Under which head is Rental income taxable? – Income from House Property or Profits or Gains from Business & Profession
Introduction
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.
Some Previous Judgements for reference
Supreme Court in the case of Chennai Properties and Investment Ltd. v. Commissioner of Income Tax, (2015) held that income in case of companies where Memorandum of Association provides for carrying on the business of letting out is in the nature of business income and chargeable accordingly and not under the head “Income from house property”.
The Supreme Court in the case of East India Housing and Land Development Trust Ltd. v. Commissioner of Income Tax (1961) observed that the company was incorporated with the object of developing a market on the land purchased for this purpose. Accordingly, shops and stalls were constructed on the land purchased.
Certain shops were let out to different tenants and rental income was received by the assessee company. The Supreme Court primarily proceeded on the basis that there is separate head of income provided in the Income-tax Act for taxability of income from house property and, therefore, the income is chargeable under the above head.
The facts before the Supreme Court in the case of Karanpura Development Co. Ltd. v. Commissioner of Income Tax (1961) have been that income had been received pursuant to leasing of coal mining rights.
The assessee company was formed with the object, of acquiring and disposing of the underground coal mining rights in certain coal fields and it had restricted its activities to acquiring coal mining leases over large areas, developing them as coal fields and then sub-leasing them to collieries and other companies.
The assessee had shown the income as business income. The Supreme Court observing that the object and the manner of its activities and the nature of its dealings with its properties have to be considered and accordingly had held the income to be in the nature of business income for the purpose of above case and not as income from house property.
The issue had again come up for consideration before the Supreme Court in the case of Sultan Brothers (P) Ltd. v. Commissioner of Income Tax, (1964). The Appellant had let out building fully equipped and furnished for a term of six years for running a hotel and for other ancillary purpose.
The Supreme Court observed that whether a particular letting is business has to be decided in the circumstances of each case. Further, it was observed that “each case has to be looked at from a businessman’s point of view to find out whether the letting was the doing of a business or the exploitation of his property by an owner”.
It was also observed that merely an entry in the object clause showing a particular object would not be determinative factor to arrive at an conclusion whether the income is to be treated as income from business and such a question would depend upon the circumstances of each case viz. whether the particular business is letting or not. Accordingly, in the facts of above case the Supreme Court held the income to be in the nature of business income.
In the case of Raj Dadarkar & Associates v. ACIT, the Apex court held that apart from relying on the object clause, the taxpayer would be required to produce or refer any other material to show the conduct of activities as per its constitution documents.
Based on the material produced by the taxpayer, the Apex court held that the taxpayer was unable to establish that he was engaged in any systematic or organised activity of providing services to the occupiers of the shops to constitute receipts from them as business income.
Salient principles to classify Rental Income as Business Income
- Intent of the taxpayer is to do business – this intention can be gathered from the agreement for lease, Memorandum of Association and subsequent conduct of the parties.
- 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 HP.
- Constitution documents of the taxpayer provide that the main object is to hold the properties (presumably not for gains) and let them out to earn rental income – the activities carried out by the taxpayer should be in line with the constitution documents.
Let us refer to the below example to understand this better
Mr. X’s company is in the business of manufacturing of textile. The company has income from letting out of Shop (Covered under definition of House Property). Can Mr. X claim renting of property income in Income from House Property instead of Profits or Gains from Business or Profession.
Since the main business is textile and renting income is secondary to the main object of the company, rent received from the shop should be shown under Income from house property.
The clarification was given in a case law Chennai Properties and Investments Vs CIT (2015) where the main object of the company as specified in the Memorandum of Association (MOA) should be considered for charging such income under Profits or Gains from Business or Profession or Income from House Property.
If the MOA contains renting of property as one of its main objects (along with textile business) then the same should be charged under Profits or Gains from Business or Profession and not under Income from House Property. Ensure that the MOA is reviewed before taking any decision.
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