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Background
In a recent judgement in the case of Mahindra Holidays
& Resorts (India) Ltd.1, the Special Bench of the Chennai Income-tax Appellate Tribunal (“the Tribunal”) has held that the entire timeshare membership fees receivable by the assessee upfront at the time of enrolment of a member is not income chargeable to tax in the initial year. This is on account of a contractual obligation that is attached to the receipt to provide services during the term of the membership contract.
Facts
The assessee company is in the business of selling timeshare units in its various resorts. During the previous year ending 31 March, 1998 relevant to assessment year (“AY”) 1998-99, the assessee declared a loss that was assessed under section 143(3) of the Income-tax Act, 1961 (“the Act”). During that year, the assessee had recognised timeshare income to the
1 ACIT v. Mahindra Holidays & Resorts (India) Ltd. [2010-TIOL- 262-ITAT-MAD-SB]
extent of INR 94.5 millions against the actual collection of INR 235.6 millions. The difference of INR 141.1 millions was shown under the heading “Deferred Income-Advance towards members’ facilities”. The assessee collected annual maintenance charges from the members. These charges covered the maintenance costs of the resort and did not cover major renovation and repairs. The assessment was reopened under section 147 of the Act.
In re-assessment proceedings, the assessing officer (“AO”) questioned the treatment to the deferred income given by the assessee and proposed to tax the same in the year of receipt itself. The assessee contended that only a portion of the amount attributable to the current year is recognised as income, the balance is deferred over the term of the membership contract and which however, represented lumpsum timeshare collection from the members. The AO proceeded to add a sum of INR 141.1 millions to the total income of the assessee for AY 1998-99 in this regard.
Entire timeshare membership fees not taxable in the year of receipt since service is rendered over a period of time Tax & Regulatory Services
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Aggrieved by the AO’s action, the assessee appealed to the Commissioner of Income- tax (Appeals) (“CIT(A)”), who accepted the assessee’s contentions and reversed the order passed by the AO. The Income-tax Department proceeded to contest the order of the CIT(A) before the Tribunal. A Special Bench of the Chennai Tribunal was constituted to decide on the matter.
Issue
“Whether the entire amount of time-share membership fee receivable upfront by the assessee at the time of enrolment of a member chargeable to tax in the initial year, itself when there is a contractual obligation attached to the receipt to provide services during the term of the membership contract?”
Assessee’s contentions
Before the Tribunal, the assessee raised the following contentions:
• In order to provide various facilities to the members during the term of the contract, the assessee had to incur expenditure towards transfer facility from one resort to another, split, accumulation and advancing facility, domestic and international exchange, transmission, upgrading, and so on.
• The assessee had to incur about 171% of the original investment for major renovation and replacement of assets.
• When the statute requires that income, profits and gains should accrue, arise or be received in the previous year, it contemplates three different points of time at which they can possibly be brought to charge. The actual charge being made at such a time as the assessee’s method of accounting warrants.
• The term ‘expenditure’ includes a liability which has accrued or which has been incurred, even if it is to be discharged at a future date. Where the liability is a continuing one, the amount of expenditure, if allowed in one year would give a distorted picture of the profits of a particular year. Therefore, the liability should be spread over the benefit of such benefit. A similar analogy could be drawn with regard to the term ‘income’.
• The accounting treatment followed by the assessee was in line with Accounting Standard – 9 on “Revenue Recognition” issued by the Institute of Chartered Accountants of India.
Revenue’s contentions
• There is no note in the financial statements explaining the basis of bifurcation between income and advance subscription.
• The assessee was collecting annual maintenance charges separately from its members which covered the maintenance costs of the resort.
• The Act did not recognise the concept of deferred income.
• The assessee was not under any contractual or other obligation to provide the facilities as all the requests for holidays by customers were subject to availability.
• Before the Madras High Court, in a service tax matter, the assessee had averred that the Company had no further service to be rendered once the contract and enrolment of a new member was executed.
Tribunal Ruling
• The Tribunal held that it is not justifiable to tax the entire income in a single year, i.e.
at the time of enrolment as a member. In doing so, the Tribunal was guided by the following factors:
- There are two conditions that are necessary for income which has accrued to or earned by, the assessee:
i) The assessee must have contributed to its accruing or arising by rendering services or otherwise;
ii) A debt must have come into existence and it must have acquired a right to receive the payment.
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In the present case, the Tribunal held that the assessee cannot be said to have fully contributed to its accruing by rendering services. The assessee was bound to provide accommodation to the members for one week every year for the duration of the membership. Until the assessee fulfills its obligation, the revenue cannot be recognised completely.
- The assessee had a present obligation (to provide accommodation) as a result of a past event (enrolment of members).
Conclusion
The ruling of the Special Bench is significant, especially when various assessees are involved in tax litigation on the issue of revenue recognition in general and of deferred income in particular. This ruling offers guidance on the taxability of deferred income.
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