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Before: SMT. P. MADHAVI DEVI & SHRI A. ALANKAMONY
IN THE INCOME TAX A PPELLATE TRIBUNAL HYDERABAD BENCH ‘A', HYDERABAD BEFORE SMT. P. MADHAVI DEVI, JUDICIAL MEMBER AND SHRI A. ALANKAMONY, ACCOUNTANT MEMBER Assessment Year: 2011-12 Dy. Commissioner of vs. Clean City Estates Pvt. Ltd., Income-tax, Hyderabad. Central Circle – 2(4), Hyderabad. PAN – AACCC4799H Appellant Respondent Revenue by: Shri Y.V.S.T. Sai Assessee by: Shri A.V. Raghuram Date of hearing: 11/12/2019 Date of pronouncement: 21/02/2020 O R D E R PER SMT. P. MADHAVI DEVI, J.M.:
This is an appeal filed by the Revenue against the order of CIT(A) – 12, Hyderabad, dated 10/08/2016 for AY 2012-13.
Brief facts of the case are that the assessee company engaged in the real estate business, filed its return of income for the AY 2011-12 on 28/09/2011 admitting loss of Rs. 1,44,670/-. There was a search and seizure operation in the case of Ramky Estates & Farms Ltd. on 07/02/2013, during the course of which, a Joint Development Agreement (JDA) dated 20/01/2011 entered into by the assessee along with another party with Ramky Estates & Farms Ltd. was found and seized. Therefore, a notice u/s 153C was issued to the assessee, in response to which, the assessee filed its return of income on 12/05/2014 admitting loss of Rs. 1,44,670/-.
2.1 During the course of assessment proceedings u/s 143(3) rws 153C of the Act, the AO observed that the assessee along with another had entered into a MoU with Ramky Estates & Farms Ltd. for construction of Villas on the assessee’s own land admeasuring acres 2 and 33 guntas at Chikkigubbi Village, Bidarahallibobli, Bangalore East Taluk, Bangalore and that the assessee was entitled to 30.71% of the total saleable super built up area constructed/to be constructed on the schedule property and the assessee had also received security deposit for the same. The AO observed that the assessee has treated the land as stock-in-trade in its books of account and since the assessee had handed over same for development, the AO held that the assessee transferred its portion of the land and the assessee is liable to offer the business income on the share of land which is transferred. He observed that since the assessee is following mercantile system of accounting, the assessee has to offer the business income on transfer of stock-in-trade to tax in the relevant AY. Accordingly, the AO computed the business income of the assessee at Rs. 9,29,92,155/- and brought it to tax.
Aggrieved, the assessee preferred an appeal before the CIT(A), who allowed the appeal of the assessee by holding that the business income is taxable only in the year of sale of Villas and not in the relevant AY. Against the order of CIT(A), the revenue is in appeal before us raising the following grounds of appeal: “1. On the facts and in the circumstances of the case and in law, the CIT(A) erred in deleting the addition made under the head business income of Rs. 9,29,92,155/-.
2. The CIT(A) ought to have recognized that it is a case of capital contribution by the assessee in the form of land and the developer would contribute the capital in the shape of cost of construction (Villas) and thus, it would be business income in the hands of the assessee company.
3. The CIT(A) ought to have recognized that the transfer of stock in trade of the assessee to developer as a commercial transaction for a commercial project for which the assessee has given right to the developer which directly gives rise to business income.
4. The CIT(A) has erred in ignoring the facts that the assessee is following mercantile system of accounting and received a sum of Rs. 1,22,82,610/- as a security deposit and thereby the assessee is required to offer the business income of Rs. 9,29,92,155/- for the year under consideration. 5. the appellant prays that the order of the CIT(A) on the above ground be set aside and that of the AO be restored and 6. The appellant prays that the other ground (s) that may be urged at the time of hearing.”
4. The ld. DR supported the order of AO while ld. counsel for the assessee supported the order of CIT(A).
5. Having regard to the rival contentions and material on record, we find that, undisputedly, the land, which is a subject matter of MoU/JDA with Ramky Estates & Farms Ltd. is treated as stock-in-trade by the assessee. The AO has observed that the assessee has given the said land for development and has given possession of the same to the builder for the said purpose and, therefore, he held it to be a transfer. We find that as rightly pointed out by the ld. CIT(A), the provisions of section 2(47) would apply to the transfer of a capital asset and not to the transfer of stock-in-trade. In the case of a capital asset, if it is transfer under any of the provisions of section 2(47), coupled with handing over of possession of the capital asset, capital gain is to be offered on mercantile basis in the year in which the possession is given. As rightly pointed out by the ld. CIT(A) in the case of the assessee, the land has been treated as stock-in-trade and the assessee has only contributed its portion of land to the JDA and is liable to offer business income in the year in which the stock-in-trade is sold. The CIT(A) has observed that the assessee has offered business profits in the AYs 2015-16 and 2016-17 i.e. the years in which the Villas have been sold. Since the stock-in-trade has only been contributed and has not been sold during the relevant AY, there is no receipt or accrual of business receipt during the relevant AY. Further, such position has been confirmed by the coordinate bench of Tribunal at Bangalore in the case of Dheeraj Amin Vs. ACIT in dated 30/06/2014 (to which of one us i.e. the JM is signatory). For the purpose of ready reference, the relevant paragraphs are reproduced hereunder:
“7. In view of the uncontroverted findings by the learned CIT(A), it is now a settled position that the land transferred by the assessee was held as a part of stock in trade and the gains on the transfer of this land could only arise by the virtue of the increase of closing stock value in respect of the right to 42% share in the constructed building. There is no appeal or cross objection against the order passed by the CIT(A) and the learned representative state so at the bar.
Once the land is held to be a part of the stock in trade, it ceases to be a capital asset in view of the fact that Section 2(14), as it stood at the material point of time, specifically provided that the expression “capital asset”, which means “property of any kind held by an assessee, whether or not connected with the his business or profession, but does not include (i) any stock-in-trade, consumable stores or raw material held for the purpose of business or profession…………..”. Clearly, therefore, the provisions regarding capital gains are admittedly not attracted on the facts of this case.
Once we come to the conclusions, as is inescapable in the light of the above position, that the provisions regarding capital gains are not attracted, the definition of ‘transfer’ under section 2 (47) of the Act, and of Section 53A of the Transfer of Property Act- which is relevant in the Income Tax Act only for the limited purposes of connotations of expression ‘transfer’ under section 2(47) only, have no bearing on the adjudication about taxability of notional profits in the hands of the assessee. While on this issue, we may also mention that learned Departmental Representative’s reliance judgment of Hon’ble jurisdictional High Court in the case of Dr T K Dayalu (supra), as also on Hon’ble Bombay High Court’s judgment in the case of Chaturbhuj Kapadia (supra), is wholly misplaced at both of these judgments are in the context of the computation of capital gains and in the context of connotations of the expression ‘transfer’ under section 2(47) – things which, or the reasons set out above, are wholly irrelevant in the present context.
Let us, in this light, revert to the findings of the CIT(A) wherein, relying upon the provisions of Section 53A of the Transfer of Property Act, he comes to the conclusion that the transaction is in the nature of sale, by stating that “by the virtue of (section 53A of the) Transfer of Property Act, in view of the JDA agreement and reading together transfer of Property Act and Sale of Goods Act, I am in agreement with the AO that the transfer and the consequent sale has taken place in the year when JDA has been entered”. (Emphasis by underlining supplied by us).
Learned CIT(A) was completely in error in coming to these conclusions. Relevance of Section 55A of the Transfer of Property Act, at the cost of repetition, is only for the purpose of transfer under section 2(47) which, in turn, is relevant, as it states in so many words by using the expression “transfer", in relation to a capital asset, includes”, only for the purposes of capital assets under the Income Tax Act. An asset included in the stock in trade, as we have seen a short while ago and in view of the specific provisions of Section 2 (14), cannot be included in the scope of the “capital asset”. What holds good for transfer of a capital asset, for the purposes of triggering taxability of capital gains, is in the context of a specific legal fiction, which is introduced in the Act for a limited purpose, cannot be treated as omnibus in effect. Learned CIT(A)’s inference about “transfer” of the asset, on the facts of this case, was thus wholly incorrect. He went a step further, by compounding this error, in assuming, entirely based on this misconception about ‘transfer’, that since it is a case of transfer, it has to be, as he terms it, “consequent sale” as well. When there is no transfer of asset insofar as a business transaction is concerned, there is no question of ‘consequences’ of such a transfer.
Learned Departmental Representative, however, suggests that it does not make a difference because if the profit arising on transfer of land cannot be taxed as capital gains, it can be taxed as a business profit anyway. That is precisely what the learned CIT(A) has held too.
We are unable to see any merit in this plea either.
The business transaction entered into assessee, in our humble understanding, is this. The assessee has contributed a trade asset consisting of a piece of land, admeasuring 1 acre and 96.22 cents, on which a group housing project by the name of Alexandria was to be constructed, and what he got in consideration of this transfer is the right to sell 1,28,940.26 sq. ft. constructed area in this project. In his closing stock, even if he is to substitute the part ownership of the land transferred with the value of this right to sell 1,28,940.26 square feet constructed area, it would not make any difference to the profit figures because, as far as this assessee, is concerned the cost of acquiring this right is the same as the cost of giving up the right in the hand, and, as is the settled legal position, the closing stock can only be valued at cost price or market price-whichever is less. Obviously, the cost price of this right to sell 1,28,940.26 sq ft, which has been treated as a trading asset, is less than the market price of these rights, and, therefore, these rights can only be valued at cost in the accounts.
Let us take a pause here and recall the conceptual reasons for valuing the closing stock at cost price or market price whichever is less.
In the landmark judgment of Chainrup Sampatram Vs CIT [(1953) 24 ITR 481 (SC)], Hon’ble Supreme Court has observed as follows:
……..The true purpose of crediting the value of unsold stock is to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions on which there have been actual sales in the course of the year showing the profit or loss actually realised on the year's trading. As pointed out in paragraph 8 of the Report of the Committee on Financial Risks attaching to the holding of Trading Stocks, 1919, "As the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure......From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less, than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following year's results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question." (extracted in paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to British Parliament in April, 1951). While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy. As profits for income-tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following year's account in a business that is continuing are not brought into the charge as a matter of practice, though, as already stated, loss due to a fall in price below cost is allowed even if such loss has not been actually realised. (Emphasis, by underlining, supplied by us)
The principle is thus unambiguous. The principles of conservatism, and considerations of prudence, in the accounting treatment require that no anticipated profits be treated as income until the profits are realized, and, at the same time, an anticipated loss to be deducted from commercial profits, at the first sign of its reasonable possibility. Accounting Standard 2, which is a mandatory accounting standard under section 145(2), also states that “Inventories shall be valued at cost, or net realisable value, whichever is lower.“ There may seem to be, at first sight, an element of dichotomy in this approach inasmuch as anticipated losses are taken into account and anticipatory profits are ignored, but that is the impact of accounting principles sanctioned by the statute and the law laid down by Hon’ble Supreme Court.
In view of these discussions, the conceptual foundation for this stock valuation principle are accounting principle of conservatism and business considerations of prudence, which have been noticed and approved by Hon’ble Courts above. It is for these reason that when market price of an item in the closing stock is less than its cost price to the business, the notional loss is allowed as a deduction but when market price of an item in the closing stock is more than its cost price to the business, the notional profit is not brought to tax. However, by giving the impugned directions, learned CIT(A) has ended up bringing that anticipated profit to tax.
What the assessee has got today is only a right to sell the 1,28,940.26 fts of constructed area in the Alexandria project and the profits, howsoever certain they may appear to be, will only fructify and be realized, and can even be quantified, only when this right is exercised- in part or in full. That stage has not yet come, and until that stage comes, in our considered view, such profit cannot be taxed. Unlike in a case of a capital gain which arises on parting the capital asset at the first stage itself, it is a case of business transaction which is completed when the rights so acquired by the assessee are exercised; none can make profits by dealing with himself, as is the settled legal position in the light of the settled legal position in the case of Sir Kikabhai Premchand Vs CIT [(1953) 24 ITR 506 (SC)]. It is for this reason that we are unable to uphold the action of the authorities below on the facts of this case. No matter how reasonable is it to assume that the assessee will make these profits, these profits cannot be brought to tax at this stage. That is what the legal position, for the detailed reasons set out above, is.
In our considered view, therefore, the authorities below indeed erred in bringing to tax the anticipated business profits on assessee’s entering into a development agreement with Menorah Realties Pvt Ltd in respect of the land held by the assessee as stock in trade. The impugned addition of Rs Rs.17,28,81,276 is thus deleted.” Respectfully following the said decision, we do not see any reason to interfere with the order of the CIT(A) and upholding the same, we dismiss the grounds raised by the revenue on this account.
In the result, appeal of the revenue is dismissed. Pronounced in the open court on 21st February, 2020.