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December 10, 2020

Income earned from sub-licenses is taxed under the “Income from House Property” or as “Business Income”?

by CA Shivam Jaiswal in Income Tax

Income earned from sub-licenses is taxed under the “Income from House Property” or as “Business Income”?

Treatment of rent has been a common point of dispute between the income-tax department and taxpayers. The Income can broadly fall under the following two heads of income in the Income Tax Act – Income from House Property or Profits or Gains from Business or Profession.

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, etc. (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.

Let us refer to the case of Raj Dadarkar & Associates v. ACIT, where the main issue under consideration was whether income earned from the shopping centre was required to be taxed under the head “income from House Property” instead of the head “Profits and Gains from the Business or Profession”.

Facts of the Case:

  • The assessee was a partnership firm whose main object was to take premises on rent and sub-let them or any of business mutually agreed by the parties from time to time.
  • The Market Department of the MCGB auctioned the market portion of a land on a monthly license basis to run municipal market.
  • Assessee firm participated in the auction to acquire the right to conduct the market on the market portion.
  • Assessee was the successful bidder and was handed over possession of the market portion.
  • The terms and conditions subject to which the Assessee was given the said market portion to run and maintain municipal market contained the terms and conditions of the auction.
  • The premises allotted to the Assessee firm was a bare structure, on stilt, that is, pillar/column, sans even four walls.
  • In terms of the auction, it was the Firm who had to make the entire premises fit to be used a market, including construction of walls, construction of entire common amenities like toilet blocks, etc.
  • Accordingly, after taking possession of the premises, the Firm spent substantial amount on additions/alternations of the entire premises, including demolishing the existing platform and, thereafter, reconstructing the same according to the new plan sanctioned by the MCGB.
  • The firm also obtained, in terms of the conditions of the auction, necessary registration certificate for running a business under the Shop and Establishment Act and other licenses/permissions from MCGB and other Government and semi-Government bodies for carrying on trading activities on the said premises.
  • Assessee firm was responsible for day-to-day maintenance, cleanliness and upkeep of the market premises. It also had to incur/pay water charges, electricity charges, taxes and repair charges.
  • Assessee was offering the income from the aforesaid shops and stalls sub-licensed by it under the head “Profits and Gains of Business or Profession” of the Income Tax Act, 1961. The income was also assessed accordingly.
  • However, the case of the assessee was reopened by the Assessing Officer (AO) by issuing notice under Section 148 of the Act. Thereafter, notice under Section 143(2) was issued and served by the respondent.
  • AO held that the income received by the Firm from the market stalls was assessable as “Income from House Property”

Proceedings of the Appellate Authorities and High Court (HC)

  • Being aggrieved by the reassessment order, Assessee filed an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].
  • CIT(A) allowed the appeal and reversed the action of the AO.
  • Aggrieved by the order, Department as well as Assessee filed appeals before the Income Tax Appellate Tribunal (ITAT).
  • The ITAT reversed the order of the CIT (A) and confirmed the action of the AO.
  • Being aggrieved by the order of the ITAT, Assessee preferred further appeal before the High Court.
  • The HC dismissed the appeal filed by the Assessee.
  • Aggrieved with the order of the HC, assessee filed an appeal before the Supreme Court (SC)

Observations of the SC on the contention of the assessee that letting out being the main intention of business, the same should be treated as business income

  • SC observed that there was no dispute that the assessee Firm would be treated as deemed owner of the premises.
  • The assessee’s contention was even if it was deemed owner of the premises in question, since the letting out the place and earning rents therefrom was the main business activity of the firm, then the income generated from sub-licensing the market area and earned by it should be treated as income from business and not income from the house property.
  • The submission was that the dominant test had to be applied and once it was found that dominant intention behind the activity was that of a business, the rental income would be business income.
  • SC was of the view that merely because there was an entry in the object clause of the business showing a particular object, would not be the determinative factor to arrive at a conclusion that the income was to be treated as income from business.
  • Such a question would depend upon the circumstances of each case.
  • SC observed that, reading of the object clause brought out two discernible facts:
    1. The firm had to take the premises on rent and to sub-let those premises. Thus, the business activity was of taking the premises on rent and subletting them. To this the Court observed that by legal fiction contained in Section 27(iiib), the assessee was treated as “deemed owner”
    2. The aforesaid clause also mentioned that partnership firm may take any other business as may be mutually agreed upon by the partners
  • SC observed that apart from relying upon the aforesaid clause in the partnership deed to show its objective, assessee firm had not produced or referred to any material.
  • This aspect was dealt with the ITAT. Observation of ITAT was 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/ stalls so as to constitute the receipts from them as business income.
  • ITAT being the last forum insofar as factual determination was concerned, these findings had attained finality.

Observations of the SC on similar cases

  • Assessee placed reliance was placed on the decisions of Chennai Properties & Investments Ltd. v. CIT (2015) (SC) and Rayala Corporation (P.) Ltd. v. Asstt. CIT (2016) (SC)
  • SC was of the view that decisions of Chennai Properties & Investments Ltd. and Rayala Corporation (P) Ltd v. Asstt. CIT would not be applicable to the present case.
  • In Chennai Properties & Investments Ltd v. CIT, the entire income of the Assessee was through letting out of the two properties it owned and there was no other income of the assessee except the income from letting out of the said properties, which was the business of the assessee.
  • SC held that situation was just reverse.
  • The judgment in East India Housing and Land Development Trust Ltd. v. CIT (1961) (SC) was rather applicable.
  • That was a case where the company was incorporated with the object of buying and developing landed properties and promoting and developing markets.
  • Thus, the main objective of the company was to develop the landed properties into markets.
  • It so happened that some shops and stalls, which were developed by it, had been rented out and income was derived from the renting of the said shops and stalls.
  • In those facts, the question which arose for consideration was whether the rental income that was received was to be treated as income from the house property or the income from the business?
  • SC while holding that the income shall be treated as income from the house property, rested its decision in the context of the main objective of the company and took note of the fact that letting out of the property was not the object of the company at all.
  • SC was therefore, of the opinion that the character of that income which was from the house property had not altered because it was received by the company formed with the object of developing and setting up properties.
  • In Rayala Corporation (P) Ltd the fact situation was identical to the case of Chennai Properties & Investments Ltd. and for this reason, even Rayala Corporation (P) Ltd. was inapplicable to the facts of the Assessee Firm

Conclusion by SC

Dismissing the appeal of the assessee, SC held that the object clause, as contained in the partnership deed, would not be the conclusive factor to determine under which head the income would be taxable. Matter had to be examined on the facts of each case. Thus, income earned from sub-licenses is required to be taxed under the head “Income from House Property”

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