Income Tax Appellate Tribunal - Mumbai
Wall Street Construction Ltd. And Anr. vs Joint Commissioner Of Income Tax on 22 September, 2005
Equivalent citations: [2006]101ITD156(MUM), (2006)102TTJ(MUM)505
ORDER
K.K. Boliya, A.M.
1. The Hon'ble President of Tribunal has constituted this Special Bench in the abovementioned two cases to consider and decide the following issue arising in these appeals:
Whether, where an assessee is following project-completion method of accounting, the interest identifiable with that project should be allowed as deduction in the year when the project is completed and income is offered from the project or it should be allowed on year to year basis?
2. The relevant facts, briefly stated, leading to this reference are that both the assessees are engaged in the business of construction. The admitted position is that they are following project-completion method of accounting, which means that the profits arising from a particular project are offered for taxation in the year in which that project is complete or substantially complete. In the present cases, the assessees are simultaneously constructing multiple projects and accounts are separately maintained for each project. The assessees have borrowed on interest substantial funds which are used as working capital for execution of the various construction projects. In respect of the interest expenditure referable to the borrowed funds, during the assessment years under appeal, it was claimed before the AO that such interest expenditure is not in the nature of direct cost of the project and, therefore, this expenditure has to be treated as 'period cost', Therefore, it was claimed that the interest expenditure accrued in a particular year must be deducted by way of expenditure against the assessees' income for that particular year. In other words, while the income from a particular project will be offered for taxation in the year of completion, the interest expenditure is claimed by the assessees from year to year on the basis of accrual during the particular year. It was claimed that this procedure for claiming deduction in respect of interest for each year under Section 36(1)(iii), instead of adding it to the cost of the project, was being consistently followed by the assessees. The AO rejected this claim and held that interest expenditure has to be added to the value of work-in-progress because the assessees are following project-completion method of accounting. The AO's view has been upheld by the learned CIT(A), with the result that this issue came to be further agitated before the Tribunal, These matters were heard by Tribunal, Mumbai Bench 'F' and during the course of hearing, it was claimed on behalf of the assessees that the relevant issue stands covered in the case of one of the assessees Wall Street Construction Ltd. for asst. yr. 1994-95 vide order dt. 17th Aug., 2003 (ITA No. 3477/Mum/1998), and also in the case of Natasha Construction Ltd,-for asst. yrs. 1996-97 and 1997-98 (ITA Nos. 4527 and 4528/Mum/2001). Reliance was also placed on the Hon'ble Bombay High Court decision in the case of CIT v. Lokhandwala Construction Industries Ltd. . On the other hand, on behalf of the Department it was submitted that in the case of Patel Plaza Ltd. (ITA No, 148/Murn/1999, dt. 9th July, 2001), the method of accounting was changed only in asst, yr, 1995-96 and in the case of Wall Street Construction Ltd. (supra) with effect from the asst. yr. 1992-93. It was, therefore, argued that it was incorrect to say that the method of claiming deduction for interest from year to year was consistently followed by the assessee and was accepted by the Department in earlier years. The Department also relied on the Tribunal, Mumbai 'A' Bench decision in the case of S.K. Estates (P) Ltd. v. Asstt. CIT (1997) 60 ITD 621 (Mumbai) wherein it was held that interest cost must be added to the value of work-in-progress where the assessee is following project-completion method of accounting.
3. The Tribunal found that there was divergence of opinion on this issue between different Benches of the Tribunal. It was also felt that the issue does not, per se, appear to be covered by the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra). The Tribunal, therefore, thought it proper to refer the issue to the Hon'ble President for constitution of a Special Bench of the Tribunal for resolving the controversy.
4. On behalf of the assessees, Shri Y.P. Trivedi, senior counsel appeared before us, assisted by Shri P.R. Toprani and Ms. Usha Dalai. At the outset, Shri Y.P. Trivedi posed before us the following six questions, which according to him are relevant to the issue:
(a) In a case of a builder, following project-completion method, engaged in simultaneous construction of multiple projects, whether interest cost is a period cost or it has to be added to the value of work-in-progress?
(b) Whether interest on such borrowings which cannot be directly linked to a particular project, is to be allowed from year to year or is to be added to the value of work-in-progress?
(c) What is the impact of AS No. 7 issued by the Institute of Chartered Accountants?
(d) Whether the Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra) concludes the controversy?
(e) Whether in the case of a builder following project-completion method, the work-in-progress is to be considered as stock-in-trade or capital asset?
(f) Whether a system of accounting consistently followed by the assessee and accepted by the Department in earlier years can be discarded by the Department having regard to the ratio of the Bombay High Court in the case of CIT v. Goodlas Neiolac Paints Ltd. ?
5. Developing his arguments, the learned Counsel for the assessees forcefully submitted that the issue stands concluded by the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra). It is further submitted that insofar as the case of Wall Street Construction Ltd. (supra) is concerned, the issue is squarely covered in assessee's favour by the following decisions of the Tribunal:
1. Asst, yr. 1994-95, ITA No. 3477/Mum/1998, dt. 8th July, 2003
2. Asst. yr. 1995-96, ITA No. 2840/Mum/1999, dt. 31st Oct., 2003
3. Asst. yr. 1996-97, ITA No. 2656/Mum/2000, dt. 13th Sept., 2004.
Copies of these decisions have been compiled in the paper book. The learned Counsel then submitted that since the assessees are consistently following a system of accounting whereby interest cost is being claimed in each year and the Department having accepted this system of accounting, the Department is wholly unjustified in rejecting this system of accounting in view of the finding of Hon'ble Bombay High Court in the case of Goodlas Neiolac Paints Ltd. (supra). The learned Counsel further argued that if the interest cost is not deducted under Section 36(1)(iii) on the basis of accrual from year to year, this would result into distortion in the profits shown in a case where no borrowed funds have been raised vis-a-vis a case where the construction activity has been carried out with the help of interest-bearing borrowed funds. It is pointed out that in the former, there may be no interest expenditure which can be added to the value of work-in-progress, whereas in the latter, substantially interest expenditure will have to be added to the value of work-in-progress. Eventually, when the projects are complete and the constructed premises are sold, the cost, being value of work-in-progress, will substantially vary in the two cases, whereas the market value would be the same if the projects are otherwise identical and similarly located. Shri Trivedi relied on the Hon'ble Calcutta High Court decision in the case of Tetron Commercial Ltd. v. CIT to buttress his arguments.
6. The learned Counsel for the assessee also drew support from the AS-7. He invited our attention to paras 8.4 to 8,8 of AS-7, which are reproduced below:
8.4 Costs incurred by a contractor can be divided into:
(i) costs that relate directly to a specific contract;
(ii) costs that can be attributed to the contract activity in general and can be allocated to specific contracts;
(iii) costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts.
8.5 Examples of costs that relate directly to a specific contract include:
(i) site labour costs, including supervision;
(ii) materials used for project construction;
(iii) depreciation of plant and equipment required for a contract;
(iv) costs of moving plant and equipment to and from a site.
8.6 Examples of costs that can be attributed to the contract activity in general and can be allocated to specific contracts include:
(i) insurance;
(ii) design and technical assistance;
(iii) construction overheads.
8.7 Examples of costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts, include:
(i) general administration and selling costs;
(ii) finance costs;
(iii) research and development costs;
(iv) depreciation of plant and equipment that cannot be allocated to a particular contract.
8.8 Costs referred to in para 8.7 are usually excluded from the accumulated contract costs because they do not relate to reaching the present stage of completion of a specific contract. However, in some circumstances general administrative expenses, development costs and finance costs are specifically attributable to a particular contract and are sometimes included as part of accumulated contract costs.
The learned Counsel specifically referred to para 8.8 and contended that finance costs should be usually excluded from the accumulated contract costs.
7. The learned Counsel also emphasized the point that it is well-settled proposition of law that a taxpayer is free to employ his own method of keeping accounts and for valuation of closing stock in accordance with the established method of stock valuation. The assessee is also free to change the method of accounting as well as the method of valuation of closing stock from time to time subject to the condition that the AO is satisfied that the change effected by the assessee is bona fide and the changed method is followed regularly. For this proposition, the learned "counsel relied on the following judgments:
(i) ITO v. Modi Rubber Ltd. (1993) 45 TTJ (Del) 415 : (1992) 43 ITD 396 (Del);
(ii) CIT v. Mopeds India Ltd. ;
(iii) CIT v. Carbomndum Universal Ltd. .
8. Shri Trivedi summed up his arguments by reiterating that the issue not only stands concluded by the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra) and further covered in assessee's own case by the orders of the Tribunal for preceding assessment years, but on merits also the interest has to be allowed from year to year.
9. On behalf of the Department, the case was represented by Shri K.L. Maheshwari, CIT-Departmental Representative and Shri R.N. Parbat, senior Departmental Representative. Shri Maheshwari at the outset, submitted that it is incorrect to say that the assessees have been following a consistent method of accounting wherein interest payable on borrowed funds is claimed from year to year and that such system has been accepted by the Department. It is submitted that in the books of account, the interest expenditure has been consistently segregated between different projects and added to the value of the work-in-progress as reflected in the books of account. This method of accounting has been followed by the assessees since the asst. yr. 1988-89 and in all subsequent assessment years including the assessment years under appeal. In the case of Wall Street Construction Ltd. upto the asst. yr. 1991-92 the assessee even did not claim deduction in respect of interest under Section 36(1)(iii). Similarly, in case of Patel Plaza Ltd. upto asst. yr. 1994-95 no deduction in respect of interest was claimed by the assessee. Subsequently, the assessees started claiming deduction only while computing the total income for the purpose of filing returns of income. Shri Maheshwari repeated that in the books of account, the interest expenditure is uniformly and consistently added to the value of work-in-progress. It is, therefore, argued that the assessees are actually following a consistent method of accounting where interest expenditure is added to the value of work-in-progress. Shri Maheshwari submitted that the phrase 'method of accounting' referred to in Section 145 of the IT Act indicates the method adopted by the assessee while maintaining regular books of account and not the method of computation of total income. The learned CIT-Departmental Representative also invited our attention to the provisions of Section 36(1)(iii) which prescribe that the amount of the interest paid in respect of capital borrowed for the purposes of business is to be deducted. It is submitted that the word 'paid' as defined under Section 43(2) means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the head 'Profits and gains of business or profession'. Here again, the emphasis is on the method of accounting upon the basis of which the profits are computed in the books of account. Shri Maheshwari reiterated that insofar as the books of account are concerned, the interest expenditure is added to the value of work-in-progress.
10. The learned CIT-Departmental Representative submitted that there is no dispute that the assessees are following project-completion method of accounting and all the expenses referable to a particular project are added to the cost of the project. He invited our attention to p. 9 of the AO's order in the case of Wall Street Construction Ltd. (supra) for asst. yr. 1993-94, where the remarks of the auditors in the Schedule to the annual accounts, narrating the system of accounting followed by the assessee, are reproduced as below:
The company follows completed project method of accounting, wherein the profit on sale of residential and commercial units is recognized only when the work in respect of the project is completed/substantially completed. The cost incurred and payments received while the project is in progress are accumulated and carried forward as work-in-progress under inventories and as advances received from customers under current liabilities, respectively.
11. Shri Maheshwari also invited our attention to p. 11 of the AO's order referred to above where on the basis of the order sheet noting dt. 11th March, 1997 for asst. yr. 1994-95 in the case of Wall Street Construction Ltd. (supra), the submissions made on behalf of the company by the Authorised Representatives have been reproduced as under:
The interest payment related to each project is included in the cost of each project for which account is maintained project-wise.
The other administrative expenses are apportioned and the expenses related to each project are debited to the respective accounts. Only very few expenses which cannot be allocated are debited to P&L a/c. During this year total administrative expenses have been shown at Rs. 26,61,484. Out of this, Rs. 25,03,581 has been allocated to various projects which are still under progress and the profits of which are not still under assessment during the financial year 1993-94. The balance of Rs. 1,57,903 has been debited to the P&L a/c for the year.
12. The learned CIT-Departmental Representative, therefore, contended that there is no dispute whatsoever that all expenses including administrative expenses and finance costs have been added to the cost of a particular project in the books of account. It is also submitted that 'the interest cost has been identified and segregated by the assessees' in the books of account in respect of different projects for different assessment years and details thereof are incorporated at p. 11 of the AO's order referred to above.
13. The learned CIT-Departmental Representative submitted that claiming interest from year to year under Section 36(1)(iii) has actually distorted the profits earned by the assessee of a particular project because the interest cost which pertains to one project has been claimed by the assessee against the income of another project. This has resulted into claiming of huge losses by the assessee as per details given at p. 12 of the AO's order referred to above as under:
Asst. yr. Loss 1993-94 (-) 22,85,898 1994-95 (-) 80,28,459 1995-96 (-) 1,42,72,497 1996-97 (-) 83,47,382
14. It is reiterated that assessees are offering income on completion of the project but by adopting a peculiar method they are claiming deduction for interest much earlier against the income of such projects, which are completed in these years.
15. Coming to the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra) the learned CIT-Departmental Representative forcefully argued that in that case the only issue considered by Hon'ble Bombay High Court was whether the interest on borrowed capital utilized for obtaining development rights in respect of loan was a capital expenditure or revenue expenditure allowable under Section 36(1)(iii) in the case of an assessee engaged in the business of construction of buildings. It is submitted that the relevant question as to whether the interest cost should be added to the value of work-in-progress in the case of an assessee following project-completion method, was never addressed by the Hon'ble Bombay High Court. The learned CIT-Departmental Representative submitted that the Tribunal while deciding this issue for asst. yr. 1994-95 in the case of Wall Street Construction Ltd. (supra) followed the Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra). For the subsequent asst. yrs. 1995-96 and 1996-97, the issue was considered as covered by other Benches of the Tribunal. The learned CIT-Departmental Representative invited our attention to the Tribunal's order dt. 9th July, 2001 in ITA No. 148/Mum/1999 in the case of Patel Plaza Ltd., wherein after a detailed discussion, it has been held that interest expenditure must be added to the value of work-in-progress. Similar view is stated to have been adopted by the Tribunal in the case of Mont Blanc Properties & Industries Ltd. (ITA Nos. 1051 and 1221/Bom/1994). Copies of the abovementioned orders are placed on record. The learned CIT-Departmental Representative has also placed strong reliance on the Mumbai Tribunal decision in the case of S.K. Estates (P) Ltd. v. Asstt. CIT (supra).
16. Shri Maheshwari also advocated before us what he referred to as matching concept of income and expenditure. In other words, he argued that expenditure which is relevant to the earning of income only should be deducted from such income so that a correct picture of the real income chargeable to tax can emerge. For this proposition, he relied on the Hon'ble Bombay High Court decision in the case of Tapatia Tools Ltd. v. Jt. CIT . He invited our attention to the following observations of the High Court, which are extracted below from para 22 of the order:
Therefore, under the mercantile system of accounting, in order to determine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed (expenses). Under the mercantile system of accounting, this matching is required to be done on accrual basis. Under this matching concept, revenue and income earned during an accounting period, irrespective of actual cash inflow, is required to be compared with expenses incurred during the same period, irrespective of actual outflow of cash....
This concept is also applied by the Supreme Court in the case of MIIC Ltd. (supra) under following observations:
Ordinarily, revenue expenditure which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year in which it is incurred. It cannot be spread over a number of years even if the assesses has written it off in his books, over a period of years. However, the facts may justify an assessee who has incurred expenditure in a particular year to spread and claim it over a period of ensuing years. In fact, allowing the entire expenditure in one year might give a very distorted picture of the profits of a particular year. Issuing debentures is an instance where, although the assessee has incurred the liability to pay the discount in the year of issue of debentures, the payment is to secure a benefit over a number of years. There is a continuing benefit to the business of the company over the entire period. The liability should, therefore, be spread over the period of the debentures.
Therefore, the matching concept, which we have referred to is well recognized by various judgments of the Supreme Court. In this case, the issue is whether the entire expenditure distorts the profits of a particular year. In this case, we are concerned with computation of income and, therefore, the method of accounting followed by the assessee is relevant because accrual of income is to be seen in the light of the method of accounting. We may also point out that this matching concept is also covered by Section 36(1)(iii) read with Section 43(2), which defines the word 'paid'. Both these sections form part of Chapter IV--Computation of business income. In this case, we are concerned with payment of Rs. 55 being interest of five years paid in the first year. The total amount involved is Rs. 2,72,25,000. The term 'interest' has been defined under Section 2(28A) of the Act. Briefly, interest payment is an expense under Section 36(1)(iii). Interest on monies borrowed for business purposes is an expenditure in a business [see M.L.M. Muthiah Chettiar v. CIT (1959) 35 ITR 339 (Mad)]. For claiming deduction under Section 36(1)(iii), the following conditions are required to be satisfied, viz., the capital must have been borrowed; it must have been borrowed for business purpose and the interest must be paid. The word 'paid' is defined in Section 43(2). It means payment in accordance with the method followed by the assessee. In the present case, therefore, the word 'paid' in Section 36(1)(iii) should be construed to mean paid in accordance with the method of accounting followed by the assessee i.e., the mercantile system of accounting. In the first year ending 31st March, 1996, the assessee borrowed Rs. 495 lakhs (Rs. 4.95 crores) from Maliram Makharia Stock Brokers (P) Ltd. whereas, in the accounting year ending 31st March, 1997, it borrowed Rs. 100 lakhs (Rs. 1 crore) from Sharp Knife Co. (P) Ltd. In other words, the assessee got the benefit of Rs. 495 lakhs for the accounting year 31st March, 1996 and Rs. 100 lakhs for the accounting year ending 31st March, 1997 (in all amounting to Rs. 595 lakhs). Now, if the matching concept is not applied then, the profits get distorted. In this connection, the following facts may be seen. For the year ending 31st March, 1996, the assessee has submitted that it has incurred an expenditure amounting to Rs. 2,72,25,000 as and by way of interest deductible under Section 36(1)(iii) of the IT Act. However, in the annual accounts, the said amount is not debited to the P&L a/c. It is interesting to note from the P&L a/c for the year ending 31st March, 1996, that profit after tax was Rs. 1,86,34,016. Now if the expenditure incurred was Rs. 2,72,25,000 as submitted by the assessee then the assessee could never have earned the said profit of Rs. 1,86,34,016. This is how the profit got distorted. In the annual report, the assessee has conceded that Rs. 2,72,25,000 was deferred revenue expenditure to be written off over five years. In his order, the AO has recorded a finding of fact which categorically brings out the matching concept. He has stated that for the accounting year 31st March, 1996, profit after tax increased to Rs. 1,86,34,016 from Rs. 50 lakhs in the last year ending 31st March, 1995. Therefore, the AO was right in apportioning the expenditure at 18 per cent per annum on Rs. 495 lakhs amounting to Rs. 74,250 for three days because only then the estimated expenditure could match with income of Rs. 1,86,34,016. If the expenditure was Rs. 2,72,25,000, the net profit cannot be Rs. 1,86,34,016. The assessee followed mercantile system of accounting. In their annual accounts, the assessee has shown Rs. 2,72,25,000 as deferred revenue expenditure. Therefore, in our view, the expenditure of Rs. 2,72,25,000 though paid was not incurred and, in fact, what was incurred was Rs. 74,250 for year ending 31st March, 1996. To put it in a different way, the annual accounts show that Rs. 2,72,25,000 represented interest of five years. If so, expenditure for five years cannot match with the income of one year amounting to Rs. 1,86,34,016.
17. Shri Maheshwari also relied on the Hon'ble Supreme Court decision in the case of CIT v. U.P. State Industrial Development Corpn. (1997) 139 CTR (SC) 267 : (1997) 225 ITR 703 (SC) for the proposition that in order to determine the question of taxability, well-settled legal principles as well as principles of accountancy have to be taken into account and that for the purpose of ascertaining profits and gains, the ordinary principles of commercial accounting should be applied.
18. Learned CIT-Departmental Representative also relied on the Tribunal, Calcutta Bench decision in the case of J.C.T. Ltd. v. Asstt. CIT (1998) 61 TTJ (Cal) 206 : (1998) 65 ITD 169 (Cal), in support of his contention that deduction under Section 36(1)(iii) is not available if a different treatment has been given in the books of account. He invited our attention to the ratio of this case, relevant para of which is extracted below from the head note:
Thus, there was no basis to hold that provisions of Section 36(1)(iii) supersede the provisions of Section 43(1) relating to 'actual cost' insofar as interest paid on borrowings made for acquisition of capital assets was concerned. Both the provisions co-exit. In these circumstances, the option exercised in the books of account would be decisive. In the case of an existing business, the interest paid on borrowings for acquisition of capital asset can be treated as the revenue expenditure as well as capital expenditure depending upon the view taken by the businessman on overall appraisal of the facts and circumstances of his case. While in the instant case, the assessee found it more advantageous to press for the deduction under Section 36(1)(iii) there might be assessees who may with equal vehemence contest for the capitalization of similar amounts. Thus, the provisions of Section 36(1)(iii) do not require that interest on loans taken for acquisition of fixed assets should necessarily be treated as the revenue expenditure in every case after the business has come into existence. If the interest is capitalized in the books of account and treated as part of actual cost, the provisions of Section 36(1)(iii) would not be applicable because the amount of interest paid no longer retains its separate character and existence and represents integral part of the cost of acquisition of the assets itself.
Therefore, the assessee's contention that in view of provisions of Section 36(1)(iii), the amount of interest had to be allowed as deduction irrespective of the treatment given in the books of account was not legally tenable and unacceptable. These provisions had no application on the cost of assets to the assessee which is governed by the provisions of Section 43(1) and other allied provisions pertaining to depreciation allowable, etc. Therefore, the AO was right in rejecting the assessee's claim for deduction under Section 36(1)(iii).
19. Shri Maheshwari also invited our attention to the AS-7, relevant portion of which has been reproduced above. It is submitted that para 8.8 of AS-7 makes it very clear that if finance costs are specifically attributable to a particular contract, the same have to be included as part of accumulated contract costs. The learned CIT-Departmental Representative submitted that this accounting mandate is further fortified by AS-16 issued in the year 2000, He invited our attention to the following definitions contained at para 3 of AS-16:
Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds.
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
(Emphasis, italicized in print, supplied) It is submitted that a building project would come under the definition of 'a qualifying asset'. He then referred to the method adopted for treatment of finance costs in respect of qualifying asset as prescribed at para 6 of AS-16, the relevant para of which is as under:
Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalized as part of the cost of that asset.
20. The learned CIT-Departmental Representative reiterated that the finance costs identifiable with a particular project have to be added to the cost of the project as any other method is going to distort the profits of the project.
21. In his rejoinder, Shri P.R. Toprani, attending on behalf of the assessee-company submitted that in the books of account, interest is added to the value of work-in-progress only for determination of the cost of that project and insofar as deductibility is concerned, the interest expenditure has to be allowed in the year in which the same accrues as per mandate of Section 36(1)(iii) of the IT Act.
22. We have given our careful consideration to the arguments and submissions so ably put before us by both the sides. We have also considered the relevant facts and the legal position as emerging from various judicial pronouncements with which we have been assisted. At the outset, it must be made clear that there is no dispute about the factual position in respect of the two cases. In the books of account, the interest expenditure is allocated to different projects and the interest expenditure referable to a particular project is added to the value of work-in-progress in respect of that project. A reference may be made to the Schedules annexed to and forming part of the accounts for the year ended 31st March, 1993 in the case of Wall Street Construction Ltd, Note No. 1 with the title 'System of Accounting' declares that the company follows completed project method of accounting and that the work-in-progress is valued at. cost. Note No. 2 declares that the cost of construction includes cost of land, development rights, construction, development, administration, marketing and finance. During the course of assessment proceedings, the Authorised Representatives of the assessees had categorically admitted that the assessees are following project-completion method of accounting. In the books of account, interest expenditure has been consistently identified and added to the value of work-in-progress. This factual position is conclusively established from the project-wise and assessment year-wise break of interest expenditure reproduced by the AO at p. 11 of his order in the case of Wall Street Construction Ltd. (supra) for asst. yr. 1993-94, which is reproduced below:
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91-92 92-93 93-94 94-95 95-96 96-97
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Borivli N. Manor Nil 43,999 1,28,077 22,93,887 53,46,993 10,73,288
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Pune N. Hill Nil Nil 4,614 8,73,755 9,61,671 19,19,447
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Bangalore Natasha Golf View Nil 19,49,740 33,83,951 66,93,185 36,47,818 91,09,469
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Bangalore N. Penta Nil 92,148 39,219 64,860 Nil 8
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Goa-Casa Natasha Nil Nil 19,705 2,37,796 17,34,188 Nil
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Goa-Dona Natasha Nil Nil Nil Nil 24,97,267 10,99,500
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However, deduction under Section 36(1)(iii) is claimed by the assessees while filing the returns of income as per the computation of total income.
23. In this factual scenario, it must be examined at the very beginning as to whether the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra) concludes the relevant issue. If the answer is yes, we need not proceed further in this matter as the Hon'ble Bombay High Court decision would be binding. In that case, while stating the facts, the Hon'ble High Court observed that the assessee-company was engaged in the business of construction of buildings and the assessee followed mercantile system of accounting and a "modified project-completion method" for computing its profits. The assessee secured development rights in respect of a plot of land and for this purpose, interest-bearing borrowed funds were utilized. The assessee claimed deduction in respect of interest paid under Section 36(1)(iii), which was allowed by the AO. The CIT invoked his jurisdiction under Section 263 and held that the borrowed funds were utilized in acquiring capital asset and, ' therefore, the interest was a capital expenditure. On these facts, the following question of law arose before the High Court:
Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the interest claimed as revenue expenditure amounting to Rs. 14,09,942 cannot be treated as capital expenditure and added to work-in-progress in spite of the fact that other expenses on project were being capitalized by the assessee itself and holding that the CIT was wrong in directing the AO to disallow the said interest and treat the same as capital expenditure as a part of work-in-progress, thereby quashing the order under Section 263 of the Act of the CIT?
24. The Hon'ble High Court answered the above question in the affirmative on the basis of the following reasoning as reproduced from p. 581 of the report:
From the facts found by the Tribunal on record, it is clear that the assessee undertook two-fold activities. It bought and sold flats. Secondly, the assessee was also engaged in the business of construction of buildings. The profits from both the activities were assessed under Section 28 of the IT Act. In this case, we are concerned with the second activity (hereinafter referred to, for the sake of brevity, as 'Kandivali project'). According to the CIT, the loan was raised for securing land/development rights from the Mandal, That the loan was utilized for purchasing the development rights, which, according to the CIT, constituted a capital asset. According to the CIT, since the loan was raised for securing capital asset, the interest accrued thereon constituted part of capital expenditure. This finding of the CIT was erroneous. In the case of India Cements Ltd. v. CIT it was held by the Supreme Court that in cases where the act of borrowing was incidental to the carrying on of business, the loan obtained was not an asset. That, for the purposes of deciding the claim of deduction under Section 10(2)(iii) of the Indian IT Act, 1922 [Section 36(1)(iii) of the present IT Act], it was irrelevant to consider the purpose for which the loan was obtained. In the present case, the assessee was a builder. In the present case, the assessee had undertaken the project of construction of flats under the Kandivali project. Therefore, the loan was for obtaining stock-in-trade. That, the Kandivali project constituted the stock-in-trade of the assessee. That the project did not constitute a fixed asset of the assessee. In this case, we are concerned with deduction under Section 36(1)(iii). Since the assessee had received loan for obtaining stock-in-trade (Kandivali project), the assessee was entitled to deduction under Section 36(1)(iii) of the Act. That, while adjudicating the claim for deduction under Section 36(1)(iii) of the Act, the nature of the expense--whether the expense was on capital account or revenue account--was irrelevant as the section itself says that interest paid by the assessee on the capital borrowed by the assessee was an item of deduction. That, the utilization of the capital was irrelevant for the purposes of adjudicating the claim for deduction under Section 36(1)(iii) of the Act [see the judgment of the Bombay High Court in the case of Calico Dyeing & Printing Works v. CIT ]. In that judgment, it has been laid down that where an assessee claims deduction of interest paid on capital borrowed, all that the assessee had to show was that the capital which was borrowed was used for business purpose in the relevant year of account and it did not matter whether the capital was borrowed in order to acquire a revenue asset or a capital asset, The said judgment of the Bombay High Court applies to the facts of this case.
25. From the above it becomes apparent that the case of Lokhandwala Construction Industries Ltd. (supra) arose in entirely different facts. There the Hon'ble High Court was concerned with the question as to whether the interest expenditure is a capital expenditure or revenue expenditure. The Hon'ble High Court referred to its earlier judgment in the case of Calico Dyeing & Printing Works v. CIT where it was held that for claiming deduction of interest, all that the assessee has to prove is that the capital was borrowed for business purposes and it was immaterial as to whether the borrowed funds were utilized for acquiring a capital asset or revenue asset. On the contrary, the controversy in the present appeals is totally different. Here, we are concerned with the question as to whether interest expenditure identifiable with a particular project, in the case of an assessee following project-completion method of accounting, is to be deducted as period cost from year to year or the same is to, be added to the cost of that particular project so as to allow deduction eventually in the year of completion of the project. There is no dispute regarding the nature of the expenditure being capital or revenue. We are, therefore, of the view that the Hon'ble Bombay High Court decision is not applicable to the facts of the present appeals. However, when this issue came up before the Tribunal in the case of Wall Street Construction Ltd. (supra) for asst. yr. 1994-95, the Tribunal reproduced the relevant portion of the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. (supra) and recorded the following finding at para 12 of the order:
The facts of the present case are exactly similar to the case decided by the Hon'ble Bombay High Court (supra), therefore, the enhancement of the income of the assessee by Rs. 1,01,63,484 made by the learned CIT(A) is unjustified. The addition made by the learned CIT(A) is, therefore, deleted.
For asst. yrs. 1995-96 and 1996-97 in the case of Wall Street Construction Ltd., the issue was treated by the Tribunal as covered and was accordingly decided in assessee's favour. We have already held that the decision in case of Lokhandwala Construction Industries Ltd. (supra) is not applicable to the facts of the cases before us and therefore, this issue has to be considered and decided on merits.
26. The learned Counsel for the assessee placed reliance on the Hon'ble Calcutta High Court decision in the case of Tetron Commercial Ltd. (supra). The relevant part of the ratio of this case may be extracted below from the headnote:
Whether the deduction under Section 36(1)(iii) of the IT Act, 1961, is available or not is dependent on the question whether the capital borrowed is for the purpose of the business of the assessee. If it is found that the capital was borrowed for the purpose of the business of the assessee, the interest payable thereon is admissible under the said section. It is immaterial whether the same is in the nature of capital expenditure or revenue expenditure. If the expenditure is a business expenditure which relates to any stage of the business activity carried on by the assessee, whether isolated transaction or not, it is admissible for deduction under the said section. A business commences with the activities undertaken even at the preparatory stage for setting up of the business. Acquisition of immovable property for being used in the business by borrowed capital entitles the assessee to claim benefit of the section on the interest paid thereon, even if the asset acquired is not utilized for the purpose of the business in the relevant previous year.
27. We fail to appreciate the relevance of this case relied upon by the learned Counsel for the assessee. The issue was entirely different. The learned Counsel also strongly relied on the Hon'ble Bombay High Court decision in the case of Goodlas Nerolac Paints Ltd. (supra) for the proposition that the Department is not entitled to discard a regular system of accounting consistently followed by the assessee. As already discussed by us above, the assessees have been following a system of accounting where interest expenditure is allocated project-wise and is added to the value of work-in-progress in the books of account. Therefore, in our view, the arguments of learned Counsel that the method of accounting regularly followed by the assessees has been unjustifiably discarded by the Department, does not hold in water. Further, the Hon'ble Bombay High Court decision in the case of Goodlas Nerolac Paints Ltd. (supra) does not in any way come to the rescue of the assessees, which would become clear from the relevant observations of the Hon'ble High Court, which are reproduced below from p. 5 of the report:
Before parting with this question, we consider it desirable to mention that the Tribunal is a final Judge of facts. The High Court, in reference, does not interfere with the findings of fact unless such a finding is perverse or is such that no reasonable person can come to such a finding. This will be so even when the High Court feels that it would have come to a different conclusion, if it was sitting in appeal. In that sense, when the High Court declines to interfere with a finding of fact given by the Tribunal in an earlier year, it may not mean that the High Court had approved of such a finding. This, however, does not mean that a subsequent Bench of the Tribunal should come to a conclusion totally contradictory to the conclusion reached by the earlier Bench of the Tribunal in the same case for an earlier year on a similar set of facts. Such a thing may not be in the larger public interest as it is likely to shake the confidence of the public in the system. It is, therefore, desirable that in case a subsequent Bench of the Tribunal is of the view that the finding given by the Tribunal in an earlier year requires reappraisal either because the appreciation, in its view, was not quite correct or inequitable or some new facts have come to light justifying reappraisal or reappreciation of the evidence on record, it should have the matter placed before the President of the Tribunal so that the case can be referred to a larger Bench of the Tribunal for adjudication and for which there is a provision in the IT Act.
28. The Hon'ble High Court observed that if a subsequent Bench of the Tribunal does not concur with the view adopted by an earlier Bench, the issue must be referred for constitution of a Special Bench. This is what has been done in the present cases.
29. A reference may also be made to some other cases relied upon by the learned Counsel for the assessee. In the case of Modi Rubber Ltd. (supra) decided by Tribunal, Delhi Bench, the assessee was a manufacturer of automobile tyres and tubes and the question pertained to valuation of closing stock. The ratio of this case may be reproduced below from the head note: "It is well-settled proposition of law that a taxpayer is free to employ, for the purpose of his trade, his own method of keeping accounts, and for that purpose to value his stock-in-trade in accordance with the established method of stock valuation. A method of accounting adopted by trader consistently and regularly cannot be discarded by the AO unless in his opinion the income of the trade cannot be properly deduced therefrom. It is also well-settled that the assessee is permitted to change the method of accounting as well as the method of valuation of closing stock from time to time subject to the condition that the AO is satisfied that the change effected by the assessee is bona fide for meeting the changed situation or changed circumstances and provided the change is for regular adoption.
In the instant case, the assessee has adopted the direct-cost method in respect of goods in process and finishing goods. Three factors are to be taken into account, namely, (a) cost of purchase, (b) cost of conversion, and (c) other costs incurred in the normal course of business in bringing the inventories upto their present location and conditions. It was nobody's case that cost of raw material had not been correctly taken by the assessee. In the cost of conversion direct labour, direct expenses and sub-contracted work are to be taken into account and in addition to that production overheads are to be ascertained in accordance with other direct costing or absorption costing method. The assessee, in the instant case, had taken into account salary, wages, bonus, ex gratia payments, etc. to staff and workers. It had taken into account power and fuel consumed, repair and maintenance to plant and machinery, repairs and maintenance to factory buildings. The items that had been excluded were administration overheads, selling and distribution overheads, interest and depreciation. There was no doubt about the exclusion of administrative, selling and distribution overheads. The doubt was in relation to interest and depreciation. Since in taking production overheads direct costing is permissible, the fixed costs are to be excluded in determining the cost. Fixed costs are defined to be those costs of production which by their very nature remain relatively unaffected in a definite period of time by variations in the volume of production. Depreciation would be such of the items which is charged on fixed percentage irrespective of volume of production and could be excluded in working out the production overheads for determination of cost of conversion of goods. As to the interest on finance, since the expenditure on finance had specifically been provided to be excluded in determining the cost of production, it was permissible to exclude the interest in respect of the finances. If the system of accounting was regularly followed in the subsequent assessment years, there would not be any loss to the Revenue. Once a uniform system of accounting was adopted, the determination of correct profit by such method would be fair and reasonable.
30. From the above, it may be seen that the facts were entirely different. There was no question regarding the project-completion method and determination of the cost of project in the case of a builder. The other two cases relied upon by the learned Counsel for the assessees namely, viz., Mopeds India Ltd. (supra) decided by Hon'ble Andhra Pradesh High Court and Carbomndum Universal Ltd. (supra) decided by the Madras High Court are also on the question of valuation of stock. These cases, in our view, cannot be applied for the purpose of determination of the cost of work-in-progress in the case of a builder, who is following project-completion method. For the same reasoning, we do not find much merit in the argument of learned Counsel for the assessee that adding finance costs to the value of work-in-progress would artificially' inflate the market price of the project. This argument may be relevant for a case where profits chargeable to tax is determined from year to year. In such a case, valuation of closing stock either at cost or market price whichever is lower, assumes importance. However, in the case of a builder following project-completion method of accounting, this has no relevance for the simple reason that the determination of profits chargeable to tax is postponed to the year in which the project is completed or is substantially completed. In our view, the true profits in such a case can be determined only when entire cost of the project, direct or indirect, including finance cost is added to the value of work-in-progress. This proposition is also fortified by the matching concept, as propounded by the Hon'ble Bombay High Court in the case of Tapaiia Tools Ltd. (supra). In the present cases, the assessees have identified interest cost and have allocated such cost to different projects in the books of account, but deduction in respect of interest is claimed under Section 36(1)(iii) against the income of some other projects which are completed during the relevant years, In our view, this procedure results into distortion of the correct profits which must be determined as per the project-completion method followed by the assessees.
31. For the reasons discussed above, we hold that where an assessee is following project-completion method of accounting, the interest identifiable with that project should be allowed only in the year when the project is completed and the income from that project is offered for taxation.
32. The records shall now be placed by the Registry before the Division Bench for disposal of the relevant appeals in accordance with our decision insofar as the issue referred to us is concerned and for disposal of other grounds of the appeals on merits.