Application of percentage completion method of accounting of real estate business was incorrect as the project was not in the nature of construction contract
In a recent judgment, ITAT Ahmedabad held that following the ICAI guidance note, application of the percentage completion method of accounting for revenue recognition in the contract undertaken by the real estate builder was incorrect.
ABCAUS Case Law Citation:
4722 (2025) (08) abcaus.in ITAT
In the instant case, the assessee had challenged the order passed by the CIT(A) National Faceless Appeal Centre in confirming addition made by Assessing Officer (AO) on the ground that assessee ought to have recognized revenue on the percentage completion basis and not project completion basis.
The assessee was a partnership firm engaged in the real estate business as builders and developers. During the impugned year, the assessee was engaged in the construction of a project named. The impugned year was the second year of business operations of the assessee firm.
The dispute in the present case was with regards to the method of accounting followed by the assessee for revenue recognition. While the assessee had contended that it was recognizing revenue following the project completion method and in terms of the guidelines provided by Accounting Standard-9 (‘AS-9’) pertaining to Revenue recognition issued by the Institute of Chartered Accountants of India (ICAI), the case of the AO was that the assessee ought to have followed the Percentage Completion Method as prescribed by the guidance note issued by ICAI on accounting for Real Estate transactions in 2012.
The AO made an addition to the income of the assessee holding that the assessee ought to have recognized Revenue from its Real Estate Projects by the percentage completion method.
The Tribunal observed that the entire controversy was with respect to the interpretation of guidance note issued by the ICAI on accounting for Real Estate Transactions in 2012.
The Tribunal observed that the assessee had relied on the contents of the Para 3 r.w para 4 of the Guidance Note for justifying the accounting method adopted by it, recognizing revenue only when the units constructed by it were actually sold, the Revenue, on the other hand, has relied on Para 3 r.w. para 5 of the said guidance note stating that the assessee fulfilled all the conditions specified therein and, therefore, it should have adopted the Percentage Completion Method for accounting its Revenue.
The Tribunal noted that the guidance note emphasizes the applicability of AS-9 for recognition of Revenue in Real Estate Transactions and the importance of transfer of significant risks and rewards of ownership alongwith certainty both of quantum and of receipt of consideration for recognizing Revenue. At the same time noting the manner in which such transactions are usually entered by way of an agreement to sell entered into in the initial stages of construction, it states that if the terms of such agreement demonstrate transfer of significant risks and rewards of ownership, even though legal title is not transferred, the units are to be treated as transferred to the buyers and any activity carried out by the builder thereafter to be treated as carried out on behalf of the buyer as a contractor. And in such circumstances, it states that Revenue is to be recognized following percentage completion method.
The Tribunal further noted that the guidance note states that the percentage completion method of Revenue recognition in Real Estate transactions is to be adopted when the project being executed is more in the nature of construction contract with significant risks and rewards of ownership being transferred, as per the agreement to sell entered into, at the initiation of the project itself and the outcome of the project being capable of reasonable estimation.
Therefore, as per the guidance note itself the determining factor for application of percentage completion method of accounting for Revenue recognition in Real Estate Transactions is, when the risks and rewards in the saleable units / project is transferred at the initiation of the project itself, when agreement to sell is entered into with buyers, and the Project thereafter remains more in the nature of a construction contract.
The Tribunal noted that in the instant case, the assessee had consistently pleaded that in its case it cannot be said to be a construction contract, pointing out that the builder employs his own money in the project, there is no certainty of receiving bookings initially and even the agreement entered into with the buyers at the initial stage cannot be said to tantamount to transfer of all risks and rewards to the buyers. The assessee has pointed out that the buyers had liberty to cancel the booking at any stage and there was no penalty leviable for cancellation of bookings and that even the revenue from sale of units was not fixed, but, it was always negotiable with the buyer. The assessee has consistently pleaded that the risk and rewards stood transferred to the buyers only at the time of transfer of ownership by legal title or at the time of handing over possession of property.
The Tribunal observed that the assessee stated that the project undertaken by it had no characteristics of a construction contract for applicability of percentage completion method for Revenue recognition, and the Revenue had not controverted this very pertinent contention of the assessee by examining any agreement to sale entered into by the buyers.
The Tribunal observed that the Revenue failed to understand the spirit of the guidance note and has relied merely on the existence of conditions reflecting certainty of outcome of the project, to hold that percentage completion method was applicable in the present case. The Revenue had pointed out the existence of conditions listed in para 5.3 of the guidance note of more than 25% of project expenses being incurred, 25% of the project being sold, 10% of the Revenue being collected, to state that percentage completion method ought to have been followed by the assessee. But the guidance note states these parameters to be indicators only of certainty of project outcome. The other essential condition of the project being more of a construction contract was not established by the Revenue.
The Tribunal stated that the existence of certainty in outcome of project coupled with the contract being in economic substance a construction contract, was required to exist as per the guidance note for applicability of percentage completion method of Revenue recognition. And the Revenue failed to establish that the project was in the nature of construction contract.
The Tribunal held that application of the percentage completion method of accounting for revenue recognition in the contract undertaken by the assessee during the year was incorrect.
Accordingly, the addition was directed to be deleted.
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