CA MANOJ GUPTA
( Expert )
28 April 2011
IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH 'F' MUMBAI
Assessment Year: 2005-06
M/s UNIQUE ENTERPRISES
G/8, AMIN BUILDING, 69
E R RPAD, MUMBAI-400003
INCOME TAX OFFICER
WARD-13(1)(3), AAYAKAR BHAVAN
J Sudhakar Reddy, AM and V Durga Rao, JM
Dated : August 20, 2010
Appellant Rep by: Shri Yogesh Thar
Respondent Rep by: Shri R M Tiwari
Per: J Sudhakar Reddy:
This appeal filed by the assessee is directed against the order dated 08.07.2008 of the Commissioner of Income-tax(Appeals)-XIII, Mumbai, for the assessment year 2005-06.
2. Facts in brief :-
The assessee is a builder and is engaged in the business of redevelopment of tenanted property. It follows the project completion method of accounting since its inception in the assessment year 1995-96. This method is being consistently followed and the income of project is offered for taxation in the year of completion of the project. The expenses incurred on a project are accumulated under the head “construction work-in-progress and in the final year of completion, this is taken as expenditure.
3. The assessee filed its return of income on 25.10.2005 for the assessment year 2005-06 disclosing the total income of Rs.56,974/-. The Assessing Officer, during the course of scrutiny proceedings asked the assessee to explain why the income should not be assessed on percentage/progressive completion method as per revised AS-7 issued by the Institute of Chartered Accountants of India. After considering the reply of the assessee, the Assessing Officer rejected the assessee’s contention and estimated that the assessee has completed 59.86 per cent of the project and after finding out the final sale value given by the assessee at 57.86% of 3.33 crores as the sale for the assessment year 2005-06. He deducted from the sale value so arrived, the total cost of the project upto assessment year 2005-06 and also certain administrative expenses during the year and arrived at the net profit of Rs.19,88,391/-. He further made certain disallowances on the ground that certain expenditure was personal in nature and also on account of differences in the list of purchases received from creditors as well on the ground that expenses are not allowable under section 40(a)(ia) of the Act.
4. Aggrieved, assessee carried the matter in appeal.
5. The first appellate authority rejected the contention of the assessee and held that the A.O. was correct in holding that the revised AS-7 issued by the Institute of Chartered Accountants of India applies to the assessee. In the alternative plea of the assessee that the entire profits were offered to tax in the next assessment year i.e. Assessment Year 2006-07 and that the same should be reduced from that year, the first appellate authority held that it is a valid plea and asked the Assessing Officer to reduce the profits of the next assessment.
6. On the other ground of disallowance under section 40(a)(ia), the plea of the assessee was rejected. As far as the other disallowances were concerned, the first appellate authority granted part relief.
7. Further aggrieved, the assessee is in appeal before us on the following grounds:
I. Method of accounting:
1. On the facts and circumstances of the case, the Ld. CIT(A)has erred in law and on merit in confirming ‘Project Completion Method” of offering income for tax in case of the Appellant engaged in business of Builders & Developers on their own Account.
2. The CIT(A) ought to have and considered that the Accounting Standard (AS)-7 (Revised 2002) is not applicable to builders/developers.
3. The appellant prays that the “Project Completion Mehtod” be accepted for the purpose of payment of income tax on income by the assessee.
4. Alternatively, assessed income for the year should be in the same proportion as percentage completed this year to total income on completion of the project.
II. Expenses disallowed u/s.40(a)(ia).
1. On the facts and circumstances of the case and in law the CIT(A) has erred in confirming a disallowance of the expenses u/s.13,22,989/-.
2. The CIT(A) ought to have and considered that the appellant had not claimed these as expenses in the profit and loss account as it follows project completion method of offering income to tax, which it has so in A.Y.2006-08 as the project was completed in that year. All these expenses have been accumulated under the head “construction work-in-progress” under current assets’ hence, question of disallowance does not arise.
3. The CIT(A) has also not considered the amendment in sec.40(a)(ia) interested w.e.f.01.04.2005 granting relief in depositing of TDS.
Alternatively, in the event disallowance is upheld, the same should be allowed as deduction as expenses in A.Y. 2006-07 in terms of proviso to section 40(a)(ia) as the TDS has been deposited in the subsequent year.
III. Disallowance of various expenses amounting to Rs. 71,880/-
1. On the facts and circumstances of the case and in law the CIT(A) has erred in disallowing various expenses of Rs. 71,880/-.
8. Shri Yogesh Thar, learned counsel for the assessee submitted that he is not pressing ground II(1) and II(2) with regard to disallowance under section 40a(ia)of the Act, as well as the disallowance of various expenses amounting to Rs.71,880/- , which is ground No. III. He wishes to agree on Ground No. I and ground No. II(3) and (4).
9. On ground No. I, the learned counsel for the assessee submitted that before AS-7 was issued by the Institute of Chartered Accountants of India, the Tribunal in the case of Champion Construction (5 ITD ) has accepted the completion of contract method as an appropriate method of computing income. He relied on para 18 at page 507 of that order. He further drew our attention to AS- 7, as it exist prior to its revision in the year 2002 as well as the AS-7 issued in the year 2002 by the Institute of Chartered Accountants of India and submitted that the revised Accounting Standard does not apply to builders and real estate developers. He pointed out that the Institute of Chartered Accountants of India in the Compendium of Opinion, Vol. XXIII, in response to a query, has stated that AS-7 does not apply to the real estate developers. The copy of the same has been filed. He vehemently contended that the assessee is consistently following the project completion method of accounting, since its inception and has accordingly offered to tax the entire income in the next assessment year i.e. 2006-07, which incidentally happens to be the last year of business operations of the firm. He drew the attention of the Bench to pages 60-68 of the paper book which runs into 76 pages and submitted that the cost incurred on construction flats and quantum of advances received, demonstrate that the case falls within the ratio of the decision in the case of Champion Construction Co. He also pointed out that the Institute of Chartered Accountants of India has issued a Guidance Note on Recognition of Revenue by Real Estate Developers in 2006. He filed a copy of the same and argued that even as per this Guidance Note read with the Agreement of Sale, executed by the assessee, it is clear that the risks and the rewards of ownership have not been transferred to the buyer and the seller retains effective control of the goods transferred. He took this Bench to para 5, para 11 and para 19, etc. of the Agreement and argued that no legal right to sell or transfer accrued to the assessee. He submitted that the assessee would have a right to sell only if possession is given or at least if the flat is ready. He relied on the decision of the Bangalore Bench ‘B’ of the Tribunal in the case of Prestige Estate Projects (P) Ltd. V. DCIT(ITA No. 218/Bang/2009 for A.Y. 2005-06) Order dated 11th September 2009 (2010) 33 DTR (Bang.)(Trib.) 514, and submitted that the issue is covered in his favour. He submitted that in the case of real estate developer, the profit accrues only on sale and not otherwise. He pointed out the errors in the computation of income done by the assessee.
10. On the issue of disallowance of section 40(a)(ia), he submitted that the assessee has not sought any allowance of expenditure during this year and, therefore, the question of disallowance does not arise. He relied on the decision of the Mumbai Bench of the Tribunal in the case of Savala Associates v. ITO (2010) 35 SOT 148(Mum). On a query from the bench, he submitted that the Assessing Officer may be directed to re-work the work-in-progress, after deleting the expenditure on which no deduction of tax was made.
11. The learned Departmental Representative, Shri R.M. Tiwari, on the other hand, opposed the contention of the assessee and submitted that the AS-7 is applicable to builders and contractors. He relied on the order of the first appellate authority and argued that revenue recognition has to be done as per AS-7 read with AS-9. He referred to para 2.1.3 of the order of the CIT(A) and submitted that opinion given by the Institute of Chartered Accountants of India clearly shows that the opinion was specific, to the queries and the facts of that case. Even otherwise, he submitted that as per the Guidance Note of the Institute of Chartered Accountants of India, the assessee is bound to declare income during the year. He took this Bench through the Guidance Note and submitted that, even if there is an Agreement of Sale, the income should be offered. He made these submission after drawing the attention of the Bench to various claims of the ground of sale. His case is that the sale is partly complete and that risks have passed. He supported the orders of the authorities below and relied on the order of the ld. CIT(A). On sec.40(a)(ia), he agreed for the matter being set aside to A.O.
12. Rival contentions heard. On careful consideration of the facts and circumstances of the case and a perusal of the papers on record and the orders of the authorities below, as well as the case laws cited, we hold as follows:
13. The assessee in this case is a builders and real estate developer. The undisputed fact is that the assessee follows project completion method of accounting since its inception in the year 1996. It has been offering income by this method of accounting and the department has been accepting the same over the years. The other undisputed fact is that the assessee has declared that the project is completed in the assessment year 2005-06 and the assessee has offered the income on project completion method in that year. Thus, only the year of taxation is under dispute. The issue is whether the method of accounting followed by the assessee has been rightly rejected by the A.O. The A.O’s contention, which is affirmed by the CIT(A) is that AS-7 issued by the Institute of Chartered Accountants of India is applicable to the builders and real estate developers. This finding in our opinion is erroneous. AS-7 prior to its revision in the year 2002 dealt with the Accounting for Construction Contracts, in the financial statements of enterprises. We extract a part of this statement for ready reference:
“This statement deals with accounting for construction contracts in the financial statements of enterprises undertaking such contracts thereafter referred to as “contractors”). The statement also applies to enterprises undertaking construction activities of the type dealt with in this statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale.” [Emphasis own]
14. A perusal of the above makes it clear that the statement applied to builder and real estate developers. In AS-7, as revised in the year2002, the scope of the statement is given as follows:
“Scope (1) This statement should be applied in accounting for construction contracts in the financial statements of contractors”.
A Construction contract is defined as follows:
“A construction contract is a contract specifically negotiated for the construction of an asset or a combination of asset that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.”
From reading of the above makes it clear that revised AS-7 issued in the year 2002, does not apply to builders and real estate consultants. The Institute of Chartered Accountants of India has in reply to a query given in the Compendium of Opinions – Vol.XXIII – 95 Query No. 15 as stated as follows:
5. In the light of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the revised AS-7 would be applicable t the company for accounting for new housing projects, which may be undertaken by the company on or after 01.04.2003 on the same business model as mentioned in the facts of the case.
(b) In case revised As-7 is not applicable to the company, whether the company can value its inventories in accordance with Accounting Standard (AAS)2, “Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, considering the definition of inventory as ‘an asset in the process of production for the purpose of sale’, i.e. whether the activity of developing housing projects on its own account as a commercial venture by the company can be construed as a production activity.
(c) If the activities of the company cannot be considered as a production activity and consequently AS -2 is also not applicable, which Accounting Standard should be followed for recognition of revenue and valuation of its construction work-in-progress?
C. Points considered by the Committee
6. The Committee notes that Accounting Standard (AS)-7, ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India in December 1983, states in paragraph 1 that “The statement also applies to enterprises undertaking construction activities of the type dealt with in this statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale”. Therefore, the Standard was applicable to the activities carried on by the company as stated in paragraphs 1 and 2 above. The Committee also notes that the revised Accounting Standard (AS) 7, ‘Construction Contracts’, issued by the Institute of Chartered Accounts of India in 2002, does not contain the aforesaid sentence contained in the pre-revised AS-7. On the other hand, paragraph 1 of revised AS-7, clearly states that, “This Statement should be applied in accounting for construction contracts in the financial statements of contractors”. Therefore, the Committee is of the view that the revised AS 7 is not applicable to such enterprises.” [Emphasis own]
Thus, the revised AS-7 cannot be applied to enterprises which is in the business of real estate developers.
15. The Bangalore Bench of the Tribunal in the case of Prestige Estate Projects (P) Ltd.(supra) has held as follows:
“Accounts – Accounting system – Project completion method consistently followed – Assessee developer had been regularly employing project completion method which is an accepted method of accounting – Accounting Standard -7 has not been specified by the Central Government under s.145(2) – Hence, AO could not reject the accounts under s.145(3) on the ground that the assessee had not followed the prescribed method of accounting – Moreover, assessee was under bona fide belief that it was adopting a method of accounting which was applicable to it as per the report of the Expert Committee of the ICAI – Therefore, revised AS-7 cannot be applied in the case of the assessee – Even otherwise, in case revised AS-7 is to be applied, the opening inventories are to be valued as per revised AS-7- That apart, on the principle of consistency, Revenue should have accepted the method of accounting adopted by the assessee as the same was being followed for many years – Hence AO is directed to accept the project completion method of accounting.
16. Moreover, the Institute of Chartered Accountants of India has issued Guidance Note on Recognition of Revenue by Real Estate Developers. The recommendations are at para 6, which is extracted for ready reference :
“Revenue in case of real estate sales should be recognized when all the following conditions are satisfied:
(i) The seller has transferred t the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership;
(ii) No significant uncertainty exists regarding the amount of the consideration that will be derived from the real estate sales; and
(iii) It is not unreasonable to expect ultimate collection.”
From the above discussion, it is clear that the first appellate authority was not in error in upholding the view taken by the AO, that the revised AS-7 is applicable to builders and real estate developers.
17. On the facts of this case, we agree with the arguments of Shri Yogesh Thar, learned counsel for the assessee, that the decision in the case of Champion Construction Co. (supra), had laid down that when the assessee follows project completion method, it would be appropriate to offer income to tax in the year in which 80% of the construction was completed. At para 18, page 507-508, the Tribunal held as follows:
“We have examined the facts of the case from this point of view. We find that out of the total accommodation of 58,970 sq.ft. constructed, the assessee was able to sell only 25,530 sq.ft. during the previous year relevant for the assessment year 1977-78. Neither the construction of the multi-storeyed building was complete nor even the half portion of the building sold. The net sale proceeds received were much less than the total expenditure/cost incurred by the assessee upto date. In the circumstances so far as the assessment year 1977-78 is concerned we accept the assessee’s submission that it would be in order if no profits or losses are estimated from the venture for the assessment year 1977-78. the assessment for this year is, therefore, cancelled even on this score.”
18. In this year the assessee has admittedly completed only 53.95% of the construction and hence, it cannot be said that the assessee has substantially completed the project, so as to recognize income under the project completion method of accounting.
19. At para 19, the Hon’ble Tribunal in the case of Champion Construction Co. (supra) held as follows:
“However, the position as regards the assessment year 1978-79 is materially different. The construction of the building is completed in that year. Total area earmarked for sale is 61,396/- sq.ft. out of which upto the end of that year the assessee had sold 49,965 sq. ft. i.e. about 80 per cent of the area. The net receipts have far exceeded the total cost or expenditure to the assessee. Assuming there is any possibility of the assessee’s incurring some liability in future in connection with the completion of the project or otherwise, the unsold portion comprising of 12,331/- sq.ft. and the difference between the net receipts and the total expenditure and the amount actually treated as the assessee’s income are more than sufficient to take care of any such contingency.”
Thus, the methodology followed by the assessee in recognizing the income from the project under project completion method in the next year is in accordance with the propositions laid down by the Tribunal in the case of Champion Construction Co. (supra).
20. In any event, the method followed by the assessee cannot by any stretch of imagination be called as an unreasonable method. Any change in the method is revenue neutral. The revenue cannot change the method of accounting, as is sought to be done in the facts and circumstances of the case.
21. Coming to the case laws, the case of CIT v. Bill Hari Investment Ltd. (299 ITR 1 the Hon’ble Supreme Court has held as follows:
“15. Recognition/identification of income under the 1961 Act, is attainable by several methods of accounting. It may be noted that the same result could be attained by any one of the accounting methods. Completed contract method is one such method. Similarly, percentage of completion method is another such method.
16. Under completed contract method, the revenue is not recognized until the contract is complete. Under the said method, costs are accumulated during the course of the contract. The profit and loss is established in the last accounting period and transferred to P&L a/c. The said method determines results only when contract is completed. This method leads to objective assessment of the results of the contract.
17. On the other hand, percentage of completion method tries to attain periodic recognition of income in order to reflect current performance. The amount of revenue recognized under this method is determined by reference to the stage of completion of the contract. The stage of completion can be looked at under this method by taking into consideration the proportion that costs incurred to date bears to the estimated total costs of contract. 18. the above indicates the difference between completed contract method and percentage of completion method.
19. In the judgment of the Bombay High Court in Taparia Tools Ltd. (supra) it has been held that in every case of substitution of one method by another method, the burden is on the Department to prove that the method in vogue is not correct and it distorts the profits of a particular year. Under the mercantile system of accounting based on the concept of accrual, the method of accounting followed by the assessee is relevant. In the present case, there is no finding recorded by the AO that the completed contract method distorts the profits of a particular year. Moreover, as held in various judgments, the Chit Scheme is one integrated scheme spread over a period of time, sometimes exceeding 12 months. We have examined computation of tax effect in these cases and we find that the entire exercise is revenue reutral, particularly when the scheme is spread as one integrated scheme spread over a period of time.
20. As stated above, we are concerned with asst. years 1991-1992 to 1997-1998. In the past, the Department had accepted the completed contract method and because of such acceptance, the assessee, in these cases, have followed the same method of accounting, particularly in the context of chit discount. Every assessee is entitled to arrange its affairs and follow the method of accounting, which the Department has earlier accepted. It is only in those cases where the Department records a finding that the method adopted by the assessee results in distortion of profits, the Department can insist on substitution of the existing method. Further, in the present case, we find from the various statements produced before us, that the entire exercise, arising out of change of method from completed contract method to deferred revenue expenditure, is revenue neutral. Therefore, we do not wish to interfere with the impugned judgment of the High Court.
21. Before concluding, we may point out that under s.211(2) of the Companies Act, Accounting Standards (”AS”) enacted by the Institute of Chartered Accountants have now been adopted [see: judgment of this Court in J.K. Industries case (supra)]. Shri Tripathi, learned counsel for the Department, has placed reliance on AS 22 as the basis of his argument that the completed contract method should be substituted by deferred revenue expenditure (spreading the said expenditure on proportionate basis over a period of time). He also relied upon the concept of timing difference introduced by As 22. It may be stated that all these developments are of recent origin. It is open to the Department to consider these new accounting standards and concepts in future cases of chit transactions. We express no opinion in that regard. Suffice it to state that, these new concepts and accounting standards have not been invoked by the Department in the present batch of civil appeals.” [Emphasis own]
22. This judgment applies to the facts of the case in all force. The entire exercise is revenue neutral. The revenue has accepted the method over the years.
23. In the case of Chainrup Sampatram v. CIT (24 ITR 481), the Hon’ble Full Bench of the Supreme Court has held that while valuing closing stock, anticipated losses are taken into account and that the anticipated profit in the shape of appreciation in the value of stock is not brought into account. This case law, in our considered opinion, is not of much help to assessee.
24. The Ho’ble Bombay High Court in the case of CIT vs. Tata Iron & Steel Co. Ltd. (106 ITR 363) held that when the method of accounting followed by the assessee company cannot be said to be an unreasonable method, and that in such a case, even if a better method could be visualized, the method consistently followed can be accepted.
25. In view of the above discussion, we have to necessarily uphold the contention of the assessee and allow ground No. 1 of the assessee. We have allowed this ground of the assessee on the propositions discussed above, we do not give any finding on whether revenue has to be recognized in this year based on the Guidance Note issued by the Institute of Chartered Accountants of India on Recognition of Revenue by Real Estate Developers, by interpreting the Agreement of Sale, etc., as this would be an academic exercise. Accordingly, ground No. I is allowed.
28. Coming to ground No. II, as mutually agreed between the parties, we respectfully follow the order of the Mumbai Bench ‘J’ of the Tribunal in the case of Savala Associates v. ITO (35 SOT 148), we set aside the matter to the file of the A.O. on the issue of disallowance under section 40(a)(ia) of the Act. As the assessee has not claimed any expenditure, the disallowance does not arise. At the same time, the work-in-progress of the assessee has to be recomputed by excluding this expenditure, which the assessee has not claimed. Ground No. II(1) and (2) is allowed for statistical purposes.
29. Ground II(2) and (3) are dismissed as not pressed.
30. Ground Nos. III & IV are also dismissed as such.
31. In the result, the appeal of the assessee is allowed in part.
(Order pronounced on this 20.8.2010.)
CA MANOJ GUPTA