Understanding of Property under Pagadi System in India

What is the Pagdi or Pagdi System? Pagdi is a traditional and unique tenancy model in India since the pre-Independence era, although the number of people, who are tenants under such a system today, may not be high. Similar to other renting arrangements, it also involves a tenant and a landlord, and pays a nominal rent as compared to market rates, on the other hand, the difference is that the tenant is also the co-owner of the property, and has both subletting and selling rights.

History of the Pagdi System

The “pagdi-kirayedar” system was started in the pre-independence era to evade taxes paid to the British government. Under this system, verbal/oral agreements played an important role in transfer of property, wherein the tenants were given a receipt for the rent paid and further tenants made payments in full to the landlord.

According to Section 56 of the Rent Control Act, 1999, this consideration paid to the landlord as a fine, premium, or consideration (Pagdi) was legalized. The act provides authorization for a tenant to receive any amount in consideration to relinquish or transfer of his/her tenancy rights. The landlord or any person acting or purporting to act on behalf of the landlord could receive any fine, premium or other like sum or deposit or any consideration (refers to Pagdi) in respect of the grant, or renewal of a lease of any premises, or for giving his/her consent to the transfer of a lease to any other person.

Transfer of ownership in the Pagdi system

In the Pagdi system, the only differentiating element is that the tenant becomes a part-owner of the premises and not of the land. This tenant continues to pay rent to the owner as long as he/she is not sub-renting the premises. Additionally, the tenant has the choice to sell the said property nonetheless the tenant will have to give a percentage (between 30 to 50%) of the gross sale amount to the landlord.

In case of sub-letting, the old tenant who now is an owner and the original landlord of the property shall share the rent amount amongst themselves, usually at a 35:65 ratio. This facilitates for the landlord to make some money off his/her asset while evading taxes. The old tenant profited as well and the new tenant rented the premises at a very nominal rent. As there is no prescribed law about charges to be paid to a landlord for a No Objection Certificate.

Rules for inheriting tenancy rights under the Pagdi system

Section 7 (15) (d) of the Maharashtra Rent Control Act, 1999, states that a tenant’s family member who has been living with the dead tenant at the time of his/her death shall be eligible first from the family as the successor to succeed the tenancy. Upon the demise of a current pagdi tenant, the tenancy rights can only be transferred to that legal heir(s). The new tenant (legal heir) can request the landlord to issue a fresh rent receipt in the heir(s) name(s). But testamentary succession is not possible, as tenancy rights are peculiar to the tenant and therefore a tenant cannot bestow his/her tenancy rights under a Will.

Therefore, the family member who desires to claim the tenancy rights of the demised tenant must show evidence that he/she was perpetually living with the deceased tenant at the time of his/her demise. Only such a family member will get precedence over all other members of the family for the bequest of such tenancy rights over the premises.

Currently, numerous micro-markets of Mumbai, Kolkata, and Delhi practice the Pagdi system and it has been predicted that over 7.5 lakh homes in Mumbai are under the Pagdi system. Today Mumbai has around 19,642 old buildings where the Pagdi system of renting exists. Areas such as Colaba, Worli, Dadar, Mahim Fort, Parel, Lalbagh, Sewri, Warden Road, and Peddar Road have a considerable amount of tenancy of Pagdi dwellers.

Advantages of Pagdi system

  1. It is a legalized form of tenancy under the provisions of the Maharashtra Rent Control Act, 1999.
  2. Lower rents than the current market rates in major metropolitan cities Mumbai and Delhi.
  3. The tenant can be a co- owner of the premises but not of the land.
  4. The tenant as a co-owner of the property has both subletting and selling rights.
  5. Transferable tenancy to family, with conditions. Tenant’s family member who has been living with the deceased tenant at the time of his/her death shall qualify first from the family as the successor to succeed the tenancy.
  6. In case of redevelopment, the tenant can be a co-promoter.

Disadvantages of Pagdi system

Although legalized this system has many drawbacks for the owner as well as the tenants.

  1. The tenant can be a co-owner of the premises but not of the land. So, there is no satisfaction of being the owner of the property.
  2. Owners take lump-sum premium but over the period of time many years into the tenancy, the ratio goes disproportionate.
  3. Rents are very low for the premises in the prime locations of the metropolises.
  4. Lower rentals do not incentivize landlords enough for maintaining these structures, and hence they remain neglectful concerning maintenance and other repairs.
  5. Tenants have to spend from their own pockets for the renovations and repairs of the premise.
  6. Tenants may have to go forth with the redevelopment of the property.

Transfer of Tenancy rights – GST impact on ‘Pagadi System’

There is a system prevalent in some states where the transfer of tenancy rights against tenancy premium which is also known as “Pagadi system”. This is similar to any other renting system that is prevalent across the world i.e. landlord and a tenant. However, the only deviating factor is that the tenant also becomes a part owner of the house but not of the land. In the Pagadi system, the tenant acquires the tenancy rights in the property against payment of tenancy premium (Pagadi). The landlord would be owner of the property (land and building) but the possession of the same lies with the tenant. The tenant pays periodic rent to the landlord as long as he occupies the property. The tenant also has the option to sell the tenancy right of the said property and in such a case has to share a percentage of the proceed with owner of land, as laid down in their tenancy agreement. This percentage varies from anywhere between 30-50%. Alternatively, the landlord pays to tenant the prevailing tenancy premium to get the property vacated. Such properties in Maharashtra are governed by Maharashtra Rent Control Act, 1999. Following are the nature of incomes generated in the above said arrangement:

a) Tenancy premium received by landlord from incoming tenant against transfer of tenancy rights in the property.
b) Tenancy Premium received by outgoing tenant from the incoming tenant/landlord on vacating the premises.

GST shall be leviable on inter/intra state supply of goods or service or both on the value determined under section 15 at the notified rate. The term ‘Supply’ is defined to include all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business and also includes the activities specified in Schedule II. Further, Schedule II provides that any lease, tenancy, easement, licence to occupy land is a supply of services and similarly any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is also to be considered as a supply of services. Hence, the tenancy premium earned on transfer of tenancy rights attracts GST subject to the exemption given vide Sl. No. 12 of notification No. 12/2017-Central Tax(Rate) dated 28.06.2017 on ‘services by way of renting of residential dwelling for use as residence’.

Para 5 of the Schedule III of the CGST Act provides that, ‘Sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building’ shall be treated neither as a supply of goods nor asupply of services and hence out of GST levy. The tenancy premium collected by landlord is subject to stamp duty and registration charges which are levied on transfer of rights in immovable property and hence same shall not be subjected to GST as per para 5, Schedule III of the CGST Act.

Department clarification:
Recently Government has issued a circular (Circular No.44/18/2018-CGST dated 02.05.2018) where the department has opined that “the contention that stamp duty and registration charges is levied on such transfers of tenancy rights, and such transaction thus should not be subjected to GST, is not relevant. Merely because a transaction or a supply involves execution of documents which may require registration and payment of registration fee and stamp duty, would not preclude them from the scope of supply of goods and services and from payment of GST. The transfer of tenancy rights cannot be treated as sale of land or building declared as neither a supply of goods nor of services in para 5 of Schedule III to CGST Act, 2017. Thus, a consideration for the  said activity shall attract levy of GST”.

Assessee having earned tenancy premium from both residential as well as commercial properties, ITC to be reversed proportionately to the extent of income towards residential units (Exempted supplies).

Pagadi properties under RERA:

The government has been meaning to acquire pagadi properties under the Real Estate Regulatory Authority (RERA), which will offer the equivalent assistance and security to home buyers as offered to regular properties. As per the present scenario, tenants in pagadi properties are co-promoters of the development. Assuming that most are old properties, there is a necessity to redevelop such units. After Pagdi properties come under the authority of the RERA, such tenants would be eligible for compensation if the development is delayed. As of now, the Maharashtra Housing and Area Development Authority (MHADA) collects a tax from these tenants and offers help with the upkeeps of Pagdi properties.

Pagadi Properties Redevelopment in Suburbs

The Pagadi properties redevelopment rules in Mumbai Suburbs are different from that of Cessed tenanted buildings in Island City. There is a TDR system and other redevelopment systems in the suburban areas of Mumbai.

In the City, there are rules for minimum carpet area for these tenants, whereas for suburban areas, the tenants merely have the right to the prevailing occupied area. Furthermore, for cessed buildings in Mumbai, the redevelopment is done principally under D.C. Reg.No.33(7) whereby the tenants become landlords while in suburbs the landlords are not obligated to offer ownership to tenants in redeveloped buildings and can keep them as tenants.

Pagadi system in Mumbai:

In 2019, the Maharashtra government permitted a discounted additional Floor Space Index (FSI) to developers who were amenable to take on redevelopment of the pagadi properties. However, this would cause a loss of approx. 50% of the revenue for the Brihanmumbai Municipal Corporation (BMC) and a final decision on this matter yet to be taken. The 2018 BMC guidelines stated that those already living in non-cessed buildings prior to 13th June, 1996, are entitled for new flats if the property goes for a redevelopment. Even if the tenant had transferred the ownership officially and lawfully to the new tenant, the new tenant would be eligible for the same benefits.

  • Benefits for the developers who takes the responsibility of redevelopment of Pagadi buildings

The Mumbai Development Control and Promotion Regulations 2034 (DCPR) provides tantalizing incentives to the landlords of these buildings to encourage them to redevelop their properties. These incentives are given based on the total area necessary to rehabilitate the inhabitants. The rule further provides that the tenants are eligible to a minimum area of 300 sq. ft. and a maximum area of 1,292 sq. ft., free of cost. If the property area crosses the maximum cap, then the tenant needs to pay the construction cost. If the developer carries out the redevelopment of two to five pagadi buildings, he/she would be qualified for 60% incentive on FSI. If there are more than five buildings, the FSI incentive might go up to 70%.

Mumbai Development Control and Promotion Regulations 2034- 33(7)(A)- Reconstruction or redevelopment of dilapidated/unsafe existing authorized tenant occupied buildings in Suburbs and extended Suburbs and existing authorized non-cessed tenant occupied buildings in Mumbai City.

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