Ahmedabad Tribunal holds POCM not applicable to income from sale of units by real estate developers

In case of Aaryan Buildspace LLP ^[1]  (Taxpayer), the issue before Ahmedabad Bench of Income Tax Appellate Tribunal (Tribunal) arose whether real estate developer is required to recognize income on percentage of completion method (POCM) based on provisions of Income Tax laws (ITL) and ICDS III ^[2] applicable to construction contracts.

The Taxpayer, a real estate developer, undertook business of construction and sale of residential units. The Taxpayer recognized the revenue on sale of units on execution of conveyance deed and transfer of possession prescribed in Guidance Note for Real Estate Transactions (2012) by Institute of Chartered Accountants of India (ICAI). Accordingly, it followed principles of ICAI Accounting Standard-9 (AS-9). However, the Tax Authority argued that the income of the Taxpayer should be recognized as per POCM, basis specific provisions of the ITL dealing with construction and service contracts as it was engaged in construction contracts. The Tax Authority sought to tax advances received from customers during construction stage as income.  The First Appellate Authority deleted the addition on the ground that since Taxpayer is a real estate developer (and not a construction contractor), provisions of the ITL and ICDS III dealing with construction contract and POCM are not applicable. Further, principle of consistency should be applied by the Tax Authority. Accordingly,  since recognition of income on sale of units was recognized in earlier tax years in the year of transfer of possession, the same basis should be applied in current tax year. 

The Ahmedabad Tribunal held that the specific provisions of the ITL dealing with construction contracts which require application of POCM is not applicable to the Taxpayer, being a real estate developer. The Tribunal highlighted that there is fundamental distinction between the business model of a construction contractor and that of a real estate developer. A contractor executes project as per predetermined specification of its client under a contractual obligation. It does not own land or the project. The contract can be of fixed-price, cost-plus contract and time-and-material contract. On the other hand, a real estate developer owns land, undertakes entrepreneurial risks on its own account and sells units to end customer. The real estate developer does not undertake any project for the buyer or provide any construction services. The developer sells completed units to buyer and thus, it involves transaction of sale of property and not contractual construction assignment. The Tribunal also drew support from ICAI Accounting Standards i.e., AS-7 applicable to construction contracts which requires POCM for recognition of income. The specific provision of the ITL and ICDS III dealing with construction contracts are aligned with AS-7. The Taxpayer, being real estate developer, is governed by AS-9 which requires revenue recognition on transfer of significant risks and rewards. The Taxpayer has rightly applied AS-9 as per ICAI Guidance Note on Accounting for Real Estate Transactions, which states that developers should follow AS-9 and not AS-7. The Tribunal also states that mere fact that customer makes the stage-wise payment for purchase of unit does not convert the nature of the sale transaction into a construction contract.

It held that ratio of past judicial precedents ^[3]  carving out real estate developer from POCM is not overridden by the subsequent introduction of specific provisions on construction contracts under the ITL, and thus, these judicial precedents still remain relevant.

^[1] DCIT v. Aaryan Buildspace LLP Appeal No. 1204 of 2024
^[2] Income Computation and Disclosure Standards -III- Construction Contracts
^[3] ITO v. Shivalik Buildwell (P) Ltd. (ITA No. 1698/Ahd/2009, Order dated 5 August 2011) and Unity Construction v. ITO (ITA No. 1577/Ahd/2008, Order dated 28 July 2011)