ASHVI DEVELOPERS PRIVATE LIMITED,MUMBAI vs. INCOME TAX OFFICER, WARD 1(1)(1), MUMBAI, MUMBAI

The brief facts of the case are that the assessee, M/s Ashvi Developers Private Limited, is engaged in the business of real estate development. The assessee filed its return of income for A.Y. 2018-19, declaring Nil income. The assessee was developing one project “Ariisto Sommet” at Goregaon, Mumbai, jointly with Atithi Builders & Constructors Private Limited. The project had commenced in the year 2007. The assessee had been consistently following the Project Completion Method and the project-related expenditure was accumulated as work-in-progress till completion of the project.

During the assessment proceedings, the Assessing Officer noticed that the closing work-in-progress had increased from ₹386,25,66,040/- in the preceding year to ₹419,15,18,737/- during the year under consideration, resulting in an increase of ₹32,89,52,697/-. The Assessing Officer therefore asked the assessee to explain why the Percentage Completion Method should not be applied.

The assessee submitted that the project had remained stalled since 2017 because of serious financial difficulties and adverse market conditions. The assessee submitted that the project was initially started as a commercial project and was later converted into a residential-cum-retail project. The residential units were formally launched in 2016, but thereafter the project again came to a standstill. The lending banks had declared the assessee's accounts as NPA and had initiated proceedings under the SARFAESI Act. Certain customers had also approached RERA for refund of their advances.

The assessee further explained that there was no actual construction activity during F.Y. 2017-18. Out of the increase of ₹32,89,52,697/- in work-in- progress, ₹28,58,38,211/- was towards finance cost, ₹3,16,79,735/- was towards administrative expenditure and ₹75,37,341/- was towards sales promotion expenditure. The total estimated project cost was ₹1,126 crore, whereas the cumulative cost incurred up to 31.03.2018 was ₹419,15,18,737/-. The assessee also submitted that the project remained stuck at the 13th upper floor and, because of the financial difficulties, no definite date of completion could be given.

The Assessing Officer, however, held that section 43CB of the Act read with ICDS-III and ICDS-IV required the assessee to follow the Percentage Completion Method. He took the estimated project cost of ₹1,126 crore and the cumulative cost of ₹419,15,18,737/- and worked out the percentage of completion at 37.22%. He then applied this percentage to the cumulative ₹130,35,63,563/- customer advances of and computed turnover at ₹48,51,86,358/-. After reducing the current year's direct cost of ₹32,89,52,697/- and indirect expenditure of ₹11,715/-, the Assessing Officer computed taxable income at ₹15,62,21,946/-.

The assessee carried the matter in appeal before the learned CIT(Appeals). The assessee submitted before the CIT(Appeals) that the assessee was a real estate developer and had consistently followed the Project Completion Method from the beginning of the project. The assessee also pointed out that the same method had been accepted by the Department in scrutiny assessments for A.Ys. 2016-17 and 2017-18. The assessee further submitted that in A.Y. 2022-23 also, though an addition under the Percentage Completion Method had initially been proposed on the basis of the assessment order for the present year, no such addition was made after considering the assessee's explanation.

The assessee also contended that section 43CB of the Act applies only to a construction contract or a contract for providing services and had no application to a real estate developer developing and selling property on its own account. The assessee further submitted that ICDS-III could not be applied to the assessee's project because the project had commenced before 01.04.2016 and the transitional provisions permitted continuation of the method regularly followed before that date. The assessee also pointed out that there was no construction activity during the relevant year and the increase in work-in- progress was mainly on account of finance cost and administrative expenditure.

The learned CIT(Appeals), however, held that the assessee was required to follow the Percentage Completion Method in view of section 43CB of the Act. He further observed that the increase in work-in-progress during the year amounted to ₹32,89,52,697/-, comprising finance cost of ₹28,58,38,211/-, administrative cost of ₹3,16,79,735/- and sales promotion cost of ₹75,37,341/-. He did not merely confirm the income of ₹15,62,21,946/- assessed by the Assessing Officer but directed the Assessing Officer to bring to tax the entire amount of ₹32,89,52,697/-. The CIT(Appeals) enhanced income and also dismissed the appeal of the assessee.

The assessee is in appeal before us against the aforesaid order passed by the learned CIT(Appeals).

The assessee has, in substance, challenged the orders of the lower authorities on the grounds that (i) section 43CB of the Act does not apply to its real estate development project (ii) that ICDS-III does not apply to a project which had commenced before 01.04.2016 (iii) that the Project Completion Method consistently followed by the assessee had been accepted by the Department in A.Ys. 2016-17 and 2017-18 and again in A.Y. 2022-23 (iv) that even under the Percentage Completion Method no income could be recognised during the year since no actual construction activity had taken place; that the computation made by the Assessing Officer was incorrect and (v) that the enhancement made by the learned CIT(Appeals) was bad in law as no notice of enhancement had been given.

We have heard the rival submissions and perused the material available on record. The first issue for our consideration is whether section 43CB of the Act could at all be applied to the assessee. The assessee is admittedly engaged in the business of real estate development. It is developing the project on its own account and at its own commercial risk. It is not carrying out construction work for another person under a construction contract, nor is it rendering construction services to another person.

Section 43CB of the Act applies to profits arising from a “construction contract” or a “contract for providing services”. In our view, a real estate developer developing and selling property on its own account cannot be treated at par with a construction contractor merely because its business involves construction activity. A contractor executes work for another person for an agreed consideration, whereas a developer undertakes the project at its own risk and earns income from the sale of the developed units. This distinction cannot be ignored while applying section 43CB of the Act.

We also find that the learned CIT(Appeals) was not justified in observing that the Project Completion Method could not be followed because the realisation period exceeded ninety days. The ninety-day condition in the proviso to section 43CB applies to certain contracts for providing services. It does not convert a real estate development project into a construction contract or service contract merely because the project continues for more than ninety days.

There is another important aspect. The project in the present case admittedly commenced in 2007. The transitional provision of ICDS-III provides that where a construction contract commenced on or before 31.03.2016 and remained incomplete on that date, the revenue and cost relating to such contract shall be recognised on the basis of the method regularly followed by the assessee before 01.04.2016. The assessee had consistently followed the Project Completion Method from the beginning of the project. Therefore, even if ICDS- III were otherwise applicable to the assessee, the transitional provision supports the continuation of the method regularly followed by the assessee.

It is also relevant that the Department had accepted the Project Completion Method followed by the assessee in scrutiny assessments for A.Ys. 2016-17 and 2017-18 in respect of the very same project. Further, in A.Y. 2022- 23, though the Assessing Officer initially proposed an addition by applying the Percentage Completion Method, no such addition was ultimately made after considering the assessee's explanation. There is nothing on record to show any material change in the nature of the assessee's business or project in A.Y. 2018- 19 which would justify adopting a different method only for this year.

Even otherwise, the computation made by the Assessing Officer under the Percentage Completion Method cannot be sustained. The basic purpose of this method is to recognise revenue and profit with reference to the progress of work during the relevant period. The profit recognised for a particular year must therefore have some reasonable relation with the work actually carried out during that year.

In the present case, the material on record shows that there was no actual construction activity during F.Y. 2017-18. The increase of ₹32,89,52,697/- in work-in-progress mainly represented finance cost, administrative expenditure and sales promotion expenditure. The project had remained stalled because of severe financial difficulties and the lending banks had already initiated recovery proceedings.

The Assessing Officer worked out the project as 37.22% complete by comparing the total cost incurred up to 31.03.2018 of ₹419.15 crore with the estimated total project cost of ₹1,126 crore. He then applied this 37.22% to the total customer advances of ₹130.35 crore and treated about ₹48.51 crore as revenue. From this amount, he reduced only the expenditure of ₹32.89 crore incurred during F.Y. 2017-18 and computed profit of about ₹15.62 crore.

The problem with the Assessing Officer’s method is that he mixed cumulative figures with current-year figures. For working out the percentage of completion and the corresponding revenue, he took the total project cost incurred from 2007 up to 31.03.2018 and the total customer advances received up to that date. However, while computing the profit, he reduced only the expenditure incurred during F.Y. 2017-18. This does not give a correct picture of the profit for the year. If cumulative figures are used for recognising revenue, the corresponding cumulative cost also has to be considered. Further, there was no actual construction activity during F.Y. 2017-18 and the increase in work-in- progress was mainly on account of finance and administrative costs. Therefore, such expenditure by itself could not lead to recognition of project profit for the year.

In our view, the method adopted by the Assessing Officer is not correct. He used cumulative figures from 2007 onwards for working out the percentage of completion and the corresponding revenue, but while computing the profit he reduced only the expenditure incurred during F.Y. 2017-18. This results in a mismatch between the revenue and the related cost. If cumulative figures are taken for recognising revenue, the corresponding cumulative cost also has to be considered. Further, there was no actual construction activity during the year and the increase in work-in-progress was mainly due to finance and administrative costs. Therefore, these costs by themselves could not result in recognition of project profit for F.Y. 2017-18.

The Project Completion Method consistently followed by the assessee is also supported by the decision of the Hon'ble Delhi High Court in Paras Buildtech India (P.) Ltd. v. CIT [2016] 382 ITR 630/[2017] 80 taxmann.com 335 (Delhi), wherein the method followed by a real estate developer was accepted. Similarly, the Hon'ble Calcutta High Court in Pr. CIT v. Salarpuria Simplex Dwelling LLP [2022] 455 ITR 712/289 Taxman 264 (Calcutta) held that the Project Completion Method was an accepted method of accounting and observed that changing the method for an isolated year may distort the true profits of the business. The High Court held that where assessee was engaged in business of construction and development of property and it had been following project completion method which had been accepted by Department in assessment year 2014-15, principle of consistency should be followed; Assessing Officer was not justified in adopting percentage completion method for A.Y. 2015-16

We now come to the enhancement made by the learned CIT(Appeals). The Assessing Officer had assessed income at ₹15,62,21,946/-. The learned CIT(Appeals), however, directed that the entire increase in work-in-progress of ₹32,89,52,697/- be brought to tax. Admittedly, no separate notice proposing such enhancement was issued to the assessee.

Section 251(2) of the Act specifically provides that the Commissioner (Appeals) shall not enhance an assessment unless the assessee has been given a reasonable opportunity of showing cause against such enhancement. This requirement is clear and mandatory. Since no such opportunity was given to the assessee before enhancing the income from ₹15,62,21,946/- to ₹32,89,52,697/-, the enhancement cannot be sustained.

Even on merits, we find no basis for treating the entire increase in work- in-progress of ₹32,89,52,697/- as income. The amount was towards finance cost, administrative expenditure and sales promotion expenditure. The learned CIT(Appeals) has not worked out any corresponding revenue which accrued merely because these costs were capitalised in work-in-progress. The enhancement therefore does not follow either the Project Completion Method or a proper application of the Percentage Completion Method.

Considering the facts in their entirety, we find that the assessee is a real estate developer and the provisions of section 43CB of the Act relating to a construction contract or contract for providing services cannot be applied to it in the manner adopted by the Tax Authorities. The project had commenced in 2007 and the assessee had consistently followed the Project Completion Method, which had also been accepted by the Department in A.Ys. 2016-17 and 2017-18 and subsequently in A.Y. 2022-23. Further, there was no actual construction activity during the year under consideration. Even otherwise, the computation made by the Assessing Officer under the Percentage Completion Method does not correctly reflect the income, if any, attributable to the year under consideration.

Accordingly, the grounds raised by the assessee are allowed.

In the result, the appeal of the assessee is allowed.