TMI Blog2005 (9) TMI 228X X X X Extracts X X X X X X X X Extracts X X X X ..... s method of accounting and that the work-in-progress is valued at cost. Note No. 2 declares that the cost of construction includes cost of land, development rights, construction, development, administration, marketing and finance. During the course of assessment proceedings, the Authorised Representatives of the assessees had categorically admitted that the assesses are following project-completion method of accounting. In the books of account, interest expenditure has been consistently identified and added to the value of work-in-progress. There was no question regarding the project completion method and determination of the cost of project in the case of a builder. However, in the case of a builder following project-completion method of accounting, this has no relevance for the simple reason that the determination of profits chargeable to tax are postponed to the year in which the project is completed or is substantially completed. In our view, the true profits in such a q case can be determined only when entire cost of the project, direct or indirect, including finance cost is added to the value of work-in-progress. This proposition is also fortified by the matching concept, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... riod cost'. Therefore, it was claimed that the interest expenditure accrued in a particular year must be deducted by way of expenditure against the assessee's income for that particular year. In other words, while the income from a particular-project will be offered for taxation in the year of completion, the interest expenditure is claimed by the assessees from year to year on the basis of accrual during the particular year. It was claimed that this procedure for claiming deduction in respect of interest for each year under section 36(1)(iii), instead of adding it to the cost of the project, was being consistently followed by the assessees. The Assessing Officer rejected this claim and held that interest expenditure has to be added to the value of work-in-progress because the assesses are following project completion method of accounting. The Assessing Officer's view has been upheld by the ld. CIT(A), with the result that this issue came to be further agitated before the Tribunal. These matters were heard by Income-tax Appellate Tribunal, Mumbai Bench 'F' and during the course of hearing, it was claimed on behalf of the assessees that the relevant issue stands covered in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he impact of Accounting Standard No. 7 issued by the Institute of Chartered Accountants? (d) Whether the Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. concludes the controversy? (e) Whether in the case of a builder following project-completion method, the work-in-progress is to be considered as stock-in-trade or capital asset? (f) Whether a system of accounting consistently followed by the assessee and accepted by the department in earlier years can be discarded by the department having regard to the ratio of the Bombay High Court in the case of CIT v. Goodlass Nerolac Paints Ltd. [1991] 188 ITR 1. 5. Developing his arguments, the ld. counsel for the assesses forcefully submitted that the issue stands concluded by the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. It is further submitted that insofar as the case of Wall Street Construction Ltd. is concerned, the issue is squarely covered in assessee's favour by the following decisions of the Tribunal: 1. A.Y. 1994-95 I.T.A. No. 3477/Mum./1998, dated 8-7-2003 2. A.Y. 1995-96 I.T.A. No. 2840/Mum./1999, dated 31-10-2003 3. A.Y. 1996-97 I.T.A. No. 2656/Mum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act activity in general and can be allocated to specific contracts include: (i) insurance; (ii) design and technical assistance; (iii) construction overheads. 8.7 Examples of costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts, include: (i) general administration and selling costs; (ii) finance costs; (iii) research and development costs; (iv) depreciation of plant and equipment that cannot be allocated to a particular contract. 8.8 Costs referred to in paragraph 8.7 are usually excluded from the accumulated contract costs because they do not relate to reaching the present stage of completion of a specific contract. However, in some circumstances general administrative expenses, development costs and finance costs are specifically attributable to a particular contract and are sometimes included as part of accumulated contract costs." The ld. counsel specifically referred to para 8.8 and contended that finance costs should be usually excluded from the accumulated contract costs. 7. The ld. counsel also emphasized the point that it is well-settled proposition of law that a tax payer is free t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nditure is uniformly and consistently added to the value of work-in-progress. It is, therefore, argued that the assessees are actually following a consistent method of accounting where interest expenditure is added to the value of work-in-progress. Shri Maheshwari submitted that the phrase 'Method of accounting' referred to in section 145 of the I.T. Act indicates the method adopted by the assessee while maintaining regular books of account and not the method of computation of total income. The ld. CIT-Departmental Representative also invited our attention to the provisions of section 36(1)(iii) which prescribes that the amount of the interest paid in respect of capital borrowed for the purposes of business is to be deducted. It is submitted that the word 'paid' as defined under section 43(2) means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the head 'Profits and gains of business or profession'. Here again, the emphasis is on the method of accounting upon the basis of which the profits are computed in the books of account. Shri Maheshwari reiterated that insofar as the books of account are concerne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st has been identified and segregated by the assessees' in the books of account in respect of different projects for different assessment years and details thereof are incorporated at page 11 of the Assessing Officer's order referred to above. 13. The ld. CIT-Departmental Representative submitted that claiming interest from year to year under section 36(1)(iii) has actually distorted the profits earned by the assessee of a particular project because the interest cost which pertains to one project has been claimed by the assessee against the income of another project. This has resulted into claiming of huge losses by the assessee as per details given at page 12 of the Assessing Officer's order referred to above as under: ----------------------------------- A.Y. Loss ----------------------------------- 1993-94 (-) 2,85,898 1994-95 (-) 80,28,459 1995-96 (-) 1,42,72,497 1996-97 (-) 83,47,382 ----------------------------------- 14. It is reiterated that assessees are offering income on completion of the project but by adopting a peculiar method they are claiming deduction for interest much earlier against the income of such projects, which are completed in these years. 15. Coming to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etermine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed (expenses). Under the mercantile system of accounting, this matching is required to be done on accrual basis. Under this matching concept, revenue and income earned during an accounting period, irrespective of actual cash-inflow, is required to be compared with expenses incurred during the same period, irrespective of actual outflow of cash. This concept is also applied by the Supreme Court in the case of MIIC Ltd. under following observations: "Ordinarily, revenue expenditure which is incurred wholly and exclusively for the purpose of business must be allowed in its entirety in the year in which it is incurred. It cannot be spread over a number of years even if the assessee has written it off in his books, over a period of years. However, the facts may justify an assessee who has incurred expenditure in a particular year to spread and claim it over a period of ensuing years. In fact, allowing the entire expenditure in one year might give a very distorted picture of the profits of a particular year. Issuing debentures is an instance where, although the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not applied then, the profits get distorted. In this connection, the following facts may be seen. For the year ending 31st March, 1996, the assessee has submitted that it has incurred an expenditure amounting to Rs. 2,72,25,000 as and by way of interest deductible under p section 36(1)(iii) of the IT Act. However, in the annual accounts, the said amount is not debited to the P L A/c. It is interesting to note from the P L A/c. for the year ending 31st March, 1996, that profit after tax was Rs. 1,86,34,016. Now if the expenditure incurred was Rs. 2,72,25,000 as submitted by assessee then the assessee could never have earned the said profit of Rs. 1,86,34,016. This is how the profit got distorted. In the Annual Report, assessee has conceded that Rs. 2,72,25,000 was deferred revenue expenditure to be written off over five years. In his order, the Assessing Officer has recorded a finding of fact which categorically brings out the matching concept. He has stated that for the accounting year 31st March, 1996, profit after tax increased to Rs. 1,86,34,016 from Rs. 50 lakhs in the last year ending 31st March, 1995. Therefore, the Assessing Officer was right in apportioning the expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with equal vehemence contest for the capitalization of similar amounts. Thus, the provisions of section 36(1)(iii) does not require that interest on loans taken for acquisition of fixed assets should necessarily be treated as the revenue expenditure in every case after the business has come into existence. If the interest is capitalized in the books of account and treated as part of actual cost, the provisions of section 36(1)(iii) would not be applicable because the amount of interest paid no longer retains its separate character and existence and represents integral part of the cost of acquisition of the assets itself. Therefore, the assessee's contention that in view of the provisions of section 36(1)(iii), the amount of interest had to be allowed as deduction irrespective of the treatment given in the books of account was not legally tenable and unacceptable. These provisions had no application on the cost of assets to the assessee which is governed by the provisions of section 43(1) and other allied provisions pertaining to depreciation allowable etc. Therefore, the Assessing Officer was right in rejecting the assessee's claim for deduction under section 36(1)(iii)." 19. Shri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect. A reference may be made to the Schedules annexed to and forming part of the accounts for the year ended 31-3-1993 in the case of Wall Street Construction Ltd. Note No. 1 with the title 'System of Accounting' declares that the company follows completed projects method of accounting and that the work-in-progress is valued at cost. Note No. 2 declares that the cost of construction includes cost of land, development rights, construction, development, administration, marketing and finance. During the course of assessment proceedings, the Authorised Representatives of the assessees had categorically admitted that the assesses are following project-completion method of accounting. In the books of account, interest expenditure has been consistently identified and added to the value of work-in-progress. This factual position is conclusively established from the project-wise and assessment year-wise break of interest expenditure reproduced by the Assessing Officer at page 11 of his order in the case of Wall Street Construction Ltd. for assessment year 1993-94, which is reproduced below: --------------------------------------------------------------- 91-92 92-93 93-94 94-95 95-96 96-97 - ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Income-tax?" 24. The Hon'ble High Court answered the following question in the affirmative, on the basis of the following reasoning as reproduced from page 581 of the Report: "From the facts found by the Tribunal on record, it is clear that the assessee undertook two-fold activities. It bought and sold flats. Secondly, the assessee was also engaged in the business of construction of buildings. The profits from both the activities were assessed under section 28 of the Income-tax Act. In this case, we are concerned with the second activity (hereinafter referred to, for the sake of brevity, as 'Kandivali project'). According to the Commissioner of Income-tax, the loan was raised for securing land/development rights from the Mandal. That the loan was utilized for purchasing the development rights, which, according to the Commissioner of Income-tax, constituted a capital asset. According to the Commissioner of Income-tax, since the loan was raised for securing capital asset, the interest accrued thereon constituted part of capital expenditure. This finding of the Commissioner of Income-tax was erroneous. In the case of India Cements Ltd. v. CIT [1966] 60 ITR 52 it was held by the Sup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he capital was borrowed for business purposes and it was immaterial as to whether the borrowed funds were utilized for acquiring a capital asset or revenue asset. On the contrary, the controversy in the present appeals is totally different. Here, we are concerned with the question as to whether interest expenditure identifiable with a particular project, in the case of an assessee following project completion method of accounting, is to be deducted as period cost from year to year or the same is to be added to the cost of that particular project so as to allow deduction eventually in the year of completion of the project. There is no dispute regarding the nature of the expenditure being capital or revenue. We are, therefore, of the view that the Hon'ble Bombay High Court decision is not applicable to the facts of the present appeals. However, when this issue came up before the Tribunal in the case of Wall Street Construction Ltd. for assessment year 1994-95, the Tribunal reproduced the relevant portion of the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. and recorded the following finding at para 12 of the order: "The facts of the presen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been following a system of accounting where interest expenditure is allocated project-wise and is added to the value of work-in-progress in the books of account. Therefore, in our view, the arguments of ld. counsel that the method of accounting regularly followed by the assessees has been unjustifiably discarded by the department, does not hold in water. Further, the Hon'ble Bombay High Court decision in the case of Goodlass Nerolac Paints Ltd. does not in any way come to the rescue of the assessees, which would become clear from the relevant observations of the Hon'ble High Court, which are reproduced below from page 5 of the Report: "Before parting with this question, we consider it desirable to mention that the Income-tax Appellate Tribunal is a final judge of facts. The High Court, in reference, does not interfere with the findings of fact unless such a finding is perverse or is such that no reasonable person can come to such a finding. This will be so even when the High Court feels that it would have come to a different conclusion, if it was sitting in appeal. In that sense, when the High Court declines to interfere with a finding of fact given by the Tribunal in an earlier y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tances and provided the change is for regular adoption. In the instant case, the assessee has adopted the direct cost method in respect of goods in process and finishing goods. Three factors are to be taken into account, namely, (a) cost of purchase, (b) cost of conversion, and (c) other cost incurred in the normal course of business in bringing the inventions up to their present location and conditions. It was nobody's case that cost of raw material had not been correctly taken by the assessee. In the cost of conversion direct labour, direct expenses and sub-contracted work are to be taken into account and in addition to that production overheads are to be ascertained in accordance with other direct costing or absorption costing method. The assessee, in the instant case, had taken into account salary, wages, bonus, ex gratia payments, etc. to staff and workers. It had taken into account power and fuel consumed, repair and maintenance to plant and machinery, repairs and maintenance to factory buildings. The items that had been excluded were administration overheads, selling and distribution overheads, interest and depreciation. There was no doubt about the exclusion of administrati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... poned to the year in which the project is completed or is substantially completed. In our view, the true profits in such a q case can be determined only when entire cost of the project, direct or indirect, including finance cost is added to the value of work-in-progress. This proposition is also fortified by the matching concept, as propounded by the Hon'ble Bombay High Court in the case of Taparia Tools Ltd. In the present cases, the assessees have identified interest cost and have allocated such cost to different projects in the books of account, but deduction " in respect of interest is claimed under section 36(1)(iii) against the income of some other projects which are completed during the relevant years. In our view, this procedure results into distortion of the correct profits which must be determined as per the project-completion method followed by the assessees. 31. For the reasons discussed above, we hold that where an assessee is following project-completion method of accounting, the interest identifiable with that project should be allowed only in the year when the project is completed and the income from that project is offered for taxation. 32. The records shall now be ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
