Department ought not to tax notional ALV, in absence of actual rent receipts by landlord

August 12, 2021

By Pankaj Bajpai

On the date of filing I-T returns, the taxpayers always remain in a hurry to complete the formalities before the schedule. Be it a salaried person, a business person, an investor or a corporate, every one wishes to save their taxes by claiming exemptions & deductions from the five heads of salary. One such head is “income from house property”. The provisions for determination of income from house property are contained in Chapter – IVC of the Income Tax Act, 1961, whose Section 22 talks about the annual value of property consisting building or lands appurtenant thereto, of which the assessee is owner, and other than such portions of which he occupies for business or profession carried on by him. Now, the term ‘Annual Letting Value’ (ALV) is defined u/s 23 of Income tax Act, as (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. 

The definition of ALV looks straight and simple, as it is made clear under the Statute that when a landlord receives rent over & above the market rate/municipal rate fixed as per Rent Control Board, then the actual rent receipts will be treated as income from house property. However, the dispute arises when the rent received by a landlord is much below the ceiling limit prescribed by the concerned authority or market rate. A somewhat similar controversy was answered by Calcutta High Court in the case of CIT vs. Bhasker Mittar, wherein a question was raised as to whether the annual letting value of a property could be a figure lower than that returned by the assesse himself in his return. 

This question was put to rest by holding that an assessee is liable to pay tax only upon such income as can be lawfully assessed under the Income Tax Act. Therefore, while framing an assessment, the ITO cannot assess any rental income to tax simply because assesse has mistakenly offered it to tax. The Calcutta High Court therefore held that there is no error in fixing the annual letting value of a premise in question in accordance with the provision of Section 23, by adopting municipal valuation even though the same is less than the annual rent returned by the assesse.  

In another landmark judgment of Supreme Court in the matter of Patel Gordhandas vs Municipal Commissioner, Ahmedabad, it was held that the criteria for determining rateable value of the building is annual rent which the owner might reasonably expect to get from a hypothetical tenant, less certain deductions. The Apex Court further even went on to hold that rateable value of a building, whether tenanted or self-occupied , is limited by the measure of standard rent arrived at by applying the principle of Rent Act, and cannot exceed the figure of standard rent so arrived at by the ITO. While fixing the rateable value, the ITO has to take into consideration the rent, which the owner of similar premises constructed earlier or situated in it or in an adjoining locality, might reasonably expect to receive from a hypothetical tenant so that there is no wide disparity between rates of rent. 

In similar line of reasoning, there is catena of judgments on the assertion of preference of fair rent vis-à-vis standard rent. Starting from ITO, Mumbai vs. M/s Makrupa Chemicals Pvt Ltd [ITA no.4376/Mum./2012] where it was held that if fair rent is less than standard rent, it is the fair rent that is to be taken as annual letting value and not standard rent. Again, in case of Tivoli Investment and Trading Co Pvt Ltd vs. Asst CIT [ITA No.2808 & 2809/Mum/1996], Mumbai it was pointed that AO is not required to substitute the fair rent determined u/s 23(1)(a) by municipal value or standard rent and he is not permitted to determine ALV on its own and discard the ratable value or standard rent. The point is that, if the provision regarding calculation of annual letting value is so clear and simple, then what is the reason for an increasing litigation on such premises. All the judgments mentioned above talk about municipal rate or standard rent, but nowhere discuss the actual rent received by the owner of a house property. 

Article 265 of Indian Constitution prescribes that no tax shall be levied or collected except by the authority of law. Further, Entry 81 to Schedule 7 of the Constitution, under which the Income tax Act is incorporated, mentions “tax on income”. Therefore, what are to be taxed are only an ‘income’ and not a ‘hypothetical sum’. Accordingly, the Income Tax Act, 1961 provides that actual rent received under normal circumstances will be reliable evidence unless the rent is inflated / deflated by reason of extraneous consideration. However, an inflated or deflated rent based on extraneous consideration may take it out of the bounds of reasonableness. There may be circumstances where the owner lets out his property at a value which is lower than the fair rent or municipal rate. Then, will it be ideal to assess the owner at the inflated sum, even when he is not in receipt of the said sum. Is it not violation of the Constitution itself, which says taxes should be levied only on real income but not hypothetical income? It is not always true that an owner deflates his rental income so as to evade payment of taxes.

Coming forward to dilute the ambiguity, the Mumbai High Court in case of CIT vs. Tip Top Typography, observed that municipal rateable value, although being a safe guide to determine fair rent, is not always binding on the AO for purposes of Section 23(1)(a). But, it failed to clear the vagueness on the issue of actual rent received/receivable. In the latest decision of M/s Europa Chemicals Pvt Ltd vs. ITO [ITA NO. 387, 388 & 390/Mum/2018], Mumbai delivered on June 15, 2018, it was clarified that the rate of rent prevalent in the market is no basis enough to override the actual rent of a property. But, the problem still persists. The reason being there is no provision in the Legislation to curb the ill effects which grants excess power in the hands of Revenue Department to tax what does not exist. Even when the Income Tax Act being a beneficial piece of legislation, no steps have been taken by the law framers to provide for an amendment for a permanent answer. The question therefore still remains, as to whether notional or real rental income is to be taxed?

Pankaj Bajpai is Senior Copy Editor at LegitEye. A Law Graduate with Honors in Taxation Law from KIIT University, Bhubaneswar, he has eight years’ work experience.

Disclaimer: The views or opinions expressed are solely of the author.