The Commissioner Of Income Taxfaridabad v. M/S. K. Streetlite Electric Corporationfaridabad

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 TaxFaridabad --- Appellant Versus M/s. K. Streetlite Electric CorporationFaridabad --- Respondent ---- CORAM:HON’BLE MR. JUSTICE ADARSH KUMAR GOELHON’BLE MR. JUSTICE AJAY KUMAR MITTAL --- PRESENT:Ms. Urvashi Dhugga, Standing Counselfor the appellant-Revenue. Mr. Anand Chhibbar, Advocatefor the respondent. --- AJAY KUMAR MITTAL, J. This order will dispose of two appeals, namely, Income-taxAppeal Nos. 65 and 238 of 2004 as a common question of law is involvedin both of them. Facts have been taken from Income-tax Appeal No. 65of 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 dated 30.5.2003, passed by the Income Tax Appellate Tribunal, New DelhiBench “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, theHon’ble ITAT has erred in law in restricting the Annual LettingValue of the property comprising of land, building, machineryetc at Rs. 1.50 lacs as against Rs. 7.80 lacs adopted by theAssessing Officer, ignoring that security of Rs. 35 lacs wasreceived from the tenant on which no interest was paid.Hon’ble ITAT has erred in law in restricting the Annual LettingValue of the property comprising of land, building, machineryetc at Rs. 1.50 lacs as against Rs. 7.80 lacs adopted by theAssessing Officer, ignoring that security of Rs. 35 lacs wasreceived from the tenant on which no interest was paid. ii)That on the facts and circumstances of the case, the Hon’bleITAT has erred in law in observing that the Revenue has notmade any effort to show that the standard rent determinableunder the Rent Act is more than the actual rent received bythe assessee even when the property in question does not fallwithin the ambit of Rent Control Act as the leased out assetincludes Plant & Machinery as well.”ITAT has erred in law in observing that the Revenue has notmade any effort to show that the standard rent determinableunder the Rent Act is more than the actual rent received bythe assessee even when the property in question does not fallwithin the ambit of Rent Control Act as the leased out assetincludes Plant & Machinery as well.” In brief, the facts necessary for adjudication as narrated in theappeal are that the assessee had been earning rental income by lettingout the facilities of factory, land, building and offices etc. It was noticedby the assessing officer that the assessee had taken interest free securityof Rs. 35 lacs from two parties, namely, M/s. Keselec India Pvt. Ltd. andM/s. ESS BEE Stampings, to whom the above assets were leased out, butthe assessee was showing a very low rental income of Rs. 1.50 lacs as Annual Letting Value (ALV) in respect of those properties. It also cameto be noticed that there was no provision for increase in rent from yearto year in the agreement. A notice was, thus, issued by the assessingofficer to the assessee to show cause why interest at the rate of 18% perannum on the interest free security be not considered as part of theannual income as the said income was in the kind of annual value. Theassessee explained that security of Rs. 35,00,000/- was received since ithad leased out substantial property, Plant and Machinery to these twoparties by virtue of the agreement with them and it had no bearing withthe rental value. The plea of the assessee was not accepted andaccordingly 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% perannum on Rs. 35 lacs taken as security, to the value of Rs. 1.50 lacs shownby the assessee. In appeal carried by the assessee, the Commissioner of In appeal carried by the assessee, the Commissioner of Income-tax (Appeals) {in short “CIT(A)”}, after relying on a judgment ofthe apex Court in Sheila Kaushik vs. CIT, (1981) 131 ITR 435 and anotherof this Court in Tilakraj vs. CIT, (1989) 178 ITR 327, deleted the notionalinterest of Rs. 6,30,000/- vide order dated 29.1.1999. Aggrieved by the order of the CIT(A), the Revenue filedappeal before the Tribunal. The Tribunal affirmed the order of the CIT(A) and consequently dismissed the appeal. Hence, this appeal by theRevenue. We have heard learned counsel for the parties and perusedthe record. Learned counsel for the Revenue submitted that the relianceof the Tribunal on the case law was totally misplaced in view of theamendment made by Taxation Laws (Amendment) Act, 1975 with effectfrom 1.4.1976, whereby Section 23 was amended. According to thelearned counsel, after the amendment, the taxability under rental incomerelates to the amount received or receivable vis-à-vis the expected rentand higher of the two forms part of income from house property.Learned counsel placed reliance on the observations made by the ApexCourt in McDowell and Co. Ltd. vs. Commercial Tax Officer, (1985) 154ITR 148 to urge that the present case relating to the security deposit ofRs. 35,00,000/- is the one which stands fully covered by the observationsrelating to the avoidance of tax made by the Apex Court. Alternatively,learned counsel submitted that in case the notional interest on interestfree security deposit is not brought to tax under the heading ‘incomefrom house property’ the same cannot escape taxability under Section 56of the Act being ‘income from other sources’. Refuting the arguments of the Revenue, learned counsel forthe assessee, besides supporting the order of the Tribunal submitted thatthe Tribunal had rightly dismissed the appeal of the Revenue. Elaboratinghis argument, learned counsel submitted that the assessee did not adoptany dubious mechanism to avoid payment of legitimate tax liability andthe security deposit was, in fact, a transaction to secure the interest ofthe assessee. The point for consideration in this appeal is, whether in thefacts and circumstances the interest that may accrue on security deposit 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 requireexamination of the issue from various facets. To enumerate, thefollowing points shall need determination:- (a)Whether the security deposit with interest free stipulation is adevice to circumvent liability of income tax and would havelegal sanction behind it?device to circumvent liability of income tax and would havelegal sanction behind it? (b)Whether the notional interest on security deposit would fallwithin the ambit of Section 23 of the Act?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 factualmatrix. It may be noticed that it is not disputed that the assessee wasreceiving a sum of Rs. 1,50,000/- per annum as rental income for landand building etc. and another sum of Rs. 1,50,000/- per annum onaccount of use of furniture and fixture etc.. However, the assesseereceived a sum of Rs. 35,00,000/- which, according to it, was interest freesecurity. The assessing officer, however, came to the conclusion that itwas a device to divert the income and the assessee was not entitled toclaim exemption on that count. Further, the written down value ofFactory, land and Building at the beginning of the accounting period wasRs. 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 leaseagreement. The contents of the agreement between the assessee and M/s. Keselec India Pvt. Ltd., as relevant for the purpose of this case, readthus: It would also be appropriate to refer to the leaseagreement. The contents of the agreement between the assessee and M/s. Keselec India Pvt. Ltd., as relevant for the purpose of this case, readthus: “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 ___________ Total: Rs.12,500/- This lease deed has been entered on 1.12.92 with effect from1.2.92. The lease is within reference to “And whereas the lessee hasoffered to undertake the manufacture of all lighting fittingsand their accessories under the brand name “Keselec” and forthat purpose to take on lease the entire facilities of thefactory, land, building, offices, Branch offices at New Delhiand Noida, plant and Machinery excluding those coveredunder the lease agreement dated 21.8.1986 between thelessor and M/s. ESS BEE Stamping.” The relevant terms of lease agreement with ESS BEE Stampings stipulatedas under: “The agreement of lease is dt. 21.8.86 as per column 1,hereby agrees to give on lease and M/s. ESSBEE herebyagrees to take on lease built up area measuringapproximately 11000 Sq. Ft. shaded in red in the planattached here to as schedule ‘B’ complete with fixtures,electrical installations, water supply arrangements and theplant, equipment, machines, jigs, fixtures, dies, tools listed inschedule ‘A’ attached herewith on terms and conditionshereinafter 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 In its return of cine assessee is showing income from leaserent of fixture, plant and machinery, dies etc. as businessincome and lease rent of usage of land and shed area asincome from house property. The clause with regard to interest free security in both theagreements reads thus: Assessee has given the security amount of Rs. 35 lacs onwhich depositor is not charging any interest. Out of this totalsecurity amount of Rs. 35 lacs , Rs. 30 lacs have been receivedfrom M/s. Keselec India Pvt. Ltd. and Rs. 5 lacs from M/s. ESSBee Stampings.” A perusal of the above lease deeds and on a conjoint readingof all the documents and an analysis of factual aspect, the irresistibleconclusion is that the security deposit of Rs. 35,00,000/- wasdisproportionate 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 amountsto 140 times of monthly rent and has no rationale with the agreed rentand the assessee had adopted a device to circumvent its taxable income.Further, rent deed did not contain any provision for increase of rent fromyear to year. Still further, the security deposit of Rs. 35,00,000/- where thevalue 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 asgenuine transaction of the security deposit. The observations of the apexCourt in McDowell and Co. Ltd.’s case (supra) apply in full vigor to thepresent 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 whetherthe provisions should be construed literally or liberally, norwhether the transaction is not unreal and not prohibited bythe statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicialprocess may accord its approval to it. A hit of this approach isto be found in the judgment of Desai J. in Wood-PolymerLtd., In re & Bengal Hotels Limited, In re (1977) 47 Comp Cas596 (Guj.) where the learned judge refused to accordsanction to the amalgamation of companies as it would leadto avoidance of tax. It is neither fair nor desirable to expect the legislature “In our view, the proper way to construe a taxing statute,while considering a device to avoid tax, is not to ask whetherthe provisions should be construed literally or liberally, norwhether the transaction is not unreal and not prohibited bythe statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicialprocess may accord its approval to it. A hit of this approach isto be found in the judgment of Desai J. in Wood-PolymerLtd., In re & Bengal Hotels Limited, In re (1977) 47 Comp Cas596 (Guj.) where the learned judge refused to accordsanction to the amalgamation of companies as it would leadto avoidance of tax. It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme toavoid taxation. It is up to the court to take stock todetermine the nature of the new and sophisticated legaldevices to avoid tax and consider whether the situationcreated by the devices could be related to the existinglegislation with the aid of ‘emerging’ techniques ofinterpretation as was done in Ramsay, Burma Oil and Dawson,to expose the devices for what they really are and to refuseto 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 andhad no real basis with the actual rent that was received by the assessee. Taking up the second issue, it may be noticed that Section 22of the Act deals with income from house property and states that annualvalue of the property of the description specified therein shall bechargeable under the head ‘income from house property’. Section 23 ofthe Act provides the manner in which annual value of any property is to be determined for the purposes of computing the income from houseproperty. Thus, S. 23 provides the formula for ascertaining the annualvalue of property. Section 23(1) as originally enacted was couched in the following terms: “23.Annual value how determined.- (1) For the purposes ofsection 22, the annual value of any property shall be deemedto be the sum for which the property might reasonably beexpected to let from year to year: Provided that where the property is in the occupationof a tenant and the taxes levied by any local authority inrespect of the property are, under the law authorizing suchlevy, payable, wholly by the owner or partly by the owner andpartly by the tenant, a deduction shall be made equal to thepart, if any, of the tenant’s liability borne by the owner.” The aforesaid provisions came up for consideration beforethe apex Court in Sheila Kaushik’s case (supra) and of this Court inTilakraj’s case (supra) wherein, interpreting the said provisions, it was laiddown that the annual value for the purpose of income tax from houseproperty where the building was situated in an area where the rentcontrol legislation was applicable, will be determined under the RentLegislation, and the standard rent determinable under the provisions ofthe Rent Control Act shall be governed as annual value if the standardrent had not been determined or actual rent received or receivable wasmore than the standard rent. However, the Taxation Laws (Amendment) 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 ofsection 22, the annual value of any property shall be deemedto be-section 22, the annual value of any property shall be deemedto be- (a)the sum for which the property might reasonably beexpected to let from year to year; orexpected to let from year to year; or 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 ofsection 22, the annual value of any property shall be deemedto be-section 22, the annual value of any property shall be deemedto be- (a)the sum for which the property might reasonably beexpected to let from year to year; orexpected to let from year to year; or (b)where the property or any part of the property is letand the actual rent received or receivable by the ownerin respect thereof is in excess of the sum referred to inclause (a), the amount so received or receivable; orand the actual rent received or receivable by the ownerin respect thereof is in excess of the sum referred to inclause (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 beexpected to let from year to year or where the property is let and annualrent received or receivable is in excess of the sum, the amount soreceived or receivable. According to Section 23(1)(b) where the propertyis actually let out, the actual amount of rent received or receivable shallform part of the income from house property. Ordinarily, the notionalinterest that may accrue on security deposit would not form part ofincome from house property as held by the Bombay High Court inCommissioner of Income Tax vs. J.K. Investors (Bombay) Ltd. (2001) 248ITR 723. However, where payment of the security deposit is tocircumvent real rent, the same shall fall within its ambit as income fromhouse property. The second issue, thus, accordingly stands answered. The CIT(A) and the Tribunal were, thus, in error in decidingthe question against the Revenue. In view of the above, the substantial questions of law areanswered accordingly and the appeals are allowed. It is held thatinterest on the security amount of Rs. 35,00,000/- will be treated asincome of the assessee. Thus, in the facts, as noticed above, it isconsidered appropriate to hold that interest at the rate of 9% per annumon the security amount of Rs. 35,00,000/- would be just to meet theends of justice and the same will be treated as taxable income of theassessee under the head ‘income from house property’ relating to theland and building. (AJAY KUMAR MITTAL) JUDGE October 27, 2010*rkmalik* (ADARSH KUMAR GOEL) JUDGE