ICDs FOR REAL ESTATE DEVELOPERS

CONTROVERSIES IN TAXATION OF REAL ESTATE PROJECTS

▸ Under the Income-tax Act, 1961 there is no specific provision as such regarding taxability of income of the real estate developers.

▸ General provisions of computation of business income prescribed u/s 28 to 44DB of the Income-tax Act shall be applicable.

▸ The income recognized by the developers as per Accounting Standards and Guidance Note issued by Institute of Chartered Accountants of India/ Ministry of Corporate Affairs (ICAI/ MCA) shall be relevant and form the basis for computation of taxable income under the Income-tax Act.

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Introduction to Taxation of Real Estate Developers

Primary issue in the case of real estate developers is to decide whether they are required to follow Completed Contract Method (CCM) or Percentage Completion Method (PCM) for revenue recognition while preparing their Annual Financial Statement.

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Appropriate method of revenue recognition for real estate developers

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Method Principle Tax Implication

Completed Contract Method (CCM)

● Revenue relating to any sales transaction is recognized when significant risks and rewards of ownership of goods are transferred.

● As per Transfer of Property Act, 1882, ownership of the property is transferred when legal title of ownership is transferred.

● Ownership of the property can be transferred only when property comes into existence and physical possession of the property is handed over.

● No taxable income is generated in the year(s) when project is under development.

● May lose the benefit of set off of brought forward losses, as unabsorbed business losses brought forward from earlier year(s) may lapse.

● Tax authorities do not appreciate the adoption of this method

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Method Principle Tax Implication

Percentage Completion Method (PCM)

● Under Percentage of Completion Method, revenue is recognized as per the stage of completion of the project on year to year basis during the development of the project.

● Significant risks and rewards of ownership of property are transferred to the buyer at the time of entering into binding sale agreement.

● Taxable income is resulted and offered to tax consistently on year to year basis.

Presently, the accounting principles for revenue recognition by real estate developer are governed by the revised ‘Guidance note on Accounting for Real Estate Transactions (Revised 2012)’ issued by the ICAI applicable from the accounting year commencing on or after 01.04.2012.

Judicial Pronouncements with respect to method of

accounting

Judicial Pronouncements

What was held

Krish infrastructures Ltd. vs. Asstt. CIT (2013) 35 taxmann.com 38 (Jaipur – Trib.)

Assessee has the liberty to choose any of the recognized method of accounting and if any method of accounting is consistently followed by the assessee, then it is beyond the power of the Assessing Officer to force the assessee to change the method of accounting from CCM to PCM and cannot reject the books of the assessee on the ground that he had not followed AS-7 for revenue recognition.

Awadhesh Builders vs. ITO (2010) 37 SOT 122 (Mum.)

In the above case, Tribunal has taken the view that after AS-7 not remaining applicable to the real estate developer with effect from 01.04.2003, they could opt for either CCM or PCM for revenue recognition.

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A. Option of the assessee to choose between CCM and PCM:

Judicial Pronouncements

What was held

CIT vs. Manish Buildwell Ltd. (2011) 245 CTR (Del) 397/(2012) 204 Taxman 106 (Delhi)/ [2011] 16 taxmann.com 27 (Delhi)

It was held that it cannot be said that the project completion method followed by the assessee would result in deferment of the payment of the taxes which are to be assessed annually under the IT Act.

CIT vs. SAS Hotels And Enterprises Ltd. (2011) 334 ITR 194 (mad.)/ [2011] 16 taxmann.com 34/[2011] 203 Taxman 90

In such circumstances, if the respondent/ assessee was regularly following the completed contract method and had not given scope for any complaint in any of the earlier years.

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B. Adoption of CCM approved by courts:

Judicial Pronouncements

What was held

Prem Enterprises vs. ITO (2012) 54 SOT 367 (Prem Enterprises vs. ITO (2012) 54 SOT 367 (Mum.)/[2012] 25 taxmann.com 179 (Mum.)Mum.)/[2012] 25 taxmann.com 179 (Mum.)

Revenue is not justified in rejecting the method of accounting followed by the assessee and substituting the same, and adopting AS-7 and then follow it up by estimation.

Surinder Pal Singh & Co. vs. ITO (2010) 35 SOT 296, ITAT Amritsar

The Assessing Officer is not justified in rejecting the method of accounting followed by the assessee.

Haware Constructions (P.) Ltd. vs. ITO ITA Nos. 5601 of 2009, 686 of 2010 dated 5/8/2011 (Mum. ‘H’ – Trib.)

There is no justification to reject the said method and apply the percentage completion method when the assessee has offered the income in the year of completion of the project.

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Judicial Pronouncements

What was held

Asstt. CIT vs. National Builders [2012] 22 taxmann.com 55 (Ahd.Trib.)/[2012] 137 ITD 277/[2013] 155 TTJ 209

It was wrong on the part of the AO to apply AS-7 and to assess the income irrespective of the year of completion of project when the amount received in advance has not reached certainty.

Asstt. CIT vs. National Builders (2012) 137 ITD 277 (Ahd.): (2013) 155 TTJ 209 (Ahd.)/ [2012] 22 taxmann.com 55 (Ahd.)

It was wrong on part of AO to assess income irrespective of year of completion of project when amount received in advance has not reached certainty and that too AO has merely estimated 10% as recognition of revenue of construction contract, without assigning any specific basis of such an estimation, such an estimation is not approved. Order of CIT(A) is upheld.

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Judicial Pronouncements

What was held

Prestige Estate Projects vs. Dy. CIT (2011) 129 ITD 342 (Bang.)

When a prospective buyer of super build-up area gave consent to the assessee developer, who simultaneously transferred ‘all significant risks’ to the prospective buyers, for all practical purposes and for the recognition of revenue, all the conditions specified in AS-9 were fulfilled, assessee’s contention that it can transfer all significant risks and rewards of ownership to the prospective buyer only at the completion of the project under JDA was not tenable and therefore, AO was justified in holding that the revenue from the projects under joint development agreement was to be assessable on percentage of completion method which was followed by assessee for other projects also.

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C. Adoption of CCM not approved by court:

Judicial Pronouncements

What was held

Challapalli Sugars Ltd. vs. CIT (1975) 98 ITR 167 (SC.)

Rule of accountancy should be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary.

CIT vs. UP State Development Corporation (1997) 225 ITR 703 (SC)/ [1997] 92 Taxman 45 (SC)

For the purposes of ascertaining profits and gains the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statute.

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D. Income to be computed as per Books of Accounts prepared as per Accounting Standards to be considered for tax computation:

Judicial Pronouncements

What was held

CIT vs. Aatur Holdings Pvt. Ltd. [2008] 302 ITR 92 (Bom.)

Nothing has been brought to our attention to show that under the provision of the Companies Act and the provisions of the Securities Contract Act that there is any other standard or statutory rules under the IT Act by which such dividend can be taxed in the hands of the assessee.

Dy. CIT vs. Lurgi India Co. Ltd. (2008) 114 ITD 1 (Delhi-Trib.)

It has been held that assessee not following project completion method but adopting 25 percent progress as benchmark for recognizing profits, this method though not being a perfect method, having been accepted by the Revenue for the last five years, it was not open to the revenue to disturb the same in this year.

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Q. Whether computation of income as per Accounting Standard Guidance Note is binding on tax authorities?

➔ Yes, as per regularly settled judicial pronouncements.

Q. Whether real estate developer can follow CCM for tax computation purpose even after issue of revised Guidance Note (2012)?

➔ No, only PCM

Q. In case, assessee follows CCM of accounting, whether income of the assessee can be recomputed and assessed by the tax authorities on the basis of PCM of accounting?

➔ Yes, if Accounting Standard/ Guidance Note is not followed

Q. Whether assessing officer can change the estimates used by the assessee for the purpose of accounting and finalization of financial statements and substitute his own opinion or estimates for computing income of the assessee?

➔ No, but contrary views have been taken by Assessing Officers.

FAQs

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Q. Can a developer follow a different method for accounting and a different method for computation?

➔ Yes, if the developer is able to substantiate that there is no other method that can be followed for computation of taxes as held in the case of Cyber Media (India) Ltd. vs. CIT (2011) 338 ITR 177 / [2011] 9 taxmann.com 220 (Delhi) / [2011] 198 Taxman 185 (Delhi)

Q. Is it mandatory for a non-corporate assessee to follow the Revised Guidance Note, 2012 issued by the Institute of Chartered Accountants of India?

➔ Yes

Q. Whether provision for foreseeable losses are an allowable expenditure for real estate developers?

➔ Yes, as per Guidance Note 2012, supported by AS-7, AS-4, AS-5 and AS-29. Also, supported through following case laws;

FAQs

Judicial Pronouncements

What was held

CIT vs. Woodward Governor India (P.) Ltd. (2009) 179 Taxman 326 (SC) / (2009) 312 ITR 254 (SC)

The ‘loss’ suffered by the assessee on account of the exchange difference as on the date of the balance sheet was an item of expenditure under section 37(1).

Asstt. CIT vs. ITD Cementation India Ltd. (2013) 36 taxmann.com 74 (Mumbai – Trib.) / 146 ITD 59 (Mum. – Trib.)

As per AS-7 assessee was entitled to make provision for foreseeable losses and said loss provided by assessee in its books of account had to be allowed in year under consideration.

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● ICDS-III is not consistent with the above stand

FAQs

17 Q. How to value inventory or WIP by real estate developers?➔ As per AS-2 inventory/ WIP should be valued at lower of Cost or NRV.

Judicial pronouncements for the same are, as under;● CIT vs. British Paints India Ltd. (1991) 188 ITR 44 (SC)/ [1991]

54 Taxman 499 (SC)● Sanjeev Woolen Mills vs. CIT (2005) 279 ITR 434/ [2005] 149

Taxman 431 (SC)● Chainrup Sampatram vs. CIT (1953) 24 ITR 481 (SC)● United Commercial Bank vs. CIT (1999) 240 ITR 355 / [1999]

106 Taxman 601 (SC)

Q. Whether advertisement expense incurred needs to be charged to Profit and Loss Account or added to WIP in case of Real Estate Developers?

➔ The same needs to be routed to Profit and Loss and claimed in the year in which they are incurred as per Revised Guidance Note, 2012.

Q. Can additions be made on the ground that different flats/units were sold by the developer at different rates?

➔ No

FAQs

Judicial Pronouncements

What was held

Sumer Ville Investments, Mumbai vs. Department of Income Tax (ITA Nos. 367 and 2657/ Mum/ 07)

● Burden of proof on the Assessing Officer

● Additions cannot be made on basis of assumptions/ presumptions.

● Flats were sold above the Stamp Duty Value

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Q. Can additions be made on amount of TDS and income mis-match under the 194-IA regime?

➔ It was in the case of Toyo Engg. India Ltd. vs. CIT (2006) 100 TTJ 373/ (2006) 5 SOT 616 ITAT, Mumbai “J” Bench that, the very nature of TDS, it might not be possible to correlate a specific amount of TDS with a specific amount of income earned in a particular Assessment Year. Nexus between TDS and income is notional or conceptual rather than specific or immediate.

Q. Is section 194-IA applicable in case of purchase of immovable property outside India?

➔ Yes

FAQs

Judicial Pronouncements

What was held

Savala Associates vs. ITO (2010) 35 SOT 148 ITAT, Mumbai ‘J’ Bench

Disallowance can only be made in case of completed projects.

ITO vs. P.C. Developers Pvt. Ltd. (Del ITAT) {2010-(ID 1) – GJX- 1133- TDEL}

Since no expense has been claimed in the year the amount cannot be disallowed.

Narne Constructions Pvt. Ltd. vs. Dy. CIT in ITA Nos. 1462 & 1463/ Hyd/ 2011, dated 25.01.2012

Unless the assessee claims this item as expense, the Assessing Officer cannot allow or disallow the same.

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Q. Whether disallowance u/s 40(A)(ia) results in reduction of WIP?➔ No

FAQs

20 Q. Are the provisions of section 194-IA attracted if payments for purchase of immovable property are made before 01.06.2013 but, registered subsequently?

➔ No, as held through a writ petition in the case of Shubhankar Estates Private Limited Vs The Senior Sub-Registrar Gandhinagar (Kacharakanahalli) and Ors. Karnataka High Court.

Q. Whether TDS u/s 194 IA is to be deducted in cases where the immovable property is gifted/ without monetary limits?

➔ No, refer Circular No. 428 dated 08.08.1985

Q. Whether new Guidance Note is applicable for projects which are commenced before 01.04.2012?

➔ Yes, if revenue of such projects have not been registered before 01.04.2012.

FAQs

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Taxability of rental income from stock-in-trade

Profits and Gains from Business and Profession

Income from House Property

Chennai Properties & Investments Limited (TS-238-SC-2015) dated 09.04.2015

CIT vs. Neha Builders (P.) Ltd. [2007] 207 CTR 231/164 Taxman 342 (Guj.)

CIT vs. D.S. Promoters & Developers (P.) Ltd. [2002] 183 Taxman 153 (Delhi)

CIT vs. Ansal Housing Finance & Leasing Co. Ltd. [2013] 29 taxmann.com 303 (Delhi) / 213 Taxman 143 (Delhi)

Late (Smt.) Nirmala Sahu vs. CIT [ITA Nos. 48 to 53 of 2007 dated 19-12-2013] (All.)

Azimganj Estates (P.) Ltd. vs. CIT [2012] 20 taxmann.com 203/206 Taxman 308/ [2013] 352 ITR 82 (Cal.)

Karanpura Development Co. Ltd. vs. Commissioner of Income-tax

CIT vs. Discovery Estates (P.) Ltd. [2013] 31 taxmann.com 180 (Delhi) / [2013] 215 Taxman 74 (Delhi-Mag.)

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Treatment of Borrowing Cost incurred by Real Estate Developers:

Judicial Pronouncements

What was held

Wall Street Construction Ltd. vs. Jt. CIT (2006) 101 ITD 156 (Mum.) (SB)

Interest expense should be claimed in the year in which the assessee offer the income for taxation.

Jt. CIT vs. K Raheja Pvt. Ltd. (206) 102 ITD 414 (Mum)

Even though interest expense is not identifiable to a part project and the assessee follows CCM, interest is allowed as per AS-7.

CIT vs. Lokhandwala Construction Inds. Ltd. [2003] 260 ITR 579 (Bom.)/ [2003] 131 Taxman 810 (Bom.) (HC)

It is not relevant whether interest paid on borrowed capital is used to acquire revenue asset or capital asset, the same should be allowed as a deduction u/s 36(1)(iii).

Following are the various Judicial Pronouncements;

Introduction:

▸ CBDT via notification no. S.O. 892 (E) dated 31st March,2015 has prescribed ten ICDS to be followed by the assessee for computation of income under the Act.

▸ There is no specific Accounting Standard prescribed by the CBDT which is applicable to real estate developers except ICDS- III corresponding to Accounting Standard 7 on construction contract has been prescribed. Principles of ICDS IV on Revenue Recognition should also be borne in mind.

▸ It is a settled principle that in absence of any specific provision under the Income Tax Act, incomes shall be recognized as per Accounting Standard issued by ICAI/MCA for the purpose of tax computation.

▸ Whether assessing officers will impose the principles laid out in ICDS-III over a specific the Guidance Note only the time will speak.

23Impact of Income Computation Disclosure Standards (“ICDS”) on Real Estate Industry.

ICDS

▸ Contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. [Para 16 of ICDS- III]

▸ The recognition of revenue and expenses by reference to the stage of completion of a contract is referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. [Para 17 of ICDS- III]

24What does ICDS- III say?

ICDS

▸ The stage of completion of a contract shall be determined with reference to:

a. The proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs; or

b. Surveys of work performed; orc. Completion of a physical proportion of the contract work.

▸ Progress payments and advances received from customers are not determinative of the stage of completion of a contract. [Para 18 of ICDS- III]

25What is stage of completion?

ICDS

▸ Only those contract costs that reflect work performed are included in costs incurred upto the reporting date. Contract costs which are excluded are:

a. Contract costs that relate to future activity on the contract;

b. Payments made to the sub-contractors in advance of work performed under the subcontractor. [Para 19 of ICDS-III]

▸ During the early stages of a contract, where the outcome of the contract cannot be estimated reliably contract revenue is recognized only to the extent of costs incurred. The early stage of a contract shall not extend beyond 25% of the stage of completion. [Para 20 of ICDS-III]

26What costs are to be included?

ICDS

How are expected losses to be recognized?

▸ They are to be recognized in proportion to percentage of completion

▸ No future losses can be booked/ recognized

How is reversal of contract revenue recognized?

▸ The same needs to be written off in the books as per provisions of section 36(1)(vii) of the Act relating to bad debts and no reversal from the contract is allowed.

How is per construction income to be treated?

▸ Pre construction income like interest dividend, capital gains needs to be taxed as a income and applicable provisions of the Act in the year in which they accrue.

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ICDS

Is ICDs III to be applied separately to each construction contract?

▸ Yes

What are the disclosure requirements under ICDs III?

▸ The amount of contract revenue recognized during the period▸ The method used to determine stage of completion▸ Amount of cost, profits, losses as on the reporting date▸ Amount of advances received upto the reporting period

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ICDS

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