Redevelopment project accounting: completed contract method permissible where project incomplete; revenue cannot force percentage completion taxation

Redevelopment of co-owned property concerned classification as capital asset versus business asset; tribunal found the record did not support the assessee's claim of capital asset, so classification as business asset was upheld. Accounting treatment dispute over percentage of completion versus completed contract methods was addressed: both methods were recognised historically, and because the project remained incomplete with no registered sale or possession, the revenue could not compel percentage completion accounting for that year; the assessee could apply completed contract method and defer taxation until completion, producing a revenue-neutral effect. Prior Supreme Court authorities were applied in support of these principles.

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Issues Involved:
1. Classification of Property as Capital Asset or Business Asset.
2. Applicability of Section 2(47) for determining Capital Gains.
3. Computation of Profits under Percentage Completion Method.
4. Inclusion of Additional Costs in Profit Computation.
5. Allowance of Additional Grounds by CIT(A).
6. Application of Cost Inflation Index for Deduction.

Issue-wise Detailed Analysis:

1. Classification of Property as Capital Asset or Business Asset:
The assessee contended that the property held was a capital asset and not a business asset. The property, known as Raj Mahal Juhu, was under redevelopment, and the assessee was entitled to three flats. The Assessing Officer (AO) and CIT(A) disagreed, stating that the assessee was engaged in the business of constructing and developing the property. It was noted that the property was held as a business asset and not a capital asset due to the nature of activities involved.

2. Applicability of Section 2(47) for Determining Capital Gains:
The assessee argued that no capital gains arose upon entering into agreements to sell three flats as the property was not transferred within the meaning of Section 2(47) of the Act. The AO observed that the assessee's activities indicated a business venture rather than holding the property as an investment. The CIT(A) upheld this view, stating that the profits from the sale of flats constituted income from business and profession.

3. Computation of Profits under Percentage Completion Method:
The AO adopted the percentage completion method to compute profits, estimating the project's completion at 63.43%. The assessee challenged this, arguing that the project was incomplete and the property was under development. The CIT(A) upheld the AO's method but granted partial relief by adjusting the cost base, reducing the computed profits.

4. Inclusion of Additional Costs in Profit Computation:
The assessee claimed that the cost of construction pending recoupment from other co-owners should be included in the cost base. The CIT(A) rejected this claim for lack of substantiation but adjusted the total estimated expenses to include land costs, thereby reducing the assessed profits from Rs. 4,65,79,478 to Rs. 2,09,95,330.

5. Allowance of Additional Grounds by CIT(A):
The Revenue appealed against the CIT(A) allowing additional grounds raised by the assessee, arguing it was not covered under exceptions in Rule 46(A)(1) and the AO was not given a reasonable opportunity to examine the evidence. The CIT(A) directed the AO to verify relevant documents before computing the cost, which was contested by the Revenue.

6. Application of Cost Inflation Index for Deduction:
The CIT(A) considered the assessee's alternative ground that 33% of the property should be treated as a capital asset converted to stock-in-trade in 2007-08. The CIT(A) applied the cost inflation index for FY 2003-04 and 2007-08, allowing a deduction of Rs. 1,56,811 from the resultant profit, reducing the taxable income to Rs. 2,08,38,519.

Conclusion:
The Tribunal concluded that the property was a business asset, not a capital asset. However, it held that the project was incomplete, and the Revenue could not thrust the percentage completion method on the assessee for the first time. The Tribunal set aside the orders of the authorities below, deleted the addition, and held the computation of gains adopting the percentage completion method was not sustainable. The assessee's appeal was partly allowed, and the Revenue's appeal was treated as infructuous.

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