1.14 Query
Treatment of land development expenditure relating to agricultural farms.
1.A department of the Government of India, which was managing four agricultural farms, was converted into a wholly owned Government company in 1969. One of the main objects of the company is “to set up and run agricultural farms for the production, primarily of seeds of food grains, fibre crops, plantation crops, oilseeds, vegetables and fruits”.
2. Presently, the company is managing 36,715 hectares of land at 11 farms located in different States. Out of these 11 farms, 6 have been taken on lease from the State Government, 5 farms have been purchased by the Government of India, which have been handed over to the company. Out of the 6 farms taken on lease, a lease agreement has already been executed in the case of 2 farms but in the case of other 4 farms it is yet to be executed.
3.The querist has mentioned that the lands taken over by the corporation were arid or marginal lands reclaimed from forests, dry river beds, alkaline soils, undulating or fallow lands without assured irrigation. In order to make these lands fit for cultivation, it was necessary to develop them by various means. Such development included leveling of undulating area, removing of rocky strata, reshaping, removal of tree stumps, chemical amendments and various other operations, both of permanent and temporary nature.
4.The querist has stated that upto 30th June, 1985, the expenditure on land development of permanent nature was treated as deferred revenue expenditure and was written off over a period varying between 20 to 30 years.
5.From July 1985, the accounting policy regarding the treatment of land development expenditure was changed as a result of which the said expenditure has not been written off since the accounting year 1985-86. According to the querist, the accounting policy was changed because of the following reasons:
(i) The Government of India, instead of renewing lease which expired in 1971 with the State Govt., felt that lands should be purchased so that planned investments for optimum returns could be made. Accordingly, lands for 5 farms were purchased by Govt. of India. The querist has further informed that the lands purchased by the Government of India were handed over to the company. The company could not own land beyond a certain limit because of the Land Ceiling Act, but the President of India, i.e., Govt. of India, can own any amount of land without any ceiling. Therefore, the land is owned by the Government. However, for all practical purposes, land will always remain with the company goes into liquidation and not before. Therefore, till the existence of the company these lands will continue with the company.
(ii) The cost which was paid by the Govt. of India for various purchased lands varied from Rs. 250/- per acre for undeveloped lands to Rs. 8,590/- per acre for developed lands. The considerable increase in the value of the land was attributable mainly to change in status of land from uncultivable to highly cultivable due to the efforts of the company by undertaking land development and other recommended agronomic practices.
(iii) While agricultural income is beyond the scope of Income-tax Act, agricultural income attracted Agricultural Income-tax in some States such as Tamil Nadu, Assam, etc. According to the relevant Agricultural Income-tax Acts, any expenditure of capital nature expended wholly and exclusively for the purpose of land is not deductible from the income. The land development write-off as aforesaid claimed by the corporation was disallowed by the Agricultural Income-tax Officer under section 5E of the Act. According to him, such land development expenditure was capital in nature and cannot be deducted. The company, however, contested this decision of the Agricultural Income-tax Officer and appealed to the concerned Agricultural Income-tax Appellate Tribunal. The Tribunal also in their judgement dated 25th March, 1986, upheld the contention of the Agricultural Income-tax Officer and held that land development expenditure is capital in nature and no write-off can be allowed. It was, therefore, clear that land development expenditure had to be treated as capital expenditure. This did not allow proportionate write-off as expenditure.
(iv) In the case of one of its farms, the Lease Deed signed provides that “the lessee (President of India, his successors, representatives, and assignees) may, during the term of said lease and renewal thereof, make and erect such structures and erect thereon such buildings, installations or other works, fittings, fixtures, machinery and equipment, as the lessee may require, provided always that such buildings, installations or other works, fittings and fixtures, installed machinery and equipment shall remain the property of the lessee who shall at the expiration of the term sell the same to the lessor at depreciated value.” But in case of recovery of amount relating to land development expenditure, no specific mention has been made. Since no depreciation is allowable on such developed land, in the opinion of the company, the land development expenditure becomes fully recoverable from the State in case of reversion of land to the State Govt. This claim will only be tenable if the value appears in the financial statements, otherwise the total expenditure on land development will be lost on reversion to State Governments.
(v) In all draft lease deeds being submitted in case of other farms to the State Govt. for lease of lands by the company the condition that land development will be charged without depreciation in case of reversion is being specifically included to remove any ambiguity on this issue.
(vi) According to International Accounting Standards No. 4 on Depreciation Accounting, land normally has an indefinite life and is not usually regarded as a depreciable asset unless mining is undertaken. Hence any permanent improvement to the land also becomes a part of the cost of the land and is not subject to depreciation.
6.The querist has further advanced the following arguments in support of the aforesaid change in the accounting policy. (i) The development work has involved huge costs creating capital assets as lot of qualitative values have been added into those lands making them immediately fit for cultivation. According to the querist, the concept of enduring advantage is well known in the field of Jurisprudence. The Supreme Court of India has recently, in the case Alembic Chemical Works company vs. C.I.T. (1989) 43 Taxman 312, taken the view that an expenditure would be treated on capital account where an enduring advantage is received only if it is in the capital field. Also, the Courts have taken the following decisions:
(a) If the expenditure is for the initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to the business that is being carried on or for extension of the business that is going on or for substantial replacement of an existing business asset, it would be capital expenditure [In Hylm Ltd. (1973) I.T.R. 326]
(b) Amount spent for filling-up the pit in the mills’ leasehold premises [Gopal Mills Co. Ltd. Vs. CIT (1952) ITR 188 (Mad.)]
(c) Amount spent for reclaiming/filling-up ditches, raising the plinth and construction of a wall on a piece of land over which licence had been granted to the assessee to install petrol pump by an oil distributing company [Veeraraghavan Vs. CIT (1976) ITR 63 (Ker.)]
(ii) The querist has pointed out that such development expenditure is of the nature of “Once for All” expenditure which is incurred for making the capital asset fit for its normal use. According to the querist, these qualitative values are always intangible assets and certainly not of fictitious nature. These qualities are not of depreciable nature in the view of the querist. All these activities have brought these lands from uncultivable nature to cultivable nature. As such, the changes brought are surely of permanent nature. Thus, the expenses incurred on these activities should not be treated as of revenue nature, deferred revenue, or book debts, but should be treated as of capital nature but not depreciable. Once these lands are being treated as cultivable lands and any expenditure on maintaining their nature during subsequent years should only be treated as of revenue nature/deferred revenue nature.
(iii) The querist has also referred to Accounting Standard 6 on ‘Deprecation Accounting’, issued by the Institute of Chartered Accountants of India, wherein, ‘Depreciation’ has been defined as a measure of the wearing out, consumption, or other loss of value, of a depreciable asset arising from use, effluxion of time or obsolescence through technology or market changes. The querist has argued that in the present case the asset created by development work is not of a depreciable nature, the qualities added by the development work do not wear out, nor are these qualities consumed by effluxion of time or obsolescence through technology or market changes.
(iv) The Accounting Standard states, according to the querist, that depreciation to be charged in an accounting year is usually based on the three factors viz., (1) historical cost, (2) expected useful life, and (3) estimated residual value. In the present case, only the historical cost can be properly quantified, the expected useful life in respect of the qualitative values put into the land by the development work is indefinite. According to the querist, such values continue to be inherent and latently possessed by the land. Further, even the estimated residual value of these development expenses resulting into the qualitative values remain the same and is equal to historical cost, as the development work done on the leasehold land which is of everlasting nature shall be continued to be possessed by the said land irrespective of its form of ownership being different, viz., leasehold, freehold, owned by the corporation, State Government, etc.
(v) The querist has further argued that trying to calculate the expected period during which the benefit from such expenditure is likely to arise would be absurd as the land would continue to enjoy these benefits for everlasting period, as said cultivable lands would not become once again rocky, marginal land, etc., and acquire their uncultivable nature which was present before these development expenses.
7. The accounts for 1985-86 were prepared on the basis of the new accounting policy and a note of the change in accounting policy was indicated in the accounting policies forming part of accounts and in the notes appended to those accounts as follows:
“The land development expenditure represents expenditure incurred on Farm site and has been treated as Fixed Assets from 1985-86. No depreciation has been provided from the year, being the development carried out by the corporation is of permanent nature.”
8. The accounts were duly certified by statutory auditors as well as Govt. Auditors (CAG-Com.) with “NIL” comments. The Government Audit in their Memo had earlier taken a stand that if the above accounting policy is to be implemented, then the land development expenditure written off during the earlier period amounting to Rs. 174.8 lakhs should also be written-back. Thus, there was a consensus with the change in accounting policy.
9. According to the querist, the accounts for 1986-87 were prepared on the basis of the aforesaid accounting policy of 1985-86 as to the land development expenditure. An objection was raised by the CAG – Commercial Audit, stating that land development expenditure should be written-off. The reasons advanced for this objection are as below:
(a) According to the accounts manual of the company this expenditure comprised expenditure on
i) Reclamation of thick jungle land which has not come so far under cultivation
ii) Lay out
iii) Channel Making
iv) Kacha Roads, and
v) Making of the farms and horticultural development expenses.
It was pointed out that the expenditure on the above items can not be termed as the expenditure of permanent nature and it was rightly being treated as deferred revenue expenditure till 1984-85 and was being written-off over the balance period of leased lands and in 20 years in the case of land purchased by the Govt. of India.
(b) While approving this accounting policy vide item 4 of 109th Board meeting, the Board decided that “on the expenditure on development of land, which is of permanent nature, no depreciation be charged as it adds to the value of land”. The Board’s decision regarding the treatment of this expenditure on the development of land, which does not belong to the company, of permanent nature is against the normally accepted accounting principles. In case this expenditure adds to the value of land, which belongs either to the State Govts. or the Govt. of India, this expenditure should have been shown as recoverable from the lessor/Govt. of India as the case may be.
(c) The company has not been successful in recovering the amount of Rs. 24.80 lakhs representing land development expenditure in a case in which the land was returned to the lessor in 1976. The company has provided the above amount of Rs. 24.80 lakh as doubtful of recovery during the current year.
(d) The land on which the land development expenditure has been incurred is not in the name of the company in lease agreements in respect of all the farms except two in respect of which the agreements are yet to be finalised. Thus, even on the basis of appreciation accounting, the company can not increase the value of land as it is not being shown in the fixed assets of the company. Thus, land development expenditure which is an intangible asset should be appropriately classified as deferred revenue expenditure for being written off during the currency of the lease period.
(e) According to Schedule VI to the Companies Act, 1956, intangible assets like goodwill, patterns, designs, trade marks and patents can be shown under fixed assets but “development expenditure” is required to be depicted under “Miscellaneous expenditure pending adjustment”. Land development expenditure is certainly of the nature of development expenditure.
(f) The Committee constituted by the Bureau of Public Enterprises to develop accounting policies for Central Public Enterprises observed, vide para 9.7 of Chapter 9 of their Report, as under: –
“Public enterprises often incur capital expenditure for assets which do not belong to them, e.g., the cost of roads, but are incurred for the purpose of facilitating their business. In such a case the expenditure so incurred should be treated in the books of account as a capital expenditure and classified as a fixed asset. The description of such item on the balance sheet should however clearly indicate that the capital expenditure is not represented by any assets owned by the company. The capital expenditure should be written-off over the approximate period of its utility but not exceeding normally five years”.
(g) The company has not so far taken over Horticulture costing Rs. 6,87,433 from the Govt. of India pending lease agreement/Govt. of India’s decision. This expenditure represents development expenditure, pertaining to the land in respect of a farm, incurred by the Govt. of India before the incorporation of the company. In view of the above, it is not clear as to how the company expects the lessor to take over and pay for the land development expenditure incurred by the company to facilitate its own business of farming.
10. With regard to para 9(c), the querist has clarified that in this case the company left the development work in-between because there was no availability of water. Therefore, there was no potential for agricultural activity in the land. Till the company left the job, it incurred the expenditure on development work amounting to Rs. 24.80 lakhs. Development expenditure could not be recovered from the Government because work was left in-between. However, in this case, the company is sure to recover the money from Central Government (The querist has submitted a copy of the letter written in this regard). In case of completely developed farms, money will be recovered from the lessor at the time of handling over of the farms to the lessor, after the expiry of the lease.
11.The querist has sought the opinion of the Expert Advisory Committee on the following issues with regard to treatment of land development expenditure:
(i) Whether non-writing off of proportionate land development expenditure every year on the above facts is a correct accounting policy adopted by the company; and
(ii) Whether the accounting policy adopted by the company to show the land development expenditure as capital expenditure, where the land does not belong to the company and is not being shown as an asset of the company since either it belongs to the Government of India or is on lease, is correct.
Opinion April 5, 1989
1.The Committee notes that in the present case, three types of land have been held by the company, viz.,
(i) Land purchased by the Government of India and handed over to the company, and which will revert to the Government only on the liquidation of the company [Refer para 5(1) of the query].
(ii) Leasehold land in respect of which lease agreement contains a clause that in case of termination of lease, the lessor will have to pay the cost of development incurred by the company.
(iii) Leasehold land the lease agreement in respect of which does not contain the clause mentioned at (ii) above.
2.The Committee is of the view that only that land development expenditure which is incurred to provide advantage of enduring benefit to the business is basically a capital expenditure. (For instance, expenditure incurred on ploughing, harrowing etc., incurred prior to the use of land for cultivation purposes for the first time should be capitalised and not every time such activities are carried out). The Committee, however, notes that it is a well accepted principle of accounting that, “the cost of an item of fixed asset comprises its purchase price, including import duties and non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use…..” [para 9.1 of Accounting Standard (AS) 10 , “Accounting for Fixed Assets”, issued by the Institute of Chartered Accountants of India]. The Committee further notes that the ‘Guidance Note on Treatment of Expenditure during Construction Period’, issued by the Research Committee of the Institute of Chartered Accountants of India, recommends in para 9.6 that “…. any part of the expenditure on levelling, clearing and grading the land which is incurred for purposes of land-scraping or for any other purposes, not connected with the construction of the project, should be treated as cost of land.” Since the development expenditure (excluding any infructuous expenditure) incurred on the agricultural land is directly attributable cost of bringing the land to its working condition for its intended use, i.e., to make it fit for cultivation, the said expenditure should be capitalised as part of land itself.
3.With regard to the land mentioned in para 1(i) above, i.e., the land purchased by the Government which has been handed over to the corporation, would revert to the Government only in the event of the liquidation of the corporation. Thus, for all practical purposes, i.e., in ‘substance’ this land is the asset of the corporation although in ‘form’ it belongs to the Government. According to the ‘substance over form’ consideration of preparation of accounts, this land should be shown as an asset in the balance sheet of the corporation, with appropriate disclosure that the land is owned by the Government. The corporation might have obtained land from the Government at a concessional or at a nominal rate. Since the financial accounts are drawn on the historical cost basis, the fixed assets may not be revalued. In case of fixed asset acquired by way of an outright gift, a nominal value may, however, be assigned thereto, the basic concept being to treat the fixed asset on historical cost basis. Alternatively, the fixed asset may be revalued with the help of an authorised valuer and the difference in the cost and the value may be credited to the “ Capital Reserve Account.” [Para 11 of ‘Guidance Note on Accounting for Capital Based Grants’, issued by the Research Committee of the Institute of Chartered Accountants of India]. In case the corporation has not paid anything to the Government in respect of the said land, it should be shown in its balance sheet at a nominal value of Re. 1/- keeping in view the historical cost concept or at its fair market value as on the date of handing over to the corporation with a corresponding credit to capital reserve not to be distributed as dividend. The land development expenditure should then be added to the cost so arrived at. Accordingly, no depreciation has to be provided in respect of such land as the land has indefinite life. In brief, in all the aforesaid types of land mentioned in para 1 above, the development expenditure cannot be shown separately as a fixed asset but should form a part of the cost of land itself.
4. Regarding leasehold land, the lease agreement in respect of which contains a clause providing for recovery of development expenditure from the lessor on termination of lease, the relevant development expenditure should be first added as cost of the leasehold land as per (i) above. Cost of the land so arrived at minus the residual value, i.e., the recoverable development expenditure, should be written-off as depreciation over the lease term.
5. Where the expenditure incurred on development of land becomes a part of the leasehold land as per para 3 above, it should be written off as part of cost of leasehold land over the life of the lease, in view of the fact that the said land has limited useful life*.
6.The Committee is also of the view that infructuous expenditure incurred on the land, i.e., the expenditure which is not expected to generate future benefits should not be capitalised but should be written off in the year in which it is determined or in case the amount involved is too large, it might be treated as a deferred revenue expenditure to be written off in three years or so.
7. On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 11, is as below:
(i) The treatment of land development expenditure made by the corporation is not proper. The expenditure should be treated as suggested in paras 2 to 6 above.
(ii) The accounting policy adopted by the company to show the land development expenditure separately as capital expenditure in all types of land is not an acceptable accounting policy. ____________________________________________________________________________ * Accounting Standard (AS) 6, on ‘Depreciation Accounting’ is applicable to land if it has a limited useful life for the enterprise. |