Controversies in taxation of real estate projects & ICDs for real estate developers

1. ICDs FOR REAL ESTATE DEVELOPERS
CONTROVERSIES IN TAXATION OF
REAL ESTATE PROJECTS

2. ▸ 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.
2
Introduction to Taxation of Real
Estate Developers

3. 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.
3
Appropriate method of revenue
recognition for real estate
developers

4. 4
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

5. 5
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.

6. Judicial Pronouncements with
respect to method of accounting

7. 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.
7
A. Option of the assessee to choose between CCM and
PCM:

8. 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.
8
B. Adoption of CCM approved by courts:

9. 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.
9

10. 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.
10

11. 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.
11
C. Adoption of CCM not approved by court:

12. 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.
12
D. Income to be computed as per Books of Accounts
prepared as per Accounting Standards to be considered for
tax computation:

13. 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.
13

14. 14
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

15. 15
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

16. 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.
16
● ICDS-III is not consistent with the above stand
FAQs

17. 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

18. 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
18
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

19. 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.
19
Q. Whether disallowance u/s 40(A)(ia) results in reduction
of WIP?
➔ No
FAQs

20. 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

21. 21
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.)

22. 22
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;

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

24. ▸ 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]
24
What does ICDS- III say?
ICDS

25. ▸ 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; or
c. 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]
25
What is stage of completion?
ICDS

26. ▸ 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]
26
What costs are to be included?
ICDS

27. 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.
27
ICDS

28. 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
28
ICDS

29. “The tax collector must love poor people, he's creating so many of them.- Bill Vaughan”
“The only thing that hurts more than paying an income tax is not having to pay an
income tax.- Thomas Dewar”
“The hardest thing to understand in the world is the income tax.- Albert Einstein”

30. Thank You
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215, Sudervilla, SV Road, Santacruz West,
Mumbai – 400054
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