Income Tax Appeal No. 65 of 2004 1 IN THE HIGH COURT OF PUNJAB AND HARYANA AT CHANDIGARH. --- Income-tax Appeal No. 65 of 2004 Date of decision: 27.10.2010 The Commissioner of Income Tax Faridabad --- Appellant Versus M/s. K. Streetlite Electric Corporation Faridabad --- Respondent ---- CORAM: HON’BLE MR. JUSTICE ADARSH KUMAR GOEL HON’BLE MR. JUSTICE AJAY KUMAR MITTAL --- PRESENT: Ms. Urvashi Dhugga, Standing Counsel for the appellant-Revenue. Mr. Anand Chhibbar, Advocate for the respondent. --- AJAY KUMAR MITTAL, J. This order will dispose of two appeals, namely, Income-tax Appeal Nos. 65 and 238 of 2004 as a common question of law is involved in both of them. Facts have been taken from Income-tax Appeal No. 65 of 2004. This appeal under Section 260A of the Income-tax Act, 1961 (for short “the Act’”) has been filed by the Revenue against the order Income Tax Appeal No. 65 of 2004 2 dated 30.5.2003, passed by the Income Tax Appellate Tribunal, New Delhi Bench “A” New Delhi, (in short “the Tribunal”) in Income-tax Appeal No. 1763/Del/99, relating to the assessment year 1995-96. The appeal was admitted on 28.8.2007 for determination of following substantial questions of law: i) That on the facts and in the circumstances of the case, the Hon’ble ITAT has erred in law in restricting the Annual Letting Value of the property comprising of land, building, machinery etc at Rs. 1.50 lacs as against Rs. 7.80 lacs adopted by the Assessing Officer, ignoring that security of Rs. 35 lacs was received from the tenant on which no interest was paid. ii) That on the facts and circumstances of the case, the Hon’ble ITAT has erred in law in observing that the Revenue has not made any effort to show that the standard rent determinable under the Rent Act is more than the actual rent received by the assessee even when the property in question does not fall within the ambit of Rent Control Act as the leased out asset includes Plant & Machinery as well.” In brief, the facts necessary for adjudication as narrated in the appeal are that the assessee had been earning rental income by letting out the facilities of factory, land, building and offices etc. It was noticed by the assessing officer that the assessee had taken interest free security of Rs. 35 lacs from two parties, namely, M/s. Keselec India Pvt. Ltd. and M/s. ESS BEE Stampings, to whom the above assets were leased out, but the assessee was showing a very low rental income of Rs. 1.50 lacs as Income Tax Appeal No. 65 of 2004 3 Annual Letting Value (ALV) in respect of those properties. It also came to be noticed that there was no provision for increase in rent from year to year in the agreement. A notice was, thus, issued by the assessing officer to the assessee to show cause why interest at the rate of 18% per annum on the interest free security be not considered as part of the annual income as the said income was in the kind of annual value. The assessee explained that security of Rs. 35,00,000/- was received since it had leased out substantial property, Plant and Machinery to these two parties by virtue of the agreement with them and it had no bearing with the rental value. The plea of the assessee was not accepted and accordingly the assessing officer determined the annual value at Rs. 7,80,000/- by adding Rs. 6,30,000/- as interest at the rate of 18% per annum on Rs. 35 lacs taken as security, to the value of Rs. 1.50 lacs shown by the assessee. In appeal carried by the assessee, the Commissioner of Income-tax (Appeals) {in short “CIT(A)”}, after relying on a judgment of the apex Court in Sheila Kaushik vs. CIT, (1981) 131 ITR 435 and another of this Court in Tilakraj vs. CIT, (1989) 178 ITR 327, deleted the notional interest of Rs. 6,30,000/- vide order dated 29.1.1999. Aggrieved by the order of the CIT(A), the Revenue filed appeal before the Tribunal. The Tribunal affirmed the order of the CIT (A) and consequently dismissed the appeal. Hence, this appeal by the Revenue. We have heard learned counsel for the parties and perused the record. Income Tax Appeal No. 65 of 2004 4 Learned counsel for the Revenue submitted that the reliance of the Tribunal on the case law was totally misplaced in view of the amendment made by Taxation Laws (Amendment) Act, 1975 with effect from 1.4.1976, whereby Section 23 was amended. According to the learned counsel, after the amendment, the taxability under rental income relates to the amount received or receivable vis-à-vis the expected rent and higher of the two forms part of income from house property. Learned counsel placed reliance on the observations made by the Apex Court in McDowell and Co. Ltd. vs. Commercial Tax Officer, (1985) 154 ITR 148 to urge that the present case relating to the security deposit of Rs. 35,00,000/- is the one which stands fully covered by the observations relating to the avoidance of tax made by the Apex Court. Alternatively, learned counsel submitted that in case the notional interest on interest free security deposit is not brought to tax under the heading ‘income from house property’ the same cannot escape taxability under Section 56 of the Act being ‘income from other sources’. Refuting the arguments of the Revenue, learned counsel for the assessee, besides supporting the order of the Tribunal submitted that the Tribunal had rightly dismissed the appeal of the Revenue. Elaborating his argument, learned counsel submitted that the assessee did not adopt any dubious mechanism to avoid payment of legitimate tax liability and the security deposit was, in fact, a transaction to secure the interest of the assessee. The point for consideration in this appeal is, whether in the facts and circumstances the interest that may accrue on security deposit Income Tax Appeal No. 65 of 2004 5 of Rs. 35,00,000/-, which was received by the assessee from the tenants, would attract tax liability? The answer to the aforesaid question would require examination of the issue from various facets. To enumerate, the following points shall need determination:- (a) Whether the security deposit with interest free stipulation is a device to circumvent liability of income tax and would have legal sanction behind it? (b) Whether the notional interest on security deposit would fall within the ambit of Section 23 of the Act? Adverting to the first point, in order to ascertain the nature of the transactions, necessarily a reference shall have to be made to factual matrix. It may be noticed that it is not disputed that the assessee was receiving a sum of Rs. 1,50,000/- per annum as rental income for land and building etc. and another sum of Rs. 1,50,000/- per annum on account of use of furniture and fixture etc.. However, the assessee received a sum of Rs. 35,00,000/- which, according to it, was interest free security. The assessing officer, however, came to the conclusion that it was a device to divert the income and the assessee was not entitled to claim exemption on that count. Further, the written down value of Factory, land and Building at the beginning of the accounting period was Rs. 17,62,000/- and that of the plant and the machinery was Rs. 1,69,000/- and furniture Rs. 48,675/-. It would also be appropriate to refer to the lease agreement. The contents of the agreement between the assessee and Income Tax Appeal No. 65 of 2004 6 M/s. Keselec India Pvt. Ltd., as relevant for the purpose of this case, read thus: “As per para 3(b) : Pay to the lessor an all inclusive sum of Rs. 12,500/- p.m. as lease rent and royalty as per Schedule ‘C’. Schedule ‘C’ Lease rent of Rs. 12,500/- per month payable as under: (a) Lease rent of fixture, Plant and machinery dies etc. : Rs. 4,500/- b) Usages of land and shed area : Rs.8,000/- ___________ Total: Rs.12,500/- This lease deed has been entered on 1.12.92 with effect from 1.2.92. The lease is within reference to “And whereas the lessee has offered to undertake the manufacture of all lighting fittings and their accessories under the brand name “Keselec” and for that purpose to take on lease the entire facilities of the factory, land, building, offices, Branch offices at New Delhi and Noida, plant and Machinery excluding those covered under the lease agreement dated 21.8.1986 between the lessor and M/s. ESS BEE Stamping.” The relevant terms of lease agreement with ESS BEE Stampings stipulated as under: Income Tax Appeal No. 65 of 2004 7 “The agreement of lease is dt. 21.8.86 as per column 1, hereby agrees to give on lease and M/s. ESSBEE hereby agrees to take on lease built up area measuring approximately 11000 Sq. Ft. shaded in red in the plan attached here to as schedule ‘B’ complete with fixtures, electrical installations, water supply arrangements and the plant, equipment, machines, jigs, fixtures, dies, tools listed in schedule ‘A’ attached herewith on terms and conditions hereinafter contained.” As per schedule ‘B’:- Schedule ‘B’ Lease rent of Rs. 12,500/- per month payable as under:- (a) Lease rent of fixture, Plan and Machinery dies etc. : Rs. 8,000/- b) Usages of land and shed area : Rs.4,500/- __________ Total : Rs.12,500/- In its return of cine assessee is showing income from lease rent of fixture, plant and machinery, dies etc. as business income and lease rent of usage of land and shed area as income from house property. The clause with regard to interest free security in both the agreements reads thus: “2.2 Interest free security: Income Tax Appeal No. 65 of 2004 8 Assessee has given the security amount of Rs. 35 lacs on which depositor is not charging any interest. Out of this total security amount of Rs. 35 lacs , Rs. 30 lacs have been received from M/s. Keselec India Pvt. Ltd. and Rs. 5 lacs from M/s. ESS Bee Stampings.” A perusal of the above lease deeds and on a conjoint reading of all the documents and an analysis of factual aspect, the irresistible conclusion is that the security deposit of Rs. 35,00,000/- was disproportionate to the actual contractual rent of Rs. 25,000/- per month, i.e. total Rs.12,500/- per month for land and building etc. and Rs.12,500/- per month for furniture, fixture, plant and machinery etc. which amounts to 140 times of monthly rent and has no rationale with the agreed rent and the assessee had adopted a device to circumvent its taxable income. Further, rent deed did not contain any provision for increase of rent from year to year. Still further, the security deposit of Rs. 35,00,000/- where the value of the property let out was 17.62 lacs, Plant and machinery of Rs. 1.69 lacs and furniture of Rs. 48,673/- cannot be held to be justified as genuine transaction of the security deposit. The observations of the apex Court in McDowell and Co. Ltd.’s case (supra) apply in full vigor to the present case which read thus: “In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid Income Tax Appeal No. 65 of 2004 9 tax, and whether the transaction is such that the judicial process may accord its approval to it. A hit of this approach is to be found in the judgment of Desai J. in Wood-Polymer Ltd., In re & Bengal Hotels Limited, In re (1977) 47 Comp Cas 596 (Guj.) where the learned judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax. It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of ‘emerging’ techniques of interpretation as was done in Ramsay, Burma Oil and Dawson, to expose the devices for what they really are and to refuse to give judicial benediction.” Thus, issue No.1 stands answered against the assessee and it is concluded that the security deposit was a sham device to avoid tax and had no real basis with the actual rent that was received by the assessee. Taking up the second issue, it may be noticed that Section 22 of the Act deals with income from house property and states that annual value of the property of the description specified therein shall be chargeable under the head ‘income from house property’. Section 23 of the Act provides the manner in which annual value of any property is to Income Tax Appeal No. 65 of 2004 10 be determined for the purposes of computing the income from house property. Thus, S. 23 provides the formula for ascertaining the annual value of property. Section 23(1) as originally enacted was couched in the following terms: “23.Annual value how determined.- (1) For the purposes of section 22, the annual value of any property shall be deemed to be the sum for which the property might reasonably be expected to let from year to year: Provided that where the property is in the occupation of a tenant and the taxes levied by any local authority in respect of the property are, under the law authorizing such levy, payable, wholly by the owner or partly by the owner and partly by the tenant, a deduction shall be made equal to the part, if any, of the tenant’s liability borne by the owner.” The aforesaid provisions came up for consideration before the apex Court in Sheila Kaushik’s case (supra) and of this Court in Tilakraj’s case (supra) wherein, interpreting the said provisions, it was laid down that the annual value for the purpose of income tax from house property where the building was situated in an area where the rent control legislation was applicable, will be determined under the Rent Legislation, and the standard rent determinable under the provisions of the Rent Control Act shall be governed as annual value if the standard rent had not been determined or actual rent received or receivable was more than the standard rent. However, the Taxation Laws (Amendment) Income Tax Appeal No. 65 of 2004 11 Act, 1975 which was made applicable w.e.f. 1.4.1976 amended Section 23. The relevant portion of amended Section 23(1) reads as under: “23. Annual value how determined.- (1) For the purpose 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 After the amendment, it makes manifest that the annual value of the property is deemed to be the rent which property might be expected to let from year to year or where the property is let and annual rent received or receivable is in excess of the sum, the amount so received or receivable. According to Section 23(1)(b) where the property is actually let out, the actual amount of rent received or receivable shall form part of the income from house property. Ordinarily, the notional interest that may accrue on security deposit would not form part of income from house property as held by the Bombay High Court in Commissioner of Income Tax vs. J.K. Investors (Bombay) Ltd. (2001) 248 ITR 723. However, where payment of the security deposit is to circumvent real rent, the same shall fall within its ambit as income from house property. The second issue, thus, accordingly stands answered. Income Tax Appeal No. 65 of 2004 12 The CIT(A) and the Tribunal were, thus, in error in deciding the question against the Revenue. In view of the above, the substantial questions of law are answered accordingly and the appeals are allowed. It is held that interest on the security amount of Rs. 35,00,000/- will be treated as income of the assessee. Thus, in the facts, as noticed above, it is considered appropriate to hold that interest at the rate of 9% per annum on the security amount of Rs. 35,00,000/- would be just to meet the ends of justice and the same will be treated as taxable income of the assessee under the head ‘income from house property’ relating to the land and building. (AJAY KUMAR MITTAL) JUDGE (ADARSH KUMAR GOEL) October 27, 2010 JUDGE *rkmalik*