Source: Kerela High Court 

Why in News? 

A bench of Justice AK Jayasankaran Nambiar and Justice KV Jayakumar held that income from sale of immovable property is to be treated as ‘Capital gains’ and not ‘business income’.    

• The Kerela High Court held this in the case of M/s Knowell Realtors India Pvt Ltd v. Assistant Commissioner of Income Tax. 

What was the Background of M/s Knowell Realtors India Pvt Ltd v. Assistant Commissioner of Income Tax Case?   

• The Company was incorporated on 27th September 1996 and is involved in the business of property leasing and sale. 
• Previously, the appellant declared rental receipts as "Income from House Property". 
• The tax returns earlier were accepted without any objection. 
• For assessment years 2012-13 and 2015-16, the tax department changed its approach.  
• The department reclassified rental receipts from "House Property Income" to "Business Income".  
• The consequence of the above was: 
  • Sale of properties now assessed as business income. 
  • It differs from the appellant's original declaration of capital gains. 
  • This potentially results in different tax implications and liability. 
• The key issue to be determined here was to determine the correct head of income for rental receipts under the Income Tax Act.

What were the Court’s Observations?  

• The Court observed that it is a basic requirement that the tax assessment should be uniform and consistent. 
• The Court noted that the assessee has been deriving income from letting out the house property owned by it in all the years prior and subsequent to the assessment year. 
• It was further noted that merely because in a given year the assessee affected sale of its properties it cannot be said that he has embarked upon the business of selling and buying the properties over the years. 
• Finally, the Court held that the sale of the properties in the two years under consideration should only be seen as an activity which is incidental to the activity of letting out the property for rent. 
• Thus, the Court held that the income derived by the assessee from the sale of properties owned by it during the two years in consideration can only be assessed under the head ‘capital gains’ and not as ‘business income’.

What are the Types of Taxes?

• There are two types of taxes: direct tax and indirect tax. 
• Direct Taxes: Direct taxes are levied directly on an individual's or organization's income or wealth. These are paid directly to the government by the taxpayer. These are as follows: 
  • Income Tax: Imposed on individuals, Hindu Undivided Families (HUFs), and businesses based on their income. 
  • Corporate Tax: Levied on the net income or profits of companies. 
  • Capital Gains Tax: Charged on profits earned from the sale of capital assets like property, stocks, or bonds. It can be: 
    • Short-term capital gains tax (STCG) 
    • Long-term capital gains tax (LTCG) 
  • Securities Transaction Tax (STT): Tax on transactions in the stock market, like the sale or purchase of equity shares. 
  • Dividend Distribution Tax (DDT): Paid by companies distributing dividends (abolished in 2020 and shifted to shareholders). 
  • Wealth Tax: (Abolished in 2015) Previously levied on an individual's net wealth exceeding a certain threshold. 
• Indirect Taxes: Indirect taxes are levied on goods and services and are included in the price of goods and services, paid indirectly by the consumer. Following are the types of indirect taxes: 
  • Goods and Services Tax (GST): A comprehensive tax on the supply of goods and services, subsuming several other indirect taxes. It includes: 
    • CGST: Central Goods and Services Tax 
    • SGST: State Goods and Services Tax 
    • IGST: Integrated Goods and Services Tax 
    • UTGST: Union Territory Goods and Services Tax 
  • Customs Duty: Levied on goods imported into or exported from India. 
  • Stamp Duty: Charged on legal documents such as property sale deeds. 
  • Entertainment Tax: (Subsumed under GST in most cases) Previously levied on movie tickets, events, etc. 

What is Income from “Capital Gain” and Income from “Business”? 

• Whenever the transaction involves transfer of capital assets it is income from capital gain. 
• However, when the transaction is entered in normal course of business it is business income. 
• In the case of Kenton Leisure Services (P) Ltd v. DCIT 18 taxmann.com 158 (ITA T-Cochin) (2012), the Court held that where there are multiple agreements that are interconnected all of them should be considered as a part of single, integrated transaction and should not be viewed distinctly. 
  • Also, the Court held that the entire income from these agreements have to be assessed under the head of ‘business income’. 
• In order to determine if the income is business income or the capital gaisn income following points should be considered: 
  • The Normal course of business: if the transaction is similar to normal course of business it is considered to be business income. 
  • The frequency of transaction: the greater the frequency of transaction the higher is the likelihood of it being treated as a business income. 
  • The adventure in the nature of trade: The income from adventure or concern in the nature of trade is to be treated like business income.