Short Overview : Mere raising of invoice on the contract would not dipso factor tantamount to accrual of income thus, the claim of assessee for non-taxability of unrealized income or retention money kept in the custody of the contracted as per the terms of the contract could not to be treated as accrued in mercantile system of accounting and as such, expenditure against such income was also allowable though income was not accrued to assessee.
Assessee stated that as per the accounting policy adopted by the assessee, an amount retained/deducted by the contracted to ensure satisfactory fulfillment of obligations arising from contract entered into by the assessee with the contracted was reduced from the gross receipt/turn over while determining the taxable income. The assessee recognized income from the retention money withheld by the contracted in the year of realization by the assessee from the contracted. It was thus pointed out that the refund of security deposit retained as well as refund date, both, being uncertain and contingent, the accounting policy adopted by the assessee was fully justified to determine the true income emanating from the contract in a given financial year. It was observed by the AO that the expenditure claimed by the assessee towards such retention by the contracted were contingent in nature and thus the assessee was not entitled to deduct such expenditure from the gross value of contract. The AO accordingly declined to give benefit of deduction towards retention money etc. from the gross value of contract and consequently added to the total income of the assessee equivalent to such security deposit/retention money. The CIT(A), however, found little merit in the plea of the assessee but declined to interfere with the action of the AO.
It is held that Mere raising of invoice on the contracted would not ipso facto tantamount to accrual of income. The assessee in the instant case, claims that a certain portion of bill had been kept as a lien in the custody of the contracted till the fulfillment of the conditions specified in the contract. Naturally, such retention money would accrue only where the terms of the contract stands fulfilled. In the absence of its accrual, the income cannot be taxed under mercantile system of accounting on a hypothetical basis. There was considerable force in the plea of the assessee. It was not the case of the Revenue that the work under the contract had been completely fulfilled. When seen differently, there was substance in the case made out by the assessee and it had booked the unrealized portion of the bill in the year of realization as and when happened. Therefore, the action of the assessee does not cause any prejudice to the revenue and was tax neutral. Tribunal was thus, inclined to accept the claim of the assessee for non-taxability of unrealized income kept in the custody of the contractee as per the terms of the contract. The order of the CIT(A) was set aside and the AO was directed to delete the disallowance of expenditure of Rs. 1,07,35,959 on this score.
Decision: In asses see’s favor.
IN THE ITAT, RANCHI BENCH
PRADIP KUMAR KEDIA, A.M. & MADHUMITA ROY, J.M.
Urmila RCP Projects (P) Ltd. v. DCIT
I.T.A. Nos. 30/Ran/2017, 48 & 341/Ran/2018
20 January, 2020
Appellant by: Manjeet Verma, A.R.
Respondent by:Inderjeet Singh, Sr. CIT-D.R.
Pradip Kumar Kedia, A.M.
The captioned appeals directed at the instance of assessee arise from the respective orders of the Commissioner (Appeals) (‘CIT(A)’) against different assessment years as tabulated below :–
||Name of assessee
||CIT(A)’s order dated
||AO’s order dated
||AO’s order under section
||Urmila RCP Projects Pvt. Ltd.
||143(3) of the Income Tax Act (in short ‘the Act’)
||143(3) read with section 263 of the Act
- The grievances raised being common, all the cases were heard together and disposed of by the common order.
- We shall first take up assessee’s appeal inITA No. 30/Ran/2017 concerning assessment year 2012-13.
ITA No. 30/Ran/2017 — Assessment Year 2012-13
- As per the grounds of appeal, the assessee has raised two fold grievances (i) additions made by the assessing officer on account of disallowance of expenditure of Rs. 1,07,35,959 and (ii) changeability of interest under section 234B on assessed income amounting to Rs. 17,66,016 instead of changeability of interest on returned income.
- Briefly stated, the assessee is engaged in the business of works contract in the nature of civil contract. The return of income filed by the assessee declaring total income at Rs. 1,23,66,979 was subjected to scrutiny assessment. In the course of assessment, the assessing officerinter alia confronted the assessee as to why expenditure debited to the tune of Rs. 1,07,35,959 towards retention money/security deposited KID, EOT etc. which resulted in reduction of taxable income should not be disallowed. In response, the assessee filed a detailed reply to submit that as per the accounting policy adopted by the assessee, an amount retained/deducted by the contractee to ensure satisfactory fulfillment of obligations arising from contract entered into by the assessee with the contracted is reduced from the gross receipt/turn over while determining the taxable income. As per consistently following accounting policy, the assessee recognized income from the retention money withheld by the contracted in the year of realization by the assessee from the contracted. The assessee justified the aforesaid accounting policy on the premise that having regard to the business experience, refund of security deposits/retention money is solemnly obtained due to various clauses in the contract, such as, quality parameters, performances, guarantee, timely completion and liquidated damages clause and so on and so forth. It was further submitted that, at times, certain obligation arising from contracts, such as, continuous maintenance of assets for fixed period by the assessee is more costly against the amount of security deposits retained by the contracted. In such circumstances, the assessee may opt out and forego the security deposit to avoid fulfillment of such onerous contractual obligations. It was thus pointed out that the refund of security deposit retained as well as refund date, both, being uncertain and contingent, the accounting policy adopted by the assessee is fully justified to determine the true income emanating from the contract in a given financial year.
- The assessing officer, however, was not impressed with the claim of parallel expenditure towards security deposit/retention money against gross value of contract including retention money. It was observed by the assessing officer that the expenditure claimed by the assessee towards such retention by the contracted are contingent in nature and thus the assessee is not entitled to deduct such expenditure from the gross value of contract. The assessing officer also observed that such accountancy practices cannot override the provisions of the Income Tax Act and the destructibility is required to be decided according to the principles of law and not in accordance with such accounting practice. The assessing officer accordingly declined to give benefit of deduction towards retention money etc. from the gross value of contract and consequently added an amount of Rs. 1,07,35,959 to the total income of the assessee equivalent to such security deposit/retention money.
- Aggrieved, the assessee preferred appeal before the Commissioner (Appeals). The Commissioner (Appeals), however, found little merit in the plea of the assessee and thus declined to interfere with the action of the assessing officer making following observations :–
“ Ground No. 4 of the appellant is regarding the addition of Rs. 1,07,35,959 on the ground of expenditure that it was of contingent nature. In this regard the appellant submitted that Rs. 1,07,35,959 Dr. in profit and loss account as an expenditure (security deposit and other deduction etc.) and Rs. 1,01,29,020 Cr. in profit and loss account as an income (refund of Security deposit and other deduction) was confirmed figure/actual amount and same has been deducted or refunded by the deductor/contracted. The appellant claimed that the same was also verified by the learned assessing officer during the course of Scrutiny proceeding under section 143(3). This figure/amount are not depending on the outcome of an uncertain future event such as a Court case.
[10.1] The appellant submitted that the appellant consistently followed the accounting policy since beginning in which “any deduction except income tax which is refundable or not in future same has been treated as an expenditure and if same has been received/recovered by the assessee in relation to any year treated as an income”. It is the submission of the appellant that it is the privilege/right of a company to adopt any accounting policy. For adoption of accounting policy no format of accounting policy or set of accounting policy is available in the Companies Act, 1956 or Income Tax Act, 1961. Accounting standard issued by the Institute of chartered accountants of India is applicable on the company for the company accounting and for tax purpose Accounting Standard issued by the Central Government under section 145. For opting of accounting the appellant considered the Accounting Standard issued by the ICAI and adopted by Companies Act, 1956 and for tax purposes also considered the standard issued by the Central Government under section 145 of Income Tax Act, 1961. It also followed the key governing policies Consistency, Materiality. True and fair, Prudence/Conservatism, and Disclosure. The appellant relied on several case laws to buttress its position which includes :–
(a) (2012) 19 taxman 199 (Delhi) : 2012 TaxPub(DT) 1805 (Del-HC) [reference not found].
(b) Gappumal Kanahiyalal v. CIT (1961) 42 ITR 446 (Allahabad) : 1961 TaxPub(DT) 0111 (All-HC) the proposition that if profits are to be computed in accordance with the method or accounting regularly employed by the assessee, then it is to the method of accounting that one must look. And if the method of accounting regularly employed is a method whereby litigation expenditure is, so to say, kept in a suspense account and is brought into the accounts only for the purpose of being claimed as expenditure when the fate of the litigation is clear and nothing can be recovered out of the sum expended then it ought not to matter whether the expenditure which has been kept in the suspense account was actually incurred in earlier years.
(c) United Commercial Bank v. CIT (1999) 106 Taxman 601 (SC) : 1999 TaxPub(DT) 1437 (SC) for the proposition that on the basis of the method of accountancy regularly employed by the assessee. The real income is pointed out in the income-tax return submitted by the assessee. This cannot be ignored by holding that in a balance sheet which is required to be statutorily maintained in a particular form, market value of the shares and securities is not mentioned or is mentioned in brackets.
(d) Garden Reach Ship Builders and Engineers Ltd. v. Commissioner (Appeals) (2015) 61 taxmann.com 193 (Kol-Trib) : 2015 TaxPub(DT) 2639 (Kol-Trib) for the proposition that since assessee was consistently following above practice and there was no change in practice, value of goods being stock in transit was not liable to be included in purchase.
(e) Commissioner of Income Tax v. Bilahari Investment (P). Ltd. (2008) 168 Taxman 95 (SC) : 2008 TaxPub(DT) 1709 (SC).
[10.2] The learned assessing officer in this regard has stated that the appellant had debited a sum of Rs. 1,07,35,959 in the Profit & Loss Account. The learned assessing officer held that the said sums were contigent in nature and therefore did not constitute an expenditure which could be allowed under the Income Tax Act, 1961. The learned assessing officer further held that there was no accrual of liability only an estimate was made. Reliance was placed on the following judgments of the Hon’ble Supreme Court —
- M/s. Tuticorin Alkali Chemicals & Fertilisers Ltd. v. CIT (1997) 227 ITR 172 (SC) : 1997 TaxPub(DT) 1304 (SC)
- Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC) : 1979 TaxPub(DT) 0782 (SC)
- CIT v. British Paints India Ltd. (1991) 188 ITR 44 (SC) : 1991 TaxPub(DT) 0898 (SC)
- CIT v. UP State Industrial Development Corporation (1997) 225 ITR 705 (SC) : 1997 TaxPub(DT) 1221 (SC)
[10.3] I have considered the submissions of the appellant and have perused the assessment order. The following amounts were debited by the appellant :–
||Extension of Time
||Kept in deposit
||Retention money deducted at source
||Retention money deducted at source
[10.4] I find that the appellant claims that it was to make deposits of amounts. It is also the claim of the appellant that there were two types of deductions made :–
(a) from the receipts of the appellant certain deductions are made by the contractee (this includes the sums mentioned in rows 1 to 4)
(b) security deposit of the appellant prior to the work order (row no. 5)
[10.5] It would thus be seen that the claim of the appellant is that deductions at Serial Nos. 1 to 4 were of the nature in which, while making payment the contractee deducts certain sums as a kind of ‘surety’ for timely completion of the project as well as the quality of the work done. In the case of deduction under row 1 to 4 the appellant shows the entire amount as receipt on the credit side of the profit and loss account and shows the deductions as expenses. The deposit as shown in row 5 is out of the funds available with the appellant which is also kept as performance guarantee.
[10.6] Before the claim of the appellant is analysed it would be relevant to see the document being the Letter of Award. Any deduction made can only be in terms of the contract. No contractee would be legally empowered to make deduction which are not sanctioned by the contract. A sample Letter No. SGM/RAN/DVC-RTPS-12-577, dated 12-7-2012 has been filed. Ongoing through the same the relevant clause as germane to the appeal was :–
“As per the general terms and conditions GCC Clause No. 9.0 of the Tender Document, a Performance Guarantee BG of Rs. 68. 30 lakhs (Rupees Sixty Eight Lakhs and Thirty Thousand only) is equivalent to 5% (five percent) of the contract value from any Nationalized Bank or approved schedule bank situated in the State of Jharkhand will be submitted to NBCC within 30 days from the date of issue of letter, as per the form appended as Appendix M of GCC.”
A sample copy of agreement was also filed. Article 3.0 of the Agreement for Construction of B Type Quarters (13 Blocks Three Storyed) and C Type Quarters (G+1 two Blocks) at DVC RTPS, Raghunathpur (WB) dated 18-7-2012 reads :–
“The scope of Contract consideration, terms of payment, advance, security deposit, taxes wherever applicable, insurance, agreed time line schedule, compensation for delay and all other terms and conditions contained in NBCC letter of intent no. NBCC’s SGM/RAN/DH-12-436 dated 26-6-2012 are to be read in conjunction with the aforesaid contract documents. The contract shall be duly performed by the Contractor strictly and faithfully with the terms of the contract.”
[10.7] It is clear that the Performance Guarantee had to be deposited within 30 days of the Award of the Contract. The appellant has not submitted the terms and conditions of the NBCC contract stipulations as stated above. However, in another such appeal the document was submitted. The relevant clauses of the NBCC stipulation is extracted from there as they are the same for all contracts. This reads: (relevant portions highlighted)
This agreement made the 17-2-2020 between National Projects Construction Corporation Limited having registered office at “Raja House, 30-31, Nehru Place, New Delhi (herein after called the ’employer”) on the one part and A.P. Bariar and Sons, Ratu Road, PO Hehal, Ranchi, Jharkhand (herein after called the ‘contractor’ of the other part).
- In consideration of the payment to be made by the Employer to the contractor as hereinafter mentioned, the contractor hereby covenants with the Employer to execute the complete the works and remedy any defects therein conformity in all aspects with the provisions of the contract and undertaking routine maintenance for five years.
- The employer hereby covenants to pay the contractor in consideration of the execution and completion of the works and the remedying the defects wherein and undertaking routing maintenance for five years the contract price or such other sum as may become payable under the provisions of the contract at the time and in the manner prescribed by the contract.
Part I. General Conditions of Contract
1.1 Terms which are defined in the Contract Data are not also defined in the Conditions of Contract but keep their defined meanings. Capital initials are used to identify defined terms.
The Adjudicator is the person appointed jointly by the Employer and the Contractor to resolve disputes in the first instance, as provided in the Contract Data.
Bill of Quantities means the priced and completed Bill of Quantities forming part of the Bid.
Compensation Events are those defined in Clause 40 hereunder.
The completion Date is the date of completion of the Works as certified by the Engineer, in accordance with Clause 48.1.
The Contract is the Contract between the Employer and the Contractor to execute, complete, and maintain the Works. It consists of the documents listed in Clause 2.3.
The Contract Data defines the documents and other information which comprise the Contract.
The Contractor is a person or corporate body whose Bid to carry out the Works, including routine maintenance, has been accepted by the Employer.
The Contractor’s Bid is the completed bidding document submitted by the Contractor to the Employer.
The Contract Price is the price stated in the Letter of Acceptance and thereafter as adjusted in accordance with the provisions of the Contract.
Days are calendar days: months are calendar months.
A defect is any part of the Works not completed in accordance with the Contract.
The Defects Liability Certificate is the certificate issued by the Engineer, after the Defect Liability Period has ended and upon correction of Defects by the Contractor.
The Defect Liability Period is five years calculated from the Completion Date.
Routine Maintenance is the maintenance of roads for five years as specified in the Contract Data.
Routine maintenance is the maintenance of roads for five years as specified in the Contract Data
17.1 The Contractor may commence execution of the Works on the Start Date and shall carry out the Works and Routine Maintenance in accordance with the Programme submitted by the Contractor, as updated with the approval of the Engineer, and complete them by the intended Completion Date.
32.1 (a) The Engineer shall give notice to the Contractor of any Defects before the end of the Defects Liability Period, which begins at Completion [and defined- Contract Data] and ends after five years. The Defects Liability Period shall be extended for as long as Defects remain to be corrected.
(b) Every time notice of Defect/Defects is given, the Contractor shall correct the notified Defect/Defects within the duration of time specified by the Engineer’s notice.
33.1 If the Contractor has not corrected a Defect pertaining to the Defect Liability Period under clause 32.1 and deficiencies in maintenance as per clause 32.2 of these Conditions of Contract, to the satisfaction of the Engineer, within the time specified in the Engineer’s notice, the Engineer will assess the cost of having the Defect or deficiency corrected, and the Contractor shall pay this amount, on correction of the Defect or deficiency by another agency.
38.2 The payment to the contractor will be as follows for routine maintenance of the works :–
(a) The Contractor shall submit to the Engineer a bill every month for the routine maintenance of the roads from the date the maintenance period starts, i.e., from completion date as defined in Clause 1.1. It will be supported with a copy of the record of contractor’s monthly inspection and other instructions received from the Engineer.
(b) The payment will be made six-monthly for the monthly bills received during the previous six-months.
(c) If the bill for a month is not received from the contractor by 10th day of the succeeding month or/and if the Engineer has not certified that the Contractor has carried out the maintenance, work for defects and deficiencies brought to his notice under clause 32.2. (d) within specified period, no payment will become due to the Contractor for that month.
(d) If the Contractor has failed to carry out the maintenance within the period specified by the Engineer in a given month, no payment of any kind will be due to the Contractor for that month.
43.1 The Employer shall retain security deposit of 5% and performance security of two and a half percent of the amount from each payment due to the Contractor until completion of the whole of the construction Work. No security deposit/retention shall be retained from the payments for Routine Maintenance of works. In case, the Contractor furnishes bank guarantee for the amount equal to performance security of two and a half percent retained from each payment due to Contractor, the same amount shall be repaid to the contractor subject to condition that the validity of bank guarantee is as per provision of Clause 46.2 of GCC.
43.2 On the satisfactory completion of the whole of the construction work half the total amount retained as security deposit is repaid to the Contractor, one-fourth of the total amount retained as security deposit is repaid to the Contractor at the end of 2nd year after completion of the construction work and balance of the amount retained as security deposit is repaid to the contractor at the end of 3rd years after completion of the construction work subject to condition that the Engineer has certified that all defects notified by the Engineer to the Contractor before the end of period prescribed for repayment have been corrected.
43.4 The performance security equal to the five percent of the contract price and additional performance security for Routine Maintenance as detailed in Clause 26.4 of ITB is repaid to the Contractor when the period of five years fixed for Routine Maintenance is over and the Engineer has certified that the contractor has satisfactorily carried out the Routine Maintenance of the works.
If the Routine Maintenance part of the contract is not carried out by the Contractor as per this contract, the Employer will be free Jo carry out Routine Maintenance work and the amount required for this work will be recovered from the amounts of the Contractor whatever is due.
[10.8] Salient features of the contract are :–
(a) that the contract includes defect liability and repairs and maintenance.
(b) both the defect liability and repairs maintenance begins at the end of the completion of the work and continues for a period of five years thereafter.
(c) the contractor carries on defect rectifying work and routine maintenance for five years from the completion date.
(d) the defects in the execution of contract would be corrected by the contractor. If he fails to do so it would be got done by some other agency and the contractor shall have to pay for the same.
(e) contractor shall get paid for routine maintenance.
(f) that the employer shall retain security deposit of 5% and performance security of two and a half percent of the amount from each payment due to the Contractor until completion of the whole of the construction Work.
(g) that on the satisfactory completion of the whole of the construction work half the total amount retained as security deposit is repaid to the Contractor.
[10.9] The claim of the appellant is that the security deposit never gets refunded and therefore was an out go for the appellant and hence an expense. In a way the appellant contends that looking into the nature of the contract it neither rectifies the defects (for which it is not entitled to any payment) nor does it carry on routine maintenance (for which it gets paid as and when executed).
[10.10] The appellant has treated the security deposit as an expense under section 37 of the Act. The law regarding claim of expenses is clear. The onus is clearly on the appellant to show that the expenses were incurred and that they were revenue in nature while at the same time that they were laid out wholly and exclusively for the purpose of business. The burden of proving that a particular expenditure has been laid out or expended wholly and exclusively for the purposes of business so that the assessee may be entitled to claim deduction is on the assesses. In the case of the appellant the expense in the true sense of the term has not taken place. The appellant places a security deposit in the form of a FD to the contractee. Anticipating that the same would not be returned the appellant treats the same as an expense. The question is whether this is a revenue item?
[10.11] The appellant (let us assume) has cash in bank (which is an asset) and the appellant gets the FD for (Performance Guarantee and Security Deposit) made out of the same. In this case there is no change in the over all balance sheet as one form of asset (cash in bank) gets converted into a FD (another form of asset). Let us further assume that the appellant gets back the FD it encashes it and consequently the amount under cash in bank goes up. In this way both the entries square up each other. Now let us assume that 50% of the amount only is returned. In this case the cash in bank increases by 50% on encashment. The liability side is balanced by reduction of capital of equal amount (50%). In an extreme case (as is the assumption of the appellant) the FD is forfeited. In that case the entire amount is a loss which reduces the capital by the same amount. In other words the loss is on capital account and no effect of it would be on the profit and loss account. Accordingly the same cannot be allowed as its impact would be on the capital side.
[10.12] Now let us assume that five friends join together to form a firm ‘A’ each contributing Rs. 10 lakhs. As the first instance the balance sheet would show Rs. 50 lakhs as partners capital on the liability side and Rs. 50 lakhs in bank as an asset. Now assume that the firm is awarded a contract of Rs. 5 crs. for which it has to make a FD of Rs. 25 lakhs (@5%) and place it at the disposal of the contractee. With this the balance sheet would have two entries one. cash in bank of Rs. 25 lakhs and the other Rs. 25 lakhs as FD (both as asset) balanced by the capital of Rs. 50 lakhs on the liability side. Now, (shorn of all complexities of the balance sheet) as per the appellant, the entries would mean cash in bank of Rs. 25 lakhs and capital of Rs. 25 lakhs (as the balance is treated as a loss). The balance amount would be taken to the Profit & Loss Account as a loss. Now supposing that the FD was placed at the disposal of the contractee on 31st March and no work actually had started. In that case the appellant, as per its accounting system, would claim a loss of Rs. 25 lakhs. Clearly, this is not a loss allowable under section 37 of the Act. As held in the case of Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC) : 1979 TaxPub(DT) 0782 (SC) “Whether the loss suffered by the assessee was a trading loss or not would depend on whether the loss was in respect of a trading asset or a capital asset. In the former case, it would be a trading loss bur not so in the latter.” In the case of the appellant it definitely is not a trading loss.
[10.13] Now let us examine the entry from the point of view that the appellant has understood. It has been held in Indian Molasses Co. Ltd. v. CIT (1959) 37 ITR 66 (SC) : 1959 TaxPub(DT) 0170 (SC) that there are certain principles of a fundamental character. The first is that capital expenditure cannot be attributed to revenue and vice versa. Secondly, it is equally clear that a payment in a lump sum does not necessarily make the payment a capital one. It may still possess revenue character in the same way as a series of payments. Thirdly, if there is a lump sum payment but there is no possibility of a recurrence, it is probably of a capital nature, though this is by no means a decisive test. Fourthly, if the payment of a lump sum closes the liability to make repeated and periodic payments in the future, it may generally be regarded as a payment of a revenue character and lastly, if the ownership of the money whether in point of fact or by a resulting trust be still in the taxpayer, then there is acquisition of a capital asset and not an expenditure of a revenue character.
[10.14] Side by side with these principles, there are others which arc also fundamental. The income-tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. The money may be expended on grounds of commercial expediency but not of necessity. The test of necessity is whether the intention was to earn trading receipts or to avoid future recurring payments of a revenue character. Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the trader’s pocket. Thus, in finding out what profits there be the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. But the income-tax laws do not take even, such allowance as legitimate for purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent. The former is deductible but not the latter.
[10.15] In United Commercial Bank Ltd. v. CIT (1999) 240 ITR 355 (SC) : 1999 TaxPub(DT) 1437 (SC) it was held that for the purpose of income-tax whichever method is adopted by the assessee. A true picture of the profits and gains, that is to say, the real income is to be disclosed. For determining the real income, the entries in a balance sheet required to be maintained in the statutory form may not be decisive or conclusive. In such cases, it is open to the ITO as well as the assessee to point out the true and proper income while submitting the income-tax return.
[10.16] In CIT v. Rotork Controls India Ltd. (2009) 314 ITR 62 (SC) : 2009 TaxPub(DT) 1730 (SC) it was held that a provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized 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 recognized. [Para 10] Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources from the enterprise embodying economic benefits. [Para 11] A past event that leads to a present obligation is called as an obligating event which is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events which exist independently of the future conduct of the business of the enterprise, that are recognized as a provision. For a liability to qualify for recognition, there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g., product warranties or similar contracts), the probability that an outflow will be required in settlement is determined by considering the said obligations as a whole. In this connection, it may be noted that in the case of a manufacture, and sale of one single item, the provision for warranty can constitute a contingent liability not entitled to deduction under section 37. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative but to settle that obligation. In the instant case, the assessee had been manufacturing and selling valve actuators. It was in the business from the assessment years 1983-84 onwards. Valve actuators are sophisticated goods. Over the years, the assessee had been manufacturing valve actuators in large numbers. The statistical data indicated that every year some of the manufactured actuators were found to be defective. The statistical data over the years also indicated that being sophisticated items no customer was prepared to buy valve actuators without a warranty. Therefore, warranty became an integral part of the sale price of the valve actuator(s). In other words, warranty stood attached to the sale price of the product. Therefore, warranty provision needed to be recognized because the assessee was an enterprise having a present obligation as a result of past events resulting in an outflow of resources. Lastly, a reliable estimate could be made of the amount of the obligation. In short, all the three conditions for recognition of a provision were satisfied in the instant case. [Para 12] In the instant case, one was concerned with product warranties. To give an example of product warranties, a company dealing in computers gives warranty for a period of 36 months from the date of supply. The said company considers following options : (a) account for warranty expense in the year in which it is incurred; (b) it makes a provision for warranty only when the customer makes a claim; and (c) it provides for warranty at 2 per cent of turnover of the company based on past experience (historical trend). The first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis, which is prohibited both under the Companies Act, 1956 as well as by the Accounting Standards which require accrual concept to he followed. In the instant case, the revenue was insisting on the first option which is erroneous as it rules out the accrual concept. The second option is also inappropriate, since it does not reflect the expected warranty costs in respect of revenue already recognized (accrued). In other words, it is not based on a matching concept. Under the matching concept, if revenue is recognized, the cost incurred to earn fiat revenue including warranty costs has to be fully provided for. In the instant case, when valve actuators were sold and the warranty cost was an integral part of that sale price, then the assessee had to provide for such warranty cost in its account for the relevant year, otherwise the matching concept would fail. In such a case, the second option is also inappropriate. Under the circumstances, the third option is the most appropriate because it fulfils accrual concept as well as the matching concept. For determining an appropriate historical trend, it is important that the company has a proper accounting system for capturing relationship between the nature of the sales, the warranty provisions made and the actual expenses incurred against it subsequently. Thus, the decision on the warranty provision should be based on past experience of the company. A detailed assessment of the warranty provisioning policy is required, particularly if the experience suggests that warranty provisions are generally reversed if they remain unutilized at the end of the period prescribed in the warranty. Therefore, the company should scrutinize the historical trend of warranty provisions made and the actual expenses incurred against it. On this basis, a sensible estimate should be made. The warrant)’ provision for the products should be based on the estimate at the year end of future warranty expenses. Such estimates need reassessment every year. As one reaches close to the end of the warranty period, the probability that the warranty expenses will be incurred is considerably reduced and that should be reflected in the estimation made. Whether this should be done through a pro rata reversal or otherwise would require assessment of historical trend. If warranty provisions are based on experience and historical trend(s) and if the working is robust, then the question of reversal in [he subsequent two years, in the above example, may not arise in a significant way. Hence, on the facts and circumstances of the instant case, provision for warranty was rightly made by the assessee because it had incurred a present obligation as a result of past events. There was also an outflow of resources. A reliable estimate of the obligation was also possible. Therefore, the assessee had incurred a liability during the relevant assessment years and it was entitled to deduction under section 37. Therefore, all the three conditions for recognizing a liability for the purpose of provisioning stood satisfied in the instant case. There are four important aspects of provisioning, viz., provisioning which relates to present obligation: it arises out of obligating events: it involves outflow of resources; and lastly, it involves reliable estimation of an obligation- Keeping in mind all the four aspects, the High Court should not to have interfered with the decision of the Tribunal in the instant case. [Para 13] From analysis of the various decision of the Supreme Court, in which a similar issue was decided, the principle which emerges is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and if the facts established show that defects existed in some of the items manufactured and sold, then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts under section 37. It would all depend on the data systematically maintained by the assessee. [Para 17]
[10.17] In Bharat Earth Movers v. CIT (2000) 245 ITR 428 (SC) : 2000 TaxPub(DT) 1505 (SC), the apex Court had categorically held that if a business liability has arisen in the accounting year, the deduction should be allowed even if such a liability may have to be quantified and discharged at a future date. Following passage from the aforesaid judgment is worth a quote :–
“The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.”
[10.18] In CIT v. Woodword Governor India (P) Ltd. (2009) 312 ITR 254 (SC) : 2009 TaxPub(DT) 1628 (SC) it was held that the word ‘expenditure ‘ is not defined in the Act. The word ‘expenditure’ is, therefore, required to be understood in the context in which it be used. Section 37 enjoins that any expenditure not being expenditure of the nature described in sections 30 to 36 laid out or expended wholly and exclusively for the purpose of the business, should be allowed in computing the income chargeable under the head ‘profits and gains of business’. In sections 30 to 36, the expression ‘expenses incurred’ as well as ‘allowances and depreciation’ have also been used. For example, depreciation and allowances are dealt with in section 32. Therefore, the Parliament has used the expression ‘any expenditure’ in section 37 to cover both. Therefore, the expression ‘expenditure’ as used in section 37 may, in the circumstances of a particular case, cover an amount which is really a ‘loss’, even though said amount has not gone out from the pocket of the assessee. [Para 13] The provisions of section 145 recognise the rights of a trader to adopt either the cash system or the mercantile system of accounting. The quantum of allowances permitted to be deducted under diverse heads under sections 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made dear by defining the word ‘paid’ in section 43(2), which is used in several sections from sections 30 to 43C. As meaning actually paid or incurred according to the method of accounting upon the basis of which profits or gains are computed under section 28/29. That is why, in deciding the question, as to whether the word ‘expenditure’ in section 37(1) includes the word ‘loss’, one has to read section 37(1) with sections 28, 29 and 145(1). Accounts regularly maintained in the course of business are to be taken as correct, unless there are strong and sufficient reasons to indicate that they are unreliable. Under section 28(i). One needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that m the profit and loss account, the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is lower. This is how business profits arising during the year need to be computed. This is one more reason for reading section 37(1) with section 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant, because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase in profits before actual realization. This is the theory underlying the rule that the closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purpose are to be computed in accordance with ordinary principles of commercial accounting, unless such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following year’s account in a continuing business are not brought to the charge as a matter of practice, though loss due to fall in the price below cost is allowed even though such, loss has not been realized actually. The said system of commercial accounting can be superseded or modified by legislative enactment. Under section 145(2), the Central Government is empowered to notify from time-to-time the Accounting Standards to be followed by any class of the assessees or in respect of any class of income. Accordingly, under section 209 of the Companies Act. mercantile system of accounting has been made mandatory for companies. In other words, Accounting Standard, which is continuously adopted by an assessee, can he superseded or modified by legislative intervention. However, but for such intervention or in cases falling under section 145(3), the method, of accounting undertaken by the assessee continuously is supreme. In the instant case, there was no finding given by the assessing officer on the correctness or completeness of the accounts of the assessee. Equally, there was no finding given by the assessing officer stating that the assessee had not complied with the Accounting Standards. [Para 14]
[10.19] In Calcutta Company Ltd. v. CIT (1959) 37 ITR 1 (SC) : 1959 TaxPub(DT) 0180 (SC) the Apex Court held that there was no doubt that the undertaking to carry out the developments within six months from the dates of the deeds of sale was incorporated therein and that undertaking was unconditional, the assessee appellant binding itself absolutely to carry out the same. It was not dependent on any condition being fulfilled or the happening of any event, the only condition being that it was to be carried out within six months which in view of the fact that the time was not of the essence of the contract meant a reasonable time. Whatever might be considered a reasonable time under the circumstances of the case, the setting up of that time limit did not prescribe any condition for the carrying out of that undertaking and the undertaking was absolute in terms. If that undertaking imported any liability on the appellant the liability had already accrued on the dates of the deeds of sale, though that liability was to be discharged at a future date. It was thus an accrued liability and the estimated expenditure which would be incurred in discharging the same could very, well be deducted from the profits and gains of the business. In as much as the liability which had thus accrued during the accounting year was to be discharged at a future date the amount to be expended in the discharge of that liability would have to be estimated in order that under the mercantile system of accounting the amount could be debited before it was actually disbursed. The difficulty in the estimation thereof again would not convert an accrued liability into a conditional one, because it is always open to the Income Tax authorities concerned to arrive at a proper estimate thereof having regard to all the circumstances of the case.
[10.20] Analysis of cases shows that a liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources from the enterprise embodying economic benefits. For a liability to qualify for recognition, there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g., product warranties or similar contracts), the probability that an outflow will be required in settlement is determined by considering the said obligations as a whole. Under the matching concept, if revenue is recognized, the cost incurred to earn that revenue including warranty costs has to be fully provided for.
[10.21] In the case of the appellant it is not that the appellant has provided for a certain sum (say 10% of the contract value) as a liability for future expenses on ‘defect liability’. (It must be remembered that it is only with defect liability that the appellant does not get paid. For routine maintenance it gets paid as per the contract. Both the periods run for five years after the completion date. Moreover, the Performance Guarantee sum is to be paid within 30 days of the Award of the contract and therefore cannot be made out of any running bill as claimed by the appellant). If that was the case, as it satisfied the conditions laid down in Rotork Controls (supra) it would be allowed the liability. In the case of the appellant it has treated the FD as already been forfeited and hence, according to the appellant, an expense allowable under section 37(l) of the Act. This also does not satisfy the ‘matching principles’ as stated in the case of Rotork Controls (supra) as “Under the matching concept, if revenue is recognized, the cost incurred 10 earn that revenue Including warranty costs has to be fully provided far.” In the case of the appellant the revenue recognised does not match with the funds available with the appellant out of which FD was made. The source of revenue and the FD are two disparate items. One on the revenue side and the other on the capital side.
[10.22] In the case of Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC) : 1979 TaxPub(DT) 0782 (SC) the ratio was that the way in which entries are made by an assessee in his books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. The assessee may, by making entries which are not in conformity with the proper accountancy principles, conceal profit or show loss and the entries made by him cannot, therefore, be regarded as conclusive one way or the other. It was held that “Whether the loss suffered by the assessee was a trading loss or not would depend on whether the loss was in respect of a trading asset or a capital asset. In the former case, it would be a trading loss but not so in the latter.” As held above the loss in the case of the appellant is that of a capital asset and therefore not allowable. [Incidently this case law was cited by the appellant in its favour]
[10.23] It would also be relevant to analyse the case laws cited by the appellant so as to understand its point of view. The first case is that of Woodward Governors (supra). In that case the Hon’ble SC has noted that “In conclusion, it may be slated that in order to find out if an expenditure is deductible, the following factors have to be taken into account (i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether The method adopted by (he assessee for making entries in the books both in respect of losses and gains as per nationally accepted Accounting Standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reduce the incidence of taxation”.
[10.24] The Apex Court in the above case has allowed for liabilities as expenses if certain conditions are fulfilled. However, the same has to be in respect of ‘deductible expenses”. The moot question is whether the booking of loss of the FD (its encashment for non fulfillment of the conditions of the contract) can be termed as an ” deductible expense’? As explained above the entry is not an ” ascertained liability” the expense of which had not arisen but was likely to arise in the future. In the case of the appellant it was an item of : asset” which the appellant booked as “expense’. Therefore, the principles of Woodword (supra) would not be applicable.
[10.25] Second case law relied upon by the appellant is that of Indian Mollases Co. Ltd. v. CIT (1959) 37 ITR 66 (SC) : 1959 TaxPub(DT) 0170 (SC). In this case h was held that :–
“There are certain principles of a fundamental character. The first is that capital expenditure cannot be attributed to revenue and vice versa. Secondly, it is equally clear that a payment in a lump sum does not necessarily make the payment a capital one. It may still possess revenue character in the same way as a series of payments. Thirdly, if there is a lump sum payment but there is no possibility of a recurrence, it is probably of a capital nature, though this is by no means a decisive test. Fourthly, if the payment of a lump sum closes the liability to make repeated and periodic payments in the future, it may generally be regarded as a payment of a revenue character and lastly, if the ownership of the money whether in point of fact or by a resulting trust be still in the taxpayer, then there is acquisition of a capital asset and not an expenditure of a revenue character. Side by side with these principles, there are others which are also fundamental. The income-tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. The money may be expended on grounds of commercial expediency but not of necessity. The test of necessity is whether the intention was to earn trading receipts or to avoid future recurring payments of a revenue character. Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the trader’s pocket. Thus, in finding out what profits there be, the normal accountancy practice-may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. But the income-tax laws do not take every such allowance as legitimate jot-purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent. The former is deductible but not the latter. The recurring liability of pension which is compressed into a lump payment should itself be a legal obligation, and that, if contingent, the present value of the future payments should be fairly estimable.
If the pension itself be not payable as an obligation, and-if there be a possibility-that no such, payment may be necessary in the future, the whole of the amount cannot be deducted but only the present value of the future liability, if it can be estimated.
As to the question whether the payments made towards the policy were “expenditure” within section 10(xv) of the 1922 Act, “Expenditure” is equal to “expense” and “expense” is money laid out by calculation and intention though in many uses of the word this element may not be present. But the idea of “spending” in the sense of “paying out or away” money is the primary meaning. “Expenditure” is thus what is “paid our or away” and is something which is gone irretrievably. To be an allowance within clause (xv) of section 10(2) of the 1922 Act, the money paid out or away must be (a) paid out wholly and exclusively for the purpose of the business and further (b) must not be (i) capital expenditure, (ii) personal expenses or (iii) an allowance of the character described in clauses (i) to (xiv).”
[10.26] In the above case the Apex Court has held that “Expenditure” is equal to “expense” and “expense” is money laid out by calculation and intention though in many uses of the word this element may not be present. But the idea of “spending” in the sense of “paying out or away” money is the primary meaning. “Expenditure” is thus what is “paid out or away” and is something which is gone irretrievably. To be an allowance within clause (xv) of section 10(2) of the 1922 Act, the money paid out or away must be (a) paid out wholly and exclusively for the purpose of the business and further (b) must not be (i) capital expenditure. The case of the appellant with regard to the booking of anticipated loss of money of the FD is not revenue in nature and therefore cannot be said to be an allowable liability.
[10.27] In the case of MP Financial Corporation v. CIT (1987) 165 ITR 765 (MP) : 1987 TaxPub(DT) 0425 (MP-HC) the ruling was that “As regards the deduction of the amount of discount on the bonds, the same principles as are applicable in the case of issue of debentures at discount, would be attracted in the case of issue of bonds at a discount. The amount of discount in effect, represents deferred interest. Looked at as such, a proportionate amount of discount can be written off out of revenue every year, during the period the bonds would remain outstanding. Therefore, though the assessee would not be justified in claiming deduction of the entire amount of discount In the accounting year in question, it would nevertheless be entitled to proportionate deduction spread over the period, for which the bonds would remain outstanding. This case has been approved by the Apex Court in the case of Madras Industrial Corporation v. CIT (1997) 225 ITR 802 (SC) : 1997 TaxPub(DT) 1209 (SC).
[10.28] This case too does not help the appellant as the allowable amount was ‘deferred interest’ which was a revenue item.
[10.29] The case of United Commercial Bank v. CIT (1999) 240 ITR 355 (SC) : 1999 TaxPub(DT) 1437 (SC) too the facts were very different. In that case “For reasons, the Central Government, in exercise of the powers conferred by section 53 of the Banking Regulation Act, and on the recommendation of the RBI, permitted the assessee not to disclose the market value of its investment in the balance sheet required to be maintained as per the statutory form. But as the assessee was maintaining its accounts on mercantile system, it was entitled to show its real income by taking into account the market value of such investments in arriving at the real taxable income. On that basis, therefore, the assessing officer had taxed the assessee”.
[10.30] The appellant has also relied upon the case of Rotork Controls (supra). As discussed above the case law does not help the appellant.
[10.31] Based on the above it is held that the amount of Rs. 1,07,35,959 claimed as expenses was not an allowable expense and the same was rightly disallowed by the learned assessing officer.
Ground of appeal is dismissed.
[10.32] While on the subject it would also be important to consider the alternate contention of the appellant which is that; on the one hand the learned assessing officer did not allow the expenses on security deposit as expenses, she taxed the security deposit receipt shown by the appellant as income. It is the submission of the appellant that by following a consistent method of accounting and in the endeavor to reflect true profit of its business, it had offered the refund as income of the year.
[10.33] No discussion of the issue has been made by the learned assessing officer in her order.
[10.34] I have considered the submission of the appellant. I find that under the head ‘other income’ – Schedule 4.1 of the Balance Sheet the appellant had offered incomes under the heads: ‘Other deductions’ Rs. 6,13,703 and ‘Security Deposit Refund’ Rs. 95,15,317 totalling Rs. 1,01,29,020. The question is can a deduction be allowed since the appellant had offered the refund of deposit of income. As discussed above, in my view the payment of security deposit was made out of the funds (capital) available with the appellant and therefore, was not an allowable expenses of business. Similarly, the refunds now offered for tax, as a necessary corollary, would also not constitute income. However, as the Apex Court has held in the case of Goetze (India) Ltd. v. CIT (2006) 283 ITR 306 (sic (2006) 284 ITR 323 (SC)) : 2006 TaxPub(DT) 1528 (SC) any claim of deduction (in this case income offered) has to be made by the assessee by filing a revised return. Accordingly, in view of the judgment of the Apex Court no relief can be granted to the appellant. This ground of the appellant is dismissed.”
- Further aggrieved by the denial of relief claimed towards taxability of retention money etc. on receipt basis, the assessee preferred appeal before the Tribunal.
- The learned A.R. for the assessee broadly reiterated various submissions made before the lower authorities and claimed that the expenditure claimed in the P&L account towards retention money is nothing but represents a deduction out of gross bills since the income to the extent of retention money lying at the lien and command of respective contractees as deposit is a highly contingent receivable and realization thereof hinges upon the fulfillment of severe obligations emanating from respective contracts. It was further submitted on behalf of the assessee that the amount so retained by the contractee are duly offered for taxation in the year of actual realization on fulfillment of terms on contract and thus the act of assessee do not cause any prejudice to assessee. The learned A.R. for the assessee submitted that such accounting practice adopted by the assessee is in tune with the business complexity involved as well as in sync with well-established law that income is chargeable to tax on accrual basis but however the accrual of income is dependent upon the ‘right to receive’ such income and the point of time when it becomes legally due to the assessee. It was pointed out that the assessee has consistently taken stand before the lower authorities that the ‘right to receive’ on the money retained has not accrued to the assessee merely on raising invoice as per the contract value but is dependent on actual discharge of contractual obligation to the satisfaction of the contractee. The income thus included in the gross receipt to the extent of retention money is beset with contingency and is squarely dependent upon future happenings and events. The learned A.R. for the assessee thus submitted that there is no reason for the departure from the consistently followed accounting policy by mis-appreciating the facts as well as settled law. The learned A.R. lastly added that such accounting practice not only reflects true income accrued in the hands of assessee but also is revenue neutral as the income towards retention money is duly offered for taxation in the respective years of receipt.
- The learned D.R., on the other hand, relied upon the orders of the lower authorities.
- We have carefully considered the rival submissions. The assessee in the instant case is engaged in the business of works contract mainly civil contract (building). The substantive controversy in the instant appeal is towards point of time of taxability of retention money/security deposit deducted and withheld by respective contractees in a work contract as a lien to ensure complete execution of terms of contract. It is the case of assessee that income on such retention money is accrued on complete discharge of contractual obligations to the satisfaction of contractee and thus chargeable to tax only at the time of actual realization. As stated, it is the ordinary practice in such business of civil contract that contractee deducts certain percentage of gross bill raised by the assessee towards retention money/security deposits as per terms of contract. The amount so deducted is withheld by the contractee and is realized to the assessee only upon the contractee being satisfied about the completion of the work entrusted to contractor (assessee herein) and other terms mentioned in the contract are satisfied by the contractor. As further stated, the retention money/security deposit so withheld by the contractee is debited in the P&L account and deducted from the gross receipts. Such receipt is treated as income to the assessee only on actual realization thereof on fulfillment of terms of contract as per the accounting policy consistency followed by the assessee. As pointed out, in the civil contract business, certain portion of the money out of bill raised by the assessee are retained by the contractee as a security deposit to safeguard their business interests and money so retained are realized by the contractor assessee subsequently on satisfactory execution of contract as per the terms agreed. It is thus the case of the assessee that such amount retained by the contracts are contingent upon fulfillment of terms of contract and as a corollary, right to receive payments of retention money/security deposit etc. depend on satisfaction of the third party, i.e., contractee towards execution and completion of contract as per terms of contract. It is thus the case of the assessee that income embedded in the gross bill raised on the contractee did not accrue to the assessee in the year of raising invoice to the extent of amount deducted towards retention money etc. till the time the ‘right to receive’ such income retained actually arise or accrue to the assessee. The assessee acquires a right to receive the amount retained by the contractee only at a later stage subject to the fulfillment of terms of contract to the satisfaction of the contractee. As per the assessee, the gross sales/receipts are recorded as income of the assessee in the P&L account including retention money/security deposit, KID etc. as deducted from the invoice raised to avoid mis-match of gross amount on which tax has been deducted by the contractee at applicable rates. However, the assessee has adopted the accounting procedure whereby retention money/security deposit etc. are debited/reduced separately from such gross income which encompasses retention money etc. while determining the taxable profits. The retention money/security deposits so withheld are later recognized as income in the respective years as and when the money so retained is actually realized by the Revenue. This method of accounting is stated to be followed for last many years to determine the true profits of the assessee. The Revenue, on the other hand, seeks to reject this accounting practice followed by the assessee on the ground that the expenditure towards retention money/security deposit claimed by the assessee are contingent and the assessee is obliged to pay taxes on income determined with reference to invoices raised by the assessee in pursuance of contracted regardless of certain portion thereof being retained by the contracted in the ordinary course of business.
- We find inherent fallacy in the approach adopted by the Revenue while disturbing the income declared by the assessee. The assessee herein seeks to record the income when it comes into existence in the relevant previous year. The real test for taxability of income is that if the amount is to be taxable as income, the basic conception to be kept in view is that the ‘right to receive’ the income must come into existence in the relevant previous year. The income accrues when it becomes legally due to the assessee. The date of actual receipt, of course, is not determinative for taxability of income under mercantile system of accounting. Mere raising of invoice on the contractee would notipso facto tantamount to accrual of income. The assessee in the instant case, claims that a certain portion of bill has been kept as a lien in the custody of the contractee till the fulfillment of the conditions specified in the contract. Naturally, such retention money would accrue only where the terms of the contract stands fulfilled. In the absence of its accrual, the income cannot be taxed under mercantile system of accounting on a hypothetical basis. We find considerable force in the aforesaid plea of the assessee. It is not the case of the Revenue that the work under the contract has been completely fulfilled. The unrealized portion of the bills raised by the contractor assessee is in the league of contingent income until and unless the terms and conditions of the contract stands fulfilled. We find complete merit in the argument laid on behalf of the assessee on this score. When seen differently, we also find substance in the case made out that the assessee has booked the unrealized portion of the bill in the year of realization as and when happened. Therefore, the action of the assessee does not cause any prejudice to the Revenue and is tax neutral. In such circumstances, when seen in combination, we are inclined to accept the claim of the assessee for non-taxability of unrealized income kept in the custody of the contractee as per the terms of the contract. For the reasons narrated, we set aside the order of the Commissioner (Appeals) and direct the assessing officer to delete the disallowance of expenditure of Rs. 1,07,35,959 on this score.
- The second issue pertains to chargeability of interest under section 234B of the Act amounting to Rs. 17,66,016.
- We find that identical issue has come up before the co-ordinate bench of ITAT inITO v. M/s. Anand Vihar Construction Pvt. Ltd., ITA No. 335/Ran/2017 Order, dated 28-11-2018 wherein the issue was dealt with as under :–
“16. We have heard rival submissions and perused the material on record. Prima facie the disputed issue, being charging of interest under section 234A & 234B as envisaged by learned A.R., is covered by the decision of Hon’ble jurisdictional High Court in the case of Ajay Prakash Verma in ITA No. 38 of 2010 reported in 2013(1) TMI 140. The Hon’ble Court in Para 23 & 24 held as under :–
“23. Learned counsel for the appellant submitted that it has been ordered by the assessing officer that interest be charged as per rule. Interest can be levied under section 234A and 234B of the Act. It is submitted that in view of the judgment of Full Bench of Ranchi Bench of Patna High Court delivered in the case of Smt. Tej Kumari v. Commissioner of Income Tax the interest cannot be levied over the assessed income and it can be levied only on the income declared in the return. The revenue preferred SLP before Hon’ble Supreme Court against the said judgment of the Full Bench of Patna High Court, which was dismissed by the Hon’ble Supreme Court on merits vide Order, dated 1-8-2000 by saying that there is no merit in the appeal.
- Learned counsel for the revenue could not dispute this legal position. Therefore, so far as question of law involved in this appeal that whether the interest could have been levied against the assessed income of the assessee under sections 234A and 234B is concerned, in view of the Full Bench judgment of Ranchi Bench of Patna High Court delivered in the case ofSmt. Tej. Kumari, the revenue can levy the interest only on the total income declared in the returns and not on the income assessed and determined by the assessing officer to that extent. The orders passed by the authorities below are accordingly modified and interest shall be chargeable in the light of the Full Bench judgment, referred above.”
- Learned A.R. also placed reliance on the decision of coordinate bench of the Tribunal in the case ofShri Girdhari Lal Sharma v. ITO, Ward-1(4), Jamshedpur in ITA No. 31/Ran/2013by an Order, dated 7-5-2012 in para No. 6 relying upon the above decision of the Hon’ble Jharkhand High Court held :–
“We accordingly following the above decision, direct the assessing officer to re-compute the interest under section 234B on the basis of the total income declared by the assessee in the return filed.”
- We respectfully following the decision of the jurisdictional High Court and the decision of coordinate bench of the Tribunal direct the assessing officer to recomputed the interest under section 234B on the basis of total income declared by the assessee in the return filed. This ground of Cross Objection of the assessee is allowed.”
- For the reasoning noted above, the assessing officer is directed to delete the levy of interest under section 234B of the Act.
- In the result, the ground raised by the assessee is allowed.
- In the result, the appeal of the assessee allowed.
ITA No. 48/Ran/2018 — Assessment Year 2013-14
- The grounds of appeal raised by the assessee read as under :–
“1. Rs. 64,64,521 was disallowed by assessing officer on the plea of being Contingent nature which is against the definition of contingent nature and bad in law without explaining as how the expenditure is ‘Contingent’ when the assessee has followed accounting policy as prescribed by ICAI and the standard issued by central government under section 145 of the Income Tax Act, consistently, year after year. The assessee has treated all the amounts deducted by the department at source as Bad debts. So the same should be deleted.
- The assessing officer has wrongfully levied interest of Rs. 8,02,887 on the amount of tax calculated on the above disallowance of expenses as stated at point no. 1.”
- The grievance raised as per Ground No. 1 is identical to first grievance of the assessee inITA No. 30/Ran/2017 concerned assessment year 2012-13.
In parity with the conclusions drawn therein, the aforesaid issue is concluded in favour of assessee. Ground No. 1 is allowed.
- Ground No. 2 is also adjudicated in favour of assessee in terms of para 13-15 (supra).
- In the result, Appeal of the assessee inITA No. 48/Ran/2018 for assessment year 2013-14 is allowed.
ITA No. 341/Ran/2018 — Assessment Year 2010-11
- The grounds of appeal raised by the assessee read as under :–
“1. Assessing officer added retention money/security deposit, kid etc, deducted from bill on the ground of assesses followed wrong accounting policy, without considering the reason behind adoption of accounting policy and right to receive payments of the retention money/Security deposit etc. depend on satisfaction of the contractee as per terms of contract and completion of contract. So, addition made by assessing officer Rs. 20596503 illegal or bad in law, so, addition made by assessing should be deleted.
- Assessee Dr. in profit and loss account under the heads retention money/security deposit Rs. 16193579 and Rs. Cr. In profit and loss account Rs. 4766708. But assessing officer added Rs. 20596503, Difference of Dr. Rs. 21244818 and Cr. Rs. 648315 of retention money in P & L account related to assessment year 2011-12. So, Rs. 9169632 excess added by the assessing officer. So, addition made by assessing officer is not correct, so should be deleted.”
- The grievance raised as per Ground No. 1 is identical to first grievance of the assessee inITA No. 30/Ran/2017 concerned assessment year 2012-13.
In parity with the conclusions drawn therein, the aforesaid issue is concluded in favour of assessee. Ground No. 1 is allowed.
- Ground No. 2 is also adjudicated in favour of assessee in terms of para 13-15 (supra).
- In the result, Appeal of the assessee inITA No. 341/Ran/2018 for assessment year 2010-11 is allowed.
- In the combined result, all the appeals of the assessee are allowed.