Compensation made to the flat allottees for surrendering rights allowed as business expenditure of the assessee in view of Completed Contract Method of Accounting
ABCAUS Case Law Citation:
ABCAUS 2843 (2019) (03) HC
Important Case Laws Cited/relied upon by the parties
Shahzada Nand & Sons v. CIT, Patiala (1977) 108 ITR 358 (SC)
Commissioner of Income Tax, U.P. v. Nainital Bank Ltd. (1966) 62 ITR 638 (SC)
CIT v. Sarda Binding Works 102 ITR 187 (Mad)
CIT v. Mangal Tirth Estates Ltd. 303 ITR 366 (Mad)
The Assessee was engaged to the business of construction and sale of commercial space. The Assessee developed a multi storied building (“the Project”. The Assessee was following the Completed Contract Method (CCM) as compared to the Percentage Completion Method (PCM).
The case of the Assessee was that since it followed the CCM, income was not recognised till the completion of the project. All receipts were treated as “advance” and all direct expenses were accounted for as “capital work and progress.”
Reliance was placed on the Accounting Standard (AS) 7 issued by the Institute of Chartered Accountants of India (ICAI) initially in 1983 which was revised first in 2002 and then in 2016. According to the Assessee, only on completion or substantial completion of the project, revenue was recognised.
When the project was completed, some of the allottees of the flats refused to take them for completion since the Municipal Council had changed the usage of the Lower Ground Floor (LGF). The Assessee then started negotiating with the relevant flat buyers and persuaded them to surrender their ownership and allotment letters.
Accordingly, the assessee repaid the advance money received from these flat owners. The Assessee, in addition also paid compensation in lieu of surrender of their rights in the flat.
These expenditure was claimed by the Assessee as revenue in nature and was charged to the Profit and Loss Account (P&L Account).
During the assessment proceedings, the Assessing Officer (AO) was of the view that the assessee had not paid any compensation to the allottees but had in fact repurchased these flats since the allottees had surrendered their rights in those flats.
Consequently, it was held that the compensation paid to the flat owners could not be said to be business expenditure but rather was capital investment in purchase of stock and trade. It was, however, observed that the Assessee was free to include the cost of compensation in the cost of the flats so acquired and claim deduction of the amount at the time of sale as cost of purchase of the flats. It was considered that the assessee had paid compensation amount “once and for all to repurchase the property” and this was “in fact a sale consideration and could not be allowed as business expenditure.
The AO made enquiries with some of flat owners to ascertain the treatment they had given to the said receipt of compensation in their books of accounts and income tax returns. It was found that all of them had shown the amount received from the Assessee as capital gains in their books of accounts as well as income tax returns after indexation of the cost of acquisition.
In view of the above, the AO rejected the plea of the Assessee that the payment of compensation was business expenditure. Accordingly, he held that the payment of compensation was towards “repurchase of the flat” and disallowed it by holding that it was “a capital expenditure.”
The CIT(A) allowed the payments as business expenditure of the Assessee, and the view of the AO was reversed.
The Revenue went in appeal before the Income Tax Appellate Tribunal (ITAT) which inter alia held that the said payments were made for “extraneous considerations” and were not expenditure that was expedient to the Assessee,s business. The ITAT set aside the order of the CIT(A) and restored the order of the AO.
The order of the ITAT was challenged by the assessee as perverse and contrary to the record.
The Hon’ble High Court noted that both the AO and the ITAT had overlooked the fact that the assessee follows the CCM and not the PCM. AS 7 which was originally issued by the ICAI in December 1983 was first revised in 2002. In the case of the assessee, it was AS 7, pre-revised, applied.
The Hon’ble High Court observed that as per said AS 7 when a contractor uses a particular method of accounting for a contract, then in respect of all other contracts that meet similar criteria, the same method is used. Further, the methods of accounting used by the contractor and the criteria adopted in selecting the method represents “an accounting policy.” If the contractor changes from PCM to CCM or vice versa, there has to be a disclosure to the effect of the change and its amount
The Hon’ble High Court noted that in all the AYs in question, the assessee had followed a consistent accounting policy by following the CCM. The Revenue never disputed that the assessee followed the CCM and, therefore, what logically flowed from the adoption of such accounting policy by the Assessee could not be overlooked by the Revenue.
The Hon’ble High Court concurred with the contention of the Assessee that it had not “repurchased the flats from the buyers.” The Court opined that rhe stage of parting with title/ownership in relation to commercial space allotted to the buyers had not been reached. The AO himself noted that “since the Assessee has not sold the space which has been surrendered by the buyers/allottees, therefore, the compensation paid in lieu of surrender of rights in flats/space shown in work and progress in balance-sheet will enhance the value of work and progress.”
The Hon’ble High Court also found merit in the contention of the assessee, based on AS 2 that compensation paid subsequent to the completion of the project is an “extraordinary item.” It was not “cost‟ of completion of the project and, therefore, such compensation could not be added to the value of the stock and trade of the Assessee. AS 2 governs valuation of inventories. “Cost‟ comprises all of the costs of purchase, cost of completion and other costs incurred “in bringing the inventories to their present location and condition.” That which is not relevant to bringing the stock to its present condition or location cannot be a part of its value.
The Hon’ble High Court opined that the conclusion of the ITAT that the payment was made for “extraneous consideration” appeared to be based on surmises and conjectures.
The Hon’ble High Court opined that mere fact that the space buyer‟s agreement or the allotment letter did not mandate payment of compensation would not come in the way of the Assessee treating such payment as “revenue expenditure”.
The Hon’ble High Court opined that applying the law explained by the Supreme Court in various decisions to the case in hand, the plausible conclusion is that the compensation paid by the assessee to the allottees of the commercial spaces for the surrender of their rights therein cannot be said to be disallowable on the ground of such payment having been made for “extraneous considerations.”
The Hon’ble High Court noted the distinction between the expressions for the purpose of earning profits and for purpose of the business. It was observed that as held by the Supreme Court the expression “for the purposes of business” is wider than the expression “for the purpose of earning income.” The former would include within its scope expenditure incurred on grounds of commercial expediency.”
The Hon’ble High Court observed that the assessee had a plausible explanation for making such payment of compensation to protect its “business interests.” While there was no “contractual obligation” to make the payment, it was plain that the Assessee was also looking to build its own reputation in the real estate market.
Also the Hon’ble High Court opined that the mere fact that the recipients treated the said payment as “capital gains” in their hands in their returns would not be relevant in deciding the issue whether the payment by the Assessee should be treated as “business expenditure.”
The Hon’ble High Court held that the conclusion recorded by the ITAT that the compensation was paid by the Assessee for “extraneous consideration” was perverse and contrary to the record.
Accordingly, the payment made by the Assessee to the allottees of the flats for their surrendering the rights therein was allowed as business expenditure of the Assessee.