Understanding the Goods and Services Tax Implications for Tenancy Rights

An individual who occupies land or property in exchange for rent is known as a tenant. The tenancy agreement serves as a crucial legal document, outlining the rights, responsibilities, and specific terms applicable to both the tenant and the property owner. This document may include clauses detailing particular tenancy rights. This article will clarify the concept of tenancy rights, address the complexities surrounding their taxation, and explain the applicable tax treatment.

Understanding Tenancy Rights

Beyond the fundamental right to reside in a property, an owner might grant a tenant the ability to transfer their tenancy right to another party. In this context, a tenancy right refers to the privilege of occupying or utilizing the property. The tenant typically makes an upfront payment to acquire this right, effectively becoming a partial owner of the structure but not the land itself. This arrangement is sometimes called the 'Pagdi System' in certain regions of India.

For instance, if Mr. A rents a house from Mr. X, Mr. A is the tenant and Mr. X is the property owner. Should the tenancy agreement permit Mr. A to transfer his occupancy right in Mr. X's house to a third person, this granted privilege is defined as a tenancy right. The initial payment made by Mr. A, for example, Rs. 100,000, to secure this right, is referred to as the tenancy premium.

Defining Tenancy Premium

A tenancy premium represents a payment made to acquire a specific right. This term can also describe a sum paid by a property owner to a tenant to facilitate an early vacation of the premises, prior to the agreed-upon lease termination. To illustrate this concept, consider the following two scenarios:

Scenario 1: Property owner A leases a property to tenant B, who pays a monthly rent of Rs. 10,000. Additionally, B pays A Rs. 100,000 to acquire a partial right in A's property. This Rs. 100,000 is the tenancy premium. In this case, B compensates A for sharing a degree of property right, though A retains full ownership.

Scenario 2: Property owner X rents a property to tenant Y, who pays a monthly rent of Rs. 10,000. Before the lease concludes, X pays Y Rs. 100,000 to encourage Y to vacate the property. This Rs. 100,000 is also classified as a tenancy premium, as X is compensating Y to relinquish the right to continued occupancy.

GST Taxation of Tenancy Premium

Prior to the implementation of GST, the transfer of tenancy rights was categorized as a declared service under service tax law, making the associated tenancy premium a taxable consideration. According to the GST Act's definition of 'Supply,' the provision of services encompasses activities such as leasing, tenancy, easements, and licenses to occupy land. Therefore, the transfer of tenancy rights clearly falls under the scope of supply for GST purposes.

However, the introduction of GST raised specific queries, including:

• Is GST applicable to tenancy premium when stamp duty and registration fees are paid on the transfer of tenancy rights?
• Is GST applicable to tenancy premium received by a tenant vacating a property (the outgoing tenant)?

A recent circular has clarified these ambiguities. It establishes that the requirement for documentation, registration, and payment of stamp duty or registration fees for a transaction does not negate its classification as a supply. Stamp duty and registration charges alone do not determine whether a transaction should be considered a sale of land or building.

Since the transfer of tenancy rights in exchange for a tenancy premium constitutes a supply, it is generally subject to GST. Nonetheless, the rental of residential property for residential use is explicitly exempt from GST. Consequently, if tenancy rights are transferred for residential use, GST will not be levied. When tenancy rights pertain to commercial or non-residential purposes, they are subject to GST.

In summary, it can be affirmed that:

• GST applies even when stamp duty and registration fees have been paid for the transaction.
• The tenancy premium paid to an outgoing tenant is also subject to GST.

To gain a deeper understanding of GST and associated compliance requirements, further information is available here.