Case Law Good - KPMG

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KPMG IN INDIA

KPMG Flash News27 Decemebr 2010

TAX

Revised Accounting Standard 7 Construction Contract is

applicable to only contractors and not to builders and real estateconsultants. Accordingly, the Project Completion Method

consistently followed by the taxpayer for recognising revenue in the

books of accounts cannot be regarded as an unreasonable

Recently, the Mumbai bench of the Income-tax Appellate Tribunal (the

Tribunal) in the case of Unique Enterprises1 has held that the

Accounting Standard (AS) 7 Construction Contract (revised) issued

by the Institute of Chartered Accountants of India (ICAI) is applicable

only to contractors and not to builders and real estate developers.

Accordingly, the Project Completion Method followed by the taxpayer

for recognising revenue in the books of accounts cannot be regarded as

an unreasonable. Further, the tax department cannot change the methodof accounting as any change would be a tax neutral.

Background

The ICAI issued Accounting Standard (AS) 7 Construction Contract

in the year 1983 which was later on revised in the year 2002. The AS 7

laid down the principles of accounting for construction contracts in the

financial statements of the Contractors. As per the revised AS 7 the

accounting was to be done as per percentage/progressive completion

method.

In response to a query rose, on applicability of revised AS 7 to a realestate developer, before the Expert Advisory Committee (EAC) formed

by the ICAI, the EAC observed that the pre revised AS 7 specifically

mentions about its applicability to enterprises undertaking construction

activities on their own which would include real estate developer.

However, the revised AS 7 is applicable only to Contractors.

1Unique Enterprises v. ITO [2010-TIOL-737-ITAT-MUM]

(Judgment date: 20 August 2010, Assessment Year: 2005-06)

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Facts of the Case

The taxpayer was engaged in the business of redevelopment of

tenanted property. The taxpayer was following the Project

Completion Method of accounting since its inception in the

assessment year 1995-96 and the income of the project was offered

for taxation in the year of completion of the project. The

expenditures incurred on a project were accumulated under the headconstruction work-in-progress and in the final year of completion

it was taken as expenditure.

For the Assessment Year 2005-06, the taxpayer computes its taxable

income following Project Completion Method. However, the

Assessing Officer (AO) recomputed income based on the

percentage/progressive completion method prescribed by AS 7. The

Commissioner of Income-tax (Appeals) [CIT(A)] uphold the AOs

action and held that the revised AS 7 was applicable to taxpayer.

Taxpayers Contentions

The taxpayer relied on the opinion of the EAC and contended that

revised AS 7 issued in the year 2002 was not applicable to the

taxpayer since it does not apply to builders and real estate

developers. Further, the same method of accounting followed in

earlier years had been accepted by the tax department.

The taxpayer contended that it has been consistently following the

Project Completion Method of accounting since its inception and

has accordingly offered to tax the entire income in the next

assessment year i.e. Assessment Year 2006-07. Further, before AS 7

was issued by the ICAI, the Mumbai Tribunal in the case ofChampion Construction Company

2 had accepted the Project

Completion Method as an appropriate method of computing income.

The taxpayer also relied on the Guidance Note on Recognition of

Revenue by Real Estate Developers issued by ICAI in 2006. The

taxpayer contended that Guidance Note read with the Agreement of

Sale, executed by the taxpayer, it is clear that the risks and the

rewards of ownership have not been transferred to the buyer and it

retains effective control of the property. The reliance was also

placed on the decision of the Bangalore Tribunal in the case of

Prestige Estate Projects (P) Ltd.3

Tax departments Contentions

The tax department contended that AS 7 was applicable to builders

and contractors and revenue recognition has to be done as per AS 7

read with AS 9.

2Champion Construction Company v. ITO [1983] 5 ITD 495 (Mum)3Prestige Estate Projects (P) Ltd. v. DCIT [2010] 33 DTR 514 (Bang)

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As per the Guidance Note on Recognition of Revenue by Real

Estate Developers issued by the ICAI the taxpayer is bound to

declare income during the year since the Agreements to sale entered

by the taxpayer was partly complete and the risks was already

passed.

Tribunals ruling

The Tribunal observed that the pre revised AS 7 issued by ICAI in

the year 1983, specifically included enterprises undertaking

construction activities on their own and as such to builders and real

estate developers. However, such specific inclusion is missing in the

AS 7 revised in the year 2002. The Tribunal also went through the

opinion given by the EAC on the applicability of AS 7 and held that

the revised AS 7 does not apply to builders and real estate

developers.

The method followed by the taxpayer cannot be called as an

unreasonable method and any change in the method is revenueneutral. Further, the tax department cannot change the method of

accounting which was accepted by it over the years.

The Tribunal observed that the Bangalore Tribunal in the case of

Prestige Estate Projects (P) Ltd. held that the Government has not

specified AS 7 in Section 145 of the Act and the taxpayer developer

had been regularly, under a bonafide belief, employing Project

Completion Method which is an accepted method of accounting.

Accordingly, the AO cannot reject the accounts of the taxpayer

under Section 145(3) of the Act.

The Tribunal relied on the decision of the Mumbai Tribunal in the

case of Champion Construction Co. and held that it would be

appropriate to offer income tax in the year in which 80 percent of

the construction was completed. Since the taxpayer admittedly

completed only 53.95 percent of the construction it cannot be said

that the taxpayer has substantially completed the project so as to

recognize income under the Project Completion Method of

accounting.

The Tribunal also relied on the decision of the Bombay High Court

in the case of Tata Iron & Steel Co. Ltd. 4where it was held that the

method of accounting followed by the taxpayer company cannot besaid to be unreasonable, and that in such a case, even if a better

method could be visualised, the method consistently followed

should be accepted.

Accordingly, the Tribunal allowed the taxpayers contention to

follow Project Completion Method and recognise the revenue

accordingly in the year of project completion. The Tribunal

4CIT v. Tata Iron & Steel Co. Ltd.




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refrained from deciding as to whether any revenue has to be

recognised in the relevant assessment year based on the Guidance

Note issued by ICAI considering the agreement to sale entered into

by the taxpayer.

Our Comments

This is a welcome decision by the Mumbai Tribunal wherein it has beenheld that revised AS 7 is not applicable to real estate developers and

accordingly, the Project Completion Method is not an inappropriate

method for accounting for the real estate developers.

The Tribunal also held that in the case of Project Completion Method it

would be appropriate to offer income in the year in which 80 percent of

the construction was completed. The Mumbai Tribunal in the case of

Parekh Properties (P) Ltd.5had held that though there is no general rule

for the specific percentage of the total area of the project which should

be considered to be substantially completed, it seems proper that the

income should be taxed in the year in which 75 percent of the total area

constructed by the taxpayer was sold.

It is pertinent to note that, recently, the Mumbai Tribunal in the case of

Awadhesh Builders6had held that in the case of real estate developers

following Project Completion Method, the revenue should be accounted

as per revised AS 9 Revenue Recognition. Accordingly, in such cases

income had to be accounted when the legal title of the property passes to

the buyer or when seller entered into agreement for sale and handed

over possession of real estate to the buyer under the agreement.

Further, the Supreme Court in the case of Realest Builders & Services

Ltd.7has held that the tax department needs to provide facts and figures

that the impugned method of accounting adopted by the taxpayer resultsin underestimation of profits for changing the method of accounting

under Section 145 of the Act. Otherwise, it will be presumed that the

entire exercise is revenue neutral.

5Parekh Properties (P) Ltd. v. ACIT [2003] 1 SOT 124 (Mum)6Awadhesh Builders v. ITO [2010] 37 SOT 122 (Mum)7CIT v. Realest Builders & Services Ltd [2008] 170 TAXMAN 218 (SC)


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be accurate in the future. No one should act on such information without appropriate professional advice

after a thorough examination of the particular situation.

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of the KPMG network of independent member firms

affiliated with KPMG International Cooperative (KPMG

International), a Swiss entity. All rights reserved.

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