2017 (9) TMI 514 - AT - Income Tax

Addition towards interest paid on borrowed capital - assessee s main activity is renting out properties - Held that - On verification of financial statements filed by the assessee for the relevant assessment year, the assessee s assets represent investment in purchase of property which was substantially financed by loan borrowed from UCO Bank and M/s TCG Urban Infrastructure Holdings Ltd. The assessee s main source of income is from lease rentals from the said properties. Except letting out of properties, the assessee has not carried out any other business activity. Therefore, the AO was erred in holding that loan borrowed from M/s TCG Urban Infrastructure Holdings Ltd is for the working capital requirements ignoring all evidences which proves that the said loan was borrowed for acquisition of property. Therefore, we are of the considered view that the assessee has proved nexus between purchase of property and borrowed capital and hence rightly eligible for deduction towards interest paid on loan u/s 24(b) of the Income-tax Act, 1961. The CIT(A), after considering relevant provisions has rightly deleted additions made by the AO. We do not find any error in the order of CIT(A). Hence, we uphold the order of CIT(A) on this issue and reject ground raised by the revenue. Determination of Annual Letting Value - AO has determined annual letting value of the property by estimating notional interest on interest free security deposit - Held that - In this case, on perusal of the facts available on record, we find that the assessee s actual rent received is more than the standard rent or municipal value of the property. We further observe that in the case of CIT vs J.K. Investors (Bom) Ltd (2000 (6) TMI 9 - BOMBAY High Court) has observed that if the actual rent received by the assessee is more than the fair rent, then the notional interest cannot form part of the actual rent as contemplated in section 23(1)(b) of the Act. In this case, the actual rent received by the assessee is more than the fair rent of the property. The assessee has let out its property for a monthly rent of Ras.50 per sq.ft. Therefore, we are of the considered view that the AO was erred in estimating notional interest on security deposit by following the decision in the case of Fizz Drinks vs DCIT 2003 (5) TMI 213 - ITAT DELHI-D which was totally rendered under different set of facts. Hence, considering the facts and circumstances of the case and also following the decision of Hon ble Bombay High Court in the case of CIT vs J.K. Investors (Bom) Ltd (supra), we are of the view that notional interest on security deposit cannot be included in the actual rent received or receivable from the property, if the actual rent received is more than the fair rent of the property. Addition towards rent accrued but not due - provision made towards rent accrued but not due by following AS-19 issued by ICAI - Held that - We find force in the arguments of the assessee for the reason that the ALV of the property is rent received or receivable in respect of property let out, but does not include rent accrued but not due. In this case, rent accrued but not due is not accrued to the assessee for the relevant financial year. The assessee has made a provision for proportionate rent of part of the month by following the accounting standard which is due in the next financial year. Therefore, we are of the view that the AO was erred in including rent accrued but not due for the purpose of determination of ALV of the property. The CIT(A), after considering the relevant submissions has rightly deleted additions made by the AO. We do not find any error in the order of CIT(A). Hence, we are inclined to uphold the order of CIT(A) and reject the ground raised by the revenue. Appeal filed by the revenue is dismissed.

Summary

Issues:
1. Disallowance of interest paid on borrowed capital.
2. Estimation of notional rent on interest-free security deposit.
3. Addition towards rent accrued but not due.

Analysis:

Issue 1: Disallowance of interest paid on borrowed capital:
The appellant, an assessee company engaged in property renting, filed its return for the assessment year 2010-11, declaring a total loss. The AO disallowed interest paid on a loan borrowed for property purchase, claiming it was for working capital. The CIT(A) deleted the disallowance, citing evidence of loan purpose and relevant legal precedents. The ITAT upheld the CIT(A)'s decision, emphasizing the nexus between property purchase and borrowed capital, allowing the deduction under section 24(b) of the Income-tax Act, 1961.

Issue 2: Estimation of notional rent on interest-free security deposit:
The AO estimated notional interest on a security deposit, forming part of the Annual Letting Value (ALV) of the property. The ITAT found that the actual rent received by the assessee exceeded the standard rent or municipal value, as per section 23(1)(b). Relying on the decision of the Hon'ble Bombay High Court, the ITAT held that notional interest on the security deposit should not be included if actual rent surpasses the fair rent. Consequently, the CIT(A)'s deletion of the AO's addition was upheld.

Issue 3: Addition towards rent accrued but not due:
The AO added rent accrued but not due, based on the mercantile system of accounting. The ITAT noted that rent accrued but not due should not be included in the ALV calculation, as it is not yet due to the assessee for the relevant financial year. Following the accounting standard, the CIT(A) correctly deleted the addition. The ITAT upheld the CIT(A)'s decision, rejecting the revenue's appeal.

In conclusion, the ITAT dismissed the revenue's appeal, affirming the CIT(A)'s order on all issues. The judgment highlights the importance of substantiating loan purpose, calculating ALV accurately, and adhering to accounting standards in determining rental income for property transactions.