Taxability of Income From Property

NOTE: The following discussion is under the provisions of Income Tax Ordinance, 2001 only. Provisions of Provincial Sales Tax on services will be updated over a period of time.

The 'rent' received or receivable by a person for a tax year is taxable under the head 'Income from Property'. However, any rent which is exempt from tax under any provision of the Income Tax Ordinance, 2001 shall be ignored while computing the "Rent Chargeable to Tax" (RCT) under this head. [15(1 )] 

RENT [2(49), 15(2) to (5), 16] 

"Rent" means any amount received or receivable by the owner of the land or the building for its use or occupation by some other person. Generally, the amount received or receivable is taken as rent. However, where the 'fair market rent' (FMR) is more than the actual rent, then the fair market rent shall be taken as rent. [15(4)] 

For the purposes of the Income Tax, following amounts are also included in "Rent Chargeable to Tax": 

• Any forfeited deposit received under a contract for the sale of land or a building. 
• Any obligation of the owner (e.g., property tax, etc.,) paid by the tenant.
• Any amount received by the owner from his tenant as advance, which is not adjustable against rent. (Amount determined as per section 16 of the Income Tax Ordinance shall be included in RCT. Generally, one-tenth of such advance is charged to tax every year.) 

RENT OF PROPERTIES NOT TAXABLE AS "INCOME FROM PROPERTY" 

Rental income of the following properties shall not be chargeable to tax under the head "income from Property": 

1. Any building which is let out together with the plant and machinery installed therein shall not be taxable under this head. Rather, it shall be taxable under "Income from Other Sources". Examples of such buildings are cotton ginning factories, rice mills, etc [15(3) & 39(1)(f)]
2. Any agricultural building whose income is treated as agricultural income. [41 (2)(c)] 
3. Any property which is sublet by the tenant. Only the rental income of the owner is taxable under this head and the income of the tenant from subletting the property is chargeable to tax as "Income from Other Sources". 

ADVANCES AGAINST RENTED BUILDINGS (16)

Generally, the owner of a building receives two types of advances at the time of letting out the property to a tenant. 

These are: 

• The advance which is adiustable against the rent. After the expiry of a certain period this amount will become zero as being fully adiustable against the rent payable by the tenant. 
• The advance which is not adjustable against the rent. This may further fall into: (i) Security, or (ii) Pugree. 

Both types of above stated advacces are treated separately under the Income Tax Ordinance, 2001. The legal provisions in this regard are discussed below. 

Advances Adjustable Against Rent

Where, as per rent agreement, the advance given by the tenant is adjustable against the rent payable by him to the owner of the byilding then the amount of advance is totally ignored while computing the RCT. The amount of rent (as agreed between the parties) is taken as actual rent for the period. 

Advances Not Adjustable Against Rent 

Where an advance is not adjustable against rent it is treated as income which requires a special treatment. The provisions of the law in this regard are summarized below: 

1. Any amount received as advance not adjustable against rent is divided by ten (10) and the resultant figure is added in the RCT of the property in the tax year in which it is received and nine (9) tax years next following that year [16(1)].
2. If the tenant has vacated the building and the amount of advance has been refunded before the expiry of ten (10) years, nothing shall be added in the RCT of the property in the year of refund and subsequent tax years. [16(2)]. 
3. Where the same building is rented out to another tenant. the amount to be included in the RCT shall be calculated as follows [16(3)] 

Amount of advance received frorn new tenant                                                                   XXX 

Less: Amount already charged to tax out of advance from previous tenants                    (XXX)

The balance to be charged to tax during 10 years                                                               XXX

AMOUNT RECEIVED FOR VACATING THE POSSESSION OF A PROPERTY 

Where a taxpayer receives any amount for vacating the posession of any building or any part of the building, such income less the amount paid by him for taking the possession of that building shall be deemed as his income. This will charged to tax under the head 'Income from Other Sources' in ten (10) years (starting from the year in which it is received) in equal proportion. [39(1)(k) & 39(2)]

RENT CHARGEABLE TO TAX UNDER "SALARY INCOME" [15(5)] 

Where the lessee (tenant) is a salaried person and the 'fair market rent' of the property is treated as a perquisite while determining his taxable salary income, it is a case where the property is hired by the employee and the rent is payable by the employer, then the treatment of the rent shall be as below: 

1. The fair market rent shall be taken into account while determining value of the rent-free accommodation at the time of computing taxable salary income of the person. 

2. The actual rent received or receivable shall be taken as rent chargeable to tax under "Income from property" of the owner. Under this case the comparison of the actual rent and the fair market rent shall not be made. 

ADMISSIBLE DEDUCTIONS [15A] 

Currently, 'income from property' of individuals and AOPs is covered under Separate Tax Regime (STR); hence, no deductions are admissible. However, in case of a company, this income is taxable under Normal Tax Regime. 

While computing the 'Income from Property' of a company the following deductions shall be made out of the rent chargeable to tax: 

1. In respect of repair of building a repair allowance equal to one-fifth (1/5th) of the rent chargeable to tax (RCT). 

Notes: 

i) The actual repair expenses are immaterial while computing the taxable income under the head income from property. Whether the owner has expended amount on repairs or not, a deduction equal to one-fifth (1l5th) of RCT shat be allowed. 

ii) This deduction shall be allowed before allowing any other deduction. 

2. Insurance premium paid or payable to insure the property against risk of damage and destruction.

3. Any amount paid or payable to any local authority or Government on account of the following 

i) Local rates;

ii) Tax; 

iii) Charge; or 

iv) Cess. 

In this regard the following points should be noted: 

i) The payment is made in respect of the property or income from property; 

ii) The amount is paid or payable by the owner; and 

iii) The payment should not be under any provision of the Income Tax Ordinance, 2001 

4. Amount paid as ground rent, if any. 

5. Amount paid or payable to any person or institution as cost of borrowed capital, profit, interest, share in rent, share towards appreciation in the value of property, etc. if the amount has been borrowed for any of the following objects: 

i) Acquisition of the property; 

ii) Construction of the property; 

iii) Renovation of the property; and 

iv) Reconstruction of the property. 

6. Amount of profit or interest paid on money borrowed capita1 charge, if any. 

Notes: 

i) It is to be noted that return of capital is not allowed as deduction. It is the profit, interest e.t.c. which is admissible deduction under this head. 

ii) Techntcally speaking the interest is paid on loans and not on a mortgage (which is a security available against the loan obtained). Thus apparently no deduction should be available as no interest payable on the mortgage. However. in a practice any intrest paid on any loan  which is obtained  against the mortgage of a property is being claimed and allowed as admissible deduction against the income from property. The purpose of loan is considered as irrelevant in this regard. 

7. Rent collection charges including administration and collection charges shall be allowed as deduction with the following conditions: 

i) It should have been actually incurred and paid or payable by the person in the tax year wholly and exclusively for the purpose of deriving taxable rent; 

ii) It should not exceed 6% of rent chargeable to tax (RCT); and 

iii) RCT for this purpose shall be the amount of rent before allowing any other deduction. 

8. Legal expenses incurred for defending the title or any other suit connected with the property. 

9. The amount of irrecoverable rent. 

In order to claim a deduction on account of irrecoverable rent the following conditions are to be fulfilled: 

i) The tenancy was bona-fide; 

ii) The defaulting tenant has vacated or steps have been taken to compel him to vacate the property; iii) The defaulting tenant is not in occupation of any other property of the taxpayer; 

iv) The taxpayer has taken all legal steps for the recovery of unpaid rent or has reasonable grounds to believe that legal proceedings would be useless; and 

v) The amount of unrealized rent was included in the total income of the tax year to which it relates and tax was paid thereon. 

Notes: 

1. The expense on account of irrecoverable rent shall be allowed only if the RCT has been computed on 'accrual basis'. It shall be allowed as deduction irrespective of the fact that the tax on this income has not yet been paid. 

2. The above deductions are admissible only for computing the income under the head 'Income from Property'. These deductions cannot be claimed against any other head of income. [15A(5)]

3. Due care should be exercised to ensure that the method adopted for recognition of income and claiming of deductions should be the same. 

4. Any deduction, which is inadmissible u/s 21 (under the head "Income from Business) shall also be inadmissible while determining "Income from Property". [15A(6)] 

IRRECOVERABLE RENT FOR THE CURRENT YEAR [15A(1)(j)] 

The Income Tax Ordinance (along with other conditions), provides that in order to claim a deduction on account of irrecoverable rent, the taxpayer has to prove that the unpaid rent was included in taxable income for the relevant tax year and tax was also paid on such income. 

This condition cannot be fulfilled if the unpaid rent pertains to the current tax year as the income and tax liability is being computed and the tax is yet to be paid. Under such a case the following points should be considered: 

1. Where the taxpayer compuyes his income on the basis of actual receipt, then there will be no question of including. and thereafter allowing deduction on account of irrecoverable rent. In this case it will be immaterial whether the unpaid rent pertains to any previous tax year or the current tax year. An amount shall be included in income only when it is actually received. There will be no treatment for unpaid rent. 

2. Where the taxpayer has adopted accrual system for recognizing his incomes and the irrecoverable rent belongs to the current tax year, the irrecoverable rent shall be allowed as deduction although tax on this amount has not been paid. 

RECOVERY OF UNREALIZED RENT [15A(2)] 

Where a deduction has been allowed on account of irrecoverable rent and later on it is covered (whether partly or wholly), the amount so recovered shall be included in the RCT of the tax year in which it is recovered. 

NON-PAYMENT OF AN ALLOWABLE DEDUCTION [15A(3)] 

Where a person has been allowed a deduction on accrual basis and the same has not been paid within a period of three (3) years of the end of the tax year in which deduction was allowed, the amount so unpaid shall be treated as income. It shall be included in the RCT of the tax year immediate after expiry of three (3) years. 

PAYMENT OF AN UNPAID LIABILITY [15A(4)] 

Where an unpaid liability has been treated as income and is later on paid by the taxpayer so much of the amount as has been paid shall be allowed as deduction in the tax year in which it is paid.

LIABILITY IN CASE OF CO-OWNERS (66) 

Where two or more persons jointly own a property and their respective shares in the property are definite and ascertainable, such property shall not be taxed as association of persons (AOP). Rather, share of each person shall be included in his total income. 

RENT INCLUSIVE OF UTILITIES [15(3A)] 

Where the rent includes charges for utilities (e.g. electricity, gas, water, air-conditioning, sanitation, lift, security, etc.) the whole amount received from the tenants shall not be charged to tax under the head Income from Property'. Under such a case the amount received for utilities shall be taxed under the head 'Income from Other sources'. The balance amount of rent shall be taxed as income from property. 

Notes: 

1) While computding the taxable income for services rendered, the actual expenditure (including the depreciation) incurred by the owner shall be allowed as deduction. 

2) Where the portion of the rent and the services cannot be segregated from each other, the expenses actually incurred by the owner for provision of utilities shall be deducted from the rent. The resultant figure shall be treated as Rent Chargeable to Tax. 

OWNER'S BURDEN PAYABLE BY THE TENANT 

Where the liability, which in the ordinary course is payable by the owner, is paid by the tenant, the rent (RCT) of the property shall be increased by the amount actually paid by the tenant. 

REPAIR CHARGES PAYABLE BY TENANT 

Where the repair charges are to be borne by the tenant, an amount equal to 1/5th of RCT shall be added to the amount of rent so as to arrive at the annual value of such property. 

Fort this purpose actual rent shall be taken as 4/5th of the rent chargeable to tax.

SELF-HIRING OF A PROPERTY 

Where an employee or his spouse is the owner of any such building (i.e., house, flat or apartment) that is given on rent to the employer and the employer has provided the same building to the employee against his entitlement for a rent-free accommodation, then it will have two-fold effect under the Income Tax Law. The same is discussed below. 

1. Property Income Receipt of rent of building is chargeable to tax under the head "Income from Property". Amount received by the employee or his spouse shall be a property income of the recipient and be treated accordingly. 

2. Salary Income The building is provided by the employer to his employee as a rent-free accommodation. It will be a perquisite and will be included in the 'salary income' of the employee as per Income Tax Rules, 2002.

TAXATION OF INCOME FROM PROPERTY [15 (1), (6) & (7)] 

Since tax year 2017 (starting from 01-07-2016) the scheme for taxation of 'income from property' has once again been changed. For this purpose the taxpayers have been split into two categories. 

The categories and taxation rules applicable thereto are discussed below.

Companies 

A company, as previously, shall pay tax in respect of its 'income from property' under normal tax regime. All deductions u/s 15A shall be available to a company. While computing taxable property income. The taxable income from property (RCT - Deductions) shall form part of total income and be taxed at the rates applicable to the company deriving such income. 

Individuals and Associations of Persons [15 (6) & (7)] 

'Income from property' derived by an individual or an association of person (AOP) shall be taken as a separate block of income and charged to tax at the rates specified for this purpose. 

Various legal provisions in this regard are as below: 

1. Rent chargeable to tax (RCT) shall be determined as per normal procedure

2. No deductions shall be admissible u/s 15A of the Income Tax Ordinance, 2001; 

3. An individual or an AOP shall not be taxable if:  

(i) The RCT for a tax year does not exceed Rs. 200,000; and 

(ii)The person does not have any other taxable income for the year. 

Tax on 'income from property' shall be computed at the following rates:

AT SOURCE DEDUCTION OF TAX FROM 'RENT' [155 & Division-V, Part-Ill of First Schedule] 

Following 'prescribed persons are required to deduct tax at the prescribed rates while making payment of rent, whether full, part or advance (of immovable property, furniture fixture and amount of services for such property)

1. The Government (Federal, Provincial or Local); .

2. A Company; 

3. A non-profit organization or a charitable institution; 

4. A diplomatic mission of a foreign state; 

5. A private educational institution. a boutique, a beauty ·parlour, a hospital, a clinic or a maternity home; 

6. Individuals or AOPs paying an annual gross rent of Rs. 1,500,000 or above; and 

7. Any other person notified by the Board.

Individuals or AOPs: 

Tax shall be deducted from rent paid to an individual or AOP by applying the following rates on the gross amount of rent: 

Companies: 

Tax shall be deducted from rent paid to a company by applying the following rates to the gross amount of rent received by: 

1. Filer 15% 

2. Non-filer 17.5% 

Tax is deducted on the 'gross amount of rent paid during the tax year at the applicable tax rates. 'Gross rent' includes any part of the amount received as advance not adjustable against rent. [155( 1 )].

Where tax at source has been deducted from the gross rent received, it shall be treated as advance tax adjustable against tax liability of the person for the tax year. 

CLICHED