Taxability Of Rental Income From Let Out Property – A COVID-19 Complexity U/s 23 Of The Income-tax Act, 1961

Advocate Anuj Kisnadwala has raised the interesting and relevant question as to whether, if the landlord gives the tenant a concession in the rent owing to the Covid-19 hardship, he is entitled to claim that he should be taxed only the rent actually received and not on the contracted rent. He has referred to the relevant judgements and also offered valuable guidance on the documentation that the landlord should maintain to be able to argue his case successfully before the authorities

Taxability of rental income

1)    Rental income is taxed u/s 22 and 23 of the Income-tax Act, 1961(the Act). Section 22 of the Act is a charging provision according to which ‘annual value’ of the property shall be chargeable to tax in the hands of the owner. The computation of the annual value has been prescribed u/s. 23 of the Act, the relevant part of it reads as under:

“23. (1) For the purposes of section 22, the annual value of any property shall be deemed to be—

Waiver of rent during COVID-19 lockdown period

2)    In the current crisis, tenants of the commercial premises, being used for malls, restaurants, cinemas, etc are likely to show their unwillingness to pay the rent or atleast negotiate the rentals with the owners. It would be relevant to examine the taxability of rental income in a case where rent for few months is partly or fully waived.

3)    Consider a case where the owner has let out a commercial premises, prior to COVID 19 emergency, at a monthly rent of Rs. 50,000/-. Due to unprecedented events leading to lockdown, the tenant has expressed unwillingness to pay the whole of the amount for the period of three months. Considering the situation, the owner has agreed to such request subject to tenant paying the agreed rent regularly post the period of three months. As per clause (a) of S. 23(1) of the Act, the amount of rent which can be reasonably expected from the property shall be charged to tax. In other words, a fair rent would be brought to tax under the said clause. However, as per clause (b), in case of let out property, if the rent received or receivable is higher, then such higher amount shall be brought to tax.

4)    In the present case, it may not be much difficult to contend, based on the facts of the case, that the fair rent i.e. the amount at which property can be reasonably be expected to let, is very minimal or nil. It is admitted position that no person would be willing to take commercial property on rent when property itself could not be used. A reference can also be made to directions issued by government authorities to landlords asking them not to charge rent or evict the tenants. The rent agreement, although subsisting, cannot be used as a yardstick to decide the fair rent due to material change in the circumstances and also due to unwillingness of tenant to pay the rent. Thus, the amount chargeable to tax under clause (a) would be minimal or nil.

5)    However, the tax department may take recourse to clause (b) under which rent received or receivable [if it is higher than the amount determined under clause (a)] in respect of let out property is chargeable to tax. Admittedly there is a subsisting agreement under which rent is receivable and hence the case squarely fall within the ambit of clause (b). Thus, there is a strong possibility that the owner may be taxed in respect of rent as per the agreement even though he may not receive it.

6)    Before proceeding further, it would be worthwhile to note that it would not be possible for owner to contend that since the rent for three months is not ‘receivable’, it is not liable to be taxed under clause (b). The word ‘receivable’ in that clause refers to the amount of rent which is due but yet to be received. Rent which is due but could not be realised cannot be excluded. The Hon’ble Bombay High Court in the case of CIT v. Akshay Textiles (304 ITR 401)had an occasion to consider the amendment to S. 23 of the Act vide Finance Act 2001 w.e.f. 01.04.2002 wherein the Legislature had substituted the provision and brought in S. 23(1)(b) of the Act to cover the part of the annual value which otherwise would not fall within the tax ambit before its amendment. The Hon’ble Bombay High Court held that in the context of S. 23(1)(b) of the Act, the term ‘receivable’ would mean the annual value fixed in terms of the agreement entered into between the tenant and owner. It was held that even though the amount of rentfixed as per the agreement is not received by the ownerin the relevant year, the same would be assessable to tax.

7)    In fact, when S. 23 of the Act was amended vide Finance Act 2001 w.e.f. 01.04.2002, an ‘Explanation’ to S. 23(1) (reproduced herein above) has also been added to take care of the rent which has become due but could not be realised. According to this Explanation, if rent could not be realised, the same would not be charged to tax. However, in the case under consideration, resort to this relief is not available as the relief under the said Explanation is subject to fulfilment of certain conditions as per the Rule. One of the conditions, as per the Rule (Rule 4 of the Income Tax Rules) is that the tenant has vacated the premises or steps have been taken to compel him to vacate the premises. Admittedly, this condition is not satisfied in the present case.

8)    Coming back to the core issue under consideration, it is very important to note that if owner grants waiver of the rent simplicitor, he will not be able to claim any relief. Rent once earned – having become due under valid and subsisting agreement – has to be charged to tax. Subsequent waiver would not entitle any reduction in annual value chargeable to tax. The Hon’ble Chennai Tribunal in the case of M/s CRP (India) Pvt. Ltd v. Asst. CIT 1(2) in ITA No: 97/Chny/2018 dated 08.08.2019 has held that waiver of rent from the tenant for any reason cannot be a ground not to tax the amount due from the tenant. It was held that waiver of rent payable by tenant was application of income and the rental income had accrued to the owner.

A case to reduce the rent before it is receivable

9)    If owner and tenants agree before hand that the rent is to be reduced in respect of the period yet to come, it can be validly contended that the amount under consideration has not become receivable and therefore not taxable under clause (b). However, this is possible only in a case where it is shown that parties have intended (and preferably documented their intention) to modify the agreement before the rent had accrued under the agreement. There is a fine line of distinction between rent earned but waived and rent not earned.

Events to be documented

10) In order to minimise the possibility of litigation, the parties can discuss the revised terms and enter into a supplementary agreement effective from the date from which rent is reduced. Such supplementary agreement should contain a clause stating the reason for revising the rent. It could also contain a clause that, at present, the initial agreement amount is not the fair rent of the property and hence the rent is being revised as per the market trend and as mutually agreed between the parties. Preferably, a written communication should also be exchanged between the owner and tenant before revising the rent. The tenant should communicate in writing to the owner his request to reduce the amount of rental due to the ongoing crisis. The supplementary agreement may also record that the tenant has agreed to continue the tenancy in light of modified terms of agreement.

11) Alternatively, if the agreement contains a ‘Force Majeure’ clause, the same should be invoked and the rental amount should be amended with effect from appropriate date.

Conclusion

12) It is hoped that a bonafide transaction coupled with the above safeguard would eliminate any possibility of litigation with the department. If still there be – the MANTRA is same which, one is using in this trying time – ‘कोरोनासेलड़नाहै, डरनानहींहै.’