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TMI Blog2005 (9) TMI 228X X X X Extracts X X X X X X X X Extracts X X X X ..... r project are offered for taxation in the year in which that project is complete or substantially complete. In the present cases, the assessee's are simultaneously constructing multiple projects and accounts are separately maintained for each project. The assessees have borrowed on interest substantial funds which are used as working capital for execution of the various construction projects. In respect of the interest expenditure referable to the borrowed funds, during the assessment years under appeal, it was claimed before the Assessing Officer that such interest expenditure is not in the nature of direct cost of the project and therefore, this expenditure has to be treated as 'period 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 intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he controversy. 4. On behalf of the assessees Shri Y.P. Trivedi, Sr. Counsel appeared before us, assisted by Shri P.R. Toprani and Ms. Usha Dalai. At the outset, Shri Y.P. Trivedi posed before us the following six questions, which according to him are relevant to the issue: (a) In a case of a builder, following project completion method, engaged in simultaneously construction of multiple projects, whether interest cost is a period cost or it has to be added to the value of work-in-progress? (b) Whether interest on such borrowings which cannot be directly linked to a particular project, is to be allowed from year to year or is to be added to the value of work-in-progress? (c) What is the 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 discar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a contractor can be divided into: (i) Costs that relate directly to a specific contract; (ii) Costs that can be attributed to the contract activity in general and can be allocated to specific contracts; (iii) Costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts. 8.5 Examples of costs that relate directly to a specific contract include: (i) site labour costs, including supervision; (ii) materials used for project construction; (iii) depreciation of plant and equipment required for a contract; (iv) costs of moving plant and equipment to and from a site. 8.6 Examples of costs that can be attributed to the contract 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as reflected in the books of account. This method of accounting has been followed by the assessees since the assessment year 1988-89 and in all subsequent assessment years including the assessment years under appeal. In the case of Wall Street Construction Ltd. up to the assessment year 1991-92 the assessee even did not claim deduction in respect of interest under section 36(1)(iii). Similarly, in case of Patel Plaza Ltd. up to assessment year 1994-95 no deduction in respect of interest was claimed by the assessee. Subsequently, the assessees started claiming deduction only while computing the total income for the purpose of filing returns of income. Shri Maheshwari repeated that in the books of account, the interest expenditure 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 c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... espective accounts. Only very few expenses which cannot be allocated are debited to P & L Account. During this year total administrative expenses have been shown at Rs. 26,61,484. Out of this, Rs. 25,03,581 has been allocated to various projects which are still under progress and the profits of which are not still under assessment during the financial year 1993-94. The balance of Rs. 1,57,903 has been debited to the P & L Account for the year." 12. The ld. CIT-Departmental Representative, therefore, contended that there is no dispute whatsoever that all expenses including administrative expenses and finance costs have been added to the cost of a particular project in the books of account. It is also submitted that 'the interest cost 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it has been held that interest expenditure must be added to the value of work-in-progress. Similar view is stated to have been adopted by the Tribunal in the case of Mont Blanc Properties & Industries Ltd. [IT Appeal Nos. 1051 and 1221 (Bom.) of 1994]. Copies of the above-mentioned orders are placed on p record. The ld. CIT-D.R. has also placed strong reliance on the Mumbai I.T.A.T. decision in the case of S.K. Estates (P.) Ltd. v. Asstt. CIT [1997] 60 ITD 621. 16. Shri Maheshwari also advocated before us what he referred to as matching concept of income and expenditure. In other words, he argued that expenditure which is relevant to the earning of income only should be deducted from such income so that a correct picture of the real income chargeable to tax can emerge. For this proposition, he relied on the Hon'ble Bombay High Court decision in the case of Taparia Tools Ltd. v. Jt. CIT [2003] 260 ITR 102. He invited our attention to the following observations of the High Court, which are extracted below from para 22 of the order: "Therefore, under the mercantile system of accounting, in order to determine the net income of an accounting year, the revenue and other incomes are mat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness purposes is an expenditure in a business. For claiming deduction under section 36(1)(iii) the following conditions are required to be satisfied viz., the capital must have been borrowed; it must have been borrowed for business purpose and the interest must be paid. The word 'Paid' is defined in section 43(2). It means payment in accordance with the method followed by the assessee. In the present case, therefore, the word 'Paid' in section 36(1)(iii) should be construed to mean q paid in accordance with the method of accounting followed by the assessee i.e., mercantile system of accounting. In the first year ending 31st March, 1996, the assessee borrowed Rs. 495 lakhs (Rs. 4.95 crores) from Maliram Makharia Stock Brokers (P.) Ltd. whereas, in the accounting year ending 31st March, 1997, it borrowed Rs. 100 lakhs (Rs. 1 crore) from Sharp Knife Company (P.) Ltd. In other words, the assessee for the benefit of Rs. 495 lakhs for the accounting year 31st March, 1996 and Rs. 100 lakhs for the accounting year ending 31st March, 1997 (in all amounting to Rs. 595 lakhs). Now, if the matching concept is not applied then, the profits get distorted. In this connection, the following fac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch decision in the case of JCT Ltd. v. Asstt. CIT [1998] 65 ITD 169, in support of his contention that deduction under section 36(1)(iii) is not available if a different treatment has been given in the books of account. He invited our attention to the ratio of this case, relevant para of which is extracted below from the head note: "Thus, there was no basis to hold that provisions of section 36(1)(iii) supersede the provisions of section 43(1) relating to 'actual cost' insofar as interest paid on borrowings made for acquisition of capital assets was concerned. Both the provisions co-exit. In these circumstances, the option exercised in the books of account would be decisive. In the case of an existing business, the interest paid on borrowings for acquisition of capital asset can be treated as the revenue expenditure as well as capital expenditure depending upon the view taken by the businessman on overall appraisal of the facts and circumstances of his case. While in the instant case, the assessee found it more advantageous to press for the deduction under section 36(1)(iii) there might be assessees who may with equal vehemence contest for the capitalization of similar amounts. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ticular project have to be added to the cost of the project as any other method is going to distort the profits of the project. 21. In his rejoinder, Shri P.R. Toprani, attending on behalf of the assessee-company submitted that in the books of account interest is added to the value of work-in-progress only for determination of the cost of that project and insofar as deducibility is concerned, the interest expenditure has to be allowed in the year in which the same accrues as per mandate of section 36(1)(iii) of the I.T. Act. 22. We have given our careful consideration to the arguments and submissions so ably put before us by both the sides. We have also considered the relevant facts and the legal position as emerging from various judicial pronouncements with which we have been assisted. At the outset, it must be made clear that there-is no dispute about the factual position in respect of the two cases. In the books of account, the interest expenditure is allocated to different projects and the interest expenditure referable to a particular project, is added to the value of work-in-progress in respect of that project. A reference may be made to the Schedules annexed to and forming ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f income as per the computation of total income. 23. In this factual scenario, it must be examined at the very beginning as to whether the Hon'ble Bombay High Court decision in the case of Lokhandwala Construction Industries Ltd. concludes the relevant issue. If the answer is yes, we need not proceed further in this matter as the Hon'ble Bombay High B Court decision would be binding. In that case, while stating the facts, the Hon'ble High Court observed that the assessee-company was engaged in the business of construction of buildings and the assessee followed mercantile system of accounting and a "modified project-completion method" for computing its profits. The assessee secured development rights in respect of a plot of land and for this purpose, interest-bearing borrowed funds were utilized. The assessee claimed deduction in respect of interest paid under section 36(1)(iii), which was allowed by the Assessing Officer. The CIT invoked his jurisdiction under section 263 and held that the borrowed funds were utilized in acquiring capital asset and, therefore, the interest was a capital expenditure. On these facts, the following question of law arose before the High Court: "Wheth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tock-in-trade. That, the Kandivali project constituted the stock-in-trade of the assessee. That the project did not constitute a fixed asset of the assessee. In this case, we are concerned with deduction under section 36(1)(iii). Since the assessee had received loan for obtaining stock-in-trade (Kandivali project), the assessee was entitled to deduction under section 36(1)(iii) of the Act. That while adjudicating the claim for deduction under section 36(1)(iii) of the Act the nature of the expense - whether the expense was on capital account or revenue account - was irrelevant as the section itself says that interest paid by the assessee on the capital borrowed by the assessee was an item of deduction. That, the utilization of the capital was irrelevant for the purposes of adjudicating the claim for deduction under section 36(1)(iii) of the Act. In that judgment, it has been laid down that where an assessee claims deduction of interest paid on capital borrowed all that the assessee had to show was that the capital which was borrowed was used for business purpose in the relevant year of account and it did not matter whether the capital was borrowed in order to acquire a revenue asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore us and therefore, this issue has to be considered and decided on merits. 26. The ld. counsel for the assessee placed reliance on the Hon'ble Calcutta High Court decision in the case of Tetron Commercial Ltd. The relevant part of the ratio of this case may be extracted below from the head note: "Whether the deduction under section 36(1)(iii) of the Income-tax Act, 1961, is available or not is dependent on the question whether the capital borrowed is for the purpose of the business of the assessee. If it is found that the capital was borrowed for the purpose of the business of the assessee, the interest payable thereon is admissible under the said section. It is immaterial whether the same is in the nature of capital expenditure or revenue expenditure. If the expenditure is a business expenditure which relates to any stage of the business activity carried on by the assessee, whether isolated transaction or not, it is admissible for deduction under the said section. A business commences with the activities undertaken even at the preparatory stage for setting up of the business. Acquisition of immovable property for being used in the business by borrowed capital entitles the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in an earlier year requires reappraisal either because the appreciation, in its view, was not quite correct or inequitable or some new facts have come to light justifying reappraisal or reappreciation of the evidence on record, it should have the matter placed before the President of the Tribunal so that the case can be referred to a larger Bench of the Tribunal for adjudication and for which there is a provision in the Income-tax Act." 28. The Hon'ble High Court observed that if a subsequent Bench of the Tribunal does not concur with the view adopted by an earlier Bench, the issue must be referred for Constitution of a Special Bench. This is what has been done in the present cases. 29. A reference may also be made to some other cases relied upon by the ld. counsel for the assessee. In the case of Modi Rubber Ltd. decided by I.T.A.T., Delhi Bench, the assessee was a manufacturer of Automobile tyres and tubes and the question pertained to valuation of closing stock. The ratio of this case may be reproduced below from the head note: "It is well-settled proposition of law that a taxpayer is free to employ, for the purpose of his trade, his own method of keeping accounts, and for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on overheads for determination of cost of conversion of goods. As to the interest on finance, since the expenditure on finance had specifically been provided to be excluded in determining the cost of production, it was permissible to exclude the interest in respect of the finances. If the system of accounting was regularly followed in the subsequent assessment years, there would not be any loss to the revenue. Once a uniform system of accounting was adopted, the determination of correct profit by such method would be fair and reasonable." 30. From the above, it may be seen that the facts were entirely different. There was no question regarding the project completion method and determination of the cost of project in the case of a builder. The other two cases relied upon by the ld. counsel for the assessees namely viz., Mopeds India Ltd.'s case decided by Hon'ble Andhra Pradesh High Court and Carborandum Universal Ltd.'s case decided by the Madras High Court are also on the question of valuation of stock. These cases, in our view, cannot be applied for the purpose of determination of the cost of work-in-progress in the case of a builder, who is following project - completion method ..... X X X X Extracts X X X X X X X X Extracts X X X X
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