ITAT Mumbai on advertising and promotion expenses under Project Completion Method: revenue or WIP?

Background of the dispute

The Mumbai Bench of the Income Tax Appellate Tribunal dealt with an appeal in the case of Samira Realty Projects Pvt. Ltd. Vs ACIT concerning Assessment Year 2010–11. The core controversy was whether certain business expenses should be:

  • treated as revenue expenditure and allowed in the year of incurrence, or
  • capitalized as part of work-in-progress (WIP) under the Project Completion Method (PCM) followed by the assessee.

The assessee was in the real estate business, developing bungalows and villas. For the relevant year, it had only one ongoing project at Alibaug, which was still under construction and no project revenue was recognized, as the assessee followed PCM.

During scrutiny under Section 143(3) of the Income Tax Act 1961, the Assessing Officer noticed that several expenses linked to the ongoing project were debited directly to the Profit & Loss account instead of being loaded into WIP. The AO took the view that such costs were part of the project and ought to be capitalized.

Nature of expenses in dispute

The AO identified the following expenditure items connected with the project “Pavillion”:

  • Advertisement – Rs. 15,94,657/-
  • Business Promotion – Rs. 45,78,472/-
  • Commission – Rs. 18,10,000/-
  • Loan Processing Charges – Rs. 2,22,221/-
  • Security Expenses – Rs. 2,59,007/-

According to the AO, all these expenses had a nexus with the ongoing project and, therefore, should be treated as part of WIP rather than being allowed as current year revenue expenditure under Section 37(1).

On this basis, the AO capitalized the entire amount of Rs. 1,26,30,686/- into WIP. Consequently, the returned loss of Rs. (1,31,13,794/-) was converted into a positive assessed income of Rs. 7,94,438/-.

Assessee’s contentions

In response to the AO’s queries and later before the appellate authorities, the assessee submitted that:

  1. All the impugned expenses were incurred wholly and exclusively for business purposes.
  2. The expenditure on advertisement, business promotion, commission, loan processing and security services was not tied directly to actual construction or development activities.
  3. These items were broadly aimed at:
    • building brand and business presence,
    • promoting the project and operations generally, and
    • facilitating finance and safeguarding project premises.
  4. Since these costs did not bring the inventory to its present location and condition, they should not be treated as part of project cost under Accounting Standard (AS-2) – Valuation of Inventories.

The assessee stressed that its accounting approach was consistent with AS-2, which clearly distinguishes:

  • costs forming part of inventory, and
  • costs to be treated as period expenses, such as administrative, selling, and distribution expenses which are not directly attributable to bringing inventory to its present condition.

On this basis, the assessee argued that the impugned expenses were revenue in nature and should be allowed in the year in which they were incurred.

Findings of the CIT(A)

On first appeal, the CIT(A) examined the AO’s treatment and came to a mixed conclusion:

  • The CIT(A) accepted that the expenditure was not disallowable under Section 37(1) as such (i.e., not bogus or personal in nature).
  • However, the CIT(A) agreed with the AO that, given the assessee’s method of accounting and the fact that the project was still incomplete, these expenses ought to be capitalized as part of WIP.

In other words, the CIT(A) reframed the AO’s disallowance as enhancement of WIP, by treating the same expenditure as capital in nature to be absorbed into project cost and recognized only when the project revenue is booked.

Dissatisfied, the assessee approached the Tribunal.

Arguments before the ITAT

Submissions by the assessee

The assessee, through its representative, placed strong reliance on AS-2 and judicial precedents. Key points included:

  1. Relevance of AS-2
    AS-2, in para 13, specifies that certain categories of costs are to be excluded from inventory valuation and recognized as expenses in the period incurred. These include: