Rent from Simple Letting of Property is Business Profits

Honourable Sunil Ambwani,J.  Hon’ble Pankaj Mithal,J.

“Whether on the facts and in the circumstances of the case and on a true interpretation of agreement dated 4.11.1988 and the Memorandum of Association of the assessee company (clause 3 e), the Income tax Appellate Tribunal was legally correct in holding that the income earned by the assessee from leasing out on leave and licence fee the premises in question namely Premises No. 82, 8th Floor, Sakhar Bhawan, Nariman Point, Bombay should be assessed as income from property and not income from business ?

3. The facts giving rise to these appeals, as we have gathered from the order of the Income Tax Appellate Tribunal, Allahabad, in deciding the Income Tax Appeals relating to Assessment Years 1989-90, 1990- 91, 1992-93 and 1993-94, are as follows:-

“The assessee is carrying on business of import and sale of scientific instruments. The assessee also earned commission on sale of scientific goods manufactured by foreign companies and others. The assessee purchased premises No. 82 on 8th floor, Sakhar Bha wan, Nariman Point, Bombay in 1982. The assessee was having Regional Office, but by Memorandum of Understanding dated 7th November 1987, the assessee gave the property to Citibank on Leave and Licence basis. As per clause 3 of Memorandum of Understanding dated 7th November 1987, licence fee was payable at the rate of Rs. 1,50,000 per month and, therefore, annual licence fee of the building was Rs. 18,00,000. The building was occupied by the Citbank with effect from 6th February 1988. Subsequently, by agreement dated 4th November 1988, licence fee was fixed at Rs. 25,000 for the first two years. The assesee declared income from the property under the head ‘Business Income’ but the AO assessed the annual letting value of the property at Rs.22,70,497 as under:-

1. Licence fee received as per Schedule ‘K’ on page 20 of the Annual Account		Rs. 15,70,000
2. Benefit on account of interest at the rate 15 % on the
(i) deposit of Rs. 107,50,000	6,58,437
(ii)  deposit of Rs. 12,60,000	1,89,000
(iii) deposit of Rs.5, 10,000	31,875
	8,79,312	8,79,312
		Rs.24,49,312
Less municipal taxes at the rate of Rs. 8,515.p.m for 21 months		Rs. 1,78,815

 This computation of annual income has been given at page 12 of the assessment order. The assessee has  received deposit of Rs. 12,60,000 as per Memorandum of Understanding dated 7.11.1987. This advance deposit of Rs. 12,60,000 was received by the assessee as advance free of interest which was to be adjusted by Citibank during last six months of the terms of agreement. Similarly, amount of Rs.5, 10,000 was received by the assessee free of interest from the Citibank being six months compensation in advance relating to the compensation payable during 9th and 10th year as per agreement dated 4.11.1998. Under the agreement dated 4.11.1988, the licence fee at the rate of Rs.25,000 per month was determined for the first two years as against licence fee of  Rs. 1,50,000 per month determined by Memorandum of Understanding dated 7.11.1987 with the Citibank. Presumably, the AO calculated the interest at the rate of 15 % on the amount of Rs. 12,60,000 received as interest free advance under Memorandum of Understanding dated 7.11.1987 and the amount of Rs.5, 10,0000 received under agreement dated 4.11.1988 by the assessee company from the Citibank. The interest at the rate of 15 % was calculated by the AO for the purpose of determining the municipal value of the property No. 82 (8th floor), Sakhar Bhavan, Nariman Point, Bombay for the purpose of determining the annual letting value because the assessee has received interest free advance from the Citibank. The assessee also received an amount of Rs. 1,07,50,000 by a separate agreement of the same date – 4.11.1988 as mentioned by the AO in the assessment order and this amount of Rs. 1,07,50,000 was also free of interest. There forę the AO calculated 15 % on the amount of Rs. 1,07,50,000 as the benefit enjoyed by the assessee for the purpose of determining the annual letting value of the property. The AO, therefore, assessed the income from property No. 82 (8th floor), Sakhar Bha van, Nariman Point, Bombay under the head income from house property’ and determined the annual letting value of the property at Rs.22, 70,497 as mentioned at page 13 of the assessment order.

In first appeal, the CIT (A) considered the income from property as business income. The CIT (A) has discussed the reasons for his conclusion in paragraphs 15 and 16 of his order dated 23.9.1991. The Revenue felt aggrieved and filed appeal before the Tribunal”.

4. The Tribunal relied upon CIT Vs. Smt. Indermani Jatia [77 ITR 133 (Alld)]; O.R.M. M.SP.SV. Firm Vs CIT [63 ITR 404 (SC)] and CIT Vs National Storage Pvt Ltd [66 ITR 597 (SC)] and recorded findings in para 29 as follows:-

“In view of the various decisions cited in the preceding paragraphs 11 to 22 it is clear that the assessee is deriving income from property No. 82, 8th floor, Sakhar Bhavan, Nariman Point, Bombay as owner of the property. Therefore the income from 82, 8th floor, Sakhar Bhavan, Nariman Point, Bombay is to be computed under the head ‘Income from house property and not under the head ‘Income from business’. The cases relied upon by the assessee’s counsel are not applicable to the facts of the case of the assessee before the Tribunal.”

5. Sri R.R. Agarwal, learned counsel for the appellant submits that the Company never ceased to run the business. It had two properties in Bombay. One of the properties, let out to ONGC, was not vacated, even after expiry of the lease period. An interim order was obtained by the tenant from the Court, and that the litigation is still pending. So far as the other property, the company was running its Regional Office from the property at 82, 8th floor, known as ‘Sakhar Bhavan’ situate at Nariman Point, Bombay. In order to avoid losses in the business, the appellant decided to let out the property known as ‘Sakhar Bhavan’ to City Bank. Initially an agreement was entered into between the parties, on 7.11.1987, to lease out the property for a period of 10 years. Accordingly to clause (3) of the agreement, the monthly licence fee payable was at Rs.1 ,50,000/- for the first two years; at Rs.1,65,000/- for the next two years; at Rs. 1,80,000/- for the 5^th & 6^th years; at Rs.1,95,000/- for the 7^th & 9^th years and at Rs.2,10,000/- for the 9^th and 10^th years. Clause (4) of the agreement provided that the City Bank was required to deposit a sum of Rs.12,60,000/- as interest free advance, to be adjusted in the last six months of the terms of agreement. As per clause (5), the City Bank was to grant a loan of Rs.1 .55 crores, bearing an interest at the rate of 15 % per annum, on completing legal formalities. The principal amount of the loan was to be paid by the assessee on the expiration of the term of the agreement. A fresh agreement was executed substantiating the earlier agreement on 4.11.1988, whereby licence fee was fixed at Rs. 25,000/- per month, increased by Rs.15,000/- after every two years. Simultaneously, the Bank agreed to make security deposit of Rs.1,07,50,000/-, free from interest. As per first agreement, the City Bank had agreed to advance a loan of Rs.1,55,00,000/- on an annual interest of 15 % along with interest free advance of Rs.12,60,000/-, whereas in the later agreement the bank agreed, not to charge interest on the deposit of Rs.1,07,50,000/-. The Company was thus benefited with Rs.16,12,500/- annum.

6. Sri R.R. Agarwal submits that since the company continued to run its of the business and arrangement was made with the City Bank in the business interest of the company, the letting out of the building, was by way exploitation of the business assets, for making profit. He relies upon Para 3 (e) of the Memorandum of Association of the appellant company, which authorised the Company to purchase or otherwise acquire or dispose of by sale, lease or hire any other business or factory, or movable or immovable property, or any rights and privileges, which may be deemed necessary or convenient for the purposes of the Company’s business. Clause 3 (e) of the Memorandum of Association of the Company is quoted here under:-

“(e) To purchase or otherwise acquire or dispose of by sale, lease or hire any other business or factory, or movable or immovable property, or any rights and privileges, which may be deemed necessary or convenient for the purposes of the Company’s business; and to amalgamate in part or whole, or to effect any other arrangement with any other business or concern, if conducive to the better working of the Company.”

7. Sri R.R. Agarwal, has relied upon judgement of the Supreme Court in Universal Plast Ltd Vs. Commission of Income Tax [(1999) 237 ITR 0454]. In this judgement, the Supreme Court, after considering the earlier judgements in CEPT Vs. Shri Lakshmi Silk Mills Ltd [(1951) 20 ITR 451 (S.C.)]; Commissioner of Income Tax Vs. Calcutta National Bank [(1959) 037 ITR 0171 (SC)]; Commissioner of Income Tax Vs. Vikram Cotton Mills Ltd [(1988) 169 ITR 0597 (SC)]; Narain Swadeshi Weaving Mills Vs. Commissioner of Excess Profits Tax [(1954) 026 ITR 0765 (SC)]; New Savan Sugar and Gur Refining Co. Ltd Vs. Commissioner of Income Tax [(1969) 074 ITR 0007 (SC)]; and Sultan Brothers Pvt Ltd Vs. Commissioner of Income Tax [(1964) 051 ITR 0353 (SC)], summarised the conclusions as follows:-

“(1) no precise test can be laid down to ascertain whether income (referred to by whatever nomenclature, lease, amount, rents, licence 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 also will cease to be business assets and the transaction will only be exploitation of property by an owner thereof, but not exploitation of business assets.”

8. Sri A.N. Mahajan, learned counsel for the department has relied upon following judgements:-

5. Mangla Homes P Ltd Vs. Income Tax Officer and others [(2010) 325 ITR 281 (Bombay)]

9. We need not discuss all the judgements relied upon by the learned counsel for the department, as the principle of income from property is an income of profit and gain of business, or profit and gain from the house property have been clearly laid down by the Supreme Court. The test laid down by the Supreme Court in Universal Plast Ltd (Supra) case have been followed, in almost all the subsequent judgements. We may however refer to judgement in Mangla Homes P Ltd Vs. Income Tax Officer and others [(2010) 325 ITR 281 (Bombay)].

10. In Mangla Homes P Ltd (Supra), the appellant – a private limited company was incorporated with the object of dealing in properties. The main object of the company, as contained in the memorandum of association, was to carry on business of dealing and investment in properties, flats ,warehouses, shops, commercial and residential houses, and the ancillary object was to carry on business of leasing, hire purchase, renting, selling, reselling or otherwise dispose of all forms of movable or immovable properties and assets including buildings, godowns, warehouses and real estate of any kind. The assessee purchased flats for trading purposes, at the cost of Rs.4 crores. At the time of purchase, according to the assessee, it was expected that the value of the flats would go up, after completion of repairs. The flats could not be sold because of recession in the market, and hence they were let out on licence basis, for temporary periods, for earning monthly rental income, as licence fee. The Bombay High Court distinguished the judgement of the Supreme Court in S.G. Mercantile Corporation P Ltd [(1972) 83 ITR 700 (S.C)] and CET Vs. Shri Lakshmi Silk Mills Ltd [(1951) 20 ITR 451], and held that in the facts of the case the authorities below did not commit any error in the finding that the rental income could not be treated as income from business and should be treated as income from house property.

11. In Commissioner of Income-Tax Vs. New India Industries Ltd [(1993) 201 ITR 208 (Gujarat)], the Gujarat High Court had laid down nine tests to decide as to under which head of income, the ‘rental income’ would fall. The Gujarat High Court, held that the assessee never wanted to exploit the asset as a commercial asset for any commercial gain. It acted like a prudent owner of the property. On closure of the business, instead of permitting the building to lie idle, it leased out the same with a view to earning rental income and thus the income was from ‘income from house property’. The tests laid down by the Gujarat High, to decide such matter, are quoted hereunder:-

“From the observations made by the Supreme Court and various High Courts in diverse fact-situations, dealing with question as to under which head of income, the “rental income” would fall, in our opinion, the following principles emerges :

(i)  No general principle could be laid down which is applicable to all cases and each case has to be decided on its own facts and circumstances.

(ii) Whether an income falls under one head or another has to be decided according to the common notions of a practical and reasonable man, for the Act does not provide any guidance in the matter.

(iii) In each case, what has to be seen is whether the asset is being exploited commercially by the letting out or whether it is being let out for the purpose of enjoying the rent. The distinction between the two in a narrow one hand has to depend on certain facts peculiar to each cases. Pure and simple. Commercial asset like machinery, plant, tools, industrial sheds on go-downs having high business potential stand on a different fooling from assets like land or building.

(iv)  If an assessee derived income from a commercial assets which is capable of being use as a commercial asset, then it is income from his business. Whether he uses that commercial asset himself for lets it out to somebody else to be used. The asset would not cease to be commercial asset simply because temporarily it was put out of use or it was let out to another person for his use.

(v) So long as the Commercial asset is capable of being exploited as such, its income is business income irrespective of the manner in which the asset is exploited by the owner of the business. He entitled to exploit it to his best advantage and be may do so either by using it himself personally or by letting it out to somebody else.

(vi) If the commercial asset is not capable of being used as such or as a commercial asset, then its being let out to other does not result in the accrual of business income.

(vii) When the assessee has stopped doing business altogether and when the asset ceases to have the character of business or commercial asset’s it becomes a capital asset. Qua such asset, the assessee is not carrying on any business. As the owner of the asset, he may exploit such asset but, in such circumstances, income which he receives is no longer business income but income from property owned by him and hence, “income from house property”.

(viii) When the asset is in the nature of land or building capable of being used for any other purpose and when the assessee ceases to use it is as a commercial asset either himself or even through others, the income derived by him by renting out the same would made appropriately fall under the head “Income from house property” as, like any other owner of property, he gets income from that property as owner. In such cases, it is not the factotum of his business or commercial activity which brings income to him but it is his investment in property or his ownership of property which brings income to him. In such cases, leasing of property itself is the activity. It is leased with a view to produce income, a transaction quite apart from the ordinary business activities of the ass essee.

(ix) In the descending whether an assessee dealt with its property as owner or as a businessman or as a prudent man of commerce. One must see not the form which it gave to the transaction but to the substance of the matter. In which that property is used, ownership of property and leasing it out may be done as a part of business or it may be done as a landowner. Whether it is the one or the other must necessarily depend upon the object with which the act is done. If the dominant object of leasing out in incidental to and for the purpose of the assessee’s business, the income would be business income. What has to be discovered is whether the property is subservient to the main business of the assessee.”

12. In the present case, we find that the authorities did not apply the principle laid down in Universal Plast Ltd (Supra) in deciding the issue. Though the Income Tax Appellate Tribunal relied upon Tutocorin Alkali Chemicals and Fertilisers Ltd Vs. CIT [227 ITR 172 (S.C)], Sultan Brothers Pvt Ltd Vs. CIT [51 ITR 353 (S.C.)], Commercial Properties Ltd [AIR 1928 Cal 456], East India Housing and Land Development Trust Ltd Vs CIT. [42 ITR 19 (S.C)], Punjab National Bank Ltd Vs. CIT [141 ITR 886 (Del)], CIT Vs. Indian Metal and Metallurgical Corporation [215 ITR 424 (Mad.)], CIT Vs. Arvindkumar Odhavij [213 ITR 551 (Bom)], and other cases, it did not apply the principle laid down by the Supreme Court in Universal Plat Ltd (Supra) to the facts of the present case.

13. If we apply the tests laid down by the Supreme Court in Universal Plast Ltd, to the facts of the present case, we find that all the assets of the business were not rented out by the appellant company. It was doing the main business of manufactures, imports, purchases and dealing in scientific apparatus, chemicals, chemical products, articles of glass, metal, wood, paper etc., more or less connected with science, as given clause 3 (a) of the memorandum of association. Out of the three properties at Mumbai, the property in dispute was being used for its Regional Office. In the interest of the company, it decided to let out one of its properties, to the City Bank, by way of exploitation of business assets, for making profit. The assets were let out, while carrying out other business activities. There was nothing on record, to show that the appellant had sold away the properties or abandoned its business activities. In the circumstances, in order to exploit business assets, as a prudent business decision, the appellant took interest free loan from the City Bank, rented out, one of its properties to it, and shifted its Regional Office. In this commercial venture, the appellant received a higher income regularly from its commercial assets.