House Rent Allowance - Rent Paid to Wife?

(My grandmother says in Hindi, "Salary is tankha" tan means body, kha means eat). Often my clients from industry ask my advice for reducing their tax incidence. Earning a monthly salary they often end up coughing upto 27% of their salary in TDS. With meager 1 lakh exemption limited under Section 80C of the Income-tax Act ("Act"), 1961 and standard deduction long gone, salaried tax payers bear a very high net tax rate. Exemptions for education for children like Rs 300 per month per child causes more pain than any relief. In such tax structure, House Rent Allowance (HRA) is one of the very few tax saving mechanism left at the disposal of such salaried tax payers. One of client saves Rs 1.5 lakh per annum in taxes due to HRA exemption!!

But then he actually pays around Rs 6 lakh as rent! For years, the tax-planners have advised cash neutral/ cash positive structures to claim the benefits related to Housing. Buying house in wife's name for benefit of lower stamp duty, paying rent to wife for staying the same house to claim HRA benefits have been often used mechanisms to reduce tax incidence. But then the tax authorities don't like people claiming tax benefits. Every tax planning structure is branded as tax evasion. Income from house bought in wife's name is often clubbed under clubbing provisions, rent paid to wife is disallowed. We also often pay rent to old relatives with no income source to claim HRA benefit. In a recently adjudicated case, the question of validity of rent paid to wife came under consideration of Ahmedabad bench of Income-tax Appellate Tribunal ("ITAT").

Rent Paid to Wife - is HRA claim valid? In "Bajrang Prasad Ramdharani vs ACIT (2013) 37 taxmann.com 186, the learned AO choose to disallow the rent paid by husband to his wife on the grounds that since both were living the same house and accordingly it should be treated as a self-occupied property, thus giving the whole transaction colorable nature. The learned CIT(A) also confirmed the disallowance.

The assessee took the matter to the Ahemdabad bench of ITAT. In a summary but self-explaining judgment held that as long as the conditions set in explanation to the section 10(13A) of the Act:

(a) the residential accommodation occupied by the assessee is not owned by him; and

(b) the assessee has actually incurred expenditure on payment of rent (by whatever name called) in respect of the residential accommodation occupied by him; are met, disallowance of HRA exemption to the extent allowable under the provisions of this section is not justified.

It was held that since the assessee doesn't own the house and has produced valid rent receipts to evidence the payment of rent, all the conditions for claiming HRA benefit are met. Lessons Learnt? Often we, the tax consultants tend to read the judgments with personal bias and do cherry picking of favorable paragraphs of the judgment to form our tax advices. This often results in basing our opinion on wrong judicial precedents, resulting in unnecessary litigation and consequent harassment for our clients. In this case, it is important to note that to claim HRA benefits while paying rent to relatives, it is important to ensure that:

1. The above judgment won't apply in case the income from house property is clubbed in the hands of the assessee under clubbing provisions (section 64 of the Act)

2. Please ensure that the whole transaction is tax positive. Take note of average tax rate of the payee.

3. Ensure that properly stamped rent receipts are issued on a monthly basis

4. The rent agreement is duly executed on a properly stamped paper.

5. Normally in a rented property, the electricity charges, water bill, minor repair and maintenance is borne by the tenant. Therefore, ensure that such charges are paid out of the assessee's own funds.

It should be ensured that reliance is placed on case laws in the following order before advising clients:

1. Cases wherein factual matrix matches with client's case

2. Cases wherein though the factual matrix may differ from client's facts but the judgment has a persuasive value for the client's case Before adopting any tax position, present to the client a written opinion on the subject matter including details of negative judicial precedents.

Disclaimer: the above article should not be construed as appreciation or advocacy of tax evasion. The tax consultants should be very clear of the thin line between tax evasion and tax planning. The above article is to cover the precautions that tax consultant should take while advising genuine tax planning transactions for salaried class.

For details of the case referred above: http://www.indiankanoon.org/doc/80228415/