By TIOL News Service

CHENNAI, FEB 10, 2014: THE issue before the Bench is - Whether when agreement which assessee entered into gets terminated, all expenses relating to such agreement is allowable as revenue expenditure. And the answer is YES.

Facts of the case

The assessee is engaged in the business of Realtor and Contractor. It used to enter into agreements with parties in need of huge parcel of land for construction and development work, for aggregating small pieces and finally handing over to them. Assessee entered into an agreement with ‘M’ for sourcing and aggregating land to the extent of 52 acres. On the basis of this agreement, the assessee estimated his profit and included the same amount of profit in the original return at Rs. 3.46 crores. Subsequently a revised return was filed at Rs. 34.24 lacs. The return was revised on the basis that the sale agreement entered into between the assessee and has been frustrated and the agreement was not materialized in accordance with the terms of the agreement. Later on, the agreement itself was cancelled.

AO did not accept the revised return observing that as against the overall extent of 52 acres of land, the assessee has already procured 13.12 acres and therefore, the agreement was in full force and in such circumstances, a loss cannot be anticipated as argued by the assessee. Revised return can be filed only if the assessee discovers any omission or any wrong statement in the original return. There is no such omission or a wrong statement and therefore, there is no valid ground to file a revised return.

Before CIT (A), assessee contended that income from the activity of sourcing of land could be treated as an accrued or arisen only when the assessee procured the entire area of land as required by the property developers. Assessee made a mistake by offering the amount and it was an error committed by the assessee. Neither there was any purchase of land nor was any sale of land. The land was only identified and sourced on behalf of the property developer. It is after realizing this error return was revised.

CIT (A) observed that AO has not brought on record any sale agreement or power of attorney executed by the assessee in the name of ‘M’ to state that the land was handed over to the company and the sale proceeds were received by the assessee. Even during the course of survey, no document seized showing when the sale transaction occurred between the assessee and ‘M’. Assessee has shown the advance as his sales turnover and it was a mistake on the part of the assessee to do so as the transaction was not executed in full. As the entire transaction of sale was cancelled, there is no chance for the assessee to generate any income. Thus, CIT (A) held to exclude the amount shown as profit in the original return and accept revised return but disallowed the corresponding expenditure claimed by assessee.

Revenue contended that filing of a revised return is directly governed by the provisions of law stated in Section 139(5) which provides for filing of a revised return only if any of the two conditions are satisfied. Those conditions are that the assessee must discover any omission or any wrong statement in the original return filed before the AO. In the present case, there is no case of any omission. Assessee had sourced 13.2 acres against total extent of 52 acres, which shows that during the previous year relevant to assessment year under appeal, the assessee was executing his obligations and subsequent cancellation was in subsequent year. The agreement was terminated and the assessee had to suffer loss, the assessee could claim the loss in the return filed in the subsequent assessment year. In anticipation of the loss that might happen in the subsequent assessment year, the assessee cannot withhold the income earned in the impugned assessment year.

Assessee contended that income does not generate out of an entry passed in the books of accounts. The income liable for taxation must be real and actual income. Accrual of income does not mean income arising out of wrong presumption. In the present case, as the whole agreement the assessee had earned into with ‘M’ has been terminated, there was no occasion to earn any income from any deal.

After hearing both the parties, the ITAT held that,

++ the assessee had entered into an agreement for the purpose of procuring and aggregating land. But, later on, the parties deferred on implementation of agreement and finally the agreement was terminated after the closure of the relevant previous year. Termination of agreement is not happening on a fine morning. Difference arises between the parties and they negotiate for some time and it is only after a reasonable period that the formal termination agreement would be executed. By the time the termination agreement is executed, the assessee is well aware of the fact that the agreement is not going to be executed or if it is going to be terminated on the other hand and as such, the assessee is not going to earn any income from the agreement. The assessee already had this knowledge before completing the assessment and at the time of filing the revised return, therefore, at the first instance in the original return, even if the assessee had estimated profit out of the agreement entered into with ‘M’, immediately after understanding that the agreement would not be executed, he filed the revised return. Even though the formal termination agreement was executed later on, the assessee was very well aware before the completion of assessment that the income stated in the original return was wrong. In that way, the original computation of income filed by the assessee was “wrong statement”. When that is so, the case of the assessee is covered by Section 139(5) which enables him to file a revised return to state the real income available in hands, for the purpose of assessment for the impugned assessment year. If no income is likely to arise in the hands of the assessee, there is no fun in estimating income hypothetically on the basis of accrual concept. In the present case, before the completion of assessment and before the expiry of time available for filing of revised return, the assessee observed the wrong statement made in the original return and revised the return by stating the correct income liable for taxation. Therefore, the revision made by the assessee is justified;

++ CIT (A) disallowed the expenses observing that income is excluded thus corresponding expenditure is to be excluded. Even though the agreement was vitiated, the expenses have been incurred by the assessee in the course of carrying on of his business. It is the business of the assessee to enter into agreements with big parties for procurement of large parcels of land. Sometimes, certain agreements may fail and assessee would not get any income at all from the particular agreement. That does not mean that the corresponding expenditure incurred by the assessee on such cancelled agreements were not expenses incurred for the purpose of business. What is spent is spent. Thus, the expenditure is allowed.

(See 2014-TIOL-73-ITAT-MAD)