2012 (1) TMI 279 - AT - Income Tax

Disallowing development expenses - Held that - It is useful to note that the assessee has used the percentage completion method. When an assessee follows the percentage completion method then at the completion of the project, the assessee has to make up the accounts. At that relevant time, the assessee can offer surpluses from the provisions or may claim the deficit in case the actual expenditure is more than the provisions. Hence, the revenue is not without any remedy in case the provision is excessive.

Issues Involved:

1. Deletion of addition made by the AO by disallowing development expenses.
2. Justification of provision for development expenses.
3. Consistent accounting policy for provision of development expenses.
4. Basis of estimation for provision made for development expenses.
5. Liability towards development expenses incurred in future on plots sold.

Detailed Analysis:

1. Deletion of Addition Made by the AO by Disallowing Development Expenses:

The assessee, engaged in the business of real estate development, declared a loss and made provisions for development expenses. The AO disallowed Rs. 62,34,041/- of these expenses, arguing that they were mere provisions without a scientific method to ascertain liability and were not actually incurred during the assessment year. The AO noted that the expenses were not proportionate to the provisions made and could be debited in subsequent years when actually incurred. The AO relied on decisions from Rajasthan State Mines and Mineral Ltd. Vs. CIT and TN Small Industries Development Corp. Vs. CIT.

2. Justification of Provision for Development Expenses:

The assessee argued that development expenses were direct costs attributable to sales and essential for computing true business profits. The expenses, such as construction of roads and laying pipelines, could not be completed in a single year, necessitating provisions for future costs. The provision was not for setting apart profits but for estimating future expenses. The liability for development expenses arose in the year of plot sales and should be deducted from income to calculate true profit. The assessee cited several cases, including CIT Vs. Govind Grah Nirman Sahakari Samiti Ltd., Badridas Daga Vs. CIT, and Calcutta Co. Ltd. Vs. CIT, to support the argument that such provisions are allowable expenses under the mercantile system of accounting.

3. Consistent Accounting Policy for Provision of Development Expenses:

The assessee followed a consistent accounting policy of making provisions for development expenses to be incurred on sold plots, aligning with commercial practice and trading principles. The development work had to be carried out as per JDA specifications, and the cost was included in the sale price of plots. The provision was based on an estimate of future development costs, supported by JDA's estimated expenses for similar activities.

4. Basis of Estimation for Provision Made for Development Expenses:

The assessee provided a detailed estimation of development expenses, including costs for roads, water supply, electrification, and public parks, totaling Rs. 180 per sq. yard, against which a provision of Rs. 175 per sq. yard was made. This estimation was supported by JDA's cost estimates. The assessee also provided a summary of sellable area and area sold in two schemes, Hanuman Vatika A-2 and A-3, and a year-wise chart of development expenses incurred versus provisions made.

5. Liability Towards Development Expenses Incurred in Future on Plots Sold:

The liability for development expenses did not extinguish merely because the expenses were not incurred immediately. The assessee faced genuine difficulties in carrying out development work, such as lack of approach roads and pending approvals from JDA. The liability remained due to JDA regulations, and the expenses had to be incurred eventually. The assessee cited several cases, including Bharat Earth Movers Vs. CIT and Rotork Controls India (P) Ltd Vs. CIT, to argue that provisions for future obligations are allowable expenses.

Conclusion:

The ITAT upheld the CIT(A)'s decision to delete the addition made by the AO, stating that the development expenses were allowable under the mercantile system of accounting. The tribunal noted that the assessee's method of accounting for development expenses was consistent with commercial practice and supported by legal precedents. The tribunal also emphasized that the revenue could address any discrepancies in provisions versus actual expenses at the project's completion. Consequently, the appeals of the revenue were dismissed.

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