2005 (5) TMI 552 - AT - Income Tax

Finance Costs as Period Costs Upheld; Tribunal Dismisses Revenue's Appeal, Cites Consistency and Compliance with AS-7.

The Tribunal dismissed the revenue's appeal, affirming the CIT(A)'s decision to allow the assessee to treat finance costs as period costs. It emphasized ... Business expenditure - disallowance of interest incurred on capital account in respect of incomplete projects - HELD THAT:- Relying on the decision of the Supreme Court in India Cements Ltd. v. CIT [1965 (12) TMI 22 - SUPREME COURT] and Bombay High Court in Calico Dyeing & Printing Works v. CIT[1958 (3) TMI 59 - BOMBAY HIGH COURT], the Court held that if the capital borrowed was used for business purpose in the relevant year of account, it did not matter whether the capital was borrowed in order of acquire a revenue asset or a capital asset and interest on the capital borrowed need to be allowed as a revenue expenditure u/s 36(1)(iii). In the present case, the issue is of a bit different dimension. As rightly argued by the learned Commissioner, there is no dispute on the point that the finance cost booked by the assessee-company in its books of account is revenue in nature. The said expenditure need to be allowed as a deduction in computing the income of the assessee. Revenue admits this. The question is whether the expenditure need to be allowed in the relevant previous year itself; or it should be delayed till the completion of the project when the income is recognized from the said project. So there is no dispute on the basic question that the expenditure is revenue in nature. Finance cost is also generally treated as an expenditure falling under this category. Therefore, in the Accounting Standard it has been suggested that in such cases, where the expenditure could not be attributed to a particular activity carried on by the assessee, the same may be allowed as a period cost. This issue of identity between the borrowed funds and the project works carried on by the assessee is one of the main thrust of arguments advanced by the learned counsel appearing for the assessee. It is basically a question of fact. As argued by the learned Commissioner, it may not be altogether impossible to work out the quantum of borrowed funds utilized for a project if the accounts are maintained by the assessee in such a befitting manner. Such an attribution can be made, may be at the cost of a cumbersome exercise. There is a point in the argument of the revenue that such expenditure should be deferred till the completion of the project. Therefore, we have to see that in spite of various possible dimensions and manifestations of the issue, the various Benches of the Tribunal has taken a consistent view that the claim made by the assessee for deduction of finance cost by way of interest is in conformity with the Accounting Standard-7 issued by the Institute of Chartered Accountants of India. The said Accounting Standard also does not prohibit the treatment of such expenditure as period cost where the expenditure is general in nature. Therefore, we hold that the ground raised by the revenue is liable to be dismissed. In result, this appeal is dismissed. Issues Involved:1. Treatment of Finance Cost (Interest Expenditure) in Real Estate Development Projects2. Applicability of Accounting Standard-7 (AS-7)3. Matching Principle in Accounting4. Relevance of Prior Tribunal and High Court DecisionsDetailed Analysis:1. Treatment of Finance Cost (Interest Expenditure) in Real Estate Development ProjectsThe core issue in this appeal revolves around the treatment of finance cost (interest expenditure) incurred by the assessee-company, which is engaged in real estate investment, share investment, and financing business. The assessee-company follows the completed contract method for recognizing income/loss from its real estate development projects. The assessing authority disallowed the interest expenditure of Rs. 94,70,835, arguing that it should be capitalized and deferred until the completion of the projects, rather than being claimed as a deduction on a yearly basis. The CIT(A) overturned this disallowance, leading to the revenue's appeal.2. Applicability of Accounting Standard-7 (AS-7)The CIT(A) supported the assessee's treatment of finance cost as a period cost, in line with Accounting Standard-7 issued by the Institute of Chartered Accountants of India. The CIT(A) noted that the assessee's method had been consistently accepted in previous years and by various judicial precedents, including the decisions of the ITAT Bangalore Bench and the Karnataka High Court. The CIT(A) found that the facts of the case of S.K. Estates Pvt. Ltd., relied upon by the assessing authority, were fundamentally different from the present case.3. Matching Principle in AccountingThe revenue argued that the assessee's method of deferring income recognition until project completion while claiming yearly deductions for finance costs violated the matching principle in accounting. The revenue contended that both income and corresponding expenditure should be recognized in the same period to maintain accounting propriety. However, the assessee countered that its borrowings were used for multiple business activities, making it impractical to attribute interest expenditure to specific projects. The assessee's method was defended as being in accordance with AS-7, which allows for such expenditure to be treated as a period cost when it cannot be directly attributed to specific contracts.4. Relevance of Prior Tribunal and High Court DecisionsThe Tribunal examined the consistency of prior decisions, including those in the cases of K. Raheja Development Corporation and Lokhandwala Construction Industries Ltd., which supported the assessee's treatment of finance costs as period costs. The Tribunal noted that these decisions had been upheld by higher judicial authorities, including the Karnataka High Court and the Bombay High Court. The Tribunal also acknowledged the statutory provision under section 36(1)(iii) of the Income-tax Act, 1961, which allows for the deduction of interest on borrowed capital used for business purposes, reinforcing the assessee's position.Conclusion:The Tribunal dismissed the revenue's appeal, affirming the CIT(A)'s order that allowed the assessee to treat finance costs as period costs. The Tribunal emphasized judicial propriety and consistency with prior decisions, stating that the assessee's method was in conformity with AS-7 and section 36(1)(iii) of the Income-tax Act, 1961. The appeal was thus resolved in favor of the assessee, allowing the yearly deduction of interest expenditure despite the deferred income recognition from incomplete projects.