DETERMINATION OF BUSINESS PROFIT IN PROPERTY BUSINESS - Sold parts attract taxable income even if entire project is not yet complete , cost or market value whichever is less should be adopted for stock-in-trade at year end.

[C.A. DEV KUMAR KOTHARI]

Property development business- gestation period:

Property development business involves execution of various work which are taken as a project. Depending on the size, location, local conditions, conditions of particular site, availability of finance, progress of booking by customers and payment by them and other operational factors the period required to complete the project vary.

Project meant for a single customer or several customers:

There can be circumstances when a particular project is meant for a single customer, for example development of land and construction of bungalow on  a plot of land for a particular customer will be an independent project. When such project is taken in an already developed  area the execution of project mostly involves activities relating to particular bungalow or house property.  For example in case of construction of factory building or a particular block of residential flats for the factory will be such a project.

Several bungalows or units: 

 In case of a larger project say for development of a  new housing complex or a new locality with several houses or bungalows there will be construction of bungalows or houses for several customers.  In such a case  the entire project envisage various initial activities like division and plotting of land,  development of land , providing common facilities like water supply, sewerage, common paths, street roads, street lighting, common parks etc. These are  part of larger project and these have to be completed to make any house or bungalow as fit for use and occupation.  In such cases, construction of each bungalow will  be a part of entire project yet it can be considered as an  independent project, when it is completed and handed over to customer, even if other houses or bungalows are incomplete and unsold. in the sense that it can be sold and handed over.

Project for ownership apartments:

 In case of projects for ownership apartments in a building or a group of buildings several residential flats,  office spaces or shops may be constructed. In such cases up to a stage, common activities are carried out by the promoter / developer. However, a stage comes when independent work can be carried out in any unit. For example when slab casting of all floors, brick work in all floors , common fittings for  pipes and fittings for water supply,  pipe and fittings for sewerage, electrical wiring from main point to particular floor etc. have been  completed it can be said that now each flat is an independent project.

Factually each house , bungalow or  flat is also independent project:

In fact and reality we find that many internal work are carried out as per choice of customer. The promoter fixes a minimum standard of material and work, and customer want better and additional material services in his unit. Again depending on position of booking, payment by customers, each unit (bungalow, house or flat) is to be completed.    Therefore, once the project is completed in its basic requirements, each house, bungalow or flat will be independent project.

Example:

A project for construction of twenty flats is undertaken. Out of twenty flats only 15 are booked and five flats are still not booked on behalf of customers and they are yet to be booked. The promoter complete initial work and all twenty flats are ready up to the condition of  external work and now internal work like work of flooring (which can be of several types like marble, mosaic,  marble tiles, mosaic tiles, granite, glass ,cement, wooden etc.) , sanitary fittings, electrical fittings and furnishing is to be done. All these will depend on special requirement of customer. Many times customers change their requirement from time to time before it is completed. In some cases we also find that before customer takes possession, he may change requirement in  a way that some work already completed  are changed, for example, suppose standard flooring was done earlier however the customer received some windfall gains and now he may prefer to change flooring even at additional cost.

In many situations we find that the customer takes unit complete in all respect of external and basic work, and undertake internal work himself or can later on assign such work to promoter. This happens in case of investors, who have booked units and then intend to sell or let out after some time. Therefore, depending on requirements of tenant or customers, internal work is undertaken later on.  Therefore, in such circumstances, once the unit is complete and can be handed over, it can be said that, that part of project has been completed because the unit is in a condition in which the buyer want it. 

Common costs and separate costs:

We find that in such projects there are some common costs which are for entire project   there are  independent costs for each unit (bungalow, house or flat) project. The common costs can be allocated, easily  to each unit on a scientific and reasonable basis. Independent cost for each unit can be identified and some of them which are incurred out of common pool of men and material be estimated for each unit.

We find that in such projects sale of any unit  can be done to customers. Many customers start work of  internal fittings and interior decoration immediately, many undertake such work after some time. Many keep such flats for selling or letting out in future. Therefore, once a unit is complete and is marketable or is already sold it can be said that a part of project which is marketable or sellable and is in fact sold is completed. In such cases, any proportionate expenses yet to be incurred on some common facilities or services or obligations can be estimated and provided to ascertain profit from  unit which has been.

Unfinished units are also sold:

In practical life we also find that unfinished units are also sold by promoters / developer and many times by investors. We find that an investor books flats at initial stage, and then with progress of project he transfers booking to other investors or buyers. Similarly, as discussed above, many investors purchase unfinished flats also and then they get them finished as per specific requirement at the time of use. Therefore, it can be said that unfinished project or units in a project are also marketable. The market value of such units can also be ascertained.s

Valuation of projects as stock-in-trade:

In such business, the project is stock-in-trade of the promoter/ developer. Various units may be in different stage of completion as on last day of the  previous year. Considering the fact the entire project may take longer duration to complete it is desirable that income of each year should be completed. The stock-in-trade can be valued at cost/ estimated cost and realizable value if it is lower than cost. In the present time of recession, when market value of properties have fallen and are expected to fall further by 31^st March 2009, it is desirable that estimated market value should be ascertained and if it is lower than cost, the valuation should be made on lower amount. If this method is followed, the assets will be stated at realistic value. Profit, if any will be accounted for only in case of sale of any unit. Loss due to fall in prices below cost, if any will also be accounted as on closing day of the previous year.      

Recent decision of ITAT holding each flat (sold) is alos an independent project:

The ITAT, Delhi 'E'  Bench  in the case of  M/s. Growth Techno Projects Ltd. V . ACIT  

ITA No. 563/Del/2005 in its order dated January 30, 2009 considered issue relating to project which is not completed or sold in entirety but some parts of it have been completed and some have also been sold. The Tribunal held that in such situation each flat can be regarded as an independent project, to compute income, even when the assessee follows project completion method. The observations and conclusions of the Tribunal are analyzed below:

a.       assessee had completed and sold some of flats and possession was handed over by the assessee to the buyers.

b.      The sale value being  amount of consideration was also realized from customers.

c.       The ultimate registration of the sale document in favour of the buyer was still pending. However, this is not much relevant.

d.      Important factor  which is  relevant is that  the construction of a particular flat is completed and the possession was actually handed over by the assessee to the buyer, therefore, sale was completed.

e.       Some incidental activities (like  some of common facilities or formalities to complete sale by registration of deed) may not have been completed or there may be some further obligation undertaken in the agreement for sale of flat which were to be discharged or performed by the developers in future.

f.         It can be said that the profit is referable to that part of the development of the project which has been completed (and sold).

g.        In the   present case, it is not necessary that all the flats should be first sold and then the project can be said to have been completed.

h.       Each and every flat or unit is to be treated as an independent project the profit on that part which has been completed by handing over the possession to the buyer cannot be postponed beyond the date on which the possession was handed over by the developer to the buyer.

i.          If any constructed flat is sold and the possession thereof is handed over to the buyer and any obligation is yet to be  discharged by the developer, the profit may very well have to be reported. For some incidental obligations further costs can be estimated and deducted.

j.         The contention of assessee that the entire project of constructing number of flats is to be treated as a single project and the profit would arise to the assessee only after all the flats are sold is not found to be justified on the facts of the present case.

k.       In the business of Development and Construction of property, the question may arise as whether there will be profit for each year when there are no receipts. In case, there is no receipts or sale of a particular flat is not completed, there will be then be no profits. The outlay can be carried forward at cost with the result that the value of the work in progress valued at cost will be equal to the outlay. But when there are receipts or sale of some flat is completed, proportionate profits are bound to be presumed and it may not be correct to avoid accounting profits in that year with reference to such receipts or possession of the flat having been handed over to the buyer.

l.         The whole project may be disjunctive and may be capable of being dissected where the developer is able to treat the project as discharged in part: handing over part of the constructed portion will then have to be treated as independent project and profit on that part cannot be postponed beyond that date.

m.      Where the developer goes on handing over constructed flats on each occasion, when it is handed over, there is a completed sale whether there has been registration of the document or not.

n.        Proportionate part the profits in respect of the constructed flats, in respect of which a possession was handed over, will have to be accounted.

o.      It is immaterial that the whole project may not be completed or there may be some further obligation undertaken in the agreement for sale of flat. In such a case, a reasonable provision can be made for future obligations which are yet to be discharged.

p.      As observed by learned CIT(A)   if we were to agree to the contention of the assessee, it might given rise to a possible mischief where the assessee would never conclude his project by leaving one flat incomplete indefinitely or by keeping certain liability outstanding indefinitely.

q.       The assessee's contention that sewerage and water connection were yet to be obtained and the electricity connection had yet to be sanctioned cannot be a basis to say that the project was not completed when it has been categorically established on the basis of documents and papers found during the course of survey that the actual physical possession of the flats were handed over by the assessee to the buyers.

r.        Certain liability were yet to be discharged by the assessee, the assessee can  make reasonable provision, which can be taken into account while determining proportionate cost relating to the flats which has been sold and in respect of which in profit has been booked in the relevant year following decision in case of Calcutta Company reported in (1959) 37 ITR 1 (SC).

s.        Taxability of profit cannot be postponed in respect of flats sold, when the assessee was maintaining the books of account on mercantile basis and also  following project completion method of accounting.

t.         In view of above the Tribunal  upheld the order of authorities below in holding that the profit from the flats in respect of which possession were handed over by the assessee on the basis of the documents and papers found during the course of survey, is to be assessed in the respective years in which the possession was handed over by the assessee to the buyer irrespective of the fact whether the certain liability or dues were still payable by the assessee to the bank or any other person in respect of any liability undertaken by the assessee.

u.       Any contrary material except a verbal submission has been brought by the Id. counsel for the assessee to disprove or controvert the findings of the A.O. with regard to the fact that the assessee had handed over the possession of the number of flats to the buyers after taking full consideration of the agreed price as detailed by the A.O. in the list incorporated in the assessment order.

v.        Therefore, The Tribunal held that the profit from the respective flats, details thereof is incorporated in the chart given in the body of assessment order of the assessment years under consideration are to be included in the taxable profit.

Conclusion:

The sale of any part of project should be accounted for as sale and profit or loss should be ascertained. If any incidental work or common work is pending, In practice, we find that a part of consideration is kept pending payment  by customer or some amount is kept in an escrow account. Payment against the same is released by customer or the escrow account on completion of the work. In fact in case of minor pending work, which are bound to be completed by developer, even any part payment is not kept pending.

When  a project or any part of project is completed substantially and it is marketable, and its market value can be ascertained, then it is proper to work out actual cost and market value and to value the inventory at cost or market value whichever is less.