Case Law Details
Issue- The sum and substance of the grievance of the assessee is that the Ld. CIT(A) has erred in upholding the request of the AO to disallow the future losses recognized by the company as per Accounting Standard -7 (AS-7) , as during original assessment proceedings there was no discussion or dis allowance on this ground.
Facts– The facts on record show that during remand report proceedings, the AO issued show cause notice to the assessee requiring to explain as to why 100% loss was claimed even when the project was not completed 100%. The AO asked the assessee to explain why loss should not be allowed only upto the percent of work completed and why the excessive loss of Rs. 1,58,77,508/- should not be disallowed and added back to the income of A.Y. 2003-04. In response to which the assessee explained to the AO that it was consistently following Accounting Standard-7 (AS-7) issued by the ICAI for valuation of work-in-progress. It was explained that the valuation figures were based on the actual cost recorded in the books of account and an estimate of the profit/loss on a project on completion. It was further explained that mandatory Accounting Standard requires to estimate the probable outcome of any project. During the course of executing any project it is possible that actual expenditure incurred may not be billed to the client within the same accounting period. Meaning thereby that the cost may be incurred in one accounting year and the billing in respect of that item cost is done in a subsequent accounting year. As per AS-7 such cost that relates to a future activity are recognized as an asset and classified as work-in-progress. Therefore, it was prayed that the losses claimed by the assessee should be allowed in total.
Held :- Mazagoan Dock (supra) – The question that came up for consideration was as to whether the anticipated loss on the valuation of fixed price contract in view of the mandatory requirements of the AS-7, was to be allowed in the year in which the contract had been entered into or it was to be spread over a period of contract, as was done by the assessee in earlier years. As far as the change in the method of valuation of work-in-progress was concerned, it could not be disputed that in view of mandatory requirements of the AS-7, it was a bona fide change in the method of valuation of work-in-progress, particularly in view of the qualification made in this regard by statutory auditors as well as by the Comptroller & Auditor General of India. Therefore, the observation of the Commissioner (Appeals) that the assessee had booked bogus loss was not correct. As far as the basis of estimation was concerned, the same was done on technical estimation basis and, therefore, merely because there were some variations in the figures furnished by the assessee at different stages, it could not be said that the estimated loss was not allowable.
A similar view has been taken by the Tribunal in the case of Jacobs Engineering India Pvt. Ltd. (supra) wherein the assessee’ s claims of foreseeable losses were allowed irrespective of method of accounting in terms of AS-7. In the case of Dredging International (supra), the issue before the Tribunal was whether u/s. 37(1) of the Act provision for foreseeable loss made in accordance with guidelines of AS-7 and duly debited in audited accounts of company is an allowable expenditure. The Tribunal decided the case in favor of the assessee and held that ‘yes’ it is an allowable expenditure. The Tribunal while deciding this issue has also considered the decision of Mazagaon Dock (supra).
INCOME TAX APPELLATE TRIBUNAL, MUMBAI
I.T.A. No. 3669/Mum/2011 – Assessment Year : 2004-05
The ACIT Vs. M/s. ITD Cementation India Ltd.
I.T.A. No. 2991/Mum/2011 – Assessment Year : 2004-05
M/s. ITD Cementation India Ltd. Vs. The ACIT
Date of Pronouncement: 17.05.2013
O R D E R
PER N.K. BILLAIYA, AM:
These cross appeals by the Revenue and the assessee are directed against the very same order of the Ld. CIT(A)-21, Mumbai dt.28.2.2011 pertaining to A.Y. 2004-05. As both these appeals were heard together, they are disposed of by this common order for the sake of convenience and brevity.
ITA No. 3699/M/2011 – Revenue’s appeal
2. The sum and substance of the grievance of the Revenue is that the Ld. CIT(A) ought not to have held that the accounts of the assessee could not be said to be incorrect or incomplete and by holding such the Ld. CIT(A) failed to appreciate that the AO had given a categorical and well reasoned finding in the assessment order as to why the books of accounts of the assessee company were not complete and reliable. The AO had rightly estimated the business income of the assessee at 5% of the turnover.
3. The assessee is in the business of infrastructure development which includes building up of roads, bridges, tunnels, ports, jetties etc. The job is done on contractual basis. The assessee company has entered into various projects, relating to construction of roads and bridges and also non roads projects which are spread throughout the country. During the course of the assessment proceedings, a detailed questionnaire was issued and served on the assessee. The assessee filed details/documents from time to time. The AO was of the opinion that the books of account contain many discrepancies, flaws and loopholes. The assessee was asked to produce the books of account. The assessee submitted that since its business is diversified across the country projects being in different sites, books are computerized and the same are very huge in quantity and bulky. The AO asked the assessee to produce the floppy/CD of the books of account. The AO finally issued show cause notice which incorporated the discrepancies found in the books of account following which the AO proposed to reject the books in view of Section 145(3) of the I.T. Act.
2.1. The summary of the defect note by the AO is expedited at page-55 and 56 of the Paper book. The major defect noted by the AO relate to
1) Non maintenance of day today registers. No details of closing stock of WIP
2) Unbilled WIP not included in turnover of the assessee company.
3) Non-receipt of confirmations from suppliers or receipt of part confirmations.
4) Substantial increase in all the expenses debited to Profit & Loss account.
5) No supporting evidences were available in case of expenses like travelling expenses, miscellaneous expenses etc. and
6) Ledger account not made available
3. The AO also made observations relating to the Tax Audit Report. In response to the show cause notice and the discrepancies pointed out by the AO, the assessee submitted the clarifications vide letter date 23.12.2006. It was explained that the nature of activities involved in the construction business are far different than in the case of manufacturing concern. It was further explained that the assessee is carrying construction on various project sites, most of which are in remote and far off locations, sometimes situated far away from the towns and cities. So far as observation relating to work-in-progress is concerned, the assessee submitted that work-in-progress represents cost incurred for the project but yet to be billed to the client. It was further explained that various costs including materials, labour, subcontract, establishment and overhead cost are being incurred at various project sites, the billing to the clients is based on the actual measurement of the work done and certified by the clients. The difference between the costs incurred and the value of work billed to the clients is represented by Work in Progress. The assessee showed its inability to get it certified by the engineer/architect. It was explained by the assessee that full details of all cost incurred and materials received, issued and consumed are maintained on a daily basis at all project sites. Observation relating to the details of raw materials, it was explained that monthly stock consumption report of certain sites are already been submitted.
3.1. After considering the submissions made by the assessee, the AO was of the opinion that the assessee has failed to support its submissions by not submitting the daily stock register. The AO was of the firm belief that considering the complex nature of the business of the assessee and the complicated maintenance of books of accounts, the true and correct income of the company can be ascertained only after the assessee produces complete books of accounts with supporting documents and in view of the various deficiencies noted by the AO, he proceeded to reject the books of accounts u/s. 145(3) of the Act. Thereafter, the AO went on to make the best judgement assessment u/s. 144 of the Act and estimated the business income of the assessee at the rate of 5% of the total turnover and the business income was computed at Rs. 3,155.74 lcas.
4. Aggrieved by this findings, the assessee agitated the matter before the Ld. CIT(A). Before the Ld. CIT(A) it was contended that the AO has not considered the defence of the assessee inasmuch as the records pertaining to various sites are kept at those sites and therefore it was impractical to submit all those records for verification. However it was contended that the books of accounts are statutorily audited and the auditors have not pointed out any defect in the books of account. It was also explained that there was no change in the method of accounting regularly employed by the assessee. No books of accounts were rejected by earlier Assessing Officers. The assessee explained point-wise discrepancies noticed by the AO. The assessee’s submissions were forwarded to AO by the Ld. CIT(A) for submitting Remand report thereon. In response to which, the AO submitted the Remand report vide letter dt. 26.11.2010. The AO responded point-wise to the submissions made by the assessee in respect of closing stock. The AO reported that the assessee has not given full inventory of closing stock. The closing stock of the raw material, consumables etc could not be verified because the assessee submitted details on sample basis. For other submissions, the response of the AO was that the assessee has submitted only sample details and not complete details.
4.1. After considering the facts and the submissions and the remand report of the AO, the Ld. CIT(A) was convinced with the reply of the assessee in respect to the discrepancies pointed out by the AO and considering the entire submissions/explanation, the Ld. CIT(A) was convinced that assessee’ s accounts were correct and complete following regularly the method of accounting and the accounting standards prescribed by the Government. Whatever defects were noticed by the AO were subject matter of verification and reconciliation. The Ld. CIT(A) observed that during remand report proceedings such discrepancies were duly reconciled/explained by the assessee and which have also been accepted by the AO. The Ld. CIT(A) concluded that there was no case before the AO for invoking the provisions of Sec./ 145(3) of the Act and accordingly disapproved the action of the AO rejecting the books of account of the assessee. Consequently the Ld. CIT(A) further held that the estimation of business income of the assessee @ 5% of turnover was also not in order.
5. Aggrieved by this finding, the Revenue is before us. The Ld. Departmental Representative strongly supported the assessment order. It is the say of the DR that the assessee has not furnished full and complete details as sought by the AO therefore AO was left with no choice but to reject the books of account and estimate the profits of the assessee.
6. The Ld. Counsel for the assessee reiterated that the assessee has maintained books of account following the principles of accountancy and the same method has been followed in earlier years and also in subsequent years and in none of these years, the books of account have been rejected. The Ld. Counsel for the assessee further drew our attention to the decision of the Tribunal in assessee’s own case for A.Y. 2005-06 and 2006-07 in ITA No. 4492/M/09 for A.Y. 2005-06 and ITA Nos. 4679 & 4680/M/09 for A.Y. 2005-06 & 2006-07. It is the say of the Counsel that during the remand proceedings, the AO has accepted most of the submissions relating to the books of accounts of the assessee.
7. We have considered the rival submissions and perused the orders of the lower authorities and the decision of the Tribunal relied upon by the assessee in its own case. It is an admitted fact that the business of the assessee is stretched across the country. It is also an admitted fact books of accounts are maintained project-wise at each site. Though the consolidated books of accounts are maintained in electronic form which fact has also been accepted by the AO. The main grievance of the AO is that the assessee is not maintaining day today stock register has been successfully explained by the assessee and accepted by the Ld. CIT(A) based on the Remand report of the AO. Whatever discrepancies relating to the expenses have been pointed out, in our humble view, if the AO was not satisfied with the quantum of expenses, he could have proceeded to disallow them on adhoc basis. Simply because the volume of expenses have increased during the year vis-à-vis earlier year that cannot be a ground for rejecting the books of account. The AO himself has called for information from various parties during the remand proceedings and most of the parties have responded to his notice u/s. 13 3(6) of the Act. If some of the balances remained unreconciled, the AO could have asked directly from the parties for the difference. Such unreconciled accounts cannot lead to the rejection of books of account. As seen from the assessment order, there is no finding that the books of accounts are not correct or complete. There is also no finding that the method of accounting followed by the assessee is not in accordance with the standards notified. The major plank for rejection of the books of account seems to be the unverifiable nature of expenses and non maintenance of the stock register. The Ld. CIT(A) has not only considered the above issue but also other issues raised by the AO in the remand proceedings. As seen from the remand report placed at page – 53 of the Paper Book , the AO instead of examining the voluminous of details filed, giving a complete report reiterated the objection as stated in the assessment order. As the explanations/details furnished by the assessee before the Ld. CIT(A) have been duly considered by the Ld. CIT(A) and also that these details were sent to AO for remand, we do not find any reason to defer from the findings of the Ld. CIT(A).
7.1. From a perusal of the discrepancies pointed out by the AO, it is difficult to accept that the books of accounts of the assessee are defective or incomplete from which the correct profit cannot be deduced. The books of accounts are audited , the auditors have not given any adverse comments in the maintenance of books of account or stock registers. Therefore we see no reason for not upholding the findings of the Ld. CIT(A). We confirm the findings of the Ld. CIT(A) and hold that the assessee has maintained proper books of account in accordance with the provisions of law. The appeal filed by the Revenue is dismissed.
8. Before parting, it would not be out of place to mention that the Tribunal , in assessee’s own case for A.Y. 2005-06 and 2006-07 , on identical facts and for similar reasons, has accepted the correctness of the books of account of the assessee.
ITA No. 2991/Mum/2011 – Assessee’s appeal
9. The sum and substance of the grievance of the assessee is that the Ld. CIT(A) has erred in upholding the request of the AO to disallow the future losses recognized by the company as per Accounting Standard -7 (AS-7) , as during original assessment proceedings there was no discussion or disallowance on this ground.
10. The facts on record show that during remand report proceedings, the AO issued show cause notice to the assessee requiring to explain as to why 100% loss was claimed even when the project was not completed 100%. The AO asked the assessee to explain why loss should not be allowed only upto the percent of work completed and why the excessive loss of Rs. 1,58,77,508/- should not be disallowed and added back to the income of A.Y. 2003-04. In response to which the assessee explained to the AO that it was consistently following Accounting Standard-7 (AS-7) issued by the ICAI for valuation of work-in-progress. It was explained that the valuation figures were based on the actual cost recorded in the books of account and an estimate of the profit/loss on a project on completion. It was further explained that mandatory Accounting Standard requires to estimate the probable outcome of any project. During the course of executing any project it is possible that actual expenditure incurred may not be billed to the client within the same accounting period. Meaning thereby that the cost may be incurred in one accounting year and the billing in respect of that item cost is done in a subsequent accounting year. As per AS-7 such cost that relates to a future activity are recognized as an asset and classified as work-in-progress. Therefore, it was prayed that the losses claimed by the assessee should be allowed in total.
10.1. After considering the submissions of the assessee, the AO observed that the assessee has claimed entire foreseeable losses of future years in A.Y. 2004-05. The AO was of the opinion that such claim could not be allowed because it was only based on estimate and was contingent in nature. Since no such observation was taken to its logical conclusion during the assessment proceedings, the AO requested the Ld. CIT(A) to disallow the claim of future losses claimed by the assessee.
11. The Ld. CIT(A) put a question to himself whether he has the power to make such dis allowances at the Appellate stage. The Ld. CIT(A) was of the opinion that the AO in the assessment order has indirectly disallowed the assessee’ s claim of future losses by estimating the taxable income at the rate of 5%. According to the Ld. CIT(A) issue of dis allowance of future losses was very much present before the AO during assessment proceedings though the AO did not discuss anything on this issue in assessment order since the book results were proposed to be rejected. The Ld. CIT(A) was of the firm belief that he has the power to do what the AO has omitted to it and the Ld. CIT(A) has also the power to reduce or enhance the income/addition. On the basis of the report of AO , assuming such power, the Ld. CIT(A) went on to disallow the claim of future losses by the assessee. The Ld. CIT(A) was of the firm belief that the expenses relating to business are allowable as per provisions of Sec. 28 to 43 of the Act. The expenses allowable have been specifically mentioned in the relevant section of the Act. The residuary expenses which are allowable u/s. 37(1) only. Thereafter, the Ld. CIT(A) relied upon two decisions of the Hon’ble Supreme Court in the cases of Wallfort Shares & Stock Brokers 233 CTR 42 and Indian Molasses Co. Vs CIT 37 ITR 66. The Ld. CIT(A) concluded that assessee’s claim of future losses was not fitting in the frame work of provisions of Sec. 37(1) of the Act. The Ld. CIT(A) observed that the provisions of Accounting Standard cannot over write the statutory provisions of the Act. Accordingly, the Ld. CIT(A) directed to rework out the accounts/work-in-progress by excluding there from the claim of future losses.
12. Aggrieved by this finding, the assessee is before us. The Ld. Counsel for the assessee vehemently argued that since the assessee is a limited liability company in which public are substantially interested Accounting Standards of the ICAI have to be mandatory followed and therefore the assessee has been following AS-7 relying upon the specific clauses of AS-7, the Ld. Counsel submitted that the claim of the assessee is very much in line as per the law. To substantiate, the Ld. Counsel relied upon the decisions of Mazagaon Dock Ltd. Vs JCIT 29 SOT 356 (Bom), Jacobs Engineering India Pvt. Ltd. Vs ACIT (2009)-TIO-533, ITAT Mumbai and Dredging International Vs ADI (2011) 48 SOT 430 (Mum). The ld. Counsel for the assessee concluded that in the light of Accounting Standard-7 and the judicial decisions cited herein above, the claim of the assessee deserves to be allowed.
13. Per contra, the Ld. Departmental Representative supported the orders of the lower authorities. It is the say of the Ld. DR that future losses are nothing but contingent losses and therefore cannot be allowed.
14. We have considered the rival submissions and perused the orders of the lower authorities. We have also the benefit of going through the AS-7 issued by ICAI. At the very outset, it would not be out of place to consider the provisions of Sec. 145 of the Act. Sec. 145(2) of the Act provides that the Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. It is a fact that AS-7 has not been notified by the Central Government. This does not mean that the assessee is precluded from following AS-7. A perusal of the provisions of Sec. 145 show that Accounting Standards which have been notified by the Central Government have to be mandatorily followed by the assessee. But this does not mean that the assessee cannot follow the other Accounting standards issued by ICAI. ICAI being the highest accounting body of the country , created by an Act of Parliament, Accounting Standards issued by it cannot be brushed aside lightly. On the contrary, if an assessee is following the Accounting Standards issued by ICAI, it would give more credibility and authenticity to its account. AS – 7 , inter alia , provides :
“When the outcome of a construction contract cannot be estimated reliably”
(a) Revenue should be recognized only to the extent of contract costs incurred of which recovery is probable and
(b) Contract costs should be recognized as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognized as an expense immediately in accordance with paragraph 35.”
15. It is not in dispute that the assessee is executing fixed price contract which means that the contractor has agreed to a fixed contract price or rate in some cases subject to cost escalation prices. As per AS-7, the assessee is entitled to make provision for foreseeable losses.
16. A perusal of the accounting statement of the assessee for the year under consideration shows that at para- 1.6 to the notes to the financial statement, the auditors have provided as under:
“Revenue recognition on contracts
Contract prices are either fixed or subject to price escalation clauses. Revenue from contracts is recognized on the basis of percentage completion method, and the level of completion depends on the nature and type of each contract including :
*Unbilled work-in-progress valued at lower of cost and net realizable value upto the stage of completion. Cost includes direct material, labor cost and appropriate overheads; and
* Amounts due in respect of the price and other escalation, bonus claims and/or variation in contract work approved by the customer/third parties etc. where the contract allows for such claims or variations and there is evidence that the customer/third party has accepted it.
In addition, if it is expected that the contract will make a loss, the estimated loss is provided for in the books of account.
Contractual liquidated damages, payable for delays in completion of contract work or for other causes, are accounted for as costs when such delays and causes are attributable to the company or when deducted by the client.”
17. A similar issue has been considered by the Tribunal in the case of Mazagoan Dock (supra) wherein the Tribunal has held as under:
“The question that came up for consideration was as to whether the anticipated loss on the valuation of fixed price contract in view of the mandatory requirements of the AS-7, was to be allowed in the year in which the contract had been entered into or it was to be spread over a period of contract, as was done by the assessee in earlier years. As far as the change in the method of valuation of work-in-progress was concerned, it could not be disputed that in view of mandatory requirements of the AS-7, it was a bona fide change in the method of valuation of work-in-progress, particularly in view of the qualification made in this regard by statutory auditors as well as by the Comptroller & Auditor General of India. Therefore, the observation of the Commissioner (Appeals) that the assessee had booked bogus loss was not correct. As far as the basis of estimation was concerned, the same was done on technical estimation basis and, therefore, merely because there were some variations in the figures furnished by the assessee at different stages, it could not be said that the estimated loss was not allowable. It was not disputed that the department in earlier years had allowed the loss on estimated basis having regard to the expenditure actually incurred in various years. Therefore, in principle, it was not disputed that the estimated loss under the present circumstances was an allowable deduction. However, merely because the change in method of accounting was bona fide, it could not lead to the inference that the income was also deducible property under the Act. This aspect is very evident from the first proviso to section 145 as it stood prior to the amendment by the Finance Act, 1995 with effect from 1/4/1997. It could not be disputed that from the method adopted by the assessee, the assessee ’s income could not be deducted property in the year in which the loss had been anticipated. As a matter of fact this aspect was not disputed by the Assessing Officer also. He had swayed more by the revenue loss than by the correct principle to be applied. The matching principle of accounting was not of much significance in the present context because if the loss had been properly estimated in the year in which the contract had been entered into, then it had to be allowed in that very year and could not be spread over the period of contract. The matching principle is of relevance where income and expenditure, both are to be considered together. However, in the instant case, the effect of valuation of WIP would automatically affect the profits of subsequent years accordingly. Therefore, there was no reason for not accepting in principle the assessee ’s claim as being allowable. However, in view of discrepancies pointed out by the Commissioner (Appeals) for correct estimation of loss, the matter was to be restored to the file of the AD to examine the correctness of amount claimed.”
18. A similar view has been taken by the Tribunal in the case of Jacobs Engineering India Pvt. Ltd. (supra) wherein the assessee’ s claims of foreseeable losses were allowed irrespective of method of accounting in terms of AS-7. In the case of Dredging International (supra), the issue before the Tribunal was whether u/s. 37(1) of the Act provision for foreseeable loss made in accordance with guidelines of AS-7 and duly debited in audited accounts of company is an allowable expenditure. The Tribunal decided the case in favor of the assessee and held that ‘yes’ it is an allowable expenditure. The Tribunal while deciding this issue has also considered the decision of Mazagaon Dock (supra).
19. Considering the facts of the case in the light of the accounting standards and the decisions of the Tribunal (supra),and as no distinguishing cases have been brought on records by the revenue , reversing the findings of the Ld. CIT(A) ,we direct the AO to recompute the business profits by allowing the losses provided by the assessee in its books. The appeal filed by the assessee is allowed.
21. In the result, the appeal filed by the Revenue is dismissed and the appeal filed by the assessee is allowed
Order pronounced in the open court on 17.5.2013.
