Interplay between ‘Income from House Property’ and ‘Profits and gains from Business and Profession’

Many disputes arise between the taxpayers and the Income-tax department as to whether rental income from house property should be assessed under the head “Income from House Property” (HP) or under the head “Profits and Gains from Business or Profession” (PGBP)? The dividing line is very thin, and the courts have also taken different views on seemingly similar facts. It is said that none of the heads of income under the Act can be treated as general or specific for the purpose of any one source of income. These heads are mutually exclusive. Where an item of income falls specifically under one head, the same is to be charged under that head and no other. However, for assessment purposes, decision about the head under which rental income is to be assessed, is to be taken.

Income from rental property has different connotations depending on whether it is treated as house property or business income –

  • Rental income from a property could be treated as income from House Property and/or income from Business and Profession.

  • If the property income is declared as business income, then the owner can claim a tax deduction on actual expenses.

  • Property income is considered as income from house property if the property is not used by the owner for business or professional purposes.

An individual would prefer to show rent as business income, which allows her/him to deduct all the expenses incurred to maintain the property, claim depreciation and not pay notional rent when the property is not let out. Whereas, Taxability as House Property provides a standard deduction which is limited to 30% of the income along with a deduction on interest paid on borrowed capital for the purposes of acquisition, construction, repair, reconstruction, (subject to limitations provided under the Act).

Taxpayers will always go to option of including rental income as business income which will in turn mean revenue loss for the government. The IT department, therefore, scrutinises every such case in detail to dissuade taxpayers from claiming it as business income.

The disputes also occur as the IT Act doesn’t provide definite guidelines on the treatment of rent.

On a plain reading of section 22 of the Income Tax Act, though it mentions income from house property as a heading, the section goes on to mention ‘’property consisting of any buildings or lands appurtenant thereto, of which the assessee is the owner’’. Thus, creating ambiguity on the nature of property, which should be considered for offering rental income under the head Income from House Property.

Further, according to the tax authorities the deciding factor is not the ownership of the land or leases, but the nature of the activity of the taxpayer and the nature of the operations in relation to the same. Further, the Apex/Supreme court (SC) has emphasised that for income to be characterised as business income, the activities actually carried out by the taxpayer need to be in line with its main object, according to its constitution documents.

As there are no limits or restrictions on deductions under the head PGBP, taxpayers are attracted towards classifying rental income received from lease of immovable property as PGBP. Obviously, this requires the support of facts in every case.

According to section 50 of Income tax act if an assessee has sold a capital asset forming part of block of assets (business purpose) (building, machinery etc) on which the depreciation has been allowed under Income Tax Act, the income arising from such capital asset on transfer/sale is treated as short term. Further, Section 54, 54EC & 54F talks about the capital gain arising on transfer of long-term capital assets and one may note that depreciable assets if held for a period of more than 24/36 months becomes a long-term capital asset. Section 54/54EC/54F are an independent sections & don’t make any distinction between Depreciable assets vis a vis Non-Depreciable Assets. Section 50 does not have an overriding effect over the said sections. All the Sections (54/54EC/54F) have an application where long-term capital asset is transferred. Therefore, capital gain received by an assessee on the transfer of a depreciable asset (if all other necessary conditions mentioned u/s 54EC/54F are complied with by the assessee) is eligible for the benefit under the relevant section.

The tax authorities, on the other hand, argue that rental income should be chargeable to tax as HP Income, perhaps the ease (and limitation) of deductions under HP being the driving force.

Further, if any assessee has a loss from house property, the same can be adjusted and carry forwarded under the Income Tax Act as under:

  1. Inter-source adjustment (section 70):Any loss from house property can be set-off from income of other house property. It is also called as intra-head adjustment.

  2. Inter head adjustment (section 71):The unadjusted loss can be set-off against income under any other head during the current year (no loss can be set-off against winning from lotteries, races, etc.). The assessee can set off such loss from house property up to a maximum of 2,00,000 only.

  3. Carry Forward and Set off (section 71B): Loss from house property can be carried forward for a maximum period of 8 years for set-off against income from house property.

The trend of judicial precedents and directions released by the Central Board of Direct Taxes (CBDT) reveal that the authorities are now accepting that ownership of property and leasing it out may also be done as part of a business, apart from as a mere owner. As recently as April 2017, the CBDT issued a circular, wherein it has been clarified that the income from letting out of premises or developed space along with other facilities in an industrial park or SEZ is to be charged to tax under the head PGBP and has guided the department in not filing any appeals on this issue and to withdraw or not press upon appeals already filed.

Some of these judicial precedents and directions are as follows:

1) Chennai Properties & Investments Ltd v. CIT.- [2015] 373 ITR 673 (SC) – Business Income/ PGBP

Wherein it has been held that where in terms of memorandum of association, main object of assessee-company was to acquire properties and earn income by letting out same, said income was to be brought to tax as business income and not as income from house property.

2) Rayala Corporation Pvt. Ltd v. ACIT. [2016] 386 ITR 500 (SC)- Business Income/ PGBP

Resolves business income vs house property controversy on lease-rentals in assessee’s favour:

SC reverses Madras High Court (HC) judgement and holds that rental income arising to assessee from leasing property taxable as ‘business income’ and not ‘house property’ income, notes that assessee has only one business of leasing its property. SC rules that ‘’The business of the company is to lease its property and to earn rent and therefore, the income so earned should be treated as its business income’’; SC accepts assessee’s reliance on ruling in Chennai Properties & Investments Ltd wherein the Apex Court had held that rental income received by assessee having a business of renting the property, shall be taxed as business income. Also rejects Revenue’s reliance on Apex Court ruling in G. Mercantile Corpn. (P) Ltd.

3) National Storage (P.) Ltd 1967] 66 ITR 596 (SC) – Business Income/PGBP

Income earned through letting of vaults for business purpose, taxable as business income SC concludes income earned through letting of vaults for business purpose, taxable as business income and not house property.

4) Pr. CIT v. Classique Associates Ltd- ITA No 1216 of 2016- Bombay High Court- Business Income/PGBP

Assessee is a partnership firm and is engaged in the business of development of real estate and had earned an amount of Rs.1.51 crores (rounded off) by leasing out certain flats and treated such income as the business, which was held as income from house property by assessing officer. On appeal HC relying on Commissioner of Income-tax v. Neha Builders (P.) Ltd. reported in 2008 (296) ITR 661 and of the Supreme Court in the case of Chennai Properties and Investments Ltd. v. Commissioner of Income-Tax, reported in [2015] 377 ITR 673 concluded that income generated from such source was assessee’s business income and not the assessee’s house property.

5) Keyaram Hotels P Ltd [2015] 235 Taxman 512 (SC)- Income from House property

Dismissed taxpayer’s SLP against HC-ruling holding property leasing as house property income

SC dismissed assessee’s SLP against Madras HC judgement, wherein HC had held that rental income derived from leasing of commercial property was taxable as ‘income from house property; Revenue had assessed the rental income under the head of income from house property on the ground that assessee was not engaged in any business activity; HC had applied the ratio laid down by SC in East India Housing and Land Development Trust Ltd wherein it was held that where the owner of the property exploited the property by leasing out the same and realised income byway of rent, the same was to be assessed under the head ‘Income from house property’ and not as business income; HC had also referred to principles laid down by SC in Universal Plast Ltd., Guntur Merchants Cotton Press Co. Ltd; Thus, applying SC decision in East India Housing to the facts established by the AO that assessee was not engaged in any business activity, HC had ruled that income received from letting out of the property was assessable as ‘income from house property’ and not business income

6) Shambhu Investments Pvt Ltd v. CIT- [2003] 263 ITR 143 (SC)- Income from House property

Prime object of assessee under an agreement was to let out portion of a said property to various occupants by giving them additional right of using furniture and fixtures and other common facilities for which rent was being paid month by month in addition to security free advance covering entire cost of said immovable property High Court held that it would be wrong to say that assessee was exploiting property for its commercial business activities and such business activities were primary motto and letting out property was secondary one and from agreement between two parties, it was clear that primary object was to let out portion of said property with additional right of using furniture and fixtures and other common facilities for which rent was being charged from month to month and, therefore, income derived from said property was income from property which should be assessed as such.

7) Ansal Housing & Construction Ltd v. CIT-1- [2016] 243 Taxman 144 (SC) – Income from House property- (held by HC)

Assessee’s SLP against the order by Delhi HC has been admitted by the SC vide order dated September 19, 2016. Final SC order pending

HC allowed Revenue’s appeal challenging ITAT order for AY 1994-95 and held that assessee was engaged in business of construction of house property and many flats were lying unsold. Thus, provisions of sections 22 and 23 would be applicable and assessee would be liable to pay tax on annual letting value of unsold flats as income from house property. Distinguishes assessee’s reliance on SC decision in Chennai Properties & Investments Ltd. as the main object of assessee therein was holding the properties and earning income by letting out properties. as against assessee’s case where letting out of properties wasn’t a part of its object

8) CIT 12 v. Sane & Doshi Enterprises- /[2017] 245 Taxman 128 (SC)- Income from House property- (held by HC)

SLP granted against High Court’s ruling that rental income received from unsold portion of property constructed by assessee, a real estate developer, is assessable as income from house property. Final SC order pending.

HC had held that rental income received from unsold portion of property constructed by assessee, a real estate developer, is assessable as income from house property and not business and once it is held that income is derived from property, treatment given in books of account as stock-in-trade would not alter character or nature of income.

9) CIT v. Gundecha Builders [2019] 102 27 (Bom.)- Income from House property

The honourable HC took note of the fact that the respondent-assessee was engaged in the business of developing real estate projects and letting out of property was not the business of the assessee. The honourable Court did not agree with the contentions of the revenue that the issue stood resolved in favour of revenue by the judgments of the Supreme Court in cases of Chennai Properties & Investments Ltd. (supra) and Rayala Corporation (P.) Ltd. (supra) as the Supreme Court ruling in both these cases was on a different footing. Accordingly, the High Court distinguished both these cases with the present case.

Therefore, the Court dismissed the appeal of the revenue and decided that the assessee had correctly shown its income from letting out of property under the head income from house property as the same did not pertain to its regular business.

Cases on Composite Contracts

  • Leasing of shops in a mall along with various other facilities held as assessable as business incomeand not as income from house property held in PCIT v. Krome Planet Interiors (P.) Ltd. (2019) 265 Taxman 308 (Bom) (HC)

  • Leasing the hotel and charging one percentage of total revenue held as assessable as business incomeand not as income from house property, held in CIT v. Plaza Hotels (P.) Ltd. (2019) 107 287/265 Taxman 90 (Bom.)(HC)

Further, SLP of revenue is dismissed, CIT v. Plaza Hotels (P.) Ltd. (2019) 265 Taxman 89 (SC)

  • Exploitation of property commercially by way of complex commercial activities. Held rental income earned is to be taxable as income from businessand not as Income from House Property. Held in PCIT v. City Centre Mall Nashik Pvt. Ltd (Bom)(HC)- [2020] 424 ITR 85 [Bom HC]

Question raised before the HC is “Whether, on the facts and in the circumstance of the case and in law, the Hon’ble Tribunal was justified in holding that the assessee had exploited its property commercially by way of complex commercial activities and hence, the rental income received by the assessee to be taxable as income from business and not under the head “Income from House Property’ ?” The Honourable Court considered the object clause of the company and various services provided such as marketing and promotional activities and also organising various events and programs. The Intention of the Assessee is also a material circumstance and the objects of Association, the kind of services rendered clearly point out that the Income is from Business. All the factors cumulatively taken demonstrate that the assessee had intended to enter into a Business of renting out commercial space to interested parties.

Key Take away:

The principle of law that can be derived not only from the judgment of the Mumbai High Court but also from the judgments of the Supreme Court cited above, the determining factor of treatment of a rental income under appropriate head of Income Tax law, is the real intent and main object of business/nature of trading operations of the assessee. Where it is difficult to assess the real intent behind earning a rental income, regard must be had towards the nature of trading operations or main objects of business.

Over time and after many cases, certain key principles have emerged as cornerstones or templates for characterisation of rental income.

Some of the salient principles are as follows:

  1. Intent of the taxpayer– this intention can be gathered from the agreement for lease, Memorandum of Association and subsequent conduct of the parties.

  2. Active ownership of property– if a property yields rental income by virtue of its own legal existence it would be classified as passive ownership and may be classified as income from house property.

  3. Documents available with the taxpayer– which could further provide the main object of the assessee. The activities carried out by the taxpayer should be in line with the constitution documents.

  4. Nomenclature given– The dividing line, whether rental income from house property should be assessed under the head business or under the head “house property”, is very thin. The issue should be decided in the facts and circumstances of each case and on the basis of intention of the party. The nomenclature given to the said income is irrelevant.

  5. Regular Income or Occasional Income– Where earning income by way of letting out properties does not constitute main business of the assessee and such income is earned only under occasional circumstances, it is taxable under the head ‘income from house property’. On the other hand, if facts and circumstances of the case indicate that letting out of properties is part of main business of the assessee, such income should be treated as an income from business or profession and not under income from house property.

Thus, treatment of rental income would depend upon whether it is a regular income or merely occasional income.

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