In this article we will discuss the non-applicability of ICDS III to Real Estate Developers and the Real Estate Developers are not required to follow the Percentage Completion Method.
Relevant portion of ICDS III is reproduced as below:
ICDS III – Construction Contracts’ applies the determination of income of a contractors only arising from construction contracts.
As per ICDS III,‘ Construction Contract’ means a contract specifically negotiated for the construction of an asset or a combination of an assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and includes:
- Contract for the rendering of services which are directly related to the construction of the asset, for example those for the services of project managers and architects;
- Contract for destruction or restoration of assets, and the restoration of the environment following the demolition of an assets.
So, the plain reading of the above definition clearly suggests that the construction undertaken by Real Estate Developers does not satisfy the above definition as the contract is not negotiated only for the construction of asset rather the Real Estate Developer is a person who constructs the asset as per his own schemes and designs and contracts with the buyer to sell the assets. The transaction between the residential flat purchaser and Real Estate developer is not one of mere construction of an asset or simple sale of goods but rather it is a combined contract for not only construction of the flat as also entire building with common amenities but also for transfer of legal title in the flat.
Prior to the ICDS III, AS – 7 – Construction Contracts was in force and it was also not applied to the Real Estate Developers. To clarify this more, the Expert Committee on ICDS (ICDS Committee) was constituted by the CBDT and the committee had in fact recommended that a separate ICDS should be notified for revenue recognition by Real Estate Developers.Pursuant to that, on 11thMay 2017, the CBDT has released draft ICDS on real estate transactions for public consultation. The draft ICDS on real estate transactions is largely based on ICAI’s Guidance Note on Accounting for Real Estate Transactions. Hence, from the above recommendation of the Expert Committee and on the basis of draft ICDS on real estate transactions as released by the CBDT, the very clear intention of CBDT as well as ICAI is that the Real Estate Developers are not covered by the ICDS III.
The CBDT has also clarified in the FAQ issued on 23rd March, 2017 vide Circular No 10/2017 (Reply to Question No. 12) that this ICDS is not applicable to Real Estate Developers. The Q:12 is as follows:
Q:12: Since there is no specific scope exclusion for real estate developers and Build – Operate – Transfer (BOT) projects from ICDS IV on Revenue Recognition, please clarify whether ICDS III and ICDS IV should be applied by real estate developers and BOT operators. Also, whether ICDS applicable for lease.
A:12: At present there is no specific ICDS notified for real estate developers, BOT projects and leases. Therefore, relevant provisions of the Act and ICDS shall apply to these transactions as may be applicable. The CBDT has tacitly accepted that ICDS III not applicable to Real Estate Developers.
Guidance Note on ICDS issued by ICAI also states that the ICDS III is not applicable to real estate developers. Hence, from all these instances, it is very clear that the ICDS III is not applicable to real estate developers and applies only to the contractors.
Now if we look into the applicability of percentage completion method, the Accounting Standard – 9 and guidance note on real estate transactions are relevant. For determination of the accrual of the income and the sale, the Accounting Standard – 9 read with Guidance Note for Real Estate Transactions is relevant. The Accounting Standard – 9 in respect of sale of goods in the real estate projects is explained in guidance note for Real Estate Transactions which was revised in 2017 by ICAI.
Section 5 of the Income Tax Act, 1961 states that the income is taxable in the year in which the same accrues to the taxpayer. Income is said to be ‘accrue’ when taxpayer has legal right to receive the income and accordingly, payer acknowledges a debt in favour of the taxpayer and hence there is no question of applicability of percentage completion method. Reliance can be placed on the judgment of Apex Court in the case of (CIT vs. Excel Industries Ltd (2013) 358 ITR 295 (SC). As the provisions of section 5 prevail over ICDS, contract revenue can be recognized on satisfaction of the test of accrual and not merely onthe basis of reasonable certainty of collection of contract revenue. This view is also supported by the ICAI’s Guidance Note.
AS-7 relating to construction contracts is not applicable to Developers/Builders so there is no question of recognizing the income on the percentage completion method. In support of the contention, the decision of ITAT Mumbai Bench decision in case of Awadhesh Builders v/s. ITO [37 SOT 122] is relevant in which the ITAT held that in case of real estate developer, profit is earned only when the space constructed is sold. In case, due to some reasons, the project is terminated or is abandoned, the builder has to refund the advances received from the buyers and in that case, there cannot be any profit because the flats/shops could not be sold as the construction remained incomplete. In that case, it will be only be a case of investment by the builder, profit on which will arise only on sale of flats.
Thus, from the above discussion we can conclude that the ICDS III – ‘Construction Contracts’ is only applicable to the person who is Contractor and not applicable to the Real Estate Developers.
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