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While the Income Tax laws do not restrict a tax payer, from paying rent to one’s relatives and claiming tax benefits, there are certain precautions that one should take, to ensure that the claim does not become a subject matter of litigation
The income tax laws provide certain benefits, with respect of to the rent paid by you for a residential accommodation occupied by you, in case you are a salaried person. You can claim House Rent Allowance (HRA) tax benefit under Section 10 (13A), only if you are in receipt of HRA from your employer and you are actually paying rent for the residential accommodation which is not owned by you. The law does not put any restrictions on you paying such rent to your relatives and claiming this tax benefit. However, the transaction of paying rent should be genuine and not a sham one. So, in case you are paying rent to your close relative/s and are claiming the tax benefits under Section 10 (13A), you should take certain precautions, to ensure that the claim does not become a subject matter of litigation.
Since you are availing the tax benefits for paying rent, you should enter into a leave and licence agreement with the person who owns the property. The agreement should ideally be registered. Moreover, you should also obtain the rent receipt regularly from the landlord for the rent paid, for future reference, in case the same are required by the assessing officer at the time of assessment.
Though there is no restriction on paying the rent by cash. However, to lend credibility to the transaction, you should pay the rent through proper banking channels, regularly. Even if you pay the rent by cash, you need to have corresponding adequate cash withdrawals from your bank account or you should be able to establish generation of sufficient cash, to the satisfaction of the assessing officer.
Although you can claim the tax benefits for the rent paid, the rent which that you pay to close your relative is his/her income and thus, taxable in his/her hand. So, it is in your own interest, to ensure that the rent is included in the taxable income of the recipient. Chances of the rent not being included in the income is very high, if the same is paid by you in cash and therefore, does not reflect in their bank accounts. If the total income (including the rent) of the relative, to whom you are paying the rent, does not exceed the taxable limit, then, he/she is not required to file his/her income tax return. Nevertheless, it is in your interest to ensure that it is done, to put the record straight. Please note that even if your income does not exceed the taxable limit, you can still file the same. Please obtain an acknowledgement of the return having been filed.
The Income Tax Act does not put any restriction on you claiming tax benefits with respect to home loan and HRA, simultaneously. However, the house for which you are claiming the home loan benefits and the one for which you are claiming HRA, should not be in the same vicinity, as it is unlikely that one would pay rent, while already owning a house in the same locality. However, if you are paying rent for a place which is near to your employment and availing the home loan benefit for a place from where it is difficult to commute every day, you can claim both the benefits, provided the circumstances warrant it.
If you have made an arrangement of paying rent on paper, without actually staying at that place, the tax authorities may be able to prove that the transaction is not genuine. One way, is if the address actually used by you for various communications and the one for which you are paying rent, are different. This would include the address given by you for your bank accounts, share depository account, mutual fund investment, ration card, voter ID, income tax return records and even the address given to your employer. So, in case you are genuinely paying rent, but the address for various purposes is not the same, please ensure that you change the address immediately, to avoid possible litigation.
The budget for 2017 has inserted a requirement in the Income Tax Act, for persons who pay rent of over Rs 50,000 per month for a part of the month. In such cases, you should deduct tax at the rate of 5 per cent on such rent and deposit the same to the credit of the central government.