2013 (8) TMI 483 - AT - Income Tax

Application of percentage completion method for computation of profit real-estate business Held that - Clearly, there is no question of any income unless the sale or transfer has taken place, so that the builder-seller retains no effective control of the real estate, i.e., to the degree as usually associated with the ownership, which is thus beneficially transferred. This essential condition for recognizing income being satisfied, the next step would be to determine the extent to which it could be so. We have already explained of the fundamental accounting assumptions of conservatism and prudence, which are to necessarily inform the accounting estimates and statements and, in fact, stand also statutorily recognized per the accounting standards issued by the CBDT u/s. 145 of the Act. Regarding cost plus method and valuation of WIP - Unsold project - Held that - No income can be anticipated in respect of the part of the project yet to be sold (i.e., as at the relevant year- end), so that it would be, from the stand point of reporting profit on the project, be immaterial if the sale price, as is generally the case, has increased over the period since which the project stands commenced. - if there is a sudden depression in the real estate market. If the Management considers that it cannot hold on to the project, the subsequent sales would have to be necessarily estimated at the going market rate. The same, if lower than the cost as anticipated, would impact the valuation of the WIP. This would depress the overall profit, which though, as evident, has no direct relation with the costs incurred during the year, i.e., the incremental WIP for the year. The assessee has furnished a revised chart (Table C) by eliminating the profit included in the valuation of the closing stock, so that it is valued at cost, which shows the profit on the project at 40.22% of the total cost. In view of the fact that some percentage of the total cost remains to be incurred as at the year-end, which though could be fairly assessed, in our view, adopting the said percentage (of course upon verifying the same to be correct) to the incremental cost for the year would be a fair assessment of the profit arising for the current year. As the assessee has booked the cost of land and utilities in some years, in preference to others, without furnishing any explanation for the same, much less a reasonable one, in our view, the cost of land and utilities, i.e., the basic costs, since incurred, be allotted to each year in proportion to the other costs incurred in that year. That is, a ratio of the basic cost (total) to the other (total) costs (for the entire project) be worked out, which percentage would then be applied for each year, including the current year, in proportion to the other cost for that year. The A.O. is accordingly directed to verify the afore-mentioned ratio of 40.22% as worked out by the assessee, and apply the said percentage - Decided partly in favor of assessee.

Issues Involved:
1. Validity of the Assessee's Method of Accounting.
2. Correctness of the Profit Disclosed for the 'Sai Sthaan' Project.
3. Adjustment of Profit for the 'Sai Swar' Project.

Issue-wise Detailed Analysis:

1. Validity of the Assessee's Method of Accounting:
The assessee, a real estate developer, followed the percentage completion method for accounting, which is recognized under both accountancy and law. The percentage completion method aligns with Accounting Standard (AS)-9 and Section 145 of the Income Tax Act, 1961. However, the assessee's claim of also adopting the cost-plus method was found to be incorrect. The cost-plus method is typically applicable in scenarios where income is contractually linked to costs incurred, which was not the case here. The assessee's income varied significantly year-to-year, indicating that the cost-plus method was not consistently applied. The tribunal acknowledged the percentage completion method but emphasized that the assessee must report true and fair operating results, and the Assessing Officer (AO) is authorized to make adjustments if the disclosed profits do not reflect the correct operating results.

2. Correctness of the Profit Disclosed for the 'Sai Sthaan' Project:
The AO computed the profit for the 'Sai Sthaan' project at Rs. 6,79,52,123, significantly higher than the Rs. 47,90,899 disclosed by the assessee. The AO's basis was the receipt of the Occupancy Certificate (OC) indicating project completion. The tribunal noted that the OC signifies the completion of civil construction, not necessarily the entire project, as common areas might still be incomplete. The tribunal found the assessee's profit disclosure arbitrary and lacking a clear basis. The assessee failed to provide a consistent method for estimating profits, often citing vague terms like 'market perception.' The tribunal directed the AO to verify the profit ratio of 40.22% on total costs as claimed by the assessee and apply it to the incremental Work-in-Progress (WIP) for the current year, including a proportionate allocation of basic costs like land and utilities.

3. Adjustment of Profit for the 'Sai Swar' Project:
The AO accepted the profit disclosed by the assessee for the 'Sai Swar' project. The tribunal found no basis for the assessee's grievance regarding this acceptance. The AO had disturbed the reported profits based on the receipt of the OC, which the assessee argued did not indicate project completion. The tribunal considered the matter factual and noted that costs were incurred subsequently, making the year indeterminate as the terminal year. The tribunal upheld the AO's adjustments in principle but found them selective, leading to profit distortions across years. Consequently, the assessee's method, with some correctives, was directed for application. No adjustment was warranted for the 'Sai Swar' project since the AO made no changes to the returned profit, and the terminal year adjustments would be necessary for the final year, which was not the current year for 'Sai Swar.'

Decision:
The tribunal directed the AO to verify and apply the profit ratio of 40.22% to the incremental WIP for the 'Sai Sthaan' project, including a proportionate allocation of basic costs. The assessee's method was accepted with correctives for the 'Sai Sthaan' project, while no adjustment was required for the 'Sai Swar' project. The assessee's appeal was partly allowed.

Result:
The assessee's appeal is partly allowed.

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