Introduction
Leasing commercial assets, such as machinery, office buildings, or retail spaces, is a common practice for businesses looking to generate income. The Income Tax Act, 1961, provides specific tax treatment for income earned from leasing commercial assets, but the classification depends on various factors like the nature of the lease, the asset’s use, and whether the income is from an operating lease or finance lease.
This blog will explain how income from leasing commercial assets is taxed, the different types of leases, and the deductions that can be claimed under the Income Tax Act.
Types of Leases and Their Tax Treatment
There are primarily two types of leases that affect the taxability of rental income:
- Operating Lease
- Finance Lease
1. Operating Lease
An operating lease is a lease agreement where the lessor (the owner of the commercial asset) rents out the asset to the lessee for a short term relative to the asset’s useful life. The lessor retains ownership of the asset and is responsible for its maintenance. The lessee, on the other hand, simply uses the asset for business purposes.
Tax Treatment of Income from Operating Lease
- Income Under Business Income:
Rental income received from leasing out commercial assets under an operating lease is considered business income and is taxable under the head “Profits and Gains of Business or Profession.” - Deductions for Expenses:
- The lessor can claim various deductions, including maintenance costs, insurance, and depreciation of the leased asset, against the rental income.
- Depreciation is claimed on the leased asset as per the applicable depreciation rates.
Example:
A company leases out an office building for ₹10,00,000 annually under an operating lease. The rental income is taxable under “Business Income,” and the company can claim deductions for maintenance, repairs, and depreciation.
2. Finance Lease
A finance lease is a long-term lease where the lessee assumes most of the risks and rewards of ownership. In this case, the lessor provides the asset to the lessee with the option to buy it at the end of the lease term, typically for a nominal amount.
Tax Treatment of Income from Finance Lease
- Income Under Business Income:
Income from finance leasing is treated as business income and is taxed accordingly. However, the income recognition differs from operating leases. In a finance lease, the lessor recognizes the income as per the financial structure of the lease agreement, which may include interest on the leased amount, along with the principal recovery. - Depreciation:
In case of a finance lease, the lessor may still claim depreciation on the asset, depending on the terms of the lease agreement and the transfer of risks and rewards of ownership.
Example:
A company enters into a finance lease agreement for machinery worth ₹50,00,000, and the lessee pays ₹5,00,000 annually over 10 years. The company receives interest payments, along with principal repayment, and can claim depreciation on the asset as per the terms of the lease.
Tax Treatment of Lease Premiums
In some cases, businesses may receive a lease premium or initial lease rent as part of a lease agreement. The tax treatment of such premiums is as follows:
Lease Premium
- Revenue Income: Lease premiums received upfront are typically treated as revenue income.
- Taxable in the Year of Receipt: The lease premium is taxable in the year it is received, even if the lease is for multiple years.
Example:
A business receives a ₹25,00,000 premium for leasing out land for 5 years. The entire ₹25,00,000 is taxable in the year of receipt as business income.
Deductions for Leasing Business
For businesses involved in leasing commercial assets, several deductions can be claimed to reduce taxable income:
- Depreciation on Leased Assets
- The lessor can claim depreciation on the leased asset, provided the asset is used for business purposes. The depreciation is calculated based on the prescribed rates for that type of asset.
- Operating Expenses
- Expenses related to maintenance, repairs, insurance, and other operational costs associated with the leased asset can be deducted from the rental income.
- Interest on Loans
- If the lessor has borrowed funds to purchase the commercial asset, the interest paid on the loan can also be claimed as a deduction.
Is GST Applicable on Lease Rentals?
Yes, Goods and Services Tax (GST) is applicable on lease rentals in most cases. The tax treatment is as follows:
- GST on Rental Income:
- Rent received for leasing out commercial properties is subject to GST if the lessor is a registered taxpayer under GST. The applicable rate is typically 18% on the rental income.
- GST Exemptions:
- GST does not apply to rent received from renting out residential properties, and in certain cases, if the property is used for charitable or public purposes, it may be exempt.
FAQs
1. Is income from leasing commercial property taxable under business income?
Yes, rental income from leasing commercial property is generally taxable as business income unless it falls under specific circumstances, such as owning the property purely for investment.
2. Can I claim depreciation on leased assets?
Yes, you can claim depreciation on the leased assets if they are used for business purposes, including commercial properties or machinery.
3. What is the difference between an operating lease and a finance lease?
An operating lease is a short-term lease where the lessor retains ownership of the asset, while a finance lease is a long-term lease where the lessee assumes most of the risks and rewards of ownership, often with an option to purchase the asset.
4. Is GST applicable on rental income?
Yes, GST is applicable on rental income from leasing commercial property if the lessor is registered under GST. The standard rate is 18%.
5. Are lease premiums taxable?
Yes, lease premiums received are treated as revenue income and are taxable in the year of receipt.
Conclusion
The tax treatment of income from leasing commercial assets depends on the nature of the lease and how the assets are used. Whether it’s an operating lease or a finance lease, understanding the tax implications ensures businesses comply with tax laws while optimizing deductions and minimizing tax liabilities. Proper documentation and adherence to the GST provisions further ensure seamless tax reporting and compliance.
Additional Resources
Learn more about Tax Provisions on the official Income Tax India website.
Want to consult a professional? Contact us: 09463224996
For more information and related blogs, click here.