The Income Tax Appellate Tribunal Cochin Bench in M. Damodaran Nair v. Income Tax Officer held that lease rent earned by an assessee engaged in the business of leasing and sub-letting commercial buildings is taxable as business income under Section 28 and not as income from house property under Section 22.
Assessment Proceedings and Dispute on Rental Characterization
The assessee was engaged in business activities including money lending, building operations, and the commercial taking of properties on lease for sub-letting. For assessment year 1995-96, the assessee received total rent of Rs. 2,76,750 by sub-letting commercial buildings to Canfin Homes and Oriental Insurance Company, which had been leased from the original owners (Smt. Leela Amma and Sri M. Baiju). After deducting operating and lease expenses, the assessee returned net business income of Rs. 1,01,496.
The Assessing Officer reopened the assessment under Section 147 and treated the entire lease rent as "Income from House Property" under Section 22, holding that the assessee was a deemed owner under Section 27(iiib) read with the Explanation to Section 269UA(f) because the premises had been held on lease for more than 12 years through consecutive agreements. The Commissioner of Income-tax (Appeals) affirmed the house property assessment, prompting an appeal before the ITAT.
Legal Analysis of Deemed Ownership Under Section 27(iiib)
The Tribunal examined the scope of deemed ownership under Section 27(iiib) of the Income-tax Act, 1961, introduced by the Finance Act, 1987:
- Statutory Purpose of Section 27(iiib): Designed to tax individuals who possess full beneficial ownership rights in immovable property while lacking formal registered legal title.
- Interaction with Section 269UA(f): Section 27(iiib) deems a person to be an owner only where rights are acquired through transactions specified in Section 269UA(f), such as part-performance under Section 53A of the Transfer of Property Act or power of attorney transfers.
- CBDT Circular No. 495 Clarification: Circular No. 495 dated 22 September 1987 explains that the extended definition of ownership applies to flat allotment in cooperative societies, power of attorney sales, and possession under Section 53A, not standard commercial tenancy or sub-letting arrangements.
Business Income vs House Property Income Comparison
The Tribunal held that a commercial lessee sub-letting space does not hold proprietary ownership:
| Criteria | Income from House Property (Section 22) | Profits and Gains of Business (Section 28) |
|---|---|---|
| Ownership Requirement | Requires legal or statutory deemed ownership under Section 27 | Applicable to commercial exploitation of leasehold rights |
| Consecutive Leases Exceeding 12 Years | Does not create deemed ownership without transfer of title rights | Constitutes standard operating commercial tenancy |
| Permissible Deductions | Restricted to statutory standard deduction under Section 24 | Actual operating expenses and head-lease rent deductible under Section 37 |
ITAT Ruling and Relief to the Assessee
The Tribunal held that the Assessing Officer proceeded on a fundamental misconception of law. Mere continuous tenancy over 12 years under successive lease agreements does not transform a lessee into an owner under Section 22. Because the assessee took properties on lease as a regular commercial business activity to derive profit through sub-letting, the income was properly assessable under Section 28. The ITAT set aside the orders of the lower authorities and allowed the assessee's appeal.