S. 145 — Entire amount of time-share membership fee receivable by assessee upfront at time of enrolment of a member is not income chargeable to tax in initial year on account of contractual obligation fastened to the receipt to provide services in future

The assessee was in the business of selling time share units
in its various resorts. It granted membership for a period of 25/33 years on
payment of a certain amount as membership fee. During the currency of the
membership, the member had a right to holiday for one week in a year at the
place of his choice from amongst the resorts of the assessee. He also had a
right to transfer, bequeath or gift his membership/time-share unit to any
person. The membership fee was received either in lump sum or in instalments. In
addition to the membership fee, the member was liable to pay annual maintenance
charges, irrespective of whether he made use of the resort or not. These charges
were for the maintenance and upkeep of the various resorts. Additional payment
towards utilities like electricity, water, etc. was payable if the resort was
utilised. The assessee was following the mercantile system of accounting. It
treated the membership fee as revenue receipt. However only 40% of the amount
received was offered for taxation in the year of receipt and the balance was
equally spread over the period of membership of 25 or 33 years on the ground
that it was relatable to the services to be offered to the members. The
Assessing Officer (AO) held that as per the accrual system of accounting, the
entire receipt had to be assessed as income in the year of receipt; the Act does
not recognise the concept of deferred income. He made an addition of 60% of the
receipts shown by the assessee as advance subscriptions.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
upheld the contentions of the assessee and deleted the addition in all the
years.

Aggrieved, the Department preferred an appeal to the
Tribunal. At the instance of the assessee a Special Bench was constituted to
consider the following question :

“Whether the entire amount of the time-share membership fee
receivable by the assessee upfront at the time of enrolment of a member is the
income chargeable to tax in the initial year when there is a contractual
obligation fastened to the receipt to provide the services in future over the
term of the contract ?”

(i) From the observations of the Supreme Court in E. D.
Sassoon & Co. Ltd v. CIT, (26 ITR 27) (SC), it is evident that two conditions
are necessary to say that income has accrued to or earned by the assessee.
They are, (i) it is necessary that the assessee must have contributed to its
accruing or arising by rendering services or otherwise, and (ii) a debt must
have come into existence and he must have acquired a right to receive the
payment. In the present case, a debt is created in favour of the assessee
immediately on execution of the agreement. However, it cannot be said that the
assessee has fully contributed to its accruing by rendering services. The
assessee is bound to provide accommodation to the members for one week every
year till the currency of the membership. Till the assessee fulfils its
promise, the parenthood cannot be traced to it.

(ii) The argument of the assessee that the main reason to
spread the balance amount of membership fee over the tenure of membership was
due to the fact that the assessee has to incur heavy expenditure for the
upkeep and maintenance of its resorts was not accepted since the assessee was
collecting separate charges for maintenance and use of utilities and therefore
it was held that matching concept cannot be pressed into service with regard
to the membership fee.

(iii) If the assessee is not able to provide accommodation
in any of its notified resorts, it will try to procure alternate
accommodation. This also will entail additional expenditure on the part of the
assessee over and above paying liquidated damages to the assessee. Unlike the
case in Calcuta Co. Ltd. (37 ITR 1) (SC), the liability in this case is
difficult not only to quantify but also to reasonably estimate it. The
liability is undoubtedly there. However, no scientific basis has been brought
to our notice to quantify the same even reasonably. Even if the assessee had
chosen to provide for the liability every year to comply with the matching
concept, it would have been wholly unscientific and arbitrary.

(iv) In the case of Rotork Controls India, 314 ITR 62 (SC),
the Supreme Court has observed that a provision is recognised when (a) an
enterprise has a present obligation as a result of a past event; (b) it is
probable that an outflow of resources will be required to settle the
obligation; and (c) a reliable estimate can be made of the amount of the
obligation. If these conditions are not met, no provision can be recognised.
In the present case, the assessee has a present obligation as a result of a
past event and outflow of resources is probable to settle the obligation.
Thus, first two conditions are satisfied. However, considering the nature of
activity, it is the third condition which is difficult to satisfy.

(v) Recognising the entire receipt as income can lead to
distortion. Somewhat similar, though not exactly identical, situation was face
by the Supreme Court in the case of Madras Industrial Investment Corporation
Ltd. v. CIT, 255 ITR 802 (SC). The only difference is that in the case of
Madras Industrial Investment Corporation the distortion was supposed to be on
account of expenditure, in the present case the distortion is on account of
the entire income being accounted in the year of receipt.

(vi) Since it is difficult to estimate the liability which
is likely to be incurred in future, more so in the absence of any scientific
basis or historical data, the only way to minimise the distortion is to spread
over a part of the income over the ensuing years.

(vii) The entire amount of time-share membership fee
receivable by the assessee upfront at the time of enrolment of a member is not
the income chargeable to tax in the initial year on account of contractual
obligation that is fastened to the receipt to provide services in future over
the term of contract.