IN THE ITAT HYDERABAD BENCH ‘B’
Deputy Commissioner of Income-tax, Circle 3(3), Hyderabad
Vertex Homes (P.) Ltd.
IT Appeal No. 979 (Hyd.) of 2012
[Assessment year 2008-09]
October 12, 2012
Sanjay Arora, Accountant Member
This is an Appeal by the Revenue, directed against the Order dated 30/3/2012 by the Commissioner of Income-tax (Appeals)-IV, Hyderabad, partly allowing the assessee’s appeal contesting its assessment under section 143(3) of the Income-tax Act, 1961 (‘the Act’ hereinafter) vide order dated 30.12.2010 for assessment year 2008-09.
2. None appeared for and on behalf of the assessee, even as the record confirms the service of the notice of hearing thereon.
3.1 We may, before proceeding to deal with the issue/s arising for adjudication, recount the facts of the case. One, Smt. G.Shailaja and four others, owning pieces of land, varying from 1.11 Guntas to 2.22 Guntas, falling under Survey Nos.76/B and 77/B at Hydernagar Village, Balanagar Mandal, R.R. District, obtained a no-objection certificate (NOC) from the Air Port Authority of India on 16.5.2006, to develop the said open land, measuring in aggregate to over one acre. Separate Agreements were entered into by each of these land owners with the assessee-company, in the business of civil construction; it obtaining the requisite approval from the Commissioner, Kukatpally Municipality, RR District on 30.3.2007 for construction of a residential-cum-commercial complex on the said land. The assessee returned its income for the year on 29.9.2008 at an income of Rs.35.14 lakhs, i.e., after claiming deduction u/s. 80IB(10) at Rs. 311.80 lakhs. The Assessing Officer, however, found the assessee’s claim in its respect as not maintainable, as:
(a) the construction of the proposed complex by the assessee is in the capacity of a Contractor and, thus, specifically excluded from the benefit of deduction u/s. 80IB(10) by Finance (No.2) Act, 2009 with retrospective effect from 1.4.2001. The land was never transferred to the assessee, and some of the regulatory approvals were also in the names of the land owners;
(b) the assessee has claimed the impugned deduction even as there were no sales during the year, i.e., only on Work-in-Progress (WIP), taking into account future realizations, which is clearly not acceptable; and
(c) the assessee had shown inflated profit, i.e., at 60%, as against the rate of 23% for another non-80IB project; even though the profit rate in both the cases stands reckoned on gross profit basis, the difference in their rates exhibits the inflation that attends the assessee’s claim u/s. 80IB.
3.2 The assessing officer’s (AO’s) claims were vehemently countered before the first appellate authority. Owning of land is not one of the conditions specified u/s. 80IB(10), all of which stand satisfied in the instant case. The land owners, though not paid directly in cash, were to be compensated by way of 46% share in the constructed space on the undivided land. The assessee- company was not by any means a ‘Contractor’, but a ‘Developer’, which had undertaken the relevant project (Sadguru Krupa), bearing all the risks and rewards of the development activity, i.e., of the real estate. The entire work, i.e., from conception, through execution, to finally sale, was to be performed by it, at its own cost and risk, including seeking approvals and sanction from the various authorities, deploying its own resources, i.e., men, machines and materials.
3.3 ‘Project percentage method’ is an accepted method for accounting, particularly for long term projects, which take several years for completion, accounting for the profit on a pro rata basis, i.e., as the work progresses, as against the ‘project completion method’, whereby the profit is taken into account only on the completion of the project, i.e., after several years. Though no final sales had been made, which would materialize only on the completion of the construction, yet sale agreements had been entered into, and advances received there-under. The future realizations had been estimated only on that basis. Case law, notably by the Tribunal, were cited by the assessee in respect of its argument qua the objections (a) and (b) supra by the AO, with the hon’ble high court approving its decision in the case of CIT v. Radhe Developers  204 Taxman 543.
3.4 Finally, a higher profit could not by itself be a ground for denying deduction u/s. 80IB. The assessing officer had, firstly, taken the figures of gross profit, i.e., as against that of net profit, which is the relevant figure, and on which only deduction u/s. 80IB is exigible and claimed. And, further, would vary from project to project. Then, the two projects are not comparable. While the project under reference is for ‘Apartments’, the other project (Lake View) was for ‘Villas’. The profits in any case are subject to variation from year to year, and the results of one year could not be the basis for forming an opinion with regard to the profitability of the project; the profit for the succeeding year, i.e., assessment year 2009-10, falling to 23%, with that for the other, non-80IB project climbing to 41%.
3.5 The assessee found favour with the learned CIT(A) on that basis. The terms of the agreement entered into by the assessee- company with the land owner clearly showed that the construction, on completion, was not required to be handed over back to the owners, who never intended to develop the land by setting up a housing project thereon themselves. The housing project was always within the dominant control of the assessee, who would, thus, rightly be called ‘developer’. As regards the transfer of land, there was an effective transfer u/s. 2(47) r/w s. 53A of the Transfer of Property Act, 1882, with 46% of the constructed area forming the consideration thereof.
3.6 As regards the method of accounting employed, ‘project percentage method’ is an accepted method, on the basis of which deduction u/s. 80IB(10) can be claimed and allowed, even as opined by the tribunal in the case of B.K. Pate Enterprises v. Dy. CIT,  125 TTJ 974 (Pune). The same, in fact, finds endorsement by the CBDT itself, vide its Instruction No.4 of 2009 dated 30.6.2009; it clarifying thereby that deduction u/s. 80IB(10) can be claimed from year to year, i.e., on the basis of partial completion. No defect in the book-keeping stands pointed out by the assessing officer, and the income has been arrived at after taking into account all the direct and indirect expenditure incurred during the year. As such, even though no sales had admittedly been made during the year, no fault could be pointed out where profits are estimated on the basis of future realizations, anticipated in view of the sales made, toward which advances have been received during the year. Reliance was placed on the decisions in the case of Asst. CIT v. Yug Corpn. [ITA Nos. 2700-2703/Ahd/2009, dated 17-6-2011]. Further, mere difference in profitability cannot justify denial of the assessee’s claim, as profitability differs for different projects, which, definitely, are not identical, and more so without finding any defect in the regular method of accounting, or in the manner of maintenance of books of account.
4. We have heard the party before us, and also perused the material on record.
4.1 The first issue before us is whether the assessee is a developer and builder and, thus, entitled to deduction u/s. 80IB(10) qua the Sadguru Krupa Project, or only a Contractor and, thus, not so entitled. No argument, much less materials, has been advanced or adduced before us by the Revenue to bring out any infirmity in the findings of the learned CIT(A) (refer paras 3.5 & 3.6 above), issued on the basis of the Development Agreement-cum General Power of Attorney)(GPA) entered into by the assessee with the land owners. That ownership of land is not a criteria or requirement for the builder of a housing project, which otherwise satisfies, i.e., on physical parameters, including as to its approval and completion, the conditions of s. 80IB(10), is by now well-settled; one of the earliest decisions in the matter being in the case of Radhey Developers v. ITO  23 SOT 420 (Ahd.), since affirmed by the hon’ble high court.
4.2 True, a housing project, which is the object matter of the deduction u/s. 80IB(10), i.e., where qualified in terms of the said provision, cannot be sans land, which is an intrinsic part thereof, as also of the sale price of the residential unit, and which is admittedly not owned by the assessee, so that it cannot be sold by it. But then, what is relevant is not who transfers the ownership of the land appurtenant thereto in favor of the ultimate buyer of the residential unit, but that the sale price thereof, being inclusive of the rights in land and, thus, the consideration in its respect, how is the cost of land, admittedly not purchased by the assessee, accounted for in the assessee’s books, only whereupon the true profits from the project could be arrived at?
4.3 However, as would be borne out by the development agreement-cum GPA, 46% of the constructed space and, consequently, 46% of the land continues to belong to the land owners, who have thus divested themselves, through this arrangement, of only the balance 54% of the land against the value of 46% of the construction. As such, when the assessee credits in its account only 54% of the total sale consideration arising on the sale of residential units, or, equivalently, credits only the sale of the earmarked 54% of the construction, while incurring the total cost thereof, it effectively debits the cost of land in its accounts. The only issue that would arise is the valuation of the WIP as at the close of the year. This is as the same has necessarily has to be inclusive of the cost of land (to the assessee), which, being at 46% of the total cost of construction, is yet to be incurred, and would be so only during the course of the construction period. The same, however, is a valuation aspect, for which a suggested course would be an informed provision in accounts, which would further be subject to revision at each year-end (during the said period) on the basis of the developments in the interim.
Coming back to the issue under reference, the other and perhaps legally more sound way of looking at the transaction, is that the assessee develops only 54% of the project on its own account, and the balance 46% on account of the land owners, toward discharge of the liability thereto for the land falling to its share (54%). That, however, would not matter as it, in fact, realizes profit from only its 54%, claiming deduction u/s. 80IB(10) thereon. The project, nevertheless, is one, composite project, i.e., physically, and this analysis is only toward understanding of the rights inter se of the ‘Developer’ and the ‘Land Owners’, and their financial adjustment in determining the qualifying profit, which though would not operate to modify the physical parameters of the project, i.e., the land area developed (which is to be at a minimum of one acre), etc. In fact, if anything, the same only goes to show as to how the Developer has met the interest of the Land Owners by parting with a stake in the project thereto and, thus, refurbish its claim of it being only a developer-cum-builder and not a contractor. In other words, though the assessee develops the entire project, its interest therein is limited to a part thereof (54%). Not only the assessee undertakes the entire work, even the sale function is also managed by it. It is, thus, it who pays the land owners through the value of a part of the project, i.e., 46%, rather than being paid for, similarly, by them, i.e., at 54% of its value, as a contractor would be, where not by paid in cash. The Revenue’s case on this count is without merit, and rightly rejected by the ld. CIT(A).
5.1 The second issue before us is whether, even so, the assessee’s claim for deduction u/s. 80IB(10) at Rs. 311.80 lakhs is maintainable in the absence of any sales during the year. This issue, though not specifically raised by the Revenue per its grounds of appeal, arises in the context of the Revenue’s case, i.e., as per the assessment order, relied upon by the ld. DR before us, and the pleadings made with reference thereto, so that it would stand to be covered by its ground no.1 before us. It needs to be appreciated that there is no question of any deduction u/s. 80IB(10) in the absence of accrual of any profit or, in any case, in excess of that accrued.
5.2 Without doubt, ‘project percentage method’ is an accepted accounting method, and rather, a preferable one, where the project is a long term one, apportioning profit over its construction period on a definite, reasonable basis, i.e., the quantum (ratio) of the project completed, which explains its name. However, it is not the principle that is in question, but its application in the facts and circumstances of the case.
5.3 The first thing that strikes us in the matter is: How could there be any income without ‘sale’ or ‘sale agreement/s’? Income, by definition, is a (or at least a) bilateral process, so that it has to flow from outside one’s own self, and one cannot generate it within itself. This represents (or marks) the first step. The second step is the recognition of income, i.e., the point in time when the income is or could be or ought to be recognized. The third step is its quantification, which is essentially a valuation aspect, so that it has to be, firstly, an informed estimate and, secondly, marked by conservatism, a fundamental accounting principle, since also statutorily recognized per s.145 of the Act, i.e., through the Accounting Standard -I notified there under. This represents the broad contours of the concept of income and its accounting, while in practice there could be some overlap between the different processes, and the distinction may not be as neat as it may appear to be. ‘Project Percentage Method’ comes into play at the second and third steps enumerated above.
5.4 We may now examine the facts of the case. The assessing officer states that in the absence of any sales, profits, much less correct profits, are not ascertainable, i.e., he speaks of the absence of the primary condition for accrual of income, the first step afore-referred. This finding is qua the Sadguru Krupa project. Accordingly, he denies the assessee the benefit of deduction u/s. 80IB(10). But, this ought to be a revenue neutral exercise, as, if the basis of the denial of deduction is the non-accrual of income, how could income be at all assessed, while the assessing officer does exactly that? This anomaly has also been observed by the ld. CIT(A), whose order is again bereft of any facts and figures in the matter. While there is no mention of any sale agreement with the customers in the assessment order, the ld. CIT(A) does not state either the date(s) of these agreement(s) or the aggregate value thereof or the quantum of advance(s) received there-against during the year. Without doubt, existence of these materials is a pre- requisite toward the satisfaction of the first step afore-said. Again, there is no whisper of the quantum of work completed during the year, another vital ingredient, on the strength of which alone, in view of the sale agreement(s) and the advance(s) received there-under, it is considered appropriate to book income on the project. In fact, ‘sales’ to the proportionate extent can be said to have materialized, irrespective of the fact that the transfer of property would only be on the completion of construction and its delivery. In fact, there could in practice be a time lag even between these stages, i.e., the completion of construction (so that the ‘product’ fructifies); it’s delivery (which may be conditional on the payment of the entire consideration); and the actual transfer of property (which, being an immovable property, is subject to registration with the appropriate authority).
As such, the first thing is whether income has – as a matter of fact – accrued, to whatever extent. There has to be, firstly, a third party, having agreed to buy the property (residential unit), i.e., a sale agreement, defining the various aspects, including the terms and conditions, of the transaction. This alone creates a binding, contractual relationship, leading to, subject to satisfaction of other ingredients, accrual of income, besides lending certainty to its generation (process), as well as to its realization, as it is generally accompanied by a stipulation as to advance/payment. The same becomes essential as the transaction is scheduled over a long period of time, which bestows uncertainty. Advance, thus, besides causing to provide a (regular) source of finance for the project executor, lends certainty in-as-much as it is exhibits (continuing) commitment on the part of the buyer, who thus also partakes of some risk. In fact, being only in terms of the Agreement, the same should not be, strictly speaking, construed as an ‘advance’. As afore-noted, neither the aggregate amount of the sale agreements entered into nor of the advance received there-against during the relevant year, which appears to be the first year of the project, has been mentioned by the assessee or any authority. Reasonable certainty as to the realization (of the sale proceeds) is crucial to income recognition, and both sale agreement as well as advance received in pursuance thereof are vital thereto.
5.5 Next, i.e., assuming a satisfaction on this count, comes the quantum of or the extent to which income can be said to have accrued. The same would, without doubt, depend foremost on:
(a) the quantum of work done (usually, technically specified), including its valuation;
(b) certainty of completion of construction within the time frame stipulated in the sale agreement(s) – which is itself a function of several variables, including availability of resources over the construction period.
It is, thus, only where a fair proportion of the work – usually not less than 25%, has been completed and the balance envisaged to be completed within the scheduled time (so that there is no breach of contract, which again has income implications), that it may be considered appropriate to recognize income on the project. Of course, this would be subject to it having been sold out, as there can be, on first principles, no (real) income out of one’s own self. As such, if (say) 50% of the property is sold out, and it – on physical parameters, is complete up to 30%, income could be booked at 15% (50% x 30%) of the project value. In fact, here again, as there are built in uncertainties incident on the project, viz., as regards –
• the balance 50% project being sold out at the same rate(s);
• there being no cost escalation(s) over the project period;
• the project encountering no adverse claims or legal problems;
• the project being completed in time, etc.,
resolution of which, though lying in the womb of future, is crucial to and impacts the revenue recognition thereon, some provision against income is made. As such, as against 15%, income may be recognized at (say) 13.5% (or lower), providing a 10% (or higher) margin toward the same. In fact, prudence needs to be exercised in this regard, lack of which can be perceived from the fact of the steep decline in the rate of profit from this project for the immediately succeeding year, belying the assessee’s claims, i.e., of having made a reasonable estimation.
5.6 We are, therefore, at a loss to understand the basis on which income has been booked; there being no clue as to it on record. This is all the more surprising as the assessing officer casts a genuine shadow of doubt by stating of the absence of any sales, and of the same (income) having been booked at an abnormally higher figure, quoting the percentage of profit for the year on another residential project. While, no doubt, a higher profit by itself can be no ground for denying deduction, if otherwise due, the question is: how could profit at all arise on WIP; valuation of which can bear no element of profit and, in any case, proper valuation of which is crucial to ascertainment of correct profits. The assessing officer raises valid questions, which ought to have been met by the assessee on the basis of facts and figures, duly supported, while, as aforesaid, we observe none, so that the assessee’s case in this regard, though has found approval by the first appellate authority, is completely unsubstantiated. His order, therefore, in this regard cannot find our acceptance. As regards the tribunal’s decision in the case of Yug Corpn. (supra), cited by him, the same, an unreported order, is, firstly, not on record and, two, on the basis of the discussion in its respect by him, we find no parity on facts; with we rather having found the facts in the instant case as indeterminate. The assessing officer has, we repeat, also made faux pas by assessing income, which he himself holds as having not accrued, so that there was no question of the claim for deduction u/s. 80IB there-against.
5.7 In view of the foregoing, we set aside the impugned order to this extent, and remit the issue of determination of the accrual of income, including, where so, its extent, back to the file of the AO. The assessing officer shall adjudicate the same afresh, in accordance with law, issuing specific findings of fact, and after providing a reasonable opportunity of hearing to the assessee to prove its case. Before parting, however, we may once again clarify as to the revenue neutrality of this exercise, as, if and to the extent income has not accrued, it could neither be brought to tax nor deduction in its respect claimed by, or allowed to, the assessee. The same though is crucial in the overall context of the case, inasmuch as only the real income, since accrued, can be assessed. Further, the value of the closing WIP, as assessed, shall be adopted as the opening WIP for the following year (also refer para 4.3). Also, as this is the first year of construction, and some qualifying conditions u/s. 80IB(10) are subject to satisfaction over time, which has since elapsed, the AO shall also, if not already so verified, i.e., while framing the assessment for any succeeding year(s), satisfy himself as to the satisfaction of those conditions, being, principally, though not limited to, the completion of the project within the stipulated time period, issuing definite findings in its respect. We decide the second issue accordingly.
6. In the result, Revenue’s appeal is partly allowed for statistical purposes.