Vacancy allowance to real estate developers - Relief from tax for what may not be taxed?

Introduction:

Finance Act, 2017 amended [see End Note 1] the Income-tax Act, 1961 (‘IT Act’) to provide that the annual value of building or land appurtenant thereto which is held by the assessee as stock-in trade will be deemed to be Nil for a period of one year from the end of the financial year in which the certificate of completion is obtained in respect of such property. It was explained in the Memorandum to the Finance Bill, that the provision had been inserted after “considering the business exigencies in case of real estate developers.”

However, the provisions of IT Act do not expressly provide that the income from vacant house property can be taxed in the first place. As will be discussed in the subsequent paragraphs, there are contrary views of different fora on the taxation of the house property which has been vacant throughout the year. 

The said amendment provides for a limited period relief beyond which the taxability will have to be ascertained as per regular provisions. Therefore, the inserted provision needs to be analysed in light of the judicial pronouncements to examine as to whether a benefit to this extent was required to be provided by the legislature. If the annual value can be said to be nil even without the help of this amendment, then there won’t be tax liability even beyond the one-year period specified in the said amendment. In order to appreciate the dispute, it is pertinent to understand the legal provisions providing taxation of income from house property.

Legal Provisions:

The provisions [see End Note 2] of IT Act create a charge of tax on annual value of property (consisting of buildings or land appurtenant thereto) which is owned by the assessee other than properties which are occupied for business or profession of the assessee.

The term ‘annual value’ has been defined in section 23 of the IT Act:

“(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…….”
                                                                                                   (Emphasis Supplied)

Dispute in interpretation:

It is evident from the perusal of the provisions of Section 23 of the IT Act, that the legislature seeks to tax not only the actual income which has been received by the assessee by letting out the property (vide clause (ii) of section 23(1)), but also the notional income which the assessee might have realised from letting out such property (vide clause (i) of section 23(1)). The constitutional validity of subjecting such notional income to tax has been examined by the Supreme Court [see End Note 3] and it has been upheld that the legislature is competent to tax not only what has been received by the assessee from exploitation of the property but also what can be converted income from use of property. The competency of the legislature to tax notional income is therefore, not a subject matter of dispute.

The divergence of views lies in interpretation of section 23(1)(c) of the IT Act which seeks to provide a relief in respect of vacant house properties. Section 23(1)(c) of IT Act provides that where a house property was ‘let’ but remained vacant during ‘whole or any part’ of the year owing to which the rent received or receivable is less that its lettable value (as provided in section 23(1)(a) of IT Act), then such sum received or receivable shall be deemed to be annual value of the property.

The clause, it seems, encompasses two diametrically opposite situations. On one hand, the qualifying condition for the clause is that the property should have been let out by the tax payer and on the other hand, the clause includes even those properties which have been vacant throughout the year. This peculiar use of words has led to a dispute between the taxman and the taxpayer. It is contested by the former that in case of house properties which have been vacant throughout the year, clause (c) cannot be applied, as the qualifying condition (i.e. property should be let) is not met and the annual value in such cases should be computed in terms of section 23(1)(a) of IT Act. On the other hand, the taxpayers contest the express inclusion of a property which is vacant throughout the previous year in section 23(1)(c) of IT Act makes it evident that the legislature seeks not to tax the notional income from the property. It is evident that the latter interpretation will make the annual value of property ‘nil’ and consequentially will result in a nil tax from house property.

Judicial Precedents:

There have been divergent views by different fora on interpretation of Section 23(1)(c) of IT Act:

1. In favour of revenue: Hon’ble High Court of Andhra Pradesh [see End Note 4] held that provisions of section 23(1)(c) will not apply in a situation where the property has not been let in the previous year. The Court also held that the condition of a property (which has been let) being vacant throughout the year can also be met in a case where the property is let for more than a year but is vacant throughout the year. In reaching its conclusion, the Court heavily relied on the CBDT circular [see End Note 5] and the judgment of the Hon’ble Supreme Court [see End Note 6]. In the latter case, the Supreme Court was interpreting the erstwhile provision relating to vacancy allowance contained in section 24(1)(ix) of IT Act. Since the provisions relating to vacancy allowance were pari-materia to section 23(1)(c) of the IT Act, the Court supplied the interpretation of the Hon’ble Supreme Court to section 24(1)(ix) of IT Act. Similar interpretation to section 23(1)(c) of IT Act have been supplied by Hon’ble High Court of Gujarat [see End Note 7] , Hon’ble High Court of Delhi [see End Note 8]  and Hon’ble High Court of Punjab and Haryana [see End Note 9]. The SLP preferred by the assessee against the latter judgment was dismissed by the Hon’ble Supreme Court [see End Note 10].

1.  In favour of assessee: In a matter before Mumbai Bench of ITAT [see End Note 11] , the      Bench held that since the provisions of section 23(1)(c) also cover a situation where a  property can be vacant for whole of the previous year, the income from property which has been vacant for whole of the previous year will be computed in terms of section 23(1)(c) of the IT Act. The aforesaid judgment of Mumbai Bench was followed by Pune Bench [see End Note12] and Bangalore Bench [see End Note 13]. While the judgment of Hon’ble Andhra Pradesh (supra) was not relied on by the revenue in the latter judgment, the bench in the former judgment held that the judgment of Hon’ble Court ‘cannot be read in a manner that if the property remains vacant throughout the year, section 23(1)(c) do not apply at all more so when the property was let out in the proceeding or subsequent year”. However, in a subsequent judgment, Hon’ble Mumbai Bench [see End Note 14]  held that the understanding stated in its earlier judgment could not be supplied to section 23(1)(c) as such judgment was delivered prior to the judgment of Hon’ble Andhra Pradesh High Court. But when the issue was again brought up before the Hon’ble Mumbai Bench [see End Note 15] recently, the bench did not follow the law laid down by High Courts (as per the judgment, it seems judicial precedents of High Court were not cited before the Bench by the revenue) and followed the interpretation supplied in Premsudha Exports¹¹ and held that income from property vacant throughout the year will be deemed to be Nil.    

Author’s analysis:

It is pertinent to note that the text of the section as interpreted by the Apex Court⁶ was materially different from the current text. It used the phrase ‘let and was vacant during a part of the year’ as against the present text which reads as ‘let and was vacant during the whole or any part of the year’.  The conscious insertion of the expression ‘the whole’ cannot be ignored and left redundant unless such result is unavoidable. The difficulty that one may find is as to how to reconcile the situation of whole year’s vacancy with the condition that the property should have been let. It is obvious that both cannot co-exist therefore ideal interpretation is to attribute a sense of rationality to the law maker and assume that they would not have intended self-contradictory conditions. The problem can be solved if the application of the word ‘let’ is confined to the phrase ‘any part of the year’ and not extended to ‘vacant during the whole…year’.  This interpretation will:

1. Avoid any words in the clause becoming redundant;
2. Attribute a sense of rationality to the Parliament; and
3. Would not offend one’s sense of justice else one may have to grant vacancy deduction and tax only for one day to a case of 364 days of vacancy due to one day’s letting while on the other hand tax for 365 day for a vacancy of 365 days.
4. Ensure that an objective interpretation is supplied over a subjective interpretation. Thus, subjective criteria like intent to let [see End Note 16] or the relevance of the extent of the period for which the property should be let [see End Note 17] before it becomes vacant etc., will be no consequence.

Conclusion :

Although, the High Courts seem to have unanimously held that the income from property which has been vacant whole of the previous year, will be determined in accordance with provisions of section 23(1)(a) of the IT Act, the difference in interpretation supplied by ITAT in its Orders which have been delivered even after the aforesaid judgments, has led to a situation where computation of income from a vacant house property is uncertain. In light of this fact, one may even question, as to whether the income from property held as stock in trade after the expiry of time period mentioned in provisions of section 23(5) of IT Act, can be brought to tax. Until there is a clarity which is brought to this issue by a judgment of Supreme Court, it is likely that divergent views may be taken by taxpayers and taxman as a result of which the matter may continue to be litigated.

[The author is a Senior Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Delhi]