Have you ever obtained quick cash by drawing on your credit card through rent apps? This trend is escalating and appears to be a convenient alternative, though it is significantly more risky than conventional financial maneuvers. It can invite serious scrutiny from Tax authorities and banking regulators, landing you unexpectedly in tax bills, penalties, and litigation. Learn why this practice is labelled “colorable device” and what else you need to know for your safety.
How the Rent Loop Works
This method creates the impression of a rent payment to convert your credit card limit into cash. Here is how it usually plays out:
- Credit Card Payment to a Rent App: The taxpayer uses the credit card to initiate the so-called “rent payment” through an app. These apps charge a small convenience fee that is often between 1% and 2%.
- Funds to a Related Person or Nominal Landlord: The app now transfers the “rent” amount to the bank account of the selected recipient. More often than not, this recipient turns out to be a family member (spouse/parent/sibling) or someone who pretends to be the landlord, but without actually owning that property or with a real rental agreement.
- Money Back to the Payer: The crucial step: the “landlord” returns the funds, either in whole or in part, to the original taxpayer. Thus completes the circle, wherein the taxpayer has effectively received cash from a credit card limit avoiding high cash advance charges.
This transaction is viewed by tax authorities as a “colorable device” — a transaction that appears genuine on the surface but lacks any real economic substance. The law examines the substance of any transaction rather than its mere form, as established by the Supreme Court in McDowell & Co. Ltd. v. CTO [1985 AIR 1057].
Income Tax Risks: Unexplained Funds & Disallowed Expenses
The circular transactions have grave income tax implications:
- Unexplained Cash Credits (Section 68)– If the money credited to your account cannot be adequately explained — including the source, identity, or creditworthiness of the sender — it may be treated as your income. This unexplained income shall attract a very high tax, presently at 60%, along with applicable surcharge and cess, leading to a substantial overall tax liability, besides prescribed additional penalties.
Case Law Snapshot: Section 68 and Circular Funds
In ITO vs. Daya Chand Goyal & Sons [ITAT Delhi, ITA No. 2225/Del/2012], the tribunal held:
Section 68 applies to circular funds: that these have passed through associated persons or through intricate layers without any substantive explanation as to creditworthiness or any of the other parameters to deem the underlying transactions genuine. Merely routing through banks does not substantiate the credit unless a genuine arm’s length transaction with proper documentation exists. The tribunal emphasized the doctrine of substance over form, which courts frequently rely upon in such matters.
- Unexplained Investments (Section 69):If you use these unexplainable funds to buy assets or make investments that aren’t properly recorded, they can be treated as “unexplained investments” and taxed at high rates with penalties.
- “Gifts” and Deemed Income (56(2)(x)):Tax authorities may treat amounts given to a family member as “rent,” which are subsequently returned without genuine consideration, as sham transactions. Genuine gifts from specified relatives are exempt, but if the gift becomes a pattern, it can be questioned. If the “landlord” is not a specified relative and the amount exceeds ₹50,000, it could be taxed as “income from other sources” in the hands of the recipient.
- Disallowed Business Expenses (Section 37):Such “rent” payments are likely to be disallowed if claimed as business expenses (e.g., for office use). An expense needs to be for business purposes genuinely. If there is no real rental agreement, no actual business rent usage, or the cash comes back to you, then that is not a genuine business expense. This results in increased taxable income and penalties.
- TDS Non-Compliance (Section 194-IB)-For every such monthly rent payment exceeding ₹50,000, TDS is to be deducted by individuals or HUFs. The TDS rate is 5%, which was reduced to 2% effective October 1, 2024. Therefore, for rent paid on or after October 1, 2024, the applicable TDS rate is 2%. Even when rent payments are made through rent apps, the tenant remains responsible for deducting and depositing TDS. Penalties can come into play along with the disallowance of the expense for this purpose.
- Risks of AIS/26AS Mismatch: All transactions of high value will be notified to the tax department. Likely, your rent app payments would be reflected in your AIS and Form 26AS. If these payments, being reported, do not tally with an authentic rental arrangement, that should invite red flags and warrants probably notices and inquiry for tax purposes.
How Rent App Loops Can Jeopardize Presumptive Tax Benefits
Small businesses and professionals adopting simplified presumptive taxation schemes (Sections 44AD, 44ADA, 44AE) face the greatest danger. These schemes allow the taxpayer to declare income as a fixed percentage of total receipts avoiding the hassle of detailed accounting.
The Problem: Large amounts of cash get injected into your bank account from circular rents without any explanation. The Income-tax department, on several occasions, has taken your “turnover” for presumptive schemes based on the pattern of your bank deposits. If these artificial “rent payments” are considered business income, they could trigger:
- Inflated Tax Bill: Theoretically your “presumed income” will be artificially higher, leading to a much larger tax liability than is justified by actual profits.
- Loss of Scheme Eligibility: This increased ”turnover” may push you beyond the eligibility criteria for getting covered under the simplified scheme (e.g., ₹3 crore for 44AD and ₹75 lakh for 44ADA, applicable only if 95% or more of the gross receipts are received through digital modes; otherwise, the limits are ₹2 crore and ₹50 lakh respectively). This would entail maintaining full books of accounts and lead you to a compulsory tax audit, substantially increasing your compliance burden.
- Notices and Scrutiny: The tax department may raise doubts based on discrepancies between your declared income and bank credits and issue notices for further scrutiny.
For example, suppose a freelance graphic designer covered under Section 44ADA earns a real income of ₹10 lakh and declares 50% as profit (₹5 lakh). However, due to repeated circular rent app transactions, his bank statements show credits totalling ₹40 lakh. The tax department may wrongly treat this ₹40 lakh as turnover and increase the presumed profit to ₹20 lakh. To their misfortune, worse still, they would argue about inclusions as ”turnover”, which surpasses the ₹75 lakh limit for 44ADA, deeming him unqualified and demanding full tax audit and reassessment.
Preventive Measures for Presumptive Filers:
- Clarify Non-Turnover Credits: In case large credits appear in your bank account that are truly not your business turnover (e.g. personal loan, gifts; or even circular funds), make sure they are argued well in your tax working papers. Consider attaching a brief note explaining such credits in the “Other Information” section of your Income Tax Return.
- Keep Basic Documentation: Even though detailed books are not mandatory, maintain basic documentation for significant non-business transactions that could substantiate their nature if questioned by the department.
- Segregate Accounts: Maintaining separate bank accounts for business and personal use is essential to avoid misinterpretation of transactions. This is the easiest and most effective way to avoid misinterpretation of credits in bank accounts.
GST Implications: Unwanted Registration & Penalties
The risks also come in with GST, where high bank activity can lead to unwanted GST registration and issues with Input Tax Credit (ITC).
- Unexpected GST registration: A business will generally have to register for GST when its annual turnover crosses ₹40 lakh in case of goods and ₹20 lakh in case of services (lower limits apply in some states). Due to the high volume of bank credits from circular rent payments, GST authorities may treat such credits as suspicious, even if they do not represent genuine business turnover. Their data systems could take a large inflow as part of your “aggregate turnover.”
The Bengaluru UPI Case Parallel: A nearby recent incident in Bengaluru vividly illustrates this risk. Small traders, students, and even housewives received GST notices because the total UPI credits in their personal accounts exceeded the GST registration threshold. While many of these were personal transfers, the sheer volume triggered automated notices, asking for explanations and, in many cases, GST registration.
If the tax department considers these credits as taxable “aggregate turnover,” it could lead to compulsory GST registration with retrospective effect, resulting in penalties for past non-registration and demands for GST on deemed income.
- No GST Invoice from Rent Apps: Rent payment apps are merely payment facilitators; they do not issue a GST invoice for the rent itself. The actual landlord is supposed to issue this. Without a real rental contract and a proper GST invoice from a registered landlord, the entire transaction lacks any proper GST documentation.
- Risks to the Input Tax Credit (ITC):Claiming ITC on such “rent” payments (even if the landlord is GST-registered and issues an invoice) would be highly risky. ITC may only be claimed when services are actually rendered to you. Any ITC claimed under this kind of circular or fake transaction would stand to be rejected, with a subsequent demand for its recovery, along with interest and penalties.
Banking Regulations & PMLA Risks: Beyond Tax
This raises serious concerns for banks and financial regulators, potentially attracting scrutiny from the Reserve Bank of India (RBI) and financial intelligence units.
- Misuse of Card Limits:The credit card is basically launched with full registration for payment. Converting credit limits into cash while avoiding high cash advance fees violates credit card agreements. This can lead your bank to:
- Suspend or permanently cancel your credit card.
- Blacklist you, hurting your credit score and future access to loans.
- RBI Master Directions on Credit Cards: The Reserve Bank of India (RBI) is quite comprehensive when issuing the Master Directions on Credit Card and Debit Card – Issuance and Conduct. Although “routing cash through rent apps” is not explicitly prohibited by these directions, the overall conduct of credit card operations is regulated. Emphasized provisions relate to prudent lending, transparency of charges, and responsible usage. A misrepresentation of the true nature of a transaction (e.g. misrepresenting a cash advance as rent) may be construed as a contravention of the intent of these directions and could attract scrutiny from either the card issuer or the RBI. Credit card operations must therefore be conducted in a “sound, prudent and customer friendly manner.” Self-funding diversion may be construed to deviate from these principles.
- KYC and AML Alerts: Financial institutions must comply with stringent KYC and AML regulations under the Prevention of Money Laundering Act (PMLA), 2002.
- AML Red Flags High-value, repetitive, and circular transactions, especially among related parties, are classic indicators of suspicious activity.
- Suspicious Transaction Reports: Banks are mandated to monitor expense transactions, and in instances where the transaction exhibits a lack of clear commercial rationale or unnecessary complexity, the banks are obliged to submit an STR to the Financial Intelligence Unit – India (FIU-IND).
- Investigation Risks: An STR may trigger investigations by enforcement agencies such as the Enforcement Directorate (ED), regardless of the taxpayer’s intent.
These obscure patterns of fund layering mimic money laundering techniques. You risk placing yourself in serious legal risks which include possible temporary attachment of your property as proceeds of crime and could lead to criminal liabilities under the PMLA resulting to rigorous imprisonment of three to ten years.
Real Audit Triggers and Red Flags
The professionals dealing with tax and GST are becoming more technologically advanced in their data analysis. The following red flags usually attract attention during audits:
- No Registered Rent Agreement: This is a big red flag in the case of a huge rent amount.
- Payment to Non-Property Owner: When rent is paid to somebody who does not have legal ownership of the property.
- Sudden Increase in Rent Amounts: Sudden unexplained increase of purported rent payments, especially with the time that you badly need cash.
- Circular Flow of Funds: Amounts of money that go directly or indirectly from the “landlord” back to the original taxpayer, usually rather quickly.
- Address Mismatch: Discrepancies between your “rented” property addresses and your real home/residential address.
- No Real Use of Property: Failure to prove actual occupancy or business use of the “rented” premises.
- No TDS Deduction (Section 194-IB):Failure of TDS deduction and deposit for payment of rent above the threshold.
- High “Rent” vs. Low Income: Particularly for simplified tax filers, much higher “rents” compared with actual low declared income.
Conclusion: When Is Such Something Defensible?
Using credit cards as working capital via rent payment apps involving related parties or circular fund movements is almost always an advance colourable device designed to circumvent regulations. It subjects taxpayers and associated persons to a plethora of serious legal, compliance, and financial risks, such as:
- Income tax additions and penalties.
- Unanticipated GST liabilities and notices.
- Loss of benefits under simplified tax schemes.
- Investigations under the money laundering law that could potentially result in asset confiscation and prosecution.
A transaction by way of rent apps can be considered valid only if the following conditions are satisfied:
- Genuine Rental Agreement: Wherever possible, there is a signed and registered rental agreement between the parties, who are real and unrelated.
- Real Property Use: There is genuine occupation and use of the property for what it states (yet residential, office, or warehouse).
- No Circular Funds: There is absolutely no circular movement of funds. The rent paid is actual payment for the use of the property and stays with the landlord.
- No Tax Avoidance Intent: The intention should not just be to avoid taxes or regulations.
Circular transactions through rent payment apps are easily detectable in today’s tax environment, where data and transactions are closely tracked. Transparency, genuine transactions, and complete record-keeping are now essential foundations of sound financial practice.
Key Takeaways:
- Circular rent app payments are red flags for tax authorities, easily leading to severe tax additions and penalties.
- Taxpayers under presumptive tax schemes such as 44AD/ADA/AE risk losing their benefits and being mandatorily audited.
- Such dealings have the unintended consequence of triggering GST registration liability scrutiny, putting even personal bank accounts under the watchful eye of tax authorities.
- Rent app payments to get cash from credit cards violate banking terms and can lead to the rent app being blacklisted and even trigger PMLA investigation.
- Rent payments must be backed by genuine rental agreements with actual use of property and no circular money flow to maintain legitimacy.
Need help reviewing your transactions or clearing tax red flags? Consult a qualified tax consultant before filing your return.
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Disclaimer: The article is for informational purposes only and is not to be construed as legal or tax advice. The reader is advised to consult qualified professionals before making any financial decisions.
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very good information thank you sir