IN THE ITAT MUMBAI BENCH ‘L’
Lingtec Constructors LP
versus
Income-tax Officer, (International Taxation) 1(2), Mumbai
IT APPEAL NO. 5376 (MUM.) OF 2003
[ASSESSMENT YEAR 1999-2000]
AUGUST 24, 2012
ORDER
I.P. Bansal, Judicial Member
This is an appeal by the assessee. It is directed against order passed by Ld. CIT(A)XXXI, Mumbai dated 16/05/2003 for the assessment year 1999-2000.
2. The grounds of appeal filed originally were lengthy and narrative. The assessee has filed a concise grounds of appeal which read as under:
“(1) The learned CIT(A) erred in confirming the action of Assessing Officer of considering the initial work agreements to be independent contract rather than part of a main contract.
(2) The learned CIT(A) erred in not accepting the principle of Accounting Standard 7 issued by Institute of Chartered Accountant of India.
(3) The learned CIT(A) erred in confirming the action of A.O of treating advance of Rs. 320 crores as income and Rs. 16 crores as taxable income.
(4) The learned CIT(A) erred in confirming action of A.O. of applying Rule 10 of the Income Tax Rules.
(5) The Learned CIT(A) erred in confirming the charging of interest u/s 234 B of the Income Tax Act.
(6) The appellant crave for leave to add to alter to delete or to amend any of the grounds of appeal if necessary”
3. The assessee is a non-resident firm having its registered office in the State of Delaware and the principal place of business at Enron Corporation, 1400, Smith Street, Houston, Taxas 77002. It has entered into a contract with M/s. Dabhol Power Corporation (DPC) in connection with responsibility for onshore construction work and onshore services in connection with Phase II Dabhol Power Project and the attached Liquefied Natural Gas (LNG) unloading, storage and re-gasification. During the year under consideration following contracts were entered into by the assessee with DPC.
(i) Onshore Construction Contract for Phase II of the Dabhol Power Project dated November 30, 1998.
(ii) Onshore Services Contract for Phase II of Dabhol Power Project dated November 30, 1998.
(iii) Onshore Construction Contract for LNG facility dated November 20, 1998.
(iv) Onshore Services Contract for LNG facility dated November 20, 1998.
4. According to assessee, aforementioned main contracts were not effective as of 31/3/1999 due to terms and conditions of the contract. Therefore, the assessee firm executed following contracts:
(i) Onshore Construction Initial Work Agreement (‘OnCon IWA’) dated August 31,1998 valued at USD 78,345,000; and
(ii) Onshore Construction Initial Work Agreement (‘OnCon IWA’) dated August 31,1998 valued at USD 8,266,000
It was noticed that assessee firm had incurred total expenses of Rs. 149,78,24,027/- for the execution of the above mentioned two contracts which was shown as work-in-progress in the statement of assets and liability for the year ended 31/3/1999 and it was submitted to the AO that no invoices were raised on DPC for work executed during the year. This fact is mentioned by AO in para-8 of the assessment order. It was further noticed that assessee had received a sum of Rs. 320,14,19,720/-, which was claimed to be an advance come from Enron Development Corporation (‘EDC’) and not from DPC.
5. The assessee did not disclose any income arising out of contract on the basis of clause “a” of Note-2 “Summary of Significant Accounting Policies” and it was stated as follows:
“It is the firm’s policy to recognize revenues only after 20% of the project work has been complete. The firm recognizes contract revenues for the contracts entered into with DPC under the percentage of completion method using cost incurred to date in relation to the estimated total cost of the contracts based on the appropriate stage of completion of the project. Till March 31st 1999 the firm had incurred approximately 14% of the estimated cost on the total Onshore LNG Facility contracts. Accounting Standard 7 issued by Institute of Chartered Accountants of India states that “Normally profit is not recognized in fixed price contract unless the contract has progressed to a reasonable extent. Ordinarily this test is not considered as having been satisfied unless 20 to 25% of the work is completed. As costs as compared to the estimated costs as at 31st March 1999 have been incurred only to the extent of approximately 14% of the firm has not recognized profits during the period ending 31st March 1999 and the work completed upto 31st March 1999 has been recorded as WIP in this financial statement and accordingly P&L A/c. has been prepared for the relevant year.”
6. The AO required the assessee to explain as to why the income accrued to the assessee firm during the year should not be brought to tax in the year of accrual. Vide reply dated 8/3/2002 it was submitted that the assessee recognizes the contract revenue for the contracts entered into with DPC under the “percentage of completion method” using cost incurred to date in relation to the estimated cost of the contracts based on the appropriate stage of completion of the project under the percentage of completion method revenues/profits are not recognized in fixed price contract unless the work under the contract has progressed to a reasonable extent. Ordinarily this test is not considered as having been not satisfied unless 20 to 25% of the work is completed. Reference was made to Accounting Standard-7 (AS-7) and it was submitted that the work was completed only to the extent of 14% of the total contract, therefore, assessee was not liable to declare any income having regard to the facts of the case.
7. AO vide letter dated 15/3/2002 required the assessee to explain as to why advances shown to be received by it of a sum of Rs. 320,14,19,720/-should not be treated as receipt of the firm and he disbelieved the version of the assessee that assessee did not issue/raise invoice to DPC, therefore, income did not accrue to it. Vide letter dated 20/3/2002 it was submitted by the assessee that the advance of Rs.320,14,19,720/- received from EDC are in the nature of progress payments under the aforementioned two initial work agreements “OnCon IWA”. Para 9.3 of the AS-7 states that as per “percentage of completion method” for recognizing revenue on construction contracts, progress payments and advances received from customers may not necessarily reflect stage of completion and, therefore, cannot be usually treated as equivalent to revenue earned. Reference was also made to Para 15.1 of AS-7, according to which progress payments and advances received from customers in respect of construction contracts in relation to work performed thereon are disclosed in the financial statement either as liability or shown as deduction from the amount of contract work-in-progress. It was submitted that in the financial statement progress payments and advances received from EDC in respect of work performed under “OnCon IWA” are disclosed as a liability as “advances”. Thus it was pleaded that the aforementioned amount is liability and not income per se which cannot be treated as income. The AO did not accept such submission of the assessee as according to AO as per para 7.2 of the AS-7, under the “percentage of completion method” revenue is recognized as contract activity progresses based on the stage of completion reached. The costs incurred in reaching the stage of completion are matched with this revenue, resulting reporting of results which can be attributed to the proportion of work completed. Although as per the principle of “prudence” revenue is recognized only when realized, under such method, the revenue is recognized as activity progresses even though in certain circumstances it may not be realized. The AO observed that assessee in its submission has never produced the stage of completion of contract activity, the proportion that costs incurred to date bear to the estimated total cost and the details of services conducted to measure the work performed and completion of the physical proportion of the contract work. In absence of details of the above exercise assessee did not comply with the provisions of para -7.2 of AS-7 and thus assessee was not able to show stage of contract performance completed at the end of the financial year. (para 5.2 of the assessment order) The AO also referred to disclosure clause of AS-7 which requires disclosure with regard to construction contracts regarding progress payments received and advances and retention on account of contracts included in the work-in-progress. The AO also referred to the International Accounting Standard – 11, which also require the disclosure of amount of advances received and amount of retention. From the above facts the AO has drawn the following conclusion to hold that the version of the assessee cannot be accepted.
“In view of the above discussions and for the reasons mentioned hereunder, viz:
(A) In the absence of details of stage of completion of contract furnished by the assessee, the advances received from the customer by the Assessee are being taken as income or a reasonable amount is estimated as income as discussed in the following paragraphs.
(B) Further the assessee has also not tried to prove that only 14% of the work has been completed. The onus of proving that the minimum limit for work completion as submitted by the assessee at 20% below which the profit could not be accounted for has not been discharged by the assessee. However, the loss if any had to be provided for. The assessee has at any stage and inspite of various opportunities given never tried to substantiate their claim that only 14% of the work has been completed.
(C) In the notes to accounts also, the assessee has stated that till 31st March 1999 the firm had incurred approximately 14% of estimated cost on the total onshore LNG facility contracts. However again at no stage the assessee has disclosed the estimated cost or the estimated revenue out of the total contract price in proportion to works completed and related contract cost.”
8. Again in para-11 the AO has mentioned that the assessee firm did not provide certified quantity of the work executed by it. Therefore, taking the aggregate amount aforementioned two “OnCon IWA” the AO valued those contracts at Rs.366,19,13,000/- and also taking into account the cost incurred by the assessee of work-in-progress at Rs. 149,78,24,024/- the AO has arrived at a conclusion that since assessee has completed 40% of the work, its income was liable to be assessed in the year under consideration. He estimated the taxable receipts of the assessee at RS.160 crores and taking 10% as net profit he assessed the income of the assessee at Rs.16.00 crores against nil declared by the assessee.
9. The Ld. CIT(A) confirmed the order of the AO. The assessee is aggrieved and hence, has raised aforementioned grounds of appeal.
10. Ld. A.R submitted that Ground No.1 to 4 essentially raise one issue only i.e. with regard to estimation of income during the year under consideration. He submitted that according to the note given in the financial statement unless 20 to25% of the total contract is not completed, the assessee is not under an obligation to disclose any income and this position of law has been accepted by the Mumbai Tribunal in the case of Dy. DIT (International Taxation) v. Strok Engineers & Contractors B.V. India Project Office [2010] 127 ITD 211, wherein it has been held that if the work is not completed upto 20 to 22%, till that stage, no income need to be identified and offered for taxation.
11. He further submitted that “OnCon IWA” contracts were not independent contract and those contracts have to be seen with the principal contract and while computing percentage of completion the value of the main contracts is required to be taken into consideration. He submitted that copy of all these contracts have been filed in the revised paper book which only will be referred during the course of arguments and it contains 82 pages. Copy of the main agreement is filed at page 73 to 82 of the paper book and according to attachement-4 placed at page 82 the total value of the main contract has been fixed at US$ 22,98,64,000 and Rs. 112,50,00,000. He submitted that if the total value of the contract is converted in terms of rupees total amount will be a sum of Rs. 1084,34,49,920 as per following calculations:
Rate of US$ adopted by AO in para 11 at Rs.42.28 per dollar:
