Raising of invoices per se won’t result in accrual of income

Brief of the case:

The ITAT Mumbai in the above cited case held that raising of invoices per se doesn’t result in accrual of income rather an income can be considered to have been accrued only when there is a corresponding liability of the other party to pay the amount to the assessee and there is realistic probability of realization of the income to the assessee.

Facts of the case:

• The assessee is a closely held company incorporated in USA. In India, assessee has entered into contracts with Dabhol Power Company (DPC) in respect of construction of power project in District Ratnagiri, Maharashtra. Contract was in two phases – Contract I & II. The contract –II was terminated in mid by the assessee on 17.06.2001 on account of non-payment of bills by the DPC.
• Pursuant to termination of contract with DPC, the assessee raised a claim of USD 17.73 million (Rs. 85.99 crores) which comprises of Rs. 26.47 crores for the contractual work performed till date of termination and Rs. 59.51 crores for demobilization in winding up of site operations post termination of the contract.
• Such invoices raised were, however, not credited to profit & loss account for the year ended 31.03.2002 on the plea that the ultimate collection of the said amount was not certain while raising the bill. In the notes to computation of income it was stated that amount due from DPC for the contractual work performed till date of termination and for demobilization in winding up of site operations post termination of the contract, has not been offered as income for the year.
• During the course of scrutiny assessment the AO made addition on account of receivables amounting to Rs.26.47 crores and for demobilization in winding up of site operation of Rs.59.51 crores.
• The CIT (A) confirmed the addition of Rs. 26.47 crores only in respect of contractual work till date of termination and deleted the addition of Rs.59.51 crores made by the AO on account of mobilization in winding up of site operation on the plea that invoice in this respect was never accepted by the DPC consequently same amount never accrued to the assessee.
• Against the above order of CIT (A) both the assessee and revenue are in appeal each before tribunal.

Contention of the Assessee:

• It was contended that a sum of Rs.26.47 crores did not accrue during the year on account of uncertainty of its ultimate collection while sum of Rs. 59.51 crores on account of mobilization and winding up of site operation bill did not accrue as the bill for the same was never accepted by the DPC.
• Further, it cannot be said that income has accrued merely on the ground that the assessee had been following mercantile system. It has to be considered whether there has been real income to the assessee taking into consideration the commercial and business realities of the case. Assessee placed reliance on many judicial rulings including that of Supreme Court delivered in the case of Excel Industries Ltd.
  

Contention of the Revenue:

• It was contended that the assessee was following mercantile system of accounting. Thus, as per the accepted practice between assessee and DPC, the right to receive accrues when the assessee performs the work, though the bills are raised in time bound manner as per the agreement after certification of work done and actual payment may be made at later date.

• The giving up an amount after accrual and before receipt, the assessee cannot escape taxability and the fact that would not affect the already accrued income though the assessee may claim deduction of the same as bad debts subject to fulfillment of other conditions.
  

Held by ITAT Mumbai:

• The tribunal observed that the assessee rightly following Accounting Standard -9 – Revenue Recognition did not credit the profit & loss account for the invoices raised to DPC after termination of contract because the ultimate collection of the same was not certain. Poor financial position of DPC resulted in continuous defaults in payments to many companies including assessee. The assessee terminated the contract due to non-payment of claims and on a realistic/prudent basis did not make any entry for the improbable contract revenue in its profit and loss account.
• As regards raising of invoice of Rs. 59.51 crores for demobilization in winding up of site operations post termination of the contract was not accepted by DPC and the fact of such non-acceptance by DPC has not been disputed by the department. Since the assessee had no right to receive the said amount, the said amount had not accrued to the assessee.

• it has to be considered whether there has been real income to the assessee taking into consideration the commercial and business realities of the case, for e.g. precarious financial condition, suits/disputes between parties. No real income can be said to have accrued during the pendency of dispute.
• Reliance was placed on the decision of Hon’ble Supreme Court in the case of CIT vs. Excel industries Ltd. 358 ITR 295 held that probability or improbability of realization of the income has to be considered from a realistic and practical point of view.
• Therefore, the invoices raised for which ultimate collection is uncertain taking account the business realities, the same cannot be taxed. In result the appeal of assessee was allowed in part and AO was directed to tax only the sums actually collected by the assessee.