2013 (1) TMI 891 - AT - Income Tax

Capitalisation as a part of Expenses - Assessee company is engaged in the business of commercial construction claimed deduction in respect to administrative expenses employee s remuneration and interest. AO said that these costs ought to have been also capitalized and accordingly the assessee had under-disclosed profit. Assessee explained that the construction to the extent not sold i.e. on which no profit stands booked yet represents only the assessee s work-in-progress (WIP) i.e. stock-in-trade and not a purchase of any asset/s. In fact even if it were so i.e. on capital account the interest on borrowed capital would be allowable u/s. 36(1)(iii). HELD THAT - (i) Administrative expenses Employee s Remuneration - Any cost that adds value thereto i.e. enables the bringing of the relevant inventory to the stage of its completion and location as at the year-end is to be taken into account for the purpose. Administrative expenses as it appears are only general in nature and even with regard to the employee s remuneration there is nothing to indicate that it represents an element of either direct cost of production or even of production overhead which only would enable its inclusion as a part of the cost of production/construction. As such being fixed (period) cost these stand to be written off to the profit and loss account in the year of being incurred. Entire addition to the returned income is accordingly deleted. ii) Interest Expenditure- Deduction u/s 36 (1)(iii) - Allowed or not? - A project or part thereof may be partly sold or even remain unsold for quite some time after its completion. While revenue would stand to be booked only on the part if any sold the interest cost would continue to be incurred on the entire capital even as no corresponding gain inures in terms of value addition to the project which stands in fact completed so as to increase its cost by loading the said cost thereon. It is for these reasons that interest (financing) cost is normally considered as only a period (fixed) cost and charged to the operating statement for the year in which the same is incurred. Relying on the judgement of COMMISSIONER OF INCOME-TAX VERSUS LOKHANDWALA CONSTRUCTION INDS. LTD. 2003 (1) TMI 93 - BOMBAY HIGH COURT interest cost is to allowed u/s. 36(1)(iii) irrespective of whether it stands incurred in relation to stock-in-trade or on capital account as the said section draws no such distinction. Decision in favour of Assessee. Disclosure of Gross Profit - In the verification proceedings u/s.143(3) it was explained that the said project had been completed as at the year-end up to 34% and that the profit was booked and returned following the project percentage method disclosing a gross profit of 23% on the cost of production as capitalized during the year - HELD THAT - Considering the said cost as includable in the project cost may have a direct bearing on the gross profit rate and which may therefore stand to decline from the reported and accepted rate of 23% and cannot be presumed be remain as such i.e. unchanged. Thus no adjustment to the disclosed gross profit rate on account of any of three items of expenditure under reference is required under the given facts and circumstances of the case. Revenue Appeal dismissed.

Summary

Issues:
- Capitalization of administrative expenses, employee's remuneration, and interest expenditure in the project cost for valuation of work-in-progress.
- Interpretation of Accounting Standard 2 (AS-2) on the valuation of inventories.
- Application of section 36(1)(iii) of the Income Tax Act, 1961 regarding the deductibility of interest expenditure.
- Impact of including the mentioned costs in the project cost on the gross profit rate.

Analysis:

Capitalization of Expenses:
The issue revolves around whether administrative expenses, employee's remuneration, and interest expenditure should be capitalized as part of the project cost for valuing work-in-progress. The tribunal observed that these costs do not directly contribute to the production or construction process, and hence, they are to be written off as fixed costs in the profit and loss account. The tribunal emphasized the need for costs that add value to the project to be considered for valuation purposes.

Interpretation of AS-2:
The tribunal discussed the relevance of Accounting Standard 2 (AS-2) on the valuation of inventories, noting that while AS-2 suggests considering interest expenditure in inventory valuation, it is not mandatory under the Income Tax Act. The tribunal highlighted the requirement of establishing a direct nexus between interest costs and value addition to the project for it to be included in the project cost.

Application of Section 36(1)(iii):
Regarding the deductibility of interest expenditure, the tribunal referred to section 36(1)(iii) of the Act and the case law to support its decision. It clarified that interest costs, whether incurred on stock-in-trade or capital account, are allowable deductions. The tribunal emphasized that the method of accounting regularly followed by the assessee should prevail, and the interest cost should be treated as a period cost, not to be capitalized.

Impact on Gross Profit Rate:
The tribunal highlighted that including the mentioned costs in the project cost could impact the gross profit rate, potentially leading to a decline from the reported rate of 23%. It emphasized the need to consider the impact on the gross profit rate when determining the project cost.

In conclusion, the tribunal dismissed the Revenue's appeal, stating that no adjustment to the disclosed gross profit rate was necessary based on the facts and circumstances of the case. The decision was pronounced on January 16, 2013.