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January 24, 2021

Can Property tax be deducted to compute rental value under GST?

by CA Shivam Jaiswal in GST

Can Property tax be deducted to compute rental value under GST?

Under the provisions of GST, according to Section 15 of CGST Act, the value of a supply of goods and/or services shall be the transaction value, that is the price actually paid or payable for the said supply of goods and/or services where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply. Inclusions in value of taxable supply are mentioned u/s 15(2):

  1. Taxes, cess, fees and charges other than tax leviable under GST Act.
  2. Amount that supplier is liable to pay that was incurred by recipient.
  3. Incidental expense charged by supplier and anything done in relation of supply to recipient.
  4. Interest, Late fees or Penalty for delay payment
  5. Subsidies linked to price excluding government subsidies.

Let us refer to the case of Midcon Polymers Pvt Ltd. (GST AAAR Karnataka), where the issue under consideration pertained to inclusions in the value of rental income for the purpose of arriving at the taxable value under GST

Facts of the Case:

  • The Appellant was engaged in the business of renting of commercial property on monthly rents and allied business.
  • The Appellant intended to enter into a commercial agreement of renting of immovable property with educational institution in Bangalore.
  • The contract was on the basis of the reserved monthly rent and also refundable caution deposit/security deposit.
  • As per the terms of the contract, the deposit received shall be returned without interest on the termination of the tenancy.
  • The refund of the advance caution deposit did not in any way determine the quantum of rent or enhance the services.
  • The Appellant also discharged the statutory taxes levied by the BBMP on the property and the property tax so paid was no way related to the supply of services.

Appellant approached the Authority for Advance Ruling (AAR) seeking a ruling on the following questions:

  • For the purpose of arriving at the value of rental income, whether the applicant could 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 was entitled for exemption of tax under the general exemption of Rs 20 lakhs?

The AAR held as under:

  • The applicant cannot deduct the property taxes and other statutory levies for the purpose of arriving at the value of rental income.
  • The 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 of supply of RIS service i.e monthly rent.
  • The applicant 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.
  • Aggrieved by the ruling given by the AAR, the Appellant has filed an appeal before the AppellateAuthority for Advance Ruling (AAR)

Observations of AAAR on whether the property tax paid by the Appellant to the Municipal Authority can be deducted from the monthly rental income received or not

  • The value of supply of goods and services is governed by Section 15 of the CGST Act which states that the value of supply shall be the transaction value, which is the price actually paid or payable for the said supply, where both the supplier and the recipient are not related and price is the sole consideration for sale.
  • In this case, the fact that the supplier and the recipient of the service (i.e lessee) were not related and that the rent was the sole consideration for the service of renting of immovable property, was not in dispute.
  • It was seen from the draft rental agreement that the lessee is required to pay monthly rental of Rs 1,50,000 plus applicable taxes, subject to deduction of tax as may be applicable.
  • Therefore, the amount received from the lessee towards the monthly rent as per the invoice that will be raised by the Appellant, will be the transaction value and it is on this value that GST has to be paid.
  • Section 15(2) of the CGST Act, provides for certain inclusions to the value of supply.
  • One such inclusion is that all taxes levied under any law in force will be included in the value.
  • The only taxes which qualify for exclusion from the value are the CGST, SGST, IGST, UTGST and Compensation Cess which are levied under the respective Acts.
  • Even in respect of these taxes, they can be permissible deductions subject to the condition that the supplier charges them separately in the invoice. Other than the above levies, no other statutory levy can be deducted from the value of supply.
  • AAAR observed that unlike the earlier service tax regime, where Notification No 24/2007-S.T dated 22nd May 2007 had specifically provided for abatement of the property tax paid to the local bodies from the value of taxable service of renting of immovable property, there was no such exemption/abatement provided under the GST law.
  • All taxes levied under any law in force are to be included in the value of the renting of immovable property service supplied by the Appellant.
  • Therefore, the property tax paid to the Municipal Authority (BBMP) could not be deducted from the monthly rental income for arriving at the value of supply.

Observations of AAAR on whether the notional interest on the security deposit should be taken into consideration for determining the total income from rental service or not

  • The issue was to be examined in the context of ‘supply’ and the ‘consideration’ received for the supply.
  • What constituted a ‘supply’ in GST was provided in Section 7 of the CGST Act and it included all forms of supply (such as rental) made or agreed to be made for a consideration.
  • In this case, the monthly rental received from the lessee was a consideration for the supply of the renting service.
  • The terms of the rental agreement also stated that the lessee shall pay an interest free refundable security deposit of Rs 5 crore which will be returned to lessee upon vacation of the scheduled property.
  • This security deposit was no doubt linked to the supply of the renting service.
  • However, to determine whether the security deposit was a consideration for the renting service or not, one had to refer to the definition of ‘consideration’ as given in Section 2(31) of the CGST Act.
  • According to Section 2(31), consideration in relation to the supply of goods or services includes:
    • any payment made or to be made, whether in money or otherwise, in respect of in response to, or for the inducement of the supply of goods or services, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government
    • the monetary value of any act or forbearance, whether or not voluntary, in respect of in response to, or for the inducement of the supply of goods or services, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government
  • The proviso to the above definition stated that a deposit given in respect of supply of goods or services shall not be considered as payment made for such supply unless the supplier applies the deposit as consideration for the said supply.
  • In the case of renting service, the security deposit was collected at the beginning of the term of the tenancy and was refunded to the lessee when the term of tenancy was terminated.
  • The purpose of collecting the security deposit in rental services, was to provide a security in case there was a default in payment of rent by the lessee or if there was a damage to the leased property.
  • Therefore, such security deposit could not be considered as a consideration for the rental service.
  • However, as per the proviso to Section 2(31) of the CGST Act, if, at the time of refund of the security deposit, any amount was adjusted by the supplier (lessor) towards the supply of the renting service, then it would be considered a consideration.
  • As regards the notional interest earned by the supplier on the security deposit, it was an amount earned by investing the security deposit.
  • The interest was paid by the person with who the amount was invested.
  • The interest earned by the supplier from a third person, on account of investing the security deposit amount was not a payment made by the third person “in respect of, in response to, or for the inducement of the supply of the renting service.
  • There was no connection between the payment of interest by the third person and the renting service supplied by the supplier to the lessee.
  • The phrase “ill respect of, in response to, or for the inducement of used in the above definition of ‘consideration’ as given in Section 2(31)(a) of the CGST Act, meant there must be a direct link between the supply of the service and the consideration received in the form of interest on the security deposit.
  • Such a connection was absent in this case.
  • AAAR also noted that during the period of tenancy, the monthly rent could be revised as per the terms of the agreement but there was nothing in the lease agreement to suggest that such revision in the monthly rent was influenced by the amount of security deposit paid by the lessee.
  • In the absence of any such evidence, AAAR held that in this case, the consideration received by way of monthly rental was not influenced by the security deposit given by lessee or the notional interest earned on such security deposit.
  • Therefore, AAAR disagreed with the findings of the AAR on this aspect and held that the notional interest earned on the security deposit is not to be included to the total rental income.

In conclusion, For the purpose of arriving at the value of rental income, the Appellant cannot deduct the amount paid as property tax to the Municipal Authority or any other statutory levies levied under any law for the time being in force, other than the CGST, SGST, IGST and Compensation Cess, subject to the condition that it is charged separately by the Appellant. Also, for the purpose of arriving at the total rental income, the notional interest earned on the security deposit is not to be taken into consideration.

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