2026 (1) TMI 1111 - AT - Income Tax

Real estate project accounting and tax treatment of marketing costs, interest capitalization, debenture expenses, investment interest and TDS adjustments.

Assessees adoption of the percentage completion method and ICAI guidance meant revenue was not recognised until threshold met; accordingly advertising, ... Disallowance of expenses under the heads Advertising Cost, Business Promotion, Commission paid on bookings and Interest claimed - assessee had not recognized the revenue on the basis of 'Percentage Completion Method' during the year under consideration - disallowance of business expenditures by treating the same as cost of project, as AO observed that no sales of plots/ constructed properties, have been effected during the relevant year, cannot be allowed as a business expenditure - whether matching principle adopted by the assessee? - CIT(A) allowed claim - HELD THAT:- Assessee is in the business of promotion and development of real estate. The assessee is following the method of percentage completion method and obligated to follow the mandatory accounting policies and guidance note published by the ICAI. We observed that the assessee is following the same. As per which, the assessee had to declare and recognize the revenue unless it reaches 25% of the estimated project cost or revenue, in this case, the assessee had not reached the mandatory level, hence not recognized the revenue in this impugned year. AO disallowed the expenses on the basis that assessee had not declared any revenue this year. We observed that the AO had disallowed expenses like advertisement, business promotion and commission expenses. As per the para 2.4 of the guidance note issued by the ICAI, the assessee should not consider pat of construction costs and development cost relating to selling costs. Accordingly, the assessee had treated the same as time cost and claimed the same as expenditure. Therefore,CIT(A) had rightly concluded the issue under consideration and allowed the same in favour of the assessee. Failure to substantiate nexus of interest expenditure incurred with income -DR submitted that with regard to interest on NCD, this should have capitalized and expenditure on the NCD, assessee should have claimed as deferred revenue expenditure during the life of the debenture - Debentures are a loan and whole of the debenture was issued to finance the existing project. The assessee had capitalized the same during the previous year and the claim that it has earned interest income cannot be genuine reason not to capitalize the same. In our view, the interest expenditure should be capitalized, nothing was brought on record to show that the funds were utilized other than the project. Therefore, we are inclined to direct the AO to disallow the same. Debenture issue expenditure - As relying on Secure Meters Ltd [2008 (11) TMI 66 - RAJASTHAN HIGH COURT] we are inclined to allow the expenditure claimed by the assessee, the Court held that there is no distinction between the convertible or non convertible debentures, it is in the nature of loan only. Therefore, we are inclined to allow the claim of the assessee and accordingly, we are inclined to partly allow the ground raised by the Revenue in this regard. Reduction of Project Cost by Notional Interest on Interest Free Advances to subsidiaries - DR submitted that the assessee had given 1923 crores to its sister concern - There are only negative shareholder funds. It was further submitted that the assessee was having interest free unsecured loans. Therefore, we are inclined to direct the AO disallow the interest based on the cost of capital to the assessee rather than applying notional interest of 12%. However, the same cannot increase the amount of interest actually claimed by the assessee. In the result, the grounds raised by the Revenue are partly allowed. Addition u/s 14A r.w.r. 8D - Assessee basically submitted that it has interest free funds available in the business out of interest free unsecured loans and advances from customers, further these investments were made previous assessment years, not during the impugned AY, the revenue continue accept the same in the previous assessment years - After careful consideration of the facts on record, we observed that shares of shimmer developers were invested out of advance from customers and other investments in shares were out of interest free unsecured loans. The funds out of customer advances are relating to the funds of the business, the regular funds employed in the business are out of interest bearing funds, any funds invested out of business are interest bearing funds only not out of interest free funds available in the business. As directed in the issue of notional interest free funds in the above paragraph, we direct the AO to consider the interest actually claim by the assessee and calculate the interest employed for investment in shares particularly the shares of Shimmer Developers P Ltd, the same should be restricted to the extent actually claimed by the assessee after adjusting for the interest employed towards the disallowance made by the AO on the notional interest. Therefore, the ground raised by the Revenue is partly allowed. Addition for TDS default - TDS on interest paid u/s 195 - TDS which was deposited after the close of the financial year - AO applied a reverse calculation method to determine the corresponding expenditure, arriving at a gross payment and disallowed 30% thereof, resulting in the disallowance - HELD THAT:- The said interest was paid to a non-resident, the applicable rate of TDS was 15% as per the provisions of the Act read with the relevant DTAA. Accordingly, the correct amount of TDS works out to Rs. 41,46,575 (15% of Rs. 2,76,43,835), whereas the assessee has already deposited a higher amount of Rs. 76,73,219, resulting in an excess deposit of Rs. 35,29,624. Therefore, the difference computed by the Assessing Officer through a reverse calculation method is arbitrary, devoid of merit, and legally untenable. That the tax was duly deposited within the prescribed due date under the relevant provisions of the Income Tax Act i.e. 30.11.2015. Hence, no disallowance under section 40(a)(ia) is warranted. CIT(A), has categorically concluded that this is a case of excess TDS deposit and not one of delayed deposit. Accordingly, the addition and disallowance made by the Assessing Officer were rightly deleted by the CIT(A). No documentary evidence was submitted in respect of the statutory dues paid before the AO - We considered the detailed findings of Ld CIT(A) and found that the issue was rightly adjudicated by him based on the facts that the assessee had deposited excess rather than delay in remitting the tax collection under consideration. The AO cannot resort to reverse mechanism to determine the amount to be disallowable. It should be based on actual payable amount. Therefore, we do not inclined to disturb the findings of Ld CIT(A). In the result, ground raised by the Revenue is dismissed. Issues: (i) Whether advertising, business promotion, commission and related expenses disallowed by AO as part of project cost are revenue deductible; (ii) Whether the assessees revenue recognition under Percentage of Completion Method and adherence to ICAI Guidance Note is correct; (iii) Whether interest expenditure (including on NCDs) claimed has direct nexus with income and is allowable or requires capitalization/disallowance; (iv) Whether debenture issue expenses are revenue deductible; (v) Whether notional interest on interest-free advances to group companies can be imputed and deducted from project cost; (vi) Whether disallowance under section 14A/Rule 8D in respect of investments is warranted; (vii) Whether addition under section 40(a)(ia) for alleged TDS default is justified.Issue (i): Whether advertising, business promotion and commission expenses are revenue deductible or form part of project cost.Analysis: The Tribunal examined the assessees accounting treatment and relied on Para 2.4 of the ICAI Guidance Note which excludes selling costs and certain administrative costs from construction/development cost. The AO had not disputed genuineness of expenditure nor given reasons to treat these as project costs. The CIT(A)s reliance on the Guidance Note and precedents treating selling costs as not part of project cost was accepted.Conclusion: In favour of Assessee.Issue (ii): Whether the assessee correctly applied the Percentage of Completion Method and complied with ICAI standards for revenue recognition.Analysis: The Tribunal found that the assessee followed POCM and the mandatory threshold (25% of estimated project cost) for revenue recognition was not met; AO did not dispute this fact and CIT(A) accepted it. The accounting treatment was held consistent with the Guidance Note and applicable standards.Conclusion: In favour of Assessee.Issue (iii): Whether the interest expenditure claimed (including interest on NCDs) is admissible in P&L or requires capitalization/disallowance for lack of nexus.Analysis: The Tribunal reviewed components of the interest claim (interest on NCDs and debenture issue expenses). It observed that funds raised by debentures financed the project and that no material showed use of funds other than the project. The Tribunal held that interest relating to project financing should be capitalized and therefore directed AO to disallow (i.e., not allow in P&L) interest to the extent not properly capitalized.Conclusion: In favour of Revenue.Issue (iv): Whether debenture issue expenses are allowable as revenue expenditure under section 37(1).Analysis: Following judicial authorities and reasoning that debentures constitute loans, the Tribunal accepted that debenture issue expenses can be revenue deductible and are not distinguishable on the ground of convertibility; the Tribunal found no ground to disallow them.Conclusion: In favour of Assessee.Issue (v): Whether notional interest on interest-free advances to group concerns (computed by AO at 12%) can be reduced from project cost.Analysis: The Tribunal examined source-wise chart submitted by the assessee and balance-sheet/funding position. It found advances to certain group entities were business advances and some advances were from non-interest-bearing sources; the AOs uniform imputation at 12% was not accepted. The Tribunal directed the AO to reassess by applying the assessees actual cost of capital and to limit any adjustment to the actual interest claimed, rather than the 12% notional computation.Conclusion: Partly in favour of Revenue.Issue (vi): Whether disallowance under section 14A and Rule 8D in respect of investments yielding exempt income is warranted.Analysis: The Tribunal noted that many investments were made in earlier years out of interest-free funds and that certain investments produced taxable interest; CIT(A) findings (and precedents) that section 14A is not applicable where income is taxable were accepted. The Tribunal directed AO to restrict any disallowance to the actual interest expense debited to P&L and to consider availability of interest-free funds, effectively limiting the scope of Rule 8D disallowance.Conclusion: Partly in favour of Revenue.Issue (vii): Whether addition under section 40(a)(ia) for non-deduction/delay of TDS on payments is sustainable.Analysis: The Tribunal accepted CIT(A)s finding that amounts shown by the assessee reflect excess TDS deposit (and correct TDS rate under DTAA for the non-resident payee) and that tax was deposited within statutory due dates; AOs reverse-calculation method to derive disallowance was rejected.Conclusion: In favour of Assessee.Final Conclusion: The appeals filed by the Revenue are partly allowed; the Tribunal upheld the CIT(A)s deletions in respect of selling and certain administrative expenses, allowed debenture issue expenses, directed capitalization/disallowance of interest relating to project financing, limited and remitted computation of notional interest and section 14A disallowance to the AO for recalculation on the indicated lines, and dismissed the TDS-related addition.Ratio Decidendi: Selling and administrative costs that fall within ICAI Guidance Note Para 2.4 are not part of construction/development cost and are allowable as revenue expenditure; debenture issue expenses are in principle allowable as revenue expenditure; notional imputation of interest must be based on actual funding/source and cannot be mechanically computed without regard to actual interest claimed and availability of interest-free funds.