TDS on Premium Paid for Grant of Lease

The issue has been the subject matter of adjudication in various cases and judgment largely depends on the facts of the case. In this article, the authors have analysed various judicial pronouncements in this regard and have made several observations that will help the reader understand the issue in its entirety.

Issue for Consideration

Section 194-I of the Income-tax Act, 1961 requires deduction of tax at source from payment of any income by way of rent to a resident. For this purpose, ‘rent’ has been defined to mean 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, land, or building (including factory building), or land appurtenant to a building (including factory building), ……………….. whether or not any one or all of the above are owned by the payee.

Very often, when land is taken on lease for a long period of time, say for 30 years, 50 years or 99 years, a premium is paid for such grant of lease, particularly when the lease is being taken from a Government Authority, such as an Industrial Development Corporation or a Regional Development Authority. In addition to the premium, annual rent may also be charged, which at times may be a nominal amount. The payment of such a premium has been the subject matter of several controversies, under the tax laws, surrounding the liability of the payer to deduct tax at source u/s. 194-I and his eligibility to claim deduction for such payment in computing his total income.

One of the issues is whether such a premium is really in the nature of rent for the purposes of section 194-I, and whether tax is deductible at source from such premium, or whether such premium is in the nature of a capital expenditure for the grant of lease of the land and no tax is deductible from such payment. While the Chennai bench of the Tribunal has taken the view that tax is required to be deducted at source u/s. 194-I from the payment of lease premium, the Delhi and Mumbai benches of the Tribunal have taken a contrary view that payment for such premium is a capital expenditure and no tax is required to be deducted at source thereon.

Foxconn India’s case

The issue first arose before the Chennai bench of the tribunal in the case of Foxconn India Developer (P) Ltd. vs. ITO 53 SOT 213.

In this case, the assessee was engaged in the business of developing a Special Economic Zone (SEZ) and had taken on lease, a plot of land of 151.85 acre for a period of 99 years from SIPCOT Ltd., a Tamil Nadu State Government Corporation engaged in industrial development, which was the nodal agency for development of land for SEZ at Sriperumbudur. The assessee paid an amount of Rs. 28.41 crore as upfront charges for the lease. The annual lease rent was Rs. 1 per year for 98 years and Rs. 2 in the 99th year, such rent also being paid in advance. The upfront fee was non-refundable and consisted of Rs. 27.09 crore towards non-refundable upfront charges and Rs. 1.32 crore for payment towards provision of water and pipeline up to the boundary limit.

The Assessing Officer (TDS) took the view that such payment came within the definition of rent as per the explanation to section 194-I, and that the assessee had failed to deduct tax at source thereon. He therefore treated the assessee as in default for non-deduction of TDS and raised a demand for the amount of TDS and interest thereon.

The Commissioner (Appeals) was of the view that the upfront fee was nothing but advance rent, since the annual rent was very small. According to the Commissioner (Appeals), such upfront payment obviated the problem of SIPCOT in collecting the rent annually. He therefore held that the assessing officer was justified in applying section 194-I and holding that the assessee had failed to deduct TDS. However, since the lessor had included upfront and water connections charges received by it as its income and paid tax thereon, he held that the TDS could not be recovered from the assessee following the decision of the Supreme Court in the case of Hindustan Coca-Cola Beverages 293 ITR 226, but that interest could be levied u/s. 201(1A) up to the date of payment of final installment of advance tax by SIPCOT Ltd.

Before the Tribunal, it was argued that the upfront fee was a capital outgo, and that by such payment, the assessee derived the right of possession of the land for 99 years; that the right was an asset, giving rise to an enduring benefit; that the assessee had reflected this right acquired by such payment as an asset in its balance sheet; that no tax was deductible on a capital outgo. SIPCOT Ltd. had treated the entire amount received by it as a revenue receipt and part of its business income from the area development activity, and had accordingly treated the transaction as a deemed sale of land. Reliance was placed on the decision of the Patna High Court in the case of Traders and Miners Ltd. vs. CIT 27 ITR 341, for the proposition that lease of land was a transfer of a capital asset.

The Tribunal agreed with the assessee’s contention that it had received a benefit of enduring nature, that the outgo was on capital account and that it had acquired an asset by making such payment. It noted that the assessee had derived an interest in the property since leasehold interest was a valuable right.

However, according to the Tribunal, the question was not as to whether the outgo was capital or revenue, but as to whether the upfront fee fell within the definition of ‘rent’ under the Explanation to section 194-I. According to the Tribunal, section 194-I did not differentiate between a capital outgo and a revenue outgo. It rejected the assessee’s argument that the payment was made before the date of signing of the lease agreement, as not being relevant. According to the Tribunal, it was an accepted position that the payments were for the lease of the land, that the lease was already in contemplation and that the payment would not have been made unless the lease was at least orally agreed to between the parties. Therefore, according to the Tribunal, the payment, by whatever name called, was made under a lease agreement.

According to the Tribunal, the definition of rent would definitely include payments of any type under any agreement or arrangement for the use of land. For the purposes of section 194-I, the Tribunal was of the opinion that the normal meaning of the term rent could not be used, but that the specific definition of rent had to be applied, which, in the opinion of the Tribunal, would squarely cover the payment made by the assessee to SIPCOT Ltd.

The Tribunal therefore upheld the order of the Commissioner (Appeals), holding that tax was deductible at source. Having held that the tax was deductible at source, the Tribunal however proceeded to hold that such tax could not be recovered from the assessee as the relevant taxes had already been paid by SIPCOT Ltd., and that only interest u/s. 201(1A) could be recovered from the assessee.

Navi Mumbai SEZ’s case

 The issue again came up before the Mumbai bench of the Tribunal in the case of ITO vs. Navi Mumbai SEZ (P) Ltd., 147 ITD 261.
in this case, the assessee was a special purpose  vehicle constituted by the maharashtra Government Corporation, City and industrial development Corporation of maharashtra ltd. (CidCo) and dronagiri infrastructure Private Limited for developing and operating an SEZ at  navi  mumbai.  CidCo  was  the  town  development authority for navi mumbai, and had acquired privately owned lands in that area for development work. CidCo was also appointed as the nodal agency for setting up the SeZ at navi mumbai.

a development agreement, followed by the lease deed, was entered into between CidCo and the assessee, whereunder the assessee agreed for payment of lease premium, in respect of land acquired by CidCo and allotted to the assessee, from time to time. accordingly, the  assessee  paid  lease  premium  of  rs.  50  crore  in assessment year 2006-07, rs. 946.06 crore in assessment year 2007-08, Rs. 1,033.61 crore in assessment year 2008-09,  and  rs.  146.82  crore  in  assessment  year 2009-10.

By virtue of the lease, the assessee had acquired lease- hold rights in the land for the purpose of developing, designing, planning, financing, marketing, developing necessary infrastructure, providing necessary services, operating and maintaining infrastructure, and administering and managing the SEZ to be known as the navi mumbai SEZ. the assessee had also acquired the rights to determine, levy, collect, retain, and utilise user charges, fees for provision of services and/or tariffs under the lease deed. the lease deed and development agreement assigned to the assessee the right to develop, construct and dispose of residential and commercial spaces. the assessee was also entitled to grant a sub-lease in respect of portions of the lease land, in accordance with applicable laws and as per the lease deed. the assessee was granted the power to assign its rights, title or interest or create a security interest in respect of its right, either fully or in part thereof, in favour of lenders, including the grant of step in rights in the event of default under the financing arrangements for the purposes of obtaining finance for the SEZ. under the development agreement, the assessee acquired sole rights for marketing of the SEZ and the industrial/commercial projects to potential tenants.

The assessing officer took the view that the lease premium was ‘rent’ within the meaning of the said term u/s. 194-i and that the assessee ought to have deducted tax at source from such payment. according to the assessing Officer, almost any and every payment in relation to property under lease transactions was to be treated as rent for the purposes of section 194-i and hence lease premium partook of the character of rent. according to the ao, the various restrictive clauses in the lease agreement negated the assessee’s contention that it had acquired rights in the land and not merely rights to use the land. the ao therefore held that the assessee was in default for non-deduction of tax at source on such payment.

The  Commissioner  (appeals)  noted  that  the  assessee had been allotted land for a period of 60 years on the payment of lease premium and that the lease deed and the development agreement assigned to the assessee leasehold rights, which included a bundle of rights. he held that the payment of lease premium by the assessee was for acquiring the lease and it could not be equated with rent. The Commissioner (Appeals) noted that the definition of the term ‘rent’ specifically used the term ‘for the use of,’ and that the usage was of the utmost importance in any transaction for it to be treated as rent. according to the Commissioner (appeals), a transaction of lease might have stipulations which make it a transaction identical   to the transactions between a landlord and a tenant and that was why various terms like sub-lease, tenancy, etc. had been used in the section. however, in many cases, a lease transaction might not necessarily be similar or identical to a transaction between a landlord and tenant, and instead might indicate a sale transaction, in the sense that certain more valuable rights in the property were transferred.

The Commissioner (appeals) also drew a distinction be- tween a case where the tenant or lessee used the proper- ty for his own purposes or employed it for his own benefit, in which case the consideration would be in the nature  of rent, as against a situation where the property was exploited in a manner that its identity did not remain the same and thereafter it was sold, by the lessee, for a profit, which was the situation in the assessee’s case and hence could not be termed as a transaction between a landlord and a tenant. according to the Commissioner (appeals), the latter was a case where the lessee acquired a capital right to develop the land and exploit it. the Commissioner (appeals) therefore held that the assessee had acquired rights in land and had not paid for the use of the land, and that therefore the provisions of section 194-i were not attracted.

On further appeal by the revenue, the tribunal noted that the word ‘rent’ as defined u/s. 194-I had a wider meaning than that in common parlance. the tribunal also noted that the assessee however had paid the lease premium to acquire the leasehold land and that there was no provi- sion for refund of the lease premium paid by the assessee. it took note of the decision of the Supreme Court in the case of A. R. Krishnamurthy vs. CIT 176 itr 417, wherein the apex Court held that a lease of land was a transfer  of interest in the land, that involved a transfer of title in favour of the lessee, though the lessor had the right of reversion after the period of lease terminated. it also took note of the decision of the delhi high Court in the case  of Bharat Steel Tubes Ltd. vs. CIT 252 itr 622, wherein the court held that amount paid for acquiring leasehold rights was premium, which was capital in nature, and that periodical payments made for the continuous enjoyment of the benefits under the lease amounted to rent, which was revenue in nature.

The tribunal also noted the decision of the jurisdictional Bombay high Court in the case of CIT vs. Khimline Pumps Ltd. 258 itr 459, wherein it was held that the payment made for acquiring leasehold rights from a lessee was capital in nature, and could not be treated as an advance rent. according to the tribunal, in the assessee’s case, there was a transfer of substantive interest of the lessor in the leasehold land in favour of the assessee and that the lease premium was a capital expenditure to acquire a capital asset and not for the use of the land.

The  tribunal  observed  that  in  the  case  of  foxconn  in- dia developers (supra) the Chennai bench of the tribu- nal had observed that the payment was made under the lease agreement, and had held that the payment was for use of land and not for acquisition of leasehold land. the tribunal in navi mumbai SeZ’s case therefore, was of the view that the decision of the Chennai bench in foxconn’s case was not applicable to the case before it. the tribu- nal preferred to follow the decision of the delhi tribunal in ITO vs. Indian Newspapers Society 144 itd 668, wherein it was held that the payment of the lease premium was not liable to deduction of tax at source. it also took note of the ratio of the decision of the special bench of the tribunal at mumbai in the case of Jt. CIT vs. Mukund Ltd. 13 Sot 558, where the special bench had held that premium paid for acquiring leasehold rights in land was a capital expenditure.

The mumbai bench of the tribunal therefore held that the premium paid by the assessee did not attract the provisions of section 194-i, and that no tax was required to be deducted at source on such lease premium.

A similar view had been taken earlier by the mumbai bench of the tribunal in the case of ITO vs. Wadhwa & Associates Realtors (P) Ltd. 146 itd 694, in the context of lease of land from mumbai metropolitan regional development authority.

Observations
An immovable property comprises of a bundle of rights, each of them can be separately conveyed for varied consideration to different people. for example, right to own, right to use, right to mine, right to let, right to manage and control, etc. under the general law, sale consideration is received for conveyance of absolute rights in a property while a premium is received for transfer of the partial in- terest of the owner of the property and rent is received for grant of the right to use the property for a period. each of these transfers operate in different fields and the payments there under have different implications.the receipt of the rent is in the revenue field and of the premium is in the capital field. The payment of the rent is revenue expenditure and of the premium is a capital outlay. there may be cases where it may be difficult to draw a precise line between the premium and the rent. there may also be the cases that the parties for convenient reasons chose to use such nomenclatures that do not reveal the true nature of the transactions. the distinction between premium and rent and the norms for identifying each of them is noted by the Supreme Court in the case of CIT vs. Panbari Tea Co. Ltd. 57 itr 422 in the following words:

“The real test of a salami or premium is whether the amount paid, in a lump sum or in instalments, is the consideration paid by the tenant for being let into possession. When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease are in the nature of rent. The former is a capital receipt, and the latter are revenue receipts. There may be circumstances where the parties may camouflage the real nature of the transaction by using clever phraseology.

This section (section 105 of the Transfer of Property Act), therefore brings out the distinction between the price paid for transfer of right to enjoy the property and the rent to be paid periodically to the lessor. When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease is in the nature of rent. The former is a capital income and the latter a revenue receipt.

In some cases, the so-called premium is in fact advance rent and in others, rent is deferred  price. It is not the form, but the substance of the transaction that matters. The nomenclature used may not be decisive conclusion, but it helps the court, having regard to the other circumstances, to ascertain the intention of the parties.”

It is therefore appropriate to hold that the issue that whether a payment is a premium or a rent is largely a question of fact. the facts will decide as to what has been paid is a premium or a rent, no matter what nomenclature the parties have chosen to use; the facts will decide the character of the payment, no matter it has been paid in one go or in installments. the facts that are relevant for deciding the character are whether the payer’s interest  in the property are transferred or whether the payment is for the limited purpose of use of the property for a period. Where the payment is for use of the property, the same would be on revenue account even where paid in one go for a period exceeding one year. in contrast where the payment is for acquiring a part of the interest of the owner, the same will be on capital account even where paid in installments.

Usually in the long lease, the transaction involves a transfer of interest of the owner in part and of the right to use the property as well as the separate payment being made for each of them. in such circumstances, it is fair for the parties and also for the authorities to respect the contents of the lease deed unless they do not reveal the facts but camouflage them.

An yardstick that can be safely used, in a case where the contents of the lease deed do not clearly reveal the true nature of the transaction and of the payment, is to look for the value of the property in the open market and if the premium matches such value, with a difference attributable to the limited title, it can be said that the payment was made for transfer of interest in the property.

An additional issue is whether the distinction between the two terms is to be ignored while interpreting section 194-i, given the specific definition contained in the Explanation to that section. On the first glance, one may be tempted to hold, like what was done by the Chennai bench in foxconn’s case, that any payment made under a lease, is subjected to the provisions of tax deduction at source as such payment should be termed as ‘rent’ within its extended meaning u/s. 194-I. We are afraid that the view  of the bench requires reconsideration in as much as the term ‘rent’, even u/s. 194-I, covers a payment only where it is for the use of the properties listed therein. The definition of rent in section 194-i uses the term “for the use of” clearly indicating that it is intended to cover the subsequent periodical payments, which are meant for continuous subsequent usage of the property, and not initial capital payment, meant for acquisition of the right to use the property. had section 194-i intended to also cover payments made for acquisition of the right to use property, it would have used the term “for acquisition of the right to use, or for the use of”.

The Chennai bench of the tribunal took the view that it did not matter as to whether the payment of premium was capital in nature or revenue in nature. it proceeded on the footing that the definition of ‘rent’ in section 194-I was broad enough to cover even capital payments. however, given the use of the term “for use of” in the definition, it is clear that what is covered by the definition is only a revenue expenditure, and not a capital expenditure. the distinction, as observed by the Supreme Court in Panbari tea’s case (supra), between rent (revenue) and premium (capital) also does not seem to have been taken into account by the Chennai bench of the tribunal.

In fact, if one takes the Chennai bench’s decision to its logical conclusion, even payment for outright purchase of land or building will be covered by section 194-i, as purchase of land or building includes acquisition of the right to use the land or building. this would be an absurdity, more particularly as there is a separate provision u/s. 194-ia for deduction of tax at source from payments for acquisition of immovable property.

As rightly analysed by the Special Bench of the tribunal in mukund’s case (supra), if the premium is non-refundable and there is a provision for termination of the lease prior to the end of the lease term, without refund of any part of the lease premium for the unexpired lease term, the payment of premium cannot be regarded as a payment of advance rent. unless the agreement shows that the amount of premium was paid as advance rent for all future years and that a lump sum payment of future years’ rent was paid to avail of some concession in rent, the premium paid is to be regarded as a price for obtaining the leasehold rights. in that case, the tribunal also relied upon the Supreme Court decision in the case of Durga Das Khanna vs. CIT 72 ITR 796, where the Supreme Court took a similar view in relation to a lease agreement for a cinema hall.

The delhi high Court, in the case of Krishak Bharati Co- Operative Ltd. vs. DCIT 350 ITR 24, has pointed out that payment of lease premium is a precondition for securing possession. Where the tenure of the lease is quite substantial and the lease virtually creates ownership rights in favour of the assessee, who is at liberty to construct upon the plot, and exclusive possession has been handed over to the assessee at the time of creation of the lease, the lease premium could not be regarded as advance rent to be amortised over the period of the lease.

In the case of R. K. Palshikar HUF vs. CIT 172 ITR 311 (SC), where the lease was for a long period, namely 99 years, the assessee had parted with an asset of an enduring nature, namely, the rights to possession and enjoyment to the properties leased for a period of 99 years subject to certain conditions on which the respective leases could be terminated, and a premium had been charged by the assessee in all the leases, the Supreme Court held that the grant of the leases amounted to transfer of the capital assets.

In Krishak Bharati’s case (supra), the delhi high Court observed that all the cases where the lease premium was held to be in the nature of advance rent were fact dependent. in the case of DCIT vs. Sun Pharmaceutical Industries Ltd. 329 ITR 479 (Guj), the lease premium was held to be deductible as the annual lease rent was a token amount of rs. 40. in CIT vs. Gemini Arts (P) Ltd. 254 itr 201 (mad), the rent was a nominal amount and there was no provision for increase in rent during the period of lease.

As observed by lord Greene m.r. in henriksen vs. Grafton Hotel Ltd. 24 TC 453:

“A payment of this character appears to me to fall into the same class as the payment of a premium of a lease, which is admittedly not deductible. in the case of such a premium, it is nothing to the point to say that the parties, if they had chosen, might have suppressed the premium and made a corresponding increase in the rent. no doubt they might have done so, but they did not do so in fact.” importantly, the Supreme Court in the case of durga das Khanna (supra) held that the onus is on the revenue to demonstrate that the advance rent has been camouflaged as premium and that the premium has been inflated. According to the Supreme Court, where an arm of the government is a party to the lease agreement, the burden on the Assessing Officer to prove such camouflage would be very heavy and onerous.

Therefore, in a situation where an assessee obtains substantial domain over the immovable property by payment of the lease premium, particularly where the lease premium is paid to a Government authority, the premium would be regarded as a payment for acquisition of the property for the lease period, and not as a payment for the user of the property. therefore, the provisions of section 194-I should not be attracted to such payment of lease premium. the ratio of the decisions of the mumbai and delhi benches of the tribunal, to the effect that no tax is deductible at source in respect of such premium, therefore seems to be the better view of the matter.