2018 (1) TMI 892 - AT - Income Tax

Revenue recognized from the project - Method of accounting followed - Held that - In the present case, the assessee is following Mercantile system of accounting therefore, the assessee was required to disclose the profit which accrued corresponding to the part of the work of the project executed by the assessee. AO was required to examine the agreement to sale for units and record whether any specified area of plot of land was allocated to the customers and significant risk relating to the said plot like price risk, any regulatory risk (related to state government or any local authority) was transferred by the assessee. He was also required to examine whether there was any restriction on the buyer to sale or transfer his interest in the property to a third person till complete sale consideration is paid. In our opinion, if the significant risk and reward are transferred to the buyer, the amounts received from the buyer to the extent of stage of completion of the project has accrued to the assessee and it should be subject to tax in terms of section 5 of the Act. Before us, the percentage of work completed by the assessee on the project, is not available and, thus, we are unable to compute the revenue recognized from the project. Set aside the order of lower authorities on the issue in dispute raised in both the appeals and restore the matter to the file of the Assessing Officer for deciding afresh in view of observation made by us above.

Summary

Issues Involved:
1. Confirmation of addition on account of Assured Return.
2. Treatment of expenses as capital expenses or revenue expenses.

Detailed Analysis:

1. Confirmation of Addition on Account of Assured Return:
The assessee contested the confirmation of an addition of ?1,34,37,679/- by the Commissioner of Income-tax (Appeals) [CIT(A)], arguing that these expenses were incurred to ensure sales booking and receipt of advance considering market conditions. The CIT(A) treated these expenses as capital expenses/part of inventory, contrary to the assessee's claim that they were necessary to meet market competition and should be treated as revenue expenses. The CIT(A) also observed that these expenses related to booking, which might be unidentified and potentially linked to future projects, disregarding the facts and evidence presented by the assessee, including audited financial statements and notes to accounts.

2. Treatment of Expenses as Capital Expenses or Revenue Expenses:
The Revenue appealed against the CIT(A)'s decision to delete expenses amounting to ?10,32,42,076/- under various heads, arguing these were capital in nature. The Assessing Officer (AO) had initially disallowed these expenses, treating them as part of inventory since the project was in its early stages of development. The expenses included advertisement and marketing, employees' salary, traveling, legal, brokerage, and assured return expenses. The AO believed all expenditures related to the project should be capitalized. However, the CIT(A) allowed the deletion of these disallowances except for the assured return expenses.

Tribunal's Observations and Decision:
The Tribunal noted that the assessee followed the Percentage Completion Method (PCM) for revenue recognition, as per the Institute of Chartered Accountants of India's (ICAI) guidance notes. The Tribunal agreed with the Revenue's contention that rather than disallowing the expenses, the AO should have examined the income accrued from the work completed on the project. The Tribunal observed that the AO needed to determine the revenue recognized from sales booked in proportion to the project work completed and compute the profit accordingly.

The Tribunal highlighted the importance of recognizing revenue when significant risks and rewards of ownership are transferred to the buyer, as per the ICAI guidelines and section 5 of the Income Tax Act. The AO was required to examine agreements to sale, allocation of plot areas, transfer of significant risks, and any restrictions on the buyer's ability to transfer interest in the property.

Conclusion:
The Tribunal set aside the orders of the lower authorities on the issues raised in both appeals. It restored the matter to the AO for fresh consideration, directing the AO to examine the percentage of work completed and recognize revenue accordingly. The assessee was to be afforded an adequate opportunity to present their case. Both appeals were allowed for statistical purposes. The decision was pronounced in the open court on 17th January 2018.