Delhi ITAT: Section 40(a)(ia) Disallowance Cannot Be Invoked for Interest Capitalised as Work-in-Progress
Background and Overview
A batch of appeals filed by Unitech Acacia Projects Pvt. Ltd. before the Delhi Income Tax Appellate Tribunal presented two distinct but significant legal questions — first, the obligation to deduct tax at source under Section 194-I on annual lease rent paid to statutory development authorities, and second, whether Section 40(a)(ia) disallowance can be applied to interest expenditure that has been capitalised as Work-in-Progress (WIP) rather than claimed as a deduction in the Profit & Loss Account.
The Tribunal's rulings across multiple assessment years have laid down important principles with wide-ranging implications for real estate developers and other assessees who follow the Percentage of Completion Method (POCM) of accounting.
Facts of the Case
Land Acquisition and TDS Dispute — AY 2008-09 and AY 2012-13
Unitech Acacia Projects Pvt. Ltd. (the assessee) is a Special Purpose Vehicle (SPV) formed jointly by two companies — Unitech Hi-Tech Developers Ltd. and CIG Infrastructure Pvt. Ltd. — as a condition stipulated by the New Okhla Industrial Development Authority (NOIDA) for development of residential and industrial sectors.
The assessee had acquired two parcels of land from NOIDA under lease agreements dated 03-03-2008 and 27-03-2008 for a one-time premium aggregating to Rs. 881,47,62,800/-. In addition to this one-time premium, the assessee was contractually required to pay annual lease rent at the rate of 1% of the one-time premium. Accordingly, a sum of Rs. 8,81,47,628/- was paid as annual lease rent.
Acting on NOIDA's advice that its income was not chargeable to tax by virtue of Section 10(20A) of the Income Tax Act, 1961, the assessee did not deduct any tax at source on these payments.
The Assessing Officer, however, held the assessee liable to deduct tax under Section 194-I of the Act and raised demand including interest under Section 201(1A).
In the parallel acquisition for AY 2012-13, the land was acquired vide lease deed dated 28-12-2006 read with correction deed dated 07-08-2008 for a one-time premium of Rs. 16,22,84,12,160/-.
Interest Capitalised as WIP — AY 2015-16
For Assessment Year 2015-16, the assessee paid interest on borrowings amounting to Rs. 17,03,94,058/- to Unitech Limited. Tax was not deducted at source on time on these interest payments. Following its accounting policy based on POCM (consistent with accounting standards issued by the ICAI), the assessee charged only Rs. 6,56,99,294/- to the Profit & Loss Account as a revenue expense. The remaining portion of interest was capitalised as part of Work-in-Progress (inventory).
Acknowledging its obligation under Section 40(a)(ia) of the Income Tax Act, 1961, the assessee suo motu disallowed 30% of the interest debited to the Profit & Loss Account, being Rs. 1,97,69,338/- (i.e., 30% of Rs. 6,56,99,294/-).
Despite this voluntary disallowance, the Assessing Officer disallowed the entire amount of Rs. 5,11,18,217/- under Section 40(a)(ia), including the portion of interest that had been capitalised and absorbed into WIP. The CIT(A) upheld this disallowance, and the assessee carried the matter further to the Delhi ITAT.