INDIA BUSINESS WORLD - MAY - JUNE 2007
The Month that was ...

SERVICE TAX ON RENT RECEIVED FROM PROPERTY LET OUT FOR COMMERCIAL USE

Retailers who share a portion of their earnings with landowners will not have to absorb the new service tax on rentals from properties let out for commercial use. A landowner entering into a pure revenue-sharing arrangement with a retailer is set to be exempt from service tax. Tax will, however, be charged in contracts where the property is rented or leased out to the retailer.

The decision to impose a service tax on commercial rentals, announced in this year's Budget, will come into force on June 1. Landowners who rent, let out, lease or license immovable property for commercial use will have to pay a 12% service tax on the rentals.

Service tax is generally charged on the service provider (in this case, property owner) who, in turn, passes on the burden to the service user (retailer).

This would mean a rise in the rental costs of retailers. It could dent their profits which are already under pressure due to the high rentals in an overheated real estate market. Some retailers, in fact, plan to pass on the burden to the consumer.

Tax officers will examine the terms of the contract between property owners and developer and compare it with the legal provisions.

Service tax will be charged on renting of immovable property and this includes renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course of furtherance of business.

According to a senior official, it is only logical to exempt a pure revenue sharing contract without a rental component from service tax. This is because law makers have gone by the principle of Ejusdem Generis-a Latin word "of the same kind" used to interpret loosely written statute. In this case, the phrase "similar arrangement" will cover activities like renting, leasing, letting out or licensing of immovable property.

Some tax experts, however, feel that getting a service tax exemption may not be that easy. "Even in revenue sharing arrangement the use of the property is definitely for use in the course of furtherance of business or commerce. Whether this arrangement is covered by the expression "renting of immovable property" as defined is arguable," said T R Rustagi, former Joint Secretary in the finance ministry.

Interestingly, revenue sharing is not a popular concept in India. "Revenue sharing arrangements between developers and retailers are popular in countries such as the US. McDonald, for instance, has such an arrangement in many cities in India. But the concept of a pure revenue sharing is yet to catch up in a big way in India as there are risks involved," says Promoters and Builders Association of Pune (PBAP) president Lalit Kumar Jain.

Currently, most modern formats are leased by retailers. Several lease agreements hold a clause which states that any additional tax or levy will have to be borne by the lessee. "For contracts entered in the past, service tax will be paid by the lessee. In future contracts, the amount be included as part of the rentals," said a realty developer.

Rentals are expected to touch over 15% of sales from around 7-8% in the previous years, and retailers are worried over the eroding margins. Globally, rentals constitute just 3-4% of sales for retailers, according to industry analysts.