ITO 10(2)(3), MUMBAI vs. MANAS PROPERTIES P.LTD, MUMBAI

This is an appeal filed by the Revenue against the order of CIT(A)- 2, Mumbai dated 26/09/2016 for A.Y.2013-14 in the matter of order passed u/s.143(3) of the IT Act. 2. The following grounds of appeal have been taken by the Revenue:- 1. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the Assessing Officer to delete the entire addition of Rs. 11,68,50,670/- made on account of alleged House Property income at accrual basis without appreciating the fact that the possession of the property was given to the lessee, Junobo Hotels Pvt Ltd., in which it started carrying out the structural changes." 2. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the Assessing Officer to delete the entire addition of Rs. 11,68,50,670/- made on account of alleged House Property income at accrual basis without appreciating the fact that the payment received by the assessee was M/s. Manas Properties Pvt. Ltd., termed as compensation by assessee was a misnomer, in fact it was rent receipt for use of premises." 3. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the Assessing Officer to delete the entire addition of Rs. 11,68,50,670/- made on account of alleged House Property income at accrual basis without appreciating the fact that the property of the assessee has been exploited commercially for the purpose of earning income, falls under the head house property income and the precondition that the lease rent commences after the approval from MOEF and IMCGM is a different issue and in no way it effects the receipt before the commencement of lease." 4. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing the Assessing Officer to delete the entire addition of Rs. 11,68,50,670/- made on account of alleged House Property income at accrual basis without appreciating the fact that the lessee has deducted the Tax at source from the amount of Rs. 2.10 crores given to the assessee u/s 194-1 of the Act, which deals with payment (actual/constructive) of rent."

Rival contentions have been heard and record perused.

Facts in brief are that assessee is engaged in the business of real estate construction and letting of commercial premises. The assessee filed the return of income on 30.09.2013 declaring total income at Rs. NIL and current year loss of Rs.7,49,331. During the year under consideration, the assessee has not carried out any business activity. The income credited to the profit and loss account included dividend of Rs.15,000/-, interest on loan given of Rs.11,02,56,808/- aggregating to Rs.11,02,71,808/-. Against these receipts, the assessee had debited expenses under various heads such as other taxes, insurance expenses, audit fee, other expenses etc.

In the assessment so framed u/s.143(3), AO has made addition under the head ‘income from house property’ amounting to Rs.11.76 Crores.

By the impugned order, CIT(A) deleted the same after observing as under:- 3.3. I have considered the facts, oral contentions and written submissions of the assessee as against the observation / findings of the AO in the assessment order. The only issue is whether any amount accrued to the assessee (proposed lessor) from M/s. Junobo Hotels Pvt. Ltd. (proposed lessee) or not. Hence, for the sake of convenience, all the grounds of appeal are disposed together. The assessee has leased out a property at Juhu Tara Road, Santacruz (W) Mumbai (comprising of land and building structure thereon) to M/s Junobo Hotels Pvt. Ltd to carry out a business as Hotel in the name and style of "Soho House vide lease agreement dated 18.02.2011 and subsequently amended vide dated 16.01.2012. However, as per Original Proposed Lease Agreement two distinct periods have been recognized period prior to meeting of conditions precedent has been recognized as Fit-Out period and date when conditions precedent are complied with has been treated as Rent Commencement Date. Lease rent would commence from Rent Commencement Date. Rent Commencement Date would begin only on completion of certain conditions precedent elaborated in Table B of the lease agreement. Para 8 of the Original Lease Agreement is reproduced below:- " 8.1 The parties hereto agree that both the Lessor and the Lessee undertake to fulfill their respective obligations under the specified conditions Precedent and the stipulated time frame for the obligations of the Lessor so as to commence the Lease rent from the Rent Commencement date as set out in Annexure 3 hereto as per schedule and provisions therein time being the essence or as may be mutually extended. The period referred to herein as the said Fit-Out Period shall start from the date of execution hereof and shall end one day prior to 1st October 2011 OR on the date of fulfillment of the conditions in Table B of the said M/s. Manas Properties Pvt. Ltd., conditions precedent herein, in so far as the fulfillment of the conditions precedent relate to/are incumbent on the lessor, whichever is later..... ...the Fit-out period shall be deemed to expire on the date of such commencement of business / sales. Simultaneously upon expiry of the said Fit-out period, the next day shall be deemed to be the said Rent commencement date......." Table B- Conditions relating to / incumbent on the Lessor of Annexure 1 of the Supplementary Lease Agreement is reproduced below - . - Lessor shall procure approval from the prescribed Authority files in accordance with the approved plans in pursuance of the Government Notifications dated 7th January, 2011 with regards to the Coastal Regional Zone clearance. - Lessor shall procure the revised Occupation certificate from MCGM in respect of the Building as per the said Approved Plans. Thus, I find that commencement of rent was precedent on the lessor fulfilling the said two conditions i.e. prior approvals from Ministry of Environment & Forests (MOEF) and Occupancy Certificate (OC) from MCGM. These permissions were to form the basis of Proposed Lease Agreement for this property. The lessee made these permissions approval, both in Original as well as Supplementary Lease Agreement, as "conditions precedent". I find that approval from MOEF and OC from MCGM have not been received till 31.03.2013. Thus, I find merit in the argument of the assessee that lease agreement has not fructified into "lease". The assessee has clearly provided in clause 5.6. of the Supplementary Lease Agreement, that without obtaining the approval from MOEF and MCGM, the amounts paid by lessee to lessor as compensation / advance / revised advance/ aggregate advance are merely an advance and cannot be treated as compensation for occupying the property for carrying out structural changes. It is submitted by the Authorised Representative that the hotel property is situated near the beach. As its location is in the Coastal Regulation Zone (CRZ) area, it has been extremely difficult to get the approval from MOEF since past four years. The Ld. AR also submitted that the hotel property has not been occupied by the lessee. I find force in the argument of the AR and the fact that the property has not been occupied till date strengthens the assessees case that amounts received from lessee in AY 2013-14 are as an advance and not as lease rent. I find that it has been mentioned in Para 6 of the Supplementary Lease Agreement that in case the assessee fails to procure the MOEF approval M/s. Manas Properties Pvt. Ltd., and OC by 31.12.2002, lessee will have the absolute right to terminate this supplemental agreement and the entire aggregate advance paid by the lessee shall become forthwith due and refundable by the lessor to the lessee. Para 6 of the Supplemental Lease Agreement has been reproduced below: "Without prejudice to the rights of the parties hereto under the terms of the said Agreements, it is specifically agreed between the parties hereto that in the event that on 31st December 2012, the Lessor has failed to procure the said MOEF approval, and / or has failed to procure the said OC in accordance with provisions of clause 4.3 above, except if the delay is caused on account of any failure on the part of the lessee to comply with its obligations in condition (Hi) of table A of the conditions precedent annexed hereto, then the lessee will have the absolute right to terminate this supplemental agreement and the said agreements together by giving a 3 month's written notice. Upon such termination the entire said aggregate advance paid by the lessee under the supplemental agreement (save and except taxes, if any, mentioned in the invoices raised by the lessor from time to time), shall become forthwith due and refundable by the lessor to the lessee, without any set off claims, counter claims, adjustments, of any nature whatsoever. The lessor shall use its best endeavours to claim refund of the taxes (paid by the lessee to the lessor pursuant to this supplemental agreement) from the applicable government authorities as per applicable provisions of law and upon receipt of such tax refund, forthwith refund such refunded tax amounts to the lessee. It is agreed by the parties hereto that the Lessee will thereafter not be liable to further pay the said Advance the said Revised Advances or any further payments as mentioned in clause 5.6 above or the said Compensation. Further it is clarified that upon such termination by the Lessee the consequences of termination under this Agreement and the said Agreements shall specifically follow as per the provisions thereof." I find that Para 6 of the supplemental lease agreement clearly shows the nature of payment to the assessee. I find this amount to be in the nature of an 'advance' as it is to be refunded to the lessee on non-fulfillment of the conditions precedent. The AO is of the opinion that having received advance of Rs. 2,10,00,000/- rent is accruing to the assessee company and accordingly the assessed income under House property income returned in at Rs. 11,68,50,670/-. On the other hand, the AR of the assessee argues that the tenant has just paid the advance amount but not occupied the premises for want of clearance from various statutory authorities such as Ministry of Environment 85 Forests and Occupancy Certificate from MCGM and pleads that calculating the rent at accrued basis is not correct and addition should be deleted. I have also gone through the agreement entered between the assessee and the tenant dated 16.01.2012 wherein it is categorically mentioned that lesser shall procure approval from the M/s. Manas Properties Pvt. Ltd., prescribed Authorities in accordance with the Approved Plans in pursuance of the Government Notification dated 7th January, 2011 with regards to the Coastal regional Zone Clearance. Considering the above facts on record, I am of the considered opinion that the assessee has received only advance from the tenant, Junobo Hotels Pvt. Ltd. and has not received any rent from them as they have not occupied the premises for want of Coastal Regional Zone certificate and Occupancy certification from Municipal Corporation of Greater Mumbai. Since conditions precedent have not met with consequently no compensation/rent accrued/became due, to the assessee, therefore, I am of the view that the addition made of Rs.11,68,50,670/- at accrual basis by assessing the amount as House Property income is not found to be in order and therefore, I direct the AO to delete the addition. These grounds of appeal are allowed.

From the record we found that as per Original Proposed Lease Agreement two distinct periods have been recognized (a) period prior to meeting of conditions precedent has been recognized as Fit-Out period and (b) date when conditions precedent are complied with has been treated as Rent Commencement Date. The Agreement defines what is the meaning of "Fits-Out Period" and what is the "Rent Commencement Date".

Page 26 of the Original Lease Agreement defines what is the meaning of Fits-out Period in this Proposed Lease Agreement. The relevant para 8 of Proposed Lease Agreement is reproduced below:-

We also observe that Annexure 3 of the original lease agreement has been replaced with Annexure-1 of the Supplementary Lease Agreement. The revised conditions are as under (Refer Para 3 of page no 4 of the supplementary agreement):

We have also observe that Clause-9 of the original agreement both the parties mutually agree with the payment of said lease rent by lessee commence forthwith upon the expiry of said Fit-out period. Furthermore, in the Supplementary Lease Agreement Rent Commencement Date has been defined as under: Para 4.6 of the supplementary agreement "Upon procurement of the said OC from the MCGM by the Lessor, after the Lessee has first complied with its obligations therefore as specified herein, the Rent commencement date as mentioned in the said Agreement shall automatically be deemed to become effective with immediate effect on the date of the issue."

It is very much clear from the supplementary lease agreement in para 4.6 that rent commencement date shall be deemed to become effective on procurement of Occupancy Certificate from MCGM (Municipal Corporation of Greater Mumbai). In fact it has been clarified in the agreement at different places that taking approval of MOEF and OC from MCGM were the sine qua non of the Proposed Lease Agreement. The lessee was to carry out necessary changes in the leased premises pursuant to approval of MOEF to comply with the requirements of MOEF. The lessee was required to intimate the lessor that it has carried out necessary changes as per directions of MOEF approval, and then the lessor was required to procure the OC from MCGM within 60 days. Both M/s. Manas Properties Pvt. Ltd., these requirements are also conditions precedent, which means these must precede before Proposed Lease Agreement.

Furthermore, on page 20 of Original Agreement in the clause (viii) it has been clarified that this Fits-out period will be rent free period. In other words, no rent is payable till rent commencement date, which automatically starts on procurement of OC from MCGM. However, the lessee will be liable to pay all other charges i.e. electricity, water and or any other charges payable to any of the service providers and or the maintenance and up-keep charges which shall become due and payable on the said agreement. 18. We observe that it is very clearly mentioned in various paras of the Original Lease Agreement that the conditions precedent are to be met with and if possible before end of September 2011 as per Original Lease Agreement. Subsequently, these conditions precedent have also been stipulated in Supplementary Lease Agreement but by this Supplementary Lease Agreement, the date by which approval from MOEF was to be obtained was extended to 30th June 2012. The Lease Agreement clearly states that the fits-out period start from the date of execution of the lease agreement (proposed) and shall end a day prior to 1st October, 2011 (extended to 30th June 2012 by Supplementary Lease Agreement ) or on the date of fulfillment of conditions in Table B of the said conditions precedent, whichever is later.

We also observe that as per the supplementary lease agreement, since the approval from MOEF got '"delayed, it was agreed between the proposed lessor and the lessee that some advance would be paid to the lessor in the form of compensation or advance or revised advance. Para 5 of Supplementary Lease Agreement reads as under:

It is very clear from the clause 5.1. of the supplementary agreement that compensation is payable by the lessee to the lessor from the rent commencement date. It is clear that since rent commencement date has not commenced, no compensation (term used for rent) becomes payable, during A. Y.2013-14. The assumption of the AO that lessor got right on accrual basis to get compensation was incorrect. The lessee had merely agreed to pay some advance i.e. @ Rs. 4.20 crores each quarter, pending obtaining approval from MOEF and later OC from MCGM by the lessor. Furthermore, both the proposed lessor and the lessee agreed that advance at the rate of Rs. 4.20 crores per quarter would be paid from October 2011 onwards. It is repeatedly made clear that this advance was subject to clause 5.3 and para 6 of the proposed Supplementary Lease M/s. Manas Properties Pvt. Ltd., Agreement. The relevant clauses/ paras subject to which payment of advance was agreed upon, are reproduced below: Para 5.3 It is further specifically agreed between the parties hereto that in case the Lessor is unable to procure the said MOEF Approval as provided in condition (vii) of the Table B of the said Conditions Precedent being Annexure "1" hereto then the Lessee shall be entitled not to make, on demand or at the request by the aforesaid to the Lessor until the Lessor is able to procure the said MOEF Approval. However, the payments of the said Revised Advance shall be forthwith commenced as per clause 5.1.3 above with effect from the later of 1st July, 2012 or the date of issue of the said MOEF Approval, and the Lessor will then intimate the same to the Lessee and thereafter within 5 (five) days of such receipt, such payments of said Revised Advance shall forthwith be commenced by the Lessee until procurement of the said OC by the Lessor. However, in the event that the Lessor is unable to procure the said OC within 60 (sixty) days from the said Written Intimation / said Revised Written Intimation / said MOEF Compliance Written Intimation (whichever is later) as provided in conditions (viii) of the Table B of the said Conditions Precedent, for any of the reasons which is not directly attributable to the Lessee, then the Lessee may suspend the payment of the said Advances / said Revised Advance until the Lessor procures the said OC from the said MCGM.

Thus, as per this clause 5.3., if the lessor failed to obtain approval from MOEF and subsequent OC from MCGM, the lessee could suspend payment of Advance. It is relevant to mention here that payment of advance was suspended after 30th June and only Rs. 2.10 crores was received during the year. Likewise, it will be relevant to see para 6 of Supplementary Lease Agreement which reads as under: Para 6 Without prejudice to the rights of the parties hereto under the terms of the said Agreements, it is specifically agreed between the parties hereto that in the event that on 31st December 2012, the Lessor 6.1 has failed to procure the said MOEF approval, and for M/s. Manas Properties Pvt. Ltd., 6.2 has failed to procure the said OC in accordance with provisions of clause 4.3 above, except if the delay is caused on account of any failure on the part of the lessee to comply with its obligations in condition (Hi) of table A of the conditions precedent annexed hereto, then the lessee will have the absolute right to terminate this supplemental agreement and the said agreements together by giving a 3 month's written notice. Upon such termination the entire said aggregate advance paid by the lessee under the supplemental agreement ( save and except taxes, if any, mentioned in the invoices raised by the lessor from time to time), shall become forthwith due and refundable by the lessor to the lessee, without any set off claims, counter claims, adjustments, of any nature whatsoever. The lessor shall use its best endeavours to claim refund of the taxes (paid by the lessee to the lessor pursuant to this supplemental agreement) from the applicable government authorities as per applicable provisions of law and upon receipt of such tax refund, forthwith refund such refunded tax amounts to the lessee. It is agreed by the Parties hereto that the Lessee will thereafter not be liable to further pay the said Advancethe said Revised Advances or any further payments as mentioned in clause 5.6 above or the said Compensation. Further it is clarified that upon such termination by the Lessee the consequences of termination under this Agreement and the said Agreements shall specifically follow as per the provisions thereof.

It is apparent from para 6 of Supplementary Lease Agreement that in case lessor is unable to procure the approval from MOEF and procuring the OC then the lessor shall be liable to refund the entire aggregate advance paid by the proposed lesseee. If amount is to be refunded to the lessee, then it is only an advance.

Clause 5.4 of the Supplementary Lease Agreement clarifies that the amount paid till obtaining of OC from MCGM will be merely an advance and not rent. The clause 5.4.reads as under:

The following legal and factual position emerges from plain reading of the proposed lease agreement: a) Proposed Lease Agreement would be subject to fulfillment of conditions precedent (obtaining of approval from MOEF and later OC from MCGM). This has been clarified in both in Original as well as Supplementary) was [ Clause 8.1. r.w.Table B of Annexure to the Original Proposed Lease Agreement and para 3 r.w. Table B of Annexure 1 to Supplementary Lease Agreement] The legal principle is that if the conditions precedent is not complied with the proposal does not fructify into the contract (herein lease). b) Original Proposed Lease Agreement provides for two distinct periods (a) period prior to meeting of conditions precedent has been treated as Fits-Out period, while (b) date when conditions precedent are complied with has been treated as Rent Commencement Date . Both these terms (Fits-Out period as well as Rent Commencement Date ) have been defined in para 8 and B of the Original Proposed Lease Agreement. Both these terms remain unchanged even in Supplementary Lease Agreement. c) It is clearly agreed upon between the proposed lessor and the lessee that fits-out period would be rent free i.e. period prior to obtaining of approval from MOEF and OC from MCGM will remain rent free period (on page 20 clause (xvii) of H of the Original Proposed Lease Agreement). d) The compensation is payable only on rent commencement date. For the Rent Commencement Date to start the lessor has to comply with conditions precedent, mentioned in Original Proposed Lease Agreement and Supplementary Lease Agreement (para 4 and especially clauses 4.2.; 4.6, Para 5.1.; 5.3, 5.4 and 5.6 and para 6 of the Supplementary Lease Agreement}, e) The compensation / advance / revised advance / aggregate advance shall not be treated as payment of the lease rent or amenity charges, (clause 5.4. of Supplementary Lease Agreement) f) Only upon procurement of approval from MOEF and OC from MCGM the compensation shall be treated and appropriated by the lessor as compensation. (clause 5.6. of Supplementary Lease Agreement). Without obtaining the approval from MOEF and OC from MCGM the amount paid as compensation / advance / revised advance/aggregate advance is merely M/s. Manas Properties Pvt. Ltd., an advance and cannot be treated as compensation for occupying the property for carrying out structural changes (clause 4.6., 5.1. and 5.6. of Supplementary Lcaso Agreement). g) Conditions precedent have to be met with otherwise whatever advance is given, it is refundable to the lessee. [Para 6 of Supplementary Lease Agreement].

It is also relevant to mention here that proposed lessee had treated the amount of Rs 2.10 crores given to the proposed lessor during the impugned period as "advance" and that AO during last year in scrutiny assessment accepted the claim of the assessee that the amount received was only an "advance" and did not form taxable income.

The AO also did not consider the fact that only advance of Rs 2.10 crores has been received during the impugned period and no further advance was received after 30.06.2012. The AO did not take into consideration the confirmation given by the proposed lessee that amount given pending compliance of conditions precedent (obtaining of approval from MOEF and later OC from MCGM) has been treated in its (lessee) books of accounts as "advance".

As conditions precedent have not been complied with, so nothing has become due to the proposed lessor. In this background, finding of the AO that amount of compensation / advance/ revised advance was due to the lessor at the rate of Rs. 4.20 crores per quarter is not tenable. The addition made by AO on selective reading of the proposed lease agreement was not justified.