ADJUSTABLE AND REFUNDABLE DEPSOIT SHOULD NOT BE SUBJECT TO TDS from rent or other income– A REVIEW OF PROVISIONS AND CIRCULARS.

[C.A. DEV KUMAR KOTHARI]

Theme and scope of this article:

The theme of this article is whether advance or deposit money received from tenant is ‘income by way of rent’, and tax should be deducted from the same?

Other aspects of TDS from rent are considered and referred only to the extent necessary for the main theme.

Tax Deduction from rent:

As per provisions of section 194I , tax is to be deducted, under certain circumstances while paying or crediting rent payable or  liability account for rent payable etc. whichever is early. 

Relevant provision of section 194 I

The relevant text of section 194 I, with high lights, in so far it is relevant for the purpose of this article is reproduced below:

194-I. Any person, not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of rent, shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rate of—

XX please see rates as applicable from time to time.

Provided that no deduction  …..xxxxx

Provided further …xxxxx

Explanation.—For the purposes of this section,—

[(i)“rent” means any payment, by whatever name called, under any lease, sub-lease, tenancy or any other agreement or arrangement for the use of (either separately or together) any,—

(a) land; or

(b) building (including factory building); or

(c) land appurtenant to a building (including factory building); or

(d) machinery; or

(e) plant; or

(f)  equipment; or

(g) furniture; or

(h) fittings, whether or not any or all of the above are owned by the payee;]

(ii) xxxxx

From a close reading of the section and also the highlighted portion it is clear that tax is to be deducted from:

Any income by way of rent, for the use of any plant, machinery or equipment or land or building etc (say property).

Thus, tax is to be only from income by way of rent of property let out for the use by tenant / lessee or licencee.

Deposit or advance is not income:

Any deposit or advance money paid by the tenant is not income by way of rent. As per trade practices we find several type of deposits or advances. A few examples are examined bellow in table:

Type of deposit or advance	Refund/ or adjustment	Whether it is income
Deposit –refundable on termination of agreement	This is refunded at the time of termination of agreement, after adjustment of recoverable rent or other sums, if any found due at that time from tenant.	It is not income in hands of owner and expenditure in hands of tenant. It is an asset for tenant and a liability for owner as he has to repay the same.
Adjustable deposit. Such deposit is adjusted over a period and deducted while paying rent.	This is refunded by owner by way of deduction from rent and is recoverable over a period of time by the tenant.	It is not income, it is an asset for tenant and a liability for owner as he has to repay the same over a period of time by allowing reduction from gross rent.
Deposit for electricity dues, upkeep an maintenance etc.	This is  refunded at the time of termination of agreement, after adjustment of any exceptional damages to property or  other sums due from tenant, if any on account of electricity, maintenance, etc.	It is not income, it is an asset for tenant and a liability for owner as he has to repay the same.

Examples:

A commercial space with furnishings is let out on the following terms and conditions:

A. Security or Refundable Deposit Rs.10,00,000/- 

This will be interest free and is kept as security. This will be refunded at the time of termination of agreement after deduction for any dues of rent, electricity, maintenance and unusual damages to the property and furnishings, if any.

B. Adjustable depositRs.36,00,000/- to be adjusted @ Rs.1,00,000/- per month during tenure of tenancy that is 36 months.

C. Rent per month Rs.5,00,000/-

Payment and accounting

Item A, is treated as an asset in books of account of tenant and as a liability in books of account of owner ”security deposit for office space”.

Items B is also treated similarly as an asset and a liability respectively by the tenant and the owner. On deduction from rent this amount will be reduced by Rs.1,00,000/- every month during 36 months and then it will become nil. In case of prior termination balance will be refundable.

Item C that is rent of Rs.5,00,000 is treated as an item of income in hands of owner and an items of expenditure in hands of the tenant. Every month the tenant passes the following entry:

Rent Dr.                                5,00,000

To Bank                                3,50,000

To TDS on rent                        50,000

To Adjustable rent deposit     1,00,000

(Rent for the month of  ... paid to the owner after deduction from adjustable deposit of rent Rs. 1,00,000 and TDS @ 10% on Rs. 5,00,000 being rent for the month).

We find that every month Rs.5,00,000 accrues as an income in hands of the owner and as an expenditure  in hands of the tenant.

Suppose in this case there was no adjustable deposit then the tenant will pay Rs.4,50,000 to the owner after deducting Rs.50,000 as TDS from monthly rent.

Adjustable deposit is also of refundable nature:

From two types of the deposits we find common features as follow:

Both are an item of asset in hands of tenant.

Both are an item of liability in hands of owner.

Owner repay and tenant recovers both in the manner agreed- in the above example Security deposit is refundable on termination of agreement and adjustable deposit is refundable in thirty six monthly installments, by way of deduction from rent payable.

Both are not in nature of income by way of rent in hands of owner.

Both are not in nature of expenses by way of rent in hands of tenant.

The above treatment and way of TDS is perfectly correct and is in accordance with the provisions of S. 194 I.

Thus, practice followed by some tenants to deduct tax at source from the amount of adjustable deposit is wrong.

Board’s clarification

In circular no. 718, dated 22 August,1995: F. No. 275/60/94-IT(B) the CBDT has clarified as follows in relation to certain relevant items:

Query no. 2: Whether tax is required to be deducted at source where a non-refundable deposit has been made by the tenant?

Answer: In cases where the tenant makes a non-refundable deposit, tax would have to be deducted at source as such deposit represents the consideration for the use of the land or the building, etc. and therefore partakes the nature of rent as defined in section 194-I. If however the deposit is refundable, no tax would be deductible at source. If the deposit carries interest, the tax to be deducted on the amount of interest will be governed by section 194A of the Income-tax Act.

Query no. 4: On what amount tax is to be deducted at source if the rentals include municipal tax, ground rent, etc.

Answer: the basis of tax deduction at source under section 194-I is “income by way of rent”. Rent has been defined, in Explanation (i) of section 194-I, to mean any payment under any lease, tenancy, agreement, etc. for the use of any land or building. Thus, If the municipal taxes, ground rent, etc., are borne by the tenant, no tax will be deducted on such sum.

An analysis of above answers:

Non refundable deposit

there is contradiction in use of words ‘non refundable’ and ‘deposit’. Because if a sum is a deposit, then it should be refundable on some or other time. A non refundable money can either be an item of income or a capital receipt. Therefore, it seems that if it is in nature of income by way of rent, then only tax will be deductible and if it is in nature of a capital receipt, then tax need not be deducted.

It is clear from the circular that tax need not be deducted from refundable deposit.

Adjustable deposit:

Scope of deduction - The following clarifications are also issued:

The tax is to be deducted from the actual payment and there is no need of computing notional income in respect of a deposit given to the landlord. If the deposit is adjustable against future rent, the deposit is in the nature of advance rent subject to TDS.

From Circular: No. 715, dated 8-8-1995.

It appears that there is a contradiction in the above answer when read with answers to other queries. An adjustable deposit is a refundable deposit and it is not an income or expenditure by way of rent when received or paid. Therefore, at the time of making such deposit tax is not required to be deducted. The tax has to be deducted when a sum is considered as rent and the liability of the owner is reduced from the amount of deposit. 

Problems if tax is deducted from adjustable deposit:

In case tax is deducted from adjustable deposit, problems arises because entire amount of deposit is not income of the year when deposit is made. Thus, taxable income as per computation and return and profit and loss account will not match with the total amount from which tax has been deducted in the initial year as well as in subsequent years.

Problems also arises in case of termination of agreement, change in ownership of property etc. if such even take place prior to full recovery/adjustment of advance money.

Such problems have been considered by the board in Circular : No. 5/2001, dated 2-3-2001 and suggestions have been made to allow credit of TDS in proportion of rent accruing in different years based on the TDS certificate issued in the year of making of deposit. In case of transfer of property, it has been advised that the amount of TDS which remains unallowed, on transfer of ownership will be refunded in the year in which transfer of property takes place etc. The board agrees in circulars that tax is to be deducted from income by way of rent and that the entire amount of advance rent does not accrue in the year of deposit, still deduction of tax is suggested on advance rent or adjustable deposit.

Thus, there is inconsistency in the circulars. Directions or suggestion to deduct tax from adjustable advance is contrary to the provisions of section 194 I and also contrary to other answers on other point because adjustable deposit is a refundable deposit and not a non-refundable deposit. Deduction of tax at the time of accrual of rent on the amount of gross rent will avoid all such problems.

TDS on advance rent is not even justified:

Collection of tax on advance of rent means collection of tax much before accrual of income and on contingent income. As given in the example 36 months adjustable advance is very common feature. In many cases we find adjustable advance for five years also. In such cases tax is deducted from income which will accrue long after the date of deposit. The owner/ deductee, in such cases will get credit and refund and interest after long period and interest will also not be allowed for entire period because interest will be allowed in future w.e.f. 1^st April of respective assessment year. This is not at all justified.

In views of the above, it is requested to the Board that clarification consistent with the provisions of Section 194 I be issued and directions can be given that in case of adjustable advance, tax will have to be deducted when any sum is credited to the account of owner as rent or when an adjustment is made for rent payable that is accrual of rent.

Advance tax is better option than TDS:

No doubt TDS is a measure to widen taxpayers base. However, now the government has already sufficient data base which is increasing by various compulsory PAN and TAN requirements, AIR information, other financial reporting system. Therefore, now benefit of revenue need to be looked upon from the point of early collection, proper collection, and reduced refunds.

We find that large amount of tax deducted at source become refundable Due to higher rate of TDS.

A substantial part of TDS takes place in last month of previous year and also on last day of previous year that is 31^st March. In such cases TDS can be deposited after end of the previous year by 7^th April or 31^st May as the case may be. However, when tax is deductible at any time during the year, assessee can adjust it to workout installments of advance tax which starts falling due from 15^th of June of the previous year.  

Even if TDS is deposited after previous year (say on 7^th April or on 31^st May) the person from whose income tax is deducted will be entitled to get interest w.e.f. 1^st April, if there is refund. He can adjust such TDS against advance tax payable.

Therefore, it is suggested that rates of TDS should be brought down and payment of advance tax should be preferred for benefit of revenue.