Income Tax Appellate Tribunal - Mumbai
S.K. Estates (P.) Ltd. vs Assistant Commissioner Of Income-Tax on 31 October, 1996
Equivalent citations: [1997]60ITD621(MUM)
ORDER
Garg, AM
1. This is an appeal by the assessee against the order of the Commissioner of Income-tax (Appeals) for the assessment year 1986-87.
2. The first dispute in this appeal is regarding the method of accounting being followed by the assessee and addition of Rs. 41,060 which was made by rejecting the assessee's method of accounting, viz., 'Project Completion Method'.
3. The assessee entered into an agreement with M/s. Unique Estates Development Company Limited for construction of three of its buildings for weaker sections in terms of section 21 of the Urban Land (Ceiling and Regulation) Act, 1976. The assessee was to get actual cost of the construction plus 5% thereon as its profit. The assessee treated the construction of each building as a separate project and offered income for one of such buildings. The other two buildings were though completed but no income thereof was offered on the ground that sale of the flats had not taken place and that the assessee had to wait for securing contract for additional amenities to be carried out at the requests of the intending purchasers. The Assessing Officer did not agree with the contentions of the assessee. According to him there was no relation to the accrual of income with the completion of the building as the assessee was entitled to 5% profit on the expenses incurred by it on the construction. It has incurred a sum of Rs. 2,61,256 for Panchvati I and Rs. 5,59,936 for Panchsheel II. The profit thereon at the rate of 5% is worked out at Rs. 41,060 which is added to the income of the assessee. The Assessing Officer has also not accepted the method of accounting of the assessee, viz., 'Project Completion Method', by giving the following reasons :
(i) that the department has not accepted the project completion method in the past;
(ii) that the assessee did not follow the project completion method in the past, which is a change in the method of accounting, the Company being following mercantile system in the past;
(iii) the method is not in conformity with the Income-tax Law; and
(iv) under the Income-tax Act each year is a self-contained unit and taxed accordingly.
The Assessing Officer observed that the acceptance of assessee's method of accounting was tantamount to discrimination between different categories of assessees and favouring a particular category of assessee engaged in building construction business. He therefore held that for the purpose of determining the income from construction business, the basic principle enunciated in the agreement with the developer will be followed for construction work, i.e., 5% over and above the construction cost is the profit to be taken.
4. The CIT (Appeals) upheld the order of the Assessing Officer by observing in paragraph 2.2 of his order as under :
"I have heard the learned counsel and given careful consideration to the various submissions made by him. However, I cannot persuade myself to agree with the same. At the outset, it has been admitted that the entire exercise and the so called 'arrangement' with M/s. Unique Estates Development Co. Ltd. was undertaken with a view to accommodate the said company and also with a view to by-pass the provisions of the U.L.C.R. Act. In doing so the appellant-company has relied on totally irrelevant and contrived arguments which did not help them in any way. On the other hand, I find that the Assessing Officer has given detailed and cogent reasons for arriving at the conclusion which have been summarised on pages 10 & 11 of the asst. order. Further, the appellant's submissions that the department has accepted the project completion method in the past is also not found to be correct. The Assessing Officer has rightly adopted the method for determining the income from construction business, the basic principle enunciated in the agreement for the development, i.e., 5% over and above the construction cost, in the profit. For the purpose of determining the income from profit on sale of extra amenities, the sale proceeds and value of work-in-progress as reported in the accounts has been followed, and both these actions of the Assessing Officer are confirmed."
5. We have heard the parties and considered their rival submissions. The assessee is a contractor and not a builder, and as held by Bombay Bench in the case of Peterson Candy International v. ITO [1989] 33 TTJ (Bom.) 252, the project completion method cannot be applied to the assessee. A reference may also be invited to the Patna and Delhi High Court decisions referred to by the learned Departmental Representative, in the case of Sri Sukhdeodas Jalan v. CIT [1954] 26 ITR 617; and in the case of Tirath Ram Ahuja (P.) Ltd. v. CIT [1976] 103 ITR 15. The assessee's income, as per the agreement, accrues by incurring the expenditure on behalf of the builder. It acquired a right of 5% profit on completion of the work. The assessee's plea that the sale of the flats have not been made and that the possibility of the intending purchasers to ask for certain additional amenities and consequently the assessee's liability to incur certain additional expenditure, has nothing to do with the assessee's accrual of profit from the contract with M/s. Unique Estates Development Company Limited. If the assessee has to take some other job for providing additional facilities for the intending purchasers, it would be a separate contract with the purchasers and profit and loss thereon would accrue in the year when such additional facilities were provided and the job was completed by the assessee on their behalf. In so far as the assessee's profit from the contract with M/s. Unique Estates Development Company Limited is concerned, as aforesaid, it accrue to the assessee on completion of the three buildings. The decision of the Tribunal in the case of Shapoorji Pallonji & Co. (Rajkot) (P.) Ltd. v. ITO [1994] 49 ITD 479 (Bom.), relied upon by the assessee, has no bearing on this issue. It was a case of invoking the jurisdiction under section 263 by the Commissioner of Income-tax, and the Tribunal held that the fact that profits on a project was postponed from the year of its commencement to the year of its completion could not be the basis for considering the order of the Assessing Officer to be erroneous. The method in that case was being followed from year to year and there was no dispute about the propriety of the method being followed by the assessee, which was admitted and taken as one of the recognised method of accounting. In these circumstances, in our opinion, the departmental authorities are justified in bringing the sum of Rs. 41,060 to the income of the assessee.
6. The next dispute is against the disallowance of interest of Rs. 4,95,000. This is related to 'Girnar Apartments Project', whose profits were not offered to tax by the assessee as the project was under completion and the assessee was following 'Completion of Project' method. Here, it may be noted that the assessee is a builder and that there is no dispute on assessee's profit on completion of the project. The assessee had utilised a sum of Rs. 25.91 lakhs and the interest of Rs. 4.95 lakhs is worked out on the amount spent on this project. The assessee's claim is that it is an annual revenue expenditure and, therefore, should have been allowed as a deduction even though the project to which it was related was under construction and profits thereof would be offered as and when the project is completed. The assessee referred to the decisions of the Tribunal, Bangalore Bench in the case of Motor Industries Co. Ltd. v. IAC [1995] 55 ITD 465; Bombay High Court decision in the case of Melmould Corpn. v. CIT [1993] 202 ITR 789 (Bom.); Madras Bench decision in the case of E.I.D. Parry (India) Ltd. v. Dy. CIT [1993] 46 ITD 387 and Delhi Bench decision in the case of ITO v. Modi Rubber Ltd. [1992] 43 ITD 396. All these decisions relate to the valuation of stock and it was held that the valuation of stock without including the overhead cost is a recognised method and the assessee is free to adopt the same. The finance charges, referring to the Accounting Standards (AS-7) issued by the Institute of Chartered Accountants, are categorised as indirect/overhead cost which cannot be related to a specific contract. The contention of the learned counsel for the assessee is that the interest of Rs. 4.95 lakhs cannot be related to the 'Girnar Apartments Project' and, therefore, the Income-tax Officer was not justified in disallowing the same, it being an annual expenditure incurred for the purpose of carrying on the business of the assessee. The Learned Departmental Representative, supporting the orders of the Assessing Officer and the CIT (Appeals), submitted that the interest cost though categorised as overhead or indirect cost, is identifiable and is calculated based on the utilisation of the borrowed money in the construction business at Girnar. According to him, the expenditure cannot be allowed on year to year basis when the assessee is offering the income from the contract in which the borrowed money was utilised on project completion method.
7. We have heard the parties and considered their rival submissions. In a project completion method, the expenses are to be accumulated for the period of construction and allowed as a deduction only on the completion of the project. It is explained in para 7 of the Accounting Standards as under :
"7. Accounting Treatment of Construction Contract Costs and Revenues.
7.1 Two methods of accounting for contracts commonly followed by contractors are the percentage of completion method and the completed contract method.
7.2 Under the percentage of completion method, revenue is recognised as the contract activity progresses based on the stage of completion reached. The costs incurred in reaching the stage of completion are matched with this revenue, resulting in the reporting of results which can be attributed to the proportion of work completed. Although (as per the principle of prudence) revenue is recognised only when realised under this method the revenue is recognised as the activity progresses even though in certain circumstances it may not be realised.
7.3 Under the completed contract method, revenue is recognised only when the contract is completed or substantially completed; that is, when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognised until the contract activity is substantially completed.
7.4. Under both methods, provision is made for losses for the stage of completion reached on the contract. In addition, provision is usually made for losses on the remainder of the contract.
7.5. It may be necessary for accounting purposes to combine contracts made with a single customer or to combine contracts made with several customers if the contracts are negotiated as a package or if the contracts are for a single project. Conversely, if a contract covers a number of projects and if the costs and revenues of such individual projects can be identified within the terms of the overall contract, each such project may be treated as equivalent to a separate contract."
8. Para 8 of this Accounting Standards provides as to what costs are to be accumulated in a case of completion of contract method. It reads as under :
"8. Costs to be Accumulated for construction contracts.
8.1 Costs attributable to a contract are identified with reference to the period that commences with the securing of the contract and closes when the contract is completed.
8.2. Costs not specifically attributable to any contract incurred by the contractor before a contract is secured are usually treated as expenses of the period in which they are incurred. However, if costs attributable to securing the contract can be separately identified and either the contract has been secured or there is a clear indication that the contract will be obtained, the costs are sometimes treated as applicable to the contract and are deferred. As a practical measures, costs directly identifiable with a contract are sometimes deferred until it is clear whether the contract has been secured or not.
8.3 Costs attributable to a contract include expected warranty costs. Warranty costs are provided for when such costs can be reasonably estimated.
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 paragraph 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."
9. On a plain reading of this Accounting Standard, it is evident that the finance charges which include interest in its ambit, is an indirect cost and if it is identifiable with the contract of construction, it has to be accumulated and allowed only in the year in which the contract/project is completed. In this case, admittedly the Girnar Apartments Project, in which the assessee had utilised the borrowings to the extent of Rs. 25.91 lakhs, was not complete and the income from this project is being offered by the assessee itself only on the completion of the project, the interest of Rs. 4.95 lakhs pertaining to the borrowings of Rs. 25.91 lakhs utilised in this project has to have the same treatment. The expenditure is to be accumulated and to be allowed in the year when the project is completed. The decisions of the Tribunal of Bangalore Bench; Madras Bench; and Delhi Bench; and of the Bombay High Court, referred to by the learned counsel for the assessee, are with regard to the valuation of closing stock. It was held in these cases that the closing stock can be valued without including the overhead cost, including the interest expenditure. These decisions, in our opinion, have no bearing on the issue to be decided as to whether the interest paid by the assessee relating to a project, the profits of which are being offered on completion of project method, is to be allowed in the year to which the expenditure relate or in the year in which the project is completed. As aforesaid, the assessee is following the 'Project Completion Method'. Therefore, the entire expenditure relating, which is identifiable with the project, has to be accumulated and allowed in the year when the project is completed and the income is offered from the project. In these circumstances, we do not find any merit in this ground of the assessee. It is accordingly rejected.
10. In the result, the appeal is dismissed.