Facts of the Case

The assessee, engaged in construction and sale of commercial properties, developed a multi-storey commercial complex and followed the Completed Contract Method (CCM) for accounting.

Due to a change in usage approval by NDMC, certain allottees refused to take possession of allotted commercial spaces. The assessee:

  • Refunded advances to such allottees
  • Paid additional compensation for surrender of rights

The assessee treated such compensation as revenue expenditure in its Profit & Loss Account.

The Assessing Officer (AO):

  • Treated the payment as capital expenditure (repurchase of flats)
  • Disallowed deduction

The CIT(A) allowed the claim, but the ITAT initially reversed it for AY 1995-96, leading to multiple appeals.

Issues Involved

  1. Whether compensation paid for surrender of booking rights is revenue expenditure or capital expenditure.
  2. Whether such compensation can be added to stock valuation.
  3. Whether rental income from unsold flats (stock-in-trade) is taxable as:
    • Business Income, or
    • Income from House Property.

Petitioner’s Arguments (Revenue)

  • Compensation amounted to repurchase of property, hence capital in nature.
  • Payments were not contractually required and were for extraneous considerations.
  • Since recipients treated it as capital gains, it should be capital expenditure for the assessee.
  • Rental income from stock-in-trade should be treated as business income.

Respondent’s Arguments (Assessee)

  • Unsold units were stock-in-trade, hence related expenditure is revenue in nature.
  • Compensation was paid due to commercial expediency to avoid disputes and maintain goodwill.
  • Under CCM, revenue is recognized only upon completion; hence accounting treatment must be respected.
  • Compensation is not part of cost of inventory under AS-2.
  • Rental income should be taxed as Income from House Property.

Court Findings / Judgment

The Delhi High Court held:

1. Compensation is Revenue Expenditure

  • Flats constituted stock-in-trade, not capital assets.
  • Payment was made for commercial expediency and business interests.
  • It was not a repurchase but settlement of rights before transfer of ownership.
  • Even without contractual obligation, expenditure can be allowed if commercially justified.

 Therefore, compensation is allowable as business expenditure.

2. Not Part of Stock Valuation

  • As per AS-2, only costs bringing inventory to present condition are includible.
  • Compensation paid after completion is an extraordinary expense, not inventory cost.

3. Rental Income = Income from House Property

  • Consistent judicial view accepted in earlier years.
  • Rule of consistency applied.
  • Rental income from stock-in-trade is taxable under Income from House Property.

Important Clarifications

  • Commercial expediency does not require contractual obligation.
  • Treatment in recipient’s hands (capital gains) is irrelevant for payer’s deduction.
  • Accounting method (CCM) consistently followed cannot be ignored by Revenue.
  • Revenue cannot take inconsistent positions across assessment years.

Court Order

  • Appeals of Revenue dismissed
  • Appeals of Assessee allowed
  • ITAT findings (against assessee) set aside
  • Compensation allowed as revenue expenditure

Sections Involved

  • Section 260A – Appeal to High Court
  • Section 37(1) – Business Expenditure
  • Section 24 – Income from House Property
  • Accounting Standard (AS) 7 – Construction Contracts
  • Accounting Standard (AS) 2 – Valuation of Inventories

Link to download the order -

https://delhihighcourt.nic.in/app/case_number_pdf/2019:DHC:1676-DB/SMD20032019ITA5482010.pdf

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