The real estate sector in India presents complex questions regarding the timing and method of revenue recognition. With the introduction of Section 43CB of the Income Tax Act, 1961, which mandates revenue recognition using the Percentage Completion Method (PCM) for certain contracts, developers and contractors alike face scrutiny from tax authorities. However, a crucial distinction exists between a real estate developer and a construction contractor, which must be understood to ensure accurate compliance and avoid unintended tax liabilities.
The decision in Aaryan Buildspace LLP vs. ACIT by the Ahmedabad bench of the ITAT throws light on this distinction and underscores the importance of aligning one's accounting method with the commercial substance of transactions. This article analyzes the case, clarifies the scope of Section 43CB, and outlines compliance safeguards for stakeholders in the real estate business.
Case Background
Aaryan Buildspace LLP, a real estate developer, filed its return for AY 2018–19 declaring a total income of ₹1.92 crore. The firm was engaged in the development of a residential project named “Aryan Opulence” on self-owned land. It recognized revenue based on the actual transfer of possession and execution of registered sale deeds, in line with Accounting Standard-9 (AS-9) and the ICAI’s Revised Guidance Note on Accounting for Real Estate Transactions (2012).
During the scrutiny assessment, the Assessing Officer (AO) rejected this method and applied Section 43CB of the Act, which mandates PCM for revenue recognition in the case of construction contracts. The AO treated customer advances of ₹28.30 crore as revenue, resulting in an income addition of ₹2.08 crore. However, on appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] deleted the addition. The ITAT affirmed the CIT(A)'s findings, upholding the assessee's accounting treatment.
Does Section 43CB Apply to Real Estate Developers?
Section 43CB, introduced by the Finance Act, 2018, states that the profits and gains from construction contracts or contracts for providing services shall be computed on the basis of PCM as per ICDS notified under Section 145(2).
The issue in this case was whether a real estate developer—who owns land, builds property, and sells units to customers—falls within the definition of a "contractor" under Section 43CB.
Judicial Analysis and Rationale
1. Commercial Substance: Developer vs Contractor
The Tribunal emphasized that a real estate developer operates on a fundamentally different model compared to a contractor. A developer assumes both the ownership and the associated risks of the project, makes capital investment, and sells units as goods (inventory). Revenue recognition in such a business is governed by the sale of goods principles, not by service contract principles.
In contrast, a contractor does not own the underlying asset being developed. Their income arises from rendering services under contractual terms, which often include milestone payments and client certifications—hallmarks of construction contracts under Section 43CB.
2. Recognition as per AS-9 and ICAI Guidance is Valid
The assessee had followed AS-9 and the ICAI Guidance Note, which provide that revenue in real estate is recognized upon the transfer of significant risks and rewards—usually at the time of registration and possession. This method is long accepted in law and practice, and cannot be discarded arbitrarily unless shown to distort income.
The AO did not demonstrate that the method employed by the assessee failed to reflect true profits or that there was any suppression of income. Thus, the Tribunal held that Section 43CB could not override the accepted revenue recognition method for a real estate developer.
3. Consistency and Past Acceptance
The method of accounting had been consistently followed and accepted in past assessments (e.g., AY 2015–16 and 2017–18). As per judicial precedent, once a method of accounting is regularly employed and shows a true and fair picture of profits, it cannot be rejected without cogent reasons.
Avoiding Revenue Recognition Pitfalls
For professionals and businesses in the real estate sector, the case offers important compliance insights:
A. Clearly Define Your Business Model
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If you own the land and construct buildings to sell as completed units, your role is that of a developer.
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If you undertake construction for others, based on contracts and specifications, you are a contractor and PCM under Section 43CB may apply.
B. Maintain Documentary and Legal Clarity
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Land ownership records, development agreements, and sale deeds should clearly indicate the nature of the transaction.
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Avoid entering into agreements that mimic construction contracts unless that is the actual intent.
C. Follow Recognized Accounting Standards
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Continue to apply AS-9 or IND-AS 115, as relevant.
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Refer to the ICAI Guidance Note (2012) for consistency, especially in cases involving self-owned projects.
D. Ensure Consistency and Audit Trail
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Deviations from previous years’ accounting policies must be justified.
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Ensure that auditors, project approvals, and sale documents align with the chosen method.
E. Respond Proactively During Scrutiny
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Be prepared to defend your method by explaining the commercial nature of your transactions.
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Use prior year assessments as supporting evidence where the same method was accepted.
Conclusion
The Aaryan Buildspace LLP case is a significant reaffirmation that real estate developers are not automatically bound by Section 43CB. The ruling emphasizes the need to understand the underlying legal character of transactions, rather than rely solely on payment structures or contractual terminology.
For real estate businesses, aligning accounting policies with true business substance, adhering to established guidance notes, and ensuring consistency and documentation is the key to both accurate tax compliance and avoiding disputes. Section 43CB is a powerful provision, but it is not a blanket rule for all builders. Knowing when it applies—and when it does not—can make all the difference.
