Introduction of Ind AS 115 creates tax conundrum in real estate sector

Accounting Treatments:

Prior to Ind AS 115, real estate companies would record revenue in accordance with the Guidance Note on “Accounting for Real Estate Transactions” issued by the Institute of Chartered Accountants of India using the Percentage of Completion Method (PoCM), whereas they would now be required to recognise revenue on passing the control of asset to customers.  On the transition date, i.e., 01 April, 2018, the profits of the existing under-construction projects already recognised in the books under PoCM, were required to be reversed in the books of accounts by debiting the Retained Earnings, as it does not meet the Ind AS 115 recognition criteria (transfer of control).  Going forward, the Developers will be required to recognise revenue when control of asset is passed to customers. The revenue reversed earlier would be re-recognised at this stage. 

Direct Tax Treatment: 

Until Financial Year 2017-18, the developers’ income from real estate projects was offered to tax on PoCM basis while computing business income and book profits. However, after the transition to Ind AS 115, the Tax Authorities have not issued any changes/ clarifications on whether real estate developers would offer tax on PoCM basis or on point of completion (PCM) basis going forward. Under MAT, companies have already considered profits on PoCM basis for computing book profits in earlier years. Now, on transition to Ind AS 115, whether any deduction from book profits would be available for the amount reduced from Retained Earnings on 01 April, 2018, similar to the amendment introduced at the transition from IGAAP to Ind AS. Further, in the absence of any amendment or clarification in the tax laws, whether companies would be able to claim deduction of profits re-recognised in subsequent years under the PCM, which were previously considered while computing book profits (basis PoCM)? One may argue that the recognition of income in subsequent years based on the PCM is, in substance, withdrawal from reserve and credit to profit and loss, and hence, should be deducted while computing book profits, as per Explanation (i) of section 115JB. Under normal tax provisions, in the absence of any ICDS notified for revenue recognition for real estate developers, one may argue that under section 145 of the Income-tax Act, 1961, the Tax Authorities should consider the method of accounting consistently and regularly followed by the taxpayer. Since real estate developers have already paid taxes on profits recognised earlier in its regular course under the PoCM method, it would be unfair to expect the taxpayer to pay tax again on the re-recognition of income when transferring control. The real estate industry is struggling with the lack of an express provision in the tax laws for the treatment of re-recognition of profits. Ideally, the transition to a new Ind AS should be tax neutral and not result in adverse tax consequences for taxpayers. In addition, on the basis of a cardinal principal of law that the same income cannot be taxed twice, any income that has already suffered tax in any earlier year(s), should not be included subsequently for determining the taxable income of a taxpayer. However, in the absence of any express provision or guideline, there remains ambiguity in the real estate industry on the treatment of income re-recognised in subsequent years.

The Magnitude of the Issue: 

The sector is already suffering from the global slowdown in the real estate industry and reform measures such as the implementation of The Real Estate (Regulation and Development) Act, 2016  and the Benami Transactions Act. If the industry must face adverse tax consequences on the transition to Ind AS 115, it would have a tremendous impact on the real estate sector, which may prove detrimental to the Indian economy.    In accordance with the intent of the Government to improve the ease-of-doing-business in India, the Central Board of Direct Taxation should quickly issue a clarification and lay this issue to rest.  

Authors:

Hiten Kotak – Leader, M&A Tax PwC India

 Annu Gupta – Partner, M&A Tax PwC India

Disclaimer: The views expressed in this article are personal. This article includes inputs from Ruchi Jain – Director, M&A Tax, PwC India and Prateek Aggarwal, Manager – M&A Tax, PwC India.