Taxpayer validly used Percentage of Completion Method; land rights excluded for 25% test, included when measuring completion

ITAT MUMBAI - AT held that the assessee correctly applied the Percentage of Completion Method per ICAI Guidance (Revised 2012): land and development rights are excluded when testing the 25% threshold but included thereafter to measure stage of completion. Revenue from Phase-1 was properly recognized (48.5614%); Phase-2A could not be recognized as construction/development costs reached only 19.5205%. The tribunal found consistent accounting treatment, no evidence of tax-evasion or change in method, and directed the revenue authorities to vacate additions made by the AO and sustained by CIT(A). Appeal allowed.

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ISSUES PRESENTED AND CONSIDERED

1. Whether the assessment order passed after selection for limited scrutiny was void for non-compliance with the procedural requirements governing limited scrutiny selection and communication of issues.

2. Whether, for recognition of revenue under the Percentage of Completion Method (POCM) in a joint development real estate project, (a) cost of land / cost of development rights (CDR) must be included in the computation of the stage/percentage of completion for the purpose of triggering revenue recognition thresholds; and (b) whether the assessing officer's re-computation of percentage of completion and consequent additions to income (as adjusted in remand) were sustainable.

3. Whether adjustments to taxable income on account of carried forward business losses and unabsorbed depreciation claimed by the assessee ought to be allowed in giving effect to any order.

ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Validity of limited scrutiny selection and scope of assessment

Legal framework: The scheme of limited scrutiny under the Centralised Audit Selection System (CASS) requires that notices and issue-lists accompanying selection identify the specific issues proposed for examination; relevant departmental instructions prescribe that the 143(2) notice indicate selection method/issues in limited scrutiny cases.

Precedent treatment: The question of procedural regularity in selection for scrutiny is a factual and procedural one; no judicial precedent was reinterpreted or overruled by the Tribunal on this point - the finding on this ground was rendered academic by the disposal of the substantive quantum issue.

Interpretation and reasoning: The assessing officer's records did not show the 143(2) notice carrying reasons or expressly specifying limited scrutiny issues; the AO's later remand report concluded the system selection was CASS 2018 and that the notice did not explicitly state reasons. Even assuming limited scrutiny, the AO's 142(1) communications were broad enough to cover examination of accounting and revenue recognition under POCM. The Tribunal observed that since the substantive addition was deleted, the procedural challenge became academic and was not adjudicated on merits.

Ratio vs. Obiter: Obiter - no final determination on validity of selection procedure because substantive relief rendered the point moot.

Conclusion: The Tribunal did not decide the procedural issue; it treated it as academic given the deletion of the disputed additions and declined to adjudicate further on the matter.

Issue 2 - Inclusion of land / CDR in computing percentage of completion under POCM and sustainability of AO's additions

Legal framework: The Guidance Note on Accounting for Real Estate Transactions (Revised 2012) (ICAI) and Accounting Standards (AS 7, AS 9, AS 10) govern application of POCM. Key provisions: (i) project costs ordinarily comprise cost of land/CDR, borrowing costs and construction/development costs (para 2.2); (ii) the stage of completion for triggering revenue recognition is to be measured with reference to construction and development costs (excluding land/CDR) for the 25% threshold (para 5.3(b)), while computation of revenue once threshold met is by reference to entire project costs including land/CDR (para 5.4); (iii) conditions for application of POCM include reliable estimate of revenues/costs and satisfaction of threshold indicators (paras 5.2-5.3).

Precedent treatment: The Tribunal relied on established accounting guidance rather than overruling or distinguishing judicial precedents; it cited principles that account practices consistently applied across years are not to be disturbed without cogent reason and referred to precedential value of consistent earlier conclusions (citing principle that subsequent years with same facts/law should follow earlier treatment), but did not overrule case law.

Interpretation and reasoning: The Tribunal analysed the Guidance Note and concluded: (a) For determining whether the 25% construction threshold is met, only construction and development costs (as defined in para 2.2(c) and elaborated in para 2.3) are to be considered - land/CDR excluded; (b) Once the threshold is satisfied using construction costs, the full project cost (including land/CDR) is used to determine stage of completion and revenue amount to be recognized. Applying that methodology to facts, the assessee's computation for Phase-1 (48.5614% based on construction/development costs) properly exceeded the 25% threshold and thus permitted recognition of revenue under POCM for Phase-1; Phase-2A Maple did not reach the 25% construction threshold (19.5205%) and thus no revenue should have been recognized for Maple in AY 2017-18. The AO had included CDR/land in both budgeted and actual costs for the purpose of determining the threshold, producing higher percentages of completion (66.39% and 39.59%), and thereby arrived at large additions. The Tribunal found the AO's reworking to be based on an erroneous application of the Guidance Note: AO wrongly included land/CDR in determining whether the 25% construction benchmark was met. Further, the Tribunal observed that RERA/OC evidence and the assessee's consistent accounting practice undermined the AO's rationale for disturbing the assessee's POCM computations. The Tribunal also assessed that even the AO's projected gross profit for Phase-1 exceeded a sustainable estimate of total project profits; accordingly the AO's additions (even as reduced in remand) were excessive.

Ratio vs. Obiter: Ratio - correct application of the ICAI Guidance Note requires exclusion of land/CDR when testing the 25% construction/development-cost threshold for triggering POCM recognition; inclusion of land/CDR thereafter for computing revenue quantum is permissible. Ratio - remedial conclusion that AO's additions based on inclusion of land/CDR at threshold stage were unsustainable. Obiter - observations on RERA data and consistency of accounting practice supporting the assessee's position.

Conclusions: (a) The assessee correctly excluded land/CDR when determining whether the 25% construction threshold was met and properly recognised revenue for Phase-1 but not for Phase-2A (Maple) in AY 2017-18. (b) The assessing officer's methodology of including land/CDR at the threshold stage was inconsistent with the Guidance Note and produced unsustainable additions. (c) The large addition originally made (Rs. 229.29 crores) and the reduced remand figure were both found to be unsustainable; the Tribunal deleted the additions and allowed the appeal on this main ground.

Issue 3 - Claim for set-off of carried forward business loss and unabsorbed depreciation

Legal framework: Taxability adjustments and reliefs (set-off/carry forward) are to be given effect to subject to determination of actual loss in respective years and compliance with statutory filing requirements.

Precedent treatment: Treated as consequential to substantive income determination; no separate precedent re-analysis.

Interpretation and reasoning: The remand report and the Tribunal noted carried forward losses/unabsorbed depreciation schedules; some earlier-year losses were not allowable due to late filing or because assessed loss was nullified by additions. The Tribunal held that such losses would be considered at the stage of giving effect to any order, subject to actual determination in relevant assessment years.

Ratio vs. Obiter: Obiter/consequential - the finding is procedural: carry-forward claims are to be given effect subject to verification in implementation.

Conclusions: Allowance of carried forward business losses/unabsorbed depreciation was acknowledged as admissible in principle but subject to actual determination and compliance; final effect to be given while giving effect to the Tribunal's order.

Overall Disposition

The Tribunal deleted the substantive additions to income made by the assessing officer (and maintained by the first appellate authority to the extent of remand) because the assessing officer's inclusion of land/CDR in testing the POCM threshold was inconsistent with the ICAI Guidance Note and produced unsustainable additions; consequential claims (loss carry-forwards) to be addressed when giving effect to the order. The procedural challenge to limited scrutiny remained academic in view of the substantive deletion.

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