Percentage completion method followed by the developer is acceptable

DCIT Vs Gopuram Developers (ITAT Mumbai)

ITAT Mumbai held that appellant is recognizing the revenue on the basis of percentage completion method since inception of the firm as per the Accounting Standards. There is no change or modification in the accounting method hence addition unsustainable.

Facts- The return of income filed by the assessee was selected for scrutiny and statutory notices issued under the Act, were issued and complied with. The assessment under section 143(3) of the Act was completed on 22/02/2016 after making certain additions/disallowances including additions of Rs.5,93,35,636/- under the head “income from business and profession” and addition of Rs.49,13,037/- under the head “income from house property”. Aggrieved, the assessee preferred the appeal before the Ld. FAA. After considering submissions of the assessee, the Ld. FAA allowed the appeal of the assessee. Aggrieved with the finding of the Ld.FAA, the Revenue is in appeal before the Tribunal.

Conclusion- A.O. ignored the percentage completion method of revenue recognition consistently followed by the assessee in assessment years prior to the assessment year under consideration i.e. A.Y. 2009-10 and opined that project of the assessee was completed therefore entire profit should have been declared in the year under consideration. In our opinion, the Ld. FAA after considering the submission of the assessee and analyzing facts of the case, correctly upheld the percentage completion method of Revenue recognition following the judicial precedents, and therefore we do not find any error in the order of the Ld.FAA on the issue in dispute.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

This appeal filed by the Revenue is directed against order dated 31/03/2022 passed by the Ld. National Faceless Appeal Centre (NFAC), Delhi [hereinafter shall be referred as Ld. First Appellate Authority or FAA] for assessment year 2013-14, raising following grounds:

“1) Whether on the facts and circumstances of the case and in law, the CIT(A) was right in deleting the addition of Rs.5,93,35,636/- being profit determined on the project undertaken by the assessee, failing to appreciate that the assessee was following percentage completion method of accounting and the AO had worked out the profits accordingly in para 4.5 of the assessment order

2) Whether on the facts and circumstances of the case and in law, the CIT(A) was right in deleting the addition of Rs.5,93,35,636/- being profit determined on the project undertaken by the assessee, failing to appreciate that the assessee itself had estimated the profits from the project at Rs.5 crores during the course of survey proceedings and had given post dated cheques amounting to Rs.1.50 crore towards the tax liability.

3) Whether on the facts and circumstances of the case and in law, the CIT(A) was right in deleting the addition on account of income from house property determined on the closing stock of flats held by the assessee.

4) The appellant craves leave to amend, modify and alter any grounds of appeal during the course of hearing of this case.”

2. Briefly stated facts of the case are that the assessee is a builder and developer and was engaged in the construction work. In the case, a survey action u/s 133A of the Income Tax Act, 1961 (in short the Act) was carried out on 03-10-2022, wherein the Partner of the firm, Shri Kamal U. Jain stated voluntarily offered income of Rs. 5 crore relevant to year under confidential from the sale of Real Estate project. For the year under consideration, the assessee filed return of income on 20/09/2013 declaring total income of Rs.40,43,750/-. The return of income filed by the assessee was selected for scrutiny and statutory notices issued under the Act, were issued and complied with. The assessment under section 143(3) of the Act was completed on 22/02/2016 after making certain additions/disallowances including additions of Rs.5,93,35,636/- under the head “income from business and profession” and addition of Rs.49,13,037/- under the head “income from house property”. Aggrieved, the assessee preferred the appeal before the Ld. FAA. After considering submissions of the assessee, the Ld. FAA allowed the appeal of the assessee. Aggrieved with the finding of the Ld.FAA, the Revenue is in appeal before the Tribunal raising the grounds as reproduced above.

3. Before us, the Ld. counsel of the assessee filed a paper book containing pages from 1 to 208.

4. The ground No.1 and 2 of the appeal of the Revenue relate to deletion of the addition of 5,93,35,636/- by the Ld. FAA , which was made by the Ld. Assessing Officer in respect of profit offered during the survey proceeding.

5. Facts qua the issue in dispute are that during scrutiny proceeding, the Ld. Assessing Officer observed that assessee undertaken the construction work of the project namely “Jeerawali residency” at Ghatkoper Mumbai. This project was started in the year 2001 and completed during the year under consideration. The assessee shown closing stock of flats for 10,28,44,296/- The Ld. Assessing Officer noted that during the course of survey action dated 03/10/2012 under Section 133A of the Act, the partner of firm, Shri Kamal U. Jain voluntarily declared total income of Rs. 5 crore in respect of the project. The objection of the Ld. Assessing Officer is that even after completion of the project, the assessee did not declare profit from the said project. Before the Ld. Assessing Officer, it was submitted that during the course of survey action the assessee offered income of Rs. 5 crore on account of sale of flat only, but due to recession in property market, those flats could not be sold in the year under consideration. Further, it was explained that during survey proceeding income was in respect of offered as in when flats which would be sold in subsequent years. The Ld. A.O. rejected the contention of the assessee and computed the addition of Rs.5,93,35,636/- observing as under:

In the case of assessee, it is also found that the work is fully completed and thus the uncertainly of cost escalation is not arises. Further, the capital of partners shown in balance sheet at Rs.12,66,54,470/- whereas stock of flats shown at Rs.10,28,44,296/- which show that there will be no interest burden on the assessee. In view of this fact, the cost of the asset constructed by the assessee will not be affected. The assessee has blocked its capital in the stock of flats for only the reason to make more and more profit by prolonging the sales.

In view of the above discussion and fact finding of the case, the profit on the project till 31.03.2013 is worked out as under:

Cost of project (construction area 58712 sq.fts) – Rs.22,38,96,938/-

Cost of construction per sq. feet                     Rs.3,813/-

Area sold by the assessee                              18476 sq. feet

Cost of area sold                                              Rs7,04,48,988/-

Sale price determined for 18476 sq.fts.      Rs.13,20,15,004/-

Less:- cost of area sold as worked above Rs.7,04,48,988/-

Thus, Profit worked out at                              Rs.6,15,66,016/-

Therefore, the income determined on the project for the year as under: Profit as per working above  Rs.6,15,66,016/-

Less:- Income offered by the assessee

A.Y. 2010-11                 Rs.15,91,170/-

A.Y. 2011-12                 Rs.6,39,210/-           Rs.22,30,380/-

Income from the project for the year under consideration Rs.5,93,35,636/-

It is evident from the statement of the partner of the assessee which was recorded at the time of survey that they were estimated and offered the income for the year at Rs.5,00,00,000/- after discussion with the partners and on reasonable base. However, the assessee has not paid the taxes on the income declared during the survey. During the course of assessment proceedings, a proper working as shown above is done on the base of submissions made by the assessee and accordingly income on the project is determined. Hence, the income from the project for A.Y 2013-14 is worked out at Rs.5,93,35,636/- and added to the total income of the assessee. Penalty proceedings u/s. 271(1)(c) of the Act is initiated separately.

6. On further appeal, before the Ld. FAA the assessee mainly submitted that it was consistently following percentage completion method and profit had been offered to tax as and when it was accrued to the assessee. The Ld. FAA after in considering submission of the assessee that income from the project had been offered by the assessee over a period of years, made a view that income from project had been already declared by the assessee in subsequent assessment years on sale of flats following the percentage completion method for recognizing profit from the project of real estate development. The relevant finding of the Ld. FAA is reproduced as under:

1. The impugned assessment order and contentions of the appellant have been thoroughly considered. The appellant is a firm involved in the business of real estate development. The firm has carried out only one redevelopment project named “Jeeravali” at Ghatkopar in Mumbai. The project was started in the year 1999 which continued till the year under consideration and beyond. In this case survey action u/s. 133A of the Act, 1961 was conducted on 03.10.2012. During the course of survey proceedings statement of Sh. Kamal U. Jain, the partner of appellant firm, was recorded wherein he declared total income of Rs.5 crore for the previous year relevant to A. Y * (0.2013 – 14) . As per answer to Question no. 16 the partner of the firm agreed to pay advance tax on the total income of 5 crores from “the sale of flats accordingly.” The undisputed fact is that during the course of survey u/s. 133A no incrimination documents/ evidences were found and impounded by the survey team. The statement of the partner which is reproduced in the assessment order (supra) is a testimony to this undisputed fact. Therefore the first aspect on which A.O. has delved upon does not hold ground as the statement of disclosure by the partner of the firm appears to be conditional in nature and the disclosure made during the survey proceedings is not backed up by contemporaneous incriminating evidences. Further the appellant firm was not able to sell the remaining flats which is evident from the perusal of “Working of Revenue Recognized” (para 2.5.3 supra) which shows the “balance saleable area as on 31.03.2013” at 15697 sq ft. In view of these facts, it is held that the statement of Sh. Kamal U. Jain disclosing an income of Rs. 5 crore for the A.Y. 2013-14 is contingent in nature and hence not enforceable.

2. The second aspect on which A.O. has relied is the method of accounting and method of revenue recognition. The A.O. states that the method of revenue recognition being followed by the appellant is such that it allows the appellant to postpone the tax liability. The undisputed fact is that the appellant is following mercantile system of accounting and the appellant is recognizing the revenue on the basis of percentage competition method since inception of the firm. There is no change or modification in the accounting method and the method of revenue recognition. The method of revenue recognition adopted by the appellant is as per the Accounting Standards. There are two methods of revenue recognition as per the Accounting Standards, viz. Project Completion Method and Percentage Completion Method. Both these method are being followed in the cases of Real Estate Development / Builders. In the instant case the revenue has been recognized as per the Percentage Completion Method which is evident from para 2.5.3 (supra) wherein the “Working of Revenue Recognized” has been reproduced.

3. In the assessment order the A.O. has computed the profit on the project till 31.03.2013 which is reproduced below:

Cost of project (construction area 58712 sq.fts.) Rs.22,38,96,938/-

Cost of construction per sq. feet                      Rs.3,813/-

Area sold by the assessee                               18476sq.feet

Cost of area sold                                             Rs.7.04.48.988/-

Sale price determined for 18476sq.fts. Rs.13,20,15,004/-

Less:- cost of area sold as worked above Rs.7.04.48.988/-

Thus, Profit worked out at                  Rs.6,15,66,016/-

Therefore, the income determined on the project for the year as under:

Profit as per working above                            Rs.6,15,66,016/

Less:- Income offered by the assessee

A.Y. 2010 -11           Rs.15,91.170/-

A.Y. 2011-12            Rs.6,39,210/            Rs.22,30,380/-

Income from the project for the year under consideration Rs.5,93,35,636/-

It is evident from the statement of the partner of the assessee which was recorded at the time of survey that they were estimated and offered the income for the year at Rs.5,00,00,000/ after discussion with the partners and on reasonable base. However, the assessee has not paid the taxes on the income declared during the survey. During the course of assessment proceedings, a proper working as shown above is done on the base of submissions made by the assessee and accordingly income on the project is determined. Hence, the income from the project for A.Y. 2013-14 Is worked out at Rs.5,93,35,636/- and added to the total income of the assessee.

From the perusal of the assessment order and the above “computation of the profit on the project” it becomes abundantly clear that the A.O. is neither following the Project Completion Method nor the Percentage Completion Method. The A.O. has not invoked the provisions of Section 145(3) and has not rejected the books of a/c before proceeding to compute the profit on the project by applying certain assumptions which are contrary to the Accounting Standards.

7. The Ld. FAA relied on the decision of the Hon’ble Supreme Court in the case of CIT v/s Realest builders and services Ltd.(supra) observing as under:

The main factor influencing the judgment of the A.O. is the disclosure of Rs 5 crore made by the partner of the firm during the course of survey proceedings. The Hon’ble Supreme Court in the case of CIT vs. Realest Builders & Services Ltd 170 Taxman 218 (SC) has held as under:

“Under section 145, it is always open to the department to insist on the change in the method of accounting followed by the assessee over the years if the impugned method of accounting results in underestimation of profits/net income. In the instant case, no allegation of that nature was ever made by the department. [Para 6]

In cases where the department wants to tax an assessee on the ground of the liability arising in a particular year, it should always ascertain the method of accounting followed by the assessee in the past and whether change in method of accounting was warranted on the ground that profit is being underestimated under the impugned method of accounting. If the Assessing Officer comes to the conclusion that there is underestimation of profits, he must give facts and figures in that regard and demonstrate to the Court that the impugned method of accounting adopted by the assessee results in underestimation of profits and is, therefore, rejected. Otherwise, the presumption would be that the entire exercise is revenue neutral. In the instant case, that exercise had never been undertaken. The Assessing Officer was required to demonstrate both the methods, one adopted by the assessee and the other by the department. In the circumstances, there was no reason to interfere with the conclusion given by the High Court. [Para 7]”

The ratio of the above judgment of Hon’ble Apex Court is applicable to the facts of the case under consideration of the A.O. has failed miserably to demonstrate that there is underestimation of profit by the impugned method of accounting adopted by the Appellant and how the method adopted by the A.O is most appropriate method as per the facts of the case. In the present case the A.O. during the course of Assessment Proceedings had simply issued show cause notice to the appellant asking it to show cause as to why the income should not be considered as Rs. 5 crore as against the returned income. This fact clearly indicates that the A.O. has come to a conclusion of underestimation of profits based on the fact that the disclosure of Rs. 5 crore was made by the appellant. Further the A.O. has not undertaken the exercise to demonstrate that the impugned method of accounting followed by the appellant results in underestimation of profits.

The method of computation of profit on the project till 31.03.2013 is erroneous as the A.O. has failed to appreciate that the project undertaken by the appellant firm is a redevelopment project. The basic condition and the major component of expenditure for any redevelopment project is the permanent alternate accommodation which is to be provided to the tenants free of cost in lieu of their present accommodation. The other important expenditure is the rent payment to the tenants till handing over of the possession of flats as alternate accommodation in the redeveloped project. It is pertinent here to A.O. mention that the total area constructed in Jeeravali project is 58712 sq ft out of which the area of 24539 sq ft has been handed over to the tenants against the alternate accommodation free of cost. Therefore, the net saleable area is 34173 sq ft. The A.O. has erroneously considered the total area of 58712 sq ft as saleable area and accordingly has worked out cost of construction per sq ft at Rs.3813/-. If the cost of construction is recomputed on the net saleable area then it comes to Rs. 6552/- per sq ft. then as per the computation of A.O. the profit would be Rs.10960252/-. Further the allowability of expenses of Rs.64,27,926/- incurred by the appellant for additional work reduces the profit below the returned income. The above facts make it abundantly clear that the methodology followed by the AO to compute profits of the project is adhoc and based on erroneous assumptions.

8. Further, the Ld. FAA has distinguished the decisions relied upon by the Ld. Assessing Officer with detailed finding.

9. Before us, the Ld. DR relied on the order of the Ld. Assessing Officer and submitted that the assessee did not comply with the income disclosure of 5 crore, which was offered by the assessee in the course of survey operation u/s 133A of the Act at the premises of the assessee. The Ld. DR submitted that project of the assessee had already completed and therefore, the assessee was required to offer profit from the project following the project completion method. Accordingly, he submitted that order of the Ld. FAA should be reversed and order of the Ld. Assessing Officer should be upheld.

10. Per contra, the Ld counsel of the assessee filed profit and loss accounts for the period from financial year 2008-09 to 2015­16 to show that in the period of three assessment years, post the relevant assessment year under consideration, the assessee has declared profit of 5,06,42,166/-from the project under reference, which is more than income disclosed during the course of the survey, i.e. basis for making addition of Rs.5,93,35,636/-during the year under consideration. The relevant chart submitted by the assessee is reproduced as under:

11. The Ld. counsel relied on the finding of the Ld. CIT(A) and submitted that in case of percentage completion method, the profit is declared in proportion to the cost incurred on the project as compared to the total project cost, accordingly, the assessee has offered profit from the project since 2008-09 till 2015-16 and still closing stock amounting to 3,07,23,277/- was available with the assessee for sale. Thus according to the assessee, it has already declared profit from the project more than what was offered during the course of the survey action.

12. We have heard rival submission of the parties on the issue in dispute and perused the relevant material on record. The main basis for making addition by the Assessing Officer is that the assessee has not honored the income of 5 crore, which the assessee declared during the course of survey action. The Ld. Assessing Officer was of the view that revenue should be recognized when there was reasonable certainty of ultimate collection of revenue. According to him, the project was fully completed and there was no uncertainty of escalation of price and assessee blocked its capital in the stock of flats only for the reason that assessee wanted to make more and more profit by prolonging the sales. The learner Assessing Officer accordingly determined profit on even unsold flats. The Ld A.O. ignored the percentage completion method of revenue recognition consistently followed by the assessee in assessment years prior to the assessment year under consideration i.e. A.Y. 2009-10 and opined that project of the assessee was completed therefore entire profit should have been declared in the year under consideration. In our opinion, the Ld. FAA after considering the submission of the assessee and analyzing facts of the case, correctly upheld the percentage completion method of Revenue recognition following the judicial precedents, and therefore we do not find any error in the order of the Ld.FAA on the issue in dispute, accordingly we uphold the same. The ground No. 1 and 2 of the appeal of the Revenue are accordingly dismissed.

13. In ground No.3, the Revenue has challenged deletion of the addition on account of income from house property, which was determined by the Ld. A.O. on the closing stock of the flats held by the assessee.

14. Brief facts qua the issue in dispute are that assessee shown stock of flats of 10, 28, 44, 296/- at the year end as on 31/03/2013. According to the Ld. A.O., the occupation certificate of those flats, which were treated by the assessee as stock in trade, was received but no income under the head income from house property was declared by the assessee. In view of the Ld. Assessing Officer, following the decision of the Hon’ble Delhi High Court in the case of CIT Vs Ansell Housing Finance and Leasing in ITA 18/1999, the assessee was required to compute deemed annual lettable value (ALV) of those flats and correspondingly, was repaired to declare income from house property. The Ld. Assessing Officer, treated 7% of the cost of flats as ALV of the flats, which was worked out to Rs. 70,19,910/-and after allowing deduction at the rate of 30% under section 24 of the Act (i.e. Rs. 21,05,973/-), determined income from house property at Rs. 49, 13, 937/-. The Ld. FAA following the decision of the Co-ordinate bench of the Tribunal in the case of DCIT Vs. Bangal Shapoorji housing development Private Limited (supra) deleted the addition, observing as under:

After considering catena of judicial pronouncements the Hon’ble Mumbai ITAT has concluded that the assessability of notional income, i.e. ALV in respect of unsold flats held by the assessee as stock-in-trade of its business as that of a builder and DEPASON developer is not merited. Jurisdictional ITAT has considered the judgment of the Hon’ble Delhi High Court in the case of CIT Vs. Ansal Housing Finance and Leasing Company Ltd. (2013) 354 ITR 180 (Del) which has been relied upon by the AO and the Hon’ble ITAT has decided the issue in favour of the assessee. Further the Hon’ble ITAT, in para 5 of the above reproduced decision, has held that the newly inserted Section 23(5)vide Finance Act, 2017 w.e.f. 01.04.2018 is applicable prospectively i.e. w.e.f. A.Y. 2018­19, the same, thus, would not have no bearing on the year under consideration. Since the jurisdictional ITAT has decided this issue in favour of the assessee, respectfully following the above mentioned judgement of the Hon’ble Guj HC(supra) and above referred decisions of Hon’ble Mumbai ITAT the addition on account of notional rent of Rs. 70,19,910/- is hereby deleted. Accordingly, the grounds of appeal 3 and 4 are allowed.

15. Before us the Ld. Departmental Representative relied on the decision of the Hon’ble Delhi High Court in the case of Ansal housing finance and leasing (supra), which was relied upon by the Ld. Assessing Officer.

16. On the other hand, the Ld. counsel of the assessee relied on the finding of the Ld. CIT(A) on the issue in dispute.

17. We have heard rival submission of the parties on the issue in dispute and perused the relevant material on record. The issue in dispute is whether, from the flats held by an assessee as a stock in trade, the deemed rental income under the head income from house property should be assessed or not. The Hon’ble Delhi High Court in the case of Ansal housing finance and leasing (supra) has held that stock is to be treated as house property of the assessee and therefore liable for deemed rental income or ALV and same has to be computed under the head ‘income from house property’. Whereas, contrary view has been taken by the Hon’ble High Court of Gujarat in the case of CIT Vs Neha Builders Private Limited (2006) 296 ITR 661 (Guj). The coordinate bench of the Tribunal in the case of Bangal Shapoorji housing development Private Limited (supra) after considering various decisions including the decision of Hon’ble Delhi High Court (supra) and decision of the Hon’ble Gujarat High Court(supra), directed the Ld. Assessing Officer to delete the addition made towards the ALV of the flats held by the assessee as stock in trade of its business as that of a builder and developer. In our opinion, there is no error in the order of the Ld. FAA on the issue in dispute, which has been passed after following binding precedent on the issue in dispute. We accordingly uphold the same. The ground No.3 of the appeal of the Revenue is accordingly dismissed.

18. In the result, the appeal filed by the Revenue is accordingly dismissed.