Recently, the Mumbai Bench of the Tax Tribunal1 had an occasion to examine the taxability of advance received towards development rights, having linkage to performance conditions stipulated in the Development Agreement. Further, while the order is passed after 90 days, the Tax Tribunal has observed that the period of lockdown is required to be excluded in computation of the 90 days and after excluding this period, the order is passed within 90 days. We, at BDO in India, have summarised the ruling of the Mumbai Tribunal and provided our comments on the impact of this decision.
Facts of the Case
Taxpayer being a builder and developer, entered into an agreement to redevelop a slum property with six co-operative societies (whose members were the slum dwellers). Pursuant to the agreement, the development rights were transferred to the taxpayer. Subsequently, the taxpayer entered into joint venture agreement with Shivalik Ventures Pvt. Ltd (SVPL). Under the joint venture agreement, taxpayer transferred development rights for a consideration of INR 54mn to SVPL. The consideration was to be paid to taxpayer as under:
- INR 8.6mmn - at the time of entering into the joint venture agreement,
- INR 22.68mn - on "obtaining IOA and commencement certificate" by the joint venture; and
- INR 22.68mn - when all slum dwellers vacate and shift to transit accommodation.
Under the Joint Venture Agreement, certain obligations (procure / obtain LOI and IOA from Slum Rehabilitation Authority, obtain consent from six societies for SVPL to develop the property, shifting of all slum dwellers to temporary alternate accommodation vacating the property etc.) were casted on the taxpayer. Further, the Joint Venture Agreement provided that INR 8.6mn was to be refunded if the taxpayer was not able to get 25 percent of the slum dwellers to vacate the said property within 5 years. As the amount was contingent, the taxpayer treated INR 8.6 Mn as advance and did not offer it to tax.
However, the tax officer treated the entire consideration as taxable on the following basis:
- Taxpayer follows "mercantile method of accounting" under which the transactions are recognised as and when they take place, the revenue is to be recorded when earned and the expenses are reported when incurred.
- The taxpayer had transferred the development rights and handed over the possession of the property. It qualifies as 'transfer' under section 53A of the Transfer of Property Act, 1872.
- Since, the taxpayer follows mercantile system, the accrual of income does not depend on the receipt of income and therefore, the income was earned when transfer was complete.
- The condition to treat INR 8.6mn as an advance till 25% slum dwellers vacate the property by modifying agreement was a colourable device to evade taxes.
Aggrieved, the taxpayer filed an appeal with the First Appellate Authority which ruled in taxpayer's favour and hence Tax Officer preferred an appeal before the Tax Tribunal.
The Tax Tribunal held that the income has not accrued to the taxpayer in the year in which INR 8.6 mn was received. While coming to this conclusion, the Tax Tribunal made the following observations:
- While the taxpayer was to help SVPL to get the development rights in favour of the joint venture, the payment was to be received by him "as original developer appointed by the said societies" and this payment cannot be read in isolation with all its obligations under the joint venture arrangement. It was a composite agreement, irrespective of whether we look at the modifications or not, and all the terms of the agreement were to be read in conjunction of each other.
- When a taxpayer had an obligation to perform something, and the same has not been performed, nor is the taxpayer in a position to perform such obligations, then partial payment for fulfilling these obligations cannot be treated as income in the hands of taxpayer.
- Since the obligations under the Joint Venture Agreement have not been performed, the income in question never accrued to the taxpayer.
- Following principle of Conservatism (which was recognized in Supreme Court's decision in case of Chainrup Sampatram2), loss is to be accounted as soon as it can be reasonably anticipated, but anticipated profits are not to be accounted until they actually arise.
- Until the obligations for performance of which an amount is received, such a receipt cannot have an income character in the hands of the person who is still to perform such obligations. For this, it relied on Supreme Court's decision in case of E.D. Sassoon & Co Ltd.3
- Under mercantile method of accounting, the relevant point of time is not the actual receipt of income but the point of time when right to receive that income, in character, crystallised.
- Even if the modification in the agreement is ignored, the fact still remains that the income could accrue only on performance of obligations. Further, it is not open for the tax officer to disregard the modifications in agreement merely because it results in clear and unambiguous negation of tax liability in the hands of taxpayer.
The Tax Tribunal also stated that while the order has been passed well beyond the time limit laid down under Rule 34(5) of the Income Tax (Appellate Tribunal) Rules, 1962 i.e. 90 days from the date of hearing, due to the current extraordinary times arising on account of COVID-19 pandemic, the period of lockdown needs to be excluded in computation of the 90 days. For this, the Tax Tribunal referred to the decision of JSW Ltd wherein it had been held that for the purpose of computing the period of 90 days, the period during which the lockdown was in force needs to be excluded.
While the Tax Tribunal's reiterates that the concept of accrual of income still holds good, it is pertinent to note that the ruling is pronounced for the fiscal year when Income Computation and Disclosure Standards (ICDS) were not issued. Unlike Accounting Standard 9 - Revenue Recognition which permits recognising revenue when there is reasonable certainty its collection, ICDS IV on Revenue Recognition does not refer to the test of 'reasonable certainty of ultimate collection' for service contracts. Further, ICDS IV does not recognise completed contract method for service contract (except where the contract period is upto 90 days). Hence, one needs to take into cognizance ICDS while relying on this Tribunal decision.
1 ITO vs Newtech (India) Developers [ITA No. 3251/Mum/2018 (Mumbai Tribunal)]
2 Chainrup Sampatram Vs CIT [(1953) 24 ITR 481 (SC)]
3 E D Sassoon & Co Ltd Vs CT [(1954) 36 ITR 27 (SC)]
4 DCIT Vs JSW Ltd  116 taxmann.com 565 (Mumbai Tribunal)
Originally published 18 June 2020
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