Construction cost and saleable project area should be considered while recognizing revenue

Krishna E-Campus Pvt. Ltd. Vs DCIT (ITAT Bangalore)

ITAT Bangalore held that from clause (5) of Guidance Note issued by ICAI that the cost of construction and also saleable project area needs to be taken into account while recognizing revenue under the Percentage Completion Method.

Facts- The only issue contended by the assessee in this appeal is regarding recognition of revenue under the Percentage Completion Method [PCM] as per Accounting Standards [AS] issued by the Institute of Chartered Accountants of India [ICAI].

Conclusion- It is clear from clause (5) of Guidance Note issued by ICAI that the cost of construction and also saleable project area needs to be taken into account while recognizing revenue under the PCM.

In the present case, we notice that the condition mentioned in clause (c) of para 5.3 of the ICAI Guidance Note is not satisfied since the saleable area for the year under consideration as a percentage tot the total saleable area (104685 / 526645 sq.ft.) is much less than 25%. Further, from the cost perspective, we notice that the AO has considered the revalued value of cost of land for the purpose of arriving at the total project, instead of actual cost of the land.

We find force in the argument of the ld. AR and are of the considered view that the cost of land and the estimated project cost have to be looked into, based on the facts and the documentary evidence. We, therefore, remit the issue back to the Assessing Officer with a direction that percentage of cost and saleable area have to be recomputed in accordance with para 5.3 of the ICAI Guidance Note. The AO is also directed to take into consideration the conditions prescribed in para 5.3 of the ICAI Guidance Note are cumulative and needs to be satisfied in toto and consider the revenue recognition accordingly, after giving opportunity of being heard to the assessee.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

This appeal by the assessee is against the order dated 9.4.2019 of the CIT(Appeals)-4, Bengaluru for the assessment year 2015-16.

2. The only issue contended by the assessee in this appeal is regarding recognition of revenue under the Percentage Completion Method [PCM] as per Accounting Standards [AS] issued by the Institute of Chartered Accountants of India [ICAI].

3. The assessee is a company engaged in developing property and constructing residential apartments and commercial complex. It filed its return of income for the AY 2015-16 on 25.12.2015 declaring a loss of Rs.94,92,127. The case was selected for scrutiny.

4. The Assessing Officer referred the case to the Transfer Pricing Officer [TPO] to determine the arm’s length price [ALP] in respect of the international transaction. No adjustment was determined by the TPO u/s. 92CA of the Income-tax Act, 1961 [the Act].

5. The AO called for various details with regard to the project ‘LAPAPLAZZO’. On a perusal of the submissions of the assessee, the AO noticed that the assessee hast not adopted PCM for recognition of revenue as per AS-9. Directions u/s. 144 on this issue was provided to the assessee and as per directions received from Addl.CIT, Range 4(1), assessment was concluded by the with the following observations:-

“6.1 Revenue recognition as per percentage completion method as per AS-9:-

The assessee has filed his submission vide his letter dtd: 10.12.2018 before the Addl. CIT Range-4(1), Bangalore. The assessee has submitted the calculation of revenue recognition following percentage completion method and in this calculation; the Company has shown that the percentage completion is only 20.03% which is different from the percentage of completion of the work given by the assessee at the time of the assessment proceeding before the AO which is 23.88%.

6.2 In the submission filed before the Addl. CIT Range-4(1), Bangalore dtd: 10.12.2018, the assessee has submitted a certificate from the engineer who has increase the estimated cost of the building as on 02.09.2017 to Rs. 213.39 Cr.. In the above submission dtd: 10.12.2018, the assessee has taken the estimated cost of the project at RS. 213.39 Cr. as given in the above certificate but this increase in the estimated cost of the project as on 02.09.2017.

6.3 The assessee was supposed to take the estimated cost of the project as on 31.03.2015, for the purpose , of the calculation of revenue following percentage completion of project. Hence, the calculation submitted by the assessee is rejected. Since the percentage of completion of work as on 31.03.2015 is 35.44% as calculated in the proposition dtd: 05.12.2018 reproduced on page 2 86 3 of this letter. . Hence the revenue is recognized as per calculation given on page 2 86 3 of this letter. The calculation of gross profit of Rs. 10,40,17,541/-, is tabulated as under:

6.4 Since, the level of construction is more than 25% of the construction cost and more than 10% of the agreement value has been realized. Hence, revenue will be recognizable from the above project during this period, as per AS-9.

The trading account of the company for the year is as under:

6.5 Hence, the gross profit of Rs. 10,40,17,541/- has been adopted and allowed the admissible indirect expenditure debited in the P&L account of Rs. 94,19,563/-. Accordingly the Income for Rs. 9,45,97,978/- has been added back to the return of Income for AY 2015-16.

[Addition : Rs. 9,45,97,978]”

6. Aggrieved, the assessee filed appeal before the CIT(Appeals), who confirmed the order of the AO on the basis that cost of construction has been revised by the assessee for no substantial reason and the same is done only to keep the percentage of the cost attributable to the completion below 25%, thus deferring the payment of tax. The assessee is now in appeal before the Tribunal against the order of the CIT(Appeals).

7. The ld. AR submitted that the cost as a percentage of total projected cost for the year under consideration is less than 25%. The ld. AR also submitted that the total area sold as a percentage of total saleable area is also less than 25%. He drew our attention to the relevant provisions contained in the Guidance Note issued by the ICAI whereby certain conditions are specified for recognition of revenue under PCM. It was the contention of the ld. AR that the conditions set out are cumulative in nature and have to be satisfied cumulatively. Even if one of the conditions is not satisfied, then the revenue will not be recognized in that year. Even assuming that the cost incurred is more than 25% during the year satisfying the condition in clause (b) of the Guidance Note, the condition mentioned in clause (c) is not satisfied whereby total area sold as a percentage of total saleable area is less than 25%. He therefore prayed that the addition made by the AO is to be deleted.

8. The ld. DR relied on the orders of the lower authorities.

9. We have considered the rival submissions and perused the material on record. We notice that Guidance Note issued by the ICAI contains a clause (5) which speaks about application of PCM in the accounting of real estate transactions or activities which is as follows:-

“5.3 Further to the conditions in paragraph 5.2 there is a rebuttable presumption that the outcome of a real estate project can be estimated reliably and that revenue should be recognised under the percentage completion method only when the events in (a) to (d) below are completed.

(a) All critical approvals necessary for commencement of the project have been obtained. These include, wherever applicable:

(i) Environmental and other clearances.

(ii) Approval of plans, designs, etc.

(iii) Title to land or other rights to development/ construction.

(iv) Change in land use.

(b) When the stage of completion of the project reaches a reasonable level of development. A reasonable level of development is not achieved if the expenditure incurred on construction and development costs is less than 25 % of the construction and development costs as defined in paragraph 2.2 (c) read with paragraphs 2.3 to 2.5.

(c) Atleast 25% of the saleable project area is secured by contracts or agreements with buyers.

(d) Atleast 10 % of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts. To illustrate – If there are 10 Agreements of sale and 10 % of gross amount is realised in case of 8 agreements, revenue can be recognised with respect to these 8 agreements.”

10. It is clear from the above clause that the cost of construction and also saleable project area needs to be taken into account while recognizing revenue under the PCM. In the present case, we notice that the condition mentioned in clause (c) of para 5.3 of the ICAI Guidance Note is not satisfied since the saleable area for the year under consideration as a percentage tot the total saleable area (104685 / 526645 sq.ft.) is much less than 25%. Further, from the cost perspective, we notice that the AO has considered the revalued value of cost of land for the purpose of arriving at the total project, instead of actual cost of the land. It is the contention of the ld. AR that if the original cost of purchase of land is considered, then the percentage of cost of construction would be less than 25%, thereby not satisfying the condition in clause (b) of para 5.3 of the ICAI Guidance Note. The working submitted by the ld. AR in this regard is reproduced below:-

Computation of stage of completion of project in accordance with Para 5.3(b) of the Guidance Note on Real Estate Transactions

Note: As the percentage of completion of project is less than 25%, no revenue is required to be recognised in accordance with Para 5.3(b) of Guidance Note on Real Estate Transactions read with Accounting Standard – 9.

* Note 1 – Cost of land

11. Alternatively, the ld. AR submitted that in the estimated project cost of Rs.179,02,24,904, the AO has considered only the purchase cost of the land and if the percentage needs to be calculated, the estimated project cost has to be increased by the revalued cost of land and the AO cannot take the revalued value only for the limited purpose of cost of land.

12. We find force in the argument of the ld. AR and are of the considered view that the cost of land and the estimated project cost have to be looked into, based on the facts and the documentary evidence. We, therefore, remit the issue back to the Assessing Officer with a direction that percentage of cost and saleable area have to be recomputed in accordance with para 5.3 of the ICAI Guidance Note. The AO is also directed to take into consideration the conditions prescribed in para 5.3 of the ICAI Guidance Note are cumulative and needs to be satisfied in toto and consider the revenue recognition accordingly, after giving opportunity of being heard to the assessee.

13. In the result, the appeal by the assessee is allowed for statistical purposes.

Pronounced in the open court on this 8^th day of June, 2022.