Background

Sec 194-IA was introduced by the Finance Act 2013 with effect from 01-06-2013 wherein any person responsible for paying to a resident transferor any sum by way of consideration for transfer of any immovable property (other than agricultural land), shall, at the time of credit of such sum to the account of the transferor or at the time of payment of such sum in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to 1% of such sum as TDS.

Recently the Madras HC, in the case of Foxconn India Developer (P) Ltd [TS-5158-HC-2016(MADRAS)-O] held that payment for one-time non-refundable upfront charges for acquiring leasehold rights in land for long duration (i.e. 99 years) is not 'rent'. Therefore, such lessee is not liable to deduct TDS u/s 194I. Many courts have held similar views but almost all of them did not address the applicability of Section 194-IA.

In other words, the principle question is whether S. 194-IA applies to payments made for leasehold land and/or buildings.

Leasehold rights agreements

Many state governments set up industrial boards and companies to deal with expansion of industries. Large parcels of land are marked for industrial development and is leased to entities for setting up factories and office buildings. Salient features of such agreements would be as under:

• Land is leased to eligible entity against payment of consideration of lease premium.
• The duration of such agreement would be usually long, say 99 years.
• The lessee is obligated to pay nominal rent towards rent/maintenance charges for the duration of the lease.
• The lessee is required to use the land for construction of building/factory within a specified period of time subject to the building approvals by the sanctioning authority.
• The lessee has right to mortgage the leasehold rights with the first charge on the property to the sanctioning authority.
• The lessee can also sub-lease to any party subject to the approvals of the sanctioning authority.
• The leasehold rights can be transferred subject to certain conditions.
• On the expiry of the lease period, the property in question reverts back to the lessor or is agreed to be sold to the lessee on some agreed terms.

Features of S. 194-IA

• There must be a transfer.
• The transfer must be of immovable property (other than agricultural land). Immovable property" means any land (other than agricultural land) or any building or part of a building.
• The consideration for the transfer of such immovable property must be equal to or more than 50 Lakhs.
• The person making the payment for transfer of immovable property must deduct 1% of such consideration u/s 194-IA. 

The moot question is whether there is any transfer of immovable property when leasehold rights are acquired so as to trigger “transfer” is not defined in S. 194-IA. S. 2(47) defines the word “transfer” in relation to “capital asset”. The Income Tax Act defines “capital asset” to exclude stock-in-trade. However, S. 194-IA does not indicate any such exemption of stock-in-trade. In other words, the definition of the word “transfer” must be inferred from its general sense and cannot be looked at definition used in S. 2(47). More specifically, the word “transfer” can be imported from the Transfer of Property Act, 1882. Transfer of Property Act requires all conveyance of immovable property through an instrument reduced to writing. Section 53A of the Transfer of Property Act deals with part performance. It specifies that unless the agreement otherwise provides part performance of the contract amounts to transfer of property. Therefore, the terms of agreement and the understanding between the lessor and lessee assumes great importance.

The second important question is whether right in usage of immovable property amounts to ownership of the immovable property itself. The clear answer is NO [TS-197-ITAT-2011(MUM)-O]. Review of the lease agreement between the lessor and lessee throws light on the nature of understanding between them. The lessor agrees to let the lessee use the property albeit for a very long period of time. The ownership of such property remains with the lessor and the same is substantiated by the conduct of the parties. Lessor (in this case, Governmental bodies) retain the right to approve the building or factory plans though the lessee can hypothecate the usage rights to raise debt funds.

Conclusion

Therefore, it is possible to argue that lease premium paid for leasing land and/or building for long period (say 99 years) does not result in withholding tax liability u/s 194-IA. However, care must be taken to draft the agreement between the lessor and the lessee substantiating the intention of the parties to the contract. The ownership in substance, if retained with the lessor throughout the tenure of the lease clearly indicates that what is transferred is the rights of usage of land and/or building and not the asset itself.