Karnataka High Court Rules Out Notional Rental Income on Building Without Occupancy Certificate

Background of the Dispute

The Karnataka High Court in Brigade Enterprises Ltd Vs Additional Commissioner Income Tax (Karnataka High Court) examined whether notional rental income could be brought to tax for a building that was still under construction and, crucially, did not yet have an occupancy certificate during the relevant period.

The matter reached the High Court by way of an appeal under Section 260-A of the Income Tax Act 1961, arising from Assessment Year (AY) 2010-11. The assessee, Brigade Enterprises Ltd, is a public limited company engaged in the business of developing and selling residential and commercial properties.

The appeal had earlier been admitted on three substantial questions of law, which broadly concerned:

  1. Validity of determining annual value on a notional basis for an under-construction building under Sections 22 and 23.
  2. Characterization of regularization fee paid for deviations from the sanctioned building plan – whether such fee amounts to a penalty.
  3. Whether the regularization fee is deductible as a business loss while computing profits under Section 28.

The High Court’s decision primarily turned on the first question relating to annual value and notional rent, while the second and third questions were dealt with by reference to an earlier binding decision.

Procedural History

Return, Scrutiny and Assessment

  • The assessee filed its original return of income for AY 2010-11 on 15.10.2010.
  • A revised return was later furnished on 31.03.2012, disclosing income of Rs. 6,27,87,633/-.
  • The case was selected for scrutiny, and a notice under Section 143(2) dated 25.08.2011 was issued.
  • The assessee complied with the notice and submitted the required details.

The Assessing Officer (AO), by order dated 26.02.2013, recorded that part of a building had been given to M/s. Brigade Foundation for running a school. Although the assessee did not admit any rental income for the relevant year, the AO concluded that a portion of the building was completed and therefore:

  • Treated 50% of the annual letting value that was disclosed in AY 2011-12 as applicable to AY 2010-11, on a notional basis.
  • Determined net income of Rs. 10,50,000/- as income from house property.
  • Raised a demand of Rs. 9,73,14,776/-.

First Appeal Before CIT(A)

The assessee challenged the assessment order before the Commissioner of Income Tax (Appeals). By order dated 09.06.2014, the CIT(A):

  • Partly allowed the appeal.
  • However, upheld the AO’s approach of determining annual letting value at Rs. 15,00,000/- for computing income under the head “house property” for the concerned year.

Second Appeal Before the Tribunal

The assessee carried the matter in further appeal to the Income Tax Appellate Tribunal (Tribunal) with respect to AY 2010-11.

  • The Tribunal, by order dated 16.10.2014, partly allowed the appeal.
  • Nevertheless, it confirmed the determination of annual letting value at Rs. 15,00,000/- for the purposes of computation of income from house property.

Being aggrieved, the assessee approached the Karnataka High Court under Section 260-A.

Substantial Questions of Law Before the High Court

The High Court admitted the appeal on the following three substantial questions of law: