The taxation of upfront lease premium paid for long-term land leases has once again come under scrutiny, as taxpayers and tax authorities continue to differ on whether such payments attract Tax Deducted at Source (TDS) as “rent” or should be treated akin to a property transfer.
The issue typically arises in transactions where land is leased for exceptionally long durations—often ranging from 60 to 99 years—with the lessor charging a substantial one-time lease premium at the inception of the agreement.
Nature of Long-Term Lease Arrangements
Under these long-term lease agreements, lessees are granted extensive rights that closely resemble ownership. These rights usually include uninterrupted possession of the land for the lease period, freedom to construct buildings in accordance with local laws, the ability to mortgage leasehold rights for raising finance, and the authority to obtain utilities such as power and telecommunication connections.
In addition, lessees are generally responsible for paying local taxes and complying with environmental and labour regulations. Sub-leasing is permitted, though often subject to the lessor’s consent. Notably, lessors frequently classify the upfront lease premium received as “revenue from operations” in their financial statements.
The Core Legal Question
The central question confronting lessees is whether TDS should be deducted at 10% under Section 194-I of the Income Tax Act, 1961, which governs rent payments, or at 1% under Section 194-IA, which applies to the transfer of immovable property.
Section 194-I defines “rent” broadly to include payments under any lease or similar arrangement for the use of land or buildings. On this basis, tax authorities have often taken the position that lease premium qualifies as rent and have raised demands where lessees deducted TDS at a lower rate.
In several cases, lessees who deducted tax at 1% under Section 194-IA have faced demands for the differential 9%, along with interest, from TDS officers.
Judicial Guidance from High Courts and the Supreme Court
The matter has been extensively litigated. A landmark ruling by the Delhi High Court in CIT (TDS) v. The Indian Newspaper Society laid down important principles to determine the nature of such payments. The Court emphasised that the characterization depends on factual aspects, including whether the payment is for lease premium rather than periodic rent, whether comprehensive rights over the land are transferred, and how the lessor treats the receipt in its own tax filings.
The Delhi High Court also relied on earlier Supreme Court judgments, including A.R. Krishnamurthy v. CIT and R.K. Palshikar v. CIT, which held that the transfer of leasehold rights for a long duration creates an asset of enduring nature, even if subject to certain conditions.
Similar views were echoed by the Madras High Court in cases involving Foxconn India Developer Limited and Tril Info Park Limited. Importantly, the Income Tax Department chose not to challenge these rulings further.
CBDT Circular and Its Impact
In October 2016, the Central Board of Direct Taxes (CBDT) issued Circular No. 35/2016, providing much-needed clarity. The circular stated that lump-sum or one-time lease premium paid upfront for acquiring long-term leasehold rights—where such payment is not adjustable against periodic rent—does not qualify as “rent” for the purposes of Section 194-I.
The circular further clarified that such long-term leases effectively assume the character of a “deemed sale,” and therefore, no TDS is required under Section 194-I on such payments.
The Grey Area That Remains
While the circular settles the non-applicability of Section 194-I in qualifying cases, it stops short of clarifying whether TDS should be deducted under any other provision. This has led to the view that if the transaction is akin to a transfer of a capital asset, Section 194-IA may apply, requiring TDS at 1% of the consideration or stamp duty value, whichever is higher.
However, tax experts caution that this position is highly fact-specific. The lease deed must clearly demonstrate the transfer of possession and substantial rights to the lessee, without any adjustment of the upfront premium against future rent. Even then, lessees should be prepared for potential scrutiny from assessing or TDS officers.
Way Forward for Taxpayers
Given the continued litigation and interpretational challenges, taxpayers entering into long-term lease arrangements are advised to carefully review lease documentation, evaluate the true nature of rights transferred, and adopt a defensible tax position supported by judicial precedents and CBDT guidance.
As long-term leasing becomes increasingly common in infrastructure, industrial, and real estate projects, clarity on the correct TDS treatment remains crucial for reducing disputes and ensuring compliance.
