Receipt of retention money by furnishing bank guarantee not chargeable to tax as it accrues only on a successful completion of a contract

ADIT Vs. Ballast Nadam Dredging (ITAT Mumbai)- It was held that retention money withheld by the contractee pending completion of contract work does not accrue to the assessee/ contractor in the year in which the amount is retained. We also observe that similar issue was also considered by ITAT in the case of Spirax Marshall Ltd (supra) wherein it was held that receipt of retention money against furnishing bank guarantee cannot partake character of income since it cannot be apportioned until guarantee period was over. The retention money may be received by the assessee; it cannot be apportioned until expiry of warranty period. We observe that the Hon’ble Allahabad High Court in the case of CIT vs. Yatindra and Co. (supra) held that an amount received by assessee against bank guarantee was not accrued to the assessee during the year as no absolute right to receive the amount at that stage vested.

9. Further we observed that the assessee received a part of retention money against bank guarantee in the preceding assessment years, the details of which are given by Assessing Officer at Page 2 and also mentioned herein above in Para 3 at Page 3 of this order. During the course of hearing the learned Authorized Representative submitted that the assessee is following consistently to offer for taxation the part released of retention money against bank guarantee in the assessment year in which right to receive the said release of retention money accrued to the assessee unconditionally. The learned Departmental Representative also did not dispute the above contention of learned Authorized Representative at the time of hearing.

10. In view of above facts and decisions, and particularly that similar issue has been considered by the Hon’ble Mumbai High Court in the case of Associated Cables Pvt. Ltd. (supra) which has been followed by the learned CIT (A), we do not find any reason to interfere with the order of Ld.CIT (A). Hence, we uphold his order and reject the ground of appeal taken by the department.

INCOME TAX APPELLATE TRIBUNAL, MUMBAI

I.T.A. No. 999/Mum/2008 – (Assessment Year: 2004- 05)

ADIT (IT)-3(2),

Vs.

Ballast Nadam Dredging

Date of pronouncement : 30.12.2011

ORDER.

Per B.R. Mittal, J.M.

Department has filed this appeal for the Assessment Year 2004-05 against the order of learned Commissioner of Income Tax (Appeals)-XXXIII, Dated 29.11.2007 on following ground:

“On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in deleting the retention money of Rs. 4,14,62,866/- accrued to the assessee on the ground that the retention money accrues only when the contract is completed to the satisfaction of the contractee as per the terms of contract Agreement. The ld. CIT(A) not appreciated the fact that when the assessee is following the Mercantile System of accounting and the amount of retention money received during the Financial Year 2003-04 relevant to the Assessment Year 2004-05 and reduced to that extent from the Loans and   Advances Receivable allowing the addition made of Rs. 3,09,418/- on account of provision for doubtful debts with book profit, only relying on the decision of ITAT in the case of MSEB (77 ITJ 33), wherein the Hon’ble ITAT has stated that provision for bad and doubtful debts represents a restatement of value of assets and not a liability, ignoring the Assessing Officer’s finding.”

2. At the time of hearing the learned Departmental Representative submitted that this ground is not properly drafted and as such the only issue to be considered is as to whether Ld. CIT (A) on the facts and in the circumstances of the case has erred in deleting the retention money of Rs. 4,14,62,866/- accrued to the assessee.

3. The relevant facts giving raise to this appeal are that assessee is a company incorporated in the Netherlands. The assessee was involved in execution of contract for construction of breakwaters and the associated dredging and land reclamation works at Karwar, Karnataka awarded by the Government of India. The Assessing Officer stated that assessee reduced an amount of Rs.4, 11,42,846/- on account of retention money during the year. He stated that on perusal of details filed by the assessee, as per clause 38(i)(1) of the contract, the Employer (Government of India – Navy) withheld retention money @ 5% from works executed during the year and subsequent year. The retention money withheld during the year amounted to Rs. 4,11,42,846/-. The Assessing Officer further stated that on perusal of Schedule 7 to Financial Statement, it is observed that balance of retention money decreased from Rs.4,35,62,352/- to Rs.4,32,42,332/-, while during the year Rs.4, 11,42,846/- was deducted as retention money from the bills raised during the year. He has further stated that during the year the employer  i.e., Government of India released Rs. 4,14,62,866/- against bank guarantee. The Assessing Officer has given relevant details of retention money of preceding years and assessment year under consideration in the assessment order at Page-2 in Para 4.3 as under:

It is relevant to state that as per contract entered into, retention money @ 5% had been withheld. The agreement further provided that whenever retention money reaches 2% of the contract price, contractor could ask for release of 1% of the contract price by furnishing bank guarantee. Accordingly, in the assessment year under consideration, the assessee received Rs.4, 14,62,866/- towards release of retention money against bank guarantee.

4. Since the assessee did not offer the said amount of Rs. 4,14,62,866/- for taxation in the assessment year under consideration on the ground that it would become taxable in the year when contractor satisfactorily completed the work and removed defects if any it would be taxable at that stage. The Assessing Officer brought the said amount to tax on the ground that it has accrued to the assessee during the year and is, therefore, taxable. Being aggrieved, assessee filed appeal before the first appellate authority.

5. The learned CIT (A) after considering the submission of the assessee and decision of Hon’ble Mumbai High Court in the case of CIT vs. Associated Cables Pvt. Ltd. 286 ITR 596 and also the decision in the case of DCIT vs. Spirax Marshall Ltd. 109 TT 593 and the decision of Hon’ble Allahabad High Court in the case of CIT vs. Yatindra and Co. 149 Taxman 281 has held that the assessee has not got any absolute right over the amount paid against bank guarantee out of retention money and as such the said amount could not be assessed to tax in the assessment year under consideration. Hence, this appeal by the department.

6. The learned Departmental Representative in her submission referred clauses of the agreement, which are stated by the Assessing Officer in the assessment order at Pages-2 & 3 and submitted that Government of India released 1% of the contract price out of the retention money withheld by it by furnishing bank guarantee. Since, the assessee received the amount in the assessment year under consideration, it is to be assessed in the year in which the amount has been received by the assessee as the income has accrued to it. Learned Departmental Representative submitted that the assessee has already claimed expenditure incurred in respect of contract executed and, therefore, when the amount is  released to the assessee, the same is to be taken into consideration in the year in which it is received. Ld. Departmental Representative placed reliance on the decision of DCIT vs. Amarshiv Construction (P) Ltd. 88 ITD 381, and held that amount deducted from running bills of construction work as additional security deposit for satisfactory performance of contract and it was released to assessee on furnishing bank guarantee, the said amount had accrued to the assessee in the assessment year in which bills were raised. The contention of assessee was not accepted that it was not to be considered till satisfactory completion of work. The learned Departmental Representative submitted that above case squarely apply to the case of the assessee herein and, therefore, the retention money received by assessee in the assessment year under consideration, even though it was received against bank guarantee, is the income of the assessee for the assessment year under consideration. Learned Departmental Representative submitted that reliance placed by the learned CIT (A) on the decision of Hon’ble Bombay High Court in the case of Associated Cables Pvt. Ltd (supra) is not applicable as in that case no retention money was received by the assessee but a part of that retention money was withheld by contractee and, hence, it was held that no income accrued to the assessee in the year in which the amount was retained. Learned Departmental Representative further submitted that the above decision of Mumbai High Court in the Associated Cables Pvt. Ltd. (supra) was also considered by ITAT Chandigarh Bench in the Punjab Communications Ltd. vs. DCIT 87 TTj (Chd) 440. The learned Departmental Representative submitted that in the said case the assessee received 100% of purchase price but the assessee was to give performance security to the purchaser for an amount of 5% of contract value which was in the form of bank guarantee. The assessee reduced 5% of the sale price on the ground   that if there was any defect or the assessee fails to perform its obligation liability to meet out warranty obligation the purchaser was entitled to receive the money out of this bank guarantee. However, the Tribunal held that the assessee had received 100% sale consideration, it accrued to the assessee at the time of sale and the income stood accrued to the assessee at the time of delivery of equipment because under the agreement the purchaser was not entitled to retain payment till expiry of warranty period. On the other hand the assessee would be entitled to claim deduction in respect of expenditure which he might incur for meeting out the obligations as given to the purchaser by way of warranty when any liability under the warranty clause might arise, the expenditure in respect of such obligation would be deductible in that year. The learned Departmental Representative submitted that the income which has actually accrued cannot be reduced with the probable obligations which may arise under the warranty clause. The learned Departmental Representative submitted that the Assessing Officer was justified to include the amount received by the assessee in the assessment year under consideration out of retention money as the said income has accrued to the assessee.

7. However, learned Authorized Representative supported the order of learned CIT(A). He submitted that the assessee has received retention money on furnishing bank guarantee. Therefore, release of retention money against bank guarantee does not result in conferring an unfettered right on the assessee. He further submitted that it can be considered as financing arrangement for smooth completion of the work by the assessee. He submitted that in the event the assessee could not fulfill obligations expressed in the contract, the contractee has   right to recover the retention money from the bank on the basis of the bank guarantee given by assessee. The bank has also undertaken unconditionally and irrecoverably to pay the contractee on demand by invoking bank guarantee. The learned Authorized Representative further submitted that the income has accrued to the assessee in which the right to receive particular income accrued unconditionally. He submitted that this particular contract was completed in assessment year 2006-07 and assessee recognized the retention money as income in assessment year 2006-07 and submitted that the said facts have also been considered by learned CIT(A) in Para 3.3 (ii) of Page 4 of the order. Learned Authorized Representative further submitted that similar issue has been considered by ITAT (TM) in the case of Associated Cables Pvt. Ltd. vs. DCIT 48 ITD 141. Thereafter Hon’ble Mumbai High Court considered the above decision of ITAT (TM) and confirmed the decision of the Tribunal which is reported at 286 ITR 596. The learned Authorized Representative further submitted that the decisions cited by learned Departmental Representative are not relevant to the facts of the case, as in those cases the bank guarantee was given to fulfill warranty obligations only and whereas assessee received full amount which is not a case of retention money and where he does not receive the amount.

8. We have carefully considered the orders of the authorities below and submissions of the learned representatives of both the parties. We have gone through the cases (supra) cited by learned representatives of both parties.. We observe that the similar issue has been considered by ITAT (TM) in the case of Associated Cables Pvt. Ltd (supra) as under:

“90 percent of value of assessee’s goods were billed on dispatch, and 10 percent was payable upon completion of warranty period. This amount retained was conditional on fulfillment of certain representations made by assessee to customers. As per the agreement entered into with the customers, amount retained was released against furnishing bank guarantee by a scheduled bank.”

The third member held of the tribunal had held as follows:

“… As the performance guarantee remains and is enforceable without notice to the assessee, the income from the retention money cannot be recognized. Consequently, I have to agree with the learned Accountant Member that the retention money of 10% has to be excluded in computing the total income until the period of guarantee is over.”

We observe that the Hon’ble Jurisdictional High Court in the subsequent assessment year of same assessee considered the above decision of ITAT and affirmed the said decision. It was held that retention money withheld by the contractee pending completion of contract work does not accrue to the assessee/contractor in the year in which the amount is retained. We also observe that similar issue was also considered by ITAT in the case of Spirax Marshall Ltd (supra) wherein it was held that receipt of retention money against furnishing bank guarantee cannot partake character of income since it cannot be apportioned until guarantee period was over. The retention money may be received by the assessee; it cannot be apportioned until expiry of warranty period. We observe that the Hon’ble Allahabad High Court in the case of CIT vs. Yatindra and Co. (supra) held that an amount received by assessee against bank guarantee was not accrued to the assessee during the year as no absolute right to receive the amount at that stage vested.

9. Further we observed that the assessee received a part of retention money against bank guarantee in the preceding assessment years, the details of which are given by Assessing Officer at Page 2 and also mentioned herein above in Para 3 at Page 3 of this order. During the course of hearing the learned Authorized Representative submitted that the assessee is following consistently to offer for taxation the part released of retention money against bank guarantee in the assessment year in which right to receive the said release of retention money accrued to the assessee unconditionally. The learned Departmental Representative also did not dispute the above contention of learned Authorized Representative at the time of hearing.

10. In view of above facts and decisions, and particularly that similar issue has been considered by the Hon’ble Mumbai High Court in the case of Associated Cables Pvt. Ltd. (supra) which has been followed by the learned CIT (A), we do not find any reason to interfere with the order of Ld.CIT (A). Hence, we uphold his order and reject the ground of appeal taken by the department.

11. In the result, the appeal filed by the department is dismissed.

Order pronounced in the open court on this 30th day of December, 2011.