Tc/104/2000 Of The Commr. Of Income Tax v. S.i.property

In the High Court of Judicature at Madras Dated: 08/12/2003 Coram The Hon'ble Mr. Justice R. Jayasimha BabuandThe Hon'ble Mr. Justice S.R. Singharavelu Tax Case No.104 of 2000 The Commissioner ofIncome-tax,Tamilnadu I,Madras. ... Applicant -Vs-M/s. S.I. PropertyDevelopment Pvt. Ltd.Madras . ... Respondent Tax case under Section 256 (1) of the Income Tax Act, 1961 against theorder made by the Income Tax Appellate Tribunal, Madras "B Bench, Chennai, inI.T.A. No: 1255/(Mds)/1998 dated 04.09.1992 for the assessment year 1984-85. !For applicant : Mr. K. SubramaniamSenior Standing counsel forIncome tax ^For respondent : Mr.V. Ramachandran,Senior Counsel forM/s. Anitha Sumanth :O R D E R (Order of the Court wasmade by R. Jayasimha Babu, J.) The assessment year is 1984-85. The question referred is," Whether on the facts and in the circumstances of the case, the Income-taxAppellate Tribunal was right in law in holding that the deposits of Rs.15lakhs made by M/s.Southern Investments with the assessee-company were not tobe connected with the Bangalore Project to say that the interest paid thereonwas the cost of construction of the project ?" 2. The assessee entered into an agreement on 5th January 1983 with a partnership firm Southern Investments which is referred to in the body of theagreement as a firm which owns a trade mark "S.I.". The assessee company ispart of the same group as is obvious from the very name of the assessee. 3. The agreement sets out, inter alia, that the assessee had enteredinto an agreement with the owners of a plot on Palmgrove road, Bangalore, thatit had nominated three persons to purchase the property, that it was requiredto provide finance to those persons for the purchase of the property; that theprojected cost of construction was Rs.75 lakhs; that the firm which hadexperience in the real estate field had agreed to act as a marketing andselling agent of the assessee for the proposed project and was willing todeposit a substantial sum as interest bearing security deposit to help thebuilders to finance the project; and to guarantee the builders a minimum finalsale value for the project. The agreement in its several clauses refers tothe 'project' which is the project on the schedule property. The firm whichis described in the agreement as an agent was to underwrite a minimum netrealisation of Rs.140 lakhs; bear all expenses in connection with themarketing and selling of the project; and pay 85 per cent of the collectionsfrom the prospective clients who would purchase portions of the building tothe assessee every month for the purpose of construction. 4. The agent firm was also required to pay a sum of Rs.10 lakhs as security deposit on execution of the agreement and make a further deposit ofRs.5 lakhs at the time of approval of the plans for construction. The depositso made was to bear interest at the rate of 24 per cent. The amount of thatdeposit was to be adjusted by the agent from the sale receipts of the project.The agent enjoyed a similar right to adjust the interest on that amount ofdeposit, and for that purpose the interest was to be calculated on the monthlybalance. The agent was to pay to the assessee the sum of Rs.140 lakhs even ifthe agent fail to realise the sum by effecting sales of the portions of thebuilding. The agent was further required to, if so demanded by the assessee,purchase unsold portions at the value determined by the assessee. 5. Under the head 'obligations of the builders' it was set out in that agreement, that the construction was to be put up by the assessee inconsultation with the agent and that the assessee was not in any manner todelay or withhold the construction of the project and that it was theobligation of the assessee to "..... arrange at the risk and cost of theagent any additional finance required to continue and complete the proposedconstructions". 5. Under the head 'obligations of the builders' it was set out in that agreement, that the construction was to be put up by the assessee inconsultation with the agent and that the assessee was not in any manner todelay or withhold the construction of the project and that it was theobligation of the assessee to "..... arrange at the risk and cost of theagent any additional finance required to continue and complete the proposedconstructions". 6. The assessee was required to pay to the agent a fee of 8 per centof the total sale receipts as marketing fee. The assessee claimed from itsprofits for this assessment year a sum of Rs.3.2 lakhs which it had paid tothe agent under that agreement as business expenditure. That claim wasdisallowed by the assessing officer after observing that, "... it is thepractice followed by the assessee Company to take all incomplete projectexpenses as work-in-progress and show it in the Balance Sheet. Therefore, theinterest paid on security deposit received for "Palm Tree Place" project, ofwhich work-inprogress is shown at Rs.26,69,304/-, should have been accountedas part of work-in-progress of that project and ought not to have been claimed as a deduction in the main profit and loss account as the same goes to reducethe profit from another project. Therefore, this amount will only beconsidered as part of work-in-progress under the project 'Palm Tree Place'.... " 7. That view of the assessing officer was affirmed in appeal by theCommissioner. The Commissioner, after considering the terms of the contract,concluded that, " Thus, the tenor of the agreement shows that it was entered into with thespecific purpose of financing the Bangalore project known as the "Palm TreePlace Project" and the deposit received was to enable the assessee to financethis project. The deposit was also taken by the assessee as a guarantee thata minimum final sale value would be obtained for this project by the agent." The Commissioner further noted that there was no material to hold that the sumof Rs.15 lakhs received under this agreement for this project had beendeployed or utilised by the assessee for any other project or that it hadtreated the same as part of its general working capital. 8. The assessee, however, was successful in persuading the tribunalnot to treat this as part of the project cost. The Tribunal while acceptingthe assessee's case held, " Thus it is clear that the funds made available to the assessee were not soinextricably connected with the project so as to say that the interest paidthereon was the cost of construction of the project." 9. It is evident from the recitals as also the mutual obligations set The Commissioner further noted that there was no material to hold that the sumof Rs.15 lakhs received under this agreement for this project had beendeployed or utilised by the assessee for any other project or that it hadtreated the same as part of its general working capital. 8. The assessee, however, was successful in persuading the tribunalnot to treat this as part of the project cost. The Tribunal while acceptingthe assessee's case held, " Thus it is clear that the funds made available to the assessee were not soinextricably connected with the project so as to say that the interest paidthereon was the cost of construction of the project." 9. It is evident from the recitals as also the mutual obligations set out in this agreement that the agreement was in relation to a project whichwas for construction of a multi storey building on the land described in theschedule to that agreement; that the cost of the land was Rs.20 lakhs and thecost of the construction was Rs.75 lakhs; on the date of the agreement, thesale of the land had not been completed; that the assessee had undertaken toprovide funds to the persons nominated by it to be shown as the purchasers inthe sale deed for the land; that the deposit of a substantial sum by the agentas interest bearing security was to help the assessee to finalise the projectand also to guarantee to the assessee a minimum final sale value and that theassessee was to arrange at the risk and cost of the agent any additionalfinance required to continue and complete the proposed construction. Havingregard to what has been set out in the agreement, it is not possible tosustain the Tribunal's view that the deposit was not linked to the project.10. The deposit indeed was obtained solely for the purpose offinancing the part of the cost of the project and the interest paid forobtaining such finance - though the amount is described in the agreement assecurity deposit - was in fact an expenditure which was in relation to thisproject and no other project. The use of the words ' additional finance" inclause II (b) of the agreement reinforces this view as the deposit paid underthe agreement has been regarded by the parties as part of the finance requiredfor the project and for obtaining additional finance, the agent had agreed totake the risk involved in obtaining such finance and also be responsible andliable for the cost of obtaining such additional finance. 11. Learned senior counsel for the assessee, however, submitted that as the assessing officer had used the term "work-in-progress", this financecost could not possibly be regarded as part of the work-inprogress and thatthe treatment of this interest as part of the workin-progress was whollyunjustified. Though this argument on the face of it looks attractive, allthat the assessing officer has said is that it had been the practice of theassessee company to account all the expenditure in relation to a project whichwas incomplete at the end of the assessment year as part of work-in-progressand that the assessee was in error in not including this cost also, which wasrelated to the project, in that amount which the assessee has described aswork-in-progress. What was really in issue before him was not as to whetherthis is an amount which can be regarded as part of the workin-progress and wasrequired to be excluded therefrom. He was of the view, and in our opinionrightly, that it was required to be treated as part of the project cost. 12. Learned senior counsel also drew our attention to the Standards of Accounting AS-7 "Accounting for construction Contracts", more particularlypara 8.7 therein which sets out the examples of costs that relate to theactivities of the contractor generally, but cannot be related to specificcontracts, one such cost set out therein being the finance cost. It wassubmitted by counsel that all interest paid on the deposit even if it beregarded as finance cost was required to be excluded from the cost of theproject. 13. In the same accounting standard at para 8.8 it has been madeclear that, 12. Learned senior counsel also drew our attention to the Standards of Accounting AS-7 "Accounting for construction Contracts", more particularlypara 8.7 therein which sets out the examples of costs that relate to theactivities of the contractor generally, but cannot be related to specificcontracts, one such cost set out therein being the finance cost. It wassubmitted by counsel that all interest paid on the deposit even if it beregarded as finance cost was required to be excluded from the cost of theproject. 13. In the same accounting standard at para 8.8 it has been madeclear that, " However, in some circumstances general administrative expenses, developmentcosts and finance costs are specifically attributable to a particular contractand are sometimes included as part of accumulated contract cost." Thus, all that the accounting standard provides is that if the finance costand other costs such as the general administration and selling cost, researchand development cost are contract specific then, such costs are required to beincluded as part of the project cost. In cases where such costs arespecifically attributable to the particular contract they are to be includedas part of the project cost. 14. In this case, interest paid on the deposit was in fact interestpaid on an amount which had been received by the assessee for the specificpurpose of completing the project and that was also the manner in which theagent who paid that sum had viewed it despite the fact that the description ofthe sum so paid was 'deposit'. The deposit was, under the terms of thecontract, adjustable at the instance of the agent from and out of the moneiespayable by the agent to the assessee. The project itself was to be financedwith the aid of the deposit obtained by the assessee, and by obtaining furtherfunds at the cost and risk of the agent. In this case, the relation of theagent here was not merely that of a marketing and selling agent, but was infact that of a financier which provided part of the finance required directly,and agreed to remain liable for the additional finance which the assessee wasto secure. 15. The question referred is, therefore, answered in favour of therevenue and against the assessee. gp To 1. The Assistant Registrar,Income Tax Appellate Tribunal,Rajaji Bhavan, III Floor,Besant Nagar,Madras � 90. 2. The Secretary,Central Board of Revenue,New Delhi. 3. The Commissioner ofIncome Tax,Tamil Nadu I,Madras. 4. The Commissioner ofIncome Tax,Appeals V,Madras. 5. The Inspecting AssistantCommissioner of Income Tax(Assessment),Range I,Madras. �