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Tax Department detects HRA Fraud with illegal usage of PANs!

Introduction

As 31st March have approached many clients along with my fellow colleagues are asking me for HRA deduction and its eligibility, most of the client’s fail to follow the guidelines in the act and end up paying heavy fines and penalties due-to fake HRA’s, in this article we will discuss everything about HRA including it’s meaning, conditions, case laws and mistakes which is done by assessee.

Meaning of HRA

House Rent Allowance also known as HRA is an allowance provided by employers to employees to offset the expenses of renting accommodation. While HRA forms a part of the salary, it enjoys partial tax exemption under Section 10 (13A) of the Income Tax Act of 1961, subject to certain conditions.

Basic conditions for availing HRA

1. The employee should be a salaried individual and must receive HRA

2. Employee must actually be paying rent for a residential accommodation he/she occupies

3. Employee must not own residential accommodation for which HRA is being claimed.

The exemption on HRA is calculated as minimum of the following three amounts

1. Actual HRA received from employer

2. Rent paid minus 10% of basic salary

3. 50% of basic salary if employee lives in a metro city or 40% of basic salary if the employee lives in a non-metro city. 

Metro cities in India and issues with them

Delhi, Mumbai, Chennai, and Kolkata, are the metro cities as per the Income tax act, Anticipation surrounds the possibility of expanding the definition to include burgeoning urban hubs like Bengaluru, Pune, Hyderabad, and Ahmedabad, according to reports. The driving force behind this expansion is to offer inhabitants of these cities an increased HRA deduction, possibly stimulating migration and fostering urban development.

Tax Department detects HRA Fraud with illegal usage of PANs!

As per the analysis, the rental trends across major Indian cities, revealing a notable divergence. Mumbai leads with the highest average rent of Rs 30,000-50,000 per month for a 1,000 sq ft apartment, followed closely by Delhi at Rs 20,000-30,000. Other cities like Bengaluru, Pune, Hyderabad, and Kolkata fall within the range of Rs 17,000-25,000 per month, while Ahmedabad and Chennai stand out as the most affordable, ranging from Rs 17,000-19,000.

The article questions the fairness of uniform HRA deductions across all cities, suggesting that differentiation based on actual average rentals would be more justifiable. It proposes a scenario where an individual earning Rs 10 lakh per annum is eligible for a tax deduction of Rs 5 lakh per annum or Rs 41,667 per month. However, in Mumbai, this deduction might only secure a 1,000 sq ft apartment, while in Chennai, it could afford double the space. This unintentionally favors residents in cities with lower average rentals.

The recommendation is to include Bengaluru, Pune, Hyderabad, and Ahmedabad as metros for HRA calculation, as their rental landscapes resemble those of current metro cities. However, a more nuanced approach is deemed necessary for HRA deduction, especially considering the varied property rental rates across cities, with Mumbai and Delhi being notable hotspots.

What are the provisions of TDS and PAN card?

It is mandatory to furnish the PAN card details of the individual to whom rent is being paid if the annual rent exceeds Rs. 1 lakh. This can be done by submitting Form 12BB to the employer.

Alternatively, if PAN details are not available, a declaration from the landlord stating the same, along with their name and address, must be provided to the employer. Regarding Tax Deducted at Source, for rent paid for land, building, furniture, fittings, or a combination thereof, TDS is applicable at 10% of the total amount exceeding Rs. 2.4 lakh annually. This is under section 194I for businesses or professions exceeding a turnover or gross receipts of Rs. 1 crore or Rs. 50 lakh, respectively, necessitating tax audits. But for others i.e. individuals or Hindu Undivided Families (HUFs) not liable to undergo a tax audit, TDS is applicable at 5% on rent paid if it exceeds Rs. 50,000 per month. This falls under section 194M.

Now you might be wondering about the reasons for notices are being received by salaried employees with respect to HRA

Recently Income Tax Department has sent more than 10,000 Notices to salaried employees with respect of fake or non-compliant HRA.

What are the mistakes that are committed by salaried employees while claiming HRA as a Tax deduction?

The first one is they are not making any rent agreement with the party, this case is especially while paying rent to family members for claiming deduction in taxes, also in case of relatives or friends who are earning less income. Remember in case it happens to be a scrutiny for your HRA deduction it may be disallowed if there is no rent agreement and you need to pay back taxes on the disallowed income along with interest and penalty.

Secondly, many professionals and tax preparers rely just on rent receipt as evidence for claiming HRA, in this case, tax officer or AO might not get satisfied and may demand more evidence by the taxpayer and in the absence of that evidence may disallow the income.

Third is some employees are just concerned of bogus entries and do not pay rent in the bank account of the landlord, especially while claiming rent paid to family members assuming to show rent paid in cash.

Case laws concerned

In the case of Mrs. Meena Vaswani vs. ACIT [2017] 164 ITD 120 (Mum Trib.), the assessee paid rent to her mother without providing any supporting evidence such as a leave and license agreement or payment through bank transactions. The submission of mere affidavits and rent receipts from the mother was deemed insufficient. Additionally, upon inspection by the Department, the claim made by the assessee was disproved. Consequently, the Income Tax Appellate Tribunal (ITAT) disallowed the HRA exemption to the assessee.

My points: As I have explained this point above, that AO might not get satisfied and may demand more evidence in case one solely has rent receipts.

In the case of Abhay Kumar Mittal vs. DCIT [2022] 194 ITD 224 (Del Trib.), a salaried individual had paid rent to his wife for a house registered in her name, and the wife had her own sources to acquire the property. The rent income was declared as ‘income from House Property’ in the wife’s income tax return. The Income Tax Appellate Tribunal (ITAT) ruled that the Revenue’s argument against the husband paying rent to his wife “lacks legal merit.” The ITAT affirmed that it is legally permissible for a husband to pay rent to his wife.

In the case of Bajrang Prasad Ramdharani vs. CIT [2013] 60SOT 66 (Ahd Trib.), the assessee paid rent to his wife for a house jointly owned by them, and they resided together in the same house. The rent was paid through bank transfers, and rent receipts were submitted as evidence. The Income Tax Appellate Tribunal (ITAT) concluded that the assessee fulfilled the conditions of the provision, namely, occupying the house and paying rent. Therefore, the assessee was deemed eligible to claim exemption under section 10(13A).

From the above case laws it is very clear that only the following two conditions need to be satisfied first employee must actually be paying rent for a residential accommodation and must not own the residential accommodation for which HRA is being claimed.

Now what is the case?

The cases first came to light when authorities found alleged rent receipts of around Rs 1 crore by an individual. Further probe revealed that the individual indeed did not receive the rent that was shown against his name.

The case prompted the income tax department to further investigate the matter and it turned out that there was rampant misuse of PANs by unscrupulous individuals to claim tax deductions from their employers. So much so that officials have now come across cases where employees of certain companies have used the same PAN to claim tax deductions.

Tax officials have announced a crackdown on employees who have made fraudulent claims, with the aim of recovering owed taxes. It remains uncertain whether legal action will be pursued against these individuals. This situation underscores another occurrence of PAN misuse, often without the cardholder’s knowledge. Complicating matters further is the current application of TDS only for monthly rents exceeding Rs. 50,000 or annual payments surpassing Rs. 6 lakh. Consequently, many employees have exploited this loophole to evade taxes on rental income.

Are employers liable for this?

Tax officials have emphasized that the responsibility rests solely on the employee, absolving the employer of any liability, even in cases where multiple individuals cite the same PAN for rent payments. While employers are not required to conduct extensive investigations, they are expected to implement reasonable checks and balances when verifying proof of rent paid for HRA exemption. Some employers have established policies wherein employees found to have submitted false claims for HRA or LTA shall face termination from employment.

In conclusion, the recent revelation of HRA fraud involving illegal usage of PANs highlights a concerning trend of tax evasion among certain individuals. The Income Tax Department’s crackdown on fraudulent claims underscores the seriousness of the issue and the need for stringent enforcement measures. While the responsibility primarily falls on the employees making the false claims, there are calls for employers to exercise greater diligence in verifying proof of rent paid for HRA exemption. However, it’s important to note that employers themselves are not inherently liable for such fraudulent activities. Moving forward, it’s crucial for both individuals and employers to adhere to tax regulations and uphold integrity in tax-related matters to maintain the integrity of the system.

My advice: File your ITR by taking genuine deductions and exemptions to avoid any legal issues.

Author Bio

CA Aman Rajput, Practicing Chartered Accountant Contact me at 8209604735 Email ID aman.rajput @ mail.ca.in Area of practice:- Income tax, Audit, Company/LLP Incorporation or closure, Business consultancy, cost management, Financing, Startups, MSME, Finance, Virtual CFO and GST Introduct View Full Profile

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