On October 8, 2024, the Central Board of Indirect Taxes and Customs (CBIC) issued Notification No. 09/2024-Central Tax (Rate), effective from October 10, 2024, which significantly broadens the scope of the Reverse Charge Mechanism (RCM) under the Goods and Services Tax (GST) regime. This notification now requires GST-registered taxpayers to pay GST under RCM when renting commercial properties from unregistered persons.
This change has considerable implications for family-owned commercial properties, often used informally without formal agreements or rent being paid. Even if a property is used with the support of a No Objection Certificate (NOC), the GST liability can still apply. This article explores the notification's impact, associated compliance challenges, and strategies to minimise the cash flow and working capital implications of this new requirement.
Direct and indirect impacts
Direct Impacts
- Expansion of RCM Scope: GST-registered taxpayers renting commercial properties from unregistered persons now face GST liability under RCM, even if no formal rent agreements are in place.
- Increased Compliance: Taxpayers will now need to carefully assess informal arrangements within family-owned businesses and ensure GST compliance. Accurate documentation and timely disclosure of transactions in GST returns are essential.
Indirect Impacts
- Valuation Issues: Without formal agreements, determining the notional rent for GST purposes can lead to challenges, and the open market value (OMV) method will need to be applied to ensure the correct GST amount is paid.
- Cash Flow Pressure: RCM payments are to be made from the cash ledger, and input tax credit (ITC) cannot be utilised for this purpose. For businesses with limited working capital, this can create significant liquidity challenges.
The Definition of Family and Its Role in GST
Understanding the concept of family is critical for determining related-party transactions under Schedule I of the GST Act. According to Section 2(49) of the CGST Act, 2017:
"Family" means the spouse and children of the person, and the parents, grandparents, brothers, and sisters of the person if they are wholly or mainly dependent on the said person.
This definition plays a pivotal role in the context of family-owned properties, as it helps identify whether a transaction qualifies as a related-party transaction, which may attract GST under Schedule I-even if no formal consideration is involved, as long as the transaction is in the course or furtherance of business.
Key Provisions Governing RCM and Family-Owned Properties
Supply in the Course of Business
Under Section 7(1)(a) of the CGST Act, 2017, a transaction qualifies as a supply if it involves the sale, lease, or transfer of goods or services for consideration, made in the course or furtherance of business.
For related-party transactions, Schedule I mandates the payment of GST even when no consideration is exchanged, provided the transaction is in the course or furtherance of business. Importantly, business intent is assessed from the supplier's perspective.
Business Intent
Section 2(17) defines business as:
"Any trade, commerce, manufacture, profession, vocation, adventure, or any similar activity, whether or not it is for consideration and whether or not it is carried on regularly or with the intention of making a profit."
In the context of family-owned properties, the business intent of the property owner (the supplier) becomes key. For example, if a father registers his property as a commercial property with the local authorities, it reflects his commercial intent. Even if he isn't formally in business, this registration triggers GST liability under RCM if the property is rented for business use.
Example: Impact on Family-Owned Commercial Properties
Let's consider a situation where a father, an unregistered person for GST, owns a commercial property registered as such with local authorities. He allows his son, a GST-registered taxpayer, to use the property for business purposes without charging rent. Although the father is not engaged in business activities, the fact that the property is registered as commercial suggests a commercial intent.
In such cases, the son would be required to pay GST under RCM on notional rent, which must be determined based on the open market value (OMV) or as per the valuation rules outlined in Section 15 of the CGST Act.
Strategies to Manage RCM Liability and Cash Flow
To manage the impact of RCM on cash flow and working capital, taxpayers can consider the following strategies:
Draft Rent Agreements with Nominal Rent
One effective way to reduce the GST liability is by formalising the arrangement through a rent agreement with a nominal rent amount. As per Rule 28 of the CGST Rules, if the recipient (e.g., the son) is eligible to claim full input tax credit (ITC), the declared value in the invoice (nominal rent) will be accepted as the taxable value, even if it is below the OMV.
Example:
- Let's assume the OMV for renting similar commercial properties is ₹50,000 per month.
- The father and son agree on a nominal rent of ₹5,000 per month.
In this case:
- GST under RCM on OMV:₹50,000 × 18% = ₹9,000 per month.
- GST under RCM on declared rent:₹5,000 × 18% = ₹900 per month.
By using a nominal rent agreement, the GST liability reduces from ₹9,000 to ₹900 per month, significantly reducing the cash outflow.
Planning for Cash Flow and Liquidity
Since GST under RCM must be paid from the cash ledger, it's crucial to maintain adequate cash reserves. Businesses should forecast their RCM payments based on the rent amounts (formal or notional) to ensure liquidity is managed effectively. Taxpayers should:
- Keep sufficient funds in the cash ledger for RCM payments.
- Plan RCM payments ahead of time to avoid liquidity strain.
Comprehensive Documentation
Proper documentation is essential to substantiate the valuation of the property and the taxability of the rent. Businesses should retain:
- Formal rent agreements (even if nominal).
- Property registration documents that show the commercial status of the property.
- NOCs or other supporting evidence for the family arrangement.
Seek advance rulings for complex scenarios
In cases where the situation is complex or unclear (such as informal family arrangements), seeking an advance ruling under Sections 95 and 97 of the CGST Act is advisable. An advance ruling can clarify the GST liability and provide clarity in such cases.
Periodic Valuation Checks
Regularly assessing the market value of the property ensures compliance with valuation rules under Section 15. This helps businesses align their GST filings to avoid underpayment or overpayment of taxes.
Compliance Obligations for GST-Registered Recipients
For the recipient of the property (e.g., the son), the following obligations apply:
- Report GST paid under RCM in GSTR-3B, Table 3.1(d).
- Claim Input Tax Credit (ITC) in Table 4A(3) of GSTR-3B, provided the property is used exclusively for taxable business purposes.
- Retain documentation to substantiate the declared rent or valuation.
Potential Risks of Non-Compliance
Failure to comply with the provisions of RCM can lead to serious risks, including penalties and audit scrutiny. If no rent agreement exists, the tax authorities may use the market value of the property to determine the rent, which could result in an unexpected GST liability.
Given the complexities involved in valuing family-owned commercial properties, it is highly recommended to seek professional advice or advance rulings in such cases. Regular audits of property valuations and rent agreements can help mitigate risks and ensure compliance.
Conclusion
The Notification No. 09/2024 significantly impacts family-owned commercial properties, requiring careful evaluation of informal arrangements and ensuring compliance with RCM provisions. By implementing strategies such as formalising nominal rent agreements, maintaining proper documentation, seeking advance rulings, and conducting regular property valuation checks, businesses can manage their cash flow and minimise the financial burden of RCM.
A proactive approach will ensure smooth compliance, avoid penalties, and optimise tax planning for family-owned properties.
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