2020 (4) TMI 27 - AT - Income Tax

Nature of interest expenditure - ongoing projects - interest expenses claimed as deduction while computing income of the impugned assessment year - assessee is doing a real estate activity of constructing flat for further sales /renting etc. as business activity - HELD THAT - When assessee is engaged in real estate business and is constructing flats which are meant for the purpose of sale/renting purposes as a business, the interest expenses incurred on borrowings are towards revenue field and was correctly charged to Profit and Loss Account as time cost and claimed as deduction while computing income of the assessee. The assessee in the instant case in not building a capital asset rather assessee is doing a real estate activity of constructing flat for further sales /renting etc. as business activity and these ongoing projects are at different stages of completion. In our considered view, the assessee has rightly claimed interest expenses as deduction while computing income of the impugned assessment year. In any case, these interest expenses are tax neutral and even if it is added/capitalized to the inventory being unsold stock under construction as contemplated by Revenue, then also the same is to be allowed as expenses in subsequent years when Revenue is recognized from such unsold inventory - we allow appeal of the assessee

Summary

Issues Involved:
1. Disallowance of interest expenses under Section 36(1)(iii) of the Income-tax Act, 1961.
2. Application of "percentage of completion" method by the CIT(A).
3. Classification of projects as fixed assets versus stock-in-trade.
4. Availability of own funds versus borrowed funds.
5. Proof of rental income from completed flats.
6. Rejection of notional income and related explanations.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Expenses:
The assessee claimed interest expenses of ?62,21,334/- under Section 36(1)(iii) of the Income-tax Act, 1961. The AO disallowed this claim on the grounds that the real estate projects were ongoing and not yet completed or put to use. The AO noted that the assessee had borrowed interest-bearing loans and did not have sufficient own funds, thus disallowing the interest expenses as the projects were not completed.

2. Application of "Percentage of Completion" Method:
The CIT(A) upheld the AO's decision, emphasizing that the assessee did not follow the "percentage of completion" method for offering income to tax while claiming expenses. The CIT(A) noted that the assessee's projects were ongoing, and the interest expenses were related to the extension of the existing business, thus disallowing the interest claim.

3. Classification of Projects as Fixed Assets vs. Stock-in-Trade:
The AO observed that the projects were shown as 'stock-in-trade' in the balance sheet. However, the CIT(A) and AO treated the projects as fixed assets for the purpose of disallowing the interest expenses under Section 36(1)(iii), as they were not yet put to use.

4. Availability of Own Funds vs. Borrowed Funds:
The CIT(A) noted that the assessee did not have substantial own funds and relied heavily on borrowed funds for the projects. The CIT(A) found that the assessee could not provide clear evidence of fund flow to the projects, leading to the disallowance of interest expenses.

5. Proof of Rental Income from Completed Flats:
The CIT(A) observed that the assessee did not provide sufficient proof of rental income from completed flats. The AO noted that the assessee admitted rental income for some units but did not follow the percentage completion method, leading to the disallowance of interest expenses.

6. Rejection of Notional Income and Related Explanations:
The AO and CIT(A) rejected the assessee's claim of ?44,89,250/- as notional income to explain the source of own funds. The CIT(A) upheld the AO's decision, stating that the subsequent withdrawal of such disclosure for taxation was irrelevant to the issue at hand.

Tribunal's Decision:
The Tribunal observed that the assessee is engaged in the business of constructing buildings for sale or renting, and the projects are held as inventory (stock-in-trade). The Tribunal noted that the interest expenses incurred on borrowings were towards revenue field and correctly charged to the Profit and Loss Account. The Tribunal held that the assessee rightly claimed the interest expenses as deduction while computing income, as the projects were ongoing and meant for sale/renting purposes. The Tribunal allowed the appeal, stating that even if the interest expenses were capitalized to the inventory, they would be allowed as expenses in subsequent years when revenue is recognized from such inventory.

Conclusion:
The Tribunal allowed the appeal filed by the assessee, overturning the decisions of the AO and CIT(A) regarding the disallowance of interest expenses under Section 36(1)(iii) of the Income-tax Act, 1961. The Tribunal emphasized that the interest expenses were related to the revenue field and correctly claimed as deductions.