Draft Income Computation & Disclosure Standard (ICDS) on Real Estate Transactions
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Accordingly, Central Government notified 10 ICDS vide Notification No. S.O. 3079 (E) dated 29th September 2016. These ICDS are namely Income Computation and Disclosure Standard I relating to Accounting Policies, Income Computation and Disclosure Standard II relating to Valuation of Inventories, Income Computation and Disclosure Standard III relating to Construction Contracts, Income Computation and Disclosure Standard IV relating to Revenue Recognition, Income Computation and Disclosure Standard V relating to Tangible Fixed Assets , Income Computation and Disclosure Standard VI relating to the Effects of Changes in Foreign Exchange Rates, Income Computation and Disclosure Standard VII relating to Government Grants, Income Computation and Disclosure Standard VIII relating to Securities, Income Computation and Disclosure Standard IX relating to Borrowing Costs & Income Computation and Disclosure Standard X relating to Provisions, Contingent Liabilities and Contingent Assets.
These ICDS are applicable from assessment year 2017-2018 i.e. Previous Year 2016-2017 in respect of all assesses (other than an individual or a Hindu undivided family who is not required to get his accounts of the previous year audited in accordance with the provisions of section 44AB of the said Act) following the mercantile system of accounting, for the purposes of computation of income chargeable to income-tax under the head “Profits and gains of business or profession” or “Income from other sources” and not for the purpose of maintenance of books of account. So based on application of these ICDS accounting profits can be different then Income Tax Profits. In case of conflict between the provisions of the Income Tax Act, 1961 (‘the Act”) and this Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.
The Finance Minister had constituted a Committee comprising of experts from accounting field, departmental officers and representatives from the Institute of Chartered Accountants of India (ICAI) to suggest the areas in respect of which further ICDS may be notified under the Act. Accordingly committee has suggested the ICDS in respect of Real Estate Transactions and submitted the draft of the same.
The draft ICDS submitted by the committee is issued by Ministry of Finance, Government of India via Press Information Bureau dated 11-05-2017 based on the the Guidance Note issued on Real Estate Transactions issued by ICAI.
The draft ICDS on Real Estate Transactions along with the significant changes suggested in ICDS vis-a-vis the Guidance Note issued by ICAI are uploaded on the Income-tax website at http://www.incometaxindia.gov.in. The Central Board of Direct Taxes (CBDT) invites comments from stakeholders on the draft ICDS on Real Estate Transactions, which may be submitted to Director TPL-III by e-mail at dirtpl3@nic.in by 26th May,2017.
So it is important for the Real Estate Industry to understand the said draft and send their comments on or before 26th May, 2017. The said practice of issuing final version after acting on comments received on exposure draft from stakeholders is in line with Development and publication of an International Financial Reporting Standard (IFRS). Real Estate Industry is busy in understanding and applying the provisions of Real Estate (Regulation and Development) Act, 2016 popularly known as RERA. Now CBDT has issued Draft Income Computation and Disclosure Standards on Real Estate Transactions.
This Draft Income Computation and Disclosure Standard on Real Estate Transactions shall be applicable for determination of income from all forms of transactions in real estate, which refers to land as well as buildings and rights in relation thereto. This will include:
a) Sale of plots of land (including long term sale type leases) without any developments for e.g. Sale of plot of land only after making Non Agricultural Plot popularly known as NA Plots.
b) Sale of plots of land (including long term sale type leases) with development in the form of common facilities for e.g. Special Economic Zone (SEZ) development.
c) Development and sale of residential and commercial units, row houses, independent houses, with or without an undivided share in land i.e. New Development on land.
d) Acquisition, utilization and transfer of development rights i.e. TDR.
e) Redevelopment of existing buildings and structures i.e. Redevelopment Projects.
f) Joint development agreements (JDA) for any of the above activities.
There are two methods prescribed here for Revenue Recognition for Real Estate Projects
Method 1
Where the economic substance is similar to construction contracts, Projects revenue and project cost shall be recognised as revenue and cost respectively by reference to the stage of completion of project on the last date of the previous year also referred to as the percentage of completion method (POCM).
For applying the percentage of completion method in respect of a project, the provisions of ICDS III on Construction Contract shall apply mutatis mutandis.
Construction contract is defined under ICDS III as under;
| “Construction contract” is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and includes : |
| (i) contract for the rendering of services which are directly related to the construction of the asset, for example, those for the services of project managers and architects; |
| (ii) contract for destruction or restoration of assets, and the restoration of the environment following the demolition of assets.
Indicators that economic substance of a project is similar to a construction contract are: (a) The duration of such projects is beyond 12 months and the project commencement date and project completion date fall into different previous years. (b) Project involves activities similar to construction contracts such as land and development, structural engineering, architectural design, construction or activities of similar nature. (c) While individual units of the project are contracted to be delivered to different buyers these are independent upon or interrelated to completion of a number of common activities with or without provision of common facilities. (d) The construction or development activities form a significant proportion of the project activity. Application of Percentage of Completion Method The revenue in respect of a project shall be recognised under the percentage of completion method when:- a) The expenditure incurred on construction and development costs is 25% or more of the construction and development costs; b) 25% or more of the saleable project area is secured by contracts or agreements with buyers; and c) 10% or more of the total revenue as per the agreements of sale or any other legally enforceable documents are realised in respect of each such contracts and it is reasonably certain that the parties to such contracts will comply with the payment terms as defined in the contracts. Revenue shall be recognised in respect of such units which satisfy the condition mentioned in above para c) with reference to the percentage of completion of the project. |
Method 2
In case of a project where the economic substance is not similar to construction contract, revenue shall be recognised in accordance with Income Computation and Disclosure Standard IV relating to Revenue Recognition and provisions of para 3, para 4 and para 5 of the said standard i.e. Para’s applicable to Revenue Recognition for Sale of Goods shall apply mutatis mutandis provided:-
a) The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of real estate to a degree usually associated with ownership or the seller has effectively handed over possession of real estate unit to the buyer forming part of the transaction.
It means the transaction should not be of Sale and Lease back. A sale and leaseback constitutes an arrangement where the seller of an asset leases back the same asset from the purchaser.
b) No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales.
It means transaction should not be of a Option Deposit wherein Option will be given to the Option Deposit Holder to cancel the deal if certain conditions are not fulfilled, then in the event of cancellation of deal, Developer has to return apart from money already given by the option holder, interest/fixed return or compensation;
c) There is a reasonable certainty that the revenue will be ultimately collected from buyers.
It also means there should not be any cancellation clause in the agreement or cancellation clause should be with only Developer/Seller/Landlord and not with the buyer.
Transferable Development Rights (TDR)
| Sr. No. | TDR Method of Acquisition | Cost of Acquisition |
| 1 | Direct Purchase | Cost of Purchases |
| 2 | Development & Construction of built-up area | Amount spent on development or construction of built-up area |
| 3 | Giving up of rights over existing structures or open land | Fair value of the Development Rights so acquired |
“Fair Value” is defined as the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.
When TDR are utilised in a real estate project by a person, the cost of acquisition shall be added to the project costs.
When TDR are sold or transferred, revenue shall be recognised when both the following conditions are fulfilled:
a) Title to the development rights is transferred to the buyer; and
b) It is reasonable to expect that the revenue will be ultimately collected.
Transactions with multiple elements
If a person has entered a contract with a buyer to deliver goods or services in addition to the construction or development of real estate then contract consideration shall be split into separately identifiable components including one for the construction and delivery of real estate units. The consideration received or receivable for the contract shall be allocated to each component on the basis of the fair value of each component.
Transitional Provisions
Project revenue and project costs associated with the real estate project, which commenced on or after effective date of this standard, shall be recognised in accordance with the provisions of this standard. But project revenue and project costs associated with the real estate project, which commenced on or before effective date of this standard shall be recognised based on previous method regularly followed by the person.
But, when project will be considered as commenced is not defined in this ICDS.
Few Significant changes made in the draft ICDS on Real Estate transactions vis-a-vis Guidance Note on Real Estate transactions issued by the ICAI is as under
1) Definition of Project:
As per Guidance Note:
The set of units which are connected by a common set of amenities will constitute a single project.
As per this draft ICDS :
The Committee recommends use of term ‘Basic facilities’ in place of common amenities like club-house, entertainment, sports, gymnasium, health club, restaurants etc.
“Project” is defined as the smallest group of units, plots or saleable spaces, as the case may be, which are linked with a common set of basic facilities, if any, in such a manner that unless the facilities are made available and functional, these units, plots or saleable spaces cannot be put to their intended effective use. A larger venture shall be split into smaller projects when these basic conditions are fulfilled.
Impact of this change as per my Best Estimate
Larger Project can be broken down into a smaller project so revenue recognition may be done earlier, so Government will be benefited by this provision. Industry has to submit representation to stop this change because it will be difficult to keep a record of revenue and cost of smaller project wise for taxation purpose. It also means Industry has to pay tax on advance and more time employees will have to spend to find out cost and revenue smaller project wise as per Income Tax i.e. Book Profit and Taxation profit may be different.
However they might have brought this change in line with Explanation to Section 3 (2) of RERA Act which reads as under:
“For the purpose of this section, where the real estate project is to be developed in phases, every such phase shall be considered a stand-alone real estate project, and the promoter shall obtain registration under this Act for each phase separately.”
2) Definition of Project Cost:
As per Guidance Note:
The guidance note contains illustrative list of items to be included, allocated or excluded in the project cost.
As per this draft ICDS :
The said illustrations have been excluded in the standard while retaining the main principle that costs that cannot be attributable to any project activity or cannot be allocated to project shall be excluded from project cost.
Impact of this change as per my Best Estimate
No major impact.
3) Real Estate Projects :
As per Guidance Note:
The revenue in respect of real estate projects is required to be recognised based on principles of either AS 9 Revenue Recognition or AS 7 Accounting for Construction Contracts, depending upon economic substance of the project. The Guidance Note also provides that in case where economic substance of the project is in the nature of construction contract, the revenue is required to be recognised as per POCM in accordance of AS 7.
As per this draft ICDS :
The proposed ICDS retains the same principles for recognition of revenue and cost without usage of illustrative language of Guidance Note to provide simplicity and certainty.
Impact of this change as per my Best Estimate
No major impact.
4) Application of POCM For Real Estate projects:
As per Guidance Note:
a. The Guidance Note contains four conditions to be satisfied for recognition of revenue including the condition of obtaining all critical approvals.
b. Further, The Guidance note permits all methods for determination of stage of completion like cost incurred, survey of work done, technical estimation etc. The guidance Note however puts a cap on recognition of revenue based on stage of completion determined with reference to project cost incurred.
As per this draft ICDS :
a. Only three conditions are specified for application of POCM & 4th condition of obtaining critical approvals is not specified under this draft ICDS. As the recognition of revenue is deferred up to incurrence of 25% of construction and development cost (which does not include land cost), so the committee is of the view that condition for recognition of revenue of obtaining critical approval is not relevant. Due to introduction of The Real Estate (Regulation and Development) Act, 2016 (RERA), the said condition may not be relevant.
b. In accordance with the provisions of ICDS III relating to Construction Contract, the proposed ICDS does not provide for capping the recognition of revenue based on stage of completion determined with reference to project cost incurred.
Impact of this change as per my Best Estimate
a. As per Section 3 (1) of RERA Act, no developer shall sell or offer for sale any apartment unless Real Estate project is registered with RERA. One of the requirement for registration of Real Estate project under RERA as mentioned in Section 4(2) (C) is an authenticated copy of the approvals and commencement certificate is to be submitted. So theoretically even if condition of obtaining all critical approvals is removed but practically under now RERA regime to fulfil condition 3 of obtaining 10% or more of the total revenue as per the agreements of sale or any other legally enforceable documents are realised in respect of each such contract will be fulfilled only if Real Estate Project is registered under RERA & Real Estate Project under RERA can be registered only if approvals and commencement certificate is in place so if condition 4 which is done away with is completed then only condition 3 can be fulfilled.
So practically there will be no impact of this change due to RERA.
b. If a company is booking revenue as per Guidance note then revenue recognition as per POCM will be capped on stage of completion determined with reference to project cost incurred. But for determining revenue as per POCM under draft ICDS, the stage of completion can be determined with reference to
| i) the proportion that contract costs incurred for work performed up to the reporting date bear to the estimated total contract costs; or | ||||||||||||
| ii) surveys of work performed; or | ||||||||||||
| iii) completion of a physical proportion of the contract work.
Above is as per ICDS III relating to Construction Contract. And there is no cap on Revenue Recognition as per this ICDS. So if a company is following physical completion method which is completed say 45% but as per project cost method is only 35% then Revenue Recognition in Books of Accounts as per Guidance note will be capped at 35% but as per Income Tax by following this Draft ICDS company may book revenue up to 45% as there is no cap of 35%. So this will lead to recognition of higher income as per this draft ICDS. Accordingly by following this provision impact can be very high. Therefore Real Estate Industry can give representation to stop this amendment. 5. Transferable Development Rights (TDR) As per Guidance Note on Real Estate Transactions (Revised 2012): If TDR is acquired by way of giving up of rights over existing structures or open land, then TDR shall be recorded at fair value (of asset given up or asset acquired, whichever is more clearly evident) or net book value of asset given up whichever is less . As per Guidance Note on Accounting for Real Estate Transactions (for entities to whom Ind AS is applicable) Where development rights are acquired by way of giving up of rights over existing structures or open land, the development rights should be measured in accordance with the principles of exchange of assets enunciated in paragraphs 45 to 47 of Ind AS 38, Intangible Assets. As per paragraph 45 – Exchange of Assets In case of an exchange of one non-monetary asset for another, the cost of such an intangible asset is measured at fair value unless (a) the exchange transaction lacks commercial substance or (b) the fair value of neither the asset received nor the asset given up is reliably measurable. The acquired asset is measured in this way even if an entity cannot immediately derecognise the asset given up. If the acquired asset is not measured at fair value, its cost is measured at the carrying amount of the asset given up. As per Draft ICDS The development rights shall be recorded at the fair value of the development rights so acquired. Impact of this change as per my Best Estimate In the Draft ICDS, only fair value is mentioned so if fair value is not reliably measurable then what is not explained? Also in the Guidance note, there is option of fair value of assets acquired or fair value of asset given up whichever is reliably measurable is to be taken, that option is also not available in this draft ICDS. SO in the Draft ICDS only fair value of assets acquired is to be taken. We will understand this with one example,
|
Conclusion:
1. As Real Estate Industry is facing problems of lower demand, higher interest cost due to delay in getting permission, problem faced due to demonetisation, challenge of RERA etc. & few above mentioned/explained provisions where impact is immense is like a Gujarati saying ”Dukaad ma Adhikmaas”. So wherever heat is high, Industry has to send their representation on or before 26th May 2017 so that such provisions will not see light of the day in the final draft.
2. Now NIFTY has increased from 7900 to 9500 due to major reforms like GST etc and also due to expectation that interest will reduce and results of all companies will be coming good, Real Estate shares like DLF etc. are trading now more than double in few months, due to RERA more transparency will come in the Industry as Developers & Real Estate Agent will be accountable & interest will be recovered from customers also if they will not pay on time as per completion of milestones mentioned in the RERA complaint agreement & Government projects like Make in India, Smart Cities is in pipeline which will boost Real Estate Industry.
(Author- CA Jinesh Premji Gada,B.Com., ACA, ISA, M.B.A.,Head of Accounts & Taxation with HBS Realtors Pvt Ltd. ,Email cajineshgada@gmail.com)
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Can you send me the notification please