The Hindu Business Line : Don't let the higher value out

INCOME from house property is taxed on the basis of annual value under the income-tax code. This signifies the sum for which the property might reasonably be expected to be let out from year to year.

The actual rent can also be taken for assessment when the property is let out, if such rent is higher than the annual rent. But a peculiar situation arises when the tenant sublets the property for a higher rent.

Indra & Co Ltd of Kolkata owned the first floor of an old building in NSC Bose Road measuring 12,000 sq.ft. It let out 4,787 sq.ft to Times Construction in April 1987. Immediately thereafter, Times Construction sublet the space to State Bank of Bikaner & Jaipur. While the bank was paying Times Construction a rent of Rs 11,68,985 per annum, Times Construction, in turn, was paying Indra & Co only Rs 1,14,888 per annum.

In the assessment for 1992-93, the assessing officer (AO) computed the income of the company from the house property at Rs 11,68,985 instead of Rs 1,14,888 as claimed by the company.

The question was whether the income should be computed on the basis of the actual rent received by the company or the gross rent it was able to manage by subletting the same.

When the matter was taken up in appeal by the Revenue, the Calcutta High Court ruled that only the actual rent of Rs 1,14,888 was assessable.

According to the court, where none of the agreements between the tenant or the sub-tenant has been disbelieved or held to be executed as a result of collusion between the parties or as sham transaction, the annual value in the hands of landlord shall be determined on the basis of actual rent received by him and not on the basis of rent received by the tenant from the sub-tenant.

According to the court, the income assessable under Section 22 can only be Rs 1,14,888 and not Rs 11,68,985 (CIT vs Indra Co Ltd — 268 ITR 240 Calcutta 190 CTR page 625).

The judgment appears to have failed to take note of the changes in the law with effect from assessment year 1976-77. The pre-amendment law was stated by Lord McMillan in Salisbury House Estate Ltd vs Fry (15 TC 266 at 329 HL):

"If the measure is an imperfect one and when applied does not ascertain the actual income derived from the property, so much the worse for the Revenue. Discrepancies one way or the other between actual income and statutory income for tax purposes are familiar features of income-tax law. Theoretically, the annual value and the rental should correspond, for annual value is based on rent.

"If they part company one way or the other the fault lies with the imperfection of the statutory machinery for ascertaining the income from landed property, and the Inland Revenue authorities are not entitled to resort to a different measure, designed for a different source of income, if the actual rents happen to exceed the annual value."

This House of Lords ruling covered cases up to the assessment year 1975-76. If the actual rent was higher than the notional annual value, it was considered that the excess was a profit upon which no tax can be levied, for the liability of the property to be taxed is exhausted by the tax levied under this section.

If the assessment under Section 22 of the I-T Act fell short of the rent actually received, that gap could not be made up by calling the letting a trade and taxing the excess of rent under Section 28, or by taxing it under Section 56, the residuary head, even as, if the actual rent realised was nil or less than the annual value, no allowance could be made in respect of such deficit.

England abrogated the law stated in the Salisbury House Estate case and brought to tax the excess of the actual rent over the annual value (Griffiths vs Jackson — 56 TC 583).

In India, too, the law has been altered with effect from AY 1976-77. Under the amended Section 23(1), where the actual rent exceeds the sum for which the property might reasonably be expected to be let from year to year, the actual rent is deemed to be the annual value of the property, so that no part of the actual rent can now escape tax.

The Calcutta HC ruling in the Indra Ltd (supra) case related to the AY 1992-93, though the judgment was rendered in December 2003. The Revenue failed to point out the amendment to Section 23 by various Finance Acts from time to time.

There is no need to go into the nature of the sub-tenancy, whether it is sham or genuine. Annual value is no doubt a notional concept, but it always takes in the higher of the value.

(The author is a former chief commissioner of income-tax.)