Income from Renting of Real Estate-taxability under the Income-tax Act, 1961

[RameshKumar Patodia]

1. The Real Estate Industry in India has come of age and with the gradual opening up of the economy allowing participation of foreign players in the market, the market is gradually expected to perform better in the coming days with uncertainty regarding the elections and its outcome having gone. It is expected that the Budget for the year 2019 is going to give tax holiday benefits to those in Real Estate Rental Sector so as to give a boost to the sector as a whole and thereby leading to all round benefits to the economy. The country is booming with the constructions of Malls, Hospitals, Hotels and Shops etc. Rental Income is an important source of income for all real estate players throughout the country.
2. A question arises as to how the Rental Income of a Real Estate Company or an entity is to be taxed- Is it to be taxed under the head “Income from Business or profession” or under the head “Income from House Property”. This question arises because there is a specific head “Income from House property” which as the nomenclature itself suggest seeks to bring within its ambit any income from house property. In such a situation, where a real estate player who may be in the business of renting of real estate either belonging to its own or after taking the same on rent, the taxability under a particular head becomes important. A question may arise as to how the head becomes relevant- the answer lies in the fact that the manner of computation of income prescribed under both the heads of income are different and at times, it may be beneficial for a person to try to offer the income for taxation under the head Income from House Property whereas it may prove to be beneficial for a person to offer the income under the head Income from Business.

The reasons are not far and can be understood with the help of the statutory provisions in this regard:-

Statutory Provisions

Income from House Property

3. The provisions are contained in in Section 22 to 27 of Chapter IV-C of the Income-tax Act 1961. Section 22 states that “the annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner other than such portions of such property as he may occupy for the purpose of any business or profession carried on by him the profits of which are chargeable to income-tax shall be chargeable under the head “Income from house property”.

Section 23 deals with the manner in which the annual value is to be determined.

Section 24 deals with deductions from Income from house property. The way this section has been structured, there are limited deductions which are allowed while computing income from house property which contains a standard deduction of 30% of the annual value as per section 24(a) and deduction towards interest on loan where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital. There are certain restrictions prescribed in Section 24(b) in relation to the claim of interest on borrowing.

Thus, an assessee having income from house property is eligible for these two limited deductions while computing the Income from house property.

Section 25 deals with Amounts not deductible from Income from house property. Section 25A deals with Special provisions for arrears of rent and unrealized rent received subsequently.Section 26 deals property owned by co-owners and Section 27 defines “Owner of house property”, “annual charge” etc.

For the sake of brevity these sections have not been reproduced.

 Income from Profits and gains of business or profession

4. The provisions are contained in Sections 28 to 44DB of Chapter IV-D of Income-tax Act ,1961. The said provisions are elaborate and deal with various deductions which are allowed while computing the income under the head Profits and gains of business or profession which inter alia includes interest on borrowed capital which is also allowed while computing income from house property as seen above albeit subject to certain limitations in certain cases.
5. It therefore appears that an income which is declared under the head Income from House property, the assessee is eligible straight away to get a standard deduction of 30%. Even though there is no actual expenditure incurred and thus the cash flow of the said assessee is substantially increased assuming tax rate to be 30%. However, in case the same income is declared under the head Income from Business, this standard deduction is not allowable, though other expenses incurred are allowable.
6. The question therefore arises as to how to distinguish an income as to whether it is to be offered under the head Income from house property or under the head Income from Business since the manner of taxation under the both the heads is materially different and there is a perennial fight between the assessee and the department to try to tax the same in a manner which is beneficial to them.
7. The issue has been subject matter of litigation from time to time and the Apex Court had the occasion to deal with the same in various decisions.
8. The Apex Court recently in the case of PCIT  Vs E City Real Estate (P) Ltd 2018 (12) TMI 605 - SC ORDER granted leave to the department against the decision of the Bombay High Court in the case of THE COMMISSIONER OF INCOME TAX- 9, MUMBAI VERSUS M/S. E-CITY PROJECT CONSTRUCTION PVT. LTD. 2017 (7) TMI 779 - BOMBAY HIGH COURT where the Bombay high court had dismissed the appeal of the department in a case where the assessee had disclosed the income from business of leasing and rentals of property as business income in accordance with the policy consistently followed in earlier years. The court noted that the principle of res judicata in not applicable to income -tax proceedings and as such the manner in which the income was taxed in earlier years was of no avail, though it can be of some guidance. The Court also noted that no straight jacket formula can be laid down to conclude as to an income being an income from house property or business income. The same will have to be decided based on facts existing in each case. The court referred to the following earlier decisions of the apex court and held that as the intention of the assessee was to exploit commercially the property by way of complex commercial activities and it was not a case of letting out the property simplicitor and the rental income and the service charges thus were received by the assessee company as business income during the course of business carried out by them of operating and running a Mall as a commercial activity.

1. Sultan Brothers Private Limited Versus Commissioner Of Income-Tax, Bombay City II - 1963 (12) TMI 4 - Supreme Court
2. Shambhu Investment P. Ltd. Versus Commissioner Of Income-Tax - 2003 (1) TMI 99 - SC Order
3. M/s Chennai Properties & Investments Ltd Versus The Commissioner Of Income Tax - 2015 (5) TMI 46 - Supreme Court
4. RAJ DADARKAR & ASSOCIATES Versus ACIT – CC-46 - 2017 (5) TMI 586 - Supreme Court
5. M/s. Rayala Corporation Pvt. Ltd. Versus Assistant Commissioner of Income Tax - 2016 (8) TMI 522 - Supreme Court

Inspite of so many authorities relied upon, the apex court granted leave and this only proves that the facts of each case has to be considered and there cannot be any straight jacket formula.

9. Now let us consider the above supreme court judgements as well as some other judgements in order to further understand the guiding principles in this regard in the paragraphs to follow.
10.  The constitution bench of supreme court in the case of Sultan Bros Private Ltd Vs CIT(supra) was dealing with an assessee who had after constructing a building fitted up with furniture & fixtures for being run as a hotel let it out for being run as a hotel with a monthly rent for the building and a separate monthly rent for furniture & fixture. The assessee contended that the income was taxable under the head Business or in the alternate it was chargeable under the head Other sources. The court noted that the reason for the preference of the assessee to claim taxation under the head business income was that it would be entitled to much larger allowances as deductions in the computation of income then it would be eligible under other heads of income. The assessee argued that letting out of a commercial asset is a business and the assessee having let out the hotel ,it was a business. The apex court observed that whether a particular letting is business has to be decided in the circumstances of each case. Each case has to be looked at from a businessman’s point of view to find out whether the letting was done of a business or the exploitation of his property by an owner. A thing is by its very nature not a commercial asset. A commercial asset is only an asset used in a business and nothing else, and business may be carried on with practically all things. Therefore it is not possible to say that a particular activity is business because it is concerned with an asset with which trade is commonly carried on. The apex court also noted the decision of East Indian Housing and Land Development Trust Ltd Vs CIT 1960 (11) TMI 7 - SUPREME COURT where it was observed that the income derived by a company from shops and stalls is income received from property and falls under the specific head Income from house property. The character of that income is not altered because it is received by a company formed with the object of developing and setting up markets. After noting the covenants of the lease, the court held that income from the leasing or letting out of the building to be run as a hotel simplicitor cannot be held to be a business income and had to be taxed under the head income from house property, though the rental income for the furniture and fixtures was to be assessed under the head income from other sources with corresponding deductions towards depreciation etc.
11. The apex court in the case of Shambhu Investment (P) Ltd Vs CIT(supra) in a short judgement found no reason to interfere with the conclusion arrived by the Calcutta High Court from which the case arose as reported in CIT Vs Shambhu Investment Pvt Ltd 2001 (3) TMI 77 - CALCUTTA HIGH COURT wherein the Calcutta high court held that merely because income is attached to any immovable property, that cannot be the sole factor for assessment of such income as income from property. If the main intention of the assessee is to let out the property or any portion thereof the income must be considered as rental income or income from property whereas if the primary object is to exploit the immovable property by way of complex commercial activities, in that event it must be held as business income. The Calcutta high court in this case examined several decisions including the decision of the supreme court in the case of CIT Vs National Storage Pvt ltd 1967 (4) TMI 16 - SUPREME COURT where the apex court held the income from letting out of a film laboratory to be business income since the letting was a complex one.
12. In the case of Chennai Properties & Investments Ltd Vs CIT(supra), the apex court in a case where the appellant’s main object was to acquire certain properties in the city of Madras to let out such properties and earn rent from the same. The Apex Court noted the following points:-

1. The assessee had no other income except the income from letting out of the properties;
2. The main object of the company was holding the subject properties and earning income from letting out those properties;

The Court besides referring to the case of Sultan Brothers(supra) referred to an earlier decision  in the case of Karanpura Development. Co Ltd Vs CIT 1961 (8) TMI 7 - SUPREME COURT where it was pointed out that the deciding factor is not the ownership of land or leases but the nature of the activity of the assessee and the nature of the operations in relation to them. It was also observed that the objects of the company must also be kept in mind to interpret the activities.

Ultimately the apex court held that the income was to be taxed under the head income from business.

13. In the case of Rayala Corporation Pvt ltd Vs ACIT 2016 (8) TMI 522 - SUPREME COURT , the apex court noted that admittedly the assessee had only one business and that was of leasing its property and earning rent therefrom. The business of the company was to lease its property and to earn rent therefrom. In such circumstances the court held that the income was to be treated as business income.
14. Again the apex court in the case of Raj Dadarkar and associates Vs ACIT 2017 (5) TMI 586 - SUPREME COURT after referring to all the above judgements, held that the income from operating Saibaba Shopping centre was to be taxed under the head Income from House property since the Tribunal had recorded a finding that the assessee had not established that it was engaged in any systematic or organized activity of providing service to the occupiers of the shops or stalls so as to constitute business income. The Apex Court declined to interfere with this finding of the tribunal as the findings of ITAT were not challenged as being perverse before the High Court.

Conclusion

Thus, from the catena of judgements referred to hereinabove right from the decision in the case of Sultan Brothers(Supra) to E City Real Estate (P) ltd (supra), it can be seen that there is no straight jacket formula to determine the head of income in which rental income is to be taxed and each case has to be decided on its own fact as held and in such a situation the never ending disputes between assessee and department continues with each one of them trying to extract its own pound of flesh in the form of taxes.

Discussions to this article

[sm surana]

dear sir

where the assessee has only one property and the same has been let out and the assessee is also engaged in maintenance services to the tenent,what should be the correct head of incoem and which case law will match with these facts ? kindly guide.