2005 (9) TMI 228 - AT - Income Tax

Deduction in respect of interest u/s 36(1)(iii) - Business Expenditure - Value of work-in-progress - Whether, where an assessee following project completion method of accounting, the interest identifiable with that project should be allowed as deduction in the year when the project is completed and income is offered from the project or it should be allowed on year to year basis? - HELD THAT - In the books of account, the interest expenditure is allocated to different projects and the interest expenditure referable to a particular project, is added to the value of work-in-progress in respect of that project. A reference may be made to the Schedules annexed to and forming part of the accounts for the year ended 31-3-1993 in the case of Wall Street Construction Ltd. Note No. 1 with the title 'System of Accounting' declares that the company follows completed projects method of accounting and that the work-in-progress is valued at cost. Note No. 2 declares that the cost of construction includes cost of land, development rights, construction, development, administration, marketing and finance. During the course of assessment proceedings, the Authorised Representatives of the assessees had categorically admitted that the assesses are following project-completion method of accounting. In the books of account, interest expenditure has been consistently identified and added to the value of work-in-progress. There was no question regarding the project completion method and determination of the cost of project in the case of a builder. However, in the case of a builder following project-completion method of accounting, this has no relevance for the simple reason that the determination of profits chargeable to tax are postponed to the year in which the project is completed or is substantially completed. In our view, the true profits in such a q case can be determined only when entire cost of the project, direct or indirect, including finance cost is added to the value of work-in-progress. This proposition is also fortified by the matching concept, as propounded by the Hon'ble Bombay High Court in the case of Taparia Tools Ltd. 2003 (1) TMI 83 - BOMBAY HIGH COURT . In the present cases, the assessees have identified interest cost and have allocated such cost to different projects in the books of account, but deduction in respect of interest is claimed u/s 36(1)(iii) against the income of some other projects which are completed during the relevant years. In our view, this procedure results into distortion of the correct profits which must be determined as per the project-completion method followed by the assessees. Thus, we hold that where an assessee is following project-completion method of accounting, the interest identifiable with that project should be allowed only in the year when the project is completed and the income from that project is offered for taxation.

Issues Involved:
1. Treatment of interest expenditure for assessees following the project completion method of accounting.
2. Classification of interest cost as period cost or part of the value of work-in-progress.
3. Consistency of the accounting method followed by the assessee.
4. Impact of Accounting Standard No. 7.
5. Applicability of the Bombay High Court decision in Lokhandwala Construction Industries Ltd.
6. Classification of work-in-progress as stock-in-trade or capital asset.
7. Validity of changing the accounting method consistently followed by the assessee.

Detailed Analysis:

1. Treatment of Interest Expenditure:
The primary issue is whether interest identifiable with a project should be allowed as a deduction in the year of project completion or on a year-to-year basis. The Tribunal held that for assessees following the project completion method of accounting, the interest identifiable with a project should be allowed as a deduction only in the year when the project is completed and the income from that project is offered for taxation.

2. Classification of Interest Cost:
The Tribunal examined whether interest cost should be classified as a period cost or added to the value of work-in-progress. The assessees argued that interest expenditure accrued in a particular year must be deducted against the income for that year. However, the Tribunal concluded that interest cost must be added to the value of work-in-progress, aligning with the project completion method of accounting.

3. Consistency of Accounting Method:
The assessees claimed that they consistently followed a method where interest cost was claimed yearly under section 36(1)(iii). The department argued that the assessees maintained accounts where interest expenditure was added to the value of work-in-progress. The Tribunal found that the method of accounting in the books consistently added interest to the value of work-in-progress, and thus, the department's rejection of the claimed method was justified.

4. Impact of Accounting Standard No. 7:
The Tribunal referred to Accounting Standard No. 7 (AS-7) which divides costs into various categories. The Tribunal noted that finance costs should usually be excluded from accumulated contract costs unless they are specifically attributable to a particular contract. The Tribunal found that in the present cases, finance costs were identifiable and should be added to the value of work-in-progress.

5. Applicability of Lokhandwala Construction Industries Ltd.:
The Tribunal determined that the Bombay High Court decision in Lokhandwala Construction Industries Ltd. did not directly address the issue at hand. The High Court dealt with whether interest expenditure was a capital or revenue expense, not whether it should be added to work-in-progress for assessees following the project completion method. Thus, the Tribunal concluded that this decision was not applicable to the present cases.

6. Classification of Work-in-Progress:
The Tribunal examined whether work-in-progress should be considered stock-in-trade or a capital asset. It concluded that for builders following the project completion method, work-in-progress should be considered stock-in-trade, and all related costs, including interest, should be added to its value.

7. Validity of Changing Accounting Method:
The Tribunal addressed whether the department could discard a system of accounting consistently followed by the assessee. It concluded that the assessees' method of adding interest to work-in-progress in the books was consistent and justified. Therefore, the department's rejection of the claimed method of yearly deduction was valid.

Conclusion:
The Tribunal held that for assessees following the project completion method of accounting, interest identifiable with a project should be allowed as a deduction only in the year when the project is completed and the income from that project is offered for taxation. The Tribunal emphasized the importance of consistency in accounting methods and adherence to accounting standards, ultimately supporting the department's position.

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