A Chartered Accountant’s Practical Guide (FY 2025-26 edition)
Why this matters: Almost every lease—whether for a modest home or a marquee office floor—starts with an “advance” or “deposit”. The tax, GST and accounting outcome can swing sharply depending on how that money is structured. A little planning up-front saves hassles at the back-end.
1. Snapshot of the Three Common Structures
| # | Structure | What the agreement usually says | Refundability | When it actually turns into “rent” | Typical local market names |
|---|---|---|---|---|---|
| 1 | Adjustable Security Deposit (refundable) | “X months’ deposit, to be set-off against the last X months’ rent.” | Yes (only the balance, after adjustment, if any) | In the final months, as and when it is knocked-off | Security, caution deposit |
| 2 | Pure Security Deposit (refundable, non-adjustable) | “Refundable deposit to be returned intact at vacating, subject to damages.” | Yes, in full | Only if forfeited for damage / default | SD, interest-free deposit |
| 3 | Up-front Advance Rent (non-refundable) | “Advance of ₹ ___ covers first/entire lease term; non-refundable.” | No | Immediately (or spread over lease term, based on substance) | Pagadi, premium, lumpsum lease consideration |
(If your city uses a fourth flavour—deposit earns interest paid back to tenant—treat the periodic interest exactly like rent for TDS/GST; principal follows the rules below.)
2. Legal Foundations
| Law / Authority | What it says for deposits |
|---|---|
| Indian Contract Act, 1872 | Parties are free to contract terms; forfeiture allowed only if expressly provided. |
| State Rent Control Acts (e.g., Maharashtra Rent Act) | Cap deposits to 2–3 months of rent for residential units; commercial leases often stay outside these caps. |
| Registration Act, 1908 & State Stamp Acts | Stamp duty is ad-valorem on total consideration—include non-refundable advance; refundable deposit generally ignored. |
| Real Estate (Regulation & Development) Act, 2016 (RERA) | Major commercial leases (> 3-yr, > 12% of BUA) require registration; disclosures must mention advance / deposit. |
3. Income-tax Treatment
| Scenario | Landlord’s tax point | Tenant’s deduction | TDS u/s 194-I |
|---|---|---|---|
| Adjustable deposit | Taxable only in the months it is adjusted (because that is when it becomes rent received / accrued). | HRA / business rent allowed in those months. | At adjustment time (rate 10% for plant, 2% for land & building; threshold ₹ 2.4 lakh p.a.). |
| Pure refundable deposit | Not taxable when received; remains a balance-sheet liability. Taxable only if forfeited later. | No deduction. | No TDS at receipt. |
| Up-front advance rent | Taxable on receipt (lumpsum) or amortised over lease term if agreement clearly so stipulates and books follow same method. | Deductible in corresponding manner. | TDS at time of payment/credit, on entire advance treated as rent. |
Recent tweak (Finance Act, 2025): For leases > 2 years where non-refundable premium exceeds ₹ 50 lakh, the premium now attracts 1% TDS under new section 194-IBA, over and above 194-I.
4. GST Implications (CGST + SGST = 18% for commercial; residential to registered person still exempt)
| Deposit Type | Is it “consideration” today? | When is GST payable? |
|---|---|---|
| Refundable deposit (adjustable or not) | No, provided agreement records it as security and it is refunded at end. | Only if (a) adjusted against rent → GST in each adjusted month; or (b) forfeited → GST in the month of forfeiture (CBIC Circular 204/18/2024-GST). |
| Non-refundable advance | Yes. It is consideration for leasing service. | Up-front, on receipt (Time of Supply Rules 13 & 31). |
Pro-tip: Issue two documents— (a) a Deposit Receipt (non-tax invoice) for refundable deposits and (b) a Tax Invoice for rent / advance rent. Keeps audits simple.
5. Accounting Under Ind AS 116 / AS 19
Landlord
- Refundable deposit → Other Current Liability; no impact on P&L except discounting (Ind AS only)
- Non-refundable advance → Unearned Rent (liability) → recognise in P&L straight-line across lease term unless substance is outright sale of right-of-use (then Day 1 revenue).
Tenant
- Refundable deposit → Loans & Advances (asset). Under Ind AS, discount to present value; difference is prepaid rent amortised.
- Advance rent → Prepaid Expense amortised across lease term.
6. Three Worked Examples
Example 1: Adjustable Deposit
Facts: Commercial office; monthly rent ₹ 1 lakh; 3-month deposit refundable but to be set-off against last 3 months.
| Month | Cash flow | Books – Landlord | GST | TDS |
|---|---|---|---|---|
| Apr 2025 (start) | Tenant pays ₹ 3 lakh deposit + Apr rent ₹ 1 lakh | Deposit → Liability ₹ 3 lakh; Rent income ₹ 1 lakh | ₹ 18,000 | ₹ 20,000 |
| Feb-Apr 2028 (last 3 months) | No cash; each month knocks-off ₹ 1 lakh | Reduce deposit; book rent ₹ 1 lakh | ₹ 18,000 each | Tenant deducts TDS each month on deemed rent |
Example 2: Pure Refundable Deposit
Facts: Residential flat; rent ₹ 40,000; 2-month security ₹ 80,000.
Outcome: No GST (exempt residential), no TDS (tenant individual < ₹ 50k/ month rule), deposit sits untouched; if landlord later forgoes ₹ 20k for wall damage, only then GST (still exempt) and income tax on ₹ 20k.
Example 3: Non-Refundable Premium
Facts: Retail store 5-year lease; one-time premium ₹ 12 lakh, monthly rent ₹ 50,000.
| Year | Income-tax (landlord) | GST | TDS |
|---|---|---|---|
| Year 0 | Option A: Tax entire ₹ 12 lakh upfront or Option B: ₹ 2.4 lakh p.a. straight-line (documented). | GST 18% on ₹ 12 lakh in Year 0 (₹ 2.16 lakh). | Tenant deducts TDS on ₹ 12 lakh in Year 0 + monthly rent thereafter. |
7. Special Issues & FAQs
- Interest-bearing deposits – Interest credited to tenant becomes rent ⇒ GST + TDS apply on interest, not on principal.
- Top-up deposit when rent increases – Treat additional deposit like fresh deposit; tax/GST rules restart.
- Deposit funded via tenant’s loan from landlord – If set-off against rent later, interest component is separately taxable as “Income from Other Sources”.
- Early termination – Refund deposit within 30 days to avoid allegations of deemed rent; forfeiture = taxable and GST-able.
- Corporate leasebacks (sale with deposit) – Non-refundable premium often re-characterised as part of sale price for stamp duty; structure carefully.
- NRI landlord receiving deposit in NRO – Comply with FEMA (Notification 21(R)); report under Form 15CA/15CB if deposit ultimately adjusts as rent exceeding ₹ 5 lakh p.a.
8. Compliance Checklist (Landlord-side)
| Stage | Do-list |
|---|---|
| Before signing | • Cap deposit within state limits (if any) • Decide whether deposit will adjust or remain refundable • Mention clearly in clause & separate annexure. |
| At receipt | • Issue Deposit Receipt • Collect PAN of tenant • File DIR if company director involved. |
| During lease | • Reflect deposit correctly in books • Reconcile GST outward supply if adjustments begin. |
| At exit | • Prepare joint inspection report • Refund after adjusting for damages • Issue tax invoice for any forfeiture • Update TDS return if adjustments treated as rent. |
9. Latest Developments to Watch (mid-2025)
- CBDT Circular 05/2025 (May 2025): Clarifies that any deposit that is contractually set-off against rent “shall be deemed rent on the date of such contractual stipulation”, removing past ambiguity.
- Rajasthan Stamp Amendment (effective 1-Apr-2025): Counts 50% of refundable deposit towards stamp base for commercial leases > 3 yrs.
- GST Council Recommendation #56 (June 2025): To exempt security deposit forfeiture up to 20% of deposit for residential tenants—awaiting Notification.
Stay tuned; these are moving targets.
10. Plain-English Takeaways for Readers
- A refundable deposit is not income or GST right now—keep it ring-fenced and documented.
- The moment a deposit is applied or forfeited, treat it like rent received—deduct TDS, charge (or pay) GST, and offer it to tax.
- A non-refundable advance is essentially pre-paid rent; all taxes kick in upfront unless you spread it by an explicit, consistent accounting policy.
- Always split paperwork: Deposit Receipt versus Tax Invoice—lets everyone prove intent.
- If in doubt, assume the taxman will call it rent; structure and word your lease first, collect money later.
Final Word
Rental advances look innocuous, yet they straddle contract law, income-tax, GST, stamp duty, FEMA, even Ind AS nuances. A few clear paragraphs in the lease and disciplined bookkeeping make the difference between a routine audit and an expensive litigation.
Stox N Tax 
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