Govinda Bhat, C.J.
1. The Income-tax Appellate Tribunal, Bangalore Bench, has stated a case and referred under section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as 'the Act'), the following questions for the opinion of this court :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law for the purposes of computation of capital gains for the assessment year 1963-64, in estimating the fair market value as on January 1, 1954, of the property of the assessee sold in the relevant year by capitalising the net annual rental value thereof at 10 years purchase
(ii) Whether there was any material before the Tribunal for determining 10 as the number with which to multiply the net annual rental of the property of the assessee to arrive at its fair market value as on January 1, 1954 ?'
2. The assessee is an individual. For the assessment year 1963-64 he filed a return on December 9, 1963. He died on January 7, 1965, and on March 18, 1968, his legal representative filed a revised return wherein he claimed a capital loss of Rs. 89,968.
3. During the accounting year, the assessee had sold 26 shops in what is called 'Raja Market' in Bangalore City. For a consideration of Rs. 2,90,501. In the revised return the assessee estimated the fair market value of the shops as on January 1, 1954, at Rs. 3,80,469 and claimed a loss of Rs. 89,968.
4. The Income-tax Officer went into the history of the case leading to the construction of Raja Market. The assessee had constructed 121 shops which were completed during the previous three years ending March 31, 1954. On the basis of the assessee's estimate made in his income-tax assessment proceedings for the years relating to the construction of the buildings, the Income-tax Officer declined to accept the value of the aforesaid 26 shops at Rs. 3,80,469. The Income-tax Officer valued the site at Rs. 94,797 and the cost of construction at Rs. 64,210 He estimated the fair value of the 26 shops at Rs. 1,59,007 as on January 1, 1954. The consideration received for the sale of shops being Rs. 2,90,501 the Income-tax Officer determined the capital gains at Rs. 1,31,494 which was added to the income of the assessee.
5. The assessee being aggrieved by the assessment order made by the Income-tax Officer, took up the matter in appeal before the Appellate Assistant Commissioner who was of the opinion that the proper method of valuation in a case like the present one where the premises were let out to tenants, would be the rental method of valuation. He came to the conclusion that it will be reasonable to capitalise the net rent at 9.5 times and on that basis worked out the market value of the properties as on January 1, 1954, at Rs. 1,85,250 and the capital gains at Rs. 1,05,251.
6. The assessee preferred a second appeal before the Income-tax Appellate Tribunal, Bangalore Bench. The Tribunal agreed with the Appellate Assistant Commissioner that the proper method of valuation is the capitalisation of the net rental and for that purpose what has to be determined is the net rent and the rate of return which an investor of the class of property in question would expect. After stating the principles correctly the Tribunal came to the conclusion that it would would be reasonable under the circumstances to capitalise the net rental by 10 years, purchase value. The various factors which the Tribunal took account in arriving at this multiple of 10 are :
(i) The cost incurred by the assessee. The buildings were completed by March 31, 1954, and these had been estimated by capitalising the net rentals by 9.1 years' purchase.
(ii) The assessee has in the assessment years 1952-53, 1953-54 and 1954-55 himself chosen to estimate the cost of construction by capitalising the net rentals by 10 years' purchase i.e., he has taken the yield on the capital investment in the construction at 10%
(iii) The fact that the property is used as business premises and the rents may fluctuate depending upon the trends of the market. There can be periods of slump and boom.
(iv) The sales of the sites near about the places where the property is situated.
(v) The possible appreciation in the market value from the commencement and the completion of the construction of the buildings.
7. After holding that the net rental was Rs. 19,500 per annum and that it is reasonable to employ to multiple of 10 for the purpose of capitalisation. The Tribunal directed the Income-tax Officer to work out the capital gains on the said basis.
8. Though two separate questions have been referred by the Tribunal the answer to the first question will conclude the second question as well The second question in our opinion, was, therefore, unnecessary. The substance of both questions is whether there was material for the Tribunal to adopt the multiple of 10 for arriving at the fair market value of the buildings as on January 1, 1954.
9. There is no dispute as to the amount of consideration for which the shops were sold by the assessee. The dispute is as to the fair market value of the said shops as on January 1, 1954. The market value of assets like shops and buildings is required to be determined under the Act for purposes of computation of capital gains valuation is also required to be made under the Wealth-tax Act, Estate Duty Act and the Land Acquisition Act. Valuation under all these Acts is the fair market value of the property.
10. In Rustom Cavasjee Cooper v. Union of India, Shah J. (as he then was), speaking for the court, said :
'The method of determining the value of property by the application of an appropriate multiplier to the net annual income or profits is a satisfactory method of valuation of lands with buildings only if the land is fully developed i.e., it has been put to full use legally permissible and economically justifiable and the income out of the property is the normal commercial and not a controlled return or a return depreciated on account of special circumstances If the property is not fully developed or the return is not commercial the method may yield a misleading result.'
11. He further said that among the important methods of determination of compensation under the Land Acquisition Act, capitalisation of net annual profit out of the property at a rate equal in normal cases to the return from gilt-edged securities is one of the well-known methods of valuation.
12. In State of Kerala v. P. P. Hassan Koya, the same learned judge has said :
'When the property sold is land with building it is often difficult to secure reliable evidence of instance of sale of similar lands with buildings proximate in time to the date of the notification under section 4. Therefore, the method which is generally resorted to the determining the value of the land with buildings specially those used for business purposes is the method of capitalisation of return actually received or which might reasonably be received from the land and the buildings It cannot be laid down as a general rule applicable to all situations and circumstances that a multiple approximately equal to the return from gilt-edged securities prevailing at the relevant time forms an adequate basis for finding out the market value of the land
C.A. Gulanikar in his Commentary on Two Acts - Gift-tax & Wealth-tax (second edition, 1971 - Part II, page 49), while dealing with the basis of valuation has stated thus.
Basis of valuation by income method of valuation is ideally suited to this type of property for the rent realised is not generally related either to the cost of construction or the fair rental income. This is in case of new shops or establishments not subject to rent control. Security of shops and business premises will generally vary between 6% to 9% and the years' purchase between 12 and 16 years. In some cases it may go below 6% and in many instances, justify a higher than 8%.'
13. According to the learned author the following are the other important factors to be taken into consideration :
(i) type of premises;
(ii) continuity of rent which is invariably fixed to fortunes of trade and commerce.
(iii) the amount of rent; current rent must be treated with great caution.
14. Parks on Principles and practice of Valuation fourth edition pages 15-16 has stated as how the multiple figure should be determined for the purpose of capitalisation of the net income parks says :
'When a person buys a property he does it for two purposes.
1. to obtain an annual income, and
2. to obtain security for his capital.
If a property produces a net return of Rs. 1000 per annum and a purchaser desires 6% return on his capital he will pay Rs. 1000 x 100/6 = Rs. 1,000 x 16.6 = Rs. 16,666 maximum for the property. If he pays more he will not have a 6% return on his capital if he pays less, he will obtain a greater return than 6%. The multiplier of the net rent to obtain capital value is known as the years' purchase. The security of the rent which a property produces in reflected in the years' purchase. For valuation purposes, therefore, security and years' purchase are the same. Security in the form of percentage yield of capital is found by rent/capital x 100 and years' purchase is found by dividing capital by rent.
Years' purchase of security is a very arbitrary figure. One person may be satisfied with a 4% return on his capital whilst another person may want a 7% return. For the purpose of valuation the valuer is mainly concerned with market value and the percentage he applies must be the equivalent to what a reasonable and prudent business man would expect.
Interest may be termed, the payment made for the use in production of capital. A valuer is mainly concerned with land and buildings, therefore, interest is the payment made for the use of land and buildings; and it takes the form of rent. People will pay rent for a building because they received something in return. It may be a place from which he will transact his business, or it may be for a place to live in with his family. He knows that if he did not give the owner some reward for his capital, these facilities would not be available to him. Interest or rent is not merely a payment for the use of capital, but it is a payment for the temporary control of capital in general. If a person invests in a highly speculative concern such as new gold mining shares, he will expect a high rate of interest on the capital invested, because he knows that there is no safeguard that the capital will not depreciate, or that the interest paid will be maintained. Whereas, if he invested his money in Government securities, he knows that his money is as safe as it possibly can be, and that the interest will be maintained. His money having all the safeguards that can be expected, he will be satisfied with a moderate return on his capital. It is, therefore, that Government securities form a datum line from which all other forms of investments are compared.......
The return which an investor will expect from a property will depend on the characteristics of the income, as compared to that of the ideal security. He will consider if the income is secure; if there is the possibility of it being maintained for a considerable period; if the income is liable to fluctuate owing to the vagaries of trade' if the cost of collection is in a reasonable proportion to the amount collected; if the income can be collected easily and this will depend on the class of tenants likely to occupy the premises; if he wishes to realise his capital at any time, is there a reasonable chance of selling the property without making a loss. Having considered all these factors he will then consider what return would be reasonable and that figure will represent the security of the income from which the years' purchase can be easily calculated.
Every case will have to be considered on its merits, all the advantages and disadvantages must be carefully considered, and no person can lay down hard and fast rules which will govern every type of property. All that can be given are figures which will guide and help a valuer to arrive at a correct result, but much depends on the diligence and integrity of the valuer who doing his work.......'
15. The important factors that must be considered while estimating the number of years' purchase value, according to Parks are :
1. location of the premises;
2. type of premises;
3. the continuity of the rent;
4. the amount of rent.
16. The continuity of the rent is one of the most important factors to be considered. The estimate for deductions to be made from the gross rent can mostly be made from actual figures and the date available, but estimating the years' purchase can only be done by the expert who has studied the class of property. The security of rents yielded by properties in a commercial area is inferior to that of rents of houses in a residential area. Fortunes of trade and commerce fluctuate greatly.
17. Summing up the earlier discussion, this is what Parks had said at page 22 :
'To summarise generally. Residential house property, according to the circumstances and particulars of each case, will vary from a 5 to 7 1/2% security and the years' purchase will vary between 13 and 20.'
18. On the question of valuation of shops and business premises, this is what the same author has said :
'The results of many hundreds of valuations I have made on the rental basis confirm the proposition that the higher the value the less the years' purchase. Experience has shown that if 6% is fair for a property worth Rs. 50,000, 6 1/2% would be fair for a property worth Rs. 1 to 5 lakhs, and 7% to 8% for properties of Rs. 3 to 5 lakhs, respectively. To sum up briefly, security of shops and business premises will generally vary between 6 and 8% and the years' purchase between 12 and 16 and whilst the security will vary rarely, if ever, go below 6% it may in many instances justify a higher percentage than 8%.'
19. In Channaveerappa v. Land Acquisition Officer, a case under the Land Acquisition Act, this is what we have said :
'What is the proper multiple to be applied for arriving at the market value of any land if the income method valuation is adopted depends upon the nature of the agricultural land and the kind of crop/crops raised on it. There is no invariable rule that in the absence of evidence of sales of similar lands and the only evidence let in is regarding the net income, that net income should be multiplied by 20 in order to arrive at the market value. What multiple should be applied depends on the evidence as to the rate of return a purchaser of an area garden generally expects on his investment. The multiple of 20 is applied where the rate of return expected is 5% on the capital invested.'
20. In Special Land Acquisition Officer v. Siddalingiah, the principles laid down in Channaveerappa's case were followed and it was reiterated by us that 'there is no universal rule that when the capitalisation of income method is followed, the average net annual income has to be multiplied by 20. The multiple to be adopted is a matter entirely resting on the evidence as to what return investors in coffee states expect on their investments.'
21. The Income-tax Appellate Tribunal, while correctly stating the principles of valuation, has failed to give its finding as to the rate of return an investor in this class of property would expect. It is seen from the order of the Tribunal that in the case of the very assessee the Wealth-tax Officer of the Tribunal that in the case of the bury assessee the Wealth-tax Officer multiple of 17. The wealth-tax assessments were for the assessment year 1957-58 and subsequent years. When the Wealth-tax Officer had determined the fair market value by multiplying the net annual rent by 17, no reasons have been given by the Tribunal to hold that the multiple of 10 is justified for the year 1953-54.
22. The Tribunal, in our judgment, has fallen into an error when it took into consideration, the estimated cost of construction of the buildings and the sale of other sites near about the place where the property is situated. Factors (i) to (v) which were taken into account by the Tribunal and to which we have already made reference in this judgment, are not relevant for arriving at the number of years' purchase value. Gulanikar in his book referred to earlier has stated that 'the income method of valuation is ideally suited to the valuation of commercial buildings and that the rent realised is not generally related to the cost of construction'.
23. In paragraph 14 of its order, the Tribunal has rightly said that 'the cost of construction of the building to the assessee has, no doubt, no relation to the market value of that building, if sold in the open market'. Having thus stated the principle correctly, the Tribunal fell into an error when it rested its decision on the estimated cost of construction given by the assessee in his income-tax assessment proceedings. The Tribunal should have determined the rate of return which an investor in the class of property would expect. The number of years' purchase value has to be arrived at on the basis of the rate of return expected. From a perusal of the order of the Tribunal we are of the opinion that the determination of the years' purchase value was made without arriving at the rate of return which an investor in the class of property would expect in the year 1954 in Bangalore City. The factors taken into consideration by the Tribunal are irrelevant for the purpose of that determination. It should have also taken into consideration the method of valuation of the very buildings in the assessment for wealth-tax for the assessment year 1957-58. The adoption of the multiple of 10 is patently arbitrary. We have already referred to what Parks has stated on his question. According to the learned author, an investor would expect between 6% and 8% return and the years' purchase would be between 12 and 16. Same is the view taken by Gulanikar. There was no material for the Tribunal to support its conclusion that it is reasonable to adopt the multiple of 10. Our answer to question No. (i), is, therefore, in the negative and in favour of the assessee. The Tribunal has to rehear the appeal and determine the rate of return which an investor in this class of property would expect in January, 1954.
24. The assessee is entitled to his costs. Advocate's fee, Rs. 250.