2008 (2) TMI 654 - AT - Income Tax

Claim deduction of Interest paid on borrowed capital u/s 36(1)(iii) - Computation of Income from house property - Determination of annual letting value u/s 23(1)(a). Deduction for interest paid on borrowed funds under section 36(1)(iii) - HELD THAT - There is no exemption claimed under section 10(2A) of the Act by the assessee. Section 10(14) clearly states that expenditure incurred by the assessee in relation to income which does not form part of total income under the Act will not be allowed. In this case for both the assessment years there is no income earned by the assessee which does not form part of the total income under the Act. Thus we do not see any reason why the claim of the assessee is not allowable under section 36(1)(iii). Coming to the argument of the ld DR that the judgment of the Hon ble Apex Court in the case of Rajendra Prasad Moody 1978 (10) TMI 133 - SUPREME COURT is not applicable to this case we find that in the case of M. Ethurajan 2004 (7) TMI 39 - MADRAS HIGH COURT has held that the propositions laid down in Rajendra Prasad Moody s case (supra) for allowability under section 57(iii) are equally applicable for deductions claimed under section 36(1)( iii ) or section 37. Thus this argument of the Revenue is without any merit. Therefore we are of the considered opinion that the first appellate authority for the assessment year 2001-02 has rightly come to a conclusion that the claim of the assessee for the deduction under section 36(1)( iii ) has to be allowed. Taxability of income - under head Income from business or profession and not under the head Income from other sources - We uphold the order of the first appellate authority on these issues for both the assessment years and dismiss the appeals of the Revenue. Determination of annual letting value under section 23(1)(a) - actual rent received - HELD THAT - No material has been gathered by the AO and brought on record for supporting his conclusion let alone putting the same to the assessee. Even if the AO had certain material the same has not been put to the assessee and this is violation of principles of natural justice has held by the Bench in the case of Makrupa Chemicals (P.) Ltd. 2006 (9) TMI 207 - ITAT BOMBAY-F . On that ground the issue had been remanded back to the Assessing Officer in that case. In the case before us we do not feel the necessity to do so. The CIT(A) in his order has recorded that the Municipal Rateable Value as per the Delhi Municipal Authority at Rs. 22, 230. This is less than the actual rent received at Rs. 60, 000. The Assessing Officer has not made any attempt whatsoever to decide the standard rent and under these circumstances the municipal rateable value assumes significance. As the actual rent received is more than the municipal rateable value and in view of the decision of the Hon ble Supreme Court in the case of Sheila Kaushish 1981 (8) TMI 1 - SUPREME COURT . we hold that the actual rent received should be taken as municipal rateable value. We also find that the facts and circumstances of this case warrants taking into consideration the huge deposit while determining the fair market value. Wherever deposits are high the rent is bound to be low In any event as Rent Control Act applies to this property only standard rent can be taken as the annual letting value. In the absence of standard rent municipal rateable value is to be taken. As municipal rateable value is less than the actual rent the actual rent shall be the fair market value. In the result we uphold the contentions of Shri Mistry and allow both the appeals filed by the assessee. In the result the appeals filed by the assessee are allowed and the appeals filed by the Revenue are dismissed.

Summary

Issues Involved:
1. Deduction for interest paid on borrowed funds under section 36(1)(iii).
2. Determination of annual letting value of let-out property.

Issue-wise Detailed Analysis:

1. Deduction for Interest Paid on Borrowed Funds under Section 36(1)(iii):

*Facts and Background:*
The assessee, along with M/s. Radian Tex Fab P Ltd., formed a partnership firm named "M/s. Shreenath Enterprises" with the objective of dealing in commodities, shares, and securities, and providing finance. The assessee borrowed funds from M/s. Reliance Capital Ltd. and invested them in the partnership firm, claiming the interest payable as a deduction under section 36(1)(iii). The Assessing Officer disallowed the deduction under section 14A, arguing that the income from the partnership firm was exempt under section 10(2A) and thus the related expenditure should be disallowed. The first appellate authority, however, allowed the deduction, stating that the interest income was taxable under section 28(v) and referenced the Supreme Court judgment in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519.

*Arguments and Contentions:*
The Revenue argued that the investment in the partnership firm was exempt under section 10(2A) and thus any related expenditure should be disallowed under section 14A. They also contended that the judgment in Rajendra Prasad Moody was not applicable as it pertained to section 57(iii) and not section 36(1)(iii). For the assessment year 2002-03, the Revenue suggested restricting the allowable interest to the amount of interest received by the assessee.

The assessee argued that the actual receipt of income was immaterial for the purpose of claiming the deduction and relied on the judgment in Rajendra Prasad Moody, which was applicable to deductions under sections 36(1)(iii) and 37(1) as well. The assessee also cited the judgment of the Madras High Court in CIT v. M. Ethurajan [2005] 142 Taxman 708 to support their claim.

*Tribunal's Findings:*
The Tribunal upheld the first appellate authority's order, stating that the interest earned by the assessee was taxable under section 28(v) and not exempt under section 10(2A). The Tribunal referenced the judgment in Rajendra Prasad Moody and the Madras High Court's ruling in M. Ethurajan, confirming that the principles for allowability under section 57(iii) were applicable to sections 36(1)(iii) and 37. The Tribunal concluded that the assessee's claim for deduction under section 36(1)(iii) was valid as the income was taxable under section 28(v).

2. Determination of Annual Letting Value of Let-Out Property:

*Facts and Background:*
The assessee owned a property in Vasant Vihar, New Delhi, let out to M/s. Reliance Industries Ltd. for an annual rent of Rs. 60,000 with a security deposit of Rs. 3,70,60,000. The assessee computed the annual letting value (ALV) based on the rent received and the municipal rateable value (MRV) of Rs. 22,230. The Assessing Officer, however, determined the ALV at Rs. 14,40,000, considering the municipal rent of Rs. 1,20,000. The first appellate authority upheld this determination.

*Arguments and Contentions:*
The assessee argued that the Assessing Officer erred in invoking section 23(1)(b) and that the jurisdictional High Court in CIT v. J.K. Investors (Bombay) Ltd. [2001] 248 ITR 723 (Bom.) had held that notional interest on deposits could not be considered in determining ALV. The assessee also contended that the first appellate authority wrongly upheld the Assessing Officer's decision without a proper basis for the ALV determination.

The Revenue argued that the interest-free security deposit should be considered in determining the fair market value and supported the Assessing Officer's reliance on local inquiries and reports.

*Tribunal's Findings:*
The Tribunal held that notional interest on deposits could not be considered in determining ALV under section 23(1)(b), referencing the judgment in J.K. Investors (Bombay) Ltd. The Tribunal emphasized that the standard rent was the upper limit for ALV determination and that the municipal rateable value should be considered if no standard rent was fixed. Since the actual rent received was higher than the MRV, the Tribunal concluded that the actual rent should be taken as the ALV. The Tribunal found that the Assessing Officer's reliance on undisclosed materials and local inquiries without proper evidence violated principles of natural justice. Consequently, the Tribunal allowed the assessee's appeals and dismissed the Revenue's appeals.

Conclusion:
The Tribunal upheld the assessee's claim for deduction under section 36(1)(iii) and determined the annual letting value based on the actual rent received, dismissing the Revenue's appeals and allowing the assessee's appeals.