COMPUTATION OF BUSINESS INCOME OF REAL ESTATE DEVELOPERS
Real estate sector is the fastest growing sector in the country; it provides employments to lakhs of people and has contributed a lot in the exchequer of the Government. Real Estate activity may consist of development of Townships, Residential Complexes, Commercial or Industrial Complexes etc. Real Estate projects are of long term projects, takes years to be completed.
The real estate activities are spread over many years at or its takes more than one year to complete a project, thus it involves complex issue, while calculating business income of real estate projects.
The Income Tax Act, 1961 does not provide any specific provisions for revenue recognition of real estate business. The ICAI has issued Accounting Standard -09 related to revenue recognition and Guidance Note on Recognition of Revenue by Real Estate Developers in 2006( Revised in 2012).
The ICAI has issued Accounting Standard -07 and related Guidance Note for accounting of real estate contracts.
The provisions of Sections 28 to 44DB are applicable in case of real estate activity along with other provisions and rules of the Act.
Section 145 of the Income Tax Act, 1961 related to method of accounting is also relevant for calculating revenue of real estate business.
METHOD OF ACCOUNTING FOR REVENUE RECOGNITION FOR REAL ESTATE DEVELOPER
(I) COMPLETED CONTRACT METHOD ;( CCM)
According to Accounting Standard -09, revenue relating to any, sales transaction is recognised when significance risks and rewards of ownership of goods are transferred.
In case of real estate business, the sale of immovable property, the ownership of the property is transferred as per Transfer of Property Act, 1882 when legal title of ownership is transferred. According to the provisions of Transfer of Property Act, 1882 an immovable property is transferred by way of registered sale deed or according to provisions of Section 53A of Transfer of Property Act, 1882.
In case of Completed Contract Method, the revenue is recognised, when ownership in property is transferred. Since real estate project is a long term project and the property will be transferred, when it will be completed. In this case no revenue is recognised in the years when project is under development and revenue is recognised, when project is physically completed, possession is handed over and ownership is transferred.
MAIN FEATURES OF COMPLETED CONTRACT METHOD (CCM);
1. The Revenue is recognised in the financial statements only on completion of project;
2. The consistency of income in the financial statement of developer will not be same;
3. The income will be recognised on actual basic;
4. No taxable income will be generated during the year ,when project is under development;
5. The builder or developer may use this method to defer his/its tax liabilities;
6. The real estate developer may lose benefit of Set off Depreciation or Carry Forward Losses due to long period of project and revenue recognition;
7. The benefit of Section 80-IB and other incentive provisions and benefit therein may lapse due to long period of project and revenue recognition;
8. The tax authorities do not prefer this method of accounting due to deferment of taxes.
(ii) PERCENTAGE OF COMPLETION METHOD (PCM);
Under this method the revenue is recognised as per the stage of completion of project on year to year basis during the development of the projects.
The underlying principal for adoption of Percentage of Completion Method for revenue recognition is that in case of real estate project, generally, significant risks and rewards of ownership of property are transferred to the buyer at the time of entering into binding sale agreement. Once sale agreement is entered, the developer effectively acts for the buyer in the capacity as contractor.
MAIN FEATURES OF PERCENTAGE OF COMPLETION METHOD (PCM);
1. Revenue is recognised in the financial statements on year to year basis on the stage of completion of the project at the end of each year.
2. The profit in the financial statement of developer will be reflected consistently year to year.
3. The revenue is recognised before the property come into existence and physical possession of property is handed over by developer to the buyer.
4. The income is calculated on estimated basis, considering total project revenue to be earned and total project expenses to be earned in future.
Since Income Tax Act, 1961 does not provide any specific method for calculation of income of real estate developer, so normal provisions related to head business or profession i.e. Section 28 to 44DB are applicable after considering Accounting Standards 7 & 9, read with “Guidance Note on Accounting for Real Estate Transactions (Revised 2012), issued by ICAI applicable for accounting year commencing on or after 01.04.2012.
The Court has allowed to real estate developers to choose any one of the methods for accounting and recognition of their revenue. They are free to choose CCM or PCM related to old Accounting Standard-07. After 1.04.2003 the Accounting Standard-07 has been revised and ICAI has issued guidance note for calculation and accounting of real estate projects.
In following cases , which are relating to period prior to 1.04.2003 when as per old Accounting Standard-07 applicable in such period the option are available for assesessee to adopt any one of CCM or PCM, still courts held that the real estate developers should follow PCM method;
Greater Ashoka Land & Development Company Private Limited V. Asstt. CIT (2001)79 ITD 595(Delhi) (2004)89 TTJ (Delhi) 281, Assessment Year 1988-89, the assessee argued that it has followed one venture of accounting and accordingly, profit in respect of such venture would be determined only in the year in which venture is completed. The Tribunal held that Income accruing one year cannot be deferred to future years by adopting incorrect method of accounting , with a view to postpone tax liability.
Asstt.CIT V. Prerna Premises (P.) Limited (2006) 7 SOT 288(Mumbai), Assessment years 1988-89, the assessee is a real estate developer followed project completion method of accounting. the assesssee did not recognised revenue on the ground that the construction of the project was not completed. Tribunal held that Period of Completion of project cannot be allowed to be stretched at the whims of assessee. Since 80% of the constructed area had been sold and occupied by the buyer, hence the project was deemed to be completed.