M/S GLOBAL ENTROPOLIS (VIZAG) PVT LTD ,BANGALORE vs. ASSISTANT COMMISSIONER OF INCOME TAX CIRCLE-3(1)(2), BANGALORE

The assessee is engaged in the business of developing residential townships and also provides infrastructure services. During the years under consideration, the assessee was developing residential projects and they were under construction. The said project consisted of Apartment Block IV, Apartment Block II and Villas. The assessee has offered income under percentage completion method.

We shall first take up the appeal filed for assessment year 2014-15. The first issue contested therein relates to the treatment of interest income received by the assessee. The AO noticed that the assessee has received interest income of Rs.69,78,859/- and it had set it off the same against the interest expenditure and accordingly the net interest expenditure was included in the Work in Progress. The AO took the view that the interest income is earned on parking of funds with banks and hence the same is taxable as income from other sources u/s 56 of the Act. Accordingly he assessed the same as income of the assessee.

The Ld CIT(A) noticed that the assessee has received interest from banks to the tune of Rs.3,86,678/- only. It has received major amount of Rs.53,23,206/- from a related party named M/s SPL Properties (BNE) Private Limited and balance amounts were received from some other persons. The Ld CIT(A) noticed that the assessee has not explained the nature of deposits/loans given to related party and other persons. The Ld CIT(A) also noticed that the assessee has failed to show the loans so given or deposits so made are interconnected with the borrowings and inextricably connected with the carrying on of its business. The Ld CIT(A) took support of following case laws and upheld the view taken by the AO:-

The Ld A.R submitted that the assessee has made deposits into the bank and advanced loans to other persons out of business funds and hence the interest income constitutes business income of the assessee. He further placed his reliance on the decision rendered by Hon’ble Karnataka High Court in the case of CIT vs. Hewlett Packard Global Soft Ltd (2018)(403 ITR 453)(Kar-FB) and submitted that the interest income earned by the assessee from deposits kept with banks for temporary period and the interest earned on staff loans were held to be business income of the assessee in the above said case. Accordingly he submitted that the tax authorities are not justified in the instant case in assessing the interest income as income from other sources.

On the contrary, the Ld D.R submitted that the assessee has not shown that the deposits/loans are inextricably connected with the business activities of the assessee. He further submitted that the issue before Hon’ble Karnataka High Court was whether the interest income can be said to have been derived from the export business in the context of deduction allowed u/s 10A of the Act.

We heard rival contentions and perused the record. We earlier noticed that the assessee has earned interest income of Rs.3,86,678/- only from banks and the balance amount of interest income was earned on loans given to related party and others. It is well settled proposition of law that the assessee should demonstrate that there was business compulsion to make the deposits or advance loans to support its claim that the interest income forms part of its business profits. Admittedly, the assessee herein has not demonstrated that such kinds of business compulsions did exist. As rightly pointed out by Ld D.R, the decision in the case of Hewlett Packard Global Soft Ltd (supra) has been rendered by Hon’ble Karnataka High Court on the basis of facts prevailing in that case and since the Hon’ble High Court found that the parking of funds in banks and advancing of staff loans are integral part of carrying on of export activities, it was held that the interest income cannot be de-linked from Profits and gains derived from export of articles. No such facts prevail in the instant case. Accordingly we are of the view that the assessee cannot take support from the above said decision. In the instant case, the assessee is engaged in the business of constructing residential complexes and the assessee has failed to demonstrate any business compulsion nor did it show that the advancing of loans or depositing of money in fixed deposits are integral part of its business activities. Hence we are of the view that the Ld CIT(A) was justified in confirming the assessment of interest income as income of the assessee from income from other sources.

The next issue relates to the disallowance u/s 43B of the Act. We have noticed earlier that the assessee was offering income under percentage completion method. From the details of expenditure claimed by the assessee, the AO noticed that the assessee has made provision for approval fees payable for renewal of construction plan and electricity license, i.e., the approval fee was not actually paid during the year. The AO held that the provision for approval fees is liable to be disallowed in terms of sec.43B of the Act. Before the AO, the assessee accepted for disallowance. Accordingly, the AO disallowed a sum of Rs.950.02, being the proportionate amount of approval fee included in the expenditure in terms of sec.43B of the Act. The Ld CIT(A) confirmed the same by following the decision rendered by Hon’ble Supreme Court in the case of CIT vs. Travancore Sugar & Chemicals Ltd (2015)(58 taxmann.com 86). In addition, the Ld CIT(A) also observed that the approval fees is an unascertained liability, since the quantum of fee was revised by the assessee.

The Ld A.R submitted that the provisions of sec.43B shall be attracted to any sum payable by way of “tax, duty, cess or fee, by whatever name called, under any law for the time being in force, if it is not paid before the due date for filing return of income. He submitted that the approval fees paid for renewal of construction plan and electricity license shall not fall under the category of “tax, duty or cess”. The AO has apparently considered the above said item as “fees”. He submitted that the Hon’ble Madras High Court examined the meaning of the term “fee” in the context of sec.43B of the Act in the case of M/s Tamilnadu Minerals Limited vs. JCIT (2019(5) TMI 1207). The Hon’ble Madras High Court examined the difference between a fee and tax. It took support of certain decisions and observed that the element of tax is based on the principle of compulsory exaction, while the concept of fee relates to the principle of quid pro quo. He submitted that, in the case before Hon’ble Madras High Court, the assessee therein was engaged in the business of mining, manufacture and sale of granites, quarrying granite blocks from the mines leased out to it by State Government. It paid ‘nomination charges’ @ 10% of the turnover of granite blocks, which was a special levy imposed by the Government for allotment of land for quarrying granite on nomination basis. The outstanding nomination charges was disallowed u/s 43B of the Act. The Hon’ble Madras High Court held that the nomination charges cannot be disallowed u/s 43B of the Act. The Ld A.R further placed his reliance on the decision rendered by Hon’ble Supreme Court in the case of CIT vs. Mcdowell and Co. (2009)(10 SCC 755), wherein the Hon’ble Supreme Court has observed that the expressions “tax”, “duty”, “cess” or “fee” constituting a class denotes to various kinds of imposts by State in its sovereign power of taxation to raise revenue for the State. It further held that the term “tax” under Article 265 read with Article 366(28) includes imposts of every kind viz., tax, duty, cess or fees. He submitted that the Hon’ble Supreme Court also observed that, as per Article 265 which uses expression “tax”, states that no tax shall be levied and collected except authorized by law. The Hon’ble Supreme Court has also observed that “Law” in the context of Article 265 means an Act of legislature and cannot comprise an executive order or rule without express statutory authority. He submitted that the source of power to enact laws should be traceable to a provision in the Constitution especially where the legislative powers are shared by the Centre and the States. He submitted that the decision rendered by Hon’ble Madras High Court in the case of Tamilnadu Minerals Ltd (supra) has been considered by Hon’ble Supreme Court in the case of Jindal Stainless Steels ltd (2018)(5 GSTR – OL – 164)(SC).

He submitted that fee for approval of construction plans is collected by a Statutory authority named “VUDA” and hence the same constitutes a contractual levy for rendering services and hence it may not fall under the category of “tax”, so as to attract the provisions of sec.43B of the Act. He further submitted that the assessee could not carry out construction without plan approval and hence the fee payable by the assessee cannot be considered as unascertained liability.

The Ld D.R submitted that theLd CIT(A) has also followed the decision rendered by Hon’ble Supreme Court in the case of Travancore Sugar & Chemicals Ltd (supra). He further submitted that there is no quid pro quo in collection of approval fee, since the VUDA does not provide any service in giving its approval. He submitted that the VUDA was the authority constituted by the State Government to regulate construction of buildings and it has collected the approval fees as authorized by the State Government. Accordingly he submitted that the approval fee cannot be considered as payment made for services rendered. He further submitted that the assessee has agreed for the addition u/s 43B of the Act before the AO and hence the assessee should not be allowed to contest the same.

In the rejoinder, the Ld A.R submitted that there is no estoppel against the operation of Law and hence the assessee could contest this legal position, even if it has agreed to the addition before the AO. In the alternative, the Ld A.R further submitted that the impugned disallowance would go to reduce the value of work in progress and hence the tax authorities are not justified in adding the same to the total income of the assessee.

We heard the parties and perused the record. We notice that the decision in the case of Tamilnadu Minerals Ltd (supra) was related to a fee collected as “nomination charges”. The Hon’ble Madras High Court noticed that it was simply a contractual payment of least rental specified by the State Government being the Lessor for which both the Lessor and Lessee had agreed at a prior point of time to fix and pay the said prescription of nomination charges. The said lease deed was held to be non-statutory contract between the parties. Further the quantum of nomination charges depended upon the quantum of land and the commercial exploitation of the minerals by the Assessee and hence the same was in the nature of non-statutory contractual payment. Accordingly it was held that the “nomination charges” would not fall under the category of “fees” specified in sec.43B of the Act. The other decisions relied upon by the Ld A.R, in our view, have been rendered in different context.

In the instant case, the assessee has made provision in the books of accounts for the Approval fee payable to the VUDA, which was the authority constituted by the State Government to regulate the development of City and large scale construction projects. It should be according its approval to the construction plans on the basis of parameters, rules and regulations prescribed by the State Government. Without the said approval, the assessee cannot carry out construction activities, meaning thereby, it is in the nature of statutory permission. By according approval for construction, in our view, no service is provided by VUDA. Accordingly we are of the view that the VUDA is performing a Statutory function only and hence the approval fee payable to it would fall under the category of “fees” stated in sec.43B of the Act. Accordingly we are of the view that the provision made for Approval fee payable to VUDA would fall under the ambit of sec. 43B of the Act. Accordingly, we are of the view that the Ld CIT(A) was justified in confirming the disallowance made u/s 43B of the Act. Since the assessee cannot carryout construction without plan approval, the approval fee cannot be considered as unascertained liability, since in the instant case, the assessee has provided for the amount computed as per the rules of VUDA. Revision of the amount cannot lead to the conclusion that the same is an unascertained liability. Accordingly, this observation of Ld CIT(A) is set aside.

As rightly pointed out by Ld A.R, there is no estoppel against operation of law. Hence the assessee can contend legal issues even if had agreed for the addition before the AO. Before us, the assessee has raised an alternative claim that the amount disallowed u/s 43B should be reduced from the cost of work in progress. We have noticed that the assessee is under the stage of construction and it is offering income under percentage completion method. Hence the expenses incurred by the assessee are accumulated as work in progress. Since the alternative claim of the assessee requires examination, we modify the order passed by Ld CIT(A) on this issue and restore the same to the file of AO to examine the alternative claim of the assessee.

The next issue relates to the disallowance of de-recognised sales. The facts relating thereto are discussed in brief. We have earlier noticed that the assessee is following percentage completion method. While computing the percentage of completion, the Assessee takes into consideration the flats booked by its customers. During the year under consideration, the AO noticed that the assessee has reduced certain amounts from the Sales on each of the projects and also corresponding cost. It was explained that the assessee has de-recognised certain sales, as the buyers have not met the conditions, i.e., the buyer would have defaulted in paying instalments. The AO took the view that the assessee cannot so derecognize the sales, as the assessee, in any way, will sell the flats to some other person. Accordingly, the AO held that the assessee was not right in derecognizing sales and cost. The net amount so derecognized worked out to Rs.2,11,79,659/-. The AO added the same to the total income of the assessee. The Ld CIT(A) also confirmed the same.

We heard the parties and perused the record. We notice that the assessee has placed its reliance on the Guidance note on Accounting for Real Estate transactions (Revised 2012) issued by the Institute of Chartered Accountants of India (ICAI) in support of its action for de-recognising sales and cost. The Ld CIT(A) took the view that the above said guidelines would apply to the projects commenced on or after 01-04-2012 only. He also noticed that the AO has observed in the succeeding year that many customers are regularly paying the instalments and the assessee has not returned back money to the defaulters. Accordingly he has held that the AO was justified in making the addition.

The Ld A.R submitted that though the guidance note states that it would apply to projects commenced after 1.4.2012 in the initial lines of preamble, it has also stated in the subsequent lines that the new guidelines can be followed in respect of existing projects also. He invited our attention to the following preamble of the Guidance note:-

On the contrary, the Ld D.R placed his reliance on the order passed by Ld CIT(A).

Having heard rival contentions, we are of the view that there is merit in the contentions of the assessee. The de-recognition of sales and corresponding cost results in change in the method of accounting. We notice that the assessee has chosen to follow the revised Guidance note issued by ICAI for accounting for real estate transactions. Though the revised Guidance note applies to projects commenced on or after 01-04-2012, the guidance note allows the same to be applied for the projects commenced prior to 01-04-2012 also. The Ld A.R submitted that the revised Guidance Note provides for de-recognising income, when there is default on the part of customers. Thus, we notice that the change in method of account is on account of proper reasons. In that case, we are of the view that the tax authorities are not justified in rejecting the same, without finding fault with the change.

The Ld A.R also submitted that, in the case of defaulting customers, the income cannot be said to have been accrued, since the Hon’ble Supreme Court has held in the case of Excel Industries Ltd (supra) that the probability of realization by the assessee should be seen from practical point of view.

Hence we are of the view that the assessee was justified in following revised guidance note. However we notice that the AO did not have occasion to examine the quantum of de-recognised income, since he had rejected the same. We have noticed that the Ld CIT(A) has observed that the AO has mentioned in the assessment order of succeeding year that the claim of the assessee that it was not receiving payments in relation to the derecognized income was found to be incorrect. Hence, we are of the view that the quantum of de-recognised income claimed by the assessee requires verification at the end of the AO. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and restore this issue to the file of the AO for the limited purpose of verifying the quantum of deduction claimed by the assessee towards de-recognising of sales and cost.

We shall now take up the appeal filed for AY 2015-16. The first issue relates to the treatment of interest income received by the assessee. As in the earlier year, the assessee disclosed interest income as part of its business income and netted it off against interest expenditure. However, the AO assessed the same as income under the head income from other sources and it was also confirmed by Ld CIT(A).

We have considered an identical issue in AY 2014-15 in the earlier paragraphs and confirmed the order passed by Ld CIT(A) for the reasons discussed therein. Following the same, we confirm the order passed by Ld CIT(A) on this issue in this year also.

The next issue relates to disallowance of approval fees paid to VUDA u/s 43B of the Act. Identical issue was considered by us in AY 2014-15 in the earlier paragraphs and we have held that the approval fee would be covered by the provisions of sec.43B of the Act. However we have restored the alternative contention of the assessee that the disallowed amount would go to reduce the Work in Progress, to the file of AO. Following the same, we confirm the order passed by Ld CIT(A) on this issue and restore the alternative contention to the file of the AO for his examination. Following the order passed by us in AY 2014-15, we set aside the observation of the Ld CIT(A) that the approval fee was unascertained liability.

The next issue relates to disallowance of de-recognised sales. We have considered an identical issue in AY 2014-15 in the earlier paragraphs and we have held that the assessee is entitled to change its method of accounting. However, we have restored the issue to the file of the AO for the limited purpose of examining the quantum of deduction. Following the same, we set aside the order passed by Ld CIT(A) and restore the issue to the file of the AO with similar directions.

In the result, both the appeals of the assessee are treated as partly allowed for statistical purposes.