M/S INDIABUILD VILLAS DEVELOPMENT PRIVATE LIMITED ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-3(1)(1), BANGALORE

The assessee is a company engaged in the business of deriving income from carrying out real estate development. The assessee was incorporated on 10.8.2010. For AY 2012-13, the assessee filed return of income on 29.9.2012 declaring a loss of Rs.74,69,222. The assessee during the relevant previous year did not show any income under the head ‘income from business’ and had shown only income of Rs.12,28,420 under the head ‘income from other sources’. Under the head ‘income from business’, the assessee had claimed expenses of Rs.92,02,720 and set off those expenses as loss under the head income from business and set off the same against the income from other sources. This is how the assessee declared a loss in the return of income filed.

There was a dispute between the assessee and the revenue as to whether the assessee can claim revenue expenses under the head income from business because the assessee had not set up the business during the relevant previous year and therefore these expenses have to be capitalised as capital cost and shown in the balance sheet for claiming depreciation on such cost in future. Originally, the claim of the assessee was rejected by the AO in his order of assessment u/s. 143(3) of the Income-Tax Act, 1961 [“the Act”] dated 22.12.2014. The assessee filed appeal before the CIT(Appeals), who by his order dated 31.3.2017 accepted the claim of the assessee that its business was set up during the relevant previous year, but did not allow expenses of Rs,15,65,000 claimed under the head ‘advertisement and business promotion’ expenditure of Rs.9,10,000 and Rs.5,30,000 claimed under the head ‘legal and professional charges’. According to the CIT(Appeals), these two items of expenses were linked to the project already undertaken by the assessee and therefore ought to be capitalised as part of work-in-progress and project cost of the assessee. It is not in dispute that the assessee follows AS-9 which is an Accounting Standard prescribed by the Institute of Chartered Accountants of India (ICAI). The following description of revenue recognition and the notes to the accounts of the assessee clarifies this position:-

Inventories encompass goods purchased and held for resale, for example, merchandise purchased by a retailer and held for resale, computer software held for resale, or land and other property held for resale. Inventories also encompass finished goods produced, or work in progress being produced, by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process. Inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are accounted 14 in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets." "Exclusions from the Cost of Inventories 13. In determining the cost of inventories in accordance with paragraph 6, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are: abnormal amounts of wasted materials, labour, or other (a) production costs; storage costs, unless those costs are necessary in the (b) production process prior to a further production stage; administrative overheads that do not contribute to (c) bringing the inventories to their present location and condition; and selling and distribution costs.” (d) 5. The CITA dealt with the aforesaid arguments by holding that (a) AS- 2 is not applicable to construction contracts as will be clear that it was only applicable for purchase of goods held for resale as would be clear from para 4 of AS-2, (b) advertisement and business promotion expenses as well as legal & professional charges were related to a project and cannot be allowed as a revenue expenditure and have to be capitalised as capital cost of the project. Aggrieved by the aforesaid order of CITA, the assessee is in appeal before the Tribunal.

I have heard the submissions of the ld. Counsel for the assessee and the ld. DR. The ld. Counsel for the assessee reiterated the submissions as were made before the CITA. He filed a Paperbook containing several case laws which relate to applicability of AS-7 and AS-2. Since the assessee in the present case is following AS-9, these decisions are not relevant and the ld. Counsel for the assessee was also apprised of this position. The ld. Counsel for the assessee placed reliance on Opinion of Expert Committee of ICAI dated 16.7.2003 wherein again the question was in the context of AS-2 vis-a-vis AS-7 and therefore even this Opinion is not of any use in the present case. The ld. Counsel for the assessee pointed out that both items of expenses which were treated as capital expenses attributable to the project requiring capitalisation as work-in- progress had no relevance to the project and was general administrative expenses of the assessee and therefore ought to be allowed as deduction.

I have examined this argument of the ld. Counsel for the assessee and I find that the advertisement & business promotion expenses of Rs.15,65,000 was a payment made by the assessee to Ogilvy Mather P. Ltd. [“Ogilvy” for short]. The agreement between assessee and Ogilvy is at pages 88 to 90 of PB. Perusal of the same shows that the assessee has engaged the services of Ogilvy for the purpose of corporate brand identity exercise, logo design and collateral design. In my opinion, this would be in the nature of general expenses not attributable to any project and payment to the extent it relates to the aforesaid expenses cannot be capitalised and had to be allowed as revenue expenditure. There is also another agreement for advertising with Ogilvy dated 5.9.2011. This agreement is for specific purpose of advertising of projects and therefore payments made for the said purpose will have to be treated as attributable to specific project and capitalised. The AO is directed to examine the payment of Rs.15,65,000 and to the extent it relates to corporate brand identity exercise and logo design should be allowed as revenue deduction. The AO will allow opportunity of being heard to the assessee.

As far as legal & professional charges are concerned, it is clear from the agreement between the assessee and Prashant Rana and Lenin R.K. that the assessee had engaged professionals for carrying out liasoning work in relation to Sarjapur site. Therefore payment made to these two persons are referable to a particular project and therefore these expenses have to be capitalised to the concerned project. We therefore uphold the order of the CIT(Appeals) to this extent.

We may also add that the relevant statutory provisions regarding method of accounting under the Act, are Sec.145 of the Act (prior to its amendment by the Finance Act, 2014 w.e.f. 1.4.2015 applicable in the present case) deals with Method of accounting and it reads thus:-

Vide Notification No. 9949, dated 25-1-1996 [(1996) 130 CTR (St) 33], Accounting Standard I relating to disclosure of accounting policies and Accounting Standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies had alone been notified as Accounting Standards to be followed by an Assessee and no other accounting standard has been notified.

AS-7, AS-9 issued by ICAI or the ICAI Guidance Note on Accounting for Real Estate Transactions, 2006, have not been notified and hence they do not have statutory force. The Assessee follows mercantile system of Accounting. AS-7 or AS-9 or ICAI Guidance Note on Accounting for Real Estate Transactions, 2006, cannot be said to be either Cash system or Mercantile system of accounting. All these systems of recognizing revenue have trappings of both cash system or mercantile system but cannot be said to fall strictly within the parameters of either cash system or mercantile system of accounting. For example, in a real estate project if none of the flats constructed are sold there is no need to recognize revenue as no income has accrued or arisen. However in POCM, you have to presume accrual of income based on the stage of completion of the project. This is definitely not in tune with the mercantile system of accounting. Similarly in PCM, even prior to completion of the project sale of some of the flats in a project could be made, but income from such sale is not recognized but postponed. Therefore PCM is also not strictly not in tune with the mercantile system of Accounting. We however wish to make it clear that the aforesaid observations will hold good only for AY upto AY 2012-13 because Sec.145 of the Act has undergone some statutory amendments and the position after such amendment is not and cannot be subject of decision in this appeal.

For the reasons given above, I reject the argument of the ld. Counsel for the assessee on his reliance on AS-2.

In the result, the appeal of the assessee is partly allowed for statistical purposes.