A new job or even a desire to set up an entrepreneurial venture, prompts many youngsters to move cities. House hunting for a leased flat, which fits one’s budget is tedious enough. In addition, if service tax is payable it means a higher outgo.
Thus, it is essential to know whether or not service tax applies on the monthly rentals and the security deposit paid to the landlord.
Seema Walia, a new entrepreneur, moved to Mumbai from Chandigarh and was glad to find a suitable 2BHK at Kharghar, Navi Mumbai for a monthly rental of Rs. 23,000. She also had to pay upfront an interest-free refundable security deposit equivalent to eleven months’ rent (which was the duration of the lease agreement). (All personal details changed). Security deposits are sought by landlords as a buffer for non-payment of rent or damage to the leased flat.
Walia had also inquired if the flat could double up as the registered office of her proposed start-up in the E-commerce space. Her landlord appeared confused on service tax applicability.
If service tax applied, she would have to pay Rs. 3,335 per month against the monthly rent and a one-time payment of Rs. 36,685 against the security deposit (current rate of service tax is 14.5%)
“Service tax liability in case of immovable property is determined based on the use of the property,” says Yusuf Hakim, partner at CNK & Associates, a chartered accountancy firm. In the instant case, as Walia intends to also use the flat for her start-up venture, the gross rentals would be subject to service tax levy. Security Deposits normally do not represent any consideration for services and would typically be outside the ambit of service tax, unless such security deposits are in the nature of an advance rent or are unreasonably high.
Use of flat is purely residential: A flat let out for residential purposes falls under the ‘negative list’ and there is no service tax liability as regards the rent and security deposit (irrespective of whether the deposit is refundable or not). “The service tax liability, would not apply even if the security deposit isn’t fully refunded, but part is retained by the landlord for any damages to the flat or is non-refundable in nature and is adjusted against monthly rentals,” says Hakim.
HOT TIP: It is debatable whether a parking space allotted to a tenant would fall under the negative list. But, if the tenant is entitled to a parking space along with the residential accommodation under the same agreement, and the rentals and security deposit cover both the flat and parking space for a lump-sum consideration, one could contend that there would be no service tax levy. It is best not to enter into separate agreements for a parking space, say experts.
However, some entrepreneurs do set-up their venture in a flat and this is defined in the tenancy agreement. The registered office of the start-up is also this particular address – the use of the flat in such cases is ‘commercial‘ in nature. “Here, the rental (no matter what the amount) would be subject to a service tax levy of 14.5%,” says Jayesh Gogri, director, GSC Intime Services, an indirect tax consultancy firm.
“The good news is that the refundable security deposit, typically doesn’t attract service tax, even if the property is used for commercial purposes. This is substantiated by a CBEC guide, adds Gogri. However, if the security deposit is un-refundable and is adjusted against monthly rentals, such ‘rent‘ would be subject to service tax levy.
CAUTION POINT: If the refundable security deposit for a flat used for commercial purposes is unreasonably high which could be linked to lower rentals being charged, the service tax authorities may raise a tax demand. “Even though current regulations do not provide for inclusion of any notional interest in determining the taxable value of service and subjecting such notional interest to service tax, litigation for the landlord cannot be ruled out,” says Hakim.
“In such a scenario of high refundable security deposit, an extra cautious landlord, to avoid litigation may charge collect service tax from the tenant at the time the upfront deposit payment is made,” says Gogri.
HOT TIP: If the aggregate value of taxable services (from various sources) provided by your landlord does not exceed the threshold limit of Rs. 10 lakh, the landlord would not have to levy and collect service tax. Thus, even if your flat is used for commercial purpose, there would be no service tax levy and you would not bear a higher outgo. It always pays to inquire about the service tax obligation of your landlord.