2005 (2) TMI 446 - AT - Income Tax

Summary

Issues Involved:
1. Deduction of estimated construction cost for non-saleable areas.
2. Accounting method and recognition of liability.
3. Matching principle of cost and revenue.
4. Timing of recognizing income and corresponding expenses.

Detailed Analysis:

1. Deduction of Estimated Construction Cost for Non-Saleable Areas:
The assessee-company, involved in a building project with a charitable trust, claimed a deduction of Rs. 1,08,16,500 for the estimated cost of constructing two buildings to be handed over to the trust free of cost. The AO disallowed this deduction, viewing it as a contingent liability, not an actual liability, and premature. The CIT(A) upheld this view, stating that such expenses could only be allowed when actually incurred.

2. Accounting Method and Recognition of Liability:
The assessee followed the completed contract method of accounting, offering income in the year of completion of each building and deducting the pro-rata cost of non-saleable areas. The AO, however, argued that the method of apportionment used by the assessee was not acceptable, citing the Supreme Court decision in Tuticorin Alkali Chemicals & Fertilisers Ltd. vs. CIT. The AO considered the sale of flats and the construction of free buildings as separate transactions, thus disallowing the deduction.

3. Matching Principle of Cost and Revenue:
The Tribunal found the AO's approach contradictory, as the AO recognized income from the sale of the first building but deferred the corresponding expenditure. The Tribunal emphasized the matching principle, which requires that income and related expenses be recognized concurrently. The assessee's contractual obligation to construct two free buildings was integral to the project, and the cost should be defrayed by the saleable buildings. The Tribunal supported the assessee's method of proportionately estimating and deducting this cost.

4. Timing of Recognizing Income and Corresponding Expenses:
The Tribunal noted that while the project was integrated, it was divisible into segments. Recognizing income and expenses on the completion of each segment (building) was practical and in line with accounting principles. The Tribunal referenced the case of Bharat Earth Movers vs. CIT, where the Supreme Court held that a fastened liability must be allowed as a deduction even if not quantified. The Tribunal also cited the decision in Dy. CIT vs. Rajgir Builders, where a similar deduction was allowed for estimated construction costs of non-saleable areas.

Conclusion:
The Tribunal concluded that the assessee was justified in claiming the deduction of Rs. 1,08,16,500 for the estimated cost of constructing the free buildings. This deduction aligns with the matching principle and the practical approach of segment-wise project completion. The appeal by the assessee was allowed, directing the AO to allow the deduction in computing the taxable income.