Interest Capitalization on inventory permitted; survey based profit reconstruction set aside; parking slot issue remitted for verification.

Where a developer acquires land as part of ordinary business inventory and capitalises interest as work in progress, the proviso to Section 36(1)(iii) (the put to use limitation) applies to capital assets and does not disallow interest referable to inventory; accordingly the disallowance of interest was reversed. Additions computed suo motu from survey statements without rejecting audited books or affording the assessee a reasonable opportunity to explain were held arbitrary and deleted. Treatment of four parking spaces requires factual verification of contemporaneous records; that issue is remitted to the Assessing Officer for de novo adjudication after giving the assessee opportunity to be heard.

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Issues: (i) Whether the addition of Rs. 41,14,625 made by the Assessing Officer on account of alleged under reported profit of the Welkin Star project is sustainable; (ii) Whether four parking spaces should be treated as deemed sales and addition of Rs. 20,00,000 sustained; (iii) Whether interest of Rs. 79,42,978 paid on loans for acquisition/advance of land at Ghasholi and capitalized as work in progress is disallowable under the proviso to Section 36(1)(iii) of the Income tax Act, 1961.

Issue (i): Addition of Rs. 41,14,625 as under reported profit in respect of Welkin Star project.

Analysis: The net profit was computed suo motu by the Assessing Officer without rejecting the assessee's books of account and relied on figures adopted from a partner's statement recorded during survey. The assessee finalized audited accounts after the survey and filed return on mercantile basis. The basis for the AO's computation (expenses of Rs. 1,39,84,221) was not disclosed to the assessee for explanation and was not examined or explained by the appellate authority. The procedure adopted denied the assessee a reasonable opportunity to explain and lacked an articulated basis for reconstructing profit, making the addition arbitrary.

Conclusion: Addition of Rs. 41,14,625 is deleted in favour of the assessee.

Issue (ii): Treatment of four parking spaces as deemed sales and addition of Rs. 20,00,000.

Analysis: Survey records showed sale of one parking space and impounded documents indicating valuation of parking slots; however, the assessee asserts the remaining four were unsold and has not produced contemporaneous stock records, transfer evidence, or other documentary proof to establish their unsold status. The final status of the parking spaces after project completion (unsold inventory, transfer to society, or disposal) was not verified on records by the authorities. Given these factual gaps, the matter requires verification of documentary evidence and fresh adjudication by the Assessing Officer with opportunity to the assessee.

Conclusion: The issue is remitted to the Assessing Officer for fresh adjudication after verification of records; allowed for statistical purposes in favour of the assessee.

Issue (iii): Disallowance of interest of Rs. 79,42,978 treated as capital expenditure for acquisition/advance of land at Ghasholi.

Analysis: The assessee is engaged in real estate development and treated the advance/land and interest as part of work in progress (inventory). Authorities and binding coordinate and High Court decisions relied upon recognise that acquisition/holding of land for development by a developer is part of business inventory and the proviso to Section 36(1)(iii) (the 'put to use' limitation) applies to capital assets, not inventory held in the ordinary course of business. The records show substantial advances and capitalization in WIP; for the subsequent year the asset appears in current assets, supporting the view that interest relates to business inventory and is allowable.

Conclusion: Disallowance of interest is reversed; the additions in respect of interest are allowed in favour of the assessee for the relevant assessment years.

Final Conclusion: The Tribunal deletes the addition of Rs. 41,14,625 and allows the interest capitalization claim, and remits the parking space issue to the Assessing Officer for de novo verification and decision after affording the assessee opportunity of hearing; overall the appeals are partly allowed.

Ratio Decidendi: Where a real estate developer acquires land as part of its ordinary business inventory and capitalizes interest in work in progress, the proviso to Section 36(1)(iii) (the 'put to use' limitation) applies to capital assets only and does not disallow interest referable to inventory; further, additions based solely on survey statements without rejecting audited books or affording a reasonable opportunity for explanation are unsustainable and must be set aside.

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