Quick Summary
Mere nomenclature used in the lease agreement, such as security deposit or advance deposit, will not be conclusive of the nature of the payment. The reality of the transaction will have to be looked into.
Tax law seeks to safeguard the interests of the Revenue by providing for tax deduction at source on payment of rent. Section 194I of the Income-Tax Act, 1961, came into the statute book with effect from June 1, 1994. Wherever the rent payable exceeds Rs10,000 per month, tax is to be deducted at 15 per cent if the payee is an individual or HUF and at 20 per cent in other cases.
‘Rent’ was defined in the section to mean any payment by whatever name called for the use of land or any building together with furniture and fittings.
The definition was expanded by the Taxation Laws (Amendment) Act 2006, with effect from July 13, 2006, so as to include lease of plant and machinery, equipment, furniture and fittings.
The rate of TDS for machinery, plant and equipment has been fixed at 10 per cent by the Finance Act, 2007.
Is there any way of avoiding this TDS when the amounts involved are sizeable?
The Reebok case
In this case (291 ITR 455), Reebok India entered into an agreement with ABCO Footwear Care to take on lease certain premises in New Delhi at a monthly rent of Rs 6,26,000. The lease agreement also provided for payment of security deposit of Rs 1,50,24,000. This was to be reduced every six months when rent became payable.
TDS was made under Section 194 I on the monthly rent of Rs 6,26,000. No TDS was made on the security deposit. The assessing officer (AO) passed an order holding that the security deposit was only an advance rent and should suffer TDS.
He followed up this order with levy of interest for non-payment of interest. The first two appellate authorities cancelled the levy of interest. The Revenue took up the matter in appeal before the Delhi High Court.
It was argued for the Department before the Delhi High Court that the deposit made was non-refundable and therefore represented advance consideration for use of land and building. It fell within the definition of ‘rent” given in Explanation (i) to Section 194I. Tax ought to have been deducted at source.
On behalf of the assessee, it was argued that clause 14 of the rental agreement provided for refund of the unadjusted portion of the security deposit and as such tax was not deductible unless rent became due to the landlord.
The Delhi High Court considered the matter in some detail. It pointed out that the definition of the nomenclature “rent”, as expounded in Explanation of Section 194I, amply reveals that the same is projected as a generic term which includes within the ambit of payment made on whatsoever account for occupation of a tenanted portion.
As per the Act, rent appears to be a composite concept and is not capable of being fragmented.
The moment any attempt is made to have the germane term fragmented by splitting up the amount covered by the rent, it will cease to be rent and the same will not satisfy the test of the definition.
The court ruling
The High Court extracted the various clauses in the lease agreement and pointed out that the Rs 1,50,24,000 was only in the nature of “advance rent” and not a security deposit.
The agreement laid down that the security deposit shall stand reduced every six months when the rent becomes due and payable. If it had been the security amount, then firstly, it would have been in the nature of refundable amount at the time of the termination of the lease.
Secondly, there would have been no reduction in the security amount, after every six months.
Thirdly, as per the agreement, the lessor is obliged to refund the unadjusted portion, if any, of advance/security deposit.
This clearly showed that the amount was adjustable against rent. It was in fact so adjusted. This amount was only in the nature of advance rent. There was an obligation to deduct tax at source from the payment of such advance rent. The Revenue’s appeal was accepted and the orders of the two lower appellate authorities set aside.
This case shows that great care will have to be taken while drafting lease agreements. Security deposit refundable on the termination of a lease will not be subject to TDS. Also, mere nomenclature used in the lease agreement, such as security deposit or advance deposit, will not be conclusive of the nature of the payment. The reality of the transaction will have to be looked into.
The Amending Act of 2006 has brought in payments for the use of plant and machinery, equipment, furniture and fittings, apart from payment for land and buildings.
It is possible to visualise different owners for building and for plant/machinery and they may have to contend with a composite lease agreement.
FAQ :
Section 194I of the Income-Tax Act, 1961, aims to safeguard the interests of the Revenue by requiring tax deduction at source on rent payments.
Initially, 'rent' included payments for the use of land or buildings with furniture and fittings. This definition was expanded to include lease payments for plant and machinery, equipment, furniture, and fittings.
For rent exceeding Rs 10,000 per month, TDS is 15% for individuals/HUFs and 20% for others. For machinery, plant, and equipment, the rate is 10%.
No, the label used in a lease agreement is not conclusive. The reality of the transaction is examined; if a 'security deposit' is adjustable against rent, it is considered advance rent and subject to TDS.
The Reebok India case demonstrated that a payment labeled as a security deposit, but which was refundable only after adjustment against rent and reduced periodically, was treated as advance rent and subject to TDS.
No, security deposits that are genuinely refundable upon the termination of a lease and are not adjustable against rent are generally not subject to TDS.
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