The Supreme Court held on Monday that the income earned by erstwhile rulers of a princely state or their heirs by renting out a portion of the residential palace was not taxable and rapped the Income Tax department for pursuing a case despite their income being exempted under IT law.

A bench of Justices Ranjan Gogoi and Abhay Manohar Sapre allowed a plea of the ruler of the former princely state of Kota, now a part of Rajasthan, challenging the high court order for bringing his income from rent in the Income Tax net. The ruler owns extensive properties, including two residential palaces known as Umed Bhawan Palace and the City Palace.

The ruler is using Umed Bhawan Palace for his residence and a portion of it was rented out to the ministry of defence way back in 1976.

Although the Centre had in 1950 declared residential palace of an erstwhile ruler, situated within the state, as his inalienable ancestral property to be exempted from payment of income-tax, the I-T department had in 1984 initiated proceedings for assessment of income earned from renting out a portion of the palace. The Centre had incorporated Section 10(19A) in the IT Act to give exemption to former rulers.

The department contended that IT exemption was given for personal use and income earned from the rent was taxable. Commissioner of Income Tax and Income Tax Appellate Tribunal, however, turned down the plea of the IT department which had moved the Rajasthan HC.

The HC had ruled that as so long as the ruler continued to remain in occupation of his official palace for his own use, he would be entitled to claim exemption but if he let out any part of his palace, he became disentitled to claim benefit of exemption available under Section 10(19A) for the entire palace.

"In such circumstances, he is required to pay income-tax on the income derived by him from the portion let out in accordance with the provisions of the I T Act and the benefit of exemption remains available only to the extent of portion which is in his occupation as residence," the HC had said.

Quashing the HC order, the Supreme Court held that Section 10(19A) has used the term "palace" for considering the grant of exemption to the ruler and income earned from renting out a portion of the palace was also exempted.

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"We cannot ignore this distinction while interpreting Section 10(19A) which, in our view, is significant. In our considered opinion, if the Legislature intended to spilt the Palace in part(s), alike houses for taxing the subject, it would have said so by employing appropriate language in Section 10(19A) of the IT Act.

We, however, do not find such language employed in the section," the bench said.. "Once the assessee is able to fulfil the conditions specified in section for claiming exemption under the Act then provisions dealing with grant of exemption should be construed liberally because the exemptions are for the benefit of the assessee," it said.