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Notional income in case of real estate companies

Suresh Thiyagarajan 
on 25 July 2019

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Income from unsold flats by Real Estate Companies:

We all know at any point in time companies engaged in the business of construction of residential house property will have an unsold property. Since these houses are left vacant, the only question is, could notional rent be charged on these unsold flats?

Let us see some important provisions taxing the house property income before moving on to further analysis.

According to sec 22 "If the property consists of building or land appurtenant thereto of which the assessee is the owner the same shall be charged to tax under the head Income from House Property". The annual value of the property is determined u/s 23(1), where it is charged to tax on actual rent received or expected rent, whichever is higher. It is reasonable for the department to charge to tax the income received on such house property. As per sec 24(4), if the assessee owns more than one house, at his discretion one house will be considered as self-occupied and the remaining house will be charged to tax based on the annual value determined u/s 23(1), considering the same as deemed to be let out. The important connotation in here is deemed to be let out and notional rent on houses which are not let out during the year.

Why charge Notional Rent to tax?

The underlying concept to the introduction of sec 23(1) which makes the assessee pay tax on the higher of actual rent received or expected rent is to curb the assessee from showing lower rent than what that should have reasonably been expected to be shown as income.  For example, a house which may normally fetch Rs. 10,000 p.m as rent and there is a possibility that the assessee being the owner of the property can let it out for Rs. 5,000 p.m and can get the balance Rs 5,000 in some other form of benefits from the tenant. By introducing the above provision, Rs. 10,000 (expected rent) is getting taxed in the hands of the owner.

Having known the idea behind the introduction of sec 23(1), can the same be stretched to 'deemed to be let out' concept?

As per sec 23(4), even if the house property is not let out during the year the same will be subject to tax on Notional rent basis as per sec 23(1). The idea behind this sub-section is not to make investments in house property and keep it idle. This sub-section discourages the owners to keep their house property idle to refrain from polling all the money into the property which will not yield any revenue. Hence, Sec 23(4) discourages the owners of the house property from not letting out to rent and even if it is not let out, the tax will be charged to the same on notional basis. Some might say it is harsh for taxpayers to pay tax on income which they have not even earned, but government formulates such rules from time and again to keep the money flowing instead of getting stacked together in one place. Thus, such discouraging provision is appreciated from a macroeconomic point of view.

Companies engaged in real estate face the heat of such rules. It is not common for such companies to sell off their stocks (house property in this case) as soon as it is completed. Some may able to sell and some may not be able to sell their flats. There is a possibility that it may remain vacant for a longer period than expected but thanks to the Finance budget 2018 and 2019, where it came with an explanation on how to deal with annual rental value in case if the house property is held as stock in trade.

As per the Finance Act 2019 if the assessee holds the property as stock-in-trade then the annual value of such property will be taken as nil for a period of 2 years from the end of the Financial Year in which the certificate of completion of such property is obtained from the competent authority. Though this brings huge relief for various builders across the country who still have unsold flats, there arises a serious question on whether it would be prudent to charge tax on notional rent after the expiry of two years?

We can analyze the recent judgment by Income tax Tribunal (ITAT) in the case of M/s Kolte Patil I-Ven Townships, Pune Ltd Vs ACIT.

Assessee engaged in the business of real estate and construction of the building had 32 unsold flats held as stock in trade. AO invoked sec 23(4) and added the notional rent on the above flats under the head Income from House property and charged to tax accordingly. Though the question in dispute is not whether the charging of notional rent under Income from house property or Business income but rather whether such notional rent is ever charged to tax. The above ruling given by the ITAT concurred with the assessee's view and does not allow to add notional rent as a part of the income of the assessee on such unsold 32 flats.

However, the above case was prior to Finance Act 2018 and now as sec 23(5) clearly states that only up to 2 years (effective from 01.04.2019) from the end of the year from which the certificate of completion from the competent authority was obtained, Annual Letting Value(ALV) will be considered as nil and after the above period the same will be subject to tax based on notional rent basis under the head Income from House property.

My take on charging notional rent to tax:

1. The overall point in the introduction of sec 23(4) is to discourage the owner from keeping the property idle as it will not fetch any revenue to the assessee or the department. Thus, notional rent on the unoccupied property has been brought to tax. If the property is held as a capital asset and it’s been kept idle for over a period and there is no flowing of funds from such property, thus sec 23(4) acts then as a prudent means in the above case.

2. Whether the same could be stretched to the assessee holding the property as stock in trade?

As we have discussed earlier possibilities of unsold flats by the builders could be high and this provision will act as an unnecessary burden to the builders to sell off their flats at a lower price or pay tax on notional rent for unsold flats. Before the Finance Act 2018, there is no express provision or explanation on charging notional rent to tax but with the introduction of Finance Act 2019 where the period of 2 years looks reasonable for a builder to sell his stock in trade and if not, he may have to pay tax under sec 23(5).

The repercussions of the above section on Builders from the macroeconomic point of view are,

i) Builders will aim to sell off their constructed property as soon as they are completed.

ii) Prices may come down due to clear explanation that after the expiry of 2 years notional rent will be taxable. Builders better sell off their flats at a lower price than pay tax on notional rent.

iii) Companies taking up constructions will decrease though not abruptly but at a reasonable number.

Conclusion:

It is a welcoming move to add a provision on notional rent concerning "stock-in-trade" and give a cooling-off period of 2 years for an unsold property held as stock-in-trade. But the impact of the same should be monitored from a macroeconomic point of view making changes in the long run if needed.


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Suresh Thiyagarajan 

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