Income From House Property Whether Let Out Or Not - Determination of ALV (Annual Letable Value) And Tax On Notional Rent

As per new ITR recently declared for AY 2018-19 the return form specifically asked for details of property:

(i)        Self Occupied (ITR-1 & others)

(ii)       Let out (ITR-1 & others)

(iii)      Deemed let out (ITR-2 & others)

If the property is let out, even deemed let out the detail has to be filled. The annual value of the other self occupied (deemed let out) house properties will be determined on notional basis as if these had been let out. So letout your properties if you have more than one.

Determination of ALV (Annual Let-able Value) of House Property for computing ‘income from house property’ whether let out or not:

Q1.     Where in a case the property is let out in consideration of heavy interest free security deposit with minimum rental charges.

Q2.     Where in a case the property is vacant partly and or wholly during the year.

Q3.     Whether notional interest on interest free deposits paid by employer to landlord be considered while computing perquisite value of residential accommodation provided to employee at concessional rate or fee.

Legal position on subject matter and issues:

The provisions for determination of income from house property are contained in Chapter - IVC of the Income-tax Act, 1961. Section 22 talks about the annual value of property consisting building or lands appurtenants thereto which the assessee is owner and other than such portions of which he occupy for business or profession carried on by him the profit of which are chargeable to income tax, shall be chargeable to tax under the head “Income from house property”. “Annual Value how determined” is contained in section 23 which reads as under:-

Section 23: Annual value how determined.

Sub-section (1) of section 23:

For the purposes of section 22, the annual value of any property shall be deemed to be-

(a)      the sum for which the property might reasonably be expected to let from year to year; or

(b)      where the property or any part of the property is let and the actual rent received or receivable by the owner in respect thereof is in excess of the sum referred to in clause (a), the amount so received or receivable; or

(c)       where the property or any part of the property is let and was vacant during the whole or any part of the previous year and owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the sum referred to in clause (a), the amount so received or receivable.

Therefore from the above it is clear that the ALV in a case where the property is let out would be the amount which received or receivable as the both clause of (b) and (c) of sub-section(1) of section 23 are superseded over clause (a) wherein the letable value of the property is expected reasonable to let from year to year.  

Proviso of sub-section (1) of section 23 provides deduction in relation to taxes levied by the local authority. Further as per Explanation of sub-section (1) of section 23 the amount of actual rent received or receivable, shall not include un-realised rent but unrealized rent should be proved by the following:

 (a)     the tenancy is bona fide;

(b)      the defaulting tenant has vacated, or steps have been taken to compel him to vacate the property;

(c)       the defaulting tenant is not in occupation of any other property of the assessee;

(d)      the assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfies the Assessing Officer that legal proceedings would be useless.

(Refer Rule 4 of the Income Tax Rules, 1962)

Now as per clause (a) of sub-section (1) of section 23 to determination ALV of the property there is no mandate to take the annual rent a sum for which the property might reasonably be expected to let from year to year. However, there are decisions of the Courts wherein the following principles applied to determine the annual let-able value:

(i)        ALV would be the sum at which the property may be reasonably let out by a willing lessor to a willing lessee uninfluenced by any extraneous circumstances,

(ii)       An inflated or deflated rent based on extraneous consideration may take it out of the bounds of reasonableness,

(iii)       Actual rent received, in normal circumstances, would be a reliable evidence unless the rent is inflated/deflated by reason of extraneous consideration,

(iv)       Such ALV, however, cannot exceed the standard rent as per the Rent Control Legislation applicable to the property,

(v)        if standard rent has not been fixed by the Rent Controller, then it is the duty of the assessing officer to determine the standard rent as per the provisions of rent control enactment ,

(vi )      The standard rent is the upper limit , if the fair rent is less than the standard rent , then it is the faire rent which shall be taken as the annual letting value and not the standard rent.

(Refer Kashi Prasad Kataruka vs CIT (1975) 101 ITR 810 (Patna)

In CIT vs Satya Co. Ltd  75 TM 193 (Cal-HC) while dealing with the issue whether the annual letting value fixed by the Municipal Authorities under the Delhi Municipal Authority Act can be the basis of adopting annual letting value for the purposes of Section 23 of the Act held that the provisions contained in the Delhi Municipal Corporation Act for fixing annual letting value is pari materia with Section 23 of the Act. The Court opined that the fair rent fixed under the Municipal laws, which takes into consideration everything, would form the basis of arriving at annual value to be determined under Sect ion 23(1) (a) and to be compared with actual rent and notional advantage in the form of notional interest on interest free security deposit could not be taken into consideration.

In ITO vs Baker Technical Services Pvt. Ltd., (2010) 125 ITD 1 (Mum)(TM) held that the Municipal value is only an indication as to be reasonable annual letting value of the property subject to the reduction or enhancement on the basis of other material on records. The standard rent is the more proper and reliable method and it is only guidance on the basis of which the annual letting value can be determined.

In CIT vs Tip Top Typography ITA No.1213/2011 order dated 8.08.2014 (Bombay-HC) after careful reading of the provisions of the Act and decisions relied upon by both the parties the hon’ble court consider the question of determination of “annual value” u/s 23(1)(a) in the context of:

(i)        whether the municipal valuation of the property was binding on the AO,

(ii)       whether notional interest on interest-free security deposit could be added and

(iii)      whether if the property was covered by the Rent Control Act but no standard rent there under, the AO can disregard the standard rent?

HELD by the High Court:

As regards municipal valuation:

(i)        We are not in agreement with the department that the municipal rateable value cannot be accepted as a bonafide rental value of the property and it must be discarded straightway in all cases. There cannot be a blanket rejection of the same. If that is taken to be a safe guide, then, to discard it there must be cogent and reliable material;

(ii)       The market rate in the locality is an approved method for determining the fair rental value but it is only when the AO is convinced that the case before him is suspicious, determination by the parties is doubtful that he can resort to enquire about the prevailing rate in the locality. The municipal ratable value may not be binding on the AO but that is only in cases of afore referred nature. It is definitely a safe guide.

(iii)      We agreed with the view taken by the Full Bench of the Delhi High Court. Hence, the issue of determination of the “fair rental value” in respect of properties not covered by or covered by the Rent Control Act is to be undertaken in terms of the law laid down in the Full Bench decision of the Delhi High Court in the case of CIT vs Moni Kumar Subba (2011) 333 ITR 38 (Delhi-HC-FB) the rateable value, if correctly determined under municipal laws, can be taken as ALV under section 23(1)(a); however, that value is not binding on Assessing Officer and if he can show that rateable value under municipal laws does not represent correct fair rent, then he may determine same on basis of material/evidence placed on record.

As regards addition of notional interest:

(iv)      Notional interest on the security deposit cannot be taken into account for the determination of the annual value. If the transaction itself does not reflect any of the aforestated aspects, then, merely because a security deposit which is refundable and interest free has been obtained, the AO should not presume that this sum or the interest derived therefrom at Bank rate is the income of the assessee till the determination or conclusion of the transaction. Therefore for determination of Fair Rent the notional interest on the interest free security deposit cannot be taken as the determinative factor to arrive at fair rent. The provisions of section 23(1)(a) do not mandate this.

As regards properties where standard rent is not fixed:

(v)       As regards properties covered by rent control legislation, the AO cannot brush aside the rent control legislation. The AO has to undertake the exercise contemplated by the rent control legislation for fixation of standard rent. The AO either must undertake the exercise to fix the standard rent himself and in terms of the Maharashtra Rent Control Act, 1999 if the same is applicable or leave the parties to have it determined by the Court or Tribunal under that Act.

In CIT vs Asian Hotels Ltd (2010) 323 ITR 490 (Delhi) (AY 1995-96 & 2000-01): In both these appeals the revenue has raised the question that whether the Tribunal was justified in law in holding that the notional interest on refundable interest free deposit received by the assessee in respect of a shop let out on rent was neither taxable as business profit under section 28(iv) of the Act, 1961 nor income from house property under section 23(1)(a) of the Act? 

Held, dismissing the appeals, that a plain reading of section 28(iv) indicates that the question of any notional interest on an interest free deposit being added to the income of an assessee on the basis that it may have been earned by the assessee if placed as fixed deposit, does not arise. Section 28(iv) is concerned with business income and is distinct and different from income from house property. It talks of the value of any benefit or perquisites, whether convertible into money or not arising from the business or the exercise of a profession. In the instant case the AO had determined the monetary value of the benefit stated to have accrued to the assessee by adding a sum that constituted 18 per cent simple interest on the deposit. Section 28(iv) not applicable. Section 23(1)(a) is relevant for determining the income from house property and concerns determination of the annual letting value of such property. That provision talks of the sum for which the property might be reasonably be expected to let from year to year. This contemplates the possible rent that the property might fetch and certainly not the interest in fixed deposit that may be placed by the tenant with the landlord in connection with the letting out of such property. The notional interest was not assessable as business income or as income from house property.  

In Midland International Ltd vs DCIT (2007) 109 ITD 198 (Del) held that element of notional income by calculation interest receivable on the interest free security deposit could not be considered for the purpose of determining the annual value of the property as the same is not contemplated under the provisions of section 23.

Therefore, from the above it is clear that the interest on interest free security cannot be considered for determination of ALV u/s 23(1)(a) or (b) but the AO is free to determine the fair rent if he finds that the actual rent received is less than the fair/market rent because of the reason that the assessee has received abnormally high interest free security deposit and because of that reason the actual rent received is less than the rent which the property might fetch, he can take necessary exercise in that behalf.

Therefore, the annual value for computing the income from house property would be only the amount which is received or receivable in any case and it cannot be more than that. 

Further what is rent received or receivable as per the clause 23(1)(b) of the Act? In CIT vs J. K. Investors (Bombay) Ltd. (2001) 248 ITR 723 (Bom-HC) categorically rejected the formula of addition of notional interest while determining the “fair rent” in the following manner:

“……….that under Section (23)(1)(b), the word "receivable" denotes payment of actual annual rent to the assessee. However, if in a given year a portion of the actual annual rent is in arrears, it would still come within Section (23)(1)(b) and it is for this reason that the word "receivable" must be read in the context of the word "received" in Section(23)(1)(b). In the light of the above interpretation, notional interest cannot form part of the actual rent as contemplated by Section (23)(1)(b) of the Act. We once again repeat that whether such notional interest could form part of the fair rent under section 23(1)(a) is expressly left open.”

Notional interest on deposits paid by employer to landlord cannot be considered while computing perquisite value of residential accommodation provided to an employee at concessional or free:

Even notional interest on interest free security deposit cannot be included in perquisites of the employee as value of rent in a case where an employer provides rent free accommodation or at concessional rate, taken on lease because in the Income-tax Act there is specific provision for computation the value of perquisites. In section 17(2)(ii) of the Act it will be computed as:

(i)         The actual amount of lease rental paid or payable by the employer, or

(ii)       Fifteen per cent of salary,

           whichever is lower as reduced by the rent, if any, actually paid by the employee.

Therefore, in any case value of lease rental accommodation for the purpose of perquisites cannot be exceeded by 15% of the salary. Refer section 17(2)(ii)(a(ii)/c(ii)).

This view is also supported with the judgment of Hon’ble Bombay High Court in the case of CIT vs Shankar Krishnan ITA No. 3516/2010 order dated 6.09.2011 wherein it has held that notional interest on deposits paid by employer to landlord cannot be considered while computing perquisite value of residential accommodation, rule 3 r.w.s. 17 of the Act.

Other provisions of section 23 of the Act:

Sub-section (2) of section 23:

Where the property consists of a house or part of a house which-

(a)      is in the occupation of the owner for the purposes of his own residence; or

(b)      cannot actually be occupied by the owner by reason of the fact that owning to his employment, business or profession carried on at any other place, he has to reside at that other place in a building not belonging to him,

the annual value of such house or part of the house shall be taken to be nil.

Sub-section (3) of section 23:

The provisions of sub-section (2) shall not apply if -

(a)      the house or part of the house is actually let during the whole or any part of the previous year; or

(b)      any other benefit there from is derived by the owner.

It say that, without prejudice to exception provides in sub-section (2) of section 23, if property is let out and charge rent then the amount received or receivable would be the annual value for computing tax liability under income from house property and no exemption would be granted as per sub-section(2) of section 23 of the Act.

Sub-section (4) of section 23:

Where the property referred to in sub-section (2) consists of more than one house-

(a)      the provisions of that sub-section shall apply only in respect of one of such houses, which the assessee may, at his option, specify in this behalf;

(b)      the annual value of the house or houses, other than the house in respect of which the assessee has exercised an option under clause (a), shall be determined under sub-section (1) as if such house or houses had been let. "

It provides that the exemption in respect of personal use is allowed only for one house as per the choice of the assessee. In case of more than one house property, the ALV of such other house shall be determined under sub-section (1) of section 23 of the Act, as if such house or houses had been let i.e. ALV will be determined notionally. This view is expressed and affirmed by the Hon’ble High Court in the case of Susham Singla vs CIT [2016] 76 taxmann.com 349 (Punjab & Haryana) that annual value of properties which are more than one, owned by assessee and which admittedly remained vacant throughout previous year would not be assessed under section 23(1)(c) but under section 23(1)(a) and annual value would be determined notionally. Against the aforesaid, the assessee filed an SLP which is dismissed by the Hon’ble Apex Court in [2017] 81 taxmann.com 167 (SC).

Now, therefore considering the decision of the Apex Court, there is no ambiguity in this regard as already observed in earlier in various decisions that the ALV of vacant property would be NIL u/s 23(4)(b) r.w.s. 23(1)(c) of the Act, refer DLF Office Developers vs ACIT 23 SOT 19 (Del) & Premsudha Exports Ltd vs ACIT 110 TTJ 89 (Mum). Thus, if there are more than one property the exemption will be allowed only for one property as per the choice of the assessee and the ALV of the other one would be notionally tax, determine as per the provisions of section 23(1)(a) of the Act and for that purpose the AO is free to assess the ALV after due consideration of reasonable fair market value in the area or if covered under rent control Act then it should be as per municipality value.

Further, by the Finance Act, 2017 a new sub-section (5) is inserted after sub-section (4) of section 23 w.e.f. 1.04.2018 which provides that:

“Where the property consisting of any building or land appurtenant thereto is held as stock-in-trade and the property or any part of the property is not let during the whole or any part of the previous year, the annual value of such property or part of the property, for the period up to one year from the end of the financial year in which the certificate of completion of construction of the property is obtained from the competent authority, shall be taken to be nil.”

Further, as per new ITR recently declared for AY 2018-19 the return form specifically asked for details of property:

(i)        Self Occupied (ITR-1 & others)

(ii)       Let out (ITR-1 & others)

(iii)      Deemed let out (ITR-2 & others)

If the property is let out, even deemed let out the detail has to be filled. The annual value of the other self occupied (deemed let out) house properties will be determined on notional basis as if these had been let out. However, as per law there is no mandate in section 23(1)(a) to take the annual value on mere presumption when the property is admittedly vacant. You can make enquiries to find out the comparable rent prevailing in the vicinity through brokers etc. Each property is unique so far its annual value is concerned and no standard formula can be applied for all properties in a locality.

Regards

Nem Singh