The Income Tax Appellate Tribunal, Mumbai, has clarified a critical principle in real estate taxation: interest on borrowed funds used to acquire land for development qualifies as a deductible business expense under Section 36(1)(iii) of the Income Tax Act, provided the land is held as inventory and not as a capital asset. This decision resolves long-standing ambiguity for developers and reinforces the distinction between capital and revenue expenditures in project-based businesses.
Background & Facts
The Dispute
The appellant, Welkin Developers, is a real estate development company engaged in the acquisition and development of land for residential and commercial projects. The dispute arose from additions made by the Assessing Officer (AO) for Assessment Years 2018-19 and 2019-20, concerning three key issues: (1) an alleged under-reporting of project profit, (2) deemed sales of unsold parking spaces, and (3) disallowance of interest paid on loans used to acquire land at Ghansoli.
Key Facts
- The assessee acquired land at Ghansoli through advance payments to CIDCO Ltd. for development purposes.
- For A.Y. 2018-19, the assessee paid Rs. 21,40,41,673.82 as advance for land acquisition.
- Interest of Rs. 79,42,978/- was paid to Indiabulls Finance on unsecured loans used for this land acquisition.
- The interest was capitalized under Work-in-Progress (WIP) in the books of account.
- The assessee’s books were audited by a Chartered Accountant and filed under Section 139(1).
- A survey was conducted on 15.01.2019, during which a statement was recorded from a partner.
- The project for which land was acquired received an Occupancy Certificate (OC) prior to the assessment.
- The assessee maintained five parking spaces as part of the project inventory.
- One parking space was sold for Rs. 2,00,000/-; the remaining four were claimed to be unsold.
- The AO valued each unsold parking space at Rs. 5,00,000/- and treated them as deemed sales.
- The AO computed a net profit of Rs. 41,14,625/- for the Welkin Star project based on survey statements, without rejecting the books of account.
Procedural History
- 15.01.2019: Survey conducted by Income Tax Department; statement recorded from assessee’s partner.
- 27.05.2021: AO passed assessment order for A.Y. 2018-19 under Section 143(3), making additions of Rs. 41,14,625/- (profit), Rs. 20,00,000/- (parking sales), and Rs. 79,42,978/- (interest disallowance).
- 28.09.2021: AO passed assessment order for A.Y. 2019-20 under Section 143(3), making similar additions.
- 05.07.2025: Commissioner of Income Tax (Appeals) [Ld. CIT(A)] upheld all additions.
- 09.03.2026: Hearing before ITAT Mumbai.
- 16.03.2026: Judgment pronounced.
The Parties' Positions
For the Assessee (Welkin Developers):
- Argued that the books of account were duly audited and followed the mercantile system.
- Contended that interest on land acquisition was correctly capitalized under WIP as land formed part of business inventory.
- Denied sale of four parking spaces and challenged the AO’s valuation as speculative.
- Argued that the profit addition of Rs. 41,14,625/- was based solely on a survey statement, without verifying actual expenses.
- Relied on Ashish Land & Property Developers v. ITO (ITA No. 907/Mum/2020) and CCIT v. Ceebros Hotels P. Ltd. (2022) 440 ITR 200 (Mad).
For the Revenue (Assistant Commissioner of Income Tax):
- Maintained that land acquisition was a capital activity and interest was not deductible until the asset was "put to use."
- Argued that the four unsold parking spaces should be treated as deemed sales based on survey documents and internal valuation.
- Contended that the profit addition was justified as the assessee had recognized revenue but not the corresponding profit.
- Asserted that the assessee failed to produce stock records to prove non-sale of parking spaces.
Relief Sought
The assessee sought:
- Deletion of the addition of Rs. 41,14,625/- on under-reported profit.
- Deletion of the addition of Rs. 20,00,000/- on deemed sales of parking spaces.
- Allowance of interest expenditure of Rs. 79,42,978/- under Section 36(1)(iii).
- Deletion of the addition on closing stock valuation (Ground No. 3, not pressed).
The Legal Issue
The central question was whether interest paid on borrowed funds for acquisition of land by a real estate developer qualifies as a deductible business expense under Section 36(1)(iii), when the land is held as inventory and not as a capital asset, and whether the proviso to Section 36(1)(iii) applies to such inventory.
Arguments Presented
For the Appellant/Petitioner
The Ld. AR contended that the land acquired by the assessee formed part of its business inventory, not a capital asset. Citing Ashish Land & Property Developers v. ITO and CCIT v. Ceebros Hotels P. Ltd., the appellant argued that the purchase and holding of land for development is a core business activity of real estate developers. The proviso to Section 36(1)(iii), which disallows interest until the asset is "put to use," applies only to capital assets. Since inventory is held for sale in the ordinary course of business, the interest is a revenue expenditure and deductible in the year incurred. The assessee had consistently accounted for the interest under WIP, and the books were audited. The AO’s disallowance was arbitrary and contrary to judicial precedent.
For the Respondent/State
The Ld. DR argued that the land acquisition was a capital expenditure and the interest should be capitalized until the project was completed and "put to use." For A.Y. 2018-19, the land was not reflected as a current asset, indicating it was not yet part of business operations. The revenue relied on the literal interpretation of the proviso to Section 36(1)(iii). However, for A.Y. 2019-20, the Ld. DR conceded that the land was recorded as a current asset and thus the interest should be allowed. The Ld. DR supported the AO’s additions on profit and parking sales, citing lack of documentary evidence from the assessee.
The Court's Analysis
The Tribunal examined the nature of the land acquisition and the legal framework under Section 36(1)(iii). It noted that the assessee is a real estate developer whose business involves acquiring land, developing it, and selling units. The Tribunal emphasized that the Supreme Court and High Courts have consistently held that for such businesses, land is inventory, not a capital asset.
"The purchase of inventory in the course of carrying on business should be reckoned as continuation of same business activity in the normal course and cannot be equated or termed as extension of business activity."
The Tribunal relied on the Madras High Court’s reasoning in Ceebros Hotels, which clarified that the term "put to use" in the proviso applies only to capital assets, not to inventory held for sale. The Delhi High Court in CIT v. Dhoomketu Builders was also cited to affirm that commencement of real estate business begins with land acquisition.
The Tribunal further observed that the Coordinate Bench of ITAT Mumbai in Ashish Land & Property Developers had already settled this issue in favor of the assessee for an earlier assessment year. The facts in the present case were materially identical: land acquired for development, interest capitalized under WIP, audited books, and no dispute on the business nature of the assessee.
Regarding the profit addition, the Tribunal found that the AO had computed net profit suo motu without rejecting the books of account and without providing the assessee an opportunity to explain the basis of the expenses claimed. The AO relied solely on a survey statement recorded in January 2019, while the final books were audited in March 2019. This violated the principles of natural justice.
On the parking spaces, the Tribunal noted that while the assessee admitted the sale of one parking space, it denied the sale of the remaining four. However, the assessee failed to produce stock records or project completion documents to substantiate its claim. The AO’s valuation of Rs. 5,00,000/- per parking space was based on internal documents, but the absence of evidence from the assessee made it impossible to conclude definitively. The Tribunal held that the matter required fresh adjudication with proper opportunity.
The Verdict
The appeal was partly allowed. The addition of Rs. 41,14,625/- on under-reported profit was deleted. The addition of Rs. 79,42,978/- on interest expenditure was allowed for both A.Y. 2018-19 and 2019-20. The addition of Rs. 20,00,000/- on deemed sales of parking spaces was set aside and restored to the file of the Ld. AO for fresh adjudication, with directions to the assessee to produce all stock records and project documents. Ground No. 3 was not pressed. The order was pronounced on 16.03.2026.
What This Means For Similar Cases
Interest on Land Acquisition Is Deductible for Real Estate Developers
- Practitioners can now confidently argue that interest on loans for land acquisition is allowable under Section 36(1)(iii) if the land is held as inventory.
- The proviso to Section 36(1)(iii) does not apply to inventory; it applies only to capital assets like machinery or buildings held for long-term use.
- Developers must ensure land purchases are recorded under current assets or WIP in the balance sheet to substantiate inventory status.
Documentation Is Critical for Unsold Inventory Claims
- Merely denying a sale is insufficient. Developers must maintain and produce:
- Stock registers for unsold units
- Project completion certificates
- Internal valuation reports
- Board resolutions on inventory management
- Failure to produce such records invites adverse inference, even if the AO’s valuation is speculative.
AO Cannot Compute Profit Without Rejecting Books of Account
- The AO cannot make suo motu profit additions without first rejecting the books of account under Section 145(3).
- Survey statements cannot be the sole basis for profit computation if audited books exist.
- Practitioners must raise this as a jurisdictional defect in appeals.
