2016 (5) TMI 1462 - AT - Income Tax

Nature of income - sale of land - business income or capital gains - assessee is a partnership firm, engaged in the business of development and construction - Held that - 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. 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 1971 (8) TMI 10 - SUPREME COURT 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. AO directed to treat the gains on sale of Badlapur Land as LTCG in place of business income. - Decided in favor of assessee.

Summary

Issues Involved:
1. Classification of profit from the sale of land as business income or capital gains.
2. Disallowance of ?15 lakhs incurred for the transfer of property at Badlapur.

Issue-Wise Detailed Analysis:

1. Classification of Profit from the Sale of Land:
The primary issue involves whether the profit earned on the sale of land at Badlapur should be treated as business income or capital gains. The assessee, a partnership firm engaged in development and construction, purchased land at Badlapur between 1988-1990 but did not undertake any construction activity on it. The expenses incurred on the land, including fencing and interest on borrowed funds, were capitalized and shown as work-in-progress (WIP) in the balance sheet. The assessee treated the land as an investment based on a Memorandum of Understanding (MOU) executed in 1998, wherein the partners decided not to carry on any business activity on the land and to treat it as an investment. The Assessing Officer (AO), however, treated the land as stock-in-trade and taxed the profit from its sale as business income.

The assessee argued that the capitalization of interest costs and other expenses to the WIP was contrary to the accounting treatment prescribed for inventories in Accounting Standard 2 (AS-2). The assessee also cited judicial pronouncements, including the Bombay High Court's decision in CIT Vs. Lokhandwala Construction Inds. Ltd, which supports the treatment of interest expenses as period costs for builders. The Tribunal acknowledged that the treatment given to the Badlapur land in the assessee's books of accounts was consistent with that of a capital asset. The Tribunal also noted that the conduct of the assessee, surrounding circumstances, and the MOU supported the treatment of the land as a capital asset. The Tribunal concluded that the Badlapur land should be treated as a capital asset, and the gains on its sale should be treated as long-term capital gains (LTCG) rather than business income.

2. Disallowance of ?15 Lakhs:
The second issue pertains to the disallowance of ?15 lakhs claimed by the assessee as expenses incurred for the transfer of the Badlapur property. The assessee claimed that ?12 lakhs were paid to Mrs. Rita T. Soni, one of the vendors from whom the land was purchased, who objected to the sale when she became a major. However, the assessee failed to provide evidence of this payment either during the assessment, appellate proceedings, or before the Tribunal. In the absence of any evidence, the Tribunal found no infirmity in the AO's order disallowing the amount of ?15 lakhs and adding it back to the assessee's income.

Conclusion:
The Tribunal directed the AO to treat the gains on the sale of Badlapur land as LTCG instead of business income. However, the disallowance of ?15 lakhs incurred for the transfer of property was upheld due to the lack of evidence. The appeal of the assessee was allowed in part. The order was pronounced in the open court on 25/05/2016.