ARIHANT CONSTRUCTION,MUMBAI vs. ASST CIT 18(1), MUMBAI

Rival contentions have been heard and record perused. Facts of the case are that the assessee is a partnership firm, engaged in the business of development and construction. The firm came into existence 2 in the year 1987, it purchased land at two places – one at Lalbaug and the other one at Badlapur. The assessee undertook project at Lalbaug land in the year 1993 and offered its income on its completion in the year 2001. The land at Badlapur was purchased in the year 1988-1990. No construction activity was undertaken in respect of land at Badlapur. The expenses incurred on fencing of land, interest on funds borrowed and utilized for purchase of said land etc. were capitalized with the cost of land. The assessee had never undertaken any activity of the construction on this land at Badlapur, since the land was acquired in the year 1988- 1990. Interest incurred on the funds borrowed for acquiring it and other cost incurred for its fencing etc. were added in its cost and shown as work-in-progress in the balance sheet year after year. Assessee had not claimed these expenses as revenue expenses during any of the preceding years in which these were incurred. During the year under consideration the assessee sold the land and gain was offered as capital gain, however, the AO did not accept assessee’s contention and asked the assessee as to why the gains should not be treated as income from business. It was replied that in the year 1998 there was a dispute between the partners and assessee firm was facing difficulty in completing the project at Lalbaug. Considering all the disputes and the difficulty in executing the project at Lalbaug land, both the partners of the assessee firm entered into an understanding by way of Memorandum of Understanding (MOU) executed on 4-4-1998 on a stamp paper of Rs.500/- duly notarized. Through this MOU both the partners mutually 3 decided not to carry on any business activity on this land. The partners also decided mutually and recorded the same in the MOU that the land at Badlapur shall be treated as “investment” of the assessee firm. It was also resolved that immediately on sale of Badlapur land, the firm will be dissolved. The assessee also explained the cost incurred on its fencing as well as interest on funds borrowed for its purchases, salary paid to the staff were duly capitalized and same was not claimed as revenue expenditure in any of the years. The conduct of the assessee for capitalizing all these expenses clearly proves that land was retained as “investment” rather than as stock-in-trade. However, the AO did not agree with the assessee’s contention and held that land was its stock-in-trade and profit earned on sale of land was liable to be taxed as business income rather than capital gains. Accordingly he declined indexation as well as rate of tax chargeable on capital gains.

By the impugned order CIT(A) confirmed the action of AO by disregarding the MOU executed in the year 1998. Against this order of CIT(A) assessee is in further appeal before us.

As per ld. AR the 'Accounting Standard - 2 Valuation of Inventories' issued by the Institute of Chartered Accountants Of India deals with valuation of Inventories in case of builders. The AS - 2 Para 6 defines Cost of Inventories as under: "6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in. bringing the inventories to their present location and condition. " Further Para 12 of AS - 2 deals with Other Cost relating to inventories and provides as under:

"12. Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and conditions and are, therefore, usually not included in the cost of inventories" In view of the above, it was contended that para 12 of AS - 2 specifically provides that interest and other borrowing costs are not to be included in the cost of inventories, as the same are not relating to bringing the inventories to their present location and conditions. Our attention was also invited to the 'Chart showing year wise details of Capitalisation of Badlapur Land', wherein the assessee has purchased land in A.Y.1988- 89 to 1990-91 for an aggregate consideration of Rs.10,91,016/- [i.e.Rs.1,42,350 + Rs.3,19,454 + Rs.6,29,212]. Over the period i.e. from A.Y.1988-89 to 2009-10 the assessee has capitalized expenses aggregating to Rs.99,01,310/- [i.e.Rs.1,09,92,326 - Rs.10,91,016] to cost of Badlapur Land which mainly comprises of Interest Cost and other expenses like Salary, bank charges etc.. As per ld. AR even though the assessee has shown the Badlapur Land as WIP (i.e. inventory) in its books of accounts, however, the assessee has capitalized the interest cost to the WIP (i.e. inventory) which is contrary to the accounting treatment prescribed for inventories in AS-2. Thus, the capitalization of interest cost to Badlapur land is in line with the treatment for a Capital Asset i.e. investment.

In view of the above, it was argued by ld. AR that the AO also at para 6.3(g) on page 9 has incorrectly observed that the accounting treatment given by the assessee to WIP is in consonance with the 5 principle laid down in AS-2. As per ld. AR not only the AS - 2 bars capitalization of interest cost to inventories, but even under the Income Tax law, the interest expenses are to be treated as period cost for the builders. In this regard the assessee relied on the decision of Hon'ble Jurisdictional Bombay High Court in the case of CIT Vs. Lokhandwala Construction Inds. Ltd [260 ITR 579] wherein the hon'ble High Court has laid down that interest expenses incurred on capital borrowed for project i.e. stock in trade has to be allowed as deduction u/s 36(l)(iii) of the Act in the year of its incurrence. As per ld. AR the treatment of interest given by the assessee even in the books of account are inconformity with the judicial pronouncements laid down by jurisdictional High Court as discussed above. As per ld. AR the same view was also taken by the Mumbai Tribunal in the case of Jomt Commissioner of Income Tax Vs. K. Raheja (P) Ltd [102 ITD 414](refer para 16 to 19) and in the case of M/s Motiram Tolaram Vs. ACIT [ITA No.67731Mum/2012] order dt.10.10.2014.

On the other hand, ld. DR relied on the orders of lower authorities. It was argued that assessee had treated the land and the cost capitalized as work-in-progress, therefore, the AO was correct in treating the profit accrued on its sales as business profit rather than capital gains.

We have considered rival contentions and carefully gone through the orders of authorities below and also deliberated on the judicial pronouncements referred by lower authorities in their respective orders as well as cited by ld. AR & ld. DR during the course of hearing before us. From the record we found that assessee has purchased land at Lalbaug 6 in the year 1988 to 1990, at the time of purchase its object was to construct building thereon. However, due to difficulty faced with respect to construction of building on the land take at Lalbaug, the assessee decided not to undertake any construction activity on the Badlapur land. Accordingly, an MOU was executed in the year 1998 on a stamp paper of Rs.500/-, wherein both partners mutually decided not to carry on any business activity on the land at Badlapur and it was also decided that land at Badlapur shall be treated as “investment”of the assessee firm at the cost as appearing in the balance sheet as on 31-3-1998. The treatment given by the assessee in its books of account fully supports its action of treating Lalbaug land as capital asset, insofar as interest incurred on the funds borrowed for purchase of land, cost incurred on its fencing and expenses incurred on its safety was every time capitalized and not claimed as business expenditure. Even though Badlapur land was erroneously shown as WIP in assessee’s books of accounts however, the accounting treatment given to Badlapur land in its books of accounts, is that of a Capital Asset.

From the record, we found that the assessee has capitalized interest cost in the cost of Badlapur land and this conduct of the assessee is in consonance with the treatment for a Capital Asset. It is a settled legal position that interest in respect of a Capital Asset is required to be added to the cost of Investment/Capital Asset. In this respect reliance can be placed upon the decision of Hon'ble Delhi High Court in the case of CIT Vs. MithIesh Kumari [92 ITR 9] wherein the hon'ble High Court has held 7 that the interest paid on amount borrowed for purchase of open plot of land forms part of cost of acquisition, by observing at para 8 as under: "We are in respectful agreement with the observations of the Calcutta and the Bombay High Courts in the decisions referred to above. In the present case, we find that the assessee in order to purchase the land had not only to borrow the amount of Rs.95,000 which was the consideration for the purchase of the land, but also had to pay interest of Rs. 16,878 on the amount borrowed by her. The amount of Rs. 95,000 plus the interest paid by the assessee constitutes the actual cost to the assessee of the land….” Similar view was also taken in following decisions: a) Addl. CIT Vs. K.S. Gupta [119 ITR 372](Andhra Pradesh) b) S. Balan Alias Shanmugam Balkrishnan Chettiar Vs. DCIT [120 ITD 469](pune Tribunal) c) CIT & Anr Vs. Sri Hariram Hotels (P) Ltd [188 Taxman 170](Kamataka) 10. Keeping in view the totality of facts and circumstances, we can safely conclude that although the assessee has shown the Badlapur Land as WIP (i.e. inventory) in its books of accounts, yet since its inception, the accounting treatment given to Badlapur land in its books of accounts is that of/as applicable to a Capital Asset (i.e. Investment). The Hon'bIe Supreme Court has clearly held in the case of Kedarnath Jute Mfg. Co. Ltd. Vs. CIT [82 ITR 363] that the entries in books of accounts are not conclusive and that the true nature of income/expense is determinative in deciding the taxability of income or allowability of an expense.

If we consider the surrounding circumstances and conduct of the assessee to verify the true nature of Badlapur Land ignoring the accounting entries in books of accounts then it borne out that: a) The assessee had acquired land at Badlapur in the year 1988 to 1990 and there was no development and construction activity undertaken by the assessee on 8 Badlapur land from last 20 years. No builder/businessman keeps the land undeveloped for such a long period of time b) The assessee has capitalised the interest cost and other expenses to the Cost of Badlapur Land, which is in consistence with treatment to a Capital Asset. c) The capitalization of interest cost is also in conformity with Provisions of Income Tax Act applicable to a Capital Asset. d) Capitalisation of interest cost is neither in conformity with the accounting of inventories prescribed in AS-2 nor in compliance to the provisions of Income Tax Act as laid down by the Hon'ble Bombay High Court in the case of Lokhandwala Construction (supra) and other decisions. e) The Badlapur Land was treated as Capital Asset by the assessee through MOU dt.4.04.1998 entered into between the partners of the assessee firm which was executed on Rs.500 stamp paper and is duly notarized. The AO did not accept the MOU solely on the basis of doubts, surmise and conjecture, without any basis. f) The nomenclature given to Badlapur Land as WIP in books of accounts is an inadvertent mistake on the part of the assessee, solely due to the reason that the books of accounts of the assessee firm are maintained by the partner's themselves year after year who are not qualified accountant's. Services of qualified Chartered Accountant's were not availed of by the assessee from last several years. Even the assessment proceedings were attended by one of the partner in earlier year without assistance of any qualified chartered accountant.