1. Facts of the Case
- ‘A’ Company is a legal entity formed with the specific and sole purpose of constructing residential properties and letting them out on rent.
- The company’s Memorandum of Association (MoA) clearly states that the primary business objective is the acquisition, development, and leasing of residential units.
- The company does not engage in any other line of business such as trading, manufacturing, or consultancy.
- The entire revenue of the company is derived from rent received from tenants who occupy the properties developed and owned by the company.
- The core issue is the head of income under which this rental income should be taxed under the Income Tax Act, 1961—either:
- As “Income from House Property” under Section 22, or
- As “Profits and Gains from Business or Profession” under Section 28.
2. Issues in the Case
The primary issues arising from this case are:
- What is the correct head of income under which the rental income earned by ‘A’ Company should be taxed?
- Does the fact that the company’s main objective is to carry on the business of renting property alter the tax treatment of such income?
- Can rental income, in such circumstances, be considered business income, even though under general principles, rental income is taxed as income from house property?
- How do the judicial precedents interpret similar cases, and what is the settled legal position?
3. Legal Principles Covered to Support Case Proceedings and Judgements
A. Relevant Provisions of Law
- Section 22 – Income from House Property:
Tax is charged on the annual value of property consisting of buildings or lands appurtenant thereto, owned by the assessee, unless such property is used by the owner for business or profession carried on by him. - Section 28 – Profits and Gains from Business or Profession:
Profits and gains of any business or profession carried on by the assessee during the previous year are chargeable to income tax under this head.
B. Key Judicial Precedents
- Chennai Properties and Investments Ltd. v. CIT [2015] 373 ITR 673 (SC):
- The Supreme Court held that when the main object of a company is to acquire and let out properties, and the company derives its income from such activity, the income should be assessed as business income.
- In this case, the company’s MoA stated property letting as its main business, and hence the rental income was held to be taxable under “Profits and Gains from Business or Profession.”
- Rayala Corporation Pvt. Ltd. v. ACIT [2016] 386 ITR 500 (SC):
- Reiterated the principle in Chennai Properties. The Supreme Court emphasized that the nature of the income must be examined in the context of the main business activity of the company.
- Where the business is to earn income from renting properties, such income is business income.
- East India Housing & Land Development Trust Ltd. v. CIT [1961] 42 ITR 49 (SC):
- An earlier decision where the Supreme Court held rental income as income from house property since the letting activity was not the primary business of the company.
- The distinction was that mere ownership and letting is not business unless supported by a business objective.
- CIT v. Shambhu Investment Pvt. Ltd. [2003] 263 ITR 143 (SC):
- It was held that where the dominant intention is to exploit property by way of renting, income falls under “Income from House Property.” However, this case was distinguishable as it involved letting along with services.
C. Principle of “Dominant Object” Test
- The courts have developed the “dominant object” test—if the main business of the assessee is to exploit property commercially (not passively), the income may be classified as business income.
- This is particularly relevant for companies incorporated with the business object of property leasing or renting.
4. Possible Judgement
Likely Ruling:
Given the facts that:
- ‘A’ Company was formed solely for the business of constructing and letting out houses;
- The MoA clearly defines this as the main object;
- The company does not undertake any other activity apart from this;
- All income arises from such activity; and
- There is strong judicial backing from Chennai Properties and Rayala Corporation cases,
It is most likely that the rental income will be assessed as “Profits and Gains from Business or Profession” under Section 28, and not under “Income from House Property”.
Reasoning:
- The dominant intention of the company is to earn income through a structured business model of renting.
- The activity involves systematic and continuous operation, as opposed to mere ownership of property.
- The company is treating the properties as business assets, not investment assets.
