The Hindu Business Line : Can there be understatement of income from property?

INCOME from property is computed by adopting its annual value. The computation of such annual value is to be made under Section 22 of the Income-Tax Act, 1961. Annual value was originally defined as the sum for which the property might reasonably be expected to be let from year to year. Section 23(1) was amended with effect from April 1, 1976, and it was provided that if the annual rent is an excess of the annual value, the annual rent shall be deemed to be the annual value.

Is it possible to let out the property for a rent which is below the annual value? The lease deed should provide the answer. What happens if the lessee sub-leases it for a much higher rent?

In a Calcutta High Court case, a company leased out its house property for a rent of Rs 21,000 per month. It also received interest-free advance of Rs 50 lakh from the lessee. Enquiries by the I-T Department showed that the lessee company had sub-leased the property for an annual rent of Rs 18,33,000. Naturally, the assessing officer (AO) took this figure as income from house property in the hands of the lessor. The lessor had admitted only Rs 2,52,000.

The Calcutta High Court ruled that the higher rent received by the lessee cannot be a determining factor for assessing annual value. It is the income from the house on which tax is charged. Annual value did not mean what the lessor would have earned if he were in the position of the lessee and had the opportunity to get a better rent.

The receipt of the higher rent by the lessee would not be a factor for determining the annual value. The rent received by the lessee cannot be the basis for assessing the income from the property in the hands of the lessor-assessee (CIT vs Hemraj Mahabir Prasad Ltd — 199 CTR 205).

In this case, the AO had also brought to tax notional interest in respect of the interest-free loan. The High Court ruled that notional interest for the deposit is not the actual rent received or receivable. Only the actual rent received or receivable can be taken into consideration and not any notional advantage.

The tax has to be paid by reason of the ownership of the property. The notional interest can never be added to the rent. The court referred to Schedule III of the Wealth Tax Act which has a separate procedure for determining the gross annual rent of the property. Explanation to Rule 5 of Schedule III specifically refers to deposit accepted by the lessor and charges 15 per cent per annum on such deposit for calculating gross annual rent. There is no such provision in the I-T Act.

The Calcutta High Court observed:

"The notional interest since waived on the interest-free loan not forming part or component of the rent and being irrecoverable from the lessee as rent in case of dispute, the same can never be a factor to be taken into consideration for determining the actual rent received for the purpose of Section 23(1)(b)."

In an Allahabad High Court case, the landlady had leased out her house to a person who was the accountant in the firm in which the landlady and her son were partners.

The accountant had let out these properties to other tenants for a sum higher than that stipulated under the lease deed. The lease deed was not registered. Even the stamp paper on which the agreement was executed was found to be purchased long after the date of execution of the agreement. There was a big difference between the rent the property was capable of getting and that fixed in the agreement. The salary of the accountant was reduced after the lease agreement.

The court held that the transaction with regard to the lease and the sub-lease was an artificial arrangement which was liable to be ignored in determining the annual value.

The figure mentioned in the lease agreement may be relevant only in the case of genuine leases. If the lease agreement is found to be a fake, it can be ignored and the actual rent taken [Smt. Putli Bibi vs CIT 279 ITR 294 (Allahabad)].

Section 23 has been substituted by the Finance Act, 2001 from assessment year 2002-03. The new Section retains the existing concept of annual value as being the sum for which the property might reasonably be expected to be let from year to year, that is, annual letting value.

But the concept of `annual value' has been removed in the case of let-out property. It is now provided that where the property or any part thereof is let out and the actual rent received or receivable is an excess of the annual letting value, the amount so received or receivable shall be the annual value.