Sunday January 4, 02:03 AM

Source: Indian Express Finance

Are tax benefits on real estate income restricted to 'income from business'?

By Gautam Dalvi
The taxability of lease rentals earned by real estate developers has been a contentious issue between taxpayers and the revenue department. While taxpayers ordinarily argue that such income ought to be characterised as business income, the department holds the view that such income ought to be characterised as house property income. Dominant object of letting out property - key factor in income characterisation Essentially, the dominant object of letting out the property is the key factor in income characterisation. It was held by the Calcutta High Court in the case of CIT v/s Shambhu Investments Pvt Ltd (249 ITR 47) that the primary object of the assessee while exploiting the property was of key importance. Where, on the basis of applying such test, the intention of the taxpayer was one of letting out property or any portion thereof, income was held to be house property income while where the intention was one of complex commercial activities, the income was held to be business income. This decision has since been upheld by the Supreme Court in Shambhu Investments Pvt Ltd v/s CIT (263 ITR 143). Judicial precedents on income characterisation of lease rentals The Supreme Court, in the case of National Storage Private Limited v/s CIT (66 ITR 596), while deciding on whether income from letting of property was house property income or business income held that in a case involving complex facilities / services along with property thereto, the income therefrom would be construed to be in the nature of business income. On the other hand, where the income arose from bare letting of property along with certain incidental facilities or services, the income from letting would be in the nature of house property income. A similar view was held by the Calcutta ITAT in the case of PFH Mall and Retail Management Ltd v/s ITO (298 ITR 371). On the other hand, the Supreme Court in its landmark ruling in the case of East India Housing and Land Development Trust Limited v/s CIT (42 ITR 49) concluded that income received by the assessee from shops and stalls is in the nature of house property income. Following this decision, the Supreme Court in the case of Sultan Bros (P) Ltd v/s CIT (51 ITR 353) held a similar view, and with the reasoning that, Income derived by the company from shops and stalls is income received from property and falls under the specific head described in Sec 9. The character of that income is not altered because it is received by the company formed with the object of developing and setting up markets. Accordingly, what needs to be analysed in letting out property is the intention to derive income from property per se or whether the income arises out of a composite activity where the predominant purpose is provision of service or facility in which immovable property forms a part thereof. Tax Benefits - whether dependent on income characterisation? Generally, tax benefits under the provisions of the Income Tax Act, 1961 ( the ITA ) ought to be available notwithstanding income characterisation, based however on the specific facts of each case and in particular, where income can be construed to have been derived from complex commercial activities. While the characterisation of lease rentals would essentially be fact-driven, nevertheless it assumes significant importance in cases where taxpayers (real estate developers) are entitled to tax benefits under the ITA on such earnings. In particular, eligibility of tax benefits based on characterisation of income for SEZ developers and industrial park developers would be of significant importance. In the aforesaid cases, the relevant sections of the ITA provide that taxpayers having profits and gains from the relevant activity would be entitled for the specified tax benefits under the ITA. The question therefore is, whether characterisation of income as house property income (and not business income) would curtail the eligibility of tax benefits. Arguably, computation of income under different heads ought not to change the characterisation of income in the hands of the recipient. Therefore, even where the income is characterised of house property income, it ought to be arguable to say that such income represents profits and gains from the relevant activity for the purpose of eligibility to tax benefits. In this regard, reference may be made to the decision of the Supreme Court in the case of ORMMSPSV Firm v/s CIT (63 ITR 404). Accordingly, although lease rentals earned by real estate developers may be treated as house property income for the purpose of computation under the provisions of the ITA, the eligibility to tax benefits to ought not to be lost merely on the basis of income characterisation. The authors are senior and assistant manager respectively at PricewaterhouseCoopers