Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, “D” BENCH, AHMEDABAD
Before: SMT. ANNAPURNA GUPTA & SHRI T.R. SENTHIL KUMAR
The present appeal has been filed by the assessee against the order of the Ld. Commissioner of Income Tax (Appeals), (hereinafter referred to as “CIT(A)”), National Faceless Appeal Centre (hereinafter referred to as “NFAC”), Delhi dated 10.10.2024, passed under Section 250 of the Income Tax Act, 1961 (hereinafter referred to as the “Act”) and relates to Assessment Year (A.Y.) 2016-17.
Grounds raised by the assessee read as under:
“1. Ld. CIT (A) (NFAC) erred in law and on facts in confirming addition made by AO of Rs.2,24,46,419/- on account of alleged suppression of profit.
2. Ld. CIT (A) (NFAC) erred in law and on facts in confirming addition made by AO on the ground that assessee ought to have recognized revenue on the percentage completion basis and not project completion basis ignoring that this method was accepted in the scrutiny assessment for earlier year.
3. Ld. CIT (A) (NFAC) erred in law and on facts not appreciating that as per para 3.3 of Guidance note 2012 issued by ICAI for recognition of revenue in real estate transaction is to be determined at a time when significant risks & rewards of ownership can be considered as transferred under sale agreement.
4. Ld. CIT (A) (NFAC) erred in law and on facts in confirming addition made by AO on the basis of revenue recognition as per Accounting Standard 7 whereas in absence of legal title being validly transferred to the buyer it shall be recognized as per Accounting Standard 9 followed by the appellant.
5. Ld. CIT (A) (NFAC) erred in law and on facts not appreciating submission that the appellant has already offered income on project completion method in subsequent years & the addition made during the year on percentage completion basis will tantamount to double taxation of the same income.
6. Ld. CIT (A) (NFAC) erred in law and on facts not taking into consideration that revenue recognition on the basis of percentage completion method as prescribed under Guidance note is not mandatory 7. Levy of interest u/s 234A/2348/234C & 234D of the Act is unjustified.”
8. Initiation of penalty proceedings u/s 271(1)(c) of the Act is unjustified.”
Briefly stated, the assessee before us is a partnership firm engaged in the real estate business as builders and developers. During the impugned year, the assessee was engaged in the construction of a project named “Earth Ambrosia”. The impugned year was the second year of business operations of the assessee firm. The dispute in the present case, which has resulted in addition being made to the income of the assessee, was with regards to the method of accounting followed by the assessee for revenue recognition. While the assessee had contended that it was recognizing revenue following the project completion method and in terms of the guidelines provided by Accounting Standard-9 (‘AS-9’) pertaining to Revenue recognition issued by the Institute of Chartered Accountants of India (ICAI), the premium body regulating the Accountancy Profession in the country, the case of the AO was that the assessee ought to have followed the Percentage Completion Method as prescribed by the guidance note issued by ICAI on accounting for Real Estate transactions in 2012.
4. Both the parties have referred to the guidance note issued by ICAI on accounting for Real Estate transactions in 2012 in support of their contentions. While the case of the AO was that as per this guidance note, the assessee ought to have adopted the Percentage Completion Method, the contention of the assessee was that as per this very guidance note itself, the adoption of project completion method by the assesse / AS-9 was correct. The dispute resulted in an addition being made to the income of the assessee amounting to Rs.2,24,46,419/- with the AO/CIT(A) holding that the assessee ought to have recognized Revenue from its Real Estate Projects during the impugned year of Rs.3,32,53,443/- by the percentage completion method while the assessee had disclosed profits of Rs.1,08,07,024/-. The balance accordingly, amounting to Rs.2,24,46,419/-, was added to the income of the assessee. The same was confirmed by the Ld.CIT(A).
5. Since, the entire controversy rests on the interpretation of guidance note issued by the ICAI on accounting for Real Estate Transactions in 2012, it is pertinent to reproduce the relevant portion of the said guidance note for adjudication of the issue:
“3. Accounting for Real Estate Transactions 3.1 Real estate activities and transactions take diverse forms. While some are for sale of land (developed or undeveloped), others are for construction, development or sale of units that are not complete at the time of entering into agreements for construction, development or sale. 3.2 The typical features of most construction/development of commercial and residential units have all features of a construction contract - land development. structural engineering, architectural design and construction are all present. The natures of these activities are such that often the date when the activity is commenced and the date when the activity is completed usually fall into different accounting periods. It is not unusual for such activities to spread over two or more accounting periods. 3.3 For recognition of revenue in case of real estate sales, it is necessary that all the conditions specified in paragraphs 10 and 11 of Accounting Standard (AS) 9. Revenue Recognition, are satisfied. As stated above, real estate sales take place in a variety of ways and may be subject to different terms and conditions as specified in the agreement for sale. Accordingly, the point of time at which all significant risks and rewards of ownership can be considered as transferred, is required to be determined on the basis of the terms and conditions of the agreement for sale. In case of real estate sales, the seller usually enters into an agreement for sale with the buyer at initial stages of construction. This agreement for sale is also considered to have the effect of transferring all significant risks and rewards of ownership to the buyer provided the agreement is legally enforceable and subject to the satisfaction of conditions which signify transferring of significant risks and rewards even though the legal title is not transferred or the possession of the real estate is not given to the buyer. Once the seller has transferred all the significant risks and rewards to the buyer, any acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor. Accordingly, revenue in such cases is recognised by applying the percentage of completion method on the basis of the methodology explained in AS 7. Construction Contracts. Further, where individual contracts are part of a single project, although risks and rewards may have been transferred on signing of a legally enforceable individual contract but significant performance in respect of remaining components of the project is pending, revenue in respect of such an individual contract should not be recognised until the performance on the remaining components is considered to be completed on the basis of the aforesaid principles. This Guidance Note, thus, provides guidance in the application of: Principles of AS 9 in respect of sale of goods for recognising revenue, costs and profits from transactions of real estate which are in substance similar to delivery of goods where the revenues, costs and profits are recognised when the revenue recognition process is completed; and Percentage completion method for recognising revenue, costs and profits from transactions and activities of real estate which have the same economic substance as construction contracts. 3.4 The application of the methods described in paragraph 3.3 above requires a careful analysis of the elements of the transaction, agreement, understanding and conduct of the parties to the transaction to determine the economic substance of the transaction. The economic substance of the transaction is not influenced or affected by the structure and/or legal form of the transaction or agreement.
Application of Principles of AS 9 in Respect of Sale of Goods to a Real Estate Project 4.1 The application of principles of AS 9 in respect of sale of goods requires recognition of revenues on completion of the transaction/activity when the revenue recognition process in respect of a real estate project is completed as explained in paragraph 4.2 below. 4.2 The completion of the revenue recognition process is usually identified when the following conditions are satisfied: (a) The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership: Compendium of Guidance Notes Accounting (b) The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction; (c) No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales, and (d) It is not unreasonable to expect ultimate collection of revenue from buyers 4.3 Where transfer of legal title is a condition precedent to the buyer taking on the significant risks and rewards of ownership and accepting significant completion of the seller's obligation, revenue should not be recognised till such time legal title is validly transferred to the buyer.
Application of Percentage Completion Method 5.1 The percentage completion method should be applied in the accounting of all real estate transactions/activities in the situations described in paragraph 3.3 above, i.e., where the economic substance
is similar to construction contracts. Some further indicators of such transactions/activities are: (a) The duration of such projects is beyond 12 months and the project commencement date and project completion date fall into different accounting periods. (b) Most features of the project are common to construction contracts. viz., land development, structural engineering, architectural design, construction, etc. (c) While individual units of the project are contracted to be delivered to different buyers these are interdependent upon or interrelated to completion of a number of common activities and/or provision of common amenities. (d) The construction or development activities form a significant proportion of the project activity. 5.2 This method is applied when the outcome of a real estate project can be estimated reliably and when all the following conditions are satisfied: (a) total project revenues can be estimated reliably (b) it is probable that the economic benefits associated with the project will flow to the enterprise (c) the project costs to complete the project and the stage of project completion at the reporting date can be measured reliably, and (d) the project costs attributable to the project can be clearly identified and measured reliably so that actual project costs incurred can be compared with prior estimates. When the outcome of a project can be estimated reliably, project revenues and project costs associated with the project should be recognised as revenue and expenses respectively applying the percentage of completion method in the manner detailed in paragraphs 5.3 to 5.8 below.
5.3 Further to the conditions in paragraph 5.2 there is a rebuttable presumption that the outcome of a real estate project can be estimated reliably and that revenue should be recognised under the percentage completion method only when the events in (a) to (d) below are completed. (a) All critical approvals necessary for commencement of the project have been obtained. These include, wherever applicable: (i) Environmental and other clearances. (ii) Approval of plans, designs, etc. (iii) Title to land or other rights to development/ construction. (iv) Change in land use. (b) When the stage of completion of the project reaches a reasonable level of development. A reasonable level of development is not achieved if the expenditure incurred on construction and development costs is less than 25% of the construction and development costs as defined in paragraph 2.2 (c) read with paragraphs 2.3 to 2.5. (c) Atleast 25% of the saleable project area is secured by contracts or agreements with buyers. (d) Atleast 10% of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts. To illustrate - If there are 10 Agreements of sale and 10% of gross amount is realised in case of 8 agreements, revenue can be recognised with respect to these 8 agreements. 5.4 When the outcome of a real estate project can be estimated reliably and the conditions stipulated in paragraphs 5.2 and 5.3 are satisfied, project revenue and project costs associated with the real estate project should be recognised as revenue and expenses by reference to the stage of completion of the project activity at the reporting date. For computation of revenue the stage of completion is arrived at with reference to the entire project costs incurred including land costs, borrowing costs and construction and development costs as defined in paragraph 2.2. Whilst the method of determination of stage of completion with reference to project costs incurred is the preferred method, this Guidance Note does not prohibit other methods of determination of stage of completion, e.g.. surveys of work done, technical estimation, etc. However, computation of revenue with reference to other methods of determination of stage of completion should not, in any case, exceed the revenue computed with reference to the project costs incurred method. Illustration appended to this Guidance Note clarifies the method of computation of revenue. 5.5 The project costs which are recognised in the statement of profit and loss by reference to the stage of completion of the project activity are matched with the revenues recognised resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. Costs incurred that relate to future activity on the project and payments made to sub-contractors in advance of work performed under the sub-contract are excluded and matched with revenues when the activity or work is performed. This method provides useful information to the extent of contract activity and performance during a period. 5.6 The recognition of project revenue by reference to the stage of completion of the project activity should not at any point exceed the estimated total revenues from eligible contracts/other legally enforceable agreements for sale. "Eligible contracts' means contracts/ agreements specified in paragraph 5.3 where at least 10% of the contracted amounts have been realised and there are no outstanding defaults of the payment terms in such contracts. 5.7 When it is probable that total project costs will exceed total eligible project revenues, the expected loss should be recognised as an expense immediately. The amount of such a loss is determined irrespective of: (a) commencement of project work; or (b) the stage of completion of project activity. 5.8 The percentage of completion method is applied on a cumulative basis in each reporting period to the current estimates of project revenues and project costs. Therefore, the effect of a change in the estimate of project costs, or the effect of a change in the estimate of the outcome of a project, is accounted for as a change in accounting estimate. The changed estimates are used in determination of the amount of revenue and expenses recognised in the statement of profit and loss in the period in which the change is made and in subsequent periods. 5.9 The changes to estimates referred to in paragraph 5.8 above also include changes arising out of cancellation of contracts and cases where the property or part thereof is subsequently earmarked for own use or for rental purposes. In such cases any revenues attributable to such contracts previously recognised should be reversed and the costs in relation thereto shall be carried forward and accounted in accordance with AS 10. Accounting for Fixed Assets.”
While the assessee has relied on the contents of the Para 3 r.w para 4 of the Guidance Note for justifying the accounting method adopted by it, recognizing revenue only when the units constructed by it were actually sold, the Revenue, on the other hand, has relied on Para 3 r.w. para 5 of the said guidance note stating that the assessee fulfilled all the conditions specified therein and, therefore, it should have adopted the Percentage Completion Method for accounting its Revenue.
Having gone through the contents of the guidance note, it is evident that the gist of the accounting method to be followed in Real Estate Transactions is contained in Para 3.3 of the guidance note, wherein it has been stated that even for Real Estate Transactions the general principles of Revenue recognition laid down in Accounting Standard (AS)-9 issued by the Institute of Chartered Accountants of India, the premium body regulating the accountancy profession in the country, would apply. Expounding further on this principle, para 4 of the guidance note states that in Real Estate Transactions revenue is to be recognized on completion of the activity relating to Real Estate project. The completion of Real Estate activity is recognized to happen in para 4.2 of the guidance note, when the seller transfers all significant risks and rewards of ownership, hands over possession of the real estate to the buyer, there is no uncertainty of consideration to be received from the real estate sale and it is not unreasonable to expect ultimate collection of the Revenue from buyers.
In effect, therefore the guidance note recognizes that Revenue in Real estate transactions should be recognized as per principles of Revenue recognition prescribed in AS-9, i.e. when the activity from which revenue is to arise is completed, and there is certainty both of the amount of consideration to be received as also of receipt of the consideration.
However para 3.3 of the guidance note recognizes that in Real Estate transactions the activity of sale may some times take place on initiation of the project itself, resulting in the activity remaining to be carried out being in essence only a construction contract activity. That in such circumstances the principles of revenue recognition prescribed for construction contracts in AS-7 should be applied, which is the percentage completion method. The said para emphasis that for determining the fact that sale has taken place on the initiation of the project itself, the terms of the agreement entered into with buyers are very relevant.
Para 3.3 notes that usually in real estate transactions an agreement to sell is entered into by buyers with sellers at the initial stages of construction. The guidance note states that the terms and conditions specified in the agreement for sale are determinative of the point of time when significant risks and rewards of ownership can be considered transferred. And once the agreement to sell significantly transfers all risks and rewards of ownership, then any activity carried out on the real estate only tantamounts to construction being done on behalf of the buyer as contractor. And in such circumstances Revenue is to be recognized as per AS-7, prescribed for construction contracts, by following the percentage completion method.
Thus the guidance note emphasizes the applicability of AS-9 for recognition of Revenue in Real Estate Transactions and the importance of transfer of significant risks and rewards of ownership alongwith certainty both of quantum and of receipt of consideration for recognizing Revenue. At the same time noting the manner in which such transactions are usually entered by way of an agreement to sell entered into in the initial stages of construction, it states that if the terms of such agreement demonstrate transfer of significant risks and rewards of ownership, even though legal title is not transferred, the units are to be treated as transferred to the buyers and any activity carried out by the builder thereafter to be treated as carried out on behalf of the buyer as a contractor. And in such circumstances, it states that Revenue is to be recognized following percentage completion method.
Para 5 of the guidance note, deals with the application of percentage completion method specifying the parameters to be considered for application of this method.
Para 5.1 reemphasizes the existence of economic substance of the contract being similar to construction contracts. And further goes on to elaborate other indicators pointing to the contract being a construction contract, such as duration of contract exceeding 12 months, construction activities forming major portion of project activity, etc.
Para 5.2 states that for applying percentage completion method the outcome of the project should be also be capable of being reliably estimated. It further goes on to specify the conditions demonstrating the said fact, as total project Revenues and cost being estimated reliably.
Para 5.3 states that besides the conditions specified in para 5.2, the occurrence of certain events, specified in the para, would also indicate that the outcome of the project can be estimated reliably. It lists the events as; all critical approvals for the project commencement being obtained, the project reaching a reasonable stage of development which is when atleast 25% of the project cost is incurred, atleast 25% of the project is sold, and 10% of Revenues received thereon.
The guidance note states thereafter, that on fulfilment of the above conditions, Revenue should be recognized on the basis of and in the same percentage as the stage of completion of the project.
In essence, the guidance note states that the percentage completion method of Revenue recognition in Real Estate transactions is to be adopted when the project being executed is more in the nature of construction contract with significant risks and rewards of ownership being transferred, as per the agreement to sell entered into, at the initiation of the project itself and the outcome of the project being capable of reasonable estimation.
Therefore, as per the guidance note itself the determining factor for application of percentage completion method of accounting for Revenue recognition in Real Estate Transactions is, when the risks and rewards in the saleable units / project is transferred at the initiation of the project itself, when agreement to sell is entered into with buyers, and the Project thereafter remains more in the nature of a construction contract. Para 3.3 clearly specifies the above as under:
3.3 For recognition of revenue in case of real estate sales, it is necessary that all the conditions specified in paragraphs 10 and 11 of Accounting Standard (AS) 9. Revenue Recognition, are satisfied. As stated above, real estate sales take place in a variety of ways and may be subject to different terms and conditions as specified in the agreement for sale. Accordingly, the point of time at which all significant risks and rewards of ownership can be considered as transferred, is required to be determined on the basis of the terms and conditions of the agreement for sale. In case of real estate sales, the seller usually enters into an agreement for sale with the buyer at initial stages of construction. This agreement for sale is also considered to have the effect of transferring all significant risks and rewards of ownership to the buyer provided the agreement is legally enforceable and subject to the satisfaction of conditions which signify transferring of significant risks and rewards even though the legal title is not transferred or the possession of the real estate is not given to the buyer. Once the seller has transferred all the significant risks and rewards to the buyer, any acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor. Accordingly, revenue in such cases is recognised by applying the percentage of completion method on the basis of the methodology explained in AS 7. Construction Contracts. Further, where individual contracts are part of a single project, although risks and rewards may have been transferred on signing of a legally enforceable individual contract but significant performance in respect of remaining components of the project is pending, revenue in respect of such an individual contract should not be recognised until the performance on the remaining components is considered to be completed on the basis of the aforesaid principles. This Guidance Note, thus, provides guidance in the application of: Principles of AS 9 in respect of sale of goods for recognising revenue, costs and profits from transactions of real estate which are in substance similar to delivery of goods where the revenues, costs and profits are recognised when the revenue recognition process is completed; and Percentage completion method for recognising revenue, costs and profits from transactions and activities of real estate which have the same economic substance as construction contracts.
In the present case, we have noted that the assessee has consistently pleaded that in its case it cannot be said to be a construction contract, pointing out that the builder employs his own money in the project, there is no certainty of receiving bookings initially and even the agreement entered into with the buyers at the initial stage cannot be said to tantamount to transfer of all risks and rewards to the buyers. The assessee has pointed out that the buyers had liberty to cancel the booking at any stage and there was no penalty leviable for cancellation of bookings and that even the revenue from sale of units was not fixed, but, it was always negotiable with the buyer. The assessee has consistently pleaded that the risk and rewards stood transferred to the buyers only at the time of transfer of ownership by legal title or at the time of handing over possession of property. The contention of the assessee in this regard are contained at Page 8 of the assessment order as under:
“As per Para 4.3 of the said guidance note, where transfer of legal title is a condition precedent to the buyer taking on the significant risks and rewards of ownership and accepting significant completion of the seller's obligation, revenue should not be recognized till such time legal title is validly transferred to the buyer, We like to draw your attention that, In residential construction projects, builders finalize the designs, maps & drawings on their own, get necessary approval from authority concern and start work of project. Along with construction, they start taking booking from the buyer. The builders employ their own money or borrowed money to complete the work. Booking from the buyer is not certain. They cannot wait for full booking and then start the project. They have to start the project even though they have not received any single booking. In this case, Buyer has liberty to cancel the booking at any stage if he found the project not suitable on later stage. No penalty for booking cancellation is made. In odr case, there are lots of instance found from member's ledger account that, we have received booking and after some time the same was cancelled by the proposed buyer and we have refunded the booking amount to the said person. In this case, revenue is not fixed but always negotiable with the buyer. Buying party is not fixed at starting of the project. Majority of risk is horn by the builder i.e. contractor. The Assessee Firm is Builder, who developed housing project at Vadodara by doing all the activities and procedure mentioned in above para, hence it shall recognize the revenue as per Accounting Standard 9 (Revenue Recognition) & not as per Accounting Standard- 7 (Construction Contract). As Risks and rewards transferred to the buyer at time of physical possession of property or transfer of ownership by legal title, whichever is earlier, Revenue from sale of flats is not recognized till that time. As we have executed sale deed for only 34 units during F.Y. 2015-16, we have shown building construction income only for that 34 units during the year and the remaining construction cost of the project shown as WIP as part of closing stock.”
The assessee having stated so that the project undertaken by it had no characteristics of a construction contract for applicability of percentage completion method for Revenue recognition, we find that the Revenue has not controverted this very pertinent contention of the assessee by examining any agreement to sale entered into by the buyers as noted above.
The guidance note strictly prescribes Revenue to be recognized only when all risks and rewards of ownership of a unit are transferred to the buyers as per AS-9 , i.e project completion method for Revenue recognition and categorically states that percentage completion method is to be applied only when the economic substance of the project can be said to be of a construction contract. The guidance note recommend the examination of the terms of contracts entered into with buyers by the project developers for determining its nature, whether construction contract or not. And the assessee repeatedly pointing out elements of its project pointing to the fact that it was not in the nature of a construction contract, the Revenue has miserably failed in controverting this contention of the assessee from the terms of contracts/agreement to sell entered into by the assessee with its buyers. While the assesee has consistently stated that risks and rewards of ownership were not transferred to the buyers on entering into agreement to sell, the Revenue has been unable to counter this contention of the assessee with any rebuttable evidence. Not a single agreement entered into by the assessee with the buyer has been referred to counter this contention of the assessee in any way.
The Revenue has in fact failed to understand the spirit of the guidance note and has relied merely on the existence of conditions reflecting certainty of outcome of the project, to hold that percentage completion method was applicable in the present case.(Para 4.6 of AO’s order)
The Revenue has pointed out the existence of conditions listed in para 5.3 of the guidance note of more than 25% of project expenses being incurred,25% of the project being sold, 10% of the Revenue being collected, to state that percentage completion method ought to have been followed by the assessee. But the guidance note states these parameters to be indicators only of certainty of project outcome. The other essential condition of the project being more of a construction contract was not established by the Revenue.
The fact that the Revenue has misunderstood the Guidance Note is also evident from the AO noting at para 4.8 of his order that as per para 3.3 of the Guidance note if the sellers enter into agreements for sale with buyers at the initial stage of construction then it has the effect of transferring all risks and rewards of ownership to buyers. This is an incomplete and incorrect understanding of the guidance note. What it states is that it is the terms of such agreements which will determine the transfer of risks and rewards of ownership and not mere entering into such agreements alone.
The existence of certainty in outcome of project coupled with the contract being in economic substance a construction contract, was required to exist as per the guidance note for applicability of percentage completion method of Revenue recognition. And the Revenue having failed to establish that the project was in the nature of construction contract, there was no question, we hold, of the applicability of percentage completion method for revenue recognition in the present case.
In the light of the same, application of the percentage completion method of accounting for revenue recognition in the contract undertaken by the assessee during the year is held to be incorrect and the addition, therefore, made in the hands of the assessee amounting to Rs.2,24,46,419/- is directed to be deleted.
In the result, appeal filed by the assessee is allowed in above terms.
This Order pronounced on 27/08/2025 Sd/- Sd/- (T.R. SENTHIL KUMAR) (ANNAPURNA GUPTA) JUDICIAL MEMBER ACCOUNTANT MEMBER Ahmedabad; Dated 27/08/2025 S. K. SINHA True Copy आदेश क� �ितिल�प अ�े�षत/Copy of the Order forwarded to : अपीलाथ� / The Appellant 1. ��यथ� / The Respondent. 2. संबंिधत आयकर आयु� / Concerned CIT 3. 4. आयकर आयु�(अपील) / The CIT(A)- �वभागीय �ितिनिध, आयकर अपीलीय अिधकरण, अहमदाबाद / DR, ITAT, Ahmedabad 5. 6. गाड� फाईल / Guard file. आदेशानुसार/ BY ORDER,