Taxpublishers.in - Monday Corner Answer to the Quiz for the week (21 Jul 2025)

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Quiz for the week (21 Jul 2025): Rakesh has a vacant land measuring 3000 sq.ft in a prominent location. He got a business proposal from his long-time friend Jay who wants to run a hotel. Jay has given 3 proposals to Rakesh. They are (1) lease the vacant land to Jay who may construct a building either alone or in partnership with others and pay lease rent of Rs.3 lakhs per month to Rakesh;(2) admit Rakesh also as a partner and pay 10% of daily sales as compensation or not make Rakesh a partner but pay the same amount without any monthly fixed rent; (3) advance interest-free loan to Rakesh of Rs.1 crore for putting up a construction of hotel building and adjust 5% towards recovery of loan and pay only the balance to Rakesh based on sales. Which of the proposals could be tax efficient from their perspective? Best Answer : The query given above is loaded with facts such as the land owner having a land measuring 3000 sq.ft in a prominent location and his long-term friend who wants to run a hotel by putting up a construction. The impact of each of the choices given above are discussed as under: Option 1: The vacant land would be leased and the hotel building would be put up either by his friend alone or in partnership with others. The lease rent would be Rs.3 lakhs per month. It is liable for tax deduction at source under section 194-I. Since the annual lease rent exceeds Rs.20 lakhs the land owner has to collect GST and remit the same. The hotel building constructed either alone or in partnership with others by his friend is eligible for deduction as revenue expenditure. It may be noted that Explanation 1 to section 32(1) covers only construction in leasehold building by way of renovation or extension or improvement to the building as capital expenditure which is eligible for depreciation. The GST paid to land owner is eligible for input tax credit based on whether composition scheme is opted or not, by the friend operating the hotel. Option 2: In this choice, the land owner also would become a partner with his friend and would be eligible for 10% of daily sales as compensation. Alternatively, without making the land owner as a partner, pay the same 10% of the daily sales as compensation. Whether the land owner is admitted as a partner or not, payment made to him would not be treated as rent but a sum akin to royalty and hence the consequence would follow based on the quantum of money received by him. The firm can claim the royalty paid as expenditure subject to tax deduction under section 194J. The recipient has to collect and pay GST if the royalty amount exceeds Rs.20 lakhs per annum. The sum so paid by the firm would not be liable for any disallowance under section 40(b) since it is not having the character of a compensation for the services rendered. Option 3: Obtaining interest-free loan of Rs.1 crore for putting up a construction of hotel building and adjusting 5% towards recovery of loan and paying the balance 5% by way of royalty, the recipient retains the same status as in option 2 except cash outflow of Rs.1 crore which may be more or could be less for the purpose of construction of hotel building. The payer however has to treat the gross amount @10% as royalty and deduct tax at source under section 194J. As regards GST, the recipient has to collect GST and remit the same. The payer can claim ITC on royalty paid subject to the option exercised in respect of restaurant run by it. Out of the 3 cases, the benefit seems to be in option 1 where the recipient-assessee is definite of monthly rent which is uniformly paid. As regards the payer the amount paid is eligible for deduction subject to TDS under section 194-I. The payer has to add 18% towards GST. The payer running the hotel after putting up the construction can claim the entire cost of construction as revenue expenditure which would shield the firm from income tax liability at least for a few years.

Quiz for the week (21 Jul 2025):

Rakesh has a vacant land measuring 3000 sq.ft in a prominent location. He got a business proposal from his long-time friend Jay who wants to run a hotel. Jay has given 3 proposals to Rakesh. They are (1) lease the vacant land to Jay who may construct a building either alone or in partnership with others and pay lease rent of Rs.3 lakhs per month to Rakesh;(2) admit Rakesh also as a partner and pay 10% of daily sales as compensation or not make Rakesh a partner but pay the same amount without any monthly fixed rent; (3) advance interest-free loan to Rakesh of Rs.1 crore for putting up a construction of hotel building and adjust 5% towards recovery of loan and pay only the balance to Rakesh based on sales. Which of the proposals could be tax efficient from their perspective?

Best Answer :

The query given above is loaded with facts such as the land owner having a land measuring 3000 sq.ft in a prominent location and his long-term friend who wants to run a hotel by putting up a construction. The impact of each of the choices given above are discussed as under:

Option 1: The vacant land would be leased and the hotel building would be put up either by his friend alone or in partnership with others. The lease rent would be Rs.3 lakhs per month. It is liable for tax deduction at source under section 194-I. Since the annual lease rent exceeds Rs.20 lakhs the land owner has to collect GST and remit the same. The hotel building constructed either alone or in partnership with others by his friend is eligible for deduction as revenue expenditure. It may be noted that Explanation 1 to section 32(1) covers only construction in leasehold building by way of renovation or extension or improvement to the building as capital expenditure which is eligible for depreciation. The GST paid to land owner is eligible for input tax credit based on whether composition scheme is opted or not, by the friend operating the hotel.

Option 2: In this choice, the land owner also would become a partner with his friend and would be eligible for 10% of daily sales as compensation. Alternatively, without making the land owner as a partner, pay the same 10% of the daily sales as compensation. Whether the land owner is admitted as a partner or not, payment made to him would not be treated as rent but a sum akin to royalty and hence the consequence would follow based on the quantum of money received by him. The firm can claim the royalty paid as expenditure subject to tax deduction under section 194J. The recipient has to collect and pay GST if the royalty amount exceeds Rs.20 lakhs per annum. The sum so paid by the firm would not be liable for any disallowance under section 40(b) since it is not having the character of a compensation for the services rendered.

Option 3: Obtaining interest-free loan of Rs.1 crore for putting up a construction of hotel building and adjusting 5% towards recovery of loan and paying the balance 5% by way of royalty, the recipient retains the same status as in option 2 except cash outflow of Rs.1 crore which may be more or could be less for the purpose of construction of hotel building. The payer however has to treat the gross amount @10% as royalty and deduct tax at source under section 194J. As regards GST, the recipient has to collect GST and remit the same. The payer can claim ITC on royalty paid subject to the option exercised in respect of restaurant run by it.

Out of the 3 cases, the benefit seems to be in option 1 where the recipient-assessee is definite of monthly rent which is uniformly paid. As regards the payer the amount paid is eligible for deduction subject to TDS under section 194-I. The payer has to add 18% towards GST. The payer running the hotel after putting up the construction can claim the entire cost of construction as revenue expenditure which would shield the firm from income tax liability at least for a few years.