High Court: Rental Income is Business Income if Leasing is Company's Main Object

Mumbai - In a significant ruling clarifying the taxation of rental income, a High Court bench, led by Justice G. S.Kulkarni , has held that if the primary business activity of an assessee, as per its memorandum of association, is leasing properties, then the income derived from such leasing must be assessed as 'Income from Profits and Gains of Profession or Business' and not as 'Income from house property' under the Income Tax Act, 1961. The court allowed a batch of nine appeals filed by a common appellant (assessee) against orders of the Income Tax Appellate Tribunal (Tribunal).

Case Background: A Long-Standing Dispute

The core issue spanning nine assessment years (from 1989-1990 to 2008-2009) was the correct head of income under which the assessee's rental earnings should be taxed. The assessee, a company incorporated in 1983, had its main object as carrying on the business of leasing immovable properties. Since its inception, its sole income source was from leasing out approximately 85 properties, purchased often through loans from financial institutions.

Initially, from 1983 to 1989, the assessee's lease income was assessed as 'Income from Profits and Gains of Profession or Business'. However, for the Assessment Year (AY) 1989-90, the assessee initially filed returns under 'income from house property', but later filed revised returns and additional grounds of appeal before the Commissioner of Income Tax (Appeal) [CIT(A)] claiming it as 'income from profits and gains of business'. For subsequent years, the Assessing Officer (AO) assessed the income as 'income from house property'.

Interestingly, for several intervening years (AY 1993-94 to 1999-2000, and AY 2000-01 to 2004-05), the AO assessed the income as 'income from profits and gains of business'. Despite this, the CIT(A) and subsequently the Tribunal, for the disputed years, upheld the classification as 'income from house property', primarily relying on the Supreme Court's decision in East India Housing and Land Development Trust Limited Vs. Commissioner of Income Tax (1961) .

Arguments Presented

Assessee's Contentions (Represented by Mr. Cama ):

* The Tribunal erred in solely relying on the East India Housing case, which was distinguishable. In that case, the assessee's main object was promoting and developing markets, not deriving rent.

* The assessee's memorandum of association clearly stated its main object was the business of leasing real estate, which was its only business.

* The case was squarely covered by the Supreme Court's decision in M/s. Chennai Properties & Investments Ltd. vs. The Commissioner of Income Tax (2015) , which held that if letting properties is the main object, the income is business income.

* The principle of consistency should apply, as the Revenue itself had assessed the income as business income for 11 assessment years. Reliance was placed on M/s. Radhasoami Satsang , Saomi Bagh, Agra v. CIT (1992) and Godrej & Boyce Manufacturing Company Ltd. vs. Dy. CIT (2017) .

Revenue's Contentions (Represented by Mr. Suresh Kumar ):

* The Tribunal correctly applied the East India Housing principles.

* Even if leasing is the main object, the income should not necessarily be treated as business income.

* The Chennai Properties case was not applicable.

* However, counsel fairly conceded that for several assessment years, the AO had treated the income as 'income from profits and gains of business'.

Court's Analysis and Precedents

The High Court meticulously analyzed the precedents. Justice Kulkarni , delivering the judgment, noted the Tribunal's reliance on East India Housing :

"As far as the first issue is concerned, It is squarely covered by the Judgment of the Hon'ble Supreme Court in the case of East India Housing and Land Development Trust V/s CIT, 42 ITR 49, wherein it has been held that rental income from immovable properties is to be assessed under the specific head i.e., 'Income From House Property' if such asset Is owned by the assessee even though the assessee may be in the business of real estate."

The High Court, however, found this reliance misplaced. It emphasized that "the main object of the assessee is to earn income from letting out properties," distinguishing it from situations where such income is incidental.

Distinguishing East India Housing and Applying Chennai Properties

The Court elaborated on East India Housing , where the main business was "to buy and develop landed properties and to promote and develop markets," and rental income was incidental. In contrast, the Supreme Court in Chennai Properties & Investments Ltd. dealt with a company whose main object was acquiring and letting out properties. The Supreme Court in Chennai Properties held:

"letting of the properties is in fact is the business of the assessee. The assessee therefore, rightly disclosed the income under the head ‘income from business’. It cannot be treated as ‘income from the house property’."

The High Court found the present assessee's case aligned with Chennai Properties , stating:

"In the present case, the income of the assessee is derived from letting out of the properties, which in fact, is the principal business of the assessee as seen from its main objectives... therefore, the assessee was correct in accounting such income under the head ‘income from profits and gains of business’..." (Para 24)

Principle of Consistency

The Court also gave significant weight to the argument of consistency, noting the AO's acceptance of the income as 'business income' for 11 years. Referring to M/s. Radhasoami Satsang and a recent Bombay High Court decision in Banzai Estates P. Ltd. , the Court observed:

"...where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year, unless there was any material change justifying the Revenue to take a different view of the matter." (Quoting Radhasoami Satsang )

The Court concluded:

"Thus, even on the ground of consistency, the case of the Revenue in supporting the orders passed by the Tribunal cannot be accepted." (Para 27)

Decision and Implications

The High Court set aside the impugned orders of the Tribunal. It answered the questions of law in favour of the assessee, holding that the rental income derived by the assessee from its properties was assessable as 'Income from Profits and Gains of Business'.

This judgment reinforces the principle that the 'main object' of a company is a crucial determinant in classifying its income for tax purposes. It also underscores the importance of the 'principle of consistency' in tax assessments, discouraging arbitrary changes in the treatment of income by tax authorities when facts remain unchanged. This ruling will provide clarity for real estate and leasing companies whose primary business is letting out properties.