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November 15, 2020

GST can be levied on notional interest on security deposit – AAR Karnataka

by CA Shivam Jaiswal in GST

GST can be levied on notional interest on security deposit – AAR Karnataka

Introduction of GST is considered to be a significant step in the reform of indirect taxation in India. Amalgamating of various Central and State taxes into a single tax would help mitigate the double taxation, cascading, multiplicity of taxes, classification issues, taxable event, and etc., and leading to a common national market.

Rent payment is one of those prominent expenses in any business. GST is charged on rent in few cases. When you rent out a residential property for residential purpose, it is exempt from GST. Any other type of lease or renting out of immovable property for business would attract GST at 18%, as it would be treated as a supply of service. After GST was implemented, the threshold limit for applicability of GST has been increased to Rs.20 lakh from Rs.10 lakh that was in the pre-GST era. This makes many landlords, who were earlier covered under the service tax regime to be at ease now up to another Rs.10 lakhs earned.

However, issues arise when there is confusion about what should be included in or excluded from the rental income for the purpose of the threshold limit. Let us refer to the case of Midcon Polymers Pvt. Ltd. (GST AAR Karnataka) where the applicant sought the advance ruling which were in relation to the proposed renting of immovable property service.

Facts of the Case:

  • M/s Midcon Polymers Pvt Ltd (applicant) proposed for engaging in the business of renting of commercial property on monthly rents and allied business.
  • They intended to enter in to a contractual agreement of renting of immovable property with an educational Institution in Bangalore.
  • The Contract was on the basis of the reserved monthly rent of Rs 1.5 lakhs or annual rent of Rs 18 lakhs and also refundable caution deposit of Rs 500 Lakhs, which shall be returned without interest on the termination of the tenancy.
  • Since the applicant was required as per law to refund the advance caution deposit, the same did not determine the quantum of rent.
  • The Applicant discharged the statutory taxes levied by the BBMP (Bruhut Bengaluru Mahanagar Palike) and also the deposits, which was as per the contract. These taxes being paid on the property and such deduction were legal in respect of valuing the actual receipt of rent under the contract.
  • The applicant did not have any taxable activity other than the activity of leasing out Immovable Property commercial spaces and hence they were at present claiming exemption since their turnover was less than Rs 20 Lakhs.

The applicant sought for advance ruling in respect of the following questions:

  • For the purpose of arriving at the value of rental income, whether the applicant can seek deduction of property taxes and other statutory levies.
  • For the purposes of arriving at total income from rental, whether notional interest on the security deposit should be taken into consideration.
  • Whether the applicant is entitled for exemption of tax under the general exemption of Rs.20 lakhs.

Observations of AAR on whether the property tax & other statutory levies paid/payable by the applicant can be deducted from the rental income for arriving at the value of rental income

  • According to AAR, Section 15(2) of the CGST Act 2017 is relevant to the instant issue.
  • According to Section 15(2)(a), the value of supply shall include any taxes, duties, cesses, fees and charges levied under any law for the time being in force other than this Act, the State Goods and Services Tax Act, the Union Territory Goods and Services Tax Act and the Goods and Services Tax (Compensation to States) Act, if charged separately by the supplier.
  • It could easily be inferred from Section 15(2) that any taxes, duties, cesses, fees and charges, levied under any law for the time being in force, shall include in the value of taxable supply.
  • In the instant case the property tax was levied, under the Karnataka Municipalities Act 1964, by the BBMP in Bangalore.
  • Further the only exclusions from the value of the taxable supply are the taxes, duties, cesses, fees and charges levied under the CGST Act 2017, SGST (KGST) Act 2017, UTGST Act 2017 & GST (Compensation to States) Act, subject to the condition that they are charged separately by the supplier.
  • Section 15(1) of the CGST Act 2017, with regard to value of the supply, stipulates that the value of supply of goods, services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration of the supply.
  • It was observed that in the instant case, the supplier (applicant) and the recipient were not related and price was the sole consideration of the supply and the monthly rent was the price payable.
  • Thus, the monthly rent is the transaction value and the same would be the value of supply of the impugned service of RIS.
  • In view of the above, AAR concluded that the property tax was not deductible from the value of taxable supply of “Renting of Immovable Property” service.

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Observations of AAR on whether notional interest on the security deposit should be taken into consideration for the purposes of arriving at total income from rental.

  • In this regard AAR examined relevant clauses of the draft rental agreement furnished by the applicant, which were as under:
    1. The lessee shall pay a monthly rent of Rs. 1,50,000 plus applicable taxes, subject to deduction of tax as may be applicable.
    2. The lessee shall pay to the lessor, an interest free refundable security deposit of Rs 5 Crore which will be returned to lessee upon vacation of scheduled property.
    3. The lessor shall bear and pay the property taxes and cess as applicable to the concerned authorities in regard to the scheduled property.
  • This question involved 2 parts, one being whether the security deposit so collected had to be considered as consideration towards supply of the service and the other being whether the notional interest earned on such security deposit became part of value of supply or not.
  • The security deposit so collected by the applicant shall not be considered as payment made for supply of RIS service unless the applicant applies such deposit as consideration for the said supply, in terms of proviso to Section 2(31)(b) of the CGST Act, 2017.
  • In the instant case the security deposit, taken as a guarantee against damage to property, was an interest free refundable deposit which would be returned to the lessee at the expiration of the lease period and hence would not be considered as consideration for the supply of RIS service.
  • However, at the expiry of the lease tenure, if the entire deposit or part of it was withheld and not paid back, as a charge against damages etc., then at that stage such amounts not refunded would be liable to GST.
  • The 2nd issue was the notional interest earned out of security deposit.
  • In the instant case, the applicant proposed to collect security deposit of Rs.5 Crore.
  • It was an undisputed fact that the applicant got interest out of the security deposit.
  • AAR observed, the order of Supreme Court in the case of Commissioner v. I.S.P.L. Industries Ltd (2003).
  • The Apex Court in the said case, held that notional interest on advances taken by the assessee from the buyers cannot be added to the assessable value of the goods cleared, unless there was evidence to show that the interest free deposit taken had influenced the price.
  • Therefore, to decide the instant issue, two things were required to be considered i.e. whether the notional interest on security deposit was in relation to the supply of RIS and whether the said notional interest influences the value of the supply i.e. the monthly rent.
  • The security deposit was taken invariably in all cases and it was a general practice that wherever the quantum of deposit was higher the rent charged was less and vice-versa.
  • The applicant was collecting the security deposit as their property was being leased.
  • Had the property not been leased, the applicant would not have been collected the security deposit.
  • Thus, there was a nexus between security deposit taken and the rent charged beyond doubt.
  • The security deposit collected was normally equivalent to 6 or 12 months of rent.
  • Also, it was a known fact that the higher the security deposit lower would be the monthly rent amount. In the instant case, an amount of Rs 5 Crore is proposed to be collected as security deposit and a monthly rent of Rs 1.5 lakhs.
  • However, the applicant had not furnished adequate information to decide whether actually the notional interest influenced the monthly rental amount or not.
  • Section 2(31)(b) of the CGST Act 2017 stipulated that “consideration” in relation to supply of goods, services or both included the monetary value of an act or forbearance, in respect of, in response to, or for the inducement of the supply of goods, services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government.
  • In the instant case the notional interest that the applicant earned was in respect of supply of RIS service, though it was not by the recipient of the service but from another person.
  • Therefore, AAR concluded that the notional interest had to be considered as part of value of supply of service, if and only if the said notional interest influenced the value of supply i.e. value of RIS service / monthly rent and is leviable to GST along with monthly rent at the rate applicable to monthly rent.

Observations of AAR on whether the applicant was entitled for exemption of tax under the general exemption of Rs 20 lakhs

  • Section 2(112) of CGST Act, 2017 defined total turnover in State or Union Territory as aggregate value of all taxable supplies (excluding the value of inward supplies on which tax is payable by a person on reverse charge basis) and exempt supplies made within a State or Union territory by a taxable person, exports of goods or services or both and inter-State supplies of goods or services or both made from the State or Union territory by the said taxable person but excludes central tax, State tax, Union territory tax, integrated tax and cess.
  • AAR found that the interest free security deposit did not come under the purview of supply as per Section 7 of CGST Act, 2017 since it was not a consideration as discussed above.
  • However, the notional interest on security deposit became part of consideration along with monthly rent, if it influenced the value of the supply.
  • Therefore, in view of the submission made by the applicant that they had no other business besides what they have submitted to this Authority, AAR found that they were entitled for the general exemption for registration purpose, subject to the condition that their annual total turnover which included monthly rent and notional interest, if it influenced the value of supply, did not exceed the threshold limit.

In conclusion, one cannot deduct the property taxes and other statutory levies for the purpose of arriving at the value of rental income. Also, notional interest on the security deposit shall be taken into consideration, for the purposes of arriving at total income from rental, only if it influences the value supply of RIS service i.e. monthly rent. One is entitled for exemption of tax under the general exemption of Rs.20 lakhs, subject to the condition that their annual turnover, which includes monthly rent and notional interest, if it influences the value of supply, does not exceed the threshold limit

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