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Income Tax Appellate Tribunal, “C” BENCH, AHMEDABAD
Before: SMT.ANNAPURNA GUPTA & SHRI T.R. SENTHIL KUMAR
O R D E R
PER ANNAPURNA GUPTA, ACCOUNTANT MEMBER The present appeal has been filed by the Revenue against the order passed by the Commissioner of Income Tax (Appeals)-8, Ahmedabad (in short referred to as CIT(A)), dated 26-10-2018 passed under section 250(6) of the Income Tax Act, 1961 ("the Act" for short) pertaining to Assessment Year 2014-15. 2. Ground No.1 of the Revenue’s appeal reads as under:
1. That the ld.CIT(A) has erred in law and on the facts in deleting the addition of Rs.11,20,03,956/- on account of income from project under PCM method.
2 3. As transpires from the orders of the authorities below, the issue relates to, whether income of the assessee is taxable in the impugned year or in the subsequent year ?
Brief facts being that the assessee is in the business activity as builder/ developer and had adopted Percentage Completion Method (PCM) for recognizing its income/revenue. For the impugned year the income had not been recognized by the assessee for the reason that the Guidance Note for Accounting of Income of Construction and Development Activity, issued by the Institute of Chartered Accountants of India, the regulatory body for the accounting profession, required that where PCM is followed the income is to be recognized only when 25% of the construction and development cost ,as defined under Guidance Note, has been incurred, and as per the assessee’s claim, its work was completed only to the extent of 22.73%. The working of the same is reproduced in the order of the ld.CIT(A) as under:
The AO however computed the work completed at 34%, and therefore held that income on the work completed needed to be recognized in the impugned year applying PCM as per the guidance note issued by the ICAI. The ld.CIT(A) noted that the AO while computing construction and development cost had wrongly added land cost to the same which even as per the Guidance Note needed to be excluded for the said purpose. He also noted certain other factual errors in the calculation of Construction and Development Cost and asked the assessee to re-work the same after making necessary corrections. The CDC thereafter worked out to less than 25% of the estimated project cost, at 23.88%, and the ld.CIT(A) therefore held that no income was assessable in the impugned year as per the PCM method. The relevant finding of the ld.CIT(A) from para 7.4 to 7.6 of the order is as under:
“7.4 The entire issue is regarding as to what should constitute the construction and development cost for the purpose of Percentage of Completion Method (PCM). In the cases of developers and contractors the contract revenues and expenses are recognised upon completion of the project at a certain level. The recognition of contract revenue and expense as per Accounting Standard 7 should be as below: "Recognition of Contract Revenue and Expenses 21. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35.
In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied: (a) total contract revenue can be measured reliably; (b) it is probable that the economic benefits associated with the contract will flow to the enterprise; (c) both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably; and 4
(d) the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates.
In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
(a) it is probable that the economic benefits associated with the contract will flow to the enterprise; and (b) the contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably."
7.5 Following the guidance in AS-7 as above issued by institute of Chartered Accountants of India (ICAI) the developers and contractors follow PCM to recognise the income which have been accepted by the department as well as the judicial forums. In the case at hand also AO has in principle accepted this method followed by the appellant. The PCM has two major components, one is the total cost of project as estimated which is called Estimate Project Cost (EPC) and the second component is Construction and Development Cost (CDC). When the CDC reaches at least 25% of EPC the revenue is recognised as per PCM. Source of this method is guidance note issued by ICAI in this regard which according to the appellant have been adopted substantially and with regard to the sub components of CDC in toto in the draft of ICDS (Income Computation and Disclosure Standards) of real estate transactions circulated by CBDT in May, 2017. The relevant part of guidance note of ICAI are reproduced as below:
"5. 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."
Guidance Note of ICAI: Para 2.2 to 2.5 are reproduced as below:
"2.2 Project Costs - Project costs in relation to a project ordinarily comprise (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 (f) 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."
7.6 The contention of the appellant is that as per para 2.3 as above the CDC does not include land cost and finance cost but as per AO these cost should be included in the CDC. From the guidance note as above it is clear that the CDC does not include the land cost. Appellant has also relied upon the audited accounts available in public domain of some reputed developers as mentioned in the earlier part in support of its contention that the land cost and finance cost does not form part of the CDC. Without prejudice appellant has contended that even if the finance cost is included still the CDC will not reach 25%. As regards the land cost, I am inclined to agree with the appellant for the reason that (a) the guidance note as above do not include the land cost (b) logically if the land cost is included which have been done by the AO then the threshold of 25% may reach even if no construction is carried out or no booking money is received. However, I am not inclined to accept the contention of the appellant as regards the finance cost since the appellant has not been able to demonstrate that no part of the finance cost pertain to the construction and development cost of the constructed part of the project.
From the table showing details of estimated project cost and margin as furnished by the appellant and reproduced by the AO on page No.6 of the impugned Assessment Order the estimated project cost is Rs.318.04 crores and then the margin of 9.31 % is added. These figures are not disputed. Appellant has pointed out that there is calculation error and the project cost without land taken by the AO on page No.9 for working out the percentage of work completed (28.24 %) is taken as Rs.204.14 crores whereas the same should be 240.59 crores i.e. after excluding the land cost of 77.45 crores form the total project cost of 318.04 crores. The land cost of 77.45 crores is also the part of same table and not disputed. Similarly, the actual cost till reporting period which is worked out as Rs.57.67 crores on page No.9 of the assessment order is also wrong. The correct figure should be Rs.120.30 crores minus the land and development right cost of Rs.62.85 crores which comes to Rs.57.45 crores. The working of the appellant as submitted in the appellate proceedings is as below:
"The AO has a/so made a calculation of project costs excluding land cost on pg.9 of the assessment order. It has been worked out at Rs.204,14,00,000/-. However, the same suffers from errors. The estimated projected cost without land would be Rs. 240,59,00,000 (3180400000-774500000). Refer pg.682 of the PB and table 4 of the assessment order. The cost incurred till the reporting period would be Rs.54,45,04,551 (1203050010-628545459). The data is available on pg.681 of the PB. The AO has from the estimated cost deducted actual land costs when he should have deducted estimated land costs. The AO has for inexplicable reasons mixed up the actual figures and estimates and arrived at a erroneous conclusion. The actual costs without actual land costs have also been inflated to reach a work completion of 28.24% which infact would be as under:
57,45,04,551 x 100 2405900000 i.e. 23.88% The AO has therefore made incorrect calculations, imported wrong data, mixed up estimates with actual costs and thereby worked out inflated percentage completion as demonstrated above.
The above facts are coming out from the tables in the assessment order itself which make it very clear that after excluding the land cost the Construction and Development Cost (CDC) comes to less than 25% of the estimated project cost (EPC). Hence, no income can be recognised under 8 PCM during the year. Accordingly, the addition made by the AO amounting to Rs.11,20,03,956/- are directed to be deleted. AO is directed to adopt the correct figure of Rs.23.88% as above. Ground No.3 to 7 of the appeal are accordingly partly allowed.”
Before us, the ld.DR was unable to point any infirmity in the findings of the Ld.CIT(A) that as per the guidance note issued by the ICAI for accounting of construction contracts the cost of land was to be excluded for calculating the Construction and Development cost of the project, nor was he able to controvert the factual findings of the Ld. CIT(A) that after excluding this cost of land the CDC completed by the assessee during the year was below the prescribed 25% of the Estimated cost of the project.
Since the basis of the AO for recognizing Revenue from construction contracts of the assessee during the impugned year was the CDC ,as per his calculation exceeding the prescribed limit of 25% of the estimated cost of project, which the Ld.CIT(A) has found to be factually incorrect and the Revenue has been unable to controvert the factual finding of the Ld.CIT(A) before us, we see no reason to interfere in the order of the Ld.CIT(A) upholding the claim of the assessee that no revenue was to be recognized in the impugned year from the construction projects undertaken by it. Ground no.1 raised by the Revenue is accordingly dismissed.
Ground no.2 reads as under:
2. That the ld.CIT(A) has erred in law and on the facts in deleting the disallowance of rs.6,06,86,887/-made u/s.36(1)(iii) of the I.T. Act
The above grounds relates to disallowance made of interest under section 36(1)(iii) of the Act. Since we have held in ground no.1 above that no income is assessable in the impugned year, there arises no question of claim of any expense whatsoever by the 9 assessee and therefore the addition made on account of disallowance of interest is not tenable. Ground no.2 is therefore become infructous, and is thus dismissed.
In the result, appeal of the Revenue is dismissed.