Lease/rental -House Property or business income- Intention of Parties

Intention of the parties to be considered to decide if lease/rental income is to be treated as HP income or business income

IN THE ITAT COCHIN BENCH

Assistant Commissioner of Income-tax

Versus

Palmshore Hotels (P.) Ltd.

IT APPEAL NO. 249 (COCH.) OF 2011

[ASSESSMENT YEAR 2005-06]

SEPTEMBER 14, 2012

ORDER

B.R. Baskaran, Accountant Member 

The appeal of the revenue is directed against the order dated 27-01-2011 passed by the Ld. CIT(A)-I, Trivandrum and it relates to the assessment year 2005-06.

2. The solitary issue urged in this appeal is whether the Ld. CIT(A) is justified in holding that the lease rent received by the assessee should be assessed as business income and not as income from house property.

3. The facts relating to the issue are stated in brief. The assessee herein constructed and operated a hotel by name “Hotel Palmshore” with a capacity of 35 rooms and two cottages. Since it was incurring losses, the assessee decided to give the hotel along with furnishings and equipments on license basis. Accordingly, the assessee entered into an “Agreement of License” on 11th December, 2000 with M/s. Abad Motels and Resorts (P) Ltd., who are experienced in the field of operating and managing hotels. As per the terms and conditions of the said agreement, the hotel along with the furniture, furnishings and other related items was given to the licensee for a period of 7 years. The assessee is described as “licensor” and M/s. Abad Motels and Resorts (P) Ltd. is described as “licensee”. The compensation for the giving the the management of the hotel has been fixed as per Article VIII of the agreement as under:-

“Article VIII

LICENCE FEE

In consideration of the LICENSOR permitting the LICENCEE to operate the HOTEL fully or partially the LICENCEE shall pay the LICENSOR the following Licence Fee and furnish an interest free security deposit of Rs. 20 lakhs (Rupees Twenty Lakhs). The said security deposit of Rs. 20.00 Lakhs (Rupees Twenty Lakhs) will be retained by the LICENSOR and returned to the LICENCEE on the expiry or termination of this AGREEMENT.

The LICENCEE will pay the LICENSOR the following as Licence Fee.

 ARTICLE IX

MANNER OF PAYMENT

The LICENSEE shall pay to the LICENSOR the Licence fee at the rates specified in Article VIII on equal monthly basis, the monthly Licence Fee being 1/12 of the yearly Licence Fee. Such Licence Fee for each month shall be paid on the 10th day of every succeeding calendar month. In the event of default of monthly payment consecutively for 3 (three) months the LICENCEE shall cease to have the rights under this AGREEMENT”.

4. The assessee offered the licence fee under the head “income from business”. However, the AO proposed to assess the same under the head “Income from house property”. Before the Assessing Officer, the assessee submitted that it has permitted the assessee to manage the hotel and further as per the agreement, not only the building, but also for furniture, furnishings and other equipment which are necessary for carrying out the hotel business were given to the licensee. Accordingly, it was contended that the license fee received by it should be assessed as business income. The Assessing Officer treated the license fee as “lease rent” and accordingly rejected the contentions of the assessee by placing reliance on the decision of the Hon’ble Madras High Court in the case of CIT v. Chennai Properties & Investments Ltd. [2004] 266 ITR 685. Accordingly, the Assessing Officer assessed the lease rental income under the head “Income from house property”. Aggrieved, the assessee carried the matter in appeal before the Ld. CIT(A) and the first appellate authority allowed the claim of the assessee. Aggrieved, the revenue is in appeal before us.

5. The Ld. DR submitted that the assessee has actually given the hotel building on lease on fixed rent basis and hence, the Assessing Officer was right in law in assessing the lease rental income under the head “Income from house property”. The Ld. DR placed heavy reliance on the decision of the Hon’ble Supreme Court in the case of Sultan Bros. (P.) Ltd. v. CIT [1964] 51 ITR 353 and submitted that under identical facts, the Hon’ble Supreme Court has held that the income received on letting out the hotel premises is assessable as income from house property.

6. On the contrary, the Ld. AR submitted that the assessee has given only the licence to operate the hotel to M/s. Abad Motels and Resorts (P) Ltd. as per the Agreement of License dated 11-12-2000. He further submitted that, as per the agreement, the name “Hotel Palmshore” will be suffixed with the words “An Abad Beach Resort”, which means that the assessee wanted to retain its brand name “Hotel Palmshore” even during the term of license agreement. He further submitted that the assessee entrusted the operation of the hotel along with the building, furniture, furnishings, utensils and other equipment and the said action of the assessee confirms that the agreement was entered into, only to maintain and operate the hotel. He further submitted that the assessee has also carried out promotional activities such as canvassing the customers, creating brand image, promote facilities provided in the hotel etc. Since the assessee has not transferred the right of ownership and the agreement was entered into only to operate the hotel, the lease rent received by the assessee should be treated as income from business.

7. The Ld. AR further submitted that the decision of the Madras High Court in the case of Chennai Properties & Investments Ltd.’s (supra), was with regard to the issue of interpretation of the word “house”, i.e., whether the word “House” shall include commercial building or not. Hence, the said decision is not applicable to the facts and circumstances of the instant case. The Ld. AR relied upon various decisions in support of his contentions, which are dealt with by us in the ensuing paragraphs.

8. We have heard the rival contentions and perused the record. According to the assessee, the rental income, which is described as license fee, is to be assessed under the head “Income from business”. In this regard, the Ld A.R relied upon various case law and they include one Supreme Court decision and 12 High Court decisions. The details of case law as submitted by the along with short comments are extracted below:-

 (i)  Commissioner of Excess Profits Tax v. Shri Lakshmi Silk Mills Ltd. [1951] 20 ITR 451 (SC).

(ii)  Dal Chand & Sons v. CIT [1968] 69 ITR 247 (Punj. & Har.) – Ginning Factory leased out for years a going concern – court held that income derived is ‘business income’.

(iii)  Raj Talkies v. CIT [1974] 96 ITR 499 (Pat.) – Cinema as a going concern held as business income

(iv)  CIT v. Northern India theatres (P.) Ltd. [1981] 128 ITR 497 – Leasing out Cinema House is assessable under business income.

(v)  CIT v. Laxmi Rice Mills [1987] 164 ITR 571 (MP) – Rice Mill and Theatre both leased out – rentals are chargeable to business income.

(vi)  CIT v. Mohiddin Hotels (P.) Ltd. [2006] 284 ITR 229 (Bom.) – Leasing of Hotels with Fittings & Fixtures was held to be business income.

(vii)  CIT v. Kohinoor Tobacco Products (P.) Ltd. [2006] 283 ITR 162 – Bidi manufacturing activities and let out some of its godown – assessable as business income.

(viii)  Everest Hotels Ltd. v. CIT [1978] 114 ITR 779 (Cal.) – Everest Hotels – The entire hotel business under the name and style “Hotel Mount Everest” – Rs. 7500/- leasehold rent per annum for a period of 5 years. The Court held that rental income derived from lease should be taxed u/s. 10 of the Income Tax Act, 1922. If the appellant is taxed u/s. 12(4), it loses certain other allowances u/s. 10 by reason of depreciation. In that case the Hon’ble High Court referred to the decision in Sultan Bros. (supra). Sec. 9 of the Income Tax Act, 1922 referred to Income from House Property. Sec. 10 Profit and gain of business – terms and conditions are identical.

(ix)  CIT v. Pateshwari Electrical & Associated Industries (P.) Ltd. [2006] 282 ITR 61 – Income from letting out of House Property and in addition had lease rent from letting out of Workshop, Cold Storage, Motor Garage, Raj Oil and Interest income and Misc. income – receipt of rental – business income. In that case decision of the Hon’ble Supreme Court in Sultan Bros. (supra) was referred to. The Court also considered the decision in Shri Lakshmi Silk Mills Ltd. (supra) – Plant was unused for some time, after some time let out on monthly rent – Court held that it was chargeable to “Business Income”.

(x)  CIT v. V. Shanmugham [1984] 147 ITR 692 – Building consisting of 68 rooms and with various facilities satisfied requirement of lodging house being run on commercial basis – Income derived form letting out the lodging house should be assessed under Business Income.

(xi)  Pateshwari Electrical & Associated Industries (P.) Ltd. (supra) – Rent from Cold Storage, Motor Garage etc. may be taxed under Income from Business. (Page 24).

(xii)  PFH Mall & Retail Management Ltd. v. ITO [2008] 110 ITD 337 (Kol.) – Agreement with users of Shopping Malls providing services to users – Business Income in this case also Sultan Bros. (P.) Ltd. (supra) was referred to. Karnani Properties Ltd. v. CIT [1971] 82 ITR 547 (SC) and Everest Hotels Ltd. (supra) was also considered. In page 382 the Hon’ble Court observed that the ratio of the decision of the Hon’ble Calcutta High Court is of little help to the department and actually supports the stand of the appellant. (Page No. 25 of Appeal Paper Book).

(xiii)  ITO v. Skipper Properties (P.) Ltd. [2008] 113 ITD 56 (Delhi) – Lease of Theatre for a short period – Income from lease assessable as “Business Income”. The Hon’ble Tribunal also followed the decision in Universal Plast Ltd. v. CIT [1999] 237 ITR 454.

9. In the case of Shri Lakshmi Silk Mills Ltd. (supra), the assessee therein was engaged in manufacture of silk cloth and dyeing silk yarn and it was unable to operate the dyeing plant on account of difficulty in obtaining silk yarn and hence it let out the dyeing plant temporarily. It was found that such letting out is part of the usual activity of business. In the facts of the said case, the Supreme Court held that the plant does not cease to be a commercial asset when let out temporarily and the income earned from such letting out is business income. (As explained by the Hon’ble Bombay High court in the case of Mangla Homes (P.) Ltd v. ITO [2010] 325 ITR 281. In the instant case, the assessee has not demonstrated any business difficulty and further it has not been shown that the letting out is part of the usual activity of business. Hence, in our view, the assessee could not place reliance on the decision of Hon’ble Supreme Court in the case of Shri Lakshmi Silk Mills Ltd. (supra).

10. In the case of Universal Plast Ltd. (supra) the Hon’ble Supreme Court has laid down the general principles relating to the income from leasing out the assets of the business by an assessee, which is referred by the Hon’ble Bombay High Court in the case of Mohiddin Hotels (P.) Ltd. (supra) as under:-

“The general principles laid down by the Supreme Court in this connection are thus (page 461):

(1)  no precise test can be laid down to ascertain whether income (referred to by whatever nomenclature, lease, amount, rents, license fee) received by an assessee from leasing or letting out of assets would fall under the head ‘Profits and gains of business or profession’;

(2)  it is a mixed question of law and fact and has to be determined from the point of view of a businessman in that business on the facts and in the circumstances of each case, including true interpretation of the agreement under which the assets are let out.;

(3)  where all the assets of the business are let out, the period for which the assets are let out is a relevant factor to find out whether the intention of the assessee is to go out of business altogether or to come back and restart the same.;

(4)  if only a few of the business assets are let out temporarily, while the assessee is carrying out his other business activities, then it is a case of exploiting the business assets otherwise than employing them for his own use for making profit for that business; but if the business never started or has started but ceased with no intention to be resumed, the assets will cease to be business assets and the transaction will only be exploitation of property by owner thereof, but not exploitation of business assets.”

In the case of Mohiddin Hotels (P.) Ltd. (supra) the assessee therein constructed a hotel and let it out on a fixed annual amount, from the day one when it was ready for commissioning. In the facts of the said case, the Hon’ble Bombay High Court found that there were enough materials in the record to find the intention of the parties and further they suggested that the assessee therein actually intended to exploit the hotel as its business assets, as held by Hon’ble Supreme Court in the case of Mohiddin Hotels (P.) Ltd. (supra). Under those circumstances, it was held that the rental income received there in is business income.

11. In the case of Everest Hotels Ltd. (supra) the Hon’ble Calcutta High Court found that the assessee had resumed the hotel business even before the assessment was completed by the assessing officer. Under those circumstances, the High Court held that the rental income is assessable as business income.

12. The fact that was prevailing in decision rendered by Hon’ble Madras High Court in the case of V. Shanmugham (supra) was that the assessee himself had let out the rooms in the lodging house and hence the said decision is not applicable to the assessee’s case.

13. The Hon’ble Supreme Court had an occasion to consider the issue about the nature of rental income in the case of Shambhu Investment (P.) Ltd. v. CIT [2003] 263 ITR 143, wherein the Apex Court has upheld the decision rendered by Hon’ble Calcutta High Court in that case reported in CIT v. Shambhu Investment (P.) Ltd. [2001] 249 ITR 47. The facts of that case has been explained as under by the Hon’ble Calcutta High Court.

“Shambhu Investment (P) Limited, the assessee above named, is the owner of a building at Raheja Chambers, Nariman Point, Mumbai. The said premises have been furnished by the assessee and have been let out to various persons and /or firms and/or organisations with all furniture, fixtures, light, air-conditioners for being used as “table space”. The said assessee under the agreement with those occupiers is to provide services like watch and ward staff, electricity, water and other common amenities”.

The question about its taxability, i.e. whether the rent received is business income or house property income arose before the Hon’ble High Court, which considered the test laid down by the Hon’ble Supreme Court in the case of Sultan Bros. (P.) Ltd. (supra). The relevant observations made by the Hon’ble High Court is extracted below:-

“Before taking a decision on the issue let us first deal with the decisions cited by Mr. Murarka.

(i) Sultan Brothers Pvt. Ltd. v. CIT [1964] 51 ITR 353 (SC) : A five judges’ Bench of the apex court herein has considered a case wherein the assessee constructed a building and filled it up with furniture and fixtures and let it out on lease fully equipped and furnished for the purpose of running a hotel. The lease provided for a monthly rent for the building and a hire charge for the furniture and fixtures.

Dealing with the said case, the apex court held that the letting out of the said building did not amount to the carrying on of a business and the income under the lease would not, therefore, be assessed as income from business. The apex court directed the said income to be assessed accordingly.

To decide such an issue the apex court gave a guideline that to come to a conclusion one has to find out the answer on three issues, namely: (a) Was it the intention in making the lease – and it matters not whether there is one lease or two, i.e., separate leases in respect of the furniture and the building – that the two should be enjoyed together? (b) Was it the intention to make the letting of the two practically one letting? (c) Would one have been let alone, and a lease of it accepted, without the other?

If the answers to the first two questions are in the affirmative and the last in the negative, then it has to be held that the lettings would be inseparable”.

The Hon’ble High Court, alternatively, applied the tests prescribed by the Hon’ble Supreme Court on the facts prevailing in the case of Shambhu Investments (P.) Ltd. (supra). The relevant observations made by the High Court are extracted below:-

“Let us approach the problem from another angle by applying the test suggested by the five judges” Bench in the case of Sultan Brothers Pvt. Ltd. [1964] 51 ITR 353 (SC). The three questions framed by the apex court are applied in the instant case as follows (Page 363):

(A) Was it the intention in making the lease – and it matters not whether there is one lease or two, i.e., separate leases in respect of the furniture and the building – that the two should be enjoyed together?

In the instant case there is no separate agreement for furniture and fixtures or for providing security and other amenities. The only intention, in our view, was to let out the portion of the premises to the respective occupants. Hence, the intention in making such agreement is to allow the occupants to enjoy the table space together with the furniture and fixtures. Hence, this question should be answered in the affirmative.

(B) Was it the intention to make the letting of the two practically one letting (page 363):

From a plain reading of the agreement it appears that the intention of the parties to the said agreement is clear and unambiguous by which the first party has allowed the second party to enjoy the said table space upon payment of the comprehensive monthly rent. Hence, this question should be answered in the affirmative.

(C) Would one have been let alone, and a least of it accepted, without the other (page 363)?

As we have discussed hereinbefore that it is composite table space let out to various occupants, the amenities granted to those occupants including the user of the furniture and fixtures are attached to such letting out and the last question, in view of the same, must be answered in the negative.

Applying the said test we hold that by the said agreement the parties have intended that such letting out would be an inseparable one.

Hence, we hold that the prime object of the assessee under the said agreement was to let out the portion of the said property to various occupants by giving them additional right of using the furniture and fixtures and other common facilities for which rent was being paid month by month in addition to the security fee advance covering the entire cost of the said immovable property.

In view of the facts and law discussed above we hold that the income derived from the said property is an income from property and should be assessed as such”.

The view taken by the Hon’ble Calcutta High Court was approved by the Hon’ble Supreme Court and the said decision of the Apex court is reported in Shambhu Investment (P.) Ltd. (supra).

14. The following case law relied upon by the assessee, in our view, are not applicable to the facts of the instant case, since in those cases, the assets let out consisted of building and machineries and further they were let out for a temporary period due to some adverse business conditions.

(a)  Dal Chand & Sons (supra) – Ginning factory

(b)  Raj Talkies (supra) – Cinema House

(c)  Northern India Theatres (P.) Ltd. (supra) – Cinema House

(d) Laxmi Rice Mills (supra) – Rice Mill and Theatre

(e)  Kohinoor Tobacco Products (P.) Ltd. (supra) – Bidi manufacturing

(f)  Pateshwari Electrical & Associated Industries (P.) Ltd. (supra) – House, workshop, cold storage etc.

(g)  PFH Mall & Retail Management Ltd. (supra) – Shopping Mall & providing services to users.

(h)  Skipper Properties (P.) Ltd. (supra) – Lease of theatre.

15. On a careful perusal of the various decisions, it becomes clear that the facts prevailing in each case and the intention of the parties have to be considered in order to decide the question whether the lease/rental income is to be treated as house property income or business income. The nomenclature given to the said income is irrelevant.

16. Now we shall examine the facts prevailing in the case before us. The Ld A.R submits that the assessee has given only license to operate the hotel. However, on a specific query from the bench, whether the assessee herein is accounting for daily collections made from the guests occupying the rooms and also the expenses on running the hotel, the Ld A.R fairly conceded that the assessee is receiving only the fixed licence fee mentioned in the agreement and the licensee is accounting for the daily collections and expenses in his books of account.

17. Before the AO, it was submitted that the assessee was incurring huge losses on its hotel business and hence it was leased out the hotel along with furniture, furnishing, equipments etc. for a period of seven years. On the expiry of the above said period of 7 years, the licensee shall cease to have any right on the operation of hotel. Accordingly, it was contended that the rental income is assessable as business income. The AO, however, rejected the said contentions with the following observations:-

“(a)  As per the terms and conditions of the agreement entered into by the assessee with Abad Motels, the lessee shall cease to have any right on the operation of hotel on the expiry of the said 7 years. This clause in the agreement cannot be interpreted to mean that the agreement has been executed for sole purpose of carrying out the business operations of running the hotel on behalf of the lessor. Hence, the assessee’s contention that it is the right to operate the activities of the hotel which has been transferred but not the right of ownership of the property, is not acceptable.

(b)  Moreover, the agreement had been executed for a considerably longer period of 7 years. The lease rental income received by the assessee at a fixed rate annually is for both the building as well as the furnishings which have been let out.

(c)  As long as the ownership of the property vests with the lessor, the lease rental income received as per the lease agreement is to be assessed as income from house property and not business income.

(d)  The terms and conditions of the agreement also do not contain any clause which specify that the lease rental income will vary with regard to the total turnover from business operations. The rental income has been received at a fixed rate annually and does not vary with decrease or increase in the turnover from business operations carried out by the lessee. Hence the lease rental income received by the assessee does not have any direct nexus with the business operations carried out by the lessee M/s Abad Motels and resorts Pvt. Ltd.

18. Now, we shall try to find out the intention of the assessee in leasing out the hotel building along with furniture, furnishings, equipments etc. The assessee had been running the business of hotel, but incurred huge losses. Hence, it has decided to lease out the hotel building. Though in the agreement, it is mentioned that the operation of hotel is leased out, in substance, it is only leasing out of the hotel building along with the furniture, furnishings, equipments etc. The hotel is being operated by the licensee with his own funds and staffs, which is clear from the agreement, where it is stated that the licensee shall operate the hotel by appointing his own staff with the working capital funds brought in by him. The Ld A.R has also fairly conceded that the assessee is receiving the monthly lease rent as determined in the agreement. It is a well settled proposition of law that the substance will prevail over the form. Accordingly, though the agreement entered by the assessee is titled as “Agreement of Licence”, yet on reading the various clauses of the agreement, the impugned agreement has to be considered as lease agreement for letting out the hotel building with furniture, furnishings, equipments etc. In our view, the various conditions have been imposed upon the licensee only to ensure that the hotel premises should continue to be operated as only hotel.

19. It is not a case that the assessee had to let out the hotel building for a temporary period due to some adverse business conditions. The decision to lease out the hotel building has been taken, since the assessee was incurring of huge losses in the operation of the hotel. Under these circumstances, it cannot be held that the assessee has leased for a temporary period. In fact, the lease period is 7 years, which is quite a long period.

20. As per clause III under Article XV of the agreement entered into between the assessee and the licensee, the lease period shall be automatically extended, if the licensee is constrained to pay the loan liabilities on behalf of the assessee herein and the extension shall be till such time the entire amount paid by the licensee is recovered. Thus, it cannot be categorically stated that the lease period is only seven years.

21. The intention between the parties is clearly stated in the clause numbered as ‘Item-IV’ under Article XV of the agreement, which reads as under:-

“Nothing contained herein shall be construed as creating a partnership or a joint venture or managing/selling agency or any other relationship and render either party liable except the relationship of LICENSOR and LICENCEE as herein expressly provided. Both the parties agree that the intention of the parties herein is only to create a License and under no circumstances will this licence be treated as tenancy or lease or any other arrangement, and the LICENCEE shall not acquire any such interest in THE HOTEL, by virtue of this agreement.”

This clause clearly brings out the intention of the parties. It clearly says that this agreement is not an agreement for creation of a “managing agency”, which falsifies the contention of the assessee that it has entered into this agreement only to give the operation of the hotel. Further, under this clause, it is made very clear that the intention of the parties is only to create a license, i.e., the intention is only to lease out the hotel building along with furniture, furnishings, equipments etc.

22. Now we shall apply the three questions test suggested by the five judges’ Bench in the case of Sultan Bros. (P.) Ltd. (supra).

(A) Was it the intention in making the lease – and it matters not whether there is one lease or two, i.e., separate leases in respect of the furniture and the building – that the two should be enjoyed together?

In the instant case there is no separate agreement for furniture and fixtures or for providing security and other amenities. We have already taken a view that the intention of the assessee was to let out the hotel building along with furniture, furnishings, equipments etc. Hence, this question should be answered in the affirmative.

(B) Was it the intention to make the letting of the two practically one letting (page 363):

In the instant case, the assessee has let out the hotel building along with the furniture, furnishings, equipments etc. Hence, this question should be answered in the affirmative.

(C) Would one have been let alone, and a least of it accepted, without the other (page 363)?

The answer to this question is definitely “NO”.

Hence the letting of building and furniture etc. is inseparable.

23. From the foregoing discussions, we are of the view that the intention of the assessee was to let out the hotel building and hence it cannot be considered that the assessee was exploiting the property for its commercial business purposes. Accordingly, we are of the view that the lease rent is liable to be assessed under the head “Income from house property”. Accordingly, we set aside the order of Ld CIT(A) on this issue and restore that of the assessing officer.

24. In the result, the appeal filed by the Revenue is allowed.