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Facts
The assessee, a real estate developer, followed the Percentage of Completion Method (POCM) for revenue recognition. During the assessment year 2012-13, no income was recognized as the minimum threshold for completion was not met. The Assessing Officer disallowed 90% of the revenue expenditure claimed as business expenditure, treating it as project cost.
Held
The Tribunal held that the assessee consistently followed its accounting method and incurred the expenditure wholly and exclusively for business purposes. The Assessing Officer's ad-hoc disallowance of 90% of the expenditure was considered arbitrary, especially since he himself allowed 10%.
Key Issues
Whether revenue expenditure not directly linked to a project where no revenue has been recognized should be disallowed as business expenditure or capitalized as project cost.
Sections Cited
143(3), 145(3), 37
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Income Tax Appellate Tribunal, DELHI BENCH “A”: NEW DELHI
Before: SHRI C. N. PRASAD & SHRI M. BALAGANESH
O R D E R PER M. BALAGANESH, A. M.: 1. The appeal in AY 2012-13, arises out of the order of the Commissioner of Income Tax (Appeals)-3, New Delhi [hereinafter referred to as ‘ld. CIT(A)’, in short] in Appeal No. 174/2015-16 dated 02.01.2017 against the order of assessment passed u/s 143(3) of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’) dated 19.03.2015 by the Assessing Officer, ACIT, Circle-8(1), New Delhi (hereinafter referred to as ‘ld. AO’).
The only issue to be decided in this appeal is as to whether the learned CITA was justified in confirming the ad-hoc disallowance of Rs 8,73,10,314, being 90% of revenue expenditure of Rs 9,70,11,460/- made by the learned AO under various heads which were claimed as business expenditure by the assessee in the facts and circumstances of the incident case.
We have heard the rival submissions and perused the materials available on record. The assessee company is engaged in the business of construction and development of real estate projects, which includes developing townships, housing, commercial premises and other related activities. The assessee has been consistently following the Percentage Of Completion Method (POCM) for recognition of revenue as provided in the Guidance Note on Accounting of Real Estate Transactions, read with Accounting Standard- 7 (AS 7) on ‘Construction Contracts’ issued by the Institute of Chartered Accountants of India (ICAI). During the year under consideration, no portion of income has been recognized qua the projects under development applying the POCM as the minimum threshold completion of work was not achieved. As regards the project, the assessee had considered the expenses for an amount of Rs 46,06,24,969/- as part of project cost which was reflected under the head Inventories as is evident from Schedule 14, 16 and 19 to the audited financial statements placed on record. As regards various business expenditure incurred by the assessee, the expenditure related to the project is considered as part of the inventory / project cost while other revenue expenditures are debited to the profit and loss account in terms of the Guidance Note referred supra. It may be noted that out of total regular business expenditure of Rs 16,17,54,992/-, expenditure to the extent of Rs 6,47,43,532/- is already transferred and included as part of Work in Progress (Inventory) and balance sum of Rs 9,70,11,460/- was debited to the profit and loss account in terms of the Guidance Note issued by ICAI supra. The business expenditure so debited to the profit and loss account has been claimed as deduction by the assessee in the return of income.
The case of the Learned AO is that the expenditure claimed as deduction by the assessee are directly or indirectly linked to the project and since no revenue from the project is recognized, those expenditure need to be considered as part of the project cost / inventory / work in progress and accordingly not to be allowed as deduction. The Learned AO however, considered 10 percent of the said expenditure as an allowable revenue expenditure and made an ad hoc disallowance of 90 percent there on in the sum of Rs 8,73,10,314/- and completed the assessment. This action of the Learned AO was upheld by the Learned CITA.
5. It is not in dispute that during the year under consideration, the assessee had not achieved the minimum threshold limit of completion of work so as to warrant recognition of revenue under POCM as stipulated by AS-7 (Construction Contracts) and Guidance Note on Accounting of Real Estate Transactions issued by ICAI. It is pertinent to note that the genuinity of the incurrence of the said expenditure and its business nexus are not even doubted by the revenue in the instant case. The only grievance of the revenue seems to be that no income has been recognized during the year from the projects and accordingly these expenditure are to be capitalized to be part of the inventory. In this regard, it would be relevant to seek assistance from the Guidance Note on Accounting of Real Estate transactions read with AS- 7 issued by ICAI which prescribe the method of accounting of expenditure under the application of POCM qua the recognition of revenues and project expenses as under:-
“(a) Cost of land and cost of development rights -All costs related to the acquisition of land, development rights in the land or property including cost of land, cost of development rights, rehabilitation costs, registration charges, stamp duty, brokerage costs and incidental expenses. (b) Borrowing Costs - In accordance with Accounting Standard (AS) 16, Borrowing Costs which are incurred directly in relation to a project or which are apportioned to a project. (c) Construction and development costs – These would include costs that relate directly to the specific project and costs that may be attributable to project activity in general and can be allocated to the project. 2.3 Construction costs and development costs that relate directly to a specific project include: (a) land conversion costs, betterment charges, municipal sanction fee and other charges for obtaining building permissions; (b) site labour costs, including site supervision; (c) costs of materials used in construction or development of property; (d) depreciation of plant and equipment used for the project; (e) costs of moving plant, equipment and materials to and from the project site; (f) costs of hiring plant and equipment; (g) costs of design and technical assistance that is directly related to the project; (h) estimated costs of rectification and guarantee work, including expected warranty costs; and (i) claims from third parties. 2.4 The following costs should not be considered part of construction costs and development costs if they are material: (a) General administration costs; (b) selling costs; (c) research and development costs; (d) depreciation of idle plant and equipment; (e) cost of unconsumed or uninstalled material delivered at site; and payments made to sub-contractors in advance of work performed. 2.5 Costs that may be attributable to project activity in general and can be allocated to specific projects include: (a) insurance; (b) costs of design and technical assistance that is not directly related to a specific project; (c) construction or development overheads; and (d) borrowing costs. Such costs are allocated using methods that are systematic and rational and are applied consistently to all costs having similar characteristics. The allocation is based on the normal level of project activity. Construction overheads include costs such as the preparation and processing of construction personnel payroll."
The assessee had allocated the cost of various expenditure strictly in accordance with the AS-7 and Guidance Note on Accounting of Real Estate transactions issued by ICAI by transferring the requisite portion to the project and claiming the remaining sums as revenue expenditure. The books of accounts and the book results submitted by the assessee are not sought to be rejected by the Learned AO in terms of section 145(3) of the Act. The application of Accounting Standard and Guidance Notes issued by ICAI and utilization of the same for the purpose of recognition of income under the Income Tax Act has been subject matter of due consideration by the Hon’ble Supreme Court in the case of Virtual Soft Systems Limited vs ACIT reported in 404 ITR 409 (SC) wherein the Hon’ble Apex Court had duly given due credence to the Page | 4 Accounting Standards and Guidance Notes issued by ICAI. It is well settled that earning of revenue is not a condition precedent for deduction of expenditure under section 37 of the Act. What is required to be seen is whether the business is set up and whether the expenditure incurred thereon are meant for the purpose of business. The issue in dispute was also subject matter of consideration by the Coordinate Bench of Delhi Tribunal in the case of AB Multiplex Private Limited vs ACIT in Del / 2014 wherein that assessee was engaged in the business of builders and developers; that the commercial projects of that assessee was under construction; that the expenses directly related to the project were added to the inventories (project under construction) as per its accounting policies. Certain expenses being administrative expenses and not directly related to the project were however debited in the profit and loss account and claimed as deduction. That assessing officer concluded that assessee did not have any business income and that since no business was carried out by that assessee during the year, the question of allowability of business expenditure does not arise which stood upheld by that Learned CITA. The Tribunal appreciating the existence of business activities held that the expenditure not linked / attributable to the project is allowable as deduction while computing the business income of that assessee. The facts of that case before the Delhi tribunal are squarely applicable to the facts before us.
Further in any event, we find that the Learned AO himself had allowed 10% of the total revenue expenditure as a deduction which goes to prove that he was convinced that the expenditure incurred by the assessee in the total sum of Rs 9,70,11,460/- are indeed meant wholly and exclusively for the purpose of business of the assessee. Having held so, the Learned AO erred in making an ad- hoc disallowance of 90% of the expenditure in the sum of Rs 8,73,10, 314/- which in our opinion is totally arbitrary in nature. A query was posed by the Bench to the Learned AR as to when the income has been ultimately offered to tax from the project. In response thereto, the Learned AR sought time to furnish the said details of income being offered in subsequent assessment years under POCM up to Assessment years 2022-23. We find from the perusal of the said details that certain assessments were even completed under section 143(3) of the Act by the Learned AO accepting the claim of the assessee.
In view of the aforesaid observations, we hold that assessee has followed the consistent practice of claiming deduction of revenue expenditure not related to the project since beginning i.e. from Assessment year 2011-12 onwards. We also find that the assessee’s method of accounting of claiming deduction has been accepted by the revenue in Assessment year 2011-12 except the finance cost and thereafter from Assessment year 2016-17 onwards. As far as Assessment years 2012-13 to 2015-16 are concerned, the revenue has only disputed the allowability of deduction of revenue expenditure not related to the project cost which has already been addressed by us in the present appeal. The fact of the business of the assessee being set up and expenditures being incurred wholly and exclusively for the purpose of business are not being doubted by the revenue. Considering the consistent method adopted by the assessee in the past and also in subsequent assessment years, we hold that a sum of Rs 8,73,10,314 would be squarely eligible for allowability of deduction in the year under appeal. Accordingly, the grounds raised by the assessee are hereby allowed.
In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on 31/07/2025.