MUMBAI I BENCH COMMISSIONER OF v. DELITE ENTERPRISES INCOME TAX February 26, 2008 JUDGMENT ORDER J. Sudhakar Reddy, A.M.: These are cross-appeals filed for asst. yrs. 2001-02 and 2002-03. As issues arising in all these appeals are common, for same of convenience, they were heard together and are disposed of by this consolidated order. Revenue s appeals 2. First we take up Revenue s appeals. Both appeals relate to claim of assessee for deduction for interest paid on borrowed funds under s. 36(1)(iii). 3. Facts in brief: assessee alongwith M/s Radian Tex Fab (P) Ltd. has formed partnership firm under name and Style "M/s Shreenath Enterprises". partnership deed dt. 24th July, 2000 was executed between parties. Clause 3 of partnership deed sets out objects of partnership firm as that of dealing in commodities and business of dealing in shares and securities or holding them by way of business investment, or business of providing finance whether by way of making loans or advances or otherwise for any activity or any other business or businesses as may be mutually agreed upon between parties from time to time. profits and losses of this partnership were to be shared, equally between partners. Clauses 7 and 8 of partnership deed are also relevant and are extracted for ready reference:"7. Capital Capital of Partnership shall be contributed by partners from time to time as and when considered necessary or expedient for purpose of carrying on partnership business in such proportion as parties hereto may from time to time agree upon. present capital of partnership firm is nil. 8. Interest partners may introduce capital and/or give loan to firm, which shall carry interest at rate of 12 per cent per annum or such other rates as may be mutually agreed upon between partners from time to time. Provided however, interest on capital and/or loans so payable shall not exceed aggregate amount of profit earned by firm in year and in such even interest amount payable to each partner shall be in proportion of gross interest amount calculated." 3.1 During year assessee had borrowed certain funds from M/s Reliance Capital Ltd. and had invested same in partnership firm M/s Shreenath Enterprises. interest payable to M/s Reliance Capital Ltd. was claimed as deduction under s. 36(1)(iii). AO disallowed same under s. 14A by holding that income to be derived from partnership firm would be exempt under s. 10(2A) of Act and thus expenditure relatable to earning of income is to be disallowed in terms of s. 14A.On appeal, first appellate authority considered clauses of partnership deed and held that interest income earned by assessee in terms of cl. 8 of partnership deed is taxable in hands of assessee under s. 28(v) of Act. He also referred to judgment of Hon ble Supreme Court in case of CIT vs. Rajendra Prasad Moody 1978 CTR (SC) 141: (1978) 115 ITR 519 (SC) and held that once expenditure is incurred for earning of income, non-receipt of income cannot be justifiable ground of disallowing such expenditure. Thus he allowed claim of assessee. At this juncture it should be observed that for asst. yr. 2001-02 assessee had not received any interest from firm M/s Sreenath Enterprises. For asst. yr. 2002-03 assessee received interest of Rs. 99,01,000 from M/s Shreenath Enterprises. assessee submitted that in asst. yr. 2001-02, partnership firm had incurred losses and thus as per terms of agreement no interest was earned by assessee. CIT(A) also held that interest income in question was assessable under head "Income from business or profession" and not under head "Income from other sources" as determined by AO. Revenue is also aggrieved by this finding. Thus these appeals for both assessment years have been filed by Revenue. 4. We have heard Shri Pritam Singh and Shri Bharat Bhushan, learned Departmental Representatives and Shri J.D. Mistry learned counsel for assessee. main contention of Shri Pritam Singh is that assessee has made investment in partnership, by borrowing monies from M/s Reliance Capital Ltd. He took this Bench through paper book, specifically to statement of accounts of assessee and as well as that of M/s Shreenath Enterprises to demonstrate that amount in question was in fact investment made by assessee company. He took this Bench to s. 14A and submitted that CIT(A) has not correctly appreciated this section. His case is that return of investment made in partnership firm is exempt under s. 10(2A) of Act and thus does not form part of total income and hence he submits that any expenditure incurred in relation to earning of non-taxable income is not allowable in terms of s. 14A. His case is that CIT(A) has wrongly interpreted cl. 8 of partnership deed. For asst. yr. 2001-02 he submits that assessee has not earned any income whatsoever during year from partnership concern and thus no expenditure is allowable. On reliance being placed by CIT(A) on judgment of Hon ble Supreme Court in case of Rajendra Prasad Moody (supra), learned Departmental Representative submits that in that case Hon ble apex Court was considering allowability of expenditure under s. 57(iii) and not under s. 36(1)(iii). Coming to appeal for asst. yr. 2002- 03 learned Departmental Representative submits that only amount of Rs. 99,01,000 was received by assessee and CIT(A) has determined that same is assessable as income from business. Thus he submits that allowability of interest should be restricted to this amount. 5. On other hand, Shri J.D. Mistry submits that fact whether assessee has earned certain income during year or in particular year is immaterial and cannot be ground for disallowing expenditure incurred He relied on order of first appellate authority and submitted that learned CIT(A) has rightly relied on judgment of Hon ble Supreme Court in case of Rajendra Prasad Moody (supra). He submitted that ratio laid down for applicability of s. 57(iii) is also applicable for expenditure deductible under s. 36(1)(iii) or under s. 37(1) and that Courts have repeatedly reiterated same. He relied on recent judgment of Madras High Court in case of CIT vs. M. Ethurajan (2004) 192 CTR (Mad) 378: (2005) 142 TAXMAN 708 (Mad). He took this Bench through arguments made by assessee before first appellate authority wherein number of judgments have been relied upon and submitted that first appellate authority was right in holding that assessee is entitled to claim for deduction under s. 36(1)(iii) as income in question was taxable under s. 28(v) of Act. He also took this Bench to relevant clauses of IT Act. 6. While arguing for asst. yr. 2002-03 he submits that assessee in this year has received interest and this was assessed as "income from other sources" by AO and that CIT(A) has rightly assessed it under head "Income from business or profession" proof, as per Mr. Mistry, that income earned in terms of cl. 8 of partnership deed is taxable under s. 28(v) of Act lies in assessment order for asst. yr. 2002-03. On question of proportionate disallowance canvassed by learned Departmental Representative, Shri Mistry submits that no such disallowance can be made unless certain expenditure can be relatable to exempt income. He pointed out that during year there is no exempt income earned by assessee. entire expenditure in question was relatable to earning of Rs. 99,01,000 and thus same should be allowed. 7. After hearing rival contentions and considering papers on record orders of authorities below we are of considered opinion that order of first appellate authority calls for no interference for following reasons: 7.1 assessee in this case, in pursuance of objects of carrying on of business of dealing in commodities and business of dealing in shares and securities, etc. has investment in partnership firm. Clause 8 of partnership firm clearly states that assessee shall be entitled to interest at rate of 12 per cent on capital introduced. earning of interest is capped at maximum amount of profit earned. In other words, interest on capital/loans, should not exceed aggregate amount of profit earned by firm in year. Sec. 28(v) of Act merely states that interest earned on partnership firm is taxable. For asst. yr. 2001-02 assessee had in fact earned interest of Rs. 99,01,000 and AO has brought it to tax. first appellate authority has rightly held that this receipt is taxable under head "Profits and gains of business or profession" under s. 28(v) of Act. There is no exemption claimed under s. 10(2A) of Act by assessee. Sec. 10(14) clearly states that expenditure incurred by assessee in relation to income which does not form part of total income under Act will not be allowed. In this case, for both assessment years, there is no income earned by assessee which does not form part of total income under Act. Under these circumstances we do not see any reason why claim of assessee is not allowable under s. 36(1)(iii). Coming to argument of learned Departmental Representative that judgment of Hon ble apex Court in case of Rajendra Prasad Moody (supra) is not applicable to this case, we find that Hon ble Madras High Court in case of M. Ethurajan (supra) has held that propositions laid down in Rajendra Prasad Moody s case (supra) for allowability under s. 57(iii), are equally applicable for deductions claimed under s. 36(1)(iii) or s. 37. Thus this argument of Revenue is without any merit. 7.2 In view of above discussion we are of considered opinion that first appellate authority at para 4.3 p. 15 of order for asst. yr. 2001- 02 has rightly come to conclusion that claim of assessee for deduction under s. 36(1)(iii) has to be allowed. 8. Coming to ground of Revenue for asst. yr. 2002-03 in view of above we hold that first appellate authority was right in holding that income in question is taxable under head "Income from business or profession" and not under head "Income from other sources". In fact it is taxed under s. 28(iv) of Act. 9. In result, we uphold order of first appellate authority on these issues for both assessment years and dismiss appeals of Revenue. 10. This brings us to appeals filed by assessee. sole issue in these crossappeals is as to whether first appellate authority has erred in confirming action of AO in taking annual value of let out property at Rs. 14,40,000 as against actual rent received by assessee at Rs. 60,000. 11. Facts in brief: assessee owns property at plot No. 25, D-16, Vasant Vihar, New Delhi. assessee had let out said property to M/s Reliance Industries Ltd. vide agreement dt. 8th Oct., 1998 for annual rent of Rs. 60,000 and security deposit of Rs 3,70,60,000. assessee had computed annual letting value of said property under s. 23(1)(b) of Act by taking rent received at Rs. 60,000 and offered same to tax in its returns of income. During course of assessment proceedings assessee submitted that municipal rateable value (MRV) as per Delhi Municipal Authority is Rs. 22,230 only. Thus he submits that this MRV being less than rent received, higher of two has to be taken into consideration while computing annual letting value under s. 23(1)(b) of Act. AO disagreed with assessee and computed annual letting value by considering annual rent at Rs. 14,40,000, i.e. municipal rent of Rs. 1,20,000. On appeal, first appellate authority upheld order of AO. Further aggrieved, assessee is before us. 12. Mr. Mistry, learned counsel for assessee submitted that AO was wrong in determining value by invoking provisions of s. 23(1)(b) of Act. His case is that jurisdictional High Court in case of CIT vs. J.K. Investors (Bombay) Ltd. (2001) 168 CTR (Bom) 189: (2001) 248 ITR 723 (Bom) has clearly held that notional interest on deposit cannot be considered while determining annual letting value. He further submits that first appellate authority was confused and while holding that provisions of s. 23(1)(b) of Act cannot be invoked in this case, has wrongly upheld decision. He further took this Bench to order of AO and submitted that there is no basis for AO to come to conclusion that annual letting value of property is as determined by him. He pointed out that AO in this case has simply stated that local enquiries were conducted by him and value has been determined. He vehemently contended that nothing is stated as to what were local enquiries made, what was material gathered, and what was report of Times he is referring to, etc. and submitted that such finding cannot be upheld. simple observation of AO that on enquiry it has been gathered that prevailing market rate of similar house would have rental value in range of Rs. 50,000 per month on strength of Times Property Reality Views , is no basis for making estimate, specifically when none of material is put to assessee. He further submitted that first appellate authority was wrong in observing that Rent Control Act is not applicable to this property. He submitted that property is located in Delhi and that rent is being paid for more than 10 years and that it is wrong to invoke s. 23(1)(b). Even in case of s. 23(1)(a) he submitted that AO, has to determine standard rent and fair market value in any case cannot exceed standard rent. He drew attention of Bench to findings of first appellate authority that standard rent in this case is Rs. 22,230 which is based on MRV. Thus on facts and circumstances he submits that addition in question should be deleted. 13. learned Departmental Representative, on other hand, vehemently contends that there is interest-free security deposit of Rs. 3,70,60,000 in this case and interest has to be considered while arriving at fair market value of property. He specifically submitted that s. 23(1)(b) is not applicable to facts of case and only s. 23(1)(a) has to be considered. He placed reliance on judgment on order of I Bench of Tribunal in case of ITO vs. Makrupa Chemicals (P) Ltd. (2007) 110 TTJ (Mumbai) 489: (2007) 108 ITD 95 (Mumbai) and submitted that in this case judgments of Hon ble Supreme Court in cases of Shiela Kaushish vs. CIT (1981) 24 CTR (SC) 351: (1981) 131 ITR 435 (SC), Dewan Daulat Rai Kapoor vs. New Delhi Municipal Committee (1980) 122 ITR 700 (SC) and judgment in case of Dr. Balbir Singh vs. Municipal Corporation of Delhi (1985) 46 CTR (SC) 208: (1985) 152 ITR 388 (SC) have been considered and it was held that fair rental value should be decided by taking into account various factors and what rent property would fetch on bargain between willing lessor and lessee uninfluenced by any extraneous circumstances may afford guiding test of reasonableness. supported order of first appellate authority as well as AO and submitted that AO has relied on report in Times Property-Really News and on basis of statistics given therein has arrived at their fair market value. Thus he submits that order of first appellate authority on this issue has to be upheld. 14. Joining issue, Shri Mistry took this Bench to judgment of Hon ble Supreme Court in case of Dewan Daulat Rai Kapoor (supra) and read out operative part of judgment to drive home his point that standard rent is upper limit and that fair rent cannot exist standard rent. He also submitted that Revenue authorities as well as learned Departmental Representative were under wrong impression that property in question is situated in Maharashtra. He pointed out that property in question is situated in Delhi and Rent Control Act is very much applicable and thus judgment of Hon ble apex Court in case of Shiela Kaushish (supra), Dewan Daulat Rai Kapoor s case (supra) and Dr. Balbir Singh s case (supra) are applicable with all force to facts of case and that on applicability of s. 23(1)(b), judgment of Hon ble Calcutta High Court in case of CIT vs. Satya Co. Ltd. (1997) 140 CTR (Cal) 569: (1994) 75 TAXMAN 193 (Cal) are applicable to thefacts of case. 15. We have heard rival contentions. On careful consideration of facts of case we hold as follows: 15.1 AO cannot consider notional interest on deposit while arriving at fair market value under s. 23(1)(b) of Act. judgment of jurisdictional High Court in case of J.K. Investors (Bombay) Ltd. (supra) has been approved by Supreme Court. Thus this issue has to be decided in favour of assessee. 15.2 Coming to determination of annual letting value under s. 23(1)(a) learned Departmental representative relied heavily on judgment of this Bench of Tribunal in case of Makrupa Chemicals (P) Ltd. (supra). In this order, Tribunal has at para 15 drew following conclusions: "10. Rival submissions of parties have been considered carefully in light of material placed before us and case law referred to. In our opinion, neither AO nor learned CIT (A) adjudicated matter in right prospective. AO distinguished judgment of Hon ble Bombay High Court in case of J.K. Investors (Bombay) Ltd. (supra) by observing that Hon ble Court had not expressed any opinion as to whether notional interest could be considered as part of ALV under s. 23(1)(a) of Act. Having held so, he did not proceed to determine ALV under s. 23(1)(a). On contrary, he proceeded to determine ALV under s. 23(1)(b) by taking into consideration actual rent received and notional interest on interestfree deposit by observing at p. 2 of his order interest on deposit received by assessee also partakes character of rent tough not expressly called rent . Such approach is not supported by any case law. On contrary, Hon ble Calcutta High Court judgment in case of Satya & Co. (supra) clearly holds that notional interest cannot be added to amount received. This judgment has been usefully referred and impliedly approved by Hon ble Bombay High Court in case of J.K. Investors (Bombay) Ltd. (supra). Therefore, decision of AO in determining ALV after taking into consideration notional interest was contrary to binding judgment of High Court. He also failed to consider effect of various judgments of Hon ble Supreme Court to effect that all under s. 23(1)(a) cannot exceed standard rent where property is governed by Rent Control legislation applicable to such property. [Shiela Kaushish (supra) and Dewan Daulat Rai Kapoor vs. New Delhi Municipal Committee (1980) 122 ITR 700 (SC)]. On other hand, learned CIT(A) allowed appeal of assessee merely by following High Court decisions in case of J.K. Investors (Bombay) Ltd. (supra) and Satya & Co. (supra) which are relevant when ALV is to be determined under s. 23(1)(b) of Act. ALV under s. 23(1)(b) cannot be computed unless ALV under s. 23(1)(a) has been computed by tax authorities, as is clear from said provisions. If actual rent is more than ALV determined under s. 23(1)(a), then only actual rent has to be considered as ALV of that property. That means ALV under s. 23(1)(a) or actual rent received whichever is higher is to be considered for purpose of taxation under head Income from house property . Accordingly, learned CIT (A), having held that notional interest could not be taken into consideration, should have either proceeded himself to determine ALV under s. 23(1)(a) or should have directed AO to determine same. No such direction has been issued by learned CIT(A). 11. Let us now examine and analyse legal position as laid down by Hon ble High Courts as well as Tribunal. It would be appropriate at this stage to reproduce relevant provisions s. 23(1), as originally enacted, read as under: Section 23(1). For purposes of s. 22, annual value of any property shall be deemed to be sum for which property might reasonably be expected to let from year to year. aforesaid provisions were amended by Parliament effective from 1st April, 1976. relevant portion of amended provisions reads as under: Annual value how determined. (1) For purpose of s. 22, annual value of any property shall be deemed to be (a) sum for which property might reasonably be expected to let from year to year, or (b) where property is let and annual rent received or receivable by owner in respect thereof is in excess of sum referred to in cl. (a), amount so received or receivable. 12. expression gross annual rent at which such house or building... May reasonably be expected to let from year to year as contained in s. 127(a) of Calcutta Municipal Act, 1923 which is analogous to expression in s. 23 of Act was considered by Hon ble Supreme Court in case of Corporation of Calcutta vs. Smt. Padma Devi AIR 1962 SC 151. Their Lordships at p. 153 observed as under: bargain between willing lessor and willing lessee uninfluenced by any extraneous circumstances may afford guiding test of reasonableness. inflated or deflated rate of rent based upon fraud, emergency, relationship and such other considerations may take it out of bounds of reasonableness. On same page, it was further observed as under: combined reading of said provisions leaves no room for doubt that contract for rent at rate higher than standard rent is not only not enforceable but also that landlord would be committing offence if he collected rent above rate of standard rent. One may legitimately say under those circumstances that landlord cannot reasonably be expected to let building for rent higher than standard rent. law of land with its penal consequences cannot be ignored in ascertaining reasonable expectations of landlord in matter of rent. In this view, law of land must necessarily be taken as one of circumstances obtaining in open market placing upper limit on rate of rent for which building can reasonably be expected to let. From above observations, it is clear that Municipal Committee could not determine annual value over and above standard rent. Similar view was taken in subsequent judgment in case of Corporation of Calcutta vs. Life Insurance Corporation AIR 1970 SC 1417. However, this principle was further extended by Hon ble Supreme Court in case of Guntoor Municipal Council vs. Guntoor Town Rate Payers Association AIR 1971 SC 353, by holding that where standard rent is not fixed by rent controller, then, assessing authority under Municipal enactment should determine standard rent in accordance with rent control legislation. This is apparent from following observations of their Lordships at p. 355: It is perfectly clear that landlord cannot lawfully expect to get more rent than fair rent which is payable in accordance with principles laid down in Act. assessment of valuation must take into account measure of fair rent as determinable under Act. It may be that where controller has not fixed fair rent municipal authorities will have to arrive at their own figure of fair rent but that can be done without any difficulty by keeping in view principles laid down in s. 4 of Act for determination of fair rent. 13. above decisions were considered and followed by apex Court in case of Dewan Daulat Rai Kapoor vs. New Delhi Municipal Committee (1980) 122 ITR 700 (SC). discussion on this subject would not be complete without referring to judgment of apex Court in case of Dr. Balbir Singh vs. Municipal Corporation of Delhi (1985) 46 CTR (SC) 208: (1985) 152 ITR 388 (SC) wherein it was held that in given case ratable value determined by municipal authority may be less than standard rent having regard to various attendant circumstances and consideration. In such cases Court opined that it is ratable value so determined which shall be taken for tax purposes and not standard rent. It was held that standard rent was upper limit which can t be exceeded in any case. 14. All decisions mentioned above were rendered in connection with determination of ratable value under municipal laws. ratio laid down in above decisions has been applied by apex Court for determining annual letting value under s. 23 of Act in case of Shiela Kaushish vs. CIT (1981) 24 CTR (SC) 351: (1981) 131 ITR 435 (SC) on account of similarity in provisions under municipal enactments and s. 23 of IT Act, 1961. Thus ratable value, if correctly determined, under municipal laws can be taken as ALV under s. 23(1)(a) of Act. To that extent we agree with contention of learned counsel of assessee. However, we make it clear that ratable value is not binding on AO. If AO can show that ratable value under municipal laws does not represent correct fair rent, then he may determine same on "the basis of material/ evidence placed on record. This view is fortified by decision of Patna High Court in case of Kashi Prasad Kataruka vs. CIT 1976 CTR (Pat) 95: (1975) 101 ITR 810 (Pat). 15. above discussion leads to conclusions that (i) ALV would be sum at which property may be reasonably let out by willing lessor to willing lessee uninfluenced by any extraneous circumstances (ii) inflated, or deflated rent based on extraneous consideration may take it out of bounds of reasonableness (iii) actual rent received, in normal circumstances, would be reliable evidence unless rent is inflated/deflated by reason of extraneous consideration (iv) such ALV, however, can t exceed standard rent as per rent control legislation applicable to property (v) if standard rent has not been fixed by rent controller, then it is duty of AO to determine standard rent as per provisions of rent control enactment (vi) standard rent is upper limit, if fair rent is less than standard rent, then it is fair rent which shall be taken as ALV and not he standard rent. (Emphasis supplied) 16. Still question remain to be decided is how to determine reasonable/ fair rent. apex Court has indicated in above judgments that extraneous circumstances may inflate/deflate fair rent. So question arises as to what may circumstances which may be taken in to consideration while determining fair rent. In our opinion, no particular test can be laid down since it would depend on facts of each case. (emphasis supplied). However, we find that Hon ble Supreme Court had to consider this question in case of Motichand Hirachand vs. Bombay Municipal Corporation AIR 1968 SC 441 wherein it was observed as under: It is well recognized principle in rating that both gross value and net annual value are estimated by reference to rent at which property might reasonably be expected to let from year to year. Various methods of valuation are applied in order to arrive at such hypothetical rent, for instance, by reference to actual rent paid for property or for others comparable to it or where there are no rents by reference to assessments of comparable properties or to profits carried from property or to cost of construction. Even Hon ble Bombay High Court in case of J.K. Investor (supra) has held that under s. 23 (1) of Act, AO can take in to consideration various factors like contractor s method as is apparent from following observations: At cost of repetition, it may be mentioned that under s. 23(1)(a), AO has to decide fair rent of property. While deciding fair rent, various factors could be taken into account. In such cases, various method like contractors method could be taken into account. 17. circumstances mentioned above are only illustrative and not exhaustive. Therefore, in our opinion, AO can take into consideration any circumstance which may inflate/deflate fair rent under s. 23(1)(a) of Act. If such rent is less than standard rent, then same shall be taken as fair rent otherwise standard rent shall be considered as fair and under s. 23(1)(a) of Act. Once fair rent is so determined, then applicability of s. 23(1)(b) would have to be considered. If actual rent received/receivable is higher than fair rent, then actual rent would be treated as ALV, otherwise fair rent so determined shall be taken as ALV." (Emphasis ours) 16. reading of above shows that standard rent is upper limit. property is situated in Delhi and is undisputably covered under Rent Control Act. Hence standard rent had to be arrived at fair market value should be based on facts and circumstances of case. 17. Coming to facts of case AO has relied on some undisclosed material and enquiries to arrive at rental value of Rs. 1,50,000. It is not known what are facts that are culled out from Time Property-Realty News. No material has been gathered by AO and brought on record for supporting his conclusion let alone putting same to assessee. Even if AO had certain material same has not been put to assessee and this is violation of principles of natural justice has held by Bench in case of Makrupa Chemicals (P) Ltd. (supra) at para 19. On that ground, issue had been remanded back to AO, in that case. In case before us we do not feel necessity to do so. CIT(A) at para 3 on p. 2 of his order, has recorded that Municipal Rateable Value as per Delhi Municipal Authority at Rs. 22,230. This is less than actual rent received at Rs. 60,000. AO has not made any attempt whatsoever to decide standard rent and under these circumstances, municipal rateable value assumes significance. As actual rent received is more than municipal rateable value and in view of decision of Hon ble Supreme Court in case of Shiela Kaushish (supra), we hold that actual rent received should be taken as municipal rateable value. We also find that facts and circumstances of this case, warrants taking into consideration huge deposit while determining fair market value. Wherever deposits are high, rent is bound to be low. In any event as Rent Control Act applies to this property only standard rent can be taken as annual letting value. In absence of standard rent, municipal rateable value is to be taken. As municipal rateable value is less than actual rent, actual rent shall be fair market value. In result, we uphold contentions of Shri Mistry and allow both appeals filed by assessee. 18. In result, appeals filed by assessee are allowed and appeals filed by Revenue are dismissed. *** COMMISSIONER OF INCOME TAX v. DELITE ENTERPRISES