Tax on property income depends on owner's business

Be careful before categorising it as business income to claim deductions. Court judgements have clearly defined rules for such classification

Nowadays, many individuals are investing in real estate to create a regular income stream from rent. Apart from residential property, they are increasingly looking at spaces they can rent out to banks for ATMs, godowns, small shops and even commercial complexes. However, filing tax on the income received from such rent can be tricky-it can be classified business income, income from house property, or as other income depending on owner's main line of business.

Claiming deduction

Whether your income from real estate is treated as business income or as income from house property will have a significant impact on the tax deductions you can claim. For example, there are no specific restrictions on the deductions you can claim for business income. The tax payer is free to deduct all eligible expenses from his business income. However, the tax laws do prescribe limits on the quantum of deductions a tax payer can avail on income from house property . Only 30 per cent standard deduction, municipal taxes and interest on borrowed capital can be claimed as deductions.

Classify appropriately

If an owner does not use a property for her business or professional purposes, the rental income from that property will be treated as income from house property. In other cases, it will be treated as business income. Suppose that the owner's main business is to let out property. In that case, rental income from the property, even if it is a residential property, will be considered as business income. There is a court judgement in this regard which states that if the owner runs a paying guest establishment, the income received will be assessed as business income.

However, if letting out is not the property owner's main business, then the rental income from either commercial or residential property will be taxed as income from house property. Further, if the owner holds a few properties as stock-in-trade and receives rental income from them, this will also be taxed as income from house property, unless letting out is the business of the owner.

GETTING IT RIGHT

• Whether the rental income you earn from a property gets classified as income from house property or as business income determines the tax deductions you can avail on it
   
• If you don't use the premises for your own business or professional purpose, the income will be treated as that from house property
  

 

If the owner's main line of business is to let out properties, then the rental income he earns, even from a residential property, will be treated as business income
 

Treatment of composite rent depends on whether the building and other assets are inseparable, or they have been rented out separately
 

Income from sub-letting however, can be treated as income from house property

All this makes it clear that income earned from letting out commercial property does not necessarily fall under the category of business income. This was highlighted by the Madras High Court in the case of Keyaram Hotels vs Deputy Commissioner of Income Tax.

The court ruled that if the owner is not engaged in the business activity of letting out properties, rental income received even from commercial property would be assessed as income from house property and not as business income. It observed that the owner had derived income from leasing out his property and had then disclosed it as business income. However, he had not undertaken any commercial or business activity to earn such income.

Treatment of composite rent

When an owner lets out a property along with other assets, for instance, a building with furniture or a factory building with machinery, the rent he receives is not just for the building but also for the other assets. At times, a person may also let out property and provide various facilities along with it, such as supply of water, security, etc. The rent he receives in all these cases is referred to as composite rent.

If the composite rent is inseparable, then the entire amount is charged under the head of business income or income from other sources, as the case may be. A Bombay High Court judgment clarifies this in the case of CIT vs DL Kanhere (1972). An individual had leased a cinema building with furniture. As a cinema hall and furniture are inseparable, the court ruled that his rental income was to be treated as income from other sources without any apportionment.

If the property has been let out but the tenant has been provided with additional right to use furniture and fixtures, then the rental income is income from house property whereas the income from letting out of furniture will be treated as income from other sources or business income (if the owner is in the business of letting out furniture).

Income from sub-letting

With rental charges surging, many tenants consider sub-letting a portion of their rented premises. In such a situation, the income from sub-letting cannot be treated as income from house property as the tenant can never be the owner of the property. It has to be treated as income from other sources. However, the Income Tax department has held a contrary view. According to it, since the tenant is in full control of the property, there is nothing to suggest that ownership of the premises is essential for levying tax under income from house property. In such situations, the matter will be decided on case-by-case basis.

Rental income will not be considered as income from house property in three situations: one, the property is used by the owner for his business or professional purposes; two, the owner's main activity is to let out property; and three, if rental income from the property is inseparable from rental income received for furniture or fixtures.

They key principle that tax payers must bear in mind is that the nature of the property is immaterial for determining tax treatment. This depends primarily on what the owner's main line of business is.

Sudhakar Sethuraman is partner, Lakshmanjee Repaka is manager and Mahima Jain is assistant manager at Deloitte Haskins & Sells LLP