Service tax on commercial rent: Who is to bear the additional burden?
July, 09th 2008
Imposing service tax on renting of immovable property was one of the contentious steps undertaken by the Government in its attempts to generate additional revenues. Service tax on renting of immovable property was imposed at the rate of 12.36% by the Finance Minister P. Chidambaram in Budget 2007-2008.
This proposal triggered strong reactions from many landlords who questioned the validity of the tax on the ground that service tax on commercial rent was not leviable since it was only a lease of immovable property and no taxable service was being rendered. Despite severe opposition and criticism from several quarters, the levy of such tax was confirmed vide Notification No. 23/2007- Service Tax dated 22nd May 2007.
In light of the introduction of the said tax, the author proposes to examine the following aspects:
1. Is renting of immovable property a service?
2. If so, who shall bear the onus of paying such tax?
Is renting of immovable property a service?
Against the imposition of service tax on commercial property, the Retailers Association of India has moved the Mumbai High Court seeking a stay of the levy of service tax on renting of commercial property. Despite numerous pleas, the court despite admitting the matter has refused an ad interim stay with respect to the levy of service tax on commercial property.
This is not the first time that a similar plea was taken. It has been argued that renting of immovable property is not a service at all and therefore, a levy of service tax on the renting of immovable property was constitutionally invalid. The constitutional validity of levying service tax on renting of immovable property as a service has stood the test of time amidst the courts in India. The Apex Court in Tamil Nadu Kalyana Mandapam Association v. Union of India specifically upheld the levy of service tax on Mandap Keepers. The Court observed:
A levy of service tax on a particular kind of service could not be struck down on the ground that it does not conform to a common understanding of the word "service" so long as it does not transgress any specific restriction contained in the Constitution.
In fact, making available premises for a period of few hours for the specific purpose of being utilized as a Mandap whether with or without other services would itself be a service and cannot be classified as any other kind of legal concept. It does not certainly involve transfer of moveable property nor does it involve transfer of moveable property of any kind known to law either under the Transfer of Property Act or otherwise and can only be classified as a service.
But the Kalyana Mandapam case may not have much relevance with regard to the case of commercial properties for the following reasons, viz.-
(i) Mandap can mean any immovable property which includes any furniture, fixtures, light fittings, and floor coverings let out for consideration for organizing any official social or business function.
ii) Apart from maintenance of the Mandap and the above said facilities, the Mandap keeper also provides the services of decorating and organizing the Mandap according to the needs of the client.
(iii) The management of Kalyana Mandaps involves an element of providing services like provision of food, infrastructure and entertainment.
In the case of commercial renting of immovable property, the situation is different. In common parlance, renting of immovable property merely includes handing over of vacant possession of property, unless and until it has been decided amongst the parties that the landlord shall provide additional services or facilities. It is difficult to conceive what service is being rendered by landlords for mere renting of commercial vacant premises.
However, service tax could be justifiably levied in such cases where the Landlord is providing maintenance of the common area (such as in malls and office complexes). But then, such service tax could be leviable only on the common area maintenance charges, if any and not on the commercial renting of immovable property.
The concern of the tenants is accentuated by the sudden and sharp rise in the prices of immovable property over the past few years, which has produced a sharp rise in rents of such immovable property. The levy of additional service tax only increases the rents of even otherwise unaffordable properties.
Who shall bear the additional burden of Service Tax on Immovable Property?
Several long-term lease agreements executed prior to the execution of such service tax on commercial rent were silent as to who shall bear the service tax burden. Standard lease agreements provide that all present and future taxes pertaining to the premises rented shall be payable by the landlord. By virtue of the aforesaid clause, the landlord who is already burdened with the payment of property tax and income tax will be under a further liability of payment of service tax on the commercial rent received from renting/ lease of premises. The landlord tried to escape the liability created by virtue of the aforesaid clause by passing such tax to the tenant and vice-versa.
The Notification dated 22nd May 2007 was also silent as to who shall be liable for payment of such service tax - the tenant or the landlord, thereby making the negotiations between the landlords and tenants complex and unpredictable. Resultant conflicts in the absence of appropriate clauses in the lease agreements has created circumstances whereby the tenants and the landlords both tried to dump the liability of payment of service tax on the other. This is because in most commercial lease deeds, the practice is for the landlord to pay the taxes arising with respect to the property. Landlords have claimed that such a tax did not fall under the ambit of taxes pertaining to the premises. Tenants have often refused to bear the burden of the service tax by taking a position that the landlord shall be liable to bear the burden of such service tax.
The Income Tax Department vide Circular 4/2008 dated 28th April 2008 has hinted that the onus to pay service tax lies on the tenant and TDS is to be excluded on the service tax component. Above all, service tax is an indirect tax and thus, the one utilizing the services shall be liable to pay such tax on services.
Para 3 of the circular reads as follows:
Service tax paid by the tenant doesnt partake the nature of income of the landlord. The landlord only acts as a collecting agency for Government for collection of service tax.
Therefore, it could be safely assumed that the service tax on rentals is a tax imposed on the rental and lease services provided by the landlord and not a tax on the premises rented. Hence, the tenant is liable to pay the service tax on the rental and lease services provided by the landlord, in case of ambiguity in the lease deed.
Despite the tenants liability to pay such service tax, it remains the duty of the landlord to collect such service tax and deposit it with the authorities. The recent developments in service tax law and its applicability to commercial tenancy assumes the existence of a duly valid, satisfactory and ongoing tenancy. In case of non-payment or delayed payment of rent and/ or such service tax on commercial rent, the landlord will not be entitled to a defense that the tenant refused to pay such tax, and thus he/ she has not been in a position to deposit the same. The law sees the landlord as the asessee, not the tenant. For the purposes of payment of such service tax, the landlords must register themselves with the Service Tax Office of the respective area. In case of non-payment of rent and/ or service tax by the tenant, the landlord has no choice but to pay the service tax on rent from his own pocket. However, he may later claim such amount from the defaulter tenant through a recovery suit.