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T. C. A. Ramanujam

Fixing the assessable income from property which is let out is a perennial problem for the tax administration, especially when the tenant subleases it for a rent higher than what he pays to the original lessor. Will it be correct to assess the owner-lessor on the gross income that the tenant gets by subletting it?

Bhagawani Devi owned a house in Ranchi. She let out the first and second floors of the building to Canara Bank for a rent of Rs 1,06,800. The ground floor portion was let out to a firm in which she was the partner for Rs 4,800.

In computing the total income from property, the assessing officer (AO) determined the rent for the portion let out to the firm at the same rate at which rent was received from Canara Bank for the first and second floors. This order was challenged.

The Jharkhand High Court pointed out that Section 23 of the Income-Tax Act, 1961 provides for the determination of annual value on the basis of the actual rent received or receivable by the owner in respect thereof.

Section 22 talks of ‘annual value’ which is defined in Section 2(2) as meaning the annual value as determined under Section 23. Actual rent payable by a tenant would normally be the yardstick for determining the property income. But what the law contemplates by ‘annual value’ is not actual rent received by the owner but a notional income which a hypothetical tenant would pay for the property.

The Rent Control Act will have to be taken into account. If the AO felt that the actual rent received is less than the expected rent receivable, he will be entitled to determine the annual value and the expected rent receivable as per the laws and guidelines provided under the Rent Control Act (171 Taxmann 408 Jharkhand).

The Bombay High Court considered a similar case. Akshay Textiles Trading and Agencies (P) Ltd let out three properties to three private companies which in turn sublet the same property to Reliance Industries Ltd (RIL) for a higher consideration.

The Revenue contended that the corporate veil must be lifted. The intermediate tenant, the Revenue claimed, was the alter ego of RIL. For purposes of Section 23, annual value should not be one entered into by the assessee with its tenants but the amount received by the tenant by RIL.

Even otherwise, the annual value would be the rent which RIL paid to the tenant of the assessee-company. The Revenue pleaded that the agreement between the assessee-company and the sub-tenants was sham and bogus. Even the McDowell ruling was cited in support.

Section 23 (1)(a) used the expression “the sum for which the property might reasonably be expected to be let from year to year”. This has to be considered in the context of the applicable rent laws. The Finance Act, 2001 amended Section 23 w.e.f. April 1, 2002, to cover cases where rent received was higher than the standard rent or rent based on Municipal rateable value.

Before the amendment, even if the assessee had received higher rent than the standard rent, the additional amount cannot be subjected to tax. Section 23(1)(b) was brought in to cover the part of the annual value which otherwise would not fall within the tax ambit before its amendment.

Though annual value is fixed in terms of agreement, the extra amount received over and above the agreed rent would be assessable to tax as the amount receivable. In the Akshay Textiles case, relating to the pre-amended years, the annual value would be the value as per the contract from the tenant irrespective of whether the tenant on such letting has received higher rent from RIL.

The Bombay High Court also referred to the McDowell case as understood in the later judgment in Azadi Bachao Andolan. The AO had recorded that the shareholding of the assessee-company as well as the intermediary company was held by another set of group companies and the shareholders of these group companies were once again another set of group companies of RIL. There was a crossholding of share of each other by a large number of group companies of RIL.

Unfortunately, the argument about the transaction between the assessee-company and its tenants not being independent business transaction was not strenuously canvassed at the appellate stage by the Revenue. The Bombay High Court refused to go into these questions (304 ITR 401).

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