Summary: Upfront lease premiums, common in Build-Operate-Transfer (BOT) lease agreements, involve a single, discounted payment made by the lessee at the lease’s inception, covering all future rental obligations. From the lessor’s perspective, the entire non-refundable upfront premium is generally taxable in the first year of the lease term, as the performance obligation is considered satisfied upon lease deed registration, with no provision in the Income-tax Act, 1961, for spreading the income. This has been supported by tribunal rulings. Regarding withholding tax, the lessee is not required to deduct TDS under Section 194-I on lump-sum lease premiums not adjustable against periodic rent, as clarified by CBDT Circular No. 35/2016. For the lessee’s tax deduction, while the Income Tax Act doesn’t provide explicit guidance, the Income Tax Appellate Tribunal (ITAT) Kolkata, in the Britannia Industries case, has held that upfront lease premiums are revenue expenditure, not capital, and should be amortized over the lease term rather than deducted entirely in the year of payment.
Understanding the Tax Treatment of Upfront Lease Premiums: When is it taxed? Withholding ? Deduct in One Go or Amortize?
Broadly, lease payments can be structured in two ways, from a consideration front:
1.Annual/Monthly Lease Rentals
2. Upfront Lease Premium/One Time lease Premium
In this article, we are delving into the Income tax implications in case of an upfront lease premium in a Build-Operate-Transfer(BOT) based Lease
How does upfront lease premium consideration mode work?
1.Total Lease Payments Determination:
The aggregate lease payments due over the entire lease term are first calculated, taking into account all future rental obligations and associated costs.
2. Inception Payment Instead of Periodic Rentals:
Unlike traditional lease structures where rentals are paid periodically, this model requires the lessee to make a single consolidated payment at the beginning of the lease term.
3. Application of Present Value Concept:
Because all future payments are settled upfront, the present value concept is applied. The total of the periodic lease rentals is discounted to reflect their current worth.
4. Discounting Future Cash Flows:
An appropriate discount rate—often based on the lessee’s incremental borrowing rate or a market-equivalent rate—is used to discount the total lease payments expected over the lease period to today’s value.
5. Upfront Payment to Lessor:
The lessee pays the discounted present value of all future lease rentals to the lessor at the inception date. This upfront payment fully settles the lease obligations pertaining to periodic rentals for the entire term.
From an Income tax perspective, broadly we have three questions to answer:
1. What is the tax treatment in the hands of the lessor on receipt of the upfront lease premium
2. Withholding tax implications & obligations of the lessee
3. Tax deduction in the hands of the lessee
Tax Treatment in the hands of the lessor:
1.At the outset, under a BOT agreement, the lessor is generally not required to do or perform any act or obligation under the concession agreement apart from leasing out the property. This effectively means that the performance obligation is satisfied at a point in time (on execution on of the lease deed)
2. The upfront premium amount is generally non-refundable, even if the concession agreement is terminated prematurely.
3. There is no provision in the Income-tax Act, 1961 that permits spreading over of the income to future periods. The lessor would not record non refundable lease premium as an advance, rather it is recognized as the receipt as income.
4. Consequently, there is an incidence of accrual of income as soon the lease deed is registered given that there is no corresponding liability/obligation to be performed under the lease deed
5. Therefore, the entire amount of upfront lease premium would be chargeable to tax in the hands of the lessor in the first year of the lease term
6. The characterization of income in the hands of the lessor (Business Income/House Property/Other Sources) is a separate discussion altogether basis the facts of the case
7. The above ratio has been upheld by Bangalore tribunal in the case of M/s. New Mangalore Port Trust vs ACIT ([TS-674-ITAT-2015)
Withholding tax implications & obligations of the lessee:
1.As per CBDT Circular No 35/2016 dated 13th October 2016, it is clarified that lump sum lease premium or one-time upfront lease charges, which are not adjustable against periodic rent, paid or payable for acquisition of long-term leasehold rights over land or any other property are not payments in the nature of rent within the meaning of section 194-I of the Act. Therefore, such payments are not liable for TDS under section 194-I of the Act.
2. Consequently, the lessee is not under any obligation to withhold taxes while paying the upfront lease premium as stated above.
Tax deduction in the hands of the lessee
1.The question as to the timing of deduction of lease rentals in the hands of the lessee addresses a notably complex and contentious area due to the fact that this issue is not explicitly covered under the provisions of the Income Tax Act, 1961. This lack of explicit guidance leads to differing interpretations and legal debates.
2. A question arises as to whether the upfront lease premium is a capital expenditure or a revenue expenditure. The Income Tax Appellate Tribunal (ITAT) Kolkata, in ACIT vs Britannia Industries (ITA No. 2644/Kol/2018), has held that the upfront lease premium paid for leasehold land is effectively an advance payment of rent and not a capital expenditure. Therefore, it should be deductible under section 37(1) of the Income Tax Act as a business expense rather than being capitalized
3. The next question arises as to whether the lessee is entitled to deduct the entire upfront lease premium as a business expense in the year of payment, or if it must be amortized over the duration of the lease term. As per the principle laid out in Britannia Industries ruling, the upfront lease premium has to be amortized over the lease term.
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Disclaimer: This article is for general informational purposes only and does not constitute professional tax advice. Readers should consult a qualified tax professional before making any decisions. The author and TaxGuru are not responsible for any actions taken based on this content.
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