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Commissioner Of Income Tax v. Triveni Engineering & Industries Ltd.

Delhi High Court

Nov 29, 2010

Judgment

Subsequent
References

CaseIQ

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Structured Summary of the Opinion (A.K. Sikri, J.) — 29 November 2010

Factual and Procedural Background

This appeal relates to Assessment Year 2000-01. The respondent assessee filed a return showing a loss of Rs. 12.58 crores. During assessment proceedings the Assessing Officer (AO) noticed a debit of Rs. 139 lacs to the Profit & Loss Account described as a provision for losses expected on various projects which had been substantially completed in that year; revenue from those projects had also been recognized in that year.

The AO treated the provision as a contingent liability which might arise in future (for defects and costs of rectification) and disallowed it. The Commissioner of Income Tax (Appeals) [CIT(A)] affirmed the AO's view, holding the provision to be contingent and not allowable under Section 37(1) of the Income‑tax Act.

The assessee appealed to the Income Tax Appellate Tribunal (Tribunal). The Tribunal allowed the provision on the basis that the assessee followed the completed contract method of accounting: the projects were substantially completed in the year and revenue was recognized in that year, so the provision could not be treated as contingent and was allowable as business expenditure in accordance with the consistent accounting method followed by the assessee. The Revenue appealed to this Court challenging the Tribunal's view.

Legal Issues Presented

Whether the ITAT was correct in law in allowing provision made by the assessee for future losses that may occur on account of different project works undertaken by it?
Whether the ITAT was correct in law in holding that the provision for losses was allowable as the assessee was following completed contract method of accounting?

Arguments of the Parties

Revenue's Arguments (Ms. P.L. Bansal)

The provision represented only an estimate of expenditure that might be incurred in the future and no such expenditure had actually been incurred in the relevant year; therefore it amounted to a contingent or anticipated loss and was not allowable as a deduction under Section 36 or Section 37 of the Act.
The liability had not accrued in praesenti and therefore could not be admitted under the mercantile system of accounting as a deductible expense in that year.
Reliance was placed on several Supreme Court and High Court decisions to support the proposition that anticipated or unascertained losses are not allowable.

Assessee's Arguments (Mr. Ajay Vohra)

The assessee had consistently followed the mercantile system of accounting and, for project related activities, the completed contract method in terms of Accounting Standard (AS) 7; that method had been accepted by the Revenue for prior years and was not rejected in the year under appeal.
Section 145 governs the method of accounting for computing profits and gains and an assessee is entitled to adopt a consistent, regularly employed accounting method; the AO cannot arbitrarily depart from a method consistently followed and accepted.
The assessee's accounting policies (including recognition of project profit on completion or substantial completion and making provision for foreseeable losses on substantially completed projects) conformed to notified accounting standards (Accounting Standard I and AS 7) and principles such as prudence, accrual and consistency.
The principle of matching costs with revenue justifies providing for anticipated costs up to completion in the same year when revenue (including unbilled revenue and balance billings) is recognized; reference was made to Calcutta Company Limited for the matching principle.
Ultimately, the point was said to be academic in the circumstances because the exercise was revenue neutral for a company assessed at a uniform rate of tax.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Indian Molasses Company Pvt. Ltd. v. Commissioner of Income Tax [37 ITR 66 (SC)]	Invoked by Revenue for the proposition that anticipated or unascertained losses are not allowable as deductions.	The decision was cited by Revenue; the Court recorded the Revenue's reliance but did not apply it to reach a final determination because it found the appeal to be revenue neutral in the facts of the case.
Shri Sajjan Mills Ltd. v. Commissioner of Income Tax [156 ITR 585 (SC)]	Invoked by Revenue to support the general legal proposition that contingent/anticipated losses are not deductible.	Cited by Revenue; considered by the Court as part of the general legal background but not applied to dispose of the appeal, which was dismissed on revenue neutrality grounds.
Commissioner of Income Tax v. Lachhman Das Mathura Das [124 ITR 411 (All)]	Invoked by Revenue in support of the non-allowability of anticipated/unascertained losses.	Cited by Revenue; the Court noted the reliance but did not decide the admitted legal questions because of revenue neutrality.
Commissioner of Income Tax v. Seshasayee Industries Ltd. [242 ITR 691 (Mad)]	Invoked by Revenue to demonstrate that provisions for anticipated losses are not allowable where expenditure has not in fact been incurred or accrued.	Placed before the Court by Revenue; the Court did not rely on it to decide the appeal, dismissing the appeal on other grounds.
CIT v. Bilhari Investment P. Ltd. [299 ITR 1]	Invoked by the assessee to support the primacy of a consistent and regularly followed method of accounting.	Cited by the assessee and referred to by the Court in assessing the parties' submissions; the Court found the assessee's accounting approach to have prima facie merit but did not conclusively decide the legal questions because the appeal was dismissed as revenue neutral.
CIT v. Realest Builders and Services Limited [307 ITR 202]	Invoked by the assessee to emphasise the importance of consistent accounting methods.	Considered as supporting the assessee's submissions; the Court did not need to conclusively resolve the legal issue in view of revenue neutrality.
CIT v. Woodward Governor India P. Limited [312 ITR 254]	Invoked by the assessee for the proposition that consistent method of accounting is to be respected unless shown to be incorrect or incomplete.	Referred to by the assessee and noted by the Court; not determinative for disposing of the appeal which was dismissed as revenue neutral.
Calcutta Company Limited v. Commissioner of Income Tax [37 ITR 1]	Invoked by the assessee to support the matching principle (matching costs with revenue) in recognition of project income and related expenses.	Cited by the assessee in support of the accounting approach; the Court referenced matching principle as aligning with the assessee's method but again did not resolve the admitted substantial questions because of revenue neutrality.
Commissioner of Income-tax v. Nagri Mills Co. Ltd. [33 ITR 681]	Quoted for observations criticizing litigation over the year in which a deduction is allowed where tax rates are uniform and the dispute is revenue neutral.	The Court relied on and repeated these observations to support the conclusion that the appeal could be dismissed because it was revenue neutral for a company assessed at a uniform tax rate.
Commissioner of Income Tax v. Shri Ram Pistons and Rings Ltd. [220 CTR 404]	Reiterated the same point: disputes about year of deduction may be academic where the rate of tax is uniform and do not affect overall tax collection.	The Court cited this authority to reinforce its view that, in the facts of the present case, the question of the exact year of deduction was not worth deciding and supported dismissal of the appeal.

Court's Reasoning and Analysis

The Court proceeded by summarising the factual matrix, the accounting policy followed by the assessee and the rival submissions. The analysis contains the following steps, stated as they appear in the opinion:

Acknowledgement of the general legal principle that, ordinarily, an expenditure is deductible only when it is actually incurred or has accrued in praesenti; anticipated or unascertained losses are generally not allowable.
Recognition that the assessee consistently followed the completed contract method for project activities (as per Accounting Standard 7) and that the revenue recognition policy and provision for foreseeable losses on substantially completed projects were disclosed in the assessee's accounting policies.
Observation that under the completed contract method, revenue is recognized on completion or substantial completion and, in that year, costs taken as work in progress and anticipated costs till completion are debited to the profit & loss account to determine profit or loss on that project.
Weighing competing submissions: while the AO and CIT(A) were correct in invoking the general legal rule against allowing anticipated losses, the Court found the assessee's practice—consistent with accounting standards which prescribe prudence and provision for known liabilities—to be prima facie justified in the particular factual context (projects substantially completed and revenue recognized in the same year).
Consideration of revenue neutrality: the Court noted that the provision of Rs. 139 lacs was ultimately exceeded by actual expenditure of Rs. 218.03 lacs incurred by the assessee; it was undisputed that actual expenditure is deductible. Because the assessee is a company assessed at a uniform rate of tax, shifting the year of deduction does not affect the aggregate tax payable by the Department.
Conclusion that, on the facts, it was unnecessary to answer the formulated substantial questions of law decisively because the appeal could be dismissed on the ground that the dispute was revenue neutral and therefore did not merit determination.

Holding and Implications

Holding: The appeal is DISMISSED.

Implications:

The Court declined to conclusively answer the admitted substantial questions of law because it found the controversy to be revenue neutral in the specific facts of the case (actual expenditure exceeded the provision and the assessee is a company taxed at a uniform rate).
The immediate consequence is that the Revenue's appeal against the Tribunal's allowance of the provision is dismissed; the Tribunal's conclusion stands for the purposes of this appeal.
The Court did not lay down a new general precedent on whether provisions for anticipated losses under a completed contract method are categorically allowable or not; rather, it resolved the appeal on the narrow ground of revenue neutrality and the factual acceptance of the accounting method in the year in question.

Note: This summary is confined to material expressly contained in the provided opinion. No additional facts, findings, or inferences not present in the opinion have been introduced.

Show all summary ...

A.K SIKRI, J.

1. Though various questions of law were proposed in this appeal, the appeal was admitted on the following substantial questions of law:

“(i) Whether ITAT was correct in law in allowing provision made by the assessee for future losses that may occur on account of different project works undertaken by it?

(ii) Whether ITAT was correct in law in holding that the provision for losses was allowable as the assessee was following completed contract method of accounting?”

2. The facts germane to the aforesaid questions need only be noted and the same are capitulated hereunder.

3. This appeal pertains to the Assessment Year 2000-01. For this Assessment Year, the respondent assessee had filed the return declaring a loss @ Rs. 12.58 Crores. During the assessment proceedings, the Assessing Officer (AO) noticed that the assessee had debited a sum of Rs. 139 lacs to the Profit and Loss Account as provision for losses, which occur for different projects undertaken by it. These projects had been substantially completed during the said year and revenue gain had also been recognized during the year. The AO was of the view that the provision had been made against a liability, which may arise in future due to any defect noticed in the project and liabilities incurred by removing those defects. According to him, such a liability to be incurred by a future date, was a contingent liability and therefore, he refused to acknowledge this liability and give the allowance thereof to the assessee.

4. View of the AO was confirmed by the CIT (A) in the appeal preferred by the assessee holding that this liability provided by the assessee was of a contingent nature and was not allowable under Section 37(1) of the Income Tax Act (hereinafter referred to as ‘the Act’).

5. Not satisfied with the view taken by the AO as well as CIT (A), the assessee went in appeal before the Income Tax Appellate Tribunal (hereinafter referred to as ‘the Tribunal’). The Tribunal has allowed the provision made by the assessee for aforesaid losses on the ground that the assessee was following completed contract method and provision had been made on account of losses, which may occur for the different project works undertaken by it and those projects having been substantially completed during the year. It was more so when the assessee had also recognized revenue gain on such project during this year itself. View of the Tribunal, thus, was that this cannot be called as liability of contingent nature and was allowable as business expenditure having regard to the consistent method followed by the assessee. This is how the Revenue is in appeal challenging the raison d'etre and the conclusion recorded by the Tribunal.

6. It would be advisable first to take note of the basis on which the aforesaid debit entry towards projected losses is made by the assessee in the Profit and Loss Account. In this behalf, it is explained on the basis that the respondent assessee is engaged,

inter alia, in the manufacture and sale of sugar, turbines, etc., and in project related activities in the field of setting up of sugar plants, water treatment plants and mini hydel power projects. The assessee is following ‘revenue recognition’ accounting policy consistently, as per which profit on project related activities are recognized on completion or on substantial completion of the project. The year in which the projects are completed or substantially completed, the final accounts in respect of those projects are taken in that year and on that basis, it is ascertained as to whether any profit/losses made on those projects. While doing so in that particular year, the provision is also made for foreseeable losses in respect of those projects which have been substantially completed. Even the revenue gain is recognized in that year. Therefore, the relevant previous year, in respect of projects completed/substantially completed in that year, income in respect thereof was credited to the profit and loss account, taking into account unbilled revenue as well. While recognizing the profit/loss in respect of the said projects, the respondent assessee made provision for expenses to be incurred upto the stage of completion to the extent of Rs. 1.39 Crores.

7. Learned counsel for the assessee explained that the estimates of the expenses to be incurred up to the stage of completion was based on the consistent accounting policy. This was so stated under Clause (b)(iv) of Significant Accounting Policies forming part of “Notes to Accounts and Significant Accounting Policies” is as under:

“Revenue Recognition

… …..

iv) Profit on project related activities are recognized on completion or on substantial completion of the project. Provision is, however, made for foreseeable losses, if any, in respect of projects which have been substantially completed.”

As per Accounting Standard (AS) 7 (Accounting of Construction Contracts) as applicable at the relevant time under the completed contact method, revenue is recognized only when the project is complete or substantially complete. Till that date, all costs incurred and accumulated as part of work in progress and on account payments received are shown as current liabilities. In the year, when the project is complete/substantially complete,

(i) Revenue on the project is recognized included balance billing left,

(ii) All costs taken as part of work in progress are debited to the profit and loss account and

(iii) additionally, anticipated costs till completion are also debited to the profit and loss account,

to determine the profit/loss on the particular project. It is claimed that the aforesaid method of accounting consistently and regularly followed by the respondent assessee has been accepted by the Revenue all along.

8. It is not in dispute that the AO accepted the method of accounting. However, he did not allow the aforesaid expenses on the ground that the same were contingent in nature.

9. Ms. P.L Bansal, learned counsel appearing for the Revenue, was vehement in her submission that the approach of the AO, as affirmed by the CIT(A), were perfectly justified, legal and valid as the same accorded with the provision of the Act. She argued that as no such expenditure was in fact incurred in the said year and it was only on the basis of some purported estimates that such an expenditure may arise in future, which was claimed in this year and this according to her, was not allowable under Section 36 or Section 37 of the Act. Her submission in this behalf was that as the expenses were yet to be incurred, the liability thereof could not be said to have accrued so as to allow under the mercantile system of accounting, as it was not a liability in praesenti. She also pointed out that the explanation given by the respondent assessee before the AO was that the assessee had provided for “anticipated losses” Such anticipated losses or anticipated expenses, which were unascertainable as on that date were unallowable. She referred to the various decisions of the Supreme Court and certain High Courts in support of her aforesaid arguments. These are as under:

(i) Indian Molasses Company Pvt. Ltd. v. Commissioner of Income Tax [37 ITR 66 (SC)];

(ii) Shri Sajjan Mills Ltd. v. Commissioner of Income Tax [156 ITR 585 (SC)];

(iii) Commissioner of Income Tax v. Lachhman Das Mathura Das [124 ITR 411(All)],

(iv) Commissioner of Income Tax v. Seshasayee Industries Ltd. [242 ITR 691 (Mad)].

10. Mr. Ajay Vohra, learned counsel appearing for the assessee, countered the aforesaid submissions of the learned counsel for the Revenue. He supported the decision of the Tribunal by articulating his submission with finesse, in the following manner:

1) There was a consistent and regular method accounting followed by the assessee, which was recognized and accepted by the Income Tax Department also for all previous years. It was argued that under Section 28(i) of the Act, profits and gains of business which was carried on by the assessee at any time during the previous year are chargeable under the head “profit and gains of business or profession” For calculating these profits and gains of business, Section 145 of the Act provided the method of accounting, as per which such profits and gains were computed in cash or mercantile system of accounting regularly employed by the assessee. It was a submission that no doubt, the AO was not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting had not been followed by the assessee. In the present case, the assessee had followed consistently mercantile method of accounting. In respect of project related activities, the assessee had consistently and regularly followed the completed contract method in terms of Accounting Standard (AS) 7 issued by the ICAI. This method had been accepted by the Revenue all along. Even in this year, this method was not rejected from which it would be evident that the AO was satisfied with the correctness and completeness of the accounts of the assessee and further with the method of accounting regularly employed as being scientific and rationale. In such circumstances, argued the learned counsel for the assessee that it is not open to the AO to deviate from the regularly and consistently followed method of accounting followed by the assessee and accepted by the Revenue. He argued that the Courts have highlighted the primacy of the method of accounting and held that the consistent and regular method of accounting is supreme unless the AO finds that accounts of the assessee are not correct or complete or that the method of accounting is not regularly followed/not in accordance with the notified accounting standards. For this, he relied upon the following judgments:

(i) CIT v. Bilhari Investment P. Ltd. [299 ITR 1];

(ii) CIT v. Realest Builders and Services Limited [307 ITR 202]

(iii) CIT v. Woodward Governor India P. Limited [312 ITR 254]

2) His another facet of submission was based on the proposition that being a company incorporated under the Companies Act, it was obligatory on the part of the assessee that it is the accounts must conform to the mandatory accounting standards issued by the ICAI. Referring to Para 16 of Accounting Standard-I relating to “Disclosure of Accounting Policies” He submitted that the same provides the accounting policy adopted by and assessee should be such so as to represent a true and fair view of the state of affairs of the business of the assessee. Para 9 of the said Accounting Standard - I further provides that the fundamental accounting assumptions relating to going concern consistency and accrual must be followed in preparation of the financial statements. The expressions “going concern” “accrual” and “consistency” have been defined in Para 10 which reads as under:

“10. The following have been generally accepted as fundamental accounting assumptions:-

a. Going concern. The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the sale of the operations.

b. Consistency. It is assumed that accounting policies are consistent from one period to another.

c. Accrual refers to the assumption that revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate”

Para 17 of the said Accounting Standard further provides that selection and application of accounting policy must be governed, inter alia, by “prudence” which has been explained in the following terms:

“(i) Prudence: Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.”

He thus, argued that as per Section 145(2) of the Act, it as mandatory that the assessee follows the accounting standard that may be notified by the Central Government and referred to the Notification No. SO 69(E) dated 25.1.1996 He submitted that the Central Government had notified Accounting Standard - I relating to Disclosure of Accounting Policies and therefore, following the aforesaid Accounting Standard prescribed by ICAI became mandatory even for the purposes of income tax in view of the aforesaid provisions.

3) Invoking the principle of matching cost with revenue, it was also the submission of Mr. Vohra that this principle justified the manner in which accounts were maintained by the assessee following revenue recognition in respect of project related activities as otherwise the accounts would give distorted figure of profits and losses. His submission was that when the entire revenue from the contract is recognized in the year under appeal, including unbilled revenue for which invoices have been raised in the succeeding year, on the principle of matching costs with revenue, too, the expenditure to the incurred in future, within the scope of the contract, has to be provided for and allowed deduction against the revenues from the contract. He also relied upon the case of the Supreme Court in the case of the Supreme Court in the case of Calcutta Company Limited v. Commissioner of Income Tax [37 ITR 1] that the present case was parallel to the said case where matching principle was applied by the Apex Court.

4) Last weapon which is used by Mr. Vohra from his armoury was that the issue raised by the Revenue, in any case, was only academic as the entire exercise was revenue neutral.

11. After considering the submissions, the counsel on the either side, in the given facts, we are of the prima facie view that arguments of the learned counsel for the assessee to prevail. The learned counsel for the Revenue may be correct in stating the proposition of law, generally. No doubt, unless the expenditure is actually incurred or it is accrued in the relevant year, it would not be allowed as deduction. Such a liability has to be in praesenti. However at the same time, in the given scenario where in relation to the project works undertaken by the assessee, completed contract method of accounting is followed, which is consistent with the Accounting Standards and these accounting standards also lay down the norms indicating the particular point of time when the provisions for all known liabilities and losses has to be made, the making of such a provision by the assessee appears to be justified moreso when the assessee had recognized gain as well on such project during this year itself. This appears to be in consonance with principle of matching cost and revenue as well. However, in the projected scenario of this case after taking stock of the entire situation, we are of the opinion that it is not necessary to conclusively answer the aforesaid questions formulated. It is because of the reason that we find that the entire exercise is revenue neutral. It may be pointed out that it is a matter of record that against the provision of Rs. 139 lacs, the assessee had to actually incur expenditure of Rs. 218.03 lacs, i.e, more than the provision made. It is undisputed that the expenditure incurred by the assessee on the project is admissible deduction. The only dispute that the Revenue seeks to raise is regarding the year of allowability of expenditure. Considering that the assessee is a company assessed at uniform rate of tax, the entire exercise of seeking to disturb the year of allowability of expenditure is, in any case, revenue neutral.

12. We are reminded of the classic observations made by Justice Tendolker in the case of the Commissioner of Income-tax, Delhi, Ajmer, Rajasthan and Madhya Bharat v. Nagri Mills Co. Ltd. [33 ITR 681], which reads as under:

“We have often wondered why the Income-tax authorities, in a matter such as this where the deduction is obviously a permissible deduction under the Income-tax Act, raise disputes as to the year in which the deduction should be allowed. The question as to the year in which a deduction is allowable may be material when the rate of tax chargeable on the assessee in two different years is different; but in the case of income of a company, tax is attracted at a uniform rate, and whether the deduction in respect of bonus was granted in the assessment year 1952-53 or in the assessment year corresponding to the accounting year 1952, that is in the assessment year 1953-54, should be a matter of no consequence to the Department; and one should have thought that the Department would not fritter away its energies in fighting matters of this kind. But, obviously, judging from the references that come up to us every now and then, the Department appears to delight in raising points of this character which do not affect the taxability of the assessee or the tax that the Department is likely to collect from him whether in one year or the other.”

13. The aforesaid observations of the Bombay High Court were reiterated by this Court in the case of Commissioner of Income Tax v. Shri Ram Pistons and Rings Ltd. [220 CTR 404], as under:

“Finally, we may only mention what has been articulated by the Bombay High Court in Commissioner of Income Tax, Delhi, Ajmer, Rajastha and Madhya Pradesh v. Nagri Mills Co. Ltd. [1958] 33 ITR 681 as follows:

… …. …. ….

In the reference that is before us there is no doubt that the Assessee had incurred an expenditure. The only dispute is regarding the date on which the liability had crystallized. It appears that there was no change in the rate of tax for the Assessment Year 1983-84 with which we are concerned. The question, therefore, is only with regard to the year of deduction and it is a pity that all of us have to expand so much time and energy only to determine the year of taxability of the amount.”

14. In such circumstances, we are of the view that insofar as present appeal is concerned, substantial questions of law that need to be answered does not arise. We, therefore, dismiss this appeal on this ground alone.

(A.K SIKRI)

JUDGE

(REVA KHETRAPAL)