S. 145(2): Law on how revenue should be recognized by a developer of property under the “percentage completion method” in the light of Accounting Standards AS-1, AS-7 & AS-9, the Guidance Note on Accounting for Real Estate Transactions issued by the ICAI and several judgements on the issue explained

(i) The issue in dispute relates to recognition of revenue by the assessee, which has been categorized into two broad categories – revenues where the assessee has entered into registered sale deeds with the plot buyers and secondly, where certain advances have been received from the plot buyers, where the assessee is following percentage completion method of accounting.

(ii) The assessee is engaged in development of residential township project “South City” located in village Jaisinghpura/Rampura Bujurg, near Chaksu, Tonk road, Jaipur in collaboration with M/s Shakuntalam Colonisers Pvt ltd and M/s Vastukar Colonizers Pvt Ltd. In terms of plot buyers agreement, the buyer agrees to purchase a plot of specified size and location and the agreed price covers development of internal services such as roads, electricity, water and drainage system within the peripheral limits of township. The nature of transaction under consideration is therefore sale of plots of land with development of internal common facilities within the township.

(iii) The assessee has contended that by following consistent accounting policy where the revenues are recognized on percentage completion method, during the year under consideration, revenues for the year are recognised at Rs.2,11,38,286/- as per registered sale deeds and no revenues are recognised against the advance/booking amount of Rs.4,44,28,514/- received from customers. The said accounting policy has been duly reflected in Schedule 11 of its audited financial Statement and the same is in accordance with Paras 10 and 11 of AS-9 issued by the ICAI as well as Guidance Note on “Recognition of Revenues by the Real Estate Developers” issued by the ICAI in the year 2006. The AO has also referred to the said guidance note issued by ICAI while arriving at his findings that the whole of sale proceeds in respect of registered sale deeds should be recognized as revenues and secondly, the advance received from the customers should be recognized to the extent of percentage of work completed in the township project.

(iv) As per AS 7, the recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed.

(v) In the instant case, in respect of transactions where sale deeds for plots of land have been duly executed and registered with the relevant authorities, there is no dispute that the assessee has transferred to the buyer all significant risk and rewards of ownership and the assessee retains no effective control of the real estate to a degree usually associated with ownership, and no significant uncertainty exists regarding the amount of the consideration and its collection as the same has been fully recovered prior to signing of the sale deed.

(vi) At the same time, what is equally relevant to consider is the economic substance of the transaction. As we have noted above, in terms of plot buyers agreement, the buyer agrees to purchase a plot of specified size and location and the agreed price covers development of internal services such as roads, electricity, water and drainage system within the peripheral limits of township. The economic substance of transaction under consideration is therefore sale of plots of land alongwith development of internal common facilities within the township. The buyer of plot of land is not paying merely for piece of land cut into specified size at a given location but also for development of various common facilities. There is no separate identifiable consideration for development activities which is available on record and therefore, one can only speculate and debate about whether these activities are substantial or not, the fact remains that unless such facilities are made available and functional, these plots of land cannot be put to intended use. The development activities are therefore closely linked to the sale of plot of land and the economic substance of the transaction is therefore sale and purchase of developed plots of lands. The assessee is therefore obliged to perform the specified development activities even after the sale deeds have been duly executed in favour of buyers. The revenues in such cases should therefore be recognized on proportionate basis as the acts are performed, i.e. by applying the percentage of completion method in the manner explained in Accounting Standard (AS) 7, Construction Contracts which provides that contract revenue are required to be matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. We find that the AO has not disputed the fact that the assessee is required to carry out the specified development activities and also the application of percentage of completion method of recognition of revenues but has missed this finer nuisance of interconnection between the economic substance of the transaction and application of percentage completion method of recognition of revenues while analyzing the guidance note issued by the ICAI and which has been rightly appreciated by the ld CIT(A). The stage of development of the township project has been determined by the assessee at 45.73% with reference to entire land and development cost for the whole project and is not in dispute before us. The total revenues in respect of executed sale deeds till 31.03.2012 comes to Rs 5,44,46,105 and 45.73% thereof comes to Rs 2,48,98,204 and after allowing credit for revenues already recognized in the previous year amounting to Rs 37,59,918, the revenues for the year have been rightly determined by the ld CIT(A) at Rs 2,11,38,286 and we hereby affirm his findings in this regard.