The order of the Bench was delivered by
Sanjay Arora, Accountant Member - This is an Appeal by the Revenue directed against the Order by the Commissioner of Income Tax (Appeals)-33, Mumbai ('CIT(A)' for short) dated 25.11.2010, partly allowing the assessee's appeal contesting its assessment u/s. 143(3) of the Income Tax Act, 1961 ('the Act' hereinafter) for the assessment year (A.Y.) 2007-08 vide order dated 29.12.2009.
2. The dispute in the instant case concerns the 'method of accounting' to be adopted in computing the assessee's, a builder, income from the various construction projects being undertaken by it. While the assessee admittedly follows project completion method, which it claims to do so consistently, the Revenue's stand is that the percentage completion method is to be adopted. The basis of the Revenue's stand is its' view that the revised Accounting Standard (AS)-7, issued by the Institute of Chartered Accountants of India (ICAI), is applicable to all construction contracts. The apex court had in Challapalli Sugars Ltd. v. CIT[1975] 98 ITR 167, clarified that for the purpose of computing the profits and gains of business, the principles of commercial accounting shall prevail, so that where not in conflict or inconsistent with the provisions of law, shall obtain. As explained by it, the views of the ICAI as the premier regulatory body for the profession of the accountancy had to be accorded respect. The assessee's profit on different construction projects under progress (as on 31.03.2007) was, thus, taken at 8% of the incremental work-in-progress (WIP), i.e., during the relevant year, being Rs.121.57 lacs.
3. The assessee has before us, on the basis of the view of the Expert Advisory Committee of the ICAI, which issues opinions in respect of the various queries raised by the members of the Institute on various accounting issues, clarified that as per the Institute itself, the revised AS-7, titled 'Accounting for construction contracts', applicable for contracts entered into during accounting periods commencing on or after 01.04.2003, is applicable only to contractors. The activity of developing housing project/s on own account as a commercial venture is in the nature of production activity and, therefore, is to be construed as such. Accordingly, the inventories have to be valued following AS-2 'Valuation of inventories' and the income recognized following AS-9 'Recognition of income'. The Committee notes, on the basis of the language of the revised AS-7, a difference between the two versions, i.e., prior to and subsequent to the revision, so that the revised Standard departs from the earlier one, which was admittedly applicable to both the contractors and the builders (PB pgs. 5-8). AS-9, it is contended, recognizes both the project completion and the percentage completion methods.
The ld. CIT(A) has also allowed relief to the assessee on that basis. Its stands further observed by him that the Tribunal in the assessee's own case for the two preceding years whereat the matter travelled to it, i.e., A.Ys. 1989-90 and 2003-04, accepted the assessee's case of following the project completion method as an accepted method of accounting. The foregoing sums-up the respective cases of the opposing sides as well as the controversy attending the present case.
4. We have heard the parties, and perused the material on record.
4.1 Our first observation in the matter is that the two fundamental principles of tax jurisprudence are that each year is an independent unit of assessment and, two, that the correct income for the year is to be brought to tax for that year. In CIT v. British Paints India Ltd. [1991] 188 ITR 44/54 Taxman 499 (SC), the apex court discountenanced the assessee's claim of following a method of valuing inventories consistently for the past several years where the same was found not proper, i.e., in accordance with the accepted principles of cost determination and, thus, did not lead to determination of correct profit for the year; there being no estoppel in such matters. Reference in this regard may also be made to the decision of the tribunal in the case of Dy. CITv. Daman Ganga Paper Ltd. [2014] 63 SOT 47 (URO)/44 taxmann.com 240 (Mum). As such, the assessee's claim of having followed the project completion method consistently in the past would be by itself of little consequence. Its reliance on the decision/s by the tribunal would also account for little in-as-much as the same are for years prior to the accounting period commencing from 01.04.2003, where-upon only AS-9, as itself argued by the assessee, shall hold, i.e., in the case of builders, as the assessee.
4.2 The only aspect, therefore, that is relevant and is to be examined is if the assessee had followed or that its accounts are consistent with AS-9. Toward this, the assessee claims that both the project completion and the percentage completion methods are consistent with AS-9. It seeks to support its argument with the decision by the tribunal in the case of Awadhesh Builders v. ITO [2010] 37 SOT 122 (Mum). The tribunal in that case opined that AS-9 favours project completion method. Firstly, therefore, the assessee's contention that the AS-9 does not draw any distinction between the two methods, so that it admits both, is itself contrary to that by the tribunal, which it cites in support. Secondly, neither could the same be said to have universal application, i.e., given the two fundamental principles of taxation noted supra, which would have to be observed, nor can the same said to represent the uniform view of the tribunal, and for which we may cite the decisions by it in the case of Champion Construction Co. v. ITO [1983] 5 ITD 495 (Bom) and Suresh G. Wadhwa v. Jt. CIT [2013] 37 taxmann.com 11 (Mum), to name some.
4.3 AS-9, even as explained during the course of hearing, lays down the principles of recognition of income. The statute, per sec. 145, recognizes only two methods of accounting, i.e., cash and mercantile, synonymous with the receipt and accrual method of accounting. The accrual of income (as also of expenditure) is essentially a matter of fact. The law point involved is as to when income can be said to have accrued, and which is defined as the right to receive (or, liability to pay, i.e., qua expenditure). As explained by the hon'ble apex court in, inter alia, CIT v. Chunilal Mehta & Sons (P.) Ltd. [1971] 82 ITR 54 (SC), the only relevant question to be asked under the circumstance is when the right to receive had accrued. Whether, as such, income, to any extent, has accrued is to be determined with reference to the facts and circumstances of the case, viz. the agreement of sale, etc. The issue thus is not of the validity of the method of accounting, but; the assessee following accrual method of accounting, as to whether income on the relevant projects inured to it during the relevant year, i.e., on the anvil of AS-9. The ld. Authorized Representative (AR) would during hearing seek to convince us of it being so by reading some clause/s of an agreement to sell, which he claimed to represent clause/s of a standard agreement. There has been, even as conceded to by him thereat, no examination thereof and, thus, of the relevant aspects by any of the authorities below. Two, what is to be seen, independently qua each project, is if there been a transfer of all the significant risks and reward in relation to a project, i.e., with reference to the agreement to sell. In fact, even within a project, the position may be different for different agreements. The law provides either party the right to seek performance of the contract and, thus, has to be regarded as an enforceable legal right. Of course, this has to be coupled with the uncertainty, i.e., as to the price or the ultimate realization of income, if any, that may exist inasmuch as no income can be said to have accrued where uncertainty to any significant extent obtains, qua any contract, with regard thereto - which is again a matter of fact, to be assessed on the conspectus of the facts and circumstances of the case, i.e., on the basis of the best available information. Finally, is the question of the stage of completion of a project. This assumes relevance in determining the extent to which income can be said to have accrued, i.e., its quantification. Reference in this regard may be usefully made to the decision, inter alia, in the case of Suresh G. Wadhwa (supra).
Conclusion
5. We may summarize our findings. The income arising to the assessee during a particular period has to be brought to tax for that period, and that period alone; each year being an independent unit of assessment. It is trite law that profit is to be understood in the commercial sense and, subject to the provisions of the Act, computed accordingly (refer: Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC); Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC)). The issue is not as to which of the two methods, i.e., the percentage completion or the project completion, is the correct method in-as-much as each could be valid in a particular set of facts. What is relevant is which of the two methods results in the correct reporting of the operating profit and the state of affairs of a business entity in the facts and circumstances of the case. AS-7, mandated for contractors, endorses the former method in-as-much as the risks and, thus, return, is with reference to the work undertaken, which is rightly captured in the proportionate method. The case of builders, undertaking construction on own account, is more appropriately covered by AS-9. The question, therefore, reduces to as to which of the two methods is, on facts of the case, in consonance with AS-9. The said standard stipulates the basic conditions that should obtain if the income can be said to have accrued. The first is the transfer of all significant risks and rewards of ownership. Income arises on exchange. Risk and reward are incidents of ownership. Income, thus, can be said to have accrued when there has been, i.e., given the binding legal contract, transfer of these incidents, wholly or substantially so. It is only then that the consideration received in exchange, i.e., the compensation for the release/transfer of ownership, can be said to have been so in one's own right, and the income embedded therein, accrued to the recipient. In fact, it matters little even if the consideration stands not actually received inasmuch as a debt has inured in favour of the transferor. Then, again, income cannot be said to have arisen if uncertainty to any significant extent exists as to the ultimate realization of income, so that the existence of a legal debt or a civil liability is itself not sufficient to hold of accrual of income. The Standard is thus set in terms broader than the legal concept of accrual, though is principally in agreement therewith. ICAI has also issued a Guidance Note on recognition of income for real estate developers.
The assessee's argument that AS-9 is general and admits of both the methods is correct. However, this cannot be construed to mean, as is being implied, that the assessee-builder has the right to choose as to when the profit accrues to it; the two methods varying essentially on the point in time when the income stands to be recognized - while the former allows it to be so on graded basis, the latter admits of the same on the terminus of the project. Both, it may be appreciated, admit of income which stands accrued, and there is no question of either method allowing recognition of income that has, in fact, not accrued. The reading of the clause/s of an agreement by the ld. AR was only an attempt toward clarifying that no income had in fact accrued. AS-9 therefore applies to both the methods. The distinction between the two methods does not impinge upon or is in any manner related to the accrual or otherwise of income, which, as of expenditure, is principally a matter of fact, and has under the given facts and circumstances, either inured or not so. Seeking, therefore, to draw a distinction between the two methods on the basis that the income has not accrued under one of them, while may have under another, is thus fundamentally incorrect. In fact, the said two methods of accounting are only loosely termed as such, and are, strictly speaking, not methods of accounting, but only different basis for valuation of assets and liabilities. As explained in Chunilal Mehta & Sons (P.) Ltd. (supra), there is a difference between the method of accounting and the actual entries in the accounts maintained by the assessee. Even earlier, in CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), the apex court clarified of the distinction between the method of accounting and the method adopted to value inventory. The assessee admittedly following mercantile (accrual) method of accounting, the basic question therefore that arises is if, and where so to what extent, income has arisen to it in the facts and circumstances of its case. The ld. AR would read clauses of the agreement specifying events outside the control of the builder, whereat the buyer would be obliged to assume risk. This would rather suggest transfer of all significant risks, with the events outside his control, as a calamity, being in the nature of saving clauses, absolving the builder in such circumstances. True, the buyer too could, at the same time, have the right to determine or terminate the contract at any time. Where so, the risk can be said to remain with the builder. This would however be subject to the compensation or the rights that may inure to the builder in such an event. If the property in the construction reverts to the builder, the same only implies that the same had in fact inured to the buyer earlier. Then, again, as afore-noted, the contracting parties have under law the right to seek specific performance of the contract. The matter would thus stand to be decided on the basis of the entirety of the terms and the conditions of the contract/s, to determine the question if there has been transfer of all significant risks and rewards of ownership, coupled with the absence of the uncertainty associated with the realization of the revenue, so that sale can be said to have taken place. The exercise having not been undertaken at any stage, we only consider it fit and proper under the circumstances to restore the matter back to the file of the A.O. for the purpose to adjudicate the same per a speaking order qua each project after allowing proper opportunity to the assessee to state its case. We may clarify that in doing so we have in effect only sought to determine if the conditions of accrual of income, as legally defined, stand satisfied. AS-9 only articulates the antecedent conditions thereof, and is in conformity with the legal concept of accrual of income. We decide accordingly.
6. In the result, the Revenue's appeal is allowed for statistical purposes.
The order pronounced in the open court on August 28, 2014.