CIT Vs. Aditya Prop con (P) Ltd. (Rajasthan High Court)
The present case is of acquisition of land for its development in course of real estate activity of the assessee. Assessee is about to complete one project and to continue the activities has purchased another land to develop another project. The argument of the learned Departmental Representative that the proviso would apply to the assessee’s case cannot be accepted. We are of the considered opinion that the purchase of inventory is continuation of the same business activity in routine course and cannot be termed as extension of the business activity. The proviso has been inserted to dis entitle claim of interest on funds borrowed for acquisition of capital assets for the period upto the asset is put to use. The term ‘put to use’ here applies to capital asset only because a capital assets is held to facilitate the business activity and sometimes it needs to be prepared after its acquisition for being used to facilitate the business activity. As against this, purchase and holding of inventory item itself is a business activity. In absence of this proviso, section 36(1) (iii) earlier entitled assessee to claim interest in respect of capital assets, even for the period during which they were under construction as held in various judgments pointed out by the learned Authorized Representative of the assessee. The interest was found allowable despite its capitalization in the books of accounts in the judgments. We are therefore, of the opinion that the interest on funds borrowed to purchase land which is part of inventory of the assessee company is an allowable deduction under section 36(1)(iii).
In all these appeals common question of law and facts are involved hence they are decided by this common judgment.
2. In appeal No. 164/2017, the application (21970/2017) for amending the substantial question of law is allowed.
3. The said appeal (164/2017) has not been admitted which is now admitted on the following amended substantial question of law:–
“Whether on the facts and in circumstances of the case, the assessee can claim as interest expenditure of Rs. 2,32,13,786 as business expenditure which is neither in consonance of method of accounting nor the practice/accounting policy followed by the assessee?”
4. By way of these appeals, the appellant has assailed the judgment and order of the Tribunal whereby Tribunal has dismissed the appeal of the department and confirmed the order of Commissioner (Appeals).
5. This court while admitting the appeals framed following substantial question of law:-
5.1 Appeal No. 82/2014 admitted on 17-1-2017
“Whether on the facts and in circumstances of the case, the assessee can claim as interest expenditure of Rs. 37369323 as business expenditure which is neither in consonance of method of accounting nor the practice/accounting policy followed by the assessee?”
5.2 Appeal No. 163/2017 admitted on 24-7-2017
“Whether on the facts and circumstances of the case, the assessee can claim as interest expenditure of Rs. 2,32,13,786 as business expenditure which is neither in consonance of method of accounting nor the practice/ accounting policy followed by the assessee.”
6. The facts of the case are that the assessee has sold 15973 sq. ft. of area out of total 89966 sq. ft. saleable area. The assessing officer computed cost of goods sold at Rs. 33588773 against Rs. 38485063 claimed by the assessee. The amount of difference of Rs. 4896290 was added in the total income. Further the assessing officer made addition of Rs. 1420327 on account of estimated expenditure incurred on the goods sold as the assessee did not furnish any details in respect of expenses of Rs. 80 lacs claimed by him. The assessing officer made addition of Rs. 37369323 on account of interest cost for project -2 in the value of inventory by applying AS-16.
7. Counsel for the appellant has taken us to the order of assessing officer wherein it has been observed as under:–
“4.4 I have gone through the reply of the assessee. Reply of the assessee is examined in the light of method of accounting regularly adopted by it and Accounting Standard-2 and 16. a. I would like to discuss first the specific provisions contained in the Income Tax Act, 1961 with respect to valuation of the inventories i.e. Section 145A, hence, same is reproduced below:–
“145A. Method of accounting in certain cases
Notwithstanding anything to the contrary contained in section 145,–
(a) the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head “Profits and gains of business or profession” shall be–
(I) in accordance with the method of accounting regularly employed by the assessee; and “
According to the said Section, inventory must be valued in accordance with the method regularly employed by the assessee. Now question comes what is the method of valuing the inventory employed by the Assessee? Schedule 9 attached to the Balance sheet contains significant accounting policies and relevant policies employed by the assessee with respect to the valuation of inventories as follows:–
A. ACCOUNTING POLICIES & PRACTICES
The financial statements are prepared on………
Sales Revenue, Related cost and Inventory Valuation
(a) Revenue is recognized…..
(b) Stock of land, Land development is valued at cost. Cost comprises of those cost that relates directly to a specific project of cost that can be attributed to the project activity in general and can be allocated to specific projects.”
It shows that assessee is consistently valuing inventories at cost and further the term cost also includes the cost attributed to the project in general and can be allocated to specific project. Further, while valuing the inventory of Project-1, Assessee has included the interest cost also which confirms that Assessee is following the method as stated in the Schedule 9 as discussed herein before. However, while valuing the inventory of Project-2, the policy laid down has not been adhered to, therefore, valuation of Project-2 is neither according to Assessee’s own accounting policies nor according to the policy adopted for Project-1, hence, not according to the requirement of Section 145A of the Income Tax Act,
However, to deal with the reply of the Assessee, wherein, Accounting Standard 2 and Accounting Standard 16 issued by the Institute of Chartered Accountants of India have been discussed.
B. The AS-2 deals with the valuation of inventory and it says that interest cost is usually not included in the value of inventory. It is important to note that said AS-2 use the word “Usually” means it does not bar the inclusion of interest cost to the value of inventory. Further, it can be included if other factors allows it. In the reference, AS-16 addressing the issue of borrowing cost (Interest) is important and relevant Para’s are reproduced as follows for ready reference:–
“A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.”
Para 5 of AS-16:- Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring them to a saleable condition, and investment properties. Other investments, and those inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired also are not qualifying assets.”
Para 10 of AS-16:- To the extent that funds are borrowed specifically for purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalization on that asset should be determined as the actual borrowing costs incurred on that borrowing during the period less any income on the temporary investment of those borrowings.”
Commencement of Capitalization
Para-14:- The Capitalization of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied:
(a) expenditure for the acquisition, construction or production of a qualifying asset is being incurred;
(b) Borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for its intended use or sale are in progress.”
“Para-16:- The activities necessary to prepare the asset for its intended use or sale encompass more than the physical construction of the asset. They include technical and administrative work prior to the commencement of physical construction, such as the activities associated with obtaining permits prior to the commencement of the physical construction. However, such activities exclude the holding of an asset when no production or development that changes the asset’s condition is taking place. For example, borrowing costs incurred while land is under development are capitalized during the period in which activities related to the development are being undertaken. However, borrowing costs incurred while land acquired for building purposes is held without any associated development activity do not qualify for capitalization.”
8. He contended that Commissioner (Appeals) has committed serious error in observing as under:–
“It was contended by the Revenue that the ITAT had grossly erred in law as well as in facts while holding that the revised AS-2 issued by the ICAI was mandatory for chartered accountants for finalization of accounts but it was not mandatory for the Department. It was argued by the Revenue that since the assessee had valued its stores/inventories on the cost or market price, whichever was less, therefore, it could not be now valued on realization value. That apart, it was further submitted by the Revenue that the assessee had valued thousands of items at 5 percent of the cost irrespective of the year of purchase or the condition of the item, therefore, the assessing officer had committed no error in disallowing the amount of Rs. 68,59,108 written off as obsolete stores and claimed in the profit and loss account under the head “Plant and machinery repairs”. The assessee on the other hand argued that the practice of writing down the inventories below cost to net realizable value was consistent with the view that the assets should not be carried in excess of amount to be realized from their sale or use. It was submitted that the assessee had valued its inventory which were entirely rusted, non-moving and unusable on account of its obsolescence/ damage of deterioration at cost or realization value, whichever was lower. The Hon’ble ITAT after due examination of the material on record had arrived at the categorical finding that the stores which were valued by the assessee at Rs. 3.5 Lakhs or partly consumed in subsequent years at Rs. 2.08 Lakhs and remaining portion was sold at Rs. 3.46 Lakhs and, accordingly, the value of the stores came to Rs. 6.54 Lakhs as against the value estimated by the assessee at Rs. 3.59 lakhs. Thus, keeping in view, the afore-said factual position, the valuation of the stores at 10 percent of the cost made by the Commissioner (Appeals) confirmed by the Income-tax Appellate Tribunal could not be faulted with. The Hon’ble Rajasthan High Court held that as per the provisions of section 145A of the Act of 1961, the income from business under the head “Profits and gains from business” had to be computed in accordance with method of accounting regularly employed by the assessee. Similarly, section 145A of the Act provided that the inventory would be valued in accordance with the method of accounting employed by the assessee, therefore, if the method of valuation adopted by the assessee was recognized method, then, the same could not be rejected on the ground that the net realizable value/ market value had been determined on the basis of certain estimate. It is to be noticed that the Assessing while holding that the inventories valued by the assessee at 5 percent was excessive, did not care to estimate the net realizable value of the store and proceeded to disallow the amount of Rs. 68,59,108 written off as obsolete stores and claimed in profit and loss account altogether. It had come on record that the assessee had valued the inventories such as nut, bolt, glass fuse, bearing, bushes, lock pin, pipe, screw etc., which were rusted non-moving and unusable on account of obsolescence/ damage/ deterioration by efflux of time at cost and net realization value, whichever was lower. It had also come on record that these items were 5-6 years old. It was also not disputed that the assessee had made the requisite efforts to dispose of the same. That apart, some of these items were actually sold in subsequent years at a price 8.43 percent of the cost. Thus, considering the totality of the facts and circumstances, it was held by the Hon’ble Jurisdictional High Court that the value of the stores inventory written down taken at 10 percent of the cost by the Commissioner (Appeals), could not be faulted with. Further no ulterior motive can be imputed to the appellant company to hold that claim of interest was not genuine. Even if it had been capitalized then it was allowable in the year of sale. I therefore direct the assessing officer to allow the deduction of Rs. 3,73,69,323 on account of interest under section 36(1)(iii) to the appellant company. This ground of appeal is allowed.”
9. He further contended that the tribunal has also committed error in observing as under:–
“18. We have heard the parties and perused the material available on record and also the orders of the authorities below. We find that the books of accounts of the assessee are audited and the learned Auditor has not given any adverse comment for not following the accounting standards which are mandatory for a company under section 211 of the Companies Act, 1956. We also find that there is n dispute that the said land is part of inventory for the assessee and is not a capital asset. The assessee has produced evidences of no increase in the land price and assessing officer has not brought anything on record to support that the assessee would be able to realize the interest cost incurred over and above the cost of purchase of land. In such circumstances, as per basic accounting principles of valuation of inventory that the inventory is to be valued at cost or net realizable value which -ever is lower. The uncontroverted evidences show that there is no buyer of the similar land in same vicinity at the price which is lesser than the price paid by the assessee and therefore, we are convinced with the Commissioner (Appeals) and the Authorized Representative has stated that the assessee has not taken up the project activity even till 31-3-2013. The delay in project is for economic reasons. In such circumstances, the AS-16 does not allow capitalization of interest cost along with the cost of land. It allows capitalization of interest cost only during normally period of construction and not for inordinate delay in the construction activity due to adverse market forces. There is specific requirement of AS-16, not to capitalize the interest cost along with the cost of land if it is held without any associated development activity. Accordingly, the accounting treatment of the interest cost is perfectly in line with the Accounting Standards. We further find that despite any accounting treatment, the interest on capital borrowed for the purpose of business is allowable under section 36(1) (iii). A proviso has been inserted with effect from 1.4.2004 which reads as under:–
Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction”.
The proviso specifically referred to the interest paid in respect of capital borrowed for acquisition of any asset for extension of existing business. The present case is of acquisition of land for its development in course of real estate activity of the assessee. Assessee is about to complete one project and to continue the activities has purchased another land to develop another project. The argument of the learned Departmental Representative that the proviso would apply to the assessee’s case cannot be accepted. We are of the considered opinion that the purchase of inventory is continuation of the same business activity in routine course and cannot be termed as extension of the business activity. The proviso has been inserted to dis entitle claim of interest on funds borrowed for acquisition of capital assets for the period upto the asset is put to use. The term ‘put to use’ here applies to capital asset only because a capital assets is held to facilitate the business activity and sometimes it needs to be prepared after its acquisition for being used to facilitate the business activity. As against this, purchase and holding of inventory item itself is a business activity. In absence of this proviso, section 36(1) (iii) earlier entitled assessee to claim interest in respect of capital assets, even for the period during which they were under construction as held in various judgments pointed out by the learned Authorized Representative of the assessee. The interest was found allowable despite its capitalization in the books of accounts in the judgments. We are therefore, of the opinion that the interest on funds borrowed to purchase land which is part of inventory of the assessee company is an allowable deduction under section 36(1)(iii). We accordingly reject this ground of the departmental appeal also.”
10. Counsel for the respondent has supported the order of the authorities and contended that the both the authorities have rightly held in favour of the assessee inasmuch as even if the contentions which have been advanced by the department, no tax liability has been reduced or there is any case of evasion of tax.
11. We are in complete agreement with the view taken by both the authorities i.e. Commissioner (Appeals) and tribunal.
12. In that view of the matter, the issue is answered in favour of the assessee and against the department.
13. The appeals stand dismissed.