ITAT Mumbai Quashes Deemed Rental Income Addition on Unsold Real Estate Inventory for AY 2017-18

The taxation of unsold flats held as stock-in-trade by real estate developers has historically been a highly litigated domain under the Income Tax Act 1961. The primary dispute revolves around whether a builder, whose primary business is constructing and selling properties, should be forced to pay tax on a notional or deemed rental income for completed flats that remain unsold.

In a recent and highly significant judicial pronouncement, the Income Tax Appellate Tribunal (ITAT), Mumbai Bench, delivered a decisive ruling in the case of Bhgawati Abhilasha Con Venture Vs ACIT. The Tribunal categorically held that the statutory amendment introducing the taxation of deemed rental income on unsold stock-in-trade is strictly prospective in nature. Consequently, no such notional addition can be sustained for Assessment Year (AY) 2017-18.

This comprehensive analysis delves into the factual matrix, the statutory evolution of the law, the resolution of conflicting judicial precedents, and the broader implications of this ruling for the real estate sector.

The Factual Matrix of the Dispute

The assessee, Bhgawati Abhilasha Con Venture, is an entity actively engaged in the business of real estate development and construction. During the normal course of its business operations, the assessee constructed various residential and commercial units. As is customary in the real estate industry, several completed units remained unsold at the end of the financial year and were appropriately classified and disclosed in the financial statements as "stock-in-trade".

During the scrutiny assessment proceedings for AY 2017-18, the Assessing Officer (AO) observed these unsold flats in the assessee's inventory. Relying on the premise that completed properties are capable of generating rental yield, the AO proceeded to compute a notional annual letting value for these unsold units. Consequently, the AO made an upward adjustment, adding an amount of ₹31,56,978 to the taxable income of the assessee under the head "Income from House Property".

Aggrieved by this arbitrary addition, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)] - National Faceless Appeal Centre (NFAC). However, the appellate authority concurred with the AO's viewpoint, upholding the addition of ₹31,56,978 and dismissing the assessee's appeal. This compelled the assessee to escalate the matter to the ITAT Mumbai.

Statutory Framework: The Evolution of Section 23(5)

To fully grasp the gravity of the Tribunal's decision, one must examine the legislative history of the relevant provisions within the Income Tax Act 1961.

Historically, the statute did not explicitly prescribe the tax treatment of notional rent for properties held strictly as business inventory. The Revenue authorities frequently attempted to tax unsold flats under the head "Income from House Property," arguing that the mere ownership of a completed building triggers the chargeability of annual value, irrespective of whether the property is held as an investment or as business stock.