Notional interest on disproportionate security deposits can be taxed as house property income when they mask real rent.

Notional interest on an interest-free security deposit under a leave and licence arrangement may be included in the annual letting value where the deposit is disproportionately high and appears to mask the real rent. The transaction must be read as a whole, and a licence does not create an interest in the property under the Indian Easement Act, 1882. On the facts, the deposit was treated as part of the rent structure for computing income from house property, although the rate of notional interest was reduced to reflect prevailing deposit rates. The addition was therefore sustained.

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Issues: Whether notional interest on an interest-free security deposit received under a leave and licence arrangement could be included while computing the annual letting value and taxed as income from house property.

Analysis: The assessee was a tenant who granted leave and licence rights in respect of the premises and received a substantial interest-free security deposit along with licence fee. A licence under the Indian Easement Act, 1882 does not create any interest in the property, and the transaction had to be read as a whole rather than by isolating the fee component from the security deposit. The deposit was found to be hugely disproportionate to the stated licence fee and, on the facts, was treated as a device to reduce the real rent. In such circumstances, notional interest on the security deposit was held to be relevant for determining the taxable value of the arrangement, though the rate adopted by the Assessing Officer required adjustment in light of the prevailing deposit rates.

Conclusion: Notional interest on the security deposit was includible in the taxable income under the head income from house property, and the addition was sustained with the rate reduced from 10% to 9%.

Ratio Decidendi: Where an interest-free security deposit under a lease or licence arrangement is disproportionately high and operates to mask the real rent, notional interest on that deposit may be brought to tax while computing income from house property.

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