ITAT Allowed Deduction of Municipal Taxes on Area Not Leased Out

Dream Motels (P) Ltd. Vs ITO (ITAT Mumbai)

The issue under consideration is whether treating municipal taxes paid is considered as a part of rent liable to be taxed u/s 23 of the act?

ITAT states that, upon due consideration of factual matrix, the crystal-clear position that emerges is the fact that as per the terms of lease and license agreement, the licensee alone was liable to pay all taxes / outgoings with respect of leased premises. However, the same could be paid by the assessee and the same were reimbursable by licensee. This position has also been reiterated by the assessee in its submissions. However, the liability to pay the taxes was with respect of licensed premises only which was approx. 19% (232 Sq.Meters out of 1246.66 Sq. Meters) of total area of the building. Therefore, 19% of BMC taxes amounting to Rs.7,99,519/- could be attributed to licensed premises. The proportionate amount comes to Rs.1,51,900/-. In our opinion, this amount shall be added back to the rental income of Rs.76 Lacs earned by the assessee. Consequently, the deduction of Rs.1,51,900/- shall be allowable to the assessee. The rental income, after statutory deduction of 30%, would work out to Rs.53.20 Lacs. Hence  where municipal taxes were paid by assessee for full building and out of the same, only some area on ground floor was given on rent, thus, the deduction in respect of the municipal taxes paid on the remaining area that was not leased out, would be allowable. Accordingly, the appeal is allowed.

FULL TEXT OF THE ITAT JUDGEMENT

1.1 Aforesaid appeal by assessee for Assessment Year [in short referred to as ‘AY’] 2012-13 contest the order of Ld. Commissioner of Income-Tax (Appeals)-20, Mumbai, [in short referred to as ‘CIT(A)’], Appeal No. CIT(A)-20/ITO-12(2)(1)/IT-10031/15-16 dated 28/03/2018 on following grounds of appeal: –

GROUND No. I: TREATING MUNICIPAL TAXES PAID AMOUNTING TO RS.7,99,519/- AS PART OF RENT LIABLE TO BE TAXED U/S 23 OF THE ACT:

On the facts and in circumstances of the case and in law, the CIT(A) erred in making an addition of Rs. 7,99,519/- to the annual letting value (‘ALV’) by treating the same as part of effective rent received by the appellant.

GROUND No. II: On the facts and in circumstances of the case and in law, the CIT(A) erred in not admitting and considering the additional evidence filed by the appellant.

GROUND No. III: DISALLOWANCE OF ALL EXPENDITURE DEBITED TO P/L ACCOUNT AMOUNTING TO RS. 44,52,054/-

1. On the facts and circumstances of the case and in law, the CIT(A) erred in upholding the action of the Assessing Officer (‘AO’) in disallowing the expenditure debited in the P/L Account alleging that the business of the appellant had not commenced and, therefore, the expenditure so incurred could not be allowed as a deduction.

2. On the facts and circumstances of the case and in law, the CIT(A) erred in not appreciating that for allowing deduction of expenses, setting up of business is relevant and not commencement of business.

3. The Ld. CIT(A) failed to appreciate that in the earlier three assessment years it has been accepted that the appellant’s business has been set up and, therefore, in the fourth year it could not be alleged that the business has not been set up. WITHOUT PREJUDICE TO GROUND NO. III ABOVE

GROUND NO. IV: DEDUCTION U/S 57(iii) OF THE ACT

1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) ought to have allowed the expenses of Rs. 44,52,054/- debited to P&L A/c u/s 57(iii) of the Act as being necessary to maintain corporate status of the appellant.

1.2 We have carefully heard rival submissions and perused relevant material on record including documents placed in the paper-book. We have also deliberated on various judicial pronouncements as cited before us during hearing of the appeal. Our adjudication to the subject matter of appeal would be as given in succeeding paragraphs.

2.1 Briefly stated, the assessee being resident corporate assessee earning rental income was assessed for year under consideration u/s 143(3) on 30/01/2014 wherein the income of the assessee was determined at Rs.53.20 Lacs after certain adjustments / additions as against returned income of Rs.11.07 Lacs e-filed by the assessee on 20/09/2012.

2.2 It transpired that the main object of assessee company was to run hotels, restaurants and guest houses etc. The assessee earned rental income of Rs.76 Lacs which was offered under the head Income from House Property. After deducting municipal taxes for Rs.7.99 Lacs and after claiming statutory deduction of 30%, the rental income thus offered to tax amounted to Rs.47.60 Lacs. Although the assessee claimed business expenditure of Rs.44.52 Lacs but did not reflect any business income. The broad break-up of business expenditure, except BMC Taxes, as claimed by the assessee was as follows: –

The perusal of financial statements, as placed on record, would reveal that the assessee has not practically carried out any other activity except earning rental income. The majority of the operations have been funded out of security deposits of Rs.60 Lacs received by the assessee against leave and license agreement, the income from which has been offered to tax as Income from House Property. In fixed asset, the assessee do not hold any fixed asset except building and the assessee has derived rental income by renting out ground floor of a certain building to an individual namely Shri Mahendra Shivji Udeshi vide lease and license agreement dated 02/12/2011.

2.3 Since the assessee did not carry out any business activity, Ld. AO opined that expenses were not in relation to any business activity and therefore, same were to be disallowed as business expenditure. These expenses would be restricted / allowed within the meaning of provisions of Sec.24(a) of the Act while computing property income.

2.4 Upon perusal of leave and license agreement, it transpired that the municipal taxes & other outgoings were to be borne by the licensee. Therefore, the assessee could not undertake to pay the liability of a third party. Therefore, the deduction of the same, while computing Income from House Property, was denied and the income of the assessee was determined at Rs.53.20 Lacs.

3.1 Before Ld. CIT(A), the assessee filed additional evidences which were in the shape of license issued by Health Department of Municipal Corporation of Greater Mumbai in support of the fact that the business was already set-up. Against the same, a remand report was called from Ld. AO which was duly considered.

3.2 Upon due consideration, Ld. CIT(A) opined that the licensee was required to pay the rent as well as municipal taxes. Thus, the total liability of the licensee would work out to Rs.83.99 Lacs which would be the effective rent. Therefore, Annual Let-out value of the property was to be considered as Rs.83.99 Lacs and consequently, the deduction of municipal taxes would be allowable to the assessee. The Income from House Property, computed in this manner, worked out to be Rs.53.20 Lacs.

3.3 Regarding disallowance of business expenditure, it was submitted that business was set up though it had not commenced and therefore, the expenditure would be allowable in terms of decision of Hon’ble Bombay High Court rendered in Western India Vegetable Product Ltd. V/s CIT (24 ITR 151) & CIT V/s Axis Private Equity Ltd. (ITA No.1204 of 2014). In the alternative, it was submitted that the expenditure may be allowed u/s 57(iii) of the Act under the head Income from Other Sources. However, the said pleas could not find favor with Ld. CIT(A), who opined that the assessee could not furnish evidence of having carried out any business activity during the year. Therefore, if any expenditure was incurred in respect of the business to be commenced, the same was to be amortized and claimed as deduction as preoperative expenses after the commencement of business. Finally, the grounds raised by the assessee were dismissed. It was also held that the aforesaid expenditure would not be allowable under the head Income from Other Sources. Aggrieved, the assessee is under further appeal before us.

4.1   First, we take up the issue of deduction of BMC Taxes. The perusal of leave and license agreement dated 02/12/2011 as placed on record would reveal that the assessee has leased out certain area on the ground floor (referred to as Licensed premises) of the building previously known as Sail Sagar (now known as Dream House) “A” Wing standing on Plot No. 5, Dadar Matunga Division, near Dadar Railway Station to one Shri Mahendra Shivji Udeshi for a sum of Rs.9.50 Lacs per month for the first 12 months starting from 01/08/2011. Accordingly, the assessee has earned rental income for 8 months amounting to Rs.76 Lacs during the year under consideration. As per clause-4, the licensee alone was liable to pay all taxes, levies, outgoings etc. pertaining to the licensed premises. In case of failure, the licensor may, at its discretion, could make such payment and the same was reimbursable by licensee. 4.2 As per assessee’s submissions dated 23/01/2015 filed before Ld. AO, the said premises Dream House was purchased by the assessee along with existing old tenants from M/s Shail Sagar Investments Private Limited to carry out its business activities. The Ground floor of the said property was stated to be occupied by some bank which was vacated and given on rent to Shri Mahendra Shivji Udeshi for a period of 5 years. The rent was stated to be receivable from 01/08/2011. The assessee also submitted that since necessary changes in the Municipal records were not affected, the BMC receipts were issued in the name of Landlord i.e. M/s Shail Sagar Investments Pvt. Ltd. The assessee also submitted that the taxes were paid by the assessee and claimed as deduction. It was further stated that the same shall be offered for tax upon receipt of the same from the licensee. In another submission dated 27/01/2015, the attention was drawn to the fact that the municipal taxes were paid for full building having total area of approx. 1247 square meters and out of the same, area only to the extent of 232 square meters on ground floor was given on rent. In other words, BMC taxes of Rs.7.99 Lacs were stated to be paid for full property and not for ground floor only.

4.3 Upon due consideration of factual matrix as enumerated hereinabove, the crystal-clear position that emerges is the fact that as per the terms of lease and license agreement, the licensee alone was liable to pay all taxes / outgoings with respect of leased premises. However, the same could be paid by the assessee and the same were reimbursable by licensee. This position has also been reiterated by the assessee in its submissions. However, the liability to pay the taxes was with respect of licensed premises only which was approx. 19% (232 Sq.Meters out of 1246.66 Sq. Meters) of total area of the building. Therefore, 19% of BMC taxes amounting to Rs.7,99,519/- could be attributed to licensed premises. The proportionate amount comes to Rs.1,51,900/-. In our opinion, this amount shall be added back to the rental income of Rs.76 Lacs earned by the assessee. Consequently, the deduction of Rs.1,51,900/- shall be allowable to the assessee. The rental income, after statutory deduction of 30%, would work out to Rs.53.20 Lacs. We hold so. Ground No.1 & 2 stand partly allowed.

5. So far as the issue of allowability of business expenditure is concerned, as noted by us earlier in para-2.2, the assessee has not practically carried out any other activity except earning rental income. The majority of the operations have been funded out of security deposits of Rs.60 Lacs received by the assessee against leave and license agreement, the income from which has been offered to tax as Income from House Property. In fixed asset, the assessee do not hold any fixed asset except building, a part of which have been given on rent. The relevant question would not be whether the business was actually set up or not but the relevant question would be whether the expenditure as claimed by the assessee would pass the test laid down in Section 37(1) which mandate that the expenditure should have been laid and expended wholly and exclusively for the purpose of the business. In the given factual matrix, we find that the assessee has not practically carried out any business activity during the year. Therefore, the expenditure on account of directors’ remuneration would not be allowable to the assessee. However, the expenditure as tabulated at serial nos. 2 to 6 of table extracted in para-2.2 above, could be considered as expenditure incurred to maintain the corporate personality of the assessee and therefore, the same would be allowable business expenditure. The question of deduction of the expenditure under the head Income from other sources do not arise. Ground No.3 stand partly allowed. The alternative ground to Ground No.3 stand dismissed.

6. Resultantly, the appeal stands partly allowed.

Order pronounced in the open court on 12^th March, 2020