The Hindu Business Line : Deposit with house-owner

The deposit taken from a tenant acts as a kind of security for the house-owner, if, for instance, the licensee refuses to vacate at the expiry of his agreement, or if the owner agrees to a lower rent. The taxability of this amount has been the subject matter of litigation under tax laws.

WITH outdated tenancy laws prevailing in most parts of the country making it difficult for landlords to re-possess their premises upon expiry of the period of tenancy, most house-owners venture to let their properties on lease and licence basis only if a large deposit is placed at the time of executing the lease agreement.

This acts as a security for the landlord, to some extent, if the licensee refuses to vacate at the expiry of his agreement.

However, licensees usually agree to place a large deposit only if they secure a concession in the rent. Thus, the landlord would earn interest on the security deposit which would compensate for the lower rent he gets every month.

The taxability of this amount has been the subject matter of litigation under tax laws where the Tax Department takes a stand that the lower rent actually received by the landlords should be increased by a notional amount at the market rate of interest on the deposit given by the licensee.

In C.I.T. v. Hemraj Mahabir Prasad Ltd. (279 I.T.R. 522), this point arose before the Calcutta High Court. The facts were that the assessee was the owner of a house leased out to HMPS for 21 years. Under the terms of the agreement of lease, the assessee was to receive a monthly rent of Rs 21,000. The assessee had also received an interest-free loan of Rs 50 lakh from the lessee for the period of the lease. The assessee declared its income from the house property at an annual rent of Rs 2,52,000.

On the basis of the fact that the lessee, HMPS, had let out the house at an annual rent of Rs 18,33,000 to other tenants including a nationalised bank, the Assessing Officer assessed the annual value at Rs 18,33,000 as the income of the assessee from the property.

Admittedly, HMPS was being assessed to tax in respect of its actual receipt of Rs 18,33,000 under the head "Income from other sources".

It was found that, apart from the nationalised bank, which was paying a very high rate of rent, all the other tenants were paying rent at a rate that would justify the annual income at Rs 2,52,000. The order of the Assessing Officer, however, was reversed by the Commissioner (Appeals) and this reversal was affirmed by the Tribunal.

The High Court referred to the decision of the Supreme Court in Balbir Singh v. Municipal Corporation of Delhi (152 I.T.R. 388 (SC)). In this case it was held that even if the assessee was able to show in prevailing circumstances, such as the nature of the building, its situation or state of repair, that he could not reasonably expect to get from a hypothetical tenant an amount of rent up to or equal to the standard rent, in that event, the rateable value of the building need not be determined at the standard rent.

The Calcutta High Court, in C.I.T. v. Kishanlal and Sons (Udyog) (P.) Ltd. (260 I.T.R 481), following Balbir Singh v. Municipal Corporation of Delhi (152 I.T.R. 388 (SC)), held that there may be cases where the lessor may not get the amount of rent expected as standard rent but the assessee is liable to pay tax on the income even if the house is kept vacant. Therefore, it would be the actual rent received, if it is less than the standard rent, which would be the annual value under Section 23(1)(a).

Section 23(1)(a) of the Income-tax Act, 1961, applies not only to property which is vacant and not leased, but is also applicable to property which is tenanted and subject to the continuing fixed rental. In the latter case, the property is to be treated as tenanted property and the word "vacant" is not to be read into the section.

Section 23(1)(b) refers to a situation where the rent received or receivable by the assessee is higher than the expected market rental value of the property itself. However, this would not mean that because of the presence of Clause (b), Section 23(1)(a) must refer to, and only to, vacant property that is not let out.

The Calcutta High Court, in C.I.T. v. Indra Co. Ltd. (268 I.T.R. 240), held that, in a case where none of the agreements was disbelieved or were held to be collusive, that the actual receipt by the assessee was to be the basis of consideration for assessing the income from the house property. The decisions in Smt Protima Roy (138 I.T.R. 536 (Cal)) and Smt Pratima Roy (175 I.T.R. 107 (Cal)) were distinguished on the ground that in these decisions the agreements were found to be ingenuine.

Whether a lessee receives a higher amount or not is wholly immaterial for the purpose of determining the income from the house property assessed in the hands of the lessor/assessee. In respect of a vacant house which is not let-out, a notional annual value is to be determined as being the rent if it were let out.

In such a case there would be no difficulty in determining the income from such house property on the basis of the standard rent or the municipal valuation, as the case may be. Since the provisions of Section 23(1) are identical with those of Section 174 of the Calcutta Municipal Corporation Act, 1980 ("the CMC Act"), it would not be unreasonable to assess the valuation under Section 23(1) of the house property on the basis of the annual value determined under the Calcutta Municipal Corporation Act.

Applying the principle, the Calcutta High Court held in Hemraj Mahabir Prasad Ltd.'s case that the annual value of the building should be assessed at an amount less than the annual rent actually received by the assessee. Since this property has been let out, it would be governed by Section 23(1)(b) where it is provided that the annual value is the amount of rent actually received.

If the property is let out to a tenant, who sub-lets it and gets a higher rent, the same cannot be a determining factor for assessing annual value under Section 23(1) in the hands of the lessor, where the creation of the tenancy or the lease is found to be genuine. Such a valuation has been consistently accepted by the Department.

The interpretation has to be made on the footing that even if a person does not earn any income on account of the house not being let out, he is still liable to pay income-tax on the notional value under Section 23(1)(a). The words "actual rent received" would be the rent received by the assessee, not the rent received by the lessee, which the assessee himself does not receive.

On the issue of interest-free deposit the Calcutta High Court held that the computation of the income under the head "House property" is on a deemed basis.

The tax has to be paid by reason of the ownership of the property. Even if one does not incur any sum on account of repairs, a statutory deduction therefor is allowed and, where expenses on repairs are incurred in excess of such statutory limit, no deduction for such excess is allowed.

The deductions for municipal taxes and repairs are not allowed to the extent they are borne by the tenant. However, even actual reimbursements for municipal taxes, insurance, repairs or maintenance of common facilities are not considered as part of the rent and added to the annual value. Accordingly, there is no justification for making any addition for any notional interest for determining the annual value.

Thus, the Court rightly concluded that in order to determine the annual value for the purpose of assessing the income from house property under Section 23(1)(a) where the house is not let out, the standard rent determined under the Rent Act or the annual value determined under the Calcutta Municipal Corporation Act should be the basis. However, where the house is let out and the actual rent received is higher than the standard rent or the municipal valuation, then such actual rent received would be the basis for assessing the income from house property under Section 23(1)(b).

Any benefit or advantage derived from the interest-free advance by way of earning interest or making profits by investing such deposit would be available in computing the income of the assessee under other heads. Such notional interest cannot be added to the rent in the absence of any provision to this effect in Sections 22 or 23.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)