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Can a Property on which rent is collected from financially independent children be considered as let out property?

Introduction

Can Assessee claim interest deduction while computing Income from House Property where the assessee is receiving rent from his own son and daughter who are financially independent? Is the Property in question a self-occupied property or a let out property? We will answer all these questions with the help of a case law – Moh. Hussain Habib Pathan, Mumbai vs Asst Cit 18(2), Mumbai on 6 March, 2020.

Provisions of Law:-

Let us first understand what deductions are available under Section 24 while computing Income from House Property which will help us to clearly understand the issues arising in this case.

Description	Quantum of Deductions
Standard Deduction [Section 24(a)]	30% of net annual value of the house property
Interest on Borrowed Capital [Section 24(b)] or	For let-out property, actual interest incurred on capital borrowed for acquisition, construction, repairing, re-construction to be allowed as deduction
Interest on Borrowed Capital [Section 24(b)] or	For self-occupied property, interest incurred on capital borrowed for acquisition or construction of house property to be allowed as deduction up to Rs. 2 lakhs. (only if capital is borrowed on or after 01-04-1999 and acquisition or construction is completed within 5 years)
Interest on Borrowed Capital [Section 24(b)]	For self-occupied property, interest incurred on capital borrowed for the purpose of reconstruction, repairs or renewals to be allowed as deduction up to Rs. 30,000

Impact of rent collected from financially independent children being considered as let out property:

In the case of Moh. Hussain Habib Pathan, Mumbai vs Asst Cit 18(2), Mumbai on 6 March, 2020

Facts of the Case:

Issue was pertaining to the assessee’s residential house property.
Assessee had collected rent from his major son and major daughter, who were residing in the same house with the assessee.
According to the assessee, he had collected rent of Rs. 9,00,000 from his major independent children.
Deduction on account of interest (on borrowed capital) was at Rs. 21,62,120
He computed Income from House property at Rs.15,32,120

Calculations for arriving at this figure by the assessee are as follows:-

Description	Amount
Net Annual Value (this is the amount of rent collected in this case)	9,00,000
(-) Deductions u/s 24
Standard Deduction @30%	(2,70,000)
Interest	(21,62,120)
Income from House Property	(15,32,120)

Issue of the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)]

The assessee had collected rent from his major financially independent son and daughter.
According to the AO, nobody would ideally collect rent from their children especially considering that both children were unmarried and were residing together in the same home.
The AO regarded the arrangement as merely as a tax-reducing device adopted by the assessee.
The property should have been considered as ‘self-occupied’ and not as a ‘let out’ property whose Income from House Property would be restricted to interest of Rs 1,50,000.
Hence, the loss on house property would be reduced greatly according to the AO if this property was considered as self-occupied.
Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action.
Aggrieved, the assessee preferred an appeal to the Income Tax Appellate Tribunal (ITAT)

Proceedings of ITAT

The assessee had claimed that there was nothing to show that the arrangement, which is duly supported by written agreements, furnished in the assessment proceedings, is fake or a make-believe.
Rental income cannot be overlooked or disregarded merely because it arises from close family members.
Assessee, however, was not able to, state the status, i.e., self-occupied or rented, of the said premises for the earlier or subsequent years.
Although he submitted that this is the first year of the claim of loss.
The assessee, was also unable to provide with details of the area let out of the total area available, as other family members, including the assessee, were also residing in the same premises.
The Revenue’s case, on the other hand, stated that arrangement was clearly a device to avoid tax.

Contention of ITAT

Even though the matter was highly unusual, that, however, may not be conclusive of the matter.
Being a private arrangement, not involving any third party, not informing the cooperative housing society may also not be of much consequence.
The Revenue has rested merely by doubting the genuineness of the arrangement, without probing the facts further.
Inquiry into the following questions need to be made:-

i. What is the total area, as well as its composition/ profile?

ii. How many family members, besides the assessee and the two tenants, are residing thereat?

iii. Has the area let been specified, allowing private space (a separate bedroom each) to son and daughter, who would in any case be also provided access to or user of the common area – specified or not so in the agreement/s, viz. kitchen, balcony, living area, bathrooms, etc

iv. How has the rent been received, i.e., in cash or through bank and, further, been sourced, i.e., whether from the assessee (or any other family member), or from the capital/income of the tenants.

v, Why, there was even no attempt to inquire if the arrangement was a subsisting/continuing one, or confined to a year or two, strongly suggestive of, in that case, a solely tax motivated exercise.

5. ITAT stated that a genuine arrangement cannot be disregarded as the same results or operates to minimize the assessee’s tax liability.

6. The ITAT, accordingly, in principle, was in agreement with the assessee’s claim as there is nothing on record to further the Revenue’s case of the arrangement being not a genuine arrangement, i.e., apart from being unusual.

7. The house property is in view of the rent agreements, both a self-occupied and a let out property.

8. The interest claimed (Rs. 21,62,120) is for the entire property, which therefore cannot be allowed in full against the rental income, which is for a part of the house property.

9. The assessee’s interest claim therefore cannot be allowed in full and shall have to be suitable proportioned, restricting the interest claim relatable to the self-occupied part thereof to, as allowed, Rs. 1,50,000.

10. The assessee shall provide a reasonable basis for such allocation as well as the working of the area let.

11. In view of the joint residence, be that no area (portion) is specified in the rent agreements. The number of family members living jointly; their living requirements – which may not be uniform; fair rental value of the property, etc., are some of the parameters which could be considered for the purpose.

In the result, the assessee’s appeal is partly allowed on the aforesaid terms. Apportionment of interest deduction on the basis of area which was self-occupied and area which was let out was made. Interest deduction of area which was self-occupied was restricted to Rs 1,50,000.

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