Mr. Shardul Singh, IRS (IT: 2017)
ACIT Circle 62(1), Delhi

Mr. Shardul Singh

Sh. Shardul is an IRS officer of 2017 batch. He did his Btech. in Electrical Engineering from Indian Institute of Technology-Delhi and is presently posted as ACIT Circle-62(1), Delhi.

Executive Summary

This sector specific article aims to share knowledge regarding issues faced during assessment and investigation in case of contractors. Various points of discussion include inflation of expenses, manipulation of stock, revenue recognition methods, common types of additions, how to make additions have a better standing at appellate stages, important case laws, common issues in case of Construction Joint Ventures etc.

A contractor is a person who carries out work (including supply of labour for carrying out any work) in pursuance to a contract between the contractor and another person (contractee). Under Section 2(h), the Indian Contract Act 1872 defines a contract as an agreement which is enforceable by law. Further, a contract may be an oral or written. A careful assessment and investigation of contractors becomes very important due to the nature of this business. A contractor can employ various methodologies to generate unaccounted money, use the unaccounted money in business and evade taxes. In light of various avenues available for manipulation of accounts, where cash plays a major role in many such businesses, there is a huge scope of work in this regard to plug the various loopholes employed by contractors to evade taxes. Moreover, many-a-times the contractor assessee shows very low net profit (e.g. less than 2%) and at the same time claim high refund; this attains grave importance from the point of revenue in case the claims are not genuine. Hence, during the assessment of contractors, various aspects need to be kept in mind which would help in effective scrutiny of books of accounts and prevent loss of revenue. Further, investigation becomes thoroughly important in such cases so as to bring factual material on record which would be able to stand the test of judicial scrutiny at various appellate stages. In this article, various aspects to be considered while doing assessment and investigation in case of contractors will be discussed.


One of the first and foremost thing to realize while doing assessment of contractors is to identify the areas in which the scope of manipulation is highest in terms of book of accounts of the assessee. In case of contractors, one major point to note is that most manipulation and dressing up of books of accounts is done on the debit side of Profit and Loss (P&L) account i.e. the Expenses side. As we know there are primarily two ways of reducing the taxable income in case of businesses by the assessees: one is by decreasing the income (i.e. Credit side of P&L account) and the other is by increasing the expenses (i.e. Debit side of P&L account). In case of contractors, most manipulation is done by inflating the expenses. The reason for this is that it is easier to do so compared to reduce income because TDS under Section 194C of the Income-tax Act 1961 (the Act) is deducted on the income or the contractual receipt received by the contractor from the contractee. Hence, while doing assessment, special emphasis should be made in verifying the expenses compared to the receipts.

Another high risk area in case of contractors is the maintenance of stock. Many times the contractor assessee does not perform stock-taking regularly. The assessees do not keep correct watch over stock over the year; this is also because of complexity and nature of stock. Many times materials like plywood, shuttering ply, marble, paint, tiles, steel, cement, chinaware, brick, sand etc. form part of the stock and sometimes due to complexity in maintaining stock of some of these items or due to multiple site projects the assessees end up foregoing the exercise and instead do it at one go at the end of the year, or on adhoc/ estimate basis thereby leading to huge manipulation in the balance sheet.

In this background, while doing the assessment, it becomes very important to verify the maintenance of stock by the assessee. The AO (Assessing Officer) should check for the registers maintained to satisfy himself/ herself that the stock has been maintained properly. Now comes another major point of contention in case of contractors, i.e. Valuation of stock. The method of valuation used by the assessee is explained in the audit report also. However, care should be taken during assessment to ask for valuation method item-wise and check if the same are in line with market trends. It must, hence, be checked that there are no major discrepancies in the valuation of closing stock. Otherwise, an inflated closing stock value would result in higher cost of goods sold and lower gross profit; thus, leading to less taxable income in a particular year.

While at the discussion of closing stock it is important to discuss revenue recognition in case of contractors, it is imperative that the revenue is recognized in proper manner so that income is offered to taxation in right amount by the assessee. Many civil contractors recognize revenue on the basis of bills submitted to the contractee called ‘Running bills’ which are then approved/ certified by the contractee. After certification, the revenue related to these bills is recognized by the contractor in his books. Another major revenue recognition method in case of civil construction contractors is Percentage of Completion method (POCM). The revenue recognition of this method is governed by the Accounting Standard 7 (AS 7) issued by the Institute of Chartered Accountants of India (ICAI) which corresponds to the (Income Computation and Disclosure Standards) ICDS III which is notified by the Government of India. As per this method, the revenue is recognized as per the following formula:

Percentage of Completion (POC) = Cost incurred upto reporting date/ Total Estimated Cost of the project x 100

Current year revenue = Total revenue * POC – cost incurred upto reporting date

Once the value of current year revenue to be recognized in a particular year is recognize, the taxes are paid on that corresponding revenue and the expenses are claimed in proportion to the revenue recognized in the current year as per the AS7. The point to be noted here is that sometimes the assessees do not correctly recognize revenue as per POCM. Care has to be taken that the revenue is recognized and is in line with the latest contract/ agreement.

Another point which is faced very commonly in case of contractors when it comes to revenue offered for taxation is contractual receipts of the assessee as per its P&L/ ITR and as per Form 26 AS. Great care should be taken that there should not be any difference in the receipts as per Form 26AS and as per P&L of the assessee. The assessee should not be under-reporting its revenue in the books/P&L i.e. the ITR should conform to Form 26AS. In case there is any difference, it should be reconciled by asking the assessee the reason for difference. Many times this difference arises on account of TDS under Section 194C being deducted on Gross Amount while assessee realizes the Net Amount; further, it might be a case where the TDS is deducted on Mobilization advance which is not offered for taxation by the assessee in the year in which it is received. In such cases, care has to be taken that TDS credit can be given to the assessee in such a case only when the assessee offers the corresponding income for taxation.

Now, we shall discuss most frequent types of disallowances which are made in case of contractors. Many times AOs end up doing adhoc disallowance on estimate basis. For example, unverifiable purchases or unverifiable fuel charges or unverifiable labour charges etc. and a proportion of these expenses claimed is disallowed. This practice should not be followed as it leads to arbitrariness and it does not hold ground in any of the appellate forums especially in the ITAT. In this background, order of jurisdictional ITAT in case of ACIT vs M/s. Modi Rubber Limited (ITAT Delhi) is important where it was held that disallowance made on ad hoc basis without pointing out any defects in assessee books or vouchers maintained for impugned expenses, and, the same was not, therefore, sustainable. Hence, making ad hoc disallowance should not be encouraged and it should only be made after pointing out the defects in books or faulty bills/ vouchers etc. Also, in case the scope of discrepancies in the books of accounts is high and is not limited to bills/ vouchers of one particular expenses then books of accounts should be rejected under Section 145(3) of the Income-tax Act 1961. This also stands the test of scrutiny in appeals. Moreover, one more important point to be kept in mind while making such disallowance; e.g. while considering Vehicle and Maintenance expense, a corresponding disallowance on depreciation claimed under Section 38(2) of the Income-tax Act 1961 (the Act) should also be made.

Reliance can be placed on various case laws which should be mentioned in the assessment order itself. A few of such case laws are as follows:

a. The judgment of Hon’ble Supreme Court held in the case of CIT British Paints India Ltd. [1991] 188 ITR 44/54 Taxmann 499 (SC) held that as from the books of the assessee, due to reasons detailed by the Assessing Officer in his order, correct income of the assessee was not deductible, the application of Section 145 was upheld.

b. In the case of Kesharichand Jaisukhlal (248 ITR 47) wherein the Hon’ble High Court had upheld the estimation of income consequent to rejection of books of account on the basis of various infirmities and inconsistencies in the accounts found by the AO.

c. Similarly, the Delhi High Court in the case of Chetan Dass Lachhman Dass (255 ITR 197) upheld the rejection of books of account and estimation of income wherein no evidence in respect of expenses could be produced by the said assessee.

d. In the case of Mani & Co., a contractor, was unable to produce the books of original entry and proper bills and vouchers, the Hon’ble Kerala High Court in its judgment cited in (256 ITR 373) held that the AO was justified in rejecting the work account of the assessee and estimating the profit.

e. In a recent judgment pronounced by the Hon’ble ITAT, Delhi ‘A’ Special Bench in the case of Deputy Commissioner of Income-tax vs Allied Construction (2007) 106 TTJ (Del) (SB) 595 it has been held that:

‘When purchases of material, labour payments and other expenses debited to Profit & Loss Account were unvouched and without underlying bills/ vouchers, the Assessing Officer was correct in rejecting the books of accounts of the assessee’; also in the same judgment bench has upheld decision of the AO to estimate net income of assessee at @ 8% ofwork receipts.

The finding is fortified with the authority of the Hon’ble Supreme Court as rendered in the case of Kachwala Gems Joint Commissioner of Income Tax [2007] 288 ITR 10 (SC) wherein the books of accounts of the assessee was rejected on the consideration of non-maintenance of stock register, low gross profit rate compared to previous years, low gross profit rate compared with similar assesee’s in similar business and where purchases were also not verifiable.

g. The Hon’ble Allahabad High Court has similarly held in the case of Bimalkumar Anant Kumar (288 ITR 278 Allahabad) that non-maintenance of stock register is the strong ground for rejecting the books of accounts of the assessee when it is coupled with various other irregularities.

h. The decisions in the cases, namely, Bombay Cycle Stores Co. Ltd. vs Commissioner of Income-tax as well as Ghanshyamdas Permanand vs. Commissioner of Income Tax (Nagpur High Court) supports the case of revenue in rejecting the books of accounts and estimating the correct income.

The rejection of books is one of the strongest tools which has stood the test of appeals on several occasions. The AO should carefully point out the discrepancies and inconsistencies in the books of accounts after elaborate investigation bringing material facts on record. The methodology of rejection of books of accounts plays a major role in making the assessment order strong. Subsequently, the income may also be estimated at reasonable rate of the total revenue keeping in mind also Section 44AD of the Act.

Another common type of disallowance in case of contractors is addition under Section 36(1) (va) of the Act. Many times, contractors have employees and deduct employees contribution for funds mentioned under Section 2(24)(x) of the Act i.e. EPF/ESI or any other similar fund mentioned in the provision. However, if the employees contribution is not deposited in the relevant fund before the due date, the same is treated as income under Section 36(1)(va) read with Section 2(24)(x) of the Act. The above issue has been dealt with in CBDT Circular No. 22 of 2015 dated 17.12.2015 wherein the stand of the Department regarding allowability of employer’s contribution to funds for the welfare of employees in term of Section 43B(b) of the Act has been clarified. The said Circular vide para 5 further clarifies that this Circular does not apply to claim of deduction relating to employee’s contribution to welfare funds which are governed by Section 36(1)(va) of the I-T Act 1961. Moreover, SLP in the case of ACIT vs Namdhari Seeds CA No. 1954 of 2015 and in the case of Advanta India Ltd. vs CIT SLP C No. 4577/2015 on the issue are pending before the Supreme Court. In this background, the employees’ contribution which has not been deposited in the relevant fund on or before the due date may be added back to the total income. The same is also pointed out by the auditor in Form 3CD. At the same time, it must be mentioned here that addition on this ground is contentious given the decision of Hon’ble Supreme Court in Rajasthan State Beverage Corporation Ltd. 84 185 (SC) which provides that no disallowance be made on this ground. Nevertheless, there is lack of legal clarity on the issue and SLPs are pending as mentioned above.

Furthermore, disallowance on Interest on late payment/ deduction of TDS under Section 201(1A)/206C(7) is also commonly occurring issue in case of contractors. Interest under Section 201(1A)/ 206C(7) on late payment/ deduction of TDS/ TCS is not an allowable deduction under Section 37. This view derives support from the recent decision of the Hon’ble ITAT, Mumbai Bench, Mumbai in the case of DCIT vs. Allied Media Network Pvt. Ltd. in ITA No. 3545/ MUM/2016 dated 27.06.2018, wherein the ITAT has, after considering the judgment in the cases of Bharat Commerce and Industries Ltd. (1198) 230 ITR 733 (SC), Ferro Alloys Corpn. Ltd. vs. CIT (1992) 196 ITR 406 (Bom), Martin & Harris (P) Ltd. vs. CIT (1994) 73 Taxmann 555 (Cal.), CIT vs. Chennai Properties & Investment Ltd. (1999) 105 Taxmann 346 (Mad) and DCIT vs. M/s Narayani Ispat Pvt. Ltd. (ITA No. 2127/Kol/2014 for the AY 2010-11) has held, that interest paid takes colour from nature of principal amount required to be paid but not paid in time and this principal amount being income-tax, interest is in nature of a direct tax and settlement of income-tax payable under the Act and, therefore, same cannot be regarded as compensatory payment and allowed as business expenditure.

Now, we shall discuss the Assessment of Joint Ventures (JV) which is a common occurrence in case of contractors, especially construction contractors for specified purpose or work. Usually, the JV which is an AOP, is formed in such a way that one partner provides technical expertise while the other provides financial support, or one entity is non-resident in India and the other being a resident in India; or any other such arrangement to fulfill the tender requirements.

While assessing JVs, care should be taken to carefully study the Notes to Accounts of the Assessee. These provide various insights and might have several hidden useful statements in it which could be read thoroughly to understand if the JV is trying to evade taxes in some ways. This, along with JV Agreement provides various valuable information which are useful at the time of assessment.

For instance, in one case, it was noticed that assessee is claiming depreciation as per life of its project and not as per provisions of the Act. This was in total violation of the Act under Section 32. Thus, relevant disallowance is made and depreciation is allowed only as per provisions of the Act. In another case, the JV underwent cost escalation and did not disclose the new contract value and thus furnishing a faulty POCM calculation, thus addition was made based on the discrepancy found. In yet another case, the JV agreement specifically stated that the JV would not be incurring any indirect expenses apart from sub-contract expenses to its individual JV partners yet the JV had claimed indirect expenses which were then disallowed. Also, many times JV subcontracts the whole work to the individual JV partner in case JV is formed just to meet the tender requirements to fetch the contract. In such cases, JV itself undergoing purchases should be questioned since the JV is not doing any work by itself. Such issues are commonly noted in cases of assessments of Joint Ventures.


In this section, we shall deal with points of investigations while dealing with business of contractors. Various points of investigation can be identified from P&L Account. The AO may call for stock register, labour registers, salary registers etc. More often than not such registers are neither maintained nor updated regularly and in case they are presented to the AO, there is a high chance that they might have been fabricated at the very last moment. In such instances the AO should check for the discrepancies as in such circumstances the assessee is bound to make certain mistakes, e.g. in one case, it was found that the signature from same pen and of same type was made in front of names of many employees in the salary book. The AO may ask for identity cards like AADHAAR of such person and in case any such person is bogus it can be easily known. While calling bills for various expenses AO should check if there are any GST numbers of the parties, their names, their addresses, do they have PANs or any such thing being mentioned on the bills. Many times forged bills appear to be slightly changed compared to one another for example, the font of the name of the party would change whereas the rest of the bill would remain the same; this is a clear indication that the party might not be genuine.

Further, purchases should be subjected to deep scrutiny. The bills and vouchers should be called on random basis and these should be verified. Moreover, suitable Sundry creditors may be identified, especially the ones which are more than three months old with whom purchases have been made and they should be asked to present a confirmed copy of account of assessee in their books to check in case assessee is not inflating purchases along with bills.

In case of expenses related to cartage, it should be checked whether TDS has been deducted on it. Similar exercise is required to be done in case the assessee is claiming commission expenses. If the said claim is made, the AO should go in deep towards the nature of service provided to assessee for which the assessee is claiming commission expenses. It should also be checked if the service is related to business purpose of the assessee. AO may enquire the recipient of services by use of summon under Section 131 or call for information under Section 133(6) of the Act. Similarly, AO should inquire in to the Misc. expense or Other expense claimed by the assessee to ascertain whether these are for business purposes. Further, while scrutinizing the expenses related to travelling and tour, telephone, vehicle and maintenance a personal component in use of these cannot be ruled out in case of sole proprietorship business.

Accordingly, disallowance may be made after verifying relevant registers like vehicle log book, telephone log book etc.

As far as Closing Stock is considered, special care should be taken. Contractor assessee can easily try to manipulate the figure of closing stock by valuing the closing stock as per his whims and fancies. It is a common trend in case of contractors that the closing stock is not maintained form time-to-time and it is mostly an afterthought or ad hoc estimation. This should not be allowed. AO should ask for item-wise ledger account showing the values of closing stock, then sources like the internet or local inquiries should be used to ascertain the degree of correctness with which the closing stock is valued. This should be checked because assessee can inflate closing stock to increase cost of goods sold and decrease the gross profit thus paying less and less taxes.

Now, we shall focus on the points of investigation emanating out of balance sheet. The introduction of fresh capital should be immediately flagged. Many times it is seen that contractor assessees are taking benefits of accommodation entries to introduce their own unaccounted cash into their books of accounts in the capital account head. The party from where credit entry is received may be summoned and statement should be recorded. They may be asked to submit documents establishing identity of the party, creditworthiness of the party and genuineness of the transaction (Hon’ble Supreme Court in Commissioner of Income-Tax vs Precision Finance Pvt. Ltd.) should be called for like bank statement, ITR, AADHAAR card, PAN etc. Similar exercise is required to be done in cases where there is fresh unsecured loan taken during the year or any loan taken and repaid i.e. squared up during the year. The audit report hints at this in one of its columns clearly. More importantly, unsecured loans from family members like wife, son who might not have wherewithal to pay such loans should be carefully examined.

Further, many times it is also noticed that assessee has received loans from family members. Firstly, the assessee should be asked to furnish ITR and bank statement of such family members as very often this is actually assessee’s money which is doing rounds. Care should also be taken to scrutinize the interest expenses claimed on unsecured loan taken. This may be a deal between related parties as can also be found from the Form 3CD just to take the benefit of claiming interest expenses.

Any new investments should be checked thoroughly and the source of the money to make such investment should also be inquired into by the AO. Regarding Debtors, it may be investigated whether old debtors are persisting in the balance sheet. New fixed assets should be identified. Their bills should be called. Proper proof of the installation of the fixed asset and date when it was put to use of the asset should be asked, this way excess depreciation claim used by various assessees can be stopped.

One more point of investigation which should be inquired into in-depth is payment to petty contractors. Many times, the assessee deals with small contractors by subcontracting its work to small petty contractors. No TDS is deducted on such sub-contract. This is also a point which should make the AO careful. Many times it has been noticed that many such petty sub-contractors do the business in the name of the assessee contractor while being totally out of the purview of the Income-tax Department. Such petty contractors never file return of income and thus escape the tax base entirely. Moreover, these sub-contractors operate solely in cash mode and take payments in cash only. In this way, huge amounts of unaccounted wealth is generated and promoted. Effort should be made to get a list of such petty contractors along with name, address and PAN etc., if any. Their bills/ proof of existence should be ascertained. It should be enquired if they are filing returns or not and inquiry should be made to estimate the extent of their income. Subsequently, they may be asked to file return through notice under Section 142(1) or any other action may be taken if applicable, like survey/ search (with the help of Investigation wing).

In case of JVs another, modus operandi has evolved whereby the Contract Value is revised upwards under the shelter of escalation clauses in the contract and the same are not disclosed to the Income-tax Department. Further, the revenue is not recognized many times on the basis of such revised contract values. This is relevant in case of construction-related contracts. One example of such a case can be given here in which the assessee was in contract to dig tunnels for the Delhi Metro Rail Project. Subsequently, due to circumstances like the Tunnel Boring Machine getting stuck underground where it was technically impossible to reclaim the Tunnel Boring Machine (TBM), the TBM had to be dismantled which resulted in losses for the assessee and cost escalation of the project. This led to revised contract value of the project, on the basis of which new calculation of Percentage of Completion (POC) of project had to be worked out. However, the assessee did not inform the AO of the fact that contract value has been revised and claimed excess expenses in a particular year. AO then has to, in cases where such modus operandi is suspected, call for information under Section 133(6) of the Act to ask for updated agreement if any. Then, afterwards in case something adverse is found, books of accounts have to be rejected and profit has to be estimated including estimation of POCM working based on a reasonable rate.

Another common issue which is found with contractors is that many times they do not maintain books of accounts on the regular basis, or may even maintain parallel books of accounts. Many such contractors often prepare informal books and only towards the end of the year when the time comes to file a return the assessee undergoes the exercise of fabrication of the books of accounts. This can be checked while checking the stock register, labour register and registers of other expenses which are not regularly maintained by many such contractors. Another interesting point which draws suspicion that books are being prepared at the end of the year at the time of filing of return of income is assessee paying very high Self-Assessment Tax every year while not paying any advance tax at all. Such cases should be suspected and may be identified for survey action. Hence, existence of parallel books, non-maintenance of stock/ labour etc. registers are key risk points to be kept in mind to which a contractor business is prone to.


Hence, in the above discussion, various issues encountered in case of contractors at the time of assessment, investigation are discussed. The above comprehensive sector-specific discussion would help in increasing awareness of officers while dealing with business of contractors. It would further help in plugging loopholes and spotting tax evasion techniques while dealing with these types of assessees. Further, from the point of view of revenue, it would be of great importance because this sector involves huge refund claims, low net profit declaration, substantial unaccounted income and huge tax evasion. Thus, in the interest of revenue, it is critically important that the officers should be well-versed with various issues while dealing with the business of contractors.

Source- Taxalogue 3- April to June 2020

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September 2020