False HRA declarations: Know the implications

A recent media report (The New Indian Express – April 1 Bengaluru edition) suggests that the income-tax department has unearthed around 8,000-10,000 high-value cases involving amounts exceeding Rs 10 lakh each of fraudulent House Rent Allowance (HRA) claims.

Taxpayers are said to have provided PANs of their immediate family members, friends and lower income earners, rather than the original property owners, thus helping them reduce the tax outgo. This is nothing but a deliberate attempt at tax evasion.

Given technological advancements, and the usage of data analytics, it is not possible to escape the consequences of willful tax dodging. In fact, for the taxman, it is very easy to trace the tax evaders and levy interest and penalty.

What is HRA?

HRA is an allowance to meet expenses in connection with the rent of a home. The Income Tax Act provides an exemption which will be the minimum of the following three - actual rent received from the employer, an amount equal to 50% of salary if the rented house is situated in a metro city, or 40% of the salary if the house is in any other city, and the excess of rent paid of 10% of salary.

Strangely, for income tax purposes, Bengaluru is not considered a metro city. For HRA purposes, salary means basic salary plus dearness allowance, if it forms part of a retirement benefit, plus commission on turnover, if any.

To claim tax exemption, an employee is required to submit the PAN of the property owner or the person to whom the rent is paid. The employer will deduct applicable tax at source after considering the HRA allowance. Further, the employer and the employee are required to quote the PAN of the property owner in their respective returns.

Taxpayers also need to provide valid rental agreements, rent receipts and bank statements for paying the rent. These are essential for employers to undertake reasonable verification before complying with TDS provisions and making rent receivers subject to tax.

How to deal with a notice?

Upon receipt of a notice, the taxpayer is required to submit their due response with necessary documentation within the prescribed timeframe online. The law does not prohibit an employee from claiming HRA for the rent paid to parents or other family members. However, the same may come under the department’s scrutiny in the absence of any rental agreement or cash payments rather than bank transfers. 

In case of failure to receive a reply, the department will insist the taxpayer file a revised return with or without claiming such deductions and exemptions as the case may be. As per Section 272A(2) of the Income Tax Act, failure to comply with a notice may invite penal provisions of penalty of Rs 100/- per day.

In addition, misreporting of an income, or claiming a wrongful deduction or exemption may attract penal interest at 12% per annum. Prosecution is also a possibility.

The taxpayer can also voluntarily rectify through an updated return and escape the aforesaid consequences to a great extent. For financial year 2021-22/assessment year 2022-23, the last date will be March 31, 2025 and for FY2022-23/AY 2023-24 it will be March 31, 2026.

A taxpayer can rely on a Tax Information Statement (TIS), Annual Information Statement (AIS) and Form 26AS on the e-filing website. If found that someone is paying rent to them without actual payment or no such relationship exists with the other, then they can alert the authorities, take necessary action and avoid any adverse consequences.  

The Central Board of Direct Taxes has clarified that there is no special drive to re-open such cases. The said action was taken in a small number of cases. Since the department has unearthed a new modus operandi of tax evasion, a similar exercise can extend on a larger scale in the days to come. Thus, taxpayers have no other options than remaining tax compliant and preserving tax-related documents at least for eight to ten years.