice a year, confidential, with express exclusions.
- Discretion replaced with standards: deemed-approval timelines, scheduled quality criteria and notice-and-cure mechanics instead of free-floating "sole discretion" over payment.
Two caveats from the underlying research: the MSMED protections depend on the provider's registration and investment thresholds, and state-level notifications can modulate the administration of GST, TDS and MSMED enforcement in specific contexts.
Key Authorities
- Indian Contract Act 1872, Section 59 — a payment must be applied to the debt the debtor indicates. Source
- Micro, Small and Medium Enterprises Development Act 2006, Sections 15–16 — 45-day outer payment limit; mandatory compound interest at three times the RBI bank rate, compounded monthly. Source
- Shanti Conductors (P) Ltd. v. Assam State Electricity Board (Supreme Court, 31 August 2016) — statutory interest obligations exist to deter withholding of payments to small-scale suppliers.
- Kerala Water Authority v. T.I. Raju (Supreme Court, reported 2026) — no automatic interest on delayed payment; contractual bars on interest are enforceable. Source
- Income Tax Act 1961, Sections 194C and 194J — TDS on contractor and professional/technical service payments; certificate in Form 16A due within 15 days of the statement due date. Source
- Central Goods and Services Tax Act 2017, Sections 16(2)(aa) and 16(4) — input tax credit conditional on the supplier furnishing invoice details; outer claim limit of 30 November following the financial year. Source
- X Corp v. Union of India (24 September 2025) — standards giving guidance or indicia for the exercise of discretion are not void for vagueness. Source
This analysis reflects the law as at June 2026. It is published for general information and does not constitute legal advice.