Notional Interest Cannot Be Added to Fair Rent u/s 23: Bombay HC Upholds AO’s ₹22 Lakh Market Valuation Using Comparable Instances [Read Order]

Reaffirming settled law under Section 23(1)(a) of the Income Tax Act, in a recent case, the Bombay High Court has held that notional interest on security deposits cannot be considered in determining a property’s annual value for taxation.

The assessee, Tivoli Investment & Trading Co. Pvt. Ltd., owned office premises measuring 3,275 sq. ft. on the 7th floor of “Sakhar Bhavan” at Nariman Point, Mumbai, a prime commercial location.

In November 1988, it entered into a leave and licence agreement with Citibank for a period of ten years (1989–1999). The agreed monthly licence fee was merely ₹9,825, while Citibank simultaneously advanced a hefty interest-free security deposit of ₹1.54 crore. For Assessment Years (AYs) 1990–91 and 1991–92, the assessee disclosed annual rental income of ₹1,17,900, derived solely from the licence fee.

The Assessing Officer (AO), however, found the declared income disproportionately low considering the property’s prime location and the enormous deposit involved. After inquiry, he determined the annual letting value (ALV) at ₹22 lakh under Section 23(1)(a) of the Income Tax Act, treating it as the “sum for which the property might reasonably be expected to let from year to year.”

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The Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) upheld this assessment. The assessee appealed before the Bombay High Court.

It was argued that the AO erred by disregarding the municipal rateable value and adopting a higher figure. The assessee maintained that the rateable value determined by municipal authorities should serve as the maximum benchmark for ALV.

It was further contended that the interest-free deposit was a refundable security and not a rent component, and that the AO could not attribute any notional interest or hypothetical income to it. Reliance was placed on the decision in CIT v. Tip Top Typography (2014) 368 ITR 330 (Bom), where the Court had held that notional interest on security deposits cannot be added to rent while determining fair value.

The Revenue countered that the assessee had structured the transaction to suppress rental income by stipulating a nominal licence fee and inflating the deposit amount. The municipal rateable value of ₹10,200 (fixed in 1986) was outdated and unrealistic.

The AO, therefore, rightly conducted an independent inquiry and relied on comparable rental instances in the same building, where Citibank had leased the ground and first floors at ₹43 per sq. ft. per month, to estimate fair rent at ₹50 per sq. ft. for the seventh-floor premises.

The AO’s approach, the Revenue argued, was consistent with established judicial precedent and reflected a rational determination of fair value.

The Court reaffirmed that notional interest on security deposits cannot be added to determine annual value.

The Court reiterated that hypothetical or presumed income arising from a security deposit cannot be treated as rent under Section 23(1)(a) or 23(1)(b). This principle had been settled in Tip Top Typography, J.K. Investors (Bombay) Ltd., and the Full Bench decision of the Delhi High Court in Moni Kumar Subba (333 ITR 38).

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It was further observed that the comparable market rent is a valid basis for fair value determination.

While the AO had considered the deposit, the valuation was primarily grounded on market comparables—actual rent received for similar Citibank-occupied premises in the same building. The Court noted that such an approach was legitimate and not perverse, as it reflected the real market conditions.

Also, the municipal rateable value is not binding on the AO. The Court held that the municipal valuation may be used as a guide only when it corresponds closely to the relevant assessment year and reflects prevailing rent levels.

Where the civic valuation is outdated or grossly understated, the AO is free to determine annual value independently on the basis of reliable market evidence.

And since the property was licensed for commercial use and not governed by rent control legislation, the concept of standard rent was irrelevant.

The Court found no illegality or perversity in the AO’s assessment of ₹22 lakh as the property’s annual letting value.

It was observed that the assessee’s arrangement, with an unusually high security deposit and negligible rent, was a clear attempt to understate taxable income. The AO’s method, based on comparable market rent rather than notional interest or municipal figures, was consistent with statutory provisions and judicial precedent.

Accordingly, the Division Bench Justice Alok Aradhe and Justice Sandeep V. Marne dismissed both appeals and the question of law was answered in favour of the Revenue.

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