The Pugdi System – Is it legal?

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By Dr Sanjay Chaturvedi, LLB, PhD.

The rent system has become an important aspect of day to day life in large cities like Mumbai. This is mainly due to the scarcity of available accommodation and the exorbitant prices of property. However, there are some inherent problems in this system. The illegal practice of the pugdi system was one of them. It is of interest to know how the Government of Maharashtra came to change its policy on this issue. We also will look into the illegal status of the pugdi system before the Maharashtra Rent Control Act, 1999 came into effect and how it evolved into the legal practice that it is prevalent today.

Pugdi represents a payment made by a tenant to the landlord for getting a property under statutory tenancy whereby the tenant becomes protected by the rent statute and he can occupy the property for as long as he wishes and even pass on to his heirs. In other words, he practically becomes a substantial owner. However, rent laws of states typically prohibit receipt of any money on grant of statutory tenancy. To evade this law, tenants pay and landlords receive such money unofficially in cash. The same situation arises when the property under tenancy is sought to be transferred. In this case, the incoming tenant pays money to the outgoing tenant and the landlord, once again, to both, in unaccounted cash.

Though very common, the practice creates an atmosphere and culture of tax evasion. Considering the huge extent to which properties are held in tenancies, it was not surprising to read a press report last week that black money to the tune of Rs 70,000 crore has been generated in such transactions. Now there is a move to legalize such pugdi payment. While there are many implications to this move, let us consider the tax implications.

The status of pugdi before the Maharashtra Rent Control Act, 1999:

The practice of the pugdi system is as old as the tenancy system. A premium or pugdi, as it is known widely, is a payment of money on the grant or surrender of tenancy. It is a consideration, paid either by a tenant to a landlord for grant of tenancy or, by a landlord (or a sub-tenant as the case may be) to the tenant for surrender of tenancy. The Transfer of Property Act, 1882, while defining ‘lease’ in section 105, states that a lease can be created or granted in consideration of a price, paid or promised or, of money, apart from the consideration of periodical rent. The consideration, mentioned here, is nothing but pugdi, which is a lump sum amount. As held in the Commissioner of Income Tax vs. Panbari Tea Company, AIR 1965 SC 1871, “the premium is really the price of the right to 6 occupy for a period, while rent is a return at some percentage on such price, during the period of the lease by periodical installments.” Thus, according to the Transfer of Property Act, the pugdi system is statutorily legal, unlike in the Bombay Rent Act, 1947.

According to previous rent laws applicable to Bombay, i.e. the Bombay Rent Act, 1947, “any consideration, received by a landlord or any person, acting under the landlord, other than the standard rent or permitted increase for consenting to transfer the tenancy or creating sub-tenancy or tenancy etc. was unlawful and, the landlord, on conviction, can be punished with imprisonment for a term that may extend to six months and with fine, not less than the amount of premium that he has received.”(S.18 of the said Act). Also, “any consideration, received by the tenant or any person, acting under him, for relinquishing the tenancy rights, is unlawful and may be punished with imprisonment for a term that may extend to six months and with fine, not less than the amount of premium that he has received.” (S.19 of the said Act). In spite of it being a criminal offence, people weren’t deterred from such a practice and surprisingly few complaints were lodged.

This brings to light that the need for a roof over one’s head is of much greater importance than the penal consequences of pugdi. The illegality of the pugdi system gave birth to social as well as economic evils. It led to black marketing. The amount, demanded as pugdi, was often exorbitant. The protection, given to the landlords in respect of the recovery of possession, was minimal. As a consequence, the pugdi system became very popular as it helped the landlord to recover a major sum, in relation to the actual price of the premises. Similarly, a landlord was able to pay pugdi to a tenant in order to recover possession of the premises. This would otherwise have been impossible, as the rent laws in effect at that time, offered great protection to the tenants.

As a result of this open practice, the Government rethought its policy on the pugdi system. In 1998, the Central Government announced the National Housing Policy that proposed amendments in the Rent Laws. The same Policy proposed a change in the policy on the pugdi system.

The Joint Committee unanimously decided to consider the legalization of the pugdi system as it would have many advantages. Firstly, legalizing the system would help in curbing black marketing which otherwise could not be kept in check. Secondly, the pugdi amount would be brought under the purview of tax laws and other revenues, like Stamp Duty and registration. The Government would stand to benefit from this.

The Maharashtra Rent Control Act, 1999 & Pugdi System

The new Rent Act, with various new provisions, came into effect in 1999. The Act made the pugdi system legal by virtue of section 56, which states the following:

Notwithstanding anything contained in this Act, it shall be lawful for:

the tenant or any person, acting or purporting to act on behalf of the tenant, to claim or receive any sum or any consideration, as a condition of the relinquishment, transfer or assignment of his tenancy of any premises;
the landlord or any person, acting or purporting to act on behalf of the landlord, to receive any fine, premium or other like sum or deposit or any consideration, in respect of the grant, or renewal of a lease of any premises, or for giving his consent to the transfer of a lease to any other person.

A corresponding provision has been made in S. 55 of the Act, which makes it compulsory for both parties i.e. a landlord and a tenant to make an agreement in writing and get it registered. As a result of this compulsory registration, the parties will have to pay Stamp Duty and registration charges. The Stamp Duty, in case of a grant of tenancy with premium, is levied on the amount of premium, adding to it the amount of Stamp Duty, levied on the amount of rent. Thus, the lump sum amount of premium, mentioned in a tenancy agreement, can bring large revenue to the State Government. The registration charges are also levied on the amount of premium.

The object behind legalizing the pugdi system was to keep a check on the problem of housing. This change will motivate the tenants to surrender their tenancy rights and use the pugdi amount to buy their own houses. Moreover, the disputes between tenant and landlord that arise from the vacating of premises would not occur. The practice of the non-usage of property of a tenant would also be discontinued as he can always convert his tenancy into a handsome premium. An added benefit is that the landlords will have some funds to adequately maintaining their property.

Conclusion: – Therefore, in a nutshell, the revised policy of the legislature, which has legalized the pugdi system, will definitely improve the problem of housing in cities like Mumbai. More accommodation will be available to residents of large cities, as this system will encourage the optimum use of existing accommodation.

Overall, it can be assessed that the Maharashtra Rent Control Bill, 1999 did provide a better structure to the laws in the Real Estate Sector. However, it still remains in question whether it has provided complete & adequate amount of legitimacy required for the same.

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