2022 (2) TMI 1184 - AT - Income Tax

Disallowance of proportionate interest expenditure - capital attributable to project B i.e. unfinished project - AO held that interest part on borrowing as well as partners capital attributable to project B i.e. unfinished project , cannot be allowed as an expense in respect of the profits derived from project A and same should be allowed to be capitalized to the work in progress (WIP) of project B - As per AO substantial amount of newly acquired unsecured loans and capital was used for the purchase of plot of land for project B , no income or revenue from said project has been credited, and therefore, he was of the view that interest on borrowings by way of capital and unsecured loans was required to be allocated project wise - Whether project completion method or percentage completion method for offering profit from the said projects for the purpose of the Income-tax? - HELD THAT - The assessee has not clarified before the lower authorities that whether it was following project completion method or percentage completion method for crediting income to profit and loss account. Before us, the assessee has filed a copy of submission dated 23/12/2019 before the Assessing Officer in respect of assessment year 2017-18 i.e. subsequent assessment year. In the said submission, the authorised representative of the assessee has clearly mentioned that the assessee is following percentage completion method. It is also mentioned that in the earlier year also the revenue was recognized following the percentage completion method. The learned authorised representative has also mentioned that interest expense was not claimed in computation of taxable income for A.Y.2017-18 We find that under percentage completion of method the revenue from booking or sales is credited to the profit and loss account in proportion to the expenditure incurred on the project as compared to the total cost of the project. In the assessment year under consideration, the assessee has not credited any amount of revenue on the ground that no substantial construction work was executed in the year under consideration. In such circumstances, even under the percentage completion method also the interest expenditure which is specifically related to project B cannot be allowed and it shall be eligible for deduction in percentage terms of cost of construction debited following the percentage completion method. In the instant case interest which was specifically related to project B and neither expenditure on said project was claimed nor any revenue from said project was offered in the profit and loss account. The interest corresponding to the project A has already been allowed by the Assessing Officer and only part pertaining to project B has been disallowed. This interest expenditure disallowed was not related to borrowing for maintaining business infrastructure but it was related to specific real estate project. As no significant risks and rewards of ownership of the project B were transferred by the assessee to prospective buyer, no revenue from said buyer was recognized following principle of percentage completion method. Thus, no liability in respect of interest expenses pertaining to project B was accrued, hence it is not allowable in the year under consideration. - Decided against assessee.

Summary

Issues Involved:
1. Disallowance of proportionate interest expenditure of ?70,00,371 related to Project "B" and its classification as capital expenditure.

Detailed Analysis:

1. Background and Facts:
The assessee, engaged in real estate construction, filed a return of income for the assessment year 2016-17. During the scrutiny assessment, the Assessing Officer (AO) disallowed ?70,00,371 of interest expenditure claimed by the assessee, attributing it to Project "B" and treating it as capital expenditure. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld this disallowance, leading to the present appeal before the Tribunal.

2. AO's Observations:
The AO noted that the assessee was constructing "Fortune Avenue," consisting of Project 'A' and Project 'B'. Project 'A' was completed, and sales were recorded, but no income or construction completion certificate was provided for Project 'B'. The AO observed that substantial unsecured loans and capital were used for Project 'B', and thus, interest expenses should be allocated project-wise. The AO disallowed the interest attributable to Project 'B', proposing it should be capitalized to the Work in Progress (WIP) of Project 'B'.

3. CIT(A)'s Findings:
The CIT(A) upheld the AO's decision, noting that the majority of the newly established unsecured loans and capital were used for purchasing the plot for Project 'B'. Since no significant work was done on Project 'B', the interest expenses related to it were not allowed as revenue expenses for AY 2016-17 and were to be capitalized in the WIP.

4. Assessee's Arguments:
The assessee argued that under Section 36(1)(iii) of the Income-tax Act, interest on borrowings for the purpose of business should be allowed. The assessee relied on the Bombay High Court's decision in Lokhandwala Construction Industries Ltd, which held that interest identifiable with a project should be allowed only in the year the project is completed and income is offered for taxation.

5. Tribunal's Analysis:
The Tribunal examined whether the assessee followed the project completion method or the percentage completion method for accounting income. The assessee did not clarify this before the lower authorities. However, in a subsequent submission for AY 2017-18, the assessee stated it followed the percentage completion method. Under this method, revenue is recognized in proportion to the expenditure incurred on the project. Since no substantial work was done on Project 'B' in the year under consideration, no revenue was credited, and thus, the interest related to Project 'B' was not allowable.

6. Tribunal's Decision:
The Tribunal upheld the CIT(A)'s order, agreeing that the interest expenditure related to Project 'B' should be capitalized and not allowed as a revenue expense in the year under consideration. The appeal was dismissed, confirming the disallowance of ?70,00,371.

Conclusion:
The Tribunal dismissed the appeal, sustaining the disallowance of interest expenditure related to Project 'B' and confirming its treatment as capital expenditure to be capitalized in the WIP. The decision emphasized the importance of the accounting method followed by the assessee in determining the allowability of interest expenses.