2019 (3) TMI 493 - AT - Income Tax

Unascertained liability - allowability of future development expenses - assessee following the mercantile system of accounting - matching principle applicability - assessment completed u/s 143(3) - HELD THAT - The matching principle is one of the most fundamental principles in accounting. It is an integral part of the accrual accounting system and requires that a company must record expenses in the period in which the related revenues are earned. The matching principle states that expenses should be recognised and recorded when those expenses can be matched with the revenues those expenses helped to generate. The provision was made by the assessee for the expenses in relation to the projects completed of which the revenue was recognised and since such expenses were duly identified by the assessee in respect of each and every projects and details of the same were also furnished before the AO, the provision made by the assessee represented ascertained liability. Moreover, the expenditure so provided was to be incurred in respect of the projects substantially completed, the entire revenue of which was duly recognised by the assessee in the year under consideration. The said expenditure thus was related to the revenue already recognised by the assessee in the year under consideration by following the project completion method and the same was allowable as deduction in the year under consideration as per the concept of matching principle. Similar method of accounting was followed by the assessee consistently even in the earlier years and as submitted by the learned counsel for the assessee, similar provision made for the expenses to be incurred in respect of project substantially completed in respect of which revenue was recognised was allowed by the AO even in the assessment completed u/s 143(3). In our opinion, the Ld. CIT(A) appreciated the claim made by the assessee in the right perspective and rightly allowed the same after taking into consideration, the method of accounting followed by the assessee, in the light of relevant accounting standard as well as case laws relied upon by the assessee in support. - Decided against revenue

Summary

Issues Involved:
1. Disallowance of future development expenses amounting to ?2,25,01,129/- by treating them as contingent in nature.

Issue-wise Detailed Analysis:

Disallowance of Future Development Expenses:

The revenue appealed against the order of the Commissioner of Income Tax (Appeals) [CIT(A)], which allowed the assessee's claim for future development expenses amounting to ?2,25,01,129/-. The primary contention of the Assessing Officer (AO) was that under the mercantile system of accounting, only crystallized liabilities are allowable as expenses, and since the future development expenses were estimated and not actually incurred, they were considered unascertained liabilities.

The assessee, engaged in real estate development and hospitality services, had included the future development expenses in its profit and loss account, arguing that these were ascertained liabilities based on contractual obligations to complete common facilities for sold flats. The provision was made in accordance with Accounting Standard (AS) 29 and similar provisions in Income Computation and Disclosure Standards (ICDS) X applicable from 01.04.2015 under Section 145 of the Income Tax Act.

The CIT(A) accepted the assessee's arguments, noting that the future development expenses were contractually obligated and based on purchase orders, sanctioned plans, and project engineers’ drawings. The CIT(A) also referenced the consistent accounting method followed by the assessee and prior acceptance of this method by the department, except for three assessment years (2012-13 to 2014-15).

The CIT(A) supported the decision with various judicial precedents, including:
- Consulting Engineering Services (India) Limited (250 ITR 849): Established that a consistently followed accounting system cannot be altered in subsequent years.
- Mayura Infrastructure Development Company: Affirmed that accrued liabilities, even if to be discharged in the future, are deductible.
- Ranka Colonizers Pvt. Ltd.: Supported the reasonableness and honesty of provisioning for expenses.
- Green Triveni Developers: Held that liabilities arising in the year, even if to be discharged later, are allowable.
- Spytech Buildcon: Reinforced that provisions made for expected future expenses are legitimate if made bona fide.

The CIT(A) concluded that the assessee’s method of accounting for future development expenses was consistent and in line with AS-29 and ICDS-X, and therefore, the disallowance by the AO was not justified.

Upon appeal, the Tribunal considered the submissions and the relevant material. It observed that the assessee followed the project completion method for recognizing revenue and correspondingly made provisions for future development expenses related to completed or substantially completed projects. The Tribunal emphasized the matching principle in accounting, which requires expenses to be recorded in the period in which the related revenues are earned to avoid misstatement of net income.

The Tribunal noted that the AO failed to appreciate the assessee’s method of accounting and the detailed identification of expenses for each project. The provision for future development expenses was deemed ascertained and related to the revenue recognized in the year under consideration. The Tribunal upheld the CIT(A)'s order, finding no infirmity in allowing the deduction for future development expenses.

Conclusion:

The Tribunal dismissed the revenue's appeal, affirming the CIT(A)'s decision to allow the assessee's claim for future development expenses. The judgment emphasized the importance of consistent accounting methods and the matching principle, validating the provision made by the assessee for future development expenses as legitimate and ascertained liabilities.