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IN THE ITAT MUMBAI BENCH H Awadhesh Builders* v. Income-tax Officer, Ward 15(2)(4), Mumbai
D.K. AGARWAL, JUDICIAL MEMBER AND RAJENDRA SINGH, ACCOUNTANT MEMBER IT APPEAL NOS. 3691 AND 3695 (MUM.) OF 2008 [ASSESSMENT YEAR 2005-06] DECEMBER 18, 2009

Section 145 of the Income-tax Act, 1961 - Method of accounting - System of accounting - Assessment year 2005-06 - Whether where an assessee, a builder and real estate developer, undertook construction of a residential project prior to 1-4-2003, it was free to follow either percentage completion method or project completion method and, therefore, revenue authorities were not justified in rejecting project completion method adopted by assessee and making impugned addition to its income by resorting to percentage completion method - Held, yes
FACTS

The assessee was a builder and developer. It started construction of residential project on a plot of land consisting of 56 flats and 8 shops. The assessee was following project completion method for accounting of income. Since the project was not complete, the assessee was capitalizing the work done as work-in-progress. In the course of assessment for the assessment year 2005-06, the Assessing Officer noticed that 50 per cent of total work of the project had been completed by 31-3-2005 and about 50 per cent of the total cost of the project had been received as advance. He, thus, asked the assessee to explain as to why the income should not be estimated on percentage completion method. The assessee explained that since it was a developer of the property and not a contractor, the profit could be derived only when the sale was complete which was possible only after completion of the construction. The assessee also submitted that it had declared the entire income from the project on its completion in the assessment year 2007-08. The Assessing Officer did not accept the assessees explanation. He, thus, having applied the percentage completion method added certain amount to the assessees income for the assessment year in question. On appeal, the Commissioner (Appeals) upheld the action of the Assessing Officer.

*In favour of assessee.

123 On second appeal :

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The assessee was a builder and real estate developer. The dispute was regarding year of accounting of income. The dispute was not whether the assessee had underestimated the income in a particular year. The assessee had been following project completion method as per which income had to be accounted in the year in which project was completed and the flats were sold. The assessee in the earlier assessment years followed the same method, which had been accepted by the department. However, in the relevant assessment year, the department had tried to assess the income on the basis of percentage completion method as per which the income had to be assessed on the basis of percentage of work completed during the year. The case of the department was that the profit was in-built into the quantum of work done by the assessee and, therefore, the profit had to be computed annually on the basis of work done in a particular year. [Para 2.6] It is established legal position that an assessee can follow any recognized method of accounting but the condition is that the same method has to be followed consistently. In case of a building project, the Institute of Chartered Accountants of India, which is an authority on prescribing accounting standards, had prescribed accounting standard AS-7 in 1983 for accounting of income in respect of real estate projects and in terms of AS-7, which was applicable to both contractor and real estate developer, a person was free to follow either of project completion method or percentage completion method depending upon the nature of project. The assessee, in the instant case, had followed project completion method, which was one of the prescribed methods by the Institute of Chartered Accountants of India. The accounting standard AS-7 was subsequently revised and revised statements were made applicable to housing projects undertaken on or after 1-4-2003 and as per the revised standards, revised AS-7 was applicable only to a contractor and in case of real estate developer, revised AS-9 was prescribed as per which the income had to be accounted only on completion of project when the flats were sold, i.e., when legal title passed to the buyer or when seller entered into agreement with the buyer for the sale and gave possession to the buyer under the agreement. In the instant case, the project was not complete during the year and, therefore, there was no question of passing on of the title of ownership or handing over of the possession. Thus, even in terms of the revised accounting standard, which was applicable for most part of the work done by the assessee, the income had been correctly declared as per project completion method in the year of completion. Even if one applied the old accounting standards on the ground that the project of the assessee had been undertaken prior to 1-4-2003, the assessee was free to follow either percentage completion method or project completion method. The assessee had followed project completion method which was one of the prescribed methods and the same method had been accepted by the department in the earlier years. The

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department, therefore, could not reject the method and apply percentage completion method in a subsequent year. Moreover, the assessee already following the same method, had declared the entire income in the assessment year 2007-08 when the project was complete. The same income, therefore, could not be assessed in the earlier year by rejecting the regular and recognized method being followed by the assessee. In view of the aforesaid, it was to be held that the impugned order of the Commissioner (Appeals) upholding the order of the Assessing Officer rejecting the method followed by the assessee, deserved to be set aside. [Para 2.8]
CASE REVIEW Tirath Ram Ahuja (P.) Ltd. v. CIT [1976] 103 ITR 15 (Delhi); Sri Sukhdeodas Jalan v. CIT [1954] 26 ITR 617 (Pat.) and Champion Construction Co. v. First ITO [1983] 5 ITD 495 (Bom.) (para 2.7) distinguished. CASES REFERRED TO Champion Construction Co. v. First ITO [1983] 5 ITD 495 (Bom.) (para 2.2), Tirath Ram Ahuja (P.) Ltd. v. CIT [1976] 103 ITR 15 (Delhi) (para 2.2), Sri Sukhdeodas Jalan v. CIT [1954] 26 ITR 617 (Pat.) (para 2.2), CIT v. British Paints India Ltd. [1991] 188 ITR 44/54 Taxman 499 (SC) (para 2.3), Bakshi Vikram Vikas Construction Co. (P.) Ltd. v. Dy. CIT [2007] 158 Taxman 61 (Delhi) (Mag.) (para 2.4), IRB Infrastructure Ltd. v. ITO [2008] 115 ITD 374 (Mum.) (para 2.4), CIT v. Bilahari Investments (P.) Ltd. [2008] 299 ITR 1/168 Taxman 95 (SC) (para 2.4) and CIT v. Realest Builder & Services Ltd. [2008] 307 ITR 202/170 Taxman 218 (SC) (para 2.4).

S.L. Jain for the Appellant. Keshave Saxena for the Respondent.
ORDER

Rajendra Singh, Accountant Member. - These cross-appeals are directed against the order dated 17-3-2008 of CIT(A) for the assessment year 2005-06. These appeals are being disposed off by a single consolidated order for the sake of convenience. 2. We first take up the appeal of the assessee in ITA No. 3691/M./2008. The only dispute raised by the assessee in this appeal is whether on the facts and in the circumstances of the case, CIT(A) was justified in upholding the action of the Assessing Officer to assess the income from the building project on the basis of percentage completion method instead of project completion method adopted by the assessee. 2.1 Briefly stated the facts of the case as borne out from records are as follows: The assessee-firm who was in the business as builder and developer started construction of residential project known as Sanskruti Apartment on plot at CTS Nos. 1361/A, 1362/A, 1325 of Village Dahisar, Mumbai consisting of 56 flats and 8 shops. The commencement certificate for the project had been issued by MCGB on 25-10-2002. The assessee was following project completion method for accounting of income. Since the project was not complete, the assessee was capitalizing the work done as work-in-progress. The assessee declared nil income from assessment year 2003-04 to assessment year 2006-07 the details of advances received

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against booking, the closing balance of commencement certificate were as under :

A.Y. Income returned Work-inprogress Advance received against booking

work-in-progress

Commencemen t certificate

2003-04

Nil

39,64,359

63,67,176

Up to 2nd floor, dated 12-2-2003 Up to 5th floor, dated 23-1-2004 Up to 7th floor, dated 11-11-2005

2004-05

Nil

1,81,69,769

1,82,29,167

2005-06 2006-07

Nil Nil

3,09,07,507 3,48,54,441

3,18,87,936 3,60,41,488

2.2 The Assessing Officer during the assessment proceedings noted, after hearing the representative of the assessee, that 50 per cent of total work of the project had been completed by 31-32005 and about 50 per cent of the total cost of the project had been received as advance. The Assessing Officer, therefore, asked the assessee to explain as to why the income should not be estimated on percentage completion method. The assessee explained that since it was a developer of the property and not a contractor, the profit could be derived only when the sale was complete which was possible only after completion of the construction. It was also submitted that the assessee had declared the entire income from the projects on its completion in assessment year 2007-08. The Assessing Officer, however, did not accept the explanation. It was observed by him that process of earning profit exists along with process of construction and the profit is not earned only on last day of completion of project. The assessee was under a contractual liability to complete the construction in a time bound manner and hand over the premises to the buyers as per the agreement with the buyer. The latter paid the builder amounts in stages depending upon the stage of work completed. Therefore, the argument of the assessee that it was not a contractor was not correct. The Assessing Officer referred to the decision of Tribunal in case of Champion Construction Co. v. First ITO [1983] 5 ITD 495 (Bom.), in which assessment on percentage completion method was upheld. Reliance was also placed on the judgment of Honble High Court of Delhi in case of Tirath Ram Ahuja (P.) Ltd. v. CIT [1976] 103 ITR 15 and on the judgment of Honble High Court of Patna in case of Sri Sukhdeodas Jalan v. CIT [1954] 26 ITR 617 . The Assessing Officer was, therefore, not satisfied by the method of accounting followed by the assessee and rejected the same invoking the section under section 145. He adopted the percentage completion method and estimated the profit at 10 per cent of the closing balance of advances received of Rs. 3,18,87,936 till 31-3-2005, i.e., Rs. 31,88,763. This was disputed by the assessee.

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2.3 In appeal, the assessee reiterated the submissions made earlier that the firm was a developer of the property and not a contractor and, therefore, income had to be accounted on completion of the project. The assessee referred to the guidelines issued by the Institute of Chartered Accountants regarding recognition of income from construction projects. It was argued that mere construction did not give rise to any profit and that profit arises only when the flats are sold and given possession to the buyers. The assessee placed reliance on several judgments as mentioned in para 3.1 of the order of CIT(A). CIT(A), however, did not accept the explanation of the assessee. It was observed by him that, under the Income-tax Act, income is required to be computed on annual basis. The construction was ongoing process and the profit element was embedded into the construction. Therefore, there was a profit element embedded into the work-in-progress and the profit could be computed on the basis of work-in-progress. In this case, more than 50 per cent of the project had been completed by 31-5-2005 and 50 per cent of the investment had been received as advance. It was also observed by him that the present case was comparable to the case of Champion Construction Co. (supra) in which case the construction was complete and 80 per cent of the area was sold. In the present case also the majority of the flats had been sold. The income had, therefore, to be legally recognized on substantial completion of the project on the basis of percentage completion method. In his view, there was no basic difference between a developer and a building contractor. Insofar as recognition of income was concerned, CIT(A) further observed that in case the correct profit could not be reduced from the method employed by the assessee, the Assessing Officer could always reject the method and estimate the profit. Reliance was placed on the judgment of Honble Supreme Court in case of CIT v. British Paints India Ltd. [1991] 188 ITR 441 CIT(A), accordingly, upheld the percentage completion method adopted by the Assessing Officer aggrieved by which the assessee is in appeal before Tribunal. 2.4 Before us the learned AR for the assessee reiterated the submissions made before lower authorities that the assessee was a real estate developer and not a contractor. It was submitted that as per the old accounting standard (AS-7) prescribed for accounting of income from construction projects the assessee was free to employ either percentage completion method or completed contract method depending upon the nature of project. The old AS-7 was applicable both in case of a contractor and real estate developer. The assessee was, therefore, following one of the prescribed method for accounting of income, i.e., project completion method and the method had been followed and accepted by the department in assessment years 200304 and 2004-05. It was also submitted that revised AS-7 was made applicable in respect of new housing project undertaken on or after 14-2003. He produced a copy of the opinion given

54 Taxman 499.

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by export advisory committee of the Institute of Chartered Accountants in which it was opined that revised AS-7 could not be applicable to real estate developer in which cases revised AS-9 was applicable as per which income had to be accounted when the legal title of the property passed to the buyer or when seller entered into agreement for sale and handed over possession of real estate to the buyer under the agreement. Therefore, it was submitted that even in terms of the revised guidelines, the income could be accounted only on completion of the project when the flats had been sold. It was also submitted that since the assessee had followed one of the prescribed methods and the same method had been accepted in the earlier years, the method could not be changed by the Assessing Officer in the subsequent year. The learned AR referred to several judgments in support of the stand taken by the assessee as mentioned below : (i) Bakshi Vikram Vikas Construction Co. (P.) Ltd. v. Dy. CIT [2007] 158 Taxman 61 (Delhi) (Mag.). (ii) IRB Infrastructure Ltd. v. ITO [2008] 115 ITD 374 (Mum.). (iii) CIT v. Bilahari Investments (P.) Ltd. [2008] 299 ITR 11 (SC). (iv) CIT v. Realest Builder & Services Ltd. [2008] 307 ITR 2022 (SC). 2.5 The learned DR, on the other hand, supported the orders of authorities below. It was pointed out that earlier assessments in which the assessee had employed project completion method had been completed summarily under section 143(1) and, therefore, it could not be said that the said method had been accepted by the department. It was also argued that the assessee executed agreement for sale with the parties which had been registered and, therefore, the same amounted to sale. The income, thus, had to be computed on the basis of agreement for sale in terms of which the assessee had received substantial advances. He also placed reliance on the findings given in the orders of authorities below. 2.6 We have perused the records and considered the rival contentions carefully. The assessee is a builder and real estate developer. The dispute is regarding year of accounting of income. The dispute is not whether the assessee had underestimated the income in a particular year. The assessee has been following project completion method as per which income has to be accounted in the year in which project is complete and the flats are sold. The assessee in the earlier two years followed the same method which has been accepted by the department. Though the earlier returns were accepted summarily under section 143(1), the fact is that these assessments have become final and method followed by the assessee in these years stands accepted by the department. However, in the current year, the department has tried to assess the income on the basis of percentage completion method as per which the income has to be assessed

1 2

. .

168 Taxman 95. 170 Taxman 218.

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on the basis of percentage of work completed during the year. The case of the department is that the profit is inbuilt into the quantum of work done by the assessee and, therefore, the profit has to be computed annually on the basis of work done in a particular year. The department has placed reliance on the judgment of Honble High Court of Delhi in case of Tirath Ram Ahuja (supra) and on the judgment of Honble High Court of Patna in case of Sri Sukhdeodas Jalan (supra). Reference has also been made to the decision of Tribunal in case of Champion Construction Co. (supra). 2.7 However, on careful perusal of the above orders, we find that the same are distinguishable. The case of Tirath Ram Ahuja (supra) and Sri Sukhdeodas Jalan (supra) related to the profit declared by a contractor. The case of a contractor is different from that of the real estate developer. The profit earned by a contractor depends upon the quantum of work done and is not dependent on whether the flats/shops constructed are actually sold by the owner or not. Therefore, in case of a contractor, profit can be estimated on the basis of work done. In case of real estate developer, he can earn the profit only when the space constructed sold. In case, due to some reasons, the project is terminated or is abandoned the builder has to refund the advances received from the buyers and in that case, there cannot be any profit because the flats/shops could not be sold as the construction remained incomplete. In that case, it will be only a case of investment by the builder profit from which will arise only on sale of flats. Similarly the case of Champion Construction Co. (supra) is also distinguishable as in that case construction was complete and 80 per cent of the flats had been sold. 2.8 It is established legal position that an assessee can follow any recognised method of accounting and condition is that the same method has to be followed consistently. In case of a building project, the Institute of Chartered Accountants of India which is an authority on prescribing accounting standards had prescribed accounting standard AS-7 in 1983 for accounting of income in respect of real estate projects and in terms of AS-7 which was applicable to both contractor and real estate developer, a person is free to follow either of project completion method or percentage completion method depending upon the nature of project. The assessee, in this case, has followed project completion method which is one of the prescribed methods by the Institute of Chartered Accountants of India. The accounting standard AS-7 was subsequently revised and revised statements were made applicable to housing projects undertaken on or after 1-4-2003 and as per the revised standards, revised AS-7 was applicable only to a contractor and in case of real estate developer, revised AS-9 was prescribed as per which the income has to be accounted only on completion of project when the flats are sold, i.e., when legal title passes to the buyer or when seller enters into agreement with the buyer for the sale and gives possession to the buyer under the agreement. In this case, the project was not complete during the year and, therefore, there was no question of passing on of the title of ownership or handing over of the

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possession. Thus, even in terms of the revised accounting standard which was applicable for most part of the work done by the assessee the income had been correctly declared as per project completion method in the year of completion. Even if one applies the old accounting standards on the ground that the project of the assessee had been undertaken prior to 1-4-2003, the assessee was free to follow either percentage completion method or project completion method. The assessee has followed project completion method which was one of the prescribed methods and the same method has been accepted by the department in the earlier years. Department, therefore, cannot reject the method and apply percentage completion method in a subsequent year. This view is also supported by several decisions of the Tribunal as mentioned in para 2.5 of this order earlier which have been relied upon by the learned AR of the assessee. The assessee already, following the same method, has declared the entire income in assessment year 2007-08 when the project was complete. The same income, therefore, cannot be assessed in the earlier year by rejecting the regular and recognised method being followed by the assessee. We are, therefore, unable to sustain the order of CIT(A) upholding the order of Assessing Officer rejecting the method followed by the assessee. The order of CIT(A) is set aside and the claim of the assessee is allowed. 3. The appeal of the revenue in ITA No. 3695/M./2008. In this appeal, the only dispute raised by the revenue is regarding estimation of net profit. The Assessing Officer had estimated the net profit rate at 10 per cent on the advances received till the end of the relevant assessment year. The assessee disputed the matter and submitted before CIT(A) that in the assessment year 2007-08 on completion of the project the assessee had declared net profit rate of 6.95 per cent on the basis of audited accounts. Therefore, adopting net profit rate at 10 per cent by the Assessing Officer was not correct. CIT(A) was satisfied by the claim of the assessee and observed that it would be appropriate to adopt the rate shown by the assessee on the basis of books of account maintained for assessment year 2007-08 which were audited. He, accordingly, directed the Assessing Officer to adopt the same rate of profit as taken in assessment year 2007-08. Aggrieved by the said decision the revenue is in appeal. 3.1 We have heard both the parties, perused the records and considered the matter carefully. As we have already held that income of the project can be assessed only in assessment year 2007-08 when the project was complete and not in this year the issue of estimation of profit has become infractuous. We, therefore, dismiss the appeal of the revenue as having become infractuous in view of our decision given in relation to the appeal of the assessee. 4. In the result, appeal of the assessee is allowed whereas that by the revenue is dismissed.