Prove that you tried to find a tenant for empty second house or pay tax

Ace cricketer Sachin Tendulkar was recently involved in a dispute with the income tax department. He was unable to let out a flat in Pune despite his best efforts. Tendulkar, therefore, declared the income from the flat to be nil. The income tax department, however, took the view that he had to pay tax on notional rent for the vacant flat.

Tendulkar won the case. But for most individuals it may not be easy to get this benefit. “While this (Tendulkar’s) is a favourable judgement in respect of a property that was vacant throughout the year, there are contradictory judgements on whether the vacancy allowance should be granted to a property that is not let out at all during the financial year,” says Amarpal Chadha, tax partner and India mobility leader, EY India. He adds that it may be challenging to claim the benefit of vacancy allowance as the revenue authorities may not accept the claim.

The ruling says that the cricketer made ‘reasonable effort’ to let out the property. But the term ‘reasonable effort’ is subjective and its interpretation can vary from case to case.

Taxation of rental income: If a person owns more than one house, and rents out the other properties that are not self-occupied, he needs to pay tax on rental income from them. But what happens if the property is not let out? In such cases, the house owner has to still pay tax on the notional income he would have received if the property was let out.

The Income Tax Act even prescribes a method to calculate the ‘notional rent’ for vacant properties. “Factors such as location, annual rateable value of the property fixed by municipalities, rents of similar properties in the neighbourhood, and the rent that the property is likely to fetch should be considered,” says Mridhu Malhotra, associate director, Nangia Advisors.

If a person owns multiple properties, one property of his can be considered to be his self-occupied property (SOP) and its annual value is taken to be nil. “The property owner can exercise his discretion regarding which of his properties he would like to declare as self-occupied,” says Suresh Surana, founder, RSM Astute Consulting Group. The annual value of the other properties, irrespective of whether they are let out or not, are taxed on notional basis, that is based on reasonable rent expected from the property.

Notional rent applies to multiple owners: In case siblings receive a property by way of inheritance or Will, they still need to pay notional rent. “Depending on the share of the ownership in the property, the individuals inheriting the property will need to pay notional rent on such a house,” says Chadha.

In case a person owns two houses, one of which is self-occupied and his parents or relatives stay in the other house, notional rent will still be payable. “The other house property will be considered as a deemed let out property for tax purpose,” Gopal Bohra, partner, N A Shah Associates.

Tendulkar’s case study: He owns properties in Pune - a flat in a complex called Sapphire Park that costs Rs 6.06 million, and another in a complex called Treasure Park that cost Rs 8.28 million. The second flat was rented at Rs 15,000 per month for nine months. The cricketer offered this income for tax. On the first property, however, he declared that the income from it was nil as he had been unable to find a tenant for that property despite making due effort. Tendulkar produced letters that he had sent to the developer to help him find a tenant. The assessing officer refused to buy Tendulkar's submission that he had made all possible effort. He also felt that the rent from the first flat that he had submitted for taxation was too low. Instead, he calculated the notional income from the two flats at 6 per cent of their combined value. This came to Rs 860,000. The tax department also said that there was no evidence that Tendulkar had actually sent those letters to the builder. Further, no response from the builder was available. 

The Income Tax Appellate Tribunal (ITAT) ruled in the cricketer's favour. The ITAT found the cricketer's effort to be reasonable. It also noted that someone who paid massive amounts (Rs 612 million) in tax was unlikely to produce a false letter to avoid paying tax on a much smaller amount.  

‘Reasonable effort’ is subjective: The ITAT, Mumbai, said that the words ‘property is let’ includes the intention to let and not just actual letting. There are no pre-defined activities which can be considered to constitute reasonable effort and the Income-Tax Act does not cover this aspect. It is a subjective area. Tax experts say that a house owner has to produce evidence beyond doubt to prove that he made an effort to let out the property. “The evidence would  include the communication with brokers and potential tenants, advertisement in a newspaper, and listing of the property on online broking sites with the rental amount mentioned on it,” says Naveen Wadhwa, general manager, Taxmann.com. Surana, too, emphasises that you should maintain adequate records to prove that effort was actually made to find a tenant.

Terms to know if you own multiple houses

• Deemed let out: If you own more than one house, and one or more of them is vacant, you still need to pay tax on the notional rent you could have received
• Notional rent: The rent an owner could get for a vacant house that is not self-occupied. To calculate the notional rent, the owner needs to consider factors such as rateable value fixed by municipalities and the rent similar properties fetch in the neighbourhood
• Reasonable effort to let out: If you are unable to find a tenant for your property, ensure that you have made all efforts to do so, such as appointing a broker and listing it on property websites, to claim tax benefit. Preserve all communication
• Vacancy allowance: When the tax department allows you not to pay tax on a vacant house, believing you have made reasonable efforts