Abstract
Closely held companies often acquire residential properties jointly with their directors to meet residential requirements of key managerial personnel. While such arrangements are legally permissible, they involve significant income-tax considerations due to the related party nature of the transaction. This article analyses, in a structured manner, the income-tax implications where a private limited company purchases a residential flat jointly with its director and allows the director to occupy the same, both where rent is charged and where the accommodation is provided rent-free as a perquisite, supported by judicial precedents and CBDT clarifications.
1. Background and Legal Framework
Under the Income-tax Act, 1961, there is no prohibition on a company owning a residential property, either independently or jointly with an individual, including its director. The tax treatment, however, depends upon:
- the manner of use of the property; and
- whether consideration (rent) is charged for such use.
Given that directors are specified persons, such transactions are closely examined from the perspective of arm’s length pricing, perquisite taxation, and commercial expediency.
2. Joint Ownership of Residential Property by Company and Director
Joint ownership between a company and its director is permissible provided:
- the acquisition is authorised by the Articles of Association;
- the purchase is approved by the Board of Directors;
- the ownership share and consideration paid by each co-owner are clearly identifiable; and
- the transaction is bona fide and properly documented.
For income-tax purposes, each co-owner is assessed independently in respect of his or its share in the property.
3. Scenario I – Company Charges Rent to the Director
3.1 Taxability of Rental Income in the Hands of the Company
Where the company lets out its share of the residential flat to the director and charges rent, such income is taxable under the head “Income from House Property” in accordance with section 22 of the Act. The fact that the tenant is a director does not alter the head of income.
The taxable income is computed as follows:
- Gross Annual Value (actual rent received or receivable, subject to reasonableness);
- Less: Municipal taxes actually paid;
- Less: Standard deduction at 30% under section 24(a);
- Less: Interest on borrowed capital under section 24(b), where applicable.
3.2 Arm’s Length Rent and Determination of Annual Value
Since the director is a related party, the rent charged must be at fair market value. In terms of section 23(1)(a), if the actual rent is lower than the reasonable expected rent, the Assessing Officer is empowered to adopt the market rent as the Annual Value.
Judicial authorities have consistently upheld that where rent is not at arm’s length, the reasonable expected rent may be substituted for actual rent for computing house property income.
3.3 Depreciation
Depreciation under section 32 is not allowable in respect of residential property let out and assessed under the head “Income from House Property”, as the asset is not used for the purposes of the business.
4. Scenario II – Company Does Not Charge Rent (Perquisite Model)
4.1 Income from House Property – Company’s Hands
Where the company allows the director to occupy the residential flat without charging any rent. the property is not regarded as let out and no income is chargeable under the head ‘Income from House Property’. Consequently, no deduction under section 24(a) or 24(b) is available to the company.
Providing residential accommodation rent-free or at concessional terms constitutes a taxable perquisite under section 17(2). The value of such perquisite is determined in accordance with Rule 3 of the Income-tax Rules, based on prescribed percentages of salary or fair rental value, depending upon the population of the city and other factors.
The perquisite value is taxable as salary income in the hands of the director, and the company is required to deduct tax at source under section 192.
4.2 Depreciation and Business Use
Even in the perquisite model, depreciation under section 32 is not allowable, as the property is not used for the business of the company but for the personal residence of the director. Taxing the benefit as a perquisite does not convert personal use into business use.
5. Section 40A(2)(b) and Related Party Considerations
Directors fall within the ambit of specified persons under section 40A(2)(b). While the provision directly applies to disallowance of excessive expenditure, it underscores the importance of reasonableness and arm’s length principles in transactions between a company and its directors.
Courts have emphasised that related party transactions must withstand the test of commercial expediency and reasonableness.
6. The GST Dimension: Beyond Income Tax:
Under the CGST Act 2017, renting of a residential dwelling for use as residence is notified as an exempt supply, irrespective of whether the supplier is an individual or a company and irrespective of the registration status of the recipient. Accordingly, where a company charges rent to its director for use of a residential flat purely as a residence, such transaction is generally regarded as an exempt supply under GST.
In cases where no rent is charged and the residential accommodation is provided to the director as part of employment-related benefits, a view is possible that such provision constitutes a perquisite arising out of the employer–employee relationship and therefore does not qualify as a “supply” for GST purposes. This position also finds support in the clarification issued in Circular No. 172/06/2022–GST, which recognises that benefits provided by an employer to an employee in the course of employment are not treated as supplies.
It is, however, relevant to note that Schedule I of the CGST Act deems certain transactions between related persons to be supplies even when made without consideration. While Schedule I creates a deeming fiction for the existence of supply, it does not override specific exemption notifications. Accordingly, even where the transaction is viewed as a deemed supply between related persons, the exemption applicable to renting of residential dwelling for use as residence would continue to apply, subject to the factual confirmation of residential use.
The Reverse Charge Mechanism under GST applies only to notified taxable supplies. Since renting of residential dwelling for use as residence is an exempt supply, reverse charge provisions are generally not attracted, and no GST liability is required to be discharged by the director.
Given the evolving nature of GST jurisprudence and the fact-specific approach adopted by tax authorities in closely held companies, disputes may arise where the residential use, employment nexus, or nature of accommodation is questioned. Therefore, it is advisable to maintain proper documentation evidencing residential use, employment relationship, and income-tax perquisite disclosure to mitigate potential litigation.
7. Conclusion
A private limited company may validly acquire a residential flat jointly with its director and permit its use for the director’s residence. From an income-tax perspective, charging rent at fair market value is clearly the more tax-efficient and litigation-resilient model. The rent-free perquisite model, though legally permissible, results in loss of deductions, increased compliance burden, and greater scrutiny.
In practical scenarios, such arrangements involve higher compliance, documentation, and implementation risks. During scrutiny assessments, the genuineness of the transaction, arm’s length nature, and commercial justification are often closely examined, thereby increasing litigation exposure. Careful structuring, robust documentation, and adherence to arm’s length principles are essential to ensure sustainability of such arrangements under the Income-tax Act, 1961.
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Disclaimer: The contents of this article are for general guidance and academic discussion only and do not constitute professional advice. The author assumes no responsibility for any action taken or not taken based on this article, as tax implications are subject to factual variations, statutory amendments, and judicial interpretation
About Author: The author is a Practising Chartered Accountant and founder of D Rahul & Associates, Navi Mumbai. He can be reached at ca.rahuldwivedi@gmail.com or +91-9004485377.
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