2014 (6) TMI 1017 - AT - Income Tax

Capital gain - anticipated profit to tax - assessment in which year - land held by the assessee as stock in trade - Held that - The conceptual foundation for this stock valuation principle are accounting principle of conservatism and business considerations of prudence, which have been noticed and approved by Hon ble Courts above. It is for these reason that when market price of an item in the closing stock is less than its cost price to the business, the notional loss is allowed as a deduction but when market price of an item in the closing stock is more than its cost price to the business, the notional profit is not brought to tax. However, by giving the impugned directions, learned CIT(A) has ended up bringing that anticipated profit to tax. What the assessee has got today is only a right to sell the 1,28,940.26 fts of constructed area in the Alexandria project and the profits, howsoever certain they may appear to be, will only fructify and be realized, and can even be quantified, only when this right is exercised in part or in full. That stage has not yet come, and until that stage comes, in our considered view, such profit cannot be taxed. Unlike in a case of a capital gain which arises on parting the capital asset at the first stage itself, it is a case of business transaction which is completed when the rights so acquired by the assessee are exercised; none can make profits by dealing with himself, as is the settled legal position in the light of the settled legal position in the case of Sir Kikabhai Premchand v. CIT 1953 (10) TMI 5 - SUPREME COURT . It is for this reason that we are unable to uphold the action of the authorities below on the facts of this case. The authorities below indeed erred in bringing to tax the anticipated business profits on assessee s entering into a development agreement with Menorah Realties Pvt Ltd in respect of the land held by the assessee as stock in trade - Decided in favour of assessee.

Issues Involved:
1. Taxability of gains from the development agreement.
2. Classification of the land as stock in trade or capital asset.
3. Determination of the appropriate tax year for recognizing gains.
4. Valuation of closing stock in relation to the development agreement.
5. Application of accounting principles and legal precedents.

Issue-wise Detailed Analysis:

1. Taxability of Gains from the Development Agreement:
The primary grievance of the assessee was the addition of Rs. 17,28,81,276 as short-term capital gains arising from a development agreement with Menorah Realties Pvt Ltd. The Commissioner of Income Tax (Appeals) modified this gain to be taxed as business income by adjusting the cost of acquisition and adding the value of the share in the constructed area to the closing stock. The Assessing Officer (AO) computed the gains based on the cost of construction of the assessee's share in the built-up area, taking it as consideration for the land transferred.

2. Classification of the Land as Stock in Trade or Capital Asset:
The CIT(A) and the Tribunal agreed that the land was held as stock in trade, not as a capital asset. According to Section 2(14) of the Income Tax Act, a capital asset does not include stock-in-trade. Therefore, the provisions regarding capital gains were not applicable. The Tribunal emphasized that once the land is classified as stock in trade, it ceases to be a capital asset, and the gains should be considered business profits.

3. Determination of the Appropriate Tax Year for Recognizing Gains:
The AO argued that the gains should be recognized in the assessment year 2010-11 when the development agreement was signed. However, the assessee contended that no gains arose in that year as the building project had not been cleared by regulatory bodies. The Tribunal noted that the CIT(A)'s reliance on Section 53A of the Transfer of Property Act was misplaced because it is relevant only for the purposes of capital assets under the Income Tax Act, which was not applicable in this case.

4. Valuation of Closing Stock in Relation to the Development Agreement:
The CIT(A) held that the transaction resulted in an increase in closing stock, which should be valued at the estimated cost of construction. The Tribunal disagreed, stating that the closing stock should be valued at cost price or market price, whichever is lower. The anticipated profits from the right to sell the constructed area could not be taxed until realized. The Tribunal emphasized that the principles of conservatism and prudence in accounting require that no anticipated profits be treated as income until realized.

5. Application of Accounting Principles and Legal Precedents:
The Tribunal cited the Supreme Court's judgment in Chainrup Sampatram v. CIT, which established that closing stock should be valued at cost or market price, whichever is lower. Anticipated profits should not be brought to tax until realized. The Tribunal also referenced the case of Sir Kikabhai Premchand v. CIT, reinforcing that profits cannot be made by dealing with oneself. The Tribunal concluded that the authorities erred in taxing the anticipated business profits at this stage.

Conclusion:
The Tribunal allowed the appeal, deleting the addition of Rs. 17,28,81,276. The gains from the development agreement were not taxable as capital gains but should be considered business profits, and the closing stock should be valued at cost or market price, whichever is lower. The anticipated profits from the right to sell the constructed area could not be taxed until realized.

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