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No increase in ALV of property if owner has taken interest-free deposit from tenant

February 15, 2017[2017] 78 taxmann.com 151 (Article)
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Introduction

The issue posed in the title of the Article has arisen in some cases coming up before the appellate authorities under the I.T. Act, 1961 (IT Act) and contrary views have been expressed by such authorities, where the issue posed has been answered both in affirmative and in negative. A recent decision on the issue is from the ITAT, A-Bench, Bangalore, in the case of Sobha Interiors (P.) Ltd. v. Dy. CIT, Circle-12(3), Bangalore [2017] 162 ITD 267/76 taxmann.com 275 (Bangalore - Trib.), where the issue has been answered in the affirmative vide order dt. 23rd Nov., 2016. However, before examining this decision and others on the issue, it would be pertinent first to mention the legal provisions in the IT Act relating to assessment of income from house properties.

IT Act provisions regarding assessment of income from house properties

2. These are contained in sections 22 to 27 of the IT Act. For the purpose of present discussion, only sections 22 & 23 are relevant.

Section 22

2.1 This is the charging section, which provides that income chargeable under this section should arise from (i) a building or lands appurtenant thereto; (ii) the same should be owned by the assessee; & (iii) the property should not be used by the owner for the purpose of his business or profession, which is chargeable to income-tax. There have been controversies regarding the interpretation of the words building, land appurtenant thereto, own/owners, etc., but these are not relevant in the context of the present discussion.

Section 23

2.2 This section provides how the income from property is to be arrived at for taxation under the IT Act. The important thing is to arrive at the 'Gross Annual Value' [ALV] of the property because this is the value, which is to be subjected to tax after allowing the allowances and deductions permissible under the Act. The ALV is not the value on which the property has been let out but is the value arrived at on 'inherent capacity' of a building to yield income. Thus, it becomes an artificial parameter for imposition of income-tax irrespective of the amount of rent realized from its letting out/leasing.

Determination of ALV of a building for income-tax levy

3. For this purpose, three aspects have to be considered, namely –

*Rent actually received;

*Municipal valuation for rent;

*Reasonable expected rent of the premises keeping in view, inter-alia, the factors, such as location of the property, annual ratable value of the property fixed by municipal authorities, the market conditions, the rent received for properties similar in nature/properties in neighborhood, demand and supply position of, cost of construction, etc. The higher of these amounts has to be the 'Gross ALV' for taxation under the IT Act. However, an exception to this general rule has been carved out by courts in regard to properties, which are under rent control and whose rents are fixed by rent control authorities under the rent control legislations. In such cases, the rent computed in the aforesaid manner cannot be more than the standard rent fixed by the rent control authorities.

4. Gross rent has to be reduced by permissible allowances/deductions

Tax is not to be imposed on Gross ALV

For computation of taxable income, it has to be reduced by:-

(i)   Municipal taxes [including Service Tax, if any – sec. 23];
(ii)   Unrealized rent on satisfaction of conditions mentioned in section 23(1)];
(iii)   Standard deduction [sec. 24(a)];
(iv)   Interest on borrowed capital [sec. 24(b)];
(v)   Vacancy allowance on satisfaction of the conditions prescribed.

Rent received in advance cannot form part of the ALV.

5. Examination of the Tribunal's decision (supra) and other decisions

5.1 Case of Sobha Interiors Pvt. Ltd. v. DCIT

With the background of the aforesaid legal provisions, the Bangalore Tribunal's decision can be examined.

Facts of the case

5.1.1 The assessee-company let out its house property to sister concern for a monthly rent of Rs. 5 lakhs. Later on, a supplementary lease deed was executed by which the monthly rent was refixed and reduced to Rs. 25,000/- p.m. While reducing the monthly rent, interest-free security deposit was also negotiated whereby the lessee paid the assessee an interest-free deposit of Rs. 25 crore. In view of this, the assessee reduced the annual letting value (ALV) of the rented property at Rs. 3 lakhs, which was not accepted by the AO and he assessed the ALV at Rs. 52.16 lakhs by estimating the market value of the same at Rs. 7/- per sq ft on the basis of local enquiries made by him. The AO's order was confirmed by the CIT (A).

Tribunal's decision

5.1.2 The Tribunal held that the benefit of interest-free advance received by the assessee because of which rent was reduced from Rs. 5 lakhs to Rs. 25,000/- p.m. had to be taken into account in assessing the ALV of the property. Undisputedly the property in question was let out to its sister concern vide lease deed dt. 1.4.2006 for a monthly rent of Rs. 5 lakhs. At that time, no interest-free security deposit was given or credited to the assessee's account. By supplementary lease deed dt. 29.3.2007, the terms of the lease were modified and monthly rent was reduced to Rs. 25,000/- p.m. from Rs. 5 lakhs p.m. At that time, interest-free security deposit was also negotiated. As per the revised terms of lease deed, the lessee would pay the appellant an interest-free security deposit of Rs. 25 crore, monthly rent was reduced from Rs. 5 lakhs to Rs. 25,000/- p.m. Therefore, the notional rent earned on Rs. 25 crore could not be ignored at the time of computing the ALV of the property.

In expressing the aforesaid view, the Tribunal took into account the decision of the Punj. & Har. HC in the case of K. Streetlite Electric Corpn. [2011] 336 ITR 348/[2012] 30 taxmann.com 532, where it has been categorically held that interest-free security deposit taken by the assessee hugely disproportionate to monthly rent charged is a device to circumvent liability to income-tax. Therefore, notional interest on security deposit is to be treated as income from house property.

Appraisal of the Tribunal's decision

5.1.2.1 The Tribunal's decision and the P&H HC's decision could be said to be correct on the facts of these cases as the facts clearly establish nexus between the rent charged and the interest-free deposits received. The rents were reduced/charged at lower rates - lower than the rent that could have been charged on the basis of intrinsic value of property, its location, etc., as discussed earlier. But these decisions do not establish a universal rule that rent must be increased because the owner has taken an interest-free deposit from the tenant. The position that emerges is that when the owner takes interest-free deposit from the tenant but makes no concession in charging the rent and ALV is determined, taking into the 3 factors mentioned earlier, the interest-free loan or advance cannot be a determinative factor for fixation of notional ALV. When the annual value is determined under sub-clause (a) of section 23(1) with reference to the fair rent then to such value no further addition can be made. The fair rent takes into consideration everything. The notional interest on such deposit is not any actual rent received or receivable. Under sub-clause (b) of section 23(1), only the actual rent received or receivable can be taken into consideration and not any notional advantage. The rent is an actual sum of money, which is payable by the tenant for use of the premises to the landlord. Any advantage and/or perquisite cannot be treated as rent.

5.2 Decision of the Calcutta HC in the case of CIT v. Satya Co. Ltd. [1994] 75 Taxman 193 (Cal.)

In this decision, the HC made the following observations:-

*There is no provision in section 23(1), corresponding to the provisions as contained in clause (iii) of the proviso to the Explanation (1) to rule 5 of Schedule III to the Wealth-tax Act, 1957. In the absence of such provisions, there is no justification for making addition of any notional interest on such deposit made by the tenant in determining the annual value.

*As to the impact of interest-free deposit lying with the owner of the house property as a condition running with the tenancy, it may be said that it only calls for an inference that the rent is lower than what it would have been in the absence of such condition for interest-free deposit. But that inference would be inchoate because if the rent is lower than the municipal annual value, the actual rent is to be ignored and the municipal annual value is to be the basis of the income. On the other hand, if the rent exceeds the municipal annual value, the law provides that such rent, though in excess, can alone be taken as the annual letting value u/s. 23(1). There is no mandate of law whereby the AO could convert the depression in the rate of rent into money value by assuming that market rate of interest on the deposit as the further rent received by way of benefit of interest-free deposit. Sec. 23 does not permit such calculation of the value of the benefit of interest-free deposit as part of the rent.

Regretfully, it is noticed that though this decision of the HC quoted by the assessee in its favour [see para 3 of the Tribunal order], the Tribunal preferred not to make any comments on this decision in its order.

5.3 Other decisions, which support the view regarding non-inclusion of notional amount consequent to interest-free advance as part of the ALV

5.3.1 CIT v. J.K. Investors (Bombay) Ltd. [2001] 248 ITR 723/[2000] 112 Taxman 107 (Bom.)

Where it was found that the actual rent received by the assessee was more than the fair rent even without taking into notional interest on interest-free deposit received by the assessee against letting of property, the notional interest has been held not to form part of actual rent received or receivable u/s. 23(1)(b) for the AY 1992-93. In this case, the HC has left open the question whether such notional interest could form part of the fair rent u/s. 23(1)(a).

5.3.2 CIT v. Gygnus Negri Investment (P.) Ltd. - SLP[C] No. 19723 of 2001 (2002) 253 ITR (St.) 78 (SC).

5.3.3 Radhgirdhar Holding (P.) Ltd. [SLP[C] No. 12442 of 2002 (2002) 256 ITR (St.) 47-48 (SC).

Concluding Regular

6. The legal position that emerges on the basis of discussion in earlier paragraphs is that there is no law laying down the rule that ALV of the property let out by an owner should invariably be increased by the quantum of interest that the tenant might have got from the market by advancing the loan but which he loses by giving the amount as interest-free loan/advance to property owner from whom he takes the property on rent. That will depend on the facts of each case as discussed earlier.

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