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Facts
The assessee, a real estate developer, consistently followed the 'project completion method' for revenue recognition. The AO, however, insisted on the 'percentage of completion method' (AS-9/ICDS III) leading to a significant income addition. Additionally, the AO disallowed interest expenditure under Section 36(1)(iii) for interest-free advances made by the assessee to a sister concern from mixed funds.
Held
The Tribunal upheld the CIT(A)'s decision, ruling that AS-9/ICDS III is not applicable to real estate developers and that the assessee's consistent use of the project completion method was acceptable, thereby deleting the addition related to it. Regarding the interest disallowance, the Tribunal found that the advances to the sister concern were made due to commercial expediency, based on Supreme Court precedents, and therefore deleted the disallowance under Section 36(1)(iii).
Key Issues
1. Applicability of Percentage Completion Method (AS-9/ICDS III) versus Project Completion Method for revenue recognition for a real estate developer. 2. Disallowance of interest expenditure on funds advanced interest-free to a sister concern, in relation to 'commercial expediency' under Section 36(1)(iii) of the Income Tax Act.
Sections Cited
Section 250, Section 143(3), Section 36(1)(iii)
AI-generated summary — verify with the full judgment below
Instant appeals of the revenue and the cross objections of the assessee were filed against the order of the Learned National Faceless Appeal Centre (NFAC), Delhi [for brevity, ‘Ld.CIT(A)’] passed under section 250 of the Income-tax Act, 1961 (in short, ‘the Act’), for Assessment Years 2014-15& 2015-16, respectively, date of orders01.10.2022. The impugned orders are emanated from the orders of the Learned Income-tax Officer, Ward 3(3)(2),Mumbai, order passed under section 143(3) of the Act, date of order 21/12/2017 for A.Y. 2015-16 and order passed by Learned Deputy Commissioner of Income-tax, Ward 3((3)(1), Mumbai order passed under section 143(3) of the Act, dt of order 30/012/2016 for A.Y. 2014-15.
The registry informed that both the appeals of the revenue were filed with delay of 545 days and the COs of the assessee were filed with delay of 14 days. Both the parties filed the petition for condonation delay with sufficient reason. The rival parties have no objection to condoning the delay of other. Accordingly, delay of 545 days for revenue and delay of 14days for assessee are condoned.
A.Y. 2015-16 1 "Whether in the facts and circumstances of the case, the Ld. CIT(A) was justified in deleting the- addition of Rs.41,63,778/- made under section 36(1)(iii) of the Income Tax Act without appreciating the fact that the assessee made huge interest free advances from interest bearing funds." 2 "Whether in the facts and circumstances of the case, the Ld. CIT(A) was justified in deleting the addition made of? 2,95.38,935/-under Percentage completion method without appreciating the fact that the project has been substantially completed and 73% of the total saleable area was sold out." 3 The Appellant craves leave to add, amend and/or vary the grounds of Appeal before or during the course of hearing.” A.Y. 2014-15 "Whether in the facts and circumstances of the case, the Ld. CIT (A) justified in deleting the addition of Rs. 2,42,44,952/- made under section 36(1)(iii) of the Income tax Act without appreciating the fact that the assessee made huge interest free advances from interest bearing funds." "Whether in the facts and circumstances of the case, the Ld. CIT (A) was justified in deleting the addition made of Rs. 14,94,04,279/-under Percentage completion method without appreciating the fact that the project has been substantially completed and 68% of the total saleable area was sold out." Appellant craves leave to add, amend and/or vary the grounds of appeal before or during the course of hearing.”
4. In the outset all the appeals have the same nature of fact and common issue. For brevity with the consent of both the parties AY 2015-16 is taken as lead case.
C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd 5. The brief facts of the case are that the assessee is a developer and is having four ongoing residential projects, viz. ‘C.S. No.198 (Parel), Mooldeep Project, Shell Colony and Saptshrungi. The assessee made an agreement with Abhyudaya Co- operative Bank Ltd for construction of a building on the land belonging to the assessee company measuring about 35,500 sq.ft. for a consideration of Rs.94,50,00,000/-. The assessee company records profits after completion of project following ‘projection completion method’ and for the year under consideration also the same method was followed. Now, the grievance of the Ld.AO was that the assessee has followed the AS-7 whereas the AS-9 was applicable and considering the order of PM Mohammed Meerkhan vs CIT (1969) 73 ITR 735 (SC), the Ld.AO suggested for the percentage of completion method instead of project completion method and second issue was that as per Institute of Chartered Accountants of India (ICAI)’s guidance note on accounting real estate transactions, once all significant risk and reward are transferred to the seller thereafter act like a contractor and hence, the assessee had to offer income on the basis of the percentage completion method and not for project completion method. Accordingly, the addition was made by the ld.AO amount to Rs.2,95,38,935/- on account of percentage completion method.
5.1. The next issue is that the assessee paid interest free loan to the sister concern. The assessee has a mixed fund and accordingly paid interest amount to Rs.3,58,44,111/- in relation to secured and unsecured loan. The ld.AO calculated the percentage of interest paid to the total borrowings @18.81% and after C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd detailed calculation, the amount of Rs.41,63,775/- was disallowed under section 36(1)(iii) and added back with the total income of the assessee.
Being aggrieved on the assessment order, the assessee filed an appeal before the ld. CIT(A). The ld.CIT(A), considering the submission of the assessee, allowed the appeal. Being aggrieved on the appeal order, the revenue has filed appeals before us, and the assessee has filed cross objections before the bench.
The ld.DR vehemently argued and fully relied on the assessment order. The Ld.DR has placed that the assessee is following ‘project completion method’ but after the final agreement with the said bank, the assessee has transferred the risk and was working as a contractor. So, AS-9 will be applicable for the assessee related to construction of the building of the said party.
The ld. AR argued and filed a written submission which is kept in the record. The ld.AR stated that the assessee is maintaining the project completion method from the assessment year 2010-11. Other than A.Ys. 2014-15 and 2015- 16, the assessments were completed under section 143(3) of the Act and the project completion method was accepted. The ld.AR argued that the doctrine of consistency should be maintained and respectfully relied on the order of the Hon’ble Supreme Court in the case of CIT vs Excel Industries Limited 358 ITR 295 (SC).Held C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd “As the method of computation of profits have not been disturbed by the Revenue either for the earlier assessment year. The method cannot be disturbed in this particular assessment year.”
He further stated that the project completion method is based on an on- going dispute between the assessee and Abhyudaya Co-operative Bank Ltd which has been put to finality on execution of consent terms before the Hon’ble Bombay High Court. It is pertinent to note that the conveyance of the said lands alongwith the completed building “as is where is and what is” basis has not yet been done in favour of the said bank. All the same was done as per the consent terms executed by the Hon’ble Bombay High Court by the order dated 03/04/2023.
The fact was narrated in the submission filed by the ld. AR which is reproduced as below: - “8. At this juncture, your honour's attention is also invited to the fact that the assessee company had received demolition notices from the Bombay Municipal Corporation in respect of some of the portions of the building under construction dated 25 August, 2014 and 4 November, 2015. Against the said notices, the assessee company has filed a Writ Petition in the High Court at Bombay which is bearing Writ Petition (Lodg.) No. 3545 of 2015 wherein the Court granted ad interim relief by prohibiting the action of demolition on the basis of the aforesaid notices vide its order dated 16 December, 2015 The said petition is disposed by Hon'ble High Court, Bombay vide order dated 06.06.2016. Copy of order is enclosed for your reference. On the basis of the aforesaid order, it is respectfully submitted that the building under construction at C.S. No.198. Parel, Mumbai is not completed as some of the conditions of IOD and Commencement Certificate as per C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd Bombay Municipal Corporation are not satisfied. In these circumstances, recognizing the revenue from the project under construction is not possible as various costs are required to be incurred by the assessee company, more so when the completion of the building is approximately 80% as per the certificate of Mis. VS. Vaidya & Co dated 25 April, 2014.”
We heard the rival submission and considered the documents available in record. Except the two impugned assessment years all the years assessment were completed U/s 143(3) of the Act and the project completion method was accepted. The assessee had gone through a legal battle and final completion and handover was made through the verdict of Hon’ble Jurisdictional high Court. The change of accounting method is spoiling the “Rule of Consistency”. We respectfully relied on Excel Industries Limited (supra). The ld. AO has applied the AS -9 instead of AS-7 and treated the assessee as contractor instead of developer. The ld. CIT(A) dealt the issue elaborately which is reproduced as below: - “But, the question is arising weather the ICDS III and AS-7 applicable on the Real Estate Developer or not.
Background of AS -7 The ICAI issued Accounting Standard (AS) 7- 'Construction Contract' in the year 1983 which was later on revised in the year 2002. The AS 7 laid down the principles of accounting for 'construction contracts' in the financial statements of the Contractors. As per the revised AS 7 the accounting was to be done as per percentage/progressive completion method.
C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd In response to a query rose, on applicability of revised AS 7 to a real estate developer, before the Expert Advisory Committee (EAC) formed by the ICAI, the EAC observed that the pre revised AS-7 specifically mentions about its applicability to enterprises undertaking construction activities on their own which would include real estate developer. However, the revised AS 7 is applicable only to Contractors.
The Scope of AS -7 before the revision in the year 2002 is as follows.
"This Statement deals with accounting for construction contract in the financial statement of enterprise undertaking such contract (hereinafter referred to as "Contractor") this statement will also apply to enterprise undertaking construction activities of the type dealt with in this statement not as contractor but on their own account as a venture of commercial nature where the enterprise has entered into agreement for sale".
As per above before 2002 the AS -7 was applicable on the both contractor and Real estate developer who develop the building and thereafter sale on their own account.
The Scope of AS-7 after the revision in year 2002 is as follows.
"The Standard should be applied in accounting for construction contract in the financial statement of Contractor"
As per the revise AS -7 the scope of the standard was limited to contractor only. So after revision a real estate developer/ Builder are not covered under the AS - 7, accordingly they are not required to follow the percentage of completion of method for the revenue recognition.
"This Computation and Disclosure should be applied in determination of income for a construction contract for a contractor"
Applicability of ICDS III Meaning of Construction contract as given in ICDS is as follow 2(1)(a) A "construction contract" is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and includes:
Contract for the rendering of services which are directly related to the construction of the asset, for example, those for the services of project managers and architects
Contract for destruction or restoration of assets, and the restoration of the environment following the demolition of assets.
So the ICDS apply on Construction Contractor and to service providers such as architects, project managers, etc. who generally, render services which are directly related to the construction contract. These categories of taxpayers will now be mandatorily required to compute their taxable income on POCM basis.
However this ICDS is silent whether the same is applicable to Real Estate Developers or not. But if we see applicability of ICDS – III then it will apply only on construction contract and service provider who is providing the service related to the construction contract and the Scope of ICDS III it also similar to AS -7 and as per various decided case law referred above it is decided that C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd provision of AS - 7 is not applicable on Real Estate Developer because of that it seems that there is no applicability of ICDS III on Real estate Developer and accordingly the mandatory requirement to follow the percentage of completion method for recognition of revenue under ICDS III will not applicable on Real estate developer. However matter may be go for litigation.
The ICDS III does not provide the clear contention that whether it will apply on real estate developer or not. And due to complexity of these ICDS and Business operandi of Real Estate Developer, this is not practical to follow these ICDS. Therefore, Direct Taxes Committee of ICAI made detailed representation to Central Board of Direct Taxes during the Direct Tax Workshop with CBDT which was followed by written representation to Chairman, CBDT on 31.03.2016 and Hon'ble Finance Minister, on 7.04.2016. On invitation by CBDT subsequently, the ICAI representatives met Joint Secretary (TPL-I) and Director (TPL-III) at North Block, New Delhi and 18th on April, 2016 and 27th April, 2016 and made detailed presentation on difficulties that would be faced by stakeholders on implementation of ICDS. The representations made by ICAI were considered positively by the Expert Committee on ICDS in meeting held on 12.05.2016 and ICAI was asked to prepare detailed FAQs and amendments to ICDS which were submitted on 20.05.2016. The FAQ No. 15 deal with this situation which is as under:
Question 15: Since there is no specific scope exclusion for Real estate development activity and BOT projects from ICDS IV on Revenue Recognition, please clarify whether ICDS III and IV should be applied by real estate developers and BOT operators. Also, there is no specific exclusion for lease income in ICDS IV. Please clarify whether ICDS IV is applicable for lease income.
C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd Thus, As per ICAI it is clarified that revenue recognition of real estate developer will be governed by old law. As per old law and judicial finding the developer can follow the project completion method. Once the developer follows the project completion method income will be chargeable in the year when project will get complete which is followed by the appellant.”
In our considered view, the AS-9 is not applicable to assessee and the project completion method for recognition of revenue is applicable method for the assessee. We respectfully consider the order of PM Mohammed Meerkhan(supra) but it is factually distinguishable.
The ld. AR respectfully relied on the order of the Coordinate Bench of ITAT- Mumbai in the case of Aditya Builders vs CIT [2013] 39 taxmann.com 178 (Mum- Trib) where revenue cannot trust a method of accounting on assessee thought that the method is superior. Where, assessee had been consistently following project completion method in respect of his two projects, Commissioner was not justified in directing AO to compute income of assessee from one project why applying percentage completion method. We find no reason to interfere in the impugned appeal order. The addition amount to Rs. 2,95,38,935/- is deleted.
Accordingly, the ground no-2 of the appeal of the revenue is dismissed.
Regarding the disallowance of interest expenditure claimed under section 36(1)(iii) of the Act, the brief facts are that the assessee allowed an interest free loan total amount of Rs. 23,35,07,876/- out of which amount to Rs.14,98,28,458/- C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd paid to M/s Siroya FM Construction Pvt Ltd, as said company was in financial difficulty and therefore, assessee had paid EMI to the bank from which said company has taken loan, to prevent the group loan to be classified under NPA. The assessing officer noted that only interest amount to Rs.21,70,205/- has been charged to P&L Account and rest of the interest has been transferred to capital WIP. Accordingly, the ld. AO added the amount of Rs.21,70,205/- to the total income out of total disallowance of Rs.41,63,778/- and remaining amount is reduced from WIP. Being aggrieved, the assessee carried the matter before the ld. CIT(A). The ld.CIT(A) deleted the addition, for the detailed reasons given in his appellate order. For the sake of clarify, we extract below the CIT(A)’s order: - “2.3 I have gone through the submissions and other documents/ details filed (uploaded) by the assessee and also perused the assessment order. (a) Disallowance of interest: Grounds 2 to 5 have been raised against disallowance of Interest Expenses by purview of section 36(1)(iii): - As per the AO the assessee have Long Term and Short Term Borrowings to the tune of on which total Interest incurred and paid by the assessee during the impugned financial year is Rs. 4,27,51,458/- The appellant assessee has given interest free funds amounting to Rs. 17,70,22,250/- out of which a substantial amount of interest free funds are given to its sister concern company M/s. Siroya FM Construction Pvt Ltd in nature of commercial expediency amounting to Rs. 11,74,28,850 /- as said company was in financial difficulty and therefore assessee had paid EMI to the bank from which said company has taken loan, to prevent the group to be classified under NPA. AO alleged that since, appellant assessee during the impugned financial year has diverted interest bearing funds to non C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd business purpose and hence, interest borne by the assessee to the extent of interest chargeable on the interest free loans given, is said to be the expenditure incurred not wholly and exclusively for the Page 18 of 25 AAACS7975D- SIROYA DEVELOPERS PRIVATE LIMITED A.Y. 2014-15 ITBA/NFAC/S/250/2022- 23/1046153922(1) purpose of business. AO disallowed the excess interest paid by the assessee on the loans borrowed treating them as not allowable business expenditure u/s. 36(1)(iii) of the Act. As per Sec 36(1)(iii), deduction shall be allowed for "The amount of interest paid in respect of capital borrowed for the purposes of business or profession" For the purpose of claiming deduction under the Section 36(1)(iii), presence of the undersigned three factors are essential. The assessee must have paid interest in respect of capital borrowed for the purpose of business or profession. AO has interpreted the meaning of "purpose of business or profession" in a narrow sense. It has been held in umpteen decisions of various courts including the Supreme court and several High Courts that interest deduction can be claimed even when the monies borrowed has been given to its sister concern as an interest free loan if it was commercially expedient to do so. That the expression "commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business of profession. It has been repeatedly held by the Apex Court that the expression "for the purpose of business" is wider in scope than the expression " for the purpose of earning profits. Therefore, the disallowance is hereby deleted. Facts in AY 2015-16 are similar. The addition of Rs 21,70,205/- is hereby deleted.”
Further he argued that the assessee has been maintaining the mixed fund and paid the interest amount of Rs.3,58,44,111/- on the borrowings. The assessee claimed that due to the commercial prudency, the payment was made to the sister concern, but no such urgency was brought before the assessing C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd authority. The ld. DR relied on paragraphs 5.7 of the assessment order which are reproduced below: - “5.7. It is seen that only₹ 21,70,205/- has been charged to Profit & Loss Account and rest of the interest has been transferred to WIP. Accordingly, amount of ₹ 21,70,205/- out of above disallowance is to be added to the total income and remaining amount is to be reduced from WIP. Thus, total disallowance of 41,63,778/- is made u/s.36(1)(iii) of the Income Tax Act, 1961.”
The ld. DR respectfully relied on the order of the Hon’ble High Court of Gujrat in the case of CIT, Ahmedabad-I vs. Cornerstone Exports (P.) Ltd. [2016] 67 taxmann.com 345 (Guj) where the addition was made U/s 36(1)(iii) of the Act due to absence of business expediency.
The ld.AR, on the other hand, submitted that the concept of commercial expediency is much wider in scope and includes all expenditure incurred to run the business more efficiently (not necessarily, ‘profitably’). The answer whether the particular expenditure has been commercially expended will depend on the facts and circumstances of the case as well as the act. What is to be seen is the purpose for which borrowed money is finally utilized. If the money is utilized in a way that makes commercial sense and helps in running the intended business of the assessee more efficiently, then it can be said that the interest paid in respect of borrowed money has been incurred for the purpose of commercial expediency. For this proposition, he relied on the judgement of the Hon’ble Apex Court in the C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd case of S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals) (2007) 288 ITR 1 (SC).
15.1. The Ld.AR further relied on the judgement of the Hon’ble Apex Court in the case of A.C.I.T vs. Tulip star Hotels Ltd. (2012) 21 taxmann.com 97 (SC) – “In this case, the assessee borrowed funds and used is to subscribe to the equity capital of its subsidiary company. The subsidiary company used the said funds for the purpose of acquiring the Centaur Hotel, Juhu Beach, Mumbai. The assessee paid interest on the borrowed money and claimed deduction u/s 36(1)(iii).
The AO rejected the claim, but the CIT (A), Tribunal & High Court (338 ITR 482) allowed it by relying on S.A. Builders Ltd vs. CIT 288 ITR 1 (SC). It was held that as the assessee, being a holding company had a deep interest in its subsidiary, and hence if the holding company advanced borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would be entitled to deduction of interest on its borrowed loans.”
12.2. The assessee had advanced a sum of Rs.14,98,28,458/- to its subsidiary company known as M/s. Siroya FM Construction Pvt Ltd and this advance did not carry any interest. According to the ld. AO, the assessee had borrowed the money from the banks and paid interest thereupon. A deduction was claimed as business expenditure but substantial money out of the loans taken from the Bank was diverted by giving advance to subsidiary on which no interest was charged by the assessee. Therefore, he concluded that money borrowed on which interest was paid was not for business purposes and no deduction could be allowed. Insofar as C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd loan to the subsidiary company is concerned, law in this behalf is recapitulated by this Court in the case of S.A. Builders Ltd. v. Commissioner of Income Tax (Appeals), Chandigarh [2007] 288 ITR 1 (SC). After taking note of and discussing on the scope of commercial expediency, the Hon’ble Apex Court summed up the legal position in the following manner:
"25. The expression "commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.
No doubt, as held in Madhav Prasad Jatia’s case(supra), if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under section 36(1)(iii) of the Act. In Madhav Prasad Jatia’s case (supra), the borrowed amount was donated to a college with a view to commemorate the memory of the assessee's deceased husband after whom the college was to be named, it was held by this court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.
Thus, the ratio of Madhav Prasad Jatia’s case (supra) is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed under section 36(1)(iii) of the Act.
C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd 28. In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.
It has been repeatedly held by this court that the expression "for the purpose of business" is wider in scope than the expression "for the purpose of earning profits" vide CIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140, CIT v. Birla Cotton Spinning and Weaving Mills Ltd. [1971] 82 ITR 166, etc.”
We heard the rival submission and considered the documents available in record. Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to subsidiary company of the assessee became imperative as a business expediency. The assessee paid the EMI of loan directly from the bank maintained at Kotak Mahindra Bank & Bank of Baroda to maintain the business reputation in market. The ld. DR respectfully relied on the order Cornerstone Exports (P.) Ltd (supra) where “business expediency” was not established. The said order is distinguishable. We respectfully relied on the order of S.A. Builders Ltd. (supra) and Tulip star Hotels Ltd(supra). We find no reason to interfere in the impugned appeal order.
Accordingly, ground no-1 of the revenue is dismissed.
In the result ground nos. 1 & 2 of the revenue are dismissed and ground no-3 of the revenue is general in nature.
C.O. No. 166/Mum/2024 C.O. No. 167/Mum/2024 Siroya Developers Pvt Ltd 18. Related the Cross Objection of the assessee for both the impugned assessment years are dismissed as withdrawn.
The bench has noticed that the issues raised by the revenue in the above appeals are equally similar in a set of facts and grounds. Therefore, it is not imperative to repeat the facts and various grounds raised by the revenue. Hence, the bench feels that the decision taken by us in Assessment Year 2015-16 shall apply mutatis mutandis in the appeal bearing for AY 2014-15 and follows accordingly.
In the result, the appeal of revenue & 2961/Mum/2024 and CO of the assessee CO No. 166 & 167/Mum/2024 are dismissed.
Order pronounced in the open court on 24th day of September2024.
Sd/- sd/- (GAGAN GOYAL) (ANIKESH BANERJEE) ACCOUNTANT MEMBER JUDICIAL MEMBER Mumbai,दिन ांक/Dated: 24/09/2024 Pavanan