Section 23(5) - Taxing of notional income in the hands of real-estate developer

Section 23(5) of the Income Tax Act - Explained

Real estate developer a.k.a builders as the name suggests are the people who are involved in construction of flats, bungalows and similar properties for the purpose of sale. Therefore, such properties are stock in trade for them. Correspondingly, when such properties are sold by the builders either pre or post-completion their income from the business of building construction is chargeable under the head "Profit from Business or Profession". Builders generally as a matter of practice are not interested in leasing of such property (ies) hence even the department in most of the cases, did not invoke provisions of section 23 of Income-tax Act, 1961 ('the Act') to tax the notional income deemed to accrue on completed vacant property(ies) held as stock-in-trade by the builders.

Furthermore, if in case the builder has let-out the said constructed property held as stock in trade, the annual value computed as per section 23(1) of the Act after allowing deductions mentioned under section 24 of the Act shall be taxable under head "Income from House Property" under section 22 of the Act in view of the recent judgment of Hon'ble Supreme Court in the case of Chennai Properties and Investments Ltd. v. Commissioner of Income Tax [2015] 373 ITR 673 (SC) since the main object of the company was to sell the property(ies) and not let-out the same."

Nevertheless, the issue regarding chargeability of tax on notional income deemed to accrue on completed vacant property (ies) held as stock-in-trade by the builders arose for consideration before the Hon'ble High Court of Delhi in the case of Commissioner of Income-tax v. Ansal Housing Finance and Leasing Co. Ltd. and Ors (2013) 354 ITR 180. The facts in the aforesaid case are that the assessee company was engaged in the business of development of Mini Township, construction of house property, commercial and shop complexes, etc. The Assessing Officer while passing the order of assessment for the relevant year assessed the annual letting value of the flats which the assessee had constructed, but were lying unsold under the head "Income from House Property". The assessee contended that such flats were its stock-in-trade and, therefore, the annual letting value of the flats could not be brought to tax under the head "income from house property". The Hon'ble Jurisdictional ITAT agreed to the contentions raised by the assessee and dismissed the appeal preferred by the Revenue. Correspondingly, a further appeal was preferred by the revenue before the Hon'ble Delhi High Court. The Hon'ble High Court upheld the taxability of notional income computed as section 23(1) of the Act on vacant house properties held by the builder as stock in trade.

Due to the aforesaid adversarial judgment of Hon'ble Delhi High Court, builders across the country were forced to face exorbitant tax demands. To better understand the gravity of the situation, there are more than 1.5 lacs unsold housing units in Delhi-NCR region per the survey conducted by Consultant JLL India published in TOI in March 2018 which is sufficient to raise tax demands of roughly 1890 cr. {1,50,000 (nos. of unsold flats)*50,000 (avg. expected rental) *12(months)*30%(tax rate excld cess)*70%( post std-deduction)}from Delhi-NCR region itself only. It would not be out of place to mention that such humungous tax demands are enough to put the last nail in the coffin of struggling real-estate industry facing the aftermath of demonetarization, RERA, and GST.

Considering the plight of the ailing real-estate industry, the Hon'ble Finance Minister vide Finance Act, 2017, inserted sub-section (5) to section 23 of the Act so as to provide relief from business exigencies as evident from the Memorandum to Finance Bill, 2017. The relevant extracts of sub-section (5) to section 23 of the Act are re-iterated as under:

"(5) Where the property consisting of any building or land appurtenant thereto is held as stock-in-trade and the property or any part of the property is not let during the whole or any part of the previous year, the annual value of such property or part of the property, for the period up to one year from the end of the financial year in which the certificate of completion of construction of the property is obtained from the competent authority, shall be taken to be nil."

On perusal of the above, it can be clearly inferred that the said sub-section (5) has been inserted in section 23 is beneficial for the real estate sector as it provides relief to the taxpayer builders from the draconian provisions of section 23(1) of the Act requiring payment of tax on notional rent of unsold inventory for a period of one year from end of the financial year in which completion certificate has been obtained.

Further, in this regard it is pertinent to mention that the Hon'ble Finance Minister Shri Piyush Goyal vide Finance Bill, 2019 based upon the recommendation from industry further extended relief to the taxpayer builders for one more additional year. Consequently, notional rent in respect of unsold inventory shall not be charged to tax up to two years, instead of existing one year, from the end of the financial year in which the certificate of completion is obtained from the competent authority. 

Provisions of sub-section (5), is also adverse for the real estate sector as it affirms the position laid down the Hon'ble Delhi Court, even though the SLP preferred is still pending before the Hon'ble Supreme Court, to tax the notional income as computed by section 23(1) of the Act in respect of vacant properties held by a builder as stock-in-trade.

At this juncture, it is pertinent to draw attention to the provisions of section 23(1) of the Act which provides for determination of annual let-able value ("ALV"). The relevant extracts of the same are re-iterated as under:-

"23(1). For the purposes of section 22, the annual value of any property shall be deemed to be—

(a)  The sum for which the property might reasonably be expected to let from year to year; or

(b) where the property or any part of the property is let and the actual rent received or receivable by the owner in respect thereof is in excess of the sum referred to in clause (a), the amount so received or receivable; or

(c) where the property or any part of the property is let and was vacant during the whole or any part of the previous year and owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the sum referred to in clause (a), the amount so received or receivable"

On perusal of the above, it is clearly evident that:-

• Clause (a) of sub-section (1) clearly provides that the annual value of the property shall be the expected rent same for which the property might reasonably be occupied to let from year-to-year.
• Clauses (b) and (c) provide for modification in the amount of annual value determined in terms of clause (a).
• Clause (b) provides that where the actual rent received or receivable is higher, the same will be determined to be annual value.
• Clause (c) provides for where property remains vacant and for that reason, the amount of rent received is less than the sum referred in clause (a), such lower amount will be determined to be annual value.

On perusal of the above, it may prima-facie seem that the assessee builder even after expiry of period as envisaged u/s 23(5) of the Act can still avoid tax liability based upon deemed ALV computed u/s 23(1)(a) of the Act by relying upon clause (c) of section 23(1) of the Act. However, due to divergent interpretation of expression "property is let and was vacant during the whole or part of the previous year" used in section 23(1)(c) of the Act, it is uncertain whether the assessee would be able to avoid payment of taxes if the properties remain vacant throughout the year. Nevertheless, assessee builder would still be able to claim the benefit of section 23(1)(c) of the Act if the said properties are let-out for any part of the year.

The aforesaid expression has been thoroughly examined by the Hon'ble Mumbai ITAT in the case of Premsudha Exports Pvt. Ltd. v. ACIT (110 ITD 158)(2008)4 and the key takeaways of the said judgment are mentioned as under:-

1. The expression 'property is let' used in clause (c) of section 23 (1) does not mean actual letting out of the property as the word "actually" does not appear in the expression and the legislature wherever they have considered it necessary used the term "actually" such as in section 23(3), wherein they have used expression 'house is actually let'. 

2. If "property is let" used in section 23(1)(c) means "property is actually let" then it may lead to undesirable result because in some cases, if the owner has let out a property for one month or for even one day, then that property would acquire the status of 'let out property' for the purpose of clause (c) of section 23(1) for the entire life of the property, even without any intention to let it out in the relevant year. Further, if the property is let out by the previous owner then the property will get the status of let out and the new owner will also get the vacancy allowance u/s 23(1)(c).

3. Thus, if a property is held with an intention to let out in the relevant year coupled with efforts made for letting it out, it could be said that such a property is a let-out property and the same would fall within the purview of clause (c) of section 23(1).

Further, the aforesaid analogy is also supported by following judicial precedents:- 

1. Kamal Mishra v. ITO (2008)19 SOT 251 (Del);
2. Vikas Keshav Garud v. ITO(ITA 747/Pune/2014)
3. ACIT v. Dr. Prabha Sanghi (2012)(139 ITD 504)(Del)  
4. Smt. Poonam Sawhney v. AO (2008)(20 SOT 69)(Del);
5. DLF Office Developers v. ACIT (2008)(23 SOT 19)(Del);
6. Indu Chandra v. DCIT (ITA 96/2011)(Luck);
7. Shakuntala Devi v. DDIT(ITA No. 1524/Bang/2010);
8. Aryabhatta Properties Ltd. v. ACIT (ITA No. 6928/ Mum/2011);
9. ACIT v. Suryashankar Properties Ltd. (ITA No. 5258/Mum/2013);
10. Sachin R. Tendulkar v. DCIT-23(3)(ITA No. 3755/Mum/2016)(2018).

At this juncture, it is pertinent to point out that the Hon'ble Andhra Pradesh High Court in the case of Vivek Jain v. ACIT(2011)(337 ITR 74) has expressed contrary view to the aforesaid interpretation of the statute and held that the provisions of section 23(1)(c) of the Act will not apply in a situation where the property has not been let in the previous year.

Similar interpretation of section 23(1)(c) of the Act has been supplied by the following judgments :

• Gujarat Ginning & Mfg. Co. Ltd. v.CIT (1994)(205 ITR 314) (GHC)
• Susham Singla v. CIT (2017)( 244 Taxman 302)(Punjab & Haryana HC)

It would not be out of place to mention that the judgment of Hon'ble Andhra Pradesh High Court in the case Vivek Jain was not relied by the revenue in the afore-mentioned favourable judgments namely:-

• Kamal Mishra v. ITO (2008)19 SOT 251 (Del);
• Vikas Keshav Garud v. ITO(ITA 747/Pune/2014)
• ACIT v. Dr. Prabha Sanghi (2012)(139 ITD 504)(Del)  
• Smt. Poonam Sawhney v. AO (2008)(20 SOT 69)(Del);
• DLF Office Developers v. ACIT (2008)(23 SOT 19)(Del);
• Indu Chandra v. DCIT (ITA 96/2011)(Luck);
• Shakuntala Devi v. DDIT(ITA No. 1524/Bang/2010);
• Aryabhatta Properties Ltd. v. ACIT (ITA No. 6928/ Mum/2011);
• ACIT v. Suryashankar Properties Ltd. (ITA No. 5258/Mum/2013);
• Sachin R. Tendulkar v. DCIT-23(3)(ITA No. 3755/Mum/2016)(2018).

Conclusion

As of now, the Hon'ble High Courts have unanimously held that the income from house properties which has been vacant for the whole of the previous year, shall be determined as per section 23(1)(a) of the Act. However, contrary opinion has been expressed by Hon'ble ITATs even after pronouncement of the afore-mentioned Hon'ble High Court decisions. Such divergent views have resulted in a situation where computation of income from vacant house properties is utterly uncertain.

Further, as regards to question involving computation of notional income u/s 23 of the Act from properties held as stock-in-trade by the assessee builder after expiry of period mentioned in section 23(5) of the Act as per judgement of Hon'ble Delhi High Court in the case of Ansal Housing Finance and Leasing Co. Ltd. and Ors (2013) 354 ITR 180 is still pending before the Hon'ble Supreme Court. Until clarity to the said matter is brought by a judgment of Hon'ble Supreme Court, there's absolute certainty that huge litigations will occur over the said issue.