The purpose of income tax is to levy a tax on a person’s income. The whole objective is to tax what a person earns. One of the basic concepts of taxation is that a person can only be taxed in respect of her real income, and not in respect of some notional income that she could possibly have earned. Unfortunately, our tax laws contain certain provisions for taxation of notional income, which are not in consonance with this basic concept.
Some of these provisions are really measures to prevent tax avoidance. For instance, the provision deeming a loan received by a substantial shareholder from a private company to be dividend received by him, is to prevent disguising of a dividend as a loan by a person who has some amount of control over that company, to get around payment of tax on the dividends. Similarly, the provision deeming the stamp duty valuation to be the sale price of the property for the purposes of computation of capital gains on sale of an immovable property is to check the practice of receipt of sale consideration for properties partly in black money. Such measures are, therefore, justifiable considering the purpose for which they have been enacted.
There are certain provisions deeming an income to arise on account of a benefit received in kind. Examples of this are the provisions relating to taxation of stock options or perquisites. In such a case, the benefit is actually received by one person from another, and hence taxation of something received in kind instead of in money is also justifiable.
Money not earned, yet taxed
Where one does not receive any income or benefit from any other person at all, should you be taxed on a notional income? One such case of taxation of notional income is the provision relating to taxation of annual value of a house property owned by you, which has not been let out.
In such a case, you do not earn any rent, nor do you obtain any benefit from any other person merely by owning the property. By not letting out a property, you are not seeking to evade any taxes. Yet, as the owner of the house property, you are taxed on a notional annual value, which is the fair rental value of the property.
If you own only one house, this provision may not have an impact, because the annual value of one house is to be taken as nil. However, if you own more than one house, you end up paying tax on the notional annual value of all your houses, other than one whose annual value you may choose to take as nil.
While the courts have upheld the legal validity of the provision, the issue is whether such a provision is justified from a policy perspective. Such a provision of taxation of a notional rental value was perhaps justified when it was introduced way back in 1922 on the ground that it was intended to encourage people to own not more than one house, and, given the shortage of accommodation, to encourage people who had extra houses to let them out and not leave them vacant. However, given today’s changed scenario, with rental houses readily available, is such a disincentive really required?
Pull or push
Besides, if you own land on which there is no construction, or a half-constructed house, such a provision for taxation of notional rent does not apply.
The provision applies only if you own a residential house or an office premises, which is vacant. This does seem to be inequitable, and encourages holding of land, rather than construction of a house thereon.
With substantial increase in income levels and disposable wealth, it is common for many people to own a holiday home or have a share in their ancestral home, besides owning a house in the city or town where they live and work. Should a tax be levied on such persons on income that they do not earn or would never be received by them?
Removal of this tax disincentive will also act as a stimulus for taxpayers to purchase second homes. Given the abolition of wealth tax, there should then be no hindrance to purchase of second homes from a taxation perspective.
The only negative from a taxpayer perspective of non-taxation of such annual value is that currently, since the notional annual value is taxable, the entire interest on loans taken for acquisition of the house is also deductible without any limit. If the annual value is not taxable, then such interest on a loan may also not be deductible for the taxpayer.
The government is looking at making changes to tax laws in the forthcoming budget, which could have a significant impact. This provision of taxation of notional rent in respect of a self-occupied property certainly needs to be examined for this purpose.
Gautam Nayak is a chartered accountant.
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