The tax department cannot impose tax on rental income in the hands of individual landowners if the commercial building has been constructed under a joint development agreement (JDA) and the income therefrom has already been disclosed and assessed under the present partnership form, the Income Tax Appellate Tribunal (ITAT), Bengaluru, recently ruled.
The Tribunal also held that the withdrawal of funds by landowners from the firm’s bank account did not in itself justify the imposition of tax on rental income in their hands.
The decision was made in a dispute over rental income from commercial properties developed under the JDA. The Income Tax Department treated the landowners as the actual owners of the building and distributed the rent to them despite the fact that the partnership firm had disclosed the rental proceeds.
However, in a judgment delivered on August 21, ITAT Bangalore held that the firm is a genuine legal entity and that taxing the same rental income again in the hands of landowners would amount to double taxation.
Why did the IT department impose tax on landowners?
According to the complaint, in March 2005, the landowners entered into a JDA agreement with the developer to develop their land. Subsequently, the landowners and the developer formed a registered partnership firm to develop Block C1 in the Special Economic Zone (SEZ).
The JDA agreement was entered into between the owners of Lakshmamma, her son Late Venkatesh Reddy and five daughters, V. Kothanda Reddy and his father Late Venkataswamy Reddy and builder Shyamaraju & Company (India) Pvt. OOO
After the building was built, it was rented to several companies, with the rent directly deposited into the bank account of the partner firm.
During a search conducted in June 2022, the tax office decided that the actual owners of the property were the landowners and not the partnership firm. The Assessing Officer (AO) relied, inter alia, on the withdrawal of funds by the owner-partners from the account of the firm and on the fact that property tax was paid by the landowners.
The rental income was subsequently distributed to the landowners and added to their taxable income under Residential Property Income, which in turn increased their tax liability.
How the landowners won the case
The landowners argued that the partnership firm was a genuine registered legal entity recognized by a number of government agencies as a co-developer of the SEZ. They alleged that the rental proceeds were recorded in the firm’s books and credited to its bank accounts.
They also argued that the tax department itself had assessed the firm after accepting its declared rental income and hence could not tax the same income again when it came into their hands.
ITAT Bangalore agreed with this argument. He admitted that the partnership firm is a legal entity, its partnership deed is registered and the building is leased, with the rent being directly credited to the firm’s bank account.
The Tribunal also found that the Inland Revenue had itself assessed the firm’s rental income. After hearing both sides and considering the available evidence, the authority held that the firm was the owner of Block C1 and correctly received and disclosed the rental income.
It also held that the withdrawal of funds from the firm’s account by the partners cannot itself be treated as rental income in their hands. Such withdrawals were accounted for as a debit to the partners’ capital accounts and did not result in a transfer of ownership of the building from the firm to the partners.
“The Ld.AR (learned Authorized Representative) submitted that the addition made against the assessee is not justified as she is neither a partner in the firm nor has she withdrawn any amount from the firm. The Ld.AR has also submitted that the withdrawal at best may be a liability in the capital account of the partners and should not be treated as income in the hands of individuals,” the order said.
Since the tribunal also noted that there was no specific corroborating evidence that the landowners were the real owners of Block C1, the landowners ultimately won the case. The Tax Department has been asked to eliminate the addition of rental income in the hands of taxpayers and thus appeals against undisclosed rental income have been allowed.