Leases

A lease is one of the
oldest modes of enjoying immovable property. When one speaks about
leases, one often comes across terms, such as tenancy, licence, etc.
Some of these are synonyms while some have different meaning. Although
leases have been around since numerous years, there is yet a fair deal
of confusion surrounding them. Let us try and clear some of the myths
about leases.

Section 105 of the Transfer
of Property Act, 1882 (‘the Act’) has defined the term ‘lease’ in
relation to an immovable property to mean:

(a) a transfer of a
right to enjoy such property — the person transferring the property is
called a lessor and the transferee is known as a lessee;

(b) made for a certain time. Expressly or impliedly or made in perpetuity;

(c)
in consideration of a price paid or promised or of money/share in
crops/service or any other thing of value to be rendered periodically or
on specified occasions to the transferor by the transferee who accepts
such terms. The price paid is known as premium and the money, share,
service or other thing to be rendered periodically or occasionally is
known as rent. The premium is also known as pagadi or salami.

As
opposed to a conveyance in which there is an absolute transfer of
ownership of immovable property, in the case of a lease there is only a
limited transfer of a right to enjoy the immovable property.

Once
the lessor grants a lease, he is left with two rights — right to
receive rent and a reversionary right. A reversionary right is the right
of the lessor to receive back the property once the tenure of the lease
expires. The lessor can transfer the reversionary rights. In an
interesting decision, the Supreme Court in the case of R. Kempraj v.
Barton Son & Co., (1969) 2 SCC 594 has held that even in the case of
a perpetual lease, the lessor has a reversionary right.

The
Supreme Court in A. R. Krishnamurthy, 176 ITR 417 (SC) has held that a
lease of land is a transfer of interest in the land and creates a right
in rem and there is a transfer of title in favour of the lessee though
the lessor has right of reversion after the period of the lease
terminates. The grant of a lease is a transfer of an asset. The Supreme
Court in the case of B. Arvind Kumar v. GOI, (2007) 5 SCC 745 has laid
down the essential elements of a lease of immovable property:

(a) There should be a transfer of a right to enjoy an immovable property;

(b) Such transfer may be for a certain term or in perpetuity;

 (c) The transfer should be in consideration of a premium or rent; and

(d)
The transfer should be a bilateral transaction, the transferee
accepting the terms of transfer. A lease agreement is like any other
agreement and can be oral also.

However, this would be subject to the provisions of section 107 of the Act explained later.

Tenure of lease

Unless
the lease provides otherwise a lease of immovable property, for any
purpose other than agricultural or manufacturing, shall be deemed to be a
lease from month to month, which is terminable on the part of either
the lessor or the lessee, by 15 days’ notice expiring within the end of a
month of the tenancy. Some leases contain a clause for renewal of the
lease on the same terms and conditions as the current lease except with
an increase in the rent. It should be noted that the renewal of a lease
is not automatic and it must be expressly so stated in the lease deed.

In
India, a perpetual lease is also valid — R. Kempraj v. Barton Son &
Co., (1969) 2 SCC 594. Whether a lease is a lease in perpetuity or a
monthto- month lease has been the subject-matter of great debate and is
relevant from a stamp duty perspective also (as explained below). Where
the lease deed does not specify any duration, but permits the lessee to
hold the land forever, subject to the right of the lessor to resume the
land by giving one month’s notice, there is no grant in perpetuity — B.
Arvind Kumar v. GOI, (2007) 5 SCC 745. Hence, it is important that the
lease deed clearly specifies the lease period.

Making of a lease

 U/s.107
of the Act, a lease of a period for more than one year or a lease from
year to year must be made only by way of a registered instrument. Any
other lease can be made by way of a registered instrument or by an oral
instrument accompanied by delivery of possession. In cases where a
registered instrument is executed, both the lessor and the lessee must
execute the same.

Thus, section 107 makes it mandatory for any
lease of more than one year to be in the form of a written, registered
instrument. A corollary of a registered instrument is stamping. Failure
to create a lease of more than one year by way of a registered
instrument makes the lease deed inoperative and the Courts are disabled
from using the instrument as evidence — Anthony v. KC Ittoop & Sons,
(2000) 6 SCC 394/Bajaj Auto v. Behari Lal Kohli, (1989) (4 SCC
39/Shantabai v. State of Bombay, AIR 1958 SC 532. However, the Supreme
Court also laid down an important principle in the case of Anthony v. KC
Ittoop & Sons, (2000) 6 SCC 394 in the context of leases made by
non-registered instruments:

“. . . . . . What is mentioned in
the three paragraphs of the first part of section 107 of the TP Act are
only the different modes of how leases are created. The first paragraph
has been extracted above and it deals with the mode of creating the
particular kinds of leases mentioned therein. The third paragraph can be
read along with the above as it contains a condition to be complied
with if the parties choose to create a lease as per a registered
instrument mentioned therein. All other leases, if created, necessarily
fall within the ambit of the second paragraph. . . . . . . . . . . . .

Since
the lease could not fall within the first paragraph of section 107, it
could not have been for a period exceeding one year. The further
presumption is that the lease would fall within the ambit of residuary
second paragraph of section 107 of the TP Act. . . . . . .
Non-registration of the document had caused only two consequences. One
is that no lease exceeding one year was created. Second is that the
instrument became useless so far as creation of the lease is concerned.
Nonetheless the presumption that a lease not exceeding one year stood
created by conduct of parties remains un-rebutted. . . . . .”

Thus, even in cases where leases of more than one year are not registered, a lease of one year is created.

Stamp Duty

Article 36 of Schedule I to the Bombay Stamp Act provides for the stamp duty on a lease deed, sub-lease deed.

The
rate of duty is as shown in Table 1: Hence, whether or not a lease is a
perpetual lease becomes very important from a stamp duty perspective.
In the case of perpetual leases, the duty incidence would be at 4.5% of
the market value of the property based on the Stamp Duty Ready Reckoner.

Even a monthly tenancy would be treated as a perpetual lease
because no definite period is specified. In that case, stamp duty as on a
perpetual lease would be applicable — Collector of Stamps v. Laxmibai
Saheb, AIR 1948 Bom. 336; Santosh Pundalik Madankar v. Ramdas, 1985 Mah.
LJ 973.

If no definite term for lease is fixed and it is terminable by notice, it is a perpetual lease. Though a tenancy may be described as a monthly tenancy within the purview of the Transfer of Property Act, it does not follow that the document evidences a lease for any definite period for the purposes of stamp duty — Hidayat Mohindin v. Karamullah, AIR 1961 AP 1. Similar views have also been taken in the cases of Skinner v. Arunachalam, AIR 1939 Mad. (FB) 356, Mangal Puri v. Baldeo Puri, AIR 1938 All. 304.

Lease v. Licence
A leave and licence of an immovable property is different from a lease as a lease creates an interest in the property which the licence does not since it is only a personal non-transferable right. However, in many cases, a question may arise as to whether a transaction is one of a leave and licence or one of lease. This issue has witnessed a plethora of cases and controversies as the distinction between the two is very fine. Over a period of time the Supreme Court and various High Courts have laid down several tests for distinguishing a licence from a lease, but none of them are conclusive. Some of the important judgments on this issue are Qudrat Ullah v. Municipal Board, (1974) 1 SCC 202, Konchadda Ramamurthy v. Gopinath, (1968) 2 SCR 559, Associated Hotels of India Ltd. v. R.N. Kapoor, (1960) 1 SCR 368, Dunlop Rubber Co., AIR 1968 SC 175, Behari Lal v. Chotte, AIR 1963 All. 911, Mohan Sons & Co., 78 Bom. LR 195; Delta International v. Shyam Sunder Ganeriwalla, (1999) 4 SCC 545; ICICI, (1999) 5 SCC 708 (SC). A few tests laid down by these and several other cases are the intention of the parties, their conduct and circumstances surrounding the agreements, substance of the transaction, exclusive possession in case of a lease, creation of interest in the property in case of a lease, etc. Thus, this is an issue on which there is a lot of confusion and arbitariness and there is no litmus test to differentiate one from the other. It may also be noted that there is a thin distinction between lease and leave and licence, which has led to the wide-scale misconception among many people that a leave and licence can only be for 11 months. A lease which is of more than one year is to be compulsorily registered u/s.17(1)(d) of the Registration Act, 1908 and section 107 of the Transfer of Property Act, 1882. In the event that a licence was held to be a lease, people started making licences of 11 months so that registration would not be compulsory. This led to a general impression that leave and licence agreements can only be for a term of 11 months. In a leave and licence agreement, normally, there is no right given to the licencee to assign his or her rights, whereas in a lease agreement, the licencee subject to the approval of the licensor can assign and or transfer his or her rights.

Lease v. Tenancy

The terms lease and tenancy are synonyms and are often interchangeably used. However, quite often, it is believed that the two terms are different. In fact, even the Bombay Stamp Act, 1958, till some years ago (incorrectly) believed the two to be different and provided two separate Articles under Schedule I — one for transfer of tenancy and one for transfer of a lease. The definition of a lease u/s.105 of the Act would encompass a tenancy also. Generally, tenancy refers to a duration of a month-to-month lease while a lease refers to a longer duration. However, this is only a commercial distinction and has no legal basis.

The Bombay Stamp Act has now removed the distinction between a tenancy and a lease. The stamp duty in the case of a transfer of tenancy and transfer of a lease is now the same, i.e., the same as rate specified for a conveyance under Article 25 ~ 3, 4 or 5% depending upon the location of the immovable property. The duty is leviable on the fair market value of the property as computed under the Stamp Duty Ready Reckoner.

Transfer of reversionary rights

If the landlord/lessor transfers the reversionary rights to the tenant/lessee who has taken the property on lease, then the lessee becomes the full owner of the property. The stamp duty on a transfer of a lease is the same rate as on a conveyance on the fair market value of the property computed as per the Stamp Duty Ready Reckoner. However, in case of a transfer of reversionary rights of a property by the lessor to the lessee, there is a concessional basis of valuation of the property. The value is computed at 112 times the monthly lease rent paid by the tenant and not as per the Ready Reckoner. Thus, the duty in an urban area would be @ 5% of 112 times the monthly rent of the property. This benefit is available only if the tenant is able to prove that he has been in occupation of the property for at least five years. Further, this benefit is not available in case of properties taken on leave and licence.

Doctrine of merger

When a lessee of a property acquires the reversionary rights from the lessor, the Doctrine of Merger applies and the lesser estate (the lease) merges into the larger estate (reversionary rights) — Dr. D. A. Irani, 234 ITR 850 (Bom.). The Court held that once a lessee purchases the leased property from the lessor, the lease is extinguished as the same person cannot be both the landlord and tenant at the same time. There is a drowning or sinking of the inferior right into the superior right. This principle is also recognised under the Transfer of Property Act which specifically provides for the determination of the lease in case the interests of the lessor and the lessee vest in the same person at the same time. In such a case, the period of holding of the asset would be counted from the date on which the reversionary rights were acquired. The fact that the assessee was a lessee earlier for several years would be of no consequence in determining whether or not the gain was a short-term capital gain.

Transfer of lease and section 50C

Decisions of the Income-tax Tribunal have held that a transfer of a tenancy does not attract the provisions of section 50C of the Income-tax Act — Kishori Sharad Gaitonde, AIT 2010 200 ITAT (Mum.); Atul G. Puranik, 132 ITD 499 (Mum.); Munsons Textiles, ITA No. 6320/M/2010; Tejinder Singh (2012) 19 taxmann.
com 4 (Kol.).

Auditor’s duty

The Auditor should enquire of the auditee whether it has complied with the aforesaid provisions in respect of any lease agreements executed into by it. In case the Auditor comes across a lease transaction which does not comply with any provisions of the above Acts, then he will have to consider whether appropriate disclosures should be made in the Notes to Accounts or whether the non-compliance is so material so as to warrant a qualification in his report. He may insist upon a legal opinion to support any claim which the auditee is making. He can caution the auditee of likely unpleasant consequences which might arise. It needs to be repeated and noted that an audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’ and ‘diligence’.