Tax has been deducted u/s 194A which is for interest (other than securities)
Interest as per S. 2(28A) means
"interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised .
In my understanding , this compensation in the form of interest is not actually the interest as contemplated in Income Tax Act and hence in my opinion there is no need to deduct tax .
Compensation has not been made in relation to money borrowed or debt incurred, the word "similar rights or obligation" further confirms the nature of the transaction.
But I will not blame the builder since he is also afraid that if this interest is covered and TDS was applicable then -
1. His payment will be disallowed to the extent of 30%.
2. Assessee in default for non deduction of tax at source u/s 220
3 Interest u/s 201
4. Penalty u/s 271H
5. Fees u/s 234E
6. Prosecution
7. Others which I even might not know
He would not like to take so much risk when he can deduct tax and let you claim the credit of it.
In Industry TDS is being deducted on such interest, so he is not doing something different.
Even if this builder would have approached me, I would have said TDS is not applicable but I advice you to deduct tax and let the deductee claim the credit.
For non payment of the remaining amount, you can sue him in court for non performance of the specific contract.[Let him know this]