I-T dept is watching, claiming rent as business income won't be that easy

Taxation depends on whether the property is let out to enjoy the rent or the owner is exploiting it commercially

A common point of dispute between taxpayers and the Income-Tax (I-T) authorities is the treatment of rent earned from a property. Taxpayers like to show such rent as business income as they get the benefit of depreciation, higher deduction of expenses, and the owner doesn’t need to pay any notional rent when the property is not let out. As it leads to revenue loss, the I-T department scrutinises every case in depth to see if the taxpayer should be allowed to claim rent as business income.

The primary reason for disputes is that the I-T Act doesn’t provide a definite answer on how rent from a property should be treated. It, therefore, depends on the circumstances of each case. “The courts have ruled that classification of income from rent depends on whether the property is let out to enjoy the rental income or the owner is exploiting it commercially," says Arvind Rao, founder of Arvind Rao & Associates.

In a recent decision, the Delhi bench of the Income-Tax Appellate Tribunal (ITAT) held that income from leasing a warehouse has to be assessed under the head ‘income from house property’ and not as ‘income from business or profession’. Even the clauses contained in the memorandum of association (MoA) hold no force if the dominant objective of the agreement is to enjoy rental income.

A company,  engaged in the business of warehousing and transportation and carriage of goods purchased a warehouse that was already on rent. The taxpayer declared the rental income as business income and claimed expenses under the heads finance cost, depreciation and other expenses. But during assessment the tax officer considered the various clauses of the lease deed and noted that its dominant objective was to enjoy rental income. The officer disallowed the business expenses claimed by the taxpayer.

The Commissioner of Income-tax (Appeals) upheld the officer’s order. The case went to Delhi ITAT. The assessee said that it is primarily engaged in the business of warehousing and the MoA states it clearly. But the tribunal, too, upheld the previous order. “The Tribunal noted that after purchasing the warehouse that was already on rent, the nature of usage of the warehouse and payments remained the same. Thus, the nature of transactions or income generated from the warehouse (post change in ownership) remained the same,” says a note from PwC.

If you rent a property as an individual or as a company, in most cases you need to mention rent under the section ‘income from house property’ in the income tax return (ITR) form. It doesn’t matter whether it’s a house (residential) or an office (commercial). “When rent can be classified as business income depends on each case. There are, however, broad guidelines that a taxpayer can look at to see if rent can be business income,” says Naveen Wadhwa, a chartered accountant with Taxmann.com.

Rental income can be business income when, say, a business and its assets are leased out as a going concern, or assets are leased out along with furniture and fittings and other associated structures, or in addition to leasing of properties, various other services are regularly provided (like lifts, security, or other amenities such as machinery, canteen, housekeeping, etc).

Get the classification right

Income from house property A house let out or paying guest
                                                 Commercial property leased
Income from other sources   When a tenant sublets a property
Business income                   When business and assets are leased as going concer
                                             Along with leasing, other services, such as plant and machinery, are also provided