Interest Deduction Admissibility – Builders- Loan for Construction of Residential Unit

Interest Deduction Admissibility – Builders- Loan for Construction of Residential Unit

In this piece, I am articulating a view that, in present regime, it will be difficult for builders, engage in construction and sale of Residential unit (Business Activity), to claim deduction of “Entire” Interest on loan taken for said Business Activity.

To begin, brief recapitulation of inter-play of various sections involved in above proposition is stated as under:-

a.       Section 23(5)(Inserted by Finance Act 2017) – It provide that Annual value of House property, being stock in trade  and not being let out, shall be NIL for the period of ONE year from the end of financial year in which certificate of Completion is obtained.  Thus through section 23(5), legislation indirectly clarified that Annual value of House Property, being stock in trade, is taxable under the head Income from House Property, setting aside controversy in this aspect. It is this provision, which is coming into forefront, in restricting interest deduction, exemplify later on

b.      Section 24(b) – Interest on Capital borrowed for acquisition, construction, repairing etc. is allowed as deduction in computing income chargeable under the head “Income from House Property”.

c.       Section 29- It stipulates that income referred to in section 28 shall be computed in accordance with provisions contained in Section 30 to 43D.

d.      Section 36(1)(iii)

i)                    Interest on capital borrowed for purpose of business is allowed as deduction.

ii)                   Exception – Interest on capital borrowed for acquisition of asset is not allowed as deduction for the period- from the date of borrowing till the date on which said asset is put to use. Such Interest may be capitalized in the books.

e.      Section 71(3A) – It specify that loss under the head Income from House property can be set-off against other heads of Income to the extent of Rs. 2 lacs.

f.        Section 71B – It stated that where loss under the head Income from house property cannot be set-off against other head of income under section 71, then such unabsorbed loss be carried to succeeding  assessment year (upto 8 years) for being set-off against Income from House Property.

Let me explain my proposition with an example

1.       Builder borrows Rs. 10 Cr for construction of 10 House.

2.       The Interest expenditure in first 4 years will be as under:-

a)      First FY – Rs. 1 Cr

b)      Second FY – Rs 1 Cr

c)       Third FY – Rs. 90 lacs

d)      Fourth FY – Rs. 90 lacs

3.       One of the house was completed at the end 2^nd FY  and it was sold in mid of fourth FY

Analysis of Deduction of Interest Expenditure in various FY in above example

1.       First FY – Assessee is engaged in business activity and Interest deductibility will be governed by Section 36(1)(iii). The loan is taken for construction of business asset. Since asset is not completed in First FY, the interest is not allowed as deduction and same will be capitalized in books. Thus interest of Rs. 1 Cr will be apportioned among 10 houses and Rs. 10 lacs will be added to cost of each house.

2.       Second Year – Since one of house is completed at the end of year, so in this year also, the Interest will not be allowed as deduction and same will be added to the cost of house. Thus till second year, Rs. 20 lacs has been added to cost of each house.

3.       Third Year – This year begin the ambiguity relating to completed house, elucidated as under:-

a)      The asset remain the business asset, but the income therefrom (till it is sold) is taxable under the head Income from House Property, though it will be NIL in this year, by virtue of section 23(5) in this year.

b)      The point for consideration is whether interest (Rs. 9 lacs) deductibility corresponding to completed house will be administered by Section 24(b) or section 36(1)(iii) (as assets is completed at the end of 2^nd year). Determination of relevant section assumes importance in view of restriction of inter-head loss adjustment postulated in section 71(3A). Explain as under:-

i)                    If Interest deduction is allowed under section 36(1)(iii), then same will be business expenditure and will be allowed to be set-off against other business income.

ii)                   If Interest deduction is to be governed by Section 24(b), then due to absence of any income under head Income from house property only Rs. 2 lacs will be allowed to be set-off against business income (section 71(3A)) and balance Rs. 7 lacs will be carried forward to next year for being set-off against Income from house property

iii)                 Thus in 3^rd Year, assessee will be denied deduction of interest of Rs. 7 lacs , if the same is be considered u/s 24(b).

c)       Under Income Tax legislation, expenditure is tagged to Income. If Income is taxable u/s 28, then deductibility of expenditure will be determined under section 30 to 43D. If income is taxable u/s 22, then deductibility of expenditure will be as per section 24.

d)      Thus in instant case, in my view, interest deduction will be as per section 24(b), as Income is being made taxable u/s 22, even though asset is business asset.

4.       Fourth year- The Interest deductibility in this year relating to completed house will as under:-

a)      The Annual value of house will be determined u/s 23(1). Generally rental yield on the house is 2%. So if sale price of house as taken as 2 Cr, the annual rental value will be 4 lacs.

b)      Since house is sold in mid of the year, Gross Annual value for 6 months will be Rs. 2 lacs and Interest for said period will be Rs. 4.5 lacs (50% of Rs. 9 lacs). Thus assessee will have loss of Rs. 2.5 lacs under Income from House property. Out of said loss, Rs.2 lacs will be set-off against business income and rest  Rs. 50,000 will be carried forward.

c)       Since out of 10 houses, one house has been sold and other 9 are under construction phase, the Interest for remaining 6 months corresponding to sold house will be capitalized among 9 houses.

5.       So in above example, the interest deductibility on completed house is summarized as under:-

FY	Interest Amount	Treatment	Remark
1st	10,00,000	Added to Cost of House.	Indirect deduction.
2nd	10,00,000	Added to Cost of House.	Indirect Deduction.
3rd	9,00,000	Rs. 2 lacs is allowed as deduction.	Rs. 7 lacs is carried forward U/H IHP, which will remain unutilized for assesse.
4th	4,50,000	Rs. 2 lacs allowed as deduction u/s 24(b). Rs. 2 lacs is set-off against business income.	Rs. 0.50 lacs Rs. is carried forward U/H IHP, which will remain unutilized for assesse.

Thus in above example, out of Interest of Rs. 33.50 lacs, only 26.50 lacs is allowed as deduction and rest Rs. 7.50 lacs will be dead cost (from income tax perspective).