Taxman alleged IT park firm was a tax dodge; ITAT rules for five landowners

What constitutes tax avoidance? In a recent ruling, five Bangalore landowners have secured relief from ITAT in an income tax dispute over alleged undisclosed rental income.They established that the building belonged to their partnership firm, which received rent directly into its bank account, filed income tax returns and paid taxes on the earnings.

What the case is about

In 1999, five landowners decided to develop their property into an IT park and SEZ zone. To take the project forward, they signed a memorandum of understanding (MOU) with a builder.Also Read | He bought a Rs 41.85 lakh and paid Rs 39.15 lakh but did not get possession; builder blames PMC-PMRDA jurisdiction changes, MahaRERA rejects excuse and orders interest payout to homebuyerIn 2005, the landowners and the same builder executed a registered joint development agreement (JDA). Under the arrangement, the builder was granted development rights and a Power of Attorney (POA) was executed for various purposes.

The builder also paid the landowners a refundable, interest-free deposit of Rs 37.25 lakh.As part of the development, the builder was to construct a separate C1 Block for SEZ activities. He subsequently set up a partnership firm to manage the block, retaining a 96% stake while the landowners collectively held the remaining 4%.Once the construction was completed, the firm leased the premises to several companies.

The rental payments were credited directly to its bank account.The partnership firm also filed its income tax returns and paid tax on its earnings. Meanwhile, the landowners made withdrawals from the firm in the usual course.The C1 Block was constructed and allotted to the landowners in AY 2016-17. They also paid the BBMP tax relating to the block.The arrangement continued without any apparent dispute until 2022, when the Income Tax Department conducted a search at a company associated with the landowners' family.

The findings from the operation triggered a series of disputes.Also Read | Man invested Rs 10 lakh, which tax department treated as unexplained; he first cited cash loan, then bank withdrawals as source, ITAT Nagpur deletes addition and Rs 2.11 lakh penaltyAt the centre of the tax controversy was the commercial property in Block C1, developed under the 2005 JDA.The Assessing Officer (AO) of the Income Tax Department took the position that the landowners, rather than the partnership firm, were the property's actual owners.The AO consequently viewed the firm as an arrangement designed to evade tax, maintaining that the landowners were the real owners of Block C1.The AO cited, among other reasons, withdrawals made by the landowner families that were not proportionate to their declared 4% profit-sharing entitlement. The officer also alleged that the partnership deed had not been registered.On this basis, the AO sought to assess the rental earnings from Block C1 directly in the hands of the landowners and their family members, instead of the partnership firm. The Commissioner of Appeals (CIT(A)) agreed with this position and upheld the assessment approach.The landowners subsequently challenged the decision before the Bangalore bench of the Income Tax Appellate Tribunal (ITAT) and won relief.Also Read | Landlords wanted tenant out to open a law office; he said the reason for seeking eviction had changed and other properties were available, why Delhi High Court upheld eviction

Why did the landowners win the case?

Chartered Accountant Suresh Surana told ET that the ITAT Bangalore relied on substantial documentary evidence to establish that the partnership firm was a genuine business entity.Government and statutory authorities had recognised it as a co-developer of the SEZ, while infrastructure and electricity approvals were issued in its name.

Its audited financial statements also reflected the rental earnings, and tenants paid rent directly into the firm's bank account.Surana highlighted that the Income-tax Department had itself assessed the partnership firm in previous years and accepted the rental income reported in its returns.The tribunal also dismissed the department's contention that withdrawals made by the landowner partners established that the rental earnings had actually accrued to them personally.According to the ITAT Bangalore, amounts taken out by partners are ordinarily entered in the partnership firm's books as debits to their respective capital accounts.Surana says: “Such withdrawals do not, merely for that reason, become fresh rental income in the partners' hands, nor do they transfer ownership of the underlying property from the firm to the partners.”Also Read | Woman buys Rs 1.03 crore 3BHK in Bengaluru, but builder fails to provide specially-enabled parking; Karnataka RERA orders provision within 60 days and audited maintenance accountsThe tribunal further pointed out that one of the taxpayers involved in the dispute was not a partner in the firm at all and had received no money from it.Separately, the ITAT examined the capital gains issue arising from the JDA. The Assessing Officer (AO) had proposed taxing the gains in AY 2016-17, arguing that the builder had completed the construction and handed over the developed area to the landowners during that year.The landowners maintained that the taxable transfer had taken place much earlier, when they signed the registered JDA and executed the Power of Attorney in March 2005, thereby placing effective control of the property with the builder.On examining the agreement, the tribunal found that the developer had been granted extensive and irrevocable rights from the beginning. These included access to the property, securing approvals, designing and developing the project, signing agreements with purchasers and mortgaging the property to arrange finance. The registered Power of Attorney (POA) had also vested broad authority in the developer.Based on these provisions, the ITAT Bangalore concluded that the transfer had already taken place in AY 2005-06, around the time the JDA and POA were executed. Consequently, the transfer could not be treated as having occurred in AY 2016-17 merely because the completed area was handed over to the landowners during that year.Ultimately, the taxpayers succeeded in all their appeals, with the disputed additions being deleted. The landowners secured the favourable ruling from the Bangalore ITAT on August 27, 2026.