RCM on Properties Rented from Unregistered Landlords: Challenges for Composition Taxpayers and Some Relief Strategies

The GST regime is witnessing the gradual expansion of its tax net, with considerable stability now characterizing this set of indirect levies compared to the initial years marked by rapid amendments. Thus, the GST Council recently moved to reintroduce such provisions that were frozen or kept in abeyance from its earlier stages of implementation-for example, the provisions related to RCM for supplies received from unregistered persons. This development is expected to improve tax compliance and widen the base, but it creates new challenges for taxpayers, especially small businesses and composition taxpayers.

We have already discussed the effect of this notification on family-owned commercial properties. For details, please refer to RCM on Rent for Family-Owned Properties - Impact of Notification No. 09/2024. In this article, we discuss its implications on composition taxpayers and give some tips to reduce the financial and compliance burden.

Understanding the New RCM Notification for Rental Properties

Under GST law, Reverse Charge Mechanism is shifting the liability to pay tax from the supplier to the recipient. Notification No. 09/2024 - Central Tax (Rate) has made it imperative that in respect of rent paid to an unregistered landlord by the tenant in respect of a commercial property, 18% GST be paid under RCM. This affects the small businesses and MSMEs, who mostly take up properties on rent from unregistered landlords.

The tenant has to calculate and pay the amount of GST on rent without taking the credit of ITC. Additional financial stress it may put on a composition taxpayer, as he would not get the ITC under the simplified GST regime.

Issues Related to Composition Taxpayers Under RCM

Composition taxpayers, under the simplified GST regime, are required to pay only the flat rate of tax on turnovers without the benefit of the input credit taxes. The new RCM puts an added burden on the cash flows and profitability of a business disproportionately.

For instance, suppose a composition taxpayer is renting commercial property at ₹1,00,000 per month. Here's what one will have to face in such a scenario:

• Monthly Rent: ₹1,00,000
• GST under RCM (18%): ₹1,00,000 × 18% = ₹18,000
• Annual GST Liability: ₹18,000 × 12 = ₹2,16,000

Since ITC cannot be claimed, the said ₹2,16,000 becomes a direct cost. It will surely affect their liquidity and operating margins.

Industry-wise Impact: Hospitality Industry

The already thinly cushioned hospitality sector sees manifold increase in its challenges because of the RCM.

1. Hotels that Charge Below ₹7,500/ Per Room: Under Notification No. 46/2017-Central Tax (Rate), all hotels charging below ₹7,500/ per room are levied with 5% GST sans ITC. Now, these businesses incur an additional 18% GST burden under RCM on their rentals, thus putting profitability under further pressure.
2. Stand-alone RestaurantsRestaurants that are required to pay 5% GST without ITC also bear the same burden. Unlike the luxurious ones, which have an 18% GST with ITC, these small and mid-sized restaurants don't have financial flexibility to absorb the RCM burden.

Relevant Case Laws and Implications

The rulings in M/s. Coffee Day Global Limited (KAR ADRG 13/2018) and M/s. Hotel Sandesh Private Limited (KAR ADRG 10/2021) assist in understanding the constraining tax regime of the hospitality industry, though they are not directly related to the RCM on rent for unregistered landlords.

1. M/s. Coffee Day Global Limited (KAR ADRG 13/2018)This was related to a refund of ITC. It explained businesses falling within the hospitality sector-catering, cafes, and restaurants-cannot claim ITC on any supply, particularly the services dealing in food and beverages, which this judgment very clearly represents as a limitation of indirect taxes on hospitality businesses. This is all because they cannot recover the taxes on their costs; hence, the cost element goes up.
2. M/s. Hotel Sandesh Private Limited (KAR ADRG 10/2021)This Judgment justifies the fact that when restaurants charge below ₹7,500 per room, it will attract 5% GST and allow no ITC. Further, it also indicates the stringency of the GST law for the hospitality industry wherein companies have to deal with restricted tax benefits and higher operational costs.

Both orders bring out the fact that the hospitality industry is already reeling under taxes, as the present regime denies them the full facility of recovering their taxes through ITC. The RCM on rent from unregistered landlords has been an added pressure, for which businesses, more so composition taxpayers, have to bear the additional tax load without any possibility of adjustment.

Practical Steps to Mitigate the Burden of RCM

1. Availing Section 10(2A) as Landlords for Voluntary Registration

Encouraging unregistered landlords to take voluntary registration under Section 10(2A) of the CGST Act may help alleviate some burden regarding RCM.

Salient Features of Section 10(2A)

• Applies to landlords whose aggregate turnover does not exceed ₹50 lakh in a financial year.
• The rate of tax: 6% (3% CGST + 3% SGST).
• ITC not available.
• Only intra-state supply is permitted.

Example: A landlord receiving an annual rental income of ₹12,00,000 can save a substantial amount on taxes:

• Tax under regular GST (18%): ₹12,00,000 × 18% = ₹2,16,000
• Tax under Section 10(2A) (6%): ₹12,00,000 × 6% = ₹72,000
• Savings: ₹2,16,000 - ₹72,000 = ₹1,44,000

By registering under Section 10(2A), landlords reduce their tax liability, removing the tenant's RCM obligation. However, landlords must consider compliance requirements and turnover limits under this provision.

2. Renegotiation of Rent Agreements

The restructuring of rent agreements could be one of the efficient methods to manage the Redrawing rent agreements will enable tenants to manage tax liabilities more effectively. For instance, bifurcating lease agreements into distinct parts, such as rent and maintenance charges, can significantly reduce the GST burden on the rent component.

• Example of Lease Bifurcation:
• Old agreement: ₹1,00,000 per month (all rent).
• New agreement: ₹80,000 as rent + ₹20,000 as maintenance charges.
• GST liability under RCM (on rent): ₹80,000 × 18% = ₹14,400.
• Yearly savings: ₹43,200 compared to the original liability.

Tenants can explore various modifications in lease agreements to mitigate the GST burden under RCM. Apart from splitting rent and maintenance charges, they may consider reclassifying services into separate charges, such as utilities, parking, or security, which may not attract RCM.

Additionally, introducing performance-based rent tied to business performance can lower the taxable rent component. Structuring advance rent payments or renegotiating lease terms to include components like insurance or property taxes outside the scope of rent may also reduce RCM liability.

If applied carefully, these adjustments can lower the overall taxable rent, improve cash flow, and ensure compliance with GST regulations.

3. Using the Provisions Relating to Transaction Value

The value of supply under Section 15(1) of the CGST Act is defined as the transaction value, i.e., the sum of money actually paid or payable for the good or service by the buyer to the seller when both are unrelated parties. Though this gives latitude for fixation of rent at a competitive level, undervaluation may invite the mischief of anti-evasion provisions.

Caution: Artificially reducing the rent would attract provisions under Section 122 regarding tax evasion. Businesses have to maintain arm's-length benchmarks to avoid litigation.

4. Advocacy of Policy Reforms

Industry bodies may advocate the following policy reforms:

• Exemption or reduced rates of RCM for small landlords or businesses in hospitality and other similar sectors.
• Ease of registration for landlords under Section 10(2A), thereby reducing the compliance burden.
• Showing some leniency towards the MSME sector by allowing them to avail of limited ITC on the rentals received in certain circumstances.

Benefits of Following These Approaches

1. Economical: Promotion of voluntary registration under Section 10(2A) lowers down the tax rates from 18% to 6%.
2. Reduced Compliances: Registration by landlords eliminates RCM compliances on part of the tenants.
3. Liquidity: Reduced GST liability improves liquidity, the prime need for MSMEs.
4. MSME Support: Reduced tax burden supports the sustained growth of MSMEs, which is very important for both GDP and employment.

Conclusion

There is huge discomfort for the composition taxpayer, especially those dealing in the hospitality industry, as this Reverse Charge Mechanism has been initiated on commercial property rent payable to unregistered landlords. Business houses belonging to that section mostly operate on narrow margins, and because they have no way to recover GST on rent, unlike normal taxpayers who would claim credit by Input Tax Credit, burdens come heavy upon them.

However, businesses may look for their own ways, like encouragement of voluntary registration under Section 10(2A) of the GST Act, renegotiation of the rental agreements in order to structure the consideration payments for efficiency, and use of transaction value under Section 15(1) of the CGST Act. These are some of the practical ways to mitigate the immediate financial impact of RCM.

While these remedies hold promise, let us hope that the GST Council may consider discussing this matter in future meetings and provide relief to MSMEs, helping to ease the burden on businesses and support their growth in the evolving tax landscape. A more flexible and supportive tax framework could help businesses, particularly in the MSME sector, better manage their finances, sustain growth, and contribute positively to the broader economy.

Disclaimer: The information in this article is general in nature and is not intended to be legal or financial advice. The author does not accept any liability for any loss or damage arising from the use of this information.