Wider scope of litigation under sec 23(5) on real estate developers due to increase in years to sell (YTS) because of COVID-19 Pandemic
It has been provided u/s 23(5) of the Income Tax Act,1961 that where the house property consisting of any building and land appurtenant thereto is held as stock-in-trade and the property or any part of the property is not let during the whole or any part of the previous year, the annual value of such property or part of the property, for the period up to one year from the end of the financial year in which the certificate of completion of construction of the property is obtained from the competent authority, shall be taken to be nil. This sub- section (5) has been inserted by Finance Act 2017 in existing section 23 of the Act.
Basically the section impose burden on the real estate builders to pay income tax on notional rental income on unsold units/flats held as stock in trade and remains unsold for more than a year after obtaining certificate of completion of construction from the competent authority. Income generated by invoking this section 23(5) shall be chargeable under the head house property and eligible for 30% standard deduction and interest deduction u/s 24 of the Act.
The matter was taken into consideration before the Hon’ble High court of Delhi in the case of CIT vs. Ansal Housing Finance and Leasing Co. Ltd (2013) where it was held that even if the house is NOT let out, the notional rental income is chargeable under the head house property.
Considering the impact of this section on builders and the stringent situation of the real state market government vide Finance Bill, 2019 extended relief to the taxpayer builders for one more additional year. Thus notional rent on unsold stock shall not be charged to tax upto 2 years from the end of the financial year in which the certificate of completion is obtained from the competent authority.
According to ‘India Real Estate Market Update Q1-2020-Residential ‘,released by JLL India an assessment of years to sell (YTS) reveals that the expected time to liquidate this stock has increased marginally from 3.2 years in the last quarter of 2019 to 3.3 years in Q1 2020.With anticipated slower sales in the coming quarters, the time to sell is likely to increase significantly.
This means that if section 23(5) of the Act is attracted on these unsold units then builders/real estate developers will have to pay tax on notional rental income for 1.3 year approx. (after excluding 2 years from projected YTS as stated above).This may automatically result in additional cost of project to builders and the impact can be seen by hike in property/flat prices, which will adversely affect the ultimate buyers of these units.
To understand the severity of the matter, over 12.76 lakh houses are lying unsold in India’s top 30 cities as per the report published in Business Today in June 2019. If department invokes section 23(5) it can raise tax demand of approx. 8039 cr. [12,76,000(no of unsold flats)*25000(avg expected rental)*12months*70%(post standard deduction)*30%(tax rate excld cess).
Now let’s understand how the notional rental income u/s 23(5) would be computed, So notional rental income u/s 23(5) will be computed as per sec 23(1) under which two situations may arise for calculation of annual value these are as stated below:-
*When property is not let out:- As per sec 23(1) (a) the sum for which the property might reasonably be expected to let from year to year; or
*When property is let out:- As per sec 23(1) (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.
Thus the builders may face two situation one where they have to pay tax on notional rental income for the whole year irrespective of the fact that property was vacant for the whole year or part of year as sec 23(1)(a) is attracted under this situation because the builder has not actually let out the property and have not entered into any paper work for letting out the property.
Other situation is where the builders can avoid the tax liability on notional rental income by actually letting out the property or entering into paper work for letting out the property so that sec 23(1)(c) would apply. Thus if the builder has let out the property for one month or for even a day, then that property would acquire the status of let out for applying sec 23(1)(c).So that while computing annual value for notional rental income amount of rent actually received or receivable for a month or even a day would be considered and no tax has to be paid for the period when property was vacant .
Now to summarize at the end the question whether sec 23(5) is applicable on unsold units held as stock in trade by the builders as pronounced by Hon’ble High court of Delhi in the case of CIT vs. Ansal Housing Finance and Leasing Co. Ltd (2013) is still pending before the Hon’ble Supreme court. So there is big scope for department to raise litigations over the said issue until Supreme Court gives it decision on this disputed matter.
In my view COVID-19 Pandemic can be seen as the reason behind the increase in years to sell (YTS) over the quarter as the real estate sector is one which is on red list of sectors which are badly hit by the COVID -19 pandemic and the impact of this will continue for years in this sector. Thus if this section is invoked by department on builders it would drastically affect the financial position of real estate market as a whole.