The annual value of a house property is chargeable to income tax u/s. 22 of the Income-tax Act, 1961, under the head “Income from House Property”. Section 23 provides for a deeming fiction where under “the annual value of any property shall be deemed to be:
(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 proviso to section 23 allows a deduction from the annual value, of the municipal taxes actually paid during the year. Two other deductions are also permitted by section 24 – standard deduction @ 30% of the annual value, and a deduction for the interest payable on borrowed capital, where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital.
In a case where a property has been let out, the actual rent receivable during the year would be the annual value of the property in accordance with section 23, which value will be further reduced by the deductions specified in section 24 of the Act. In many cases where a property is let out, a broker is appointed to identify a tenant, and brokerage is paid to the broker for finding the tenant. The question has arisen before the Tribunal as to whether such brokerage paid to a broker for letting of the property on rent is an allowable deduction from the actual rent receivable in computing the annual value of the property or not?
While a bench of the Mumbai Tribunal has taken the view that such brokerage is an allowable deduction, another bench of the Mumbai Tribunal has taken a contrary view that brokerage is not an allowable deduction in computing the income from house property .
Govind S. Singhania’s case
The issue came up before the Mumbai bench of the Tribunal in the case of Govind S. Singhania vs. ITO in ITA No. 4581/Mum/2005 dated 3 April 2008 (reported in July 2008 40-A BCA Journal 449).
In that case, relating to assessment year 2002-03, the assessee gave his office premises at Mittal Towers on lease to a company, and incurred expenses of Rs.30,000 for stamp duty and Rs.85,000 for brokerage on account of renewal of lease agreement. The assessing officer held that these expenses were not allowable in computing the income under the head Income from house property, because they did not fall within the category of allowable expenses that were specified by the legislature. The Commissioner (Appeals) confirmed the order of the assessing officer.
Before the Income Tax Appellate Tribunal, it was contended by the assessee that it could not have earned the rental income without incurring these expenses. The stamp duty had to be paid as per the provisions of the Stamp Act on the lease agreement, as a mandatory requirement and since the assessee had let out the premises to the company through a broker, the payment of brokerage was also an obligation on the part of the assessee, which he had to incurr in order to earn the rent. It was further argued that the assessee could have asked the tenant to pay the stamp duty and brokerage, and could have adjusted such expenditures by reducing the amount of rent, in which case the assessee would have got a lower rent equivalent to the net rent. Therefore, such expenses were overriding in nature in relation to the rent receivable and were claimed to be allowable in computing the annual value. It was further argued that it was not the actual gross rent, which was to be treated as annual letting value, but the rent (net of these expenses), which was to be treated as actual rent received by the assessee and as annual letting value.
Reliance was also placed on various decisions of the Mumbai bench of the Tribunal in the context of deductibility of the society maintenance and non-occupancy charges paid to the Society, where it had been held by the tribunal that it was the rent net of such charges, which was to be taken as the annual letting value.
The Tribunal observed that it was not in dispute that without incurring those expenses, the assessee would not have earned the rental income. Further, in computing the annual value u/s. 23(1)(b), rental income received or receivable by the owner had to be taken into consideration and such rent had to be taken net of the expenses on stamp duty and brokerage, and that the said expenses had to be deducted from the very beginning, since whatever came into the hands of the assessee was only the net amount.
The Tribunal also found substantial force in the argument of the assessee that had these expenses been borne by the tenant, and only the net rent paid by the tenant, then the amount of such net rent only would have been taken to be the annual letting value u/s. 23(1)(b). Accordingly, the tribunal held that the annual letting value should be taken net of stamp duty and brokerage paid by the assessee.
Radiant Premises’ case
The issue again recently came up before the Mumbai bench of the Tribunal in the case of Radiant Premises (P) Ltd. vs. ACIT 61 taxmann.com 204.
In this case, relating to the assessment year 2010-11, the assessee had earned a gross rental income of Rs. 1.29 crore in respect of its office premises. It had paid a brokerage of Rs.1.12 crore for sourcing and securing a suitable licensee for the office premises, being 2 months of the rent and 2% of the security deposit. After reducing 30% of the annual value amounting to Rs.0.05 crore, the assessee offered the net rental income of Rs.0.12 crore to tax under the head “Income from House Property”.
The assessing officer did not allow the deduction of Rs. 1.12 crore paid towards the brokerage, holding that the computation had to be done only in accordance with the provisions of section 23, and only standard reduction was allowable u/s. 24. According to the assessing officer, there was no express provision regarding allowance of any expenditure such as brokerage, commission, etc. for determination of the annual value of the property, except the taxes levied by the local authority on payment basis in respect of the property. Relying upon the decisions of the tribunal in the cases of Tube Rose Estates (P) Ltd. vs. ACT 123 ITD 498 (Del) and ACIT vs. Piccadilly Hotels (P) Ltd .97 ITD 564, the assessing officer disallowed the claim of brokerage paid by the assessee.
The Commissioner (Appeals) confirmed the disallowance of brokerage on the ground that such deduction of brokerage was nowhere specified either in section 23 or in section 24.
Before the Income Tax Appellate Tribunal, it was argued that the payment of brokerage was directly related to the earning of rental income, and had therefore to be deducted from the gross rent, since section 23(1)(b) contemplated the actual rent received/receivable. It was argued that in various decisions, the Tribunal had held that stamp duty charges on license agreement, maintenance charges paid to the Housing Society, etc. were allowable u/s. 23 itself, and on the same analogy, brokerage also had to be allowed.
On behalf of the Department, it was argued that no expenditure could be allowed other than those deductions or expenses as specified in sections 23 and 24. It was further argued that most of the decisions cited by the assessee were in respect of maintenance charges paid to the society, which stood on a different footing, because such charges were for the maintenance of the property itself so that rights in the property could be enjoyed.
The Tribunal negatived the plea of the assessee that the phrase “actual rent received or receivable” meant the rent, net of deductions, actually received in the hands of the assessee. According to the tribunal, what was contemplated u/s. 23 was that the annual value of the property, which was let out should be the amount of rent received or receivable by the owner from the tenant/licensee. The first and foremost condition was that the amount should be in the nature of rent as previously agreed upon between the 2 parties for the enjoyment of rights in the property let out against payment of rent. The deductions envisaged in sections 23 and 24 were only in respect of municipal taxes, 30% of the actual value and interest payable on capital borrowed for acquisition, construction, repair, etc.
According to the Tribunal, the word “rent” connoted a return given by the tenant or occupant of the land or structure to the owner for the possession and use thereof. The rent was a sum agreed between the tenant and the owner to be paid at fixed intervals for the usage of such property. The phrase “rent received” and “rent receivable” contemplated the amount received for the enjoyment of the property and certain rights in the property by the tenant. According to the Tribunal, if there was a charge directly related to the rental income or for the property without which the rights in the property could not be enjoyed by the tenant, then it could be construed as part and parcel of enjoyment of the property from where it was received, and then such charges could be held to be allowable from the rent received or receivable. However, in the Tribunal’s view, the brokerage paid to the third party had nothing to do with the rental income paid by the tenant to the owner for enjoying the property. It could therefore not be said to be a charge that had been created in the property for enjoying the rights, and at best, it was only an application of income received/receivable from the rent.
The Tribunal referred to the decision of the Delhi Tribunal in the case of Tube Rose Estates (supra), for the proposition that where services had been provided by a third party to whom the brokerage was payable, the value of such services was not included in the rent. In that case the Tribunal had also distinguished a situation where part of the rent might have become payable to a third party before it accrued to the assessee in terms of an overriding charge, in which case there was diversion of rent at source, and to that extent, could be claimed as deduction while computing the income from house property. In case of payment of brokerage, the Tribunal had held that there was no charge created on the property, much less an involuntary charge enforceable by law, which could be claimed as a deduction.
The Mumbai Tribunal expressed a view that if expenses such as brokerage, professional fees, etc. were held to be allowable, then numerous other expenses like salary or commission to an employee/agent who collected the rent may also be held to be allowable, which was not the mandate of the law. It noted that the decisions cited before it mainly pertained to maintenance charges paid to a society, which was held to be an allowable deduction u/s. 23 itself. It distinguished between maintenance charges and brokerage paid, on the basis that maintenance charges were paid for the very maintenance of the property so as to enjoy the property itself, whereas brokerage had nothing to do with the property or the rent, and was given to a third party, who had facilitated the agreement between the landlord and the tenant to rent the property. It also distinguished the case where stamp duty had been held to be allowable, on the ground that stamp duty was directly related and was in connection with the lease agreement for renting of the property.
The Mumbai bench of the Tribunal therefore held that payment of brokerage could not be allowed as deduction either u/s. 23 or u/s. 24, and confirmed the disallowance of the brokerage paid while computing the income from house property.
A similar view had also been taken by the Mumbai bench of the Tribunal in the case of Township Real Estate Developers (India) (P) Ltd. vs. ACIT 51 SOT 411.
Observations
The issue, as far as section 23 is concerned, revolves around the true meaning of the term ‘actual rent received or receivable’. This term is interpreted in a manner that leaves a room for deducting such expenditure from rent where the expenditure is found to be directly related or in connection with the agreement for letting or receipt of rent. This part even Mumbai Tribunal records with approval in the Radiant Premises’ case. Brokerage is an expenditure that is incurred for earning rent. It is also an expenditure connected to the agreement of lease. It is also not in dispute that a broker, on payment of the brokerage, fetches you the best possible rent. There are no two views about it. In fact, brokerage is more directly related to the earning of better rent than the stamp duty and maintenance charges.
Once it is admitted that the said term used in section 23 is capable of inclusion, it is fair to not limit its scope in an arbitrary manner by selecting a few expenditures in preference to the other few. The interpretation that encourages the deduction is preferable, more so when the facts suggest that the brokerage paid has the effect of fetching a better rent and perhaps a better lessee. If society charges are found to be diverted under an overriding title, there does not appear to be logic in leaving the brokerage behind.
In Radiant Premises’ case (supra), the Tribunal took the view that the brokerage was not a diversion of the rent by overriding title, whereas the society charges was a case of diversion of rent by overriding title. While doing so, the Tribunal failed to appreciate that the brokerage preceded the earning of the rent, and that had it not been for the payment of the brokerage, there may have been no earning of rent. Further, society charges are payable as a consequence of letting out on rent, and arise subsequent and consequent to the accrual of rent. Therefore, if society charges are a diversion of income by overriding title, brokerage is all the more so. Both are inextricably linked with the rental income, and paid to third parties, other than the landlord and the tenant.
It is improper to deny deduction of an expenditure on brokerage simply on the ground that the payment was made to a third party. Payment of stamp duty or maintenance charges are always made to the third party and not to a lessee. In any case, the lessor in rare cases makes a payment to the lessee and therefore the condition that the expenditure should qualify for deduction on the basis of the status of the payee is not tenable. In Tube Rose’s case (supra), the Tribunal held that brokerage was not deductible, as it was paid to a third party. That logic does not appear to be correct, since society charges, which are also paid to a third party, have been held to be deductible.
A separate deduction was provided for collection charges vide section 24(1)(vii), till assessment year 1992-93,. Thereafter the scope of deduction u/s. 24(1)(i) for repairs was enhanced to include collection charges, and the quantum of deduction thereunder was raised to 1/5th of the annual value. Subsequently, with effect from assessment year 2002-03, various other deductions allowable till then, u/s. 24, such as insurance premium, annual charge, land revenue tax, etc. along with the deduction for repairs and collection charges, were replaced by a standard deduction u/s. 24(1)(a) at 30% of the annual value.
It does not appear to be appropriate to hold that substitution of new section 24 for its older version eliminated any possibility altogether for claim of any deduction even u/s. 23 of the Act. One cannot conclude that the standard deduction of 30% is meant to cover even collection charges as well, as was done by the Tribunal in Township Real Estate Developers’ case.
The Tribunal, in the case of Banwari Lal Anand vs. ITO 62 ITD 301 (Del), for assessment year 1989-90, in the context of section 24, held that “any sum spent to collect rent”, referred to in section 24(1)(vii), should be interpreted to mean “any amount spent with an aim to collect rent” and in that view of the matter, brokerage was held allowable as an amount spent to collect rent, being an amount spent with an aim to collect rent. Does this mean that after the amendment, brokerage would now not be allowable?
It is true that in computing the income under each head, only such expenses are allowed that are specifically allowed under the specified chapters that deal with the respective head of income. Admitting this position does not rule out the fundamental understanding that only such an income can be subjected to tax which is the real income. Taxing the gross rent without deduction of the brokerage paid is a case of taxing an unreal income.
Lastly, the logic that, had the parties provided for lower rent, with brokerage payable by the tenant, the annual value would have been such lower rent, is an extremely compelling argument to support deduction of brokerage and the logic is approved in Govind Singhania’s case (supra). Can a mere change of form, without change in substance, change the annual value?
No doubt two views may be possible on the subject, the better view appears to be that, just as society charges and stamp duty are held to be allowable deductions in computing the annual value u/s. 23 itself, brokerage paid for obtaining a tenant too shall also be allowable as a deduction in computing the annual value u/s. 23. It is suggested that the law should be amended to put the issue beyond doubt by providing for a specific deduction, as doing so would make the taxation more realistic.
