Introduction
Taxation of rental income has always been a tricky subject under Indian income tax law. For decades, taxpayers, tax officers, and even courts have debated the question: Should rental income be treated as business income or income from house property?
The answer matters because the head under which the income is taxed decides what deductions and benefits a taxpayer can claim. For example, if it is business income, the taxpayer can claim actual expenses like maintenance, staff salaries, electricity, and even depreciation on the property. If it is house property income, the taxpayer is restricted to a standard deduction of 30% and deduction on interest for borrowed capital.
To resolve this long-standing confusion, the Finance (No 2) Act 2024 introduced a key change. By inserting Explanation 3 to Section 28 of the Income-tax Act, it declared that income from letting out of a residential house by the owner will always be taxed as “Income from House Property” and not as business income. This amendment takes effect from 1 April 2025.
This article explains why this change was made, how courts had earlier dealt with the issue, and what its implications may be for taxpayers and the housing sector. The aim is to simplify the debate using plain English, while still keeping the legal reasoning intact.
Why This Change Was Made
The government’s stated reason for this amendment is straightforward: many taxpayers were showing rental income as business income instead of house property income to reduce their tax burden.
Here’s why they preferred that route:
1. Business income allows actual expenses – Owners could deduct repair charges, staff salaries, electricity bills, brokerage, and even depreciation on the building.
2. No notional rent – If a property was vacant, they did not need to pay tax on a notional rental value.
3. Flexible treatment – Taxpayers could argue that letting out was part of their business activity, thus claiming more benefits.
By contrast, the House Property head is stricter:
- Only 30% standard deduction is allowed (irrespective of actual expenses).
- Interest on housing loan can be deducted, but nothing beyond that.
- Even if a property is vacant, in some cases, notional rent may still be taxed.
Thus, the government felt that people were misusing the classification to save taxes. By making a uniform rule that all residential rent is “house property income”, it hoped to bring certainty and reduce disputes. But is this move really helpful? To answer that, we need to look at what courts have said over the years.
How Courts Viewed Rental Income
Indian courts have played a major role in shaping the law on rental income. Different judgments developed guiding principles, depending on whether the letting was a simple lease or a part of a larger business activity.
1. Simple letting vs. complex letting
In East India Housing and Land Development Trust v. CIT, the Supreme Court ruled that when the owner simply rents out space without additional services, the income is house property income. But if there are extra services or facilities forming part of the arrangement, then it may be treated differently.
2. When letting is linked to services
In CIT v. National Storage Pvt. Ltd., the court observed that if the tenant is not only paying for space but also for services (for example, specialized storage with security, insurance, and facilities), then the income is closer to business income.
3. The Karnani Properties test
In Karnani Properties Ltd. v. CIT, the Supreme Court framed a four-point test:
- The activity should be continuous
- Organized like a business
- Done for a specific purpose
- With the aim of earning profits
If these conditions are satisfied, then the rental income can be seen as business income.
4. Mixed lettings under Section 56
Sometimes, letting involves not just a building but also machinery, furniture, or equipment. Under Section 56(2)(iii), if these cannot be separated, the income may be taxed as income from other sources.
In Sultan Brothers Pvt. Ltd. v. CIT, the Supreme Court gave three tests to check inseparability:
1. Did the parties intend the building and assets to be enjoyed together?
2. Did the lease essentially form one single letting?
3. Would one letting be accepted without the other?
If the answer to the first two is yes, and the third is no, then the lettings are inseparable and must be taxed together.
5. Role of intention of the owner
In Universal Plast Ltd. v. CIT, a company had stopped its business but rented out its factory machinery. The court ruled that since the intention was not to run business but to wind it up, the income should be treated as house property income. This case showed how the owner’s intention plays a decisive role.
Conclusion:
The debate over how to tax rental income has always balanced two factors:
- the intention and purpose of the taxpayer, and
- the nature of the activity carried out.
The 2024 amendment shifts the focus away from this balanced approach. By forcing all residential rental income into the category of house property income, it closes the door on many genuine cases where rental activity is run as a business.
While the government wanted to simplify matters and prevent misuse, the change may instead discourage investment in housing, complicate compliance, and even invite constitutional challenges.
The better way forward would have been to continue applying the well-developed judicial tests – looking at each case on its facts, intention, and business purpose. Taxation, after all, should not just be certain but also fair and practical.
References :
Available at : https://www.indiabudget.gov.in/budget2024-25/doc/Finance_Bill.pdf
Available at : https://indiankanoon.org/doc/555776/
Available at: https://indiankanoon.org/doc/804763/
Available at : https://indiankanoon.org/doc/1024782/
Available at : https://indiankanoon.org/doc/41029/
Available at : https://indiankanoon.org/doc/475519/
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Author: Sachin Yadav | LL.B. (3rd Year), Lovely Professional University
