Rental Income inextricably linked with setting up of project is capital receipt

 In the present case, the rents are received on a property purchased for setting up of the project and is inextricably linked to the completion of the project. Considering the fact that the assessee had taken steps to evict tenants and also paid compensation to them while getting vacant possession for completing the project, the rental receipts received during the period have to be set off to the cost of project. Accordingly, I am of the opinion that the said amounts cannot be brought to tax as ‘income from house property’, and as assessee has rightly treated them as ‘capital receipts’ and set off to work-in-progress, the stand of the assessee is consistent with the principles governing such receipts. Accordingly, the orders of the Ld. CIT(A) and A.O. are set aside and assessee’s grounds on the issue are treated as allowed. The receipts are to be considered as capital receipts only.

Full Text of the ITAT Order is as follows:-

These four appeals are filed by the assessee against the order of CIT (A)-5, Hyderabad, dated 28.12.2016. Since common issue is involved in all these appeals and as a common order was passed by Ld. CIT(A), the appeals are heard and disposed of by this common order.

2. The only issue for adjudication in all the appeals is whether the rentals received during the period of project completion is taxable or not and if so, under what head.

3. Briefly stated, assessee is a company incorporated for the purpose of development and construction of a commercial complex. It filed return of income for the A.Y. 2008-2009, declaring a total income of Rs. 1,66,630/- inter alia admitting rent from one M/s. Mithra Agencies. In subsequent years, assessee, as the project has not completed, has not offered any income. During the assessment proceedings for A.Y. 2012-2013, Assessing Officer noticed that assessee has credited the work-in-progress account as on 31.03.2012 with various amounts totaling to Rs. 24,99,733/-. When asked, assessee admitted for inclusion of interest received on the refund at Rs. 7,710/- whereas, it objected to bringing to tax the rental income received in various years. The year-wise receipt of rentals in the impugned assessment years are as under:-

3.1. Assessee submitted before the A.O. that the company purchased the property in Uppal from two companies and an individual. These properties were tenanted at the time of registration of the property and the company has spent a lot of money for evicting them. In the course of these proceedings, the company collected the rentals from the tenants. All these receipts happened in the course of evicting the tenants and therefore, the amounts received were set off against the expenditure incurred by the company in evicting the tenants. Since the property was purchased for setting up an Industrial Park and the assessee wanted vacant possession, the properties were immediately purchased and with a lot of delay in project, assessee could successfully evict the tenants incurring big loss of interest as well as delay in execution. Rentals were collected in course of evicting the tenants and, they were rightly credited to work-in-progress account as ‘capital receipts’.

4. Assessing Officer was of the opinion that the rentals received from various parties are taxable, as it has no relation with the project being set up. The Assessing Officer also noticed that assessee has taken a contrary stand as the rental income from one party was offered as ‘income from house property’ but did not include another From A.Y. 2009-10 on wards it did not disclose the rental income in the returns filed. He was of the opinion that the rents received should be assessed as ‘income from other sources’ and accordingly, he assessed the amounts in the impugned years as income from other sources.

5. Before the Ld. CIT(A) assessee contested the issue and submitted that the amounts are ‘capital receipts’ and relied on the decision of Hon’ble Supreme Court in the case of CIT vs. Bokaro Steel Limited (236 ITR 315) (SC). Ld. CIT(A) formed questions for his adjudication e., (a) Whether the rent received will be set off against work-in-progress? and (b) Whether such receipts will be taxed as income from other sources as held by the Assessing Officer? After discussing various case law, treating the rental income under the head ‘house property’, he directed the A.O. to treat the income as ‘income from house property’ and not as ‘income from other sources’ as considered by the Assessing Officer. Apart from that Ld. CIT(A) also held that this is a case where the business never started or has not started and the assets cannot be treated to be business assets and the transaction would only be exploitation of property by an owner, but not exploitation of business assets; therefore, the income should be assessed under the head ‘house property’. He also held that construction of the Industrial Park had neither been completed during the relevant assessment year nor any business had commenced.

Under these circumstances, the rental income received by the assessee, by no stretch of imagination, can be adjusted with work-in-progress. Assessee’s reliance that the amounts are capital in nature has not been adjudicated by the Ld. CIT(A) and held that the amount is asses-sable under the head ‘house property’. In his order he changed the head of income and did not allow the set off to work-in-progress. He also upheld the proceedings under section 147 as the information has come to knowledge of AO in AY 20 12-13 and no assessment u/s 143(3) was completed earlier in the impugned years.

6. In the grounds raised by the assessee, it was also contended that notice issued u/s 148 of the Act is without jurisdiction and raised other grounds that the amounts cannot be brought to tax under the head ‘house property’ and should have been set off against the expenditure, ie. work-in-progress.

7. Ld. Counsel reiterated the submissions made before the Ld. CIT(A) and submitted that assessee has incurred substantial amounts on the project and also, as explained before A.O. and CIT (A), has spent more than Rs. 27 lakhs for evicting the tenants. These amounts should not have been brought to tax as ‘income from house property’ and should have been set off to work-in-progress. Ld Counsel relied on the principles laid down by the Hon’ble Supreme Court in the case of CIT vs. Bokaro Steel Limited (236 ITR 315) (SC); CIT vs. Karnataka Power Corporation (247 ITR 268) (SC); CIT vs. Karnal Co-operative Sugar Mills Limited (243 ITR 2) (SC) and Bongaigaon Refinery And Petrochemicals Ltd vs. CIT (251 ITR 329) (SC). He further submitted that the amounts received during the period of setting up of its project, particularly income received from house property, guest house, charges from equipment and recoveries from contractors are held to be capital in nature and therefore, the amounts are not taxable during the impugned assessment years.

8. Ld DR, however, submitted that the receipts of rental income has no connection with that of setting up of project and so the amounts are taxable under the head ‘income from house property’. He relied on the principles laid down by the Hon’ble Supreme Court in the case of Raj Dadarkar & Associates vs. ACIT in Civil Appeal Nos. 6455-6460 of 2017, dated 09.05.2017 to submit that incomes are correctly assessed under the head ‘house property’. He also relied on the Coordinate Bench decision in the case of Thermal Power tech Corporation India Ltd vs. DCIT (164 ITD 449) to submit that the amounts are taxable during the period of setting up of a project. He relied on the orders of the Coordinate Bench in support of his contentions.

9. I have considered the rival contentions and perused the relevant case law relied upon. As far as rents received is concerned there can be no dispute as the incomes are received in a form of rent and therefore they are asses-sable under the head house property, particularly in view of the latest judgment of the Hon’ble Supreme Court of India in the case of Raj Dadarkar & Associates (supra), relied upon by the Ld DR. However, the issue is not whether the income is taxable under the head ‘other sources’ or under the head ‘house property’; the issue is whether the rents received by the assessee are taxable at all, pending completion of the project for which the property was acquired.

9.1. It is undisputed that assessee has purchased the said property along with tenancies. It is also undisputed that the properties are being demolished for construction of a big commercial complex, for establishing an Industrial Park. Pending eviction of the tenants and settlement with the tenants who occupied the various shops/ go downs in the properties purchased by the assessee, assessee received rentals as the properties were acquired along with the tenancies. It is not in dispute that assessee has taken legal steps and has spent considerable amounts for evicting the tenants. However, it took some time therefore, in the impugned assessment years assessee was receiving the rental income from the tenants, as stated in the table above. It is not in dispute that assessee has not completed its project during the impugned assessment years. The issue is whether the amounts can be brought to tax as ‘income from house property’ or can be set off against the project expenditure as the properties were acquired for the purpose of setting up of an Industrial Park.

10. In the case of Thermal Power tech Corporation India Ltd vs. DCIT (164 ITD 449) the issue is whether the interest earned on the unutilised borrowed funds kept in short term fixed deposits during the construction of power plant would be taxed as ‘income from other sources’. Analyzing the principles laid down by the Hon’ble Supreme Court in the case of Tuticorin Alkalin Chemicals & Fertilizers Ltd vs. CIT (227 ITR 172) and various other cases on the subject and also following the jurisdictional High Court decision in the case of CIT vs. Raasi Cements Ltd (232 ITR 554) (AP), it was held that the interest earned on borrowed funds deposited in banks during the inception of the company, prior to commencement of the business has to be brought to tax as ‘income from other sources’ u/s 57 of the Act. However, in the present case, it is not the interest earned on the deposits made either of own funds or borrowed funds. It is the rents received on the property purchased, pending eviction of the tenants and pending construction of an Industrial Park.

10.1 The Hon’ble Supreme Court in the case of CIT vs. Bokaro Steel Limited (supra) has distinguished the receipts, which are inextricably related to the construction of the project. In the case of Bokaro Steels Ltd, that company received certain income from the contractor who was assigned the job of constructing the factory. During the course of construction activities carried on by the contractor, the contractor had availed certain facilities and services from the company and paid certain consideration to the company. The nature of the services and consideration/income received by the company from the contractor are noted as below:-

i. Let out of its dwelling units to the contractor which were used for the purpose of housing the workers/labourers and staff for construction work;

ii. Hire charges received by the company from the contractor in connection with hiring of the plant and machinery owned by the company to the contractor which were used by the contractor in the construction work

iii. Interest received by the company from the contractor on account of advances made to the contractor which were used for the purpose of construction work of the factory by the contractor; and

iv. Royalty received by the company from the contractor in connection with permitting the contractor to excavate / mine the stones from the land owned by the company which were used in the construction activity of the company.

In this connection, the Hon’ble Supreme Court held that the income received by the company ie. from the contractor under various sources mentioned above is inextricably linked with the setting up of the factory building / capital structure of the company and, therefore, such income has to be treated as capital receipt going to reduce the cost of construction of the assessee company.

11. This principle laid down by the Hon’ble Supreme Court in the case of CIT vs. Bokaro Steel Limited (236 ITR 315) (SC) was followed in later case i.e., in the case of CIT vs. Karnataka Power Corporation (247 ITR 268) (SC). In that case, the question raised was whether, on the facts and in circumstances of the case, the Tribunal is right in law in upholding the order of the Commissioner (Appeals) who deleted the addition of Rs. 1,30,44,518 / – being interest receipts and hire charges from contractors, by holding that the same are in the nature of capital receipts which would go to reduce capital cost? The Hon’ble Supreme Court held that it is not in dispute that the question must be answered in the affirmative and in favour of the assessee having regard to the judgment of this Court in CIT vs. Bokaro Steel Ltd [1999] (236 ITR 315) (SC). The same principle is also reiterated in the case of CIT vs. Karnal Co-operative Sugar Mills Ltd (243 ITR 2) (SC) wherein also interest received on amounts deposited to open a letter of credit for purchase of the machinery required for setting up its plant was held to be ‘capital receipt’. The Hon’ble Supreme Court followed the principles laid down in the decision of CIT vs. Bokaro Steel Ltd (supra) while referring to the principles laid down in the case of Tuticorin Alkali Chemicals and Fertilizers Limited vs. CIT (227 ITR 272).

12. In the later decision of the CIT vs. Bongaigaon Refinary and Petrochemicals Ltd vs. CIT (252 ITR 329), the Hon’ble Supreme Court held that income from house property, guest house, charges for equipment and recoveries from contractors for supply of water and electricity received during the period of formation, is a capital receipt and the income is to be adjusted against the project cost for main business. The Hon’ble Supreme Court held as under:-

“The High Court has already held that the interest income derived by the assessee during the formative period was taxable income. What remains for consideration is the income which the assessee derived from house property, it guest house, charges for equipment and recoveries from the contractors on account of water and electricity supply. These items are covered by the decision in Bokaro Steel Ltd.’s case [1999] 236 ITR 315 (SC). To the extent that it relates to these items, i.e., items excluding interest, the question must be answered in the affirmative and in favour of the assessee. The order under challenge will stand modified to that extent.”

13. In view of the clear distinction of interest earned on surplus funds deposited during the completion of project and the receipts which are inextricably connected to setting up of the project, the law is very clear. In the present case, the rents are received on a property purchased for setting up of the project and is inextricably linked to the completion of the project. Considering the fact that the assessee had taken steps to evict tenants and also paid compensation to them while getting vacant possession for completing the project, the rental receipts received during the period have to be set off to the cost of project. Accordingly, I am of the opinion that the said amounts cannot be brought to tax as ‘income from house property’, and as assessee has rightly treated them as ‘capital receipts’ and set off to work-in-progress, the stand of the assessee is consistent with the principles governing such receipts. Accordingly, the orders of the Ld. CIT(A) and A.O. are set aside and assessee’s grounds on the issue are treated as allowed. The receipts are to be considered as capital receipts only.

14. Even though the assessee had not offered the rental incomes in the assessment years 2009-10 on wards, assessee has partly offered rental income in A.Y. 2008-09. Assessee has offered rental income from M/s. Mithra Agencies as income from house property. In the course of re-assessment proceedings, A.O. has brought further amounts received from M/s. Ramdharam Kanta also to an extent of Rs. 60,000/-. In the light of the above decision of treating the “rental receipts” as “capital receipts” during the impugned years, I hereby direct the A.O. to exclude the rent received from M/s. Ramdharam Kanta only as capital receipt. Since the proceedings initiated are u/s 147 of the Act, on the return of income filed by the assessee declaring house property income at Rs. 1,66,630/-, following the principles laid down by the Hon’ble Supreme Court in the case of CIT vs. Sun Engineering Work P. Ltd., (1992) 198 ITR 297 (SC), the amounts already offered cannot be excluded. The proceedings u/s 147 are for the benefit of the revenue aimed at gathering the escaped income of the assessee, as held by the Hon’ble Supreme Court. To that extent, in AY 2008-09 assessee’s offering of rental income in the return filed is to be accepted and cannot be excluded. In other years, the rental receipts are to be treated as capital receipts and therefore gets excluded to be adjusted in capital work in progress of the project.

15. Assessee also questioned the reopening of the assessments u/s 147 of the Act. As the information has come to the knowledge of the Assessing Officer in A.Y. 2012-13 and as no scrutiny assessments have been completed in the impugned assessment years, reopening of assessments per se is to be upheld. Consequently, the grounds of reopening of assessment are rejected.

16. In the result, four appeals of assessee are partly allowed.

Order pronounced in the open court on 17^th November, 2017.