2014 (10) TMI 533 - HC - Income Tax

Accrual of income taxable assessment year 2000-2001 or 2003-04 - business of building construction and real estate - By virtue of the sale agreement the assessee became entitled to receive nomination fees - Project completion method - Held that - Accounting Standard (AS) 7 applies to Complete Project Method. The said system deals with accounting for construction contracts in the financial statements of enterprises undertaking such contracts i.e., by the contractors. It also applies to enterprises undertaking construction activities of the type dealt within this statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale. As per the agreement, though the assessee is carrying on the business of builder and may be contractor, his role was only to identify the purchaser - the amounts due and the constructed area due to the assessee was crystallized under the agreement dated 25.6.1998. Annexure- 1 to the agreement shows, payments received prior to the agreement and balance of payments which is to be made - But under the Mercantile System of accounting, when once the said amount accrues, it has to be offered to tax in the year of accrual - when the amount is due to the assessee, a portion of which was already paid and a portion of it is payable in the near future as per the dates prescribed, the amount mentioned in the said agreement accrued on 25.6.1998 and therefore, the amount should have been offered to tax for the AY 1999-2000. Though the parties entered into agreement in 1995, there were modifications, alterations and supplementary agreements also came to be executed - Finally, the terms between the parties were crystallized under the agreement dated 25.6.1998 - when the assessee was following Mercantile System of Accounting, he should have offered to tax the amounts accrued to him under the agreement for the assessment year 1999-2000 - the order passed by the Tribunal holding that the amount to be offered to tax for the year 2003-04 applying Accounting Standard (AS) 7 and treating the transaction as Complete Project Method is opposed to the admitted facts of the case thus, the order of the Tribunal is set aside Decided in favour of revenue.

Summary

Issues:
Assessment of income from nomination fees for the year 2000-2001, application of Accounting Standard (AS) 7, determination of taxable year for income recognition, role of the assessee in the construction project, interpretation of agreements, adherence to Mercantile System of Accounting, consideration of Project Completion Method.

Analysis:
1. Assessment of Income from Nomination Fees:
The assessee, a construction company, filed its return for the year ending on 31.3.2000, declaring a loss. The Assessing Authority disallowed interest paid by the assessee on loans and brought to tax the amount received from a construction company as nomination fees. The Commissioner of Income Tax (Appeals) held that the income should be taxed for the assessment year 1999-2000, not 2000-2001. The Tribunal disagreed with both lower authorities, applying the Project Completion Method and setting aside the order, leading to appeals by both parties.

2. Application of Accounting Standard (AS) 7:
The Tribunal's decision to tax the income in 2003-04 based on AS 7 was challenged. The revenue argued that as the assessee was not a contractor, AS 7 did not apply. The assessee contended that the income should be taxed only when the constructed area was handed over, following the Complete Project Method.

3. Role of the Assessee in the Construction Project:
The agreements entered into by the parties outlined the roles and entitlements of the owner, the assessee, and the purchaser. The Tribunal found that the assessee's role was limited to identifying purchasers, and no construction responsibilities were assigned to the assessee. Thus, the application of AS 7 and the Complete Project Method was deemed inappropriate.

4. Interpretation of Agreements and Mercantile System of Accounting:
The Tribunal's decision to tax the income in 2003-04 was based on the crystallization of rights under the agreement dated 25.6.1998. However, the assessee argued that under the Mercantile System of Accounting, the income should be taxed when it accrues, which in this case was in 1999-2000. The Tribunal's reliance on AS 7 was deemed incorrect given the nature of the agreements and the assessee's role.

5. Determination of Taxable Year for Income Recognition:
The Tribunal's decision to tax the income in 2003-04 was overturned, emphasizing that under the Mercantile System of Accounting, the income should have been taxed in 1999-2000 when it accrued. The Tribunal's misapplication of AS 7 and the Complete Project Method was highlighted, and the order was set aside, favoring the revenue's contention for assessment in 1999-2000.

In conclusion, the High Court set aside the Tribunal's order, ruling in favor of the revenue for the assessment year 1999-2000. The Court emphasized the adherence to the Mercantile System of Accounting and the inapplicability of AS 7 to the specific circumstances of the case, ultimately determining the taxable year for income recognition based on the agreements and the assessee's role in the construction project.