Income Tax Appellate Tribunal - Mumbai
Associated Cables Pvt. Ltd. vs Deputy Commissioner Of Income-Tax on 25 November, 1993
Equivalent citations: [1994]48ITD141(MUM)
ORDER
R.D. Agrawala, Judicial Member
1. This is an appeal by the assessee, by status a company, in respect of the assessment year 1990-91. The grievances of the assessee are two-fold.
2. The first challenge is in respect of a sum of Rs. 52,80,660 assessed by the Assessing Officer as the appellant's income affirmed during first appeal. The other grievance of the assessee is against a disallowance of Rs. 8,400 out of the interest paid by them to various banks qua, a sum of Rs. 56,000 lent to Sri S. .G. Hoskote, one of their wholetime directors.
3. We take up the first issue first. The assessee-appellant were following the mercantile system of accounting until the assessment year 1989-90. The system underwent some change as is reflected by Note No. 9 to the accounts.
4. The assessee-company is engaged in the manufacturing of instrumentation cables. It is the assessee's case that the cables being highly sophisticated and costly ones, they are manufactured as per the specifications provided by their clients. No manufacturing was carried out by the assessee-company unless and until they received specific orders.
5. During the implementation of the manufacturing orders performance tests are carried out by the customers and tailormade items produced.
6. Billing was made of 90 per cent. of the value of the goods manufactured on despatch and delivery with the exception that 100 per cent. of excise and sales tax was charged. The remainder of the 10 per cent. of the cables cost (excluding the excise and sales tax) was payable to the assessee only on completion of the warranty period.
7. It is the assessee's case that this withheld portion of the cost, viz., 10 per cent. referred to supra, did not represent the sale as its receipt was conditional, namely, based only on the fulfilment of certain conditions made by the assessee to its customers. It was in the wake of this stand that the assessee-company did not include a sum of Rs. 67,74,740, being the retention money in their turnover declared for the accounting period under consideration. There is a bifurcation of the aforesaid sum which consists of an amount of Rs. 52,80,660 withheld out of the transactions which took place during the relevant accounting period, the balance of Rs. 14,94,034 withheld in respect of supplies made prior to the beginning of the current accounting period. The assessee thus declared a turnover of Rs. 6,89,00,558 by deducting the aforesaid retention amount from their total turnover of Rs. 7,56,75,302. There is no dispute that up to the assessment year 1989-90, the whole of the sale price despite the same practice of warranty was shown by the assessee in their turnover. The system underwent a change, as submitted by the learned authorised representative for the assessee in view of the ratio of the decision of the High Court of Calcutta in CIT v. Simpler Concrete Piles (I.) P. Ltd. [1989] 179 ITR 8.
8. The Revenue authorities did not agree with the assessee's stand. As per the Assessing Officer, since the particular goods had been supplied in the previous year and the right to receive the payment also accrued to the assessee within the same period, 100 per cent. of the price of goods had to be shown as the assessee's receipt towards the cost of such goods. About the retention money, the Assessing Officer noted that the assessee was furnishing bank guarantees against which the retention money was released to it. In his opinion, therefore, the receipts representing retention money were, at best, postponed to a later date. That this did not make any difference has been observed by the Assessing Officer, as the right to such receipts accrued to the assessee at the time of the supply of the material to its customers.
9. In the first appeal, the learned Commissioner of Income-tax (Appeals) took the view that the change effected by the assessee in their method of accounting in this year was not justified. According to him, the change was not warranted and the assessee was bound by the method regularly and consistently employed by them ; such a change would not reflect proper computation of their income.
10. Vehemently opposing, the learned authorised representative for the assessee, Sri Khare, submitted that the assessee's income could be treated only in respect of 90 per cent. of the cost of the goods supplied by them, which as per the agreement with the customers was received during the accounting period under consideration. Elaborating, we were firstly taken to a specimen contract available at page 38 of the paper book.
11. Clause 4 of this document spells out the terms of payment. As per this, 10 per cent. of the total order value shall be released against furnishing of certain documents, such as unqualified T. 0. I. acceptance, advance bank guarantee for an equivalent amount issued by a scheduled bank. Submission of pro forma invoice and security deposit bank guarantee. 90 per cent. of the total order is payable on the submission of certain other documents, none of which have any bearing on the aspect disputed before us.
12. The remainder of 10 per cent. which is contested is releasable on the fulfilment of the following conditions :
(a) Receipt and acceptance of goods at purchaser's site.
(b) Submission of all final technical documentation as required by U. I. L.
(c) Submission of performance and workmanship bank guarantee, valid for the guarantee period, for an equivalent amount issued by a scheduled bank as per the pro forma of G. N. F, C.
13. Towards transportation charges, a separate debit note shall be raised and the same shall be paid within 15 days from the date of receipt of complete goods at site.
14. All the payments will be released within 15 days (except wherever mentioned specifically) from the date of receipt of required documents as mentioned in this clause.
15. We were thereafter taken to page 50 of this document which enumerates certain general conditions applicable to the contract. The three conditions on which heavy reliance has been placed run as under :
10. Inspection.--Purchaser, its consultant and their authorised representatives, shall have the right to inspect, test and expedite or get inspected, tested and expedited, the goods at the works of the vendor or its sub-vendors at any time during manufacture and prior to shipment and to inspect, within a reasonable time after arrival of goods at the ultimate destination and during and after erection testing and commissioning. The goods shall not be deemed accepted until after the said inspection testing and commissioning. Failure to make any inspection of or payment for or acceptance of goods, shall in no way impair the purchaser's right to reject non-conforming goods or to avail itself of any other remedies to which purchaser may be entitled notwithstanding purchaser's knowledge of the non-conformity, its substantiality of the case of its discovery.
16. In the event of failure of vendor to remove the rejected goods within the time allowed, the purchaser shall, have the right to dispose of the same at the vendor's risk and cost. During the time that the rejected goods lie with the purchasers awaiting removal by the vendor, they will so lie at the vendor's risk. All goods rejected by the purchaser after receipt at the destination by the vendor within a reasonable time allowed by the purchaser not exceeding 30 days at vendor's expense and risk it shall be option of the purchaser to allow vendor to replace the rejected goods or to cancel the order for the rejected goods.
17. The vendor will permit purchaser's inspectors, consultants and their authorised representatives free access during normal working hours to its works, godown, storage or loading spots, etc., and will give them all assistance to perform their tasks, including free use of all necessary testing and control instruments. The vendor shall ensure that the same facilities are granted shall be removed by its sub vendors. All expenses relevant to the performance of the tests and connected to compilation of test reports, etc., will be borne by the vendor, unless order stipulates specifically to contrary.
11. Warranties-Guarantees.-- Vendor shall warrant to purchaser and its consultants that the goods supplied shall give the required operational performance and shall be suitable for the service intended and be of the quality specified or of the best grade of their respective varieties if no quality is specified and shall conform to the specifications, drawings, samples and other descriptions contained in the purchase order. Vendor shall guarantee purchaser and its consultants and their authorised representatives against any and all defects in design, workmanship and materials for 18 months of operation or three years from the date of acceptance of the goods by the purchaser, whichever period ends earlier. Should any defect develop during guarantee period it shall be remedied promptly free of charge by the vendor and all expenses for transportation of goods, removing the goods and replacing them, etc., necessitated for such repairs or replacements shall be borne by the vendor. The guarantee period for the replaced goods shall be at least 12 months. The goods unless otherwise expressly stated herein are ordained by the purchaser in reliance on each and all of the warranties and guarantees specified herein and implied by law or usage of trade. The said warranties and guarantees shall control even if vendor's quotation to purchaser or acknowledgment or acceptance of this purchase order attempts to disclaim the said warranties or guarantees or limits the purchaser's remedies for breach. Acceptance of goods by purchaser, its consultants or authorised representatives shall not release the vendor from responsibilities arising out of the above mentioned guarantees and warranties.
36. Terms of payment.--Unless otherwise specifically agreed to in the purchase order the payment would be made as under :
For supply and delivery order 90 per cent. of the order price of goods despatched within 30 days of presentation of despatch documents including material acceptance certificate or inspection release note 10 per cent. of the order price of goods despatched within 30 days of receipt of goods at destination subject to inspection and acceptance and receipt of a satisfactory bank guarantee for equal amount valid till the expiry of the guarantee period of the equipment materials and as per specimen attached (pro forma 2).
18. On the basis of the aforesaid terms, it was submitted by Sri Khare, learned authorised representative of the assessee that the release of the retention money representing 10 per cent. of the cost of the goods supplied Only provided a cash-flow to the assessee, but no right to receive the amount in question. He also submitted that no debt in favour of the assessee stood created before the last performance of the stipulations agreed by the assessee with its customers. The right to receive 10 per cent. of the payment, it was contended, was coterminous with the assessee's liability for the efficacy of the goods supplied. The goods, in the facts and circumstances of the case, required strict performance on the scene, i.e., customer's business place. The learned authorised representative also submitted that 10 per cent. amount remained in an inchoate state till such time the performance guarantee remained in vogue. A sample calculation of the cost and the retention money is shown at page 77, which is the assessee's bill to Messrs. Gujarat Narmada Valley Fertiliser Co. Ltd., read with page 75 being a communication by the assessee to them. Details of the total contracts during the relevant accounting period are found at page 30. Page 31 gives out the various dates when the difference of 10 per cent. deductions were credited by the assessee after the expiry of the warranty period.
19. At page 34, the details of those cases are given where retention money was received by the assessee without execution of bank guarantee. Page 37 is the summary which shows a sum of Rs. 93,977.61 received by the assessee during the current accounting period without furnishing bank guarantee which sum represents the retention money but not credited by the assessee with a view to maintain consistency. Similarly, it also shows a sum of Rs. 2,21,862.04 credited to the profit and loss account on accrual basis though not received by the assessee.
20. On the basis of these facts, Sri Khare submitted that it could not be said that the amount representing 10 per cent. of the cost of goods was the assessee's income. In his submission, neither this sum was actually received by the assessee nor the same accrued to them. According to him, there was no change of accounting involved in the case in hand and even if it amounted to a change, it was permissible as explained by the assessee as per Note 9 appended at page 116 of their paper book, being Schedule M relating to "Notes, forming part of the accounts for the period ended March 31, 3990". Reference was also made to a communication addressed by the assessee on March 18, 1992, to the Assessing Officer available at pages 4-5 and a similar communication dated September 17, 1992, available at pages 6 to 10 of the paper book, whereby the assessee explained their stand to the Assessing Officer.
21. In support of their plea, Sri Khare placed reliance on the following case-laws :
1. E. D. Sassoon and Co. Ltd. v. CIT [1954] 26 ITR 27 (SC).
2. Cotton Agents Ltd. v. CIT [1960] 40 ITR 135 (SC).
3. CIT v. A. Gajapathy Naidu [1964] 53 ITR 114 (SC).
4. Amar Nath Khandelwal v. CIT [1980] 126 ITR 322 (Delhi).
5. CIT v. Simplex Concrete Piles (I.) P. Ltd. [1989] 179 ITR 8 (Cal).
6. Udham Singh v. CIT [1988] 171 ITR 471 (Orissa) (sic).
7. CIT v. Hindustan Housing and Land Development Trust Ltd. [1986] 161 ITR 524 (SC).
8. Jehangir P. Vazifdar v. ITO [1992] 42 ITD 67 (Bom).
9. Sri Someshwar Sahakari Sakhar Kharkhana Ltd. v. ITO [1985] 11 ITD 335 (Pune) [SB].
22. Opposing strenuously the various submissions made on behalf of the assessee, the learned Departmental Representative contended that the income to the assessee-company arose by virtue of sale/supply of goods. The assessee followed consistently a particular method of accounting since inception by showing the entire cost of goods in their turnover. Nothing intervened which necessitated or justified a change in the accounting system. Referring to Clause 10 of the specimen contract available at page 53 of the paper book and reproduced hereinbefore, it was submitted on behalf of the Revenue that the provision and the arrangement for the rigorous inspection of the material during its manufacturing and before delivery took proper care of the quality control and that being so, there was nothing left which could possibly be called upon by the customer to the assessee to be done excepting anything resulting out of an act of God or a deficiency which was capable of occurring for reasons beyond human control.
23. Regarding warranty, Sri Prashant Gupta, the learned Senior Departmental Representative submitted that it is a common practice that costly and sophisticated items were sold only under a warranty so that the capital goods passed on to the customer if found defective were set right to match the standards propounded by the manufacturers. Elaborating, Sri Gupta gave the example of refrigerators and cars, etc., and contended that sometimes a few articles such as Rado watches also bore lifetime guarantee from their producers or manufacturers adding that it would be beyond imagination that in such cases the transaction of sale was never complete.
24. It was also submitted on behalf of the Department that Clause 11 of the specimen contract reproduced (at page 54) supra, suggested that the assessee guaranteed against any defects in their design, workmanship and materials for 18 months of operation or three years from the date of acceptance of goods by the purchaser whichever period ended earlier stating significantly that in the event of any such defect developing during the guarantee period it shall be remedied promptly free of charge by the vendor, there being a further guarantee for the replaced goods for a period of 12 months. It was thereafter urged that the whole of the sale price was realisable subject to the furnishing of a bank guarantee, and there was no clog or impediment put on the receipt of 10 per cent. of the amount disputed before us excepting to building up of pressure on the vendor with a view to secure their readiness for the removal of the defects in the machinery if any, for which a bank guarantee was to be furnished by them. All these factors, it was submitted, went a long way to suggest that it was only a case of postponement of the receipt of income without affecting the accrual which event was completed on the delivery of the goods. Reliance was placed to buttress this plea on a decision of the apex court in the case of Morvi Industries Ltd. v. CIT [1971] 82 ITR 835.
25. Sri Gupta also invited our attention with great emphasis to Clause 35 of the specimen contract which runs as under :
"35. Bank guarantee,--The vendor shall furnish from the State Bank of India or any other nationalised bank a bank guarantee representing 10 per cent. of the order value towards security deposit within 15 days from the order for faithful execution of the order. The bank guarantee should be as per specimen attached."
26. It was contended that the only restriction to which the payment of 10 per cent. disputed before us was put is that it would go to the assessee only on furnishing of a bank guarantee from a nationalised bank within 15 days of the execution of the order. This, it was vehemently contended, suggested that there was never any real or effective denial of the disputed amount of 10 per cent. to the assessee by their customers.
27. Referring to another clause bearing Sl. No. 36 which has also been reproduced by us hereinbefore, it was submitted by Sri Gupta that even 90 per cent. of the cost was to be paid by the customer within 30 days of the presentation or despatch of documents and certain other papers and if a particular consignment was despatched by the assessee towards the fag end of a particular accounting period, it would not mean that even where the actual payment of 90 per cent. was received by the assessee beyond that particular accounting period, the same shall not form part of their turnover of the year in which the goods were supplied. Proceeding further and concentrating on this clause itself, it was submitted that 10 per cent. of the price of goods was payable by the customer to the assessee subject to the inspection and acceptance and receipt of a satisfactory bank guarantee for an equal amount valid till the expiry of the guarantee period of the equipment materials. It was submitted that no conditions or strings were attached in respect of the receipt of this 10 per cent. barring that the customer required a bank guarantee from the assessee-company which were to take care of the fulfilment of the obligations to remove any defects, etc., in the supply of materials in terms of Clause 11 referred to (at page 54) supra. This, Sri Gupta concluded, made the sale transaction complete right at the beginning, i.e., the time when the goods went out from the assessee's premises for a particular customer and despatched according to the instructions of the latter.
28. We have given our utmost consideration to the entire gamut of material placed before us and relied on and the detailed submissions made by either side.
29. We are afraid we cannot subscribe to the approach canvassed by the assessee on the issue. There are plural reasons for our saying so.
30. As is manifest, the assessee's case primarily depends upon the interpretation of the specimen contract which has already been referred to by us in extenso in the preceding paragraphs. As regards practice and consistency are concerned, indisputably it is against the assessee inasmuch as right from the inception till up to the assessment year 1989-90, they have been showing 100 per cent. of the sale price in their turnover during the period the sale is effected.
31. Even before we proceed to examine the relevant clauses of the specimen contract more critically, we will take into consideration the assessee's submission that they were impelled by reason of the ratio of the Calcutta High Court in the case of Simplex Concrete Piles (India) Pvt. Lid. [1989] 179 ITR 8, in changing the method of accounting. In this case, the assessee, a contractor, was executing concrete piling for buildings. It credited in its accounts only 90 per cent. of the sum on the completion of contract after deducting 10 per cent. of the job value as retention money.
This money was payable to him only on the completion of the contract and the certification of the architect or engineer that the work had been satisfactorily completed. The Tribunal held that it could not be said that the right to receive payment of the remaining 10 per cent. of the value of the job done accrued as soon as it was completed and since the assessee followed the mercantile system of accounting, it credited its accounts as and when the right to receive the same accrued. It, therefore, directed the Assessing Officer to examine the question of accrual of retention money from this angle and made adjustments regarding the same, if necessary. On a reference, the High Court of Calcutta, took the view that having regard to the nature of the contract, no enforceable liability accrued or arose and accordingly, it could not be said that the assessee had any right to receive the entire amount on the completion of the work or on the submission of the bills.
32. At the outset, it may be stated that the facts of the two cases are significantly different and the ratio of the cited case cannot be applied to the present case. As stated above, in the case before us, the assessee is manufacturing sophisticated cables as per the specifications of its customers. The product manufactured by them is custom-tailored and has to be as per the specific requirement of the purchaser. Clause 10 of the contract specifically provides for the inspection of the material by the purchaser, its consultant and their authorised representatives at the works of the assessee or its sub-vendors at any time during the manufacture and prior to shipment, etc. Such a rigorous condition about the inspection of goods has the effect of assuring perfection to the satisfaction of the vendee. There was no such provision in Simplex's case [1969] 179 ITR 8 (Cal), nor was it generally possible in a work of concrete piling for buildings which was the issue before the High Court of Calcutta. In fact, in that case, the specific certificate by the architect/engineer was required to be given to say that the work had been satisfactorily completed. If in that situation, 10 per cent. of the value of job work done was retained by the customer, it certainly stood on a different footing. Herein, the inspection has to be strictly allowed by the manufacturer to the vendee or its representative and that being so, any defect pointed out by the latter is supposed to have been corrected during the manufacturing process without which there is no possibility of the shipment of the materials. Thus, on the primary facts, the two cases are distinguishable. Proceeding further, as already stated above, the only liability of the assessee-company as envisaged by Clause 11 read with Clauses 35 and 36 is that in the event of any defect, it shall be promptly remedied by them at their cost. We find sufficient force in the plea advanced on behalf of the Department that in a case where such a strict and rigorous test of inspection during manufacturing and pre-shipment has been provided, there was virtually no possibility of any major defect remaining in the articles manufactured excepting the ones which may occur due to vis major or reasons beyond anybody's control. It may also not be out of place to refer here to a query made by us to the assessee's learned authorised representative as to whether there have been any cases so far wherein the retention money of 10 per cent. was not paid by a customer to the assessee to which only a negative reply came. This also strengthens the stand of the Department that 10 per cent. of the cost of goods was retained only to act as a constant remainder to the assessee that they have to be more standard/quality-conscious failing which they would be required to rectify the defects at their cost. This 10 per cent. also, as stated above, is payable to the assessee on the furnishing of a bank guarantee of a nationalised bank within 15 days from the execution of the order.
33. We are also unable to agree with the learned authorised representative of the assessee that 10 per cent. payment is in an inchoate state and that it is not legally enforceable. If the assessee, in terms of the contract, furnishes a bank guarantee within the stipulated period, for an equal amount valid till the expiry of the guarantee period, can the customer refuse the payment. Our answer to it is a categorical "no". The only obligation of the assessee is to remain ready to remove the defects, if any found, at their own cost and that is what the document from the nationalised bank in terms of Clause 35 of the contract guarantees. The payment of 10 per cent. is patently enforceable and cannot be validly denied by the customer to the assessee.
34. As regards the entries made by the assessee in their account books, they will not have any direct bearing on the issue under consideration as what is to be seen is as to whether the amount in question has accrued or become due to the assessee or not. As seen earlier, the assessee has been manufacturing specific goods and such goods pass on to the vendee when put in a deliverable state. In the event of any defects found in such goods, the only remedy of the vendee lies in claiming performance from the assessee about the remedying of the defects at their cost and which right is guaranteed by a bank guarantee furnished by the vendor-assessee to the vendee enforceable as per the stipulations made therein. Incidentally, we may also refer to the pro forma bank guarantee available at page 66 onwards which refers to the obligation of the vendor for the due and faithful carrying out by the vendor of his obligations and liabilities in time and in the manner as provided in the order on the terms and conditions agreed to between the purchaser and the vendor. It also refers to the workmanship guarantee provided by the assessee-company and its fulfilment upon which the guarantee shall cease to have effect. In fact, it refers to the work and jobs described in the telex of indents issued by the purchaser, named as "let work" and the acceptance of the same by the vendee, only adding the need for execution of a bank guarantee for the due and faithful carrying out by the vendor of all its obligations and liabilities in time and manner as provided in the order on the terms and conditions agreed to between the parties.
35. The pith and substance of the contract read with the bank guarantee referred to supra in the absence of any contrary intention of the parties, therefore, turns out to convey that the sale is complete no sooner the goods fully ascertained in this case being specific, the moment they are in a deliverable state and despatched as per the buyer's instructions no matter as to when even 90 per cent. of the cost is received by the assessee, i.e., whether in the financial year of delivery of the goods or a little thereafter and so the 10 per cent. which for reasons as explained already is receivable only on the furnishing of the requisite bank guarantee, in view of the mercantile system of accounting adopted by the assessee.
36. We shall now briefly discuss the case-law relied on by the assessee which we have very carefully gone through.
37. The first of such cases is E. D. Bassoon and Co, Ltd. v. CIT [1954] 26 ITR 27 (SC) referred to supra. In this case, the apex court on the facts and circumstances available, took the view that the transferees had obtained under the deed of assignment and transfer only the expectancy of earning a commission in the event of the condition precedent by way of complete performance of the obligation of the managing agents under the managing agency agreement being fulfilled and the debt arising in favour of the managing agents at the end of the stated period of service contingent on the ascertainment of net profits as a result of the working of the U company during the current year.
38. As would be evident, there were several ifs and buts in that case because of which their Lordships of the apex court held that the income profits or gains by way of commission would accrue to the managing agents only at the end of the calendar year. They took the view that there was only the expectancy of earning of commission with several conditions precedent attached. Unlike there, in the case before us, as held on facts, the sale became complete and concluded except that the 10 per cent. of the value of the contract was receivable by the assessee on the furnishing of a bank guarantee.
39. Similarly in Cotton Agents Ltd.'s case [19601 40 ITR 135, the apex court, on the facts of that case held that under the managing agency agreement, no commission accrued or arose on the sale proceeds at the time of each transaction of sale, as neither any debt was created, nor any right to receive payment.
40. In the case of A Gajapathi Naidu [1964] 53 ITR 114 again, the Supreme Court took the view that in the facts and circumstances of the case, a particular receipt could not be related back to the earlier year in which the actual supplies were made by the assessee to the hospital.
41. In the case of Amar Nath Khandelwal [1980] 126 ITR 323, the High Court of Delhi on the facts of that case took the view that the income accrued to the assessee only when the bill for commission was accepted by the principals. In that case, their Lordships also held that the commission accrued to the firm and could not be assessed in the assessee's hands.
42. In Hindustan Housing and Land Development Trust Ltd.'s case [19861 161 ITR 524, the apex court was considering an issue where although the award was made in favour of the assessee enhancing the amount of compensation and such amount was receivable by him on furnishing of a security bond, this amount of additional compensation was held not to have accrued to the assessee as the entire amount was in dispute, the matter being sub judice on account of the appeal filed by the State Government. Their Lordships held that if the State Government's appeal was allowed in its entirety the right to payment of enhanced compensation would have fallen altogether.
43. In Jehangir P. Vazifdar's case [1992] 42 ITD 67, the Bombay Bench of the Tribunal to which one of us was a party, took guidance from this ratio of the summit court. In no other case-law relied on by the assessee, the position is found to be otherwise. In fact, it would be appropriate to observe that whether an income accrues to an assessee during a particular period is more a question of fact which has to be determined according to the circumstances and the material available. In the case before us, even to repeat, we would say with emphasis that the transactions between the assessee and their customers were complete the moment the specific goods ordered to be manufactured by the latter were in a deliverable state and despatched as per the buyer's instructions. Ninety per cent. was payable within a few days as specified and the remaining 10 per cent. also payable to the assessee though on the furnishing of a bank guarantee. The character of this 10 per cent. does not change merely because it is receivable by the assessee subject to a bank guarantee inasmuch as the only obligation of the assessee which could have a nexus with this 10 per cent. is that the assessee was liable to rectify and make good the defects, if any, in the items supplied by them. The transaction was complete and a debt was created inasmuch as this payment of 10 per cent. could also not be denied by the customer to the assessee if the requisite bank guarantee was furnished.
44. In view of the above, the assessee's plea is not tenable.
45. We now take up the other issue, viz., disallowance of Rs. 8,400.
46. On the facts during the assessment, it was noted by the Assessing Officer that the assessee-company had paid a sum of Rs. 56,000 to Sri S. G. Hoskote one of their wholetime directors. Since this advance was not found related to the assessee's business, in the wake of the fact that the company had paid huge sums of interest to banks, the advance of Rs. 56,000 to the director free of interest was held to be unjustified.
47. The assessee's plea that the director was not holding any shares in the company did not find favour when the issue was taken up during the first appeal.
48. Before us, it was contended by the learned authorised representative for the assessee that in the absence of any nexus established between the lending made to Sri Hoskote and the interest paid on the borrowings by the company, no disallowance was legally tenable. In the alternative, it was submitted that the lending of a small sum to a director free of interest should be taken as an act of commercial expediency by the assessee.
49. We have considered the matter carefully. Sri Hoskote is a technocrat and as a wholetime director of the company is associated with its activities since 1987. He is not holding any share and from that angle, he cannot be said to be substantially interested in the company.
50. Merely because a loan of Rs. 56,000 free of interest was advanced by the company to him for his personal use, that would not justify a notional disallowance of interest in the absence of any finding of the Revenue authorities as to any nexus much less a direct one between this lending and the interest paid by them on the borrowings.
51. The learned authorised representative for the assessee has also placed reliance on several decisions such as CIT v. Kishinchand Chellaram [1977] 109 ITR 569 (Bom) and others, but they need not be discussed in view of the absence of the Department's finding justifying disallowance. The assessee thus succeeds on this issue and the disallowance is deleted.
52. In the result, the appeal is partly allowed.
53. H. C. SRIVASTAVA (Accountant Member).--I have had the benefit of going through the order proposed by my learned brother, the Judicial Member, in this case. I am afraid, I am unable to agree with him with regard to his decision under ground of appeal No. 1 raised by the assessee.
54. The assessee is a manufacturer of custom built instrumentation cables. As the orders placed by each and every customer are of separate specifications, no standard goods are manufactured by the assessee-company. In short, the assessee is like a custom tailor who stitches cloths for each and every customer separately according to the measurements taken. This case of the assessee cannot be compared to a readymade garment manufacturer. In the case of a custom tailor, advances may be paid to the tailor who can claim the balance only after satisfying his customer with the end product tailored by him. Till the customer is satisfied the tailor does not become entitled to receive the balance of the amount.
55. The assessee billed his customers to 90 per cent. of value of the goods manufactured on despatch and delivery with the exception that 100 per cent. of excise and sales tax was charged. As per sub-paragraph (4) of paragraph 3 (at page 51) of the order of my learned brother : "The remainder of the 10 per cent. of the cables cost (excluding the excise and sales tax) was payable to the assessee only on completion of the warranty period." In my opinion, 10 per cent. of the cost of the cables did not constitute sale of part of the assessee till the customer on whose custom the cables were manufactured approved them. The assessee could raise the bill for 10 per cent. of the cost of the cable only after the warranty period was over. It is notable that in this case the goods were not readymade goods but were custom built. The warranty period depended on the assessee's supply of goods to the customer. I am of the opinion that the cost to the extent of 10 per cent. of the cables did not constitute sale and, therefore, could not form part of the turnover.
56. I am afraid I am unable to agree with the observation of the learned Judicial Member regarding his observations on the decision of the Calcutta High Court in the case of CIT v. Simplex Concrete Piles (India) Pvt. Ltd. [1989] 179 ITR 8. It will be in the fitness of things to reproduce the summary of the case given in the Income Tax Reports in this order, which is as below (headnote) :
"The assessee carried on the business of concrete piling for buildings. Up to and including the assessment year 1964-65, the assessee-company was crediting 100 per cent. of the job value but from the assessment year 1965-66, it credited only 90 per cent., deducting the retention money, which resulted in reduction of income. The Income-tax Officer treated it as a change in the method of accounting and did not accept the change, which resulted in an addition of income of Rs. 20,77,161 in the assessment year 1965-66, and Rs. 14,43,479 in the assessment year 1966-67. The Appellate Assistant Commissioner held that the retention money did not arise or accrue in the year in which the job was executed but at a later date depending on the completion of the contract and the certification by the architect/engineer that the work had been satisfactorily completed. The Tribunal found that while 90 per cent. of the job value was to be paid immediately, five per cent. was to be paid after satisfactory completion of the work and the remaining five per cent. after one year or so, and in some cases 10 per cent. was withheld till the architect gave a certificate of satisfactory completion. Therefore, the Tribunal held that it could not be said that the right to receive payment of the remaining 10 per cent. of the value of the job done accrued as soon as it was completed, and that since the assessee followed the mercantile system of accounting, it credited its accounts as and when the right to receive a sum accrued and that would be only in respect of 90 per cent. in the first instance when the job was done and the remaining only when it became due as per the terms of the contract. The Tribunal, therefore, directed the Income-tax Officer to examine the question of accrual of the retention money from this angle and make adjustment regarding the same, if necessary. On a reference :
Held, that having regarding to the terms and conditions of the contract, it could not be held that either 10 per cent. or 5 per cent., as the case may be, being retention money, became legally due to the assessee on the completion of the work. Only after the assessee fulfilled the obligations under the contract, the retention money would be released and the assessee would acquire the right to receive such retention money. Therefore, on the date when the bills were submitted, having regard to the nature of the contract, no enforceable liability accrued or arose and, accordingly, it could not be said that the assessee had any right to receive the entire amount on the completion of the work or on the submission of bills. The assessee had no right to claim any part of the retention money till the verification of satisfactory execution of the contract. Therefore, the Tribunal was right in holding that the retention money in respect of the jobs completed by the assessee during the relevant previous year should not be taken into account in computing the profits of the assessee for the assessment year in question."
57. In this case, the assessee could bill only 90 per cent. of the job value and the balance could be billed and received only after the customer on whose custom the assessee manufactured the cables finally approved of the same. I have also gone through the various terms and conditions quoted in the order of my learned brother and having regard to those terms and conditions of the said contracts, in my opinion, it cannot be held that 10 per cent. became legally due to the assessee on the completion of the work. Only after the customer was satisfied that the custom ordered cables were manufactured strictly according to his specifications that the assessee could acquire the right to receive this 10 per cent. of the cost. In my opinion, on the different dates on which the assessee submitted the bills to the customers having regard to the nature of the contract no enforceable liability accrued or arose and, therefore, the assessee had no right to receive the entire amount till the satisfaction of the customer. The assessee, in my opinion, had no right to claim any part of the 10 per cent. The bank guarantee obtained only protected the assessee's interest. The bank guarantee could be converted into sale only when the particular period of warranty was over. A bank guarantee, therefore, cannot form part of the total turnover of this assessee under such circumstances. I am, therefore, of the opinion that the decision of the Calcutta High Court clearly applies to the facts of this case. I am of the opinion that the facts of this case are materially not distinguishable from the Calcutta High Court decision.
58. I do not find any force in the plea advanced on behalf of the Department and accepted by my learned Brother that in a case where such a strict and vigourous test of inspection during manufacturing and pre-shipment has been provided there was virtually no possibility of any major defect remaining in the articles manufactured excepting the one which may occur due to the reasons beyond anybody's control. In the past, the assessee has been claiming the expenditure incurred by it on carrying out repair activities on such custom manufactured cables on actual basis. The Department has been considering the claim of the assessee on year to year basis and has been allowing or disallowing the same on the merits of every year. What the assessee has done now is that it has, instead of claiming actual outgoings as deduction on repairs, submitted that approximately 10% of the total turnover excluding central excise and sales tax have not reached it. Very recently, the Income-tax Appellate Tribunal, Bombay, by their order in I. T. A. No. 3296/Bom/88 in the case of Hakimrai Jaichand Forgings Pvt. Ltd. (Now known as Amforge Ltd.) v. ITO dated 7-1-1993 have decided almost a similar issue in favour of the assessee. I, therefore, hold that the assessee is entitled to the relief claimed by it under the ground of appeal No. 1.
59. Accordingly, the assessee's appeal is allowed.
ORDER OF REFERENCE TO THIRD meMBER
60. Since there is a difference of opinion amongst us on the point at issue, the following question, on which there is a difference, is referred to the Hon'ble President for reference to a Third Member as laid down in Section 255(4) :
"Whether, on the facts and circumstances of the case, the sum of Rs. 52,80,660 could be said to accrue or arise to the assessee as its income during the relevant accounting year ?"
ORDER OF THIRD MEMBER T.N.C. Rangarajan, Vice President
61. The admitted facts of this case, briefly stated, are that the assessee is a company engaged in the manufacture of instrumentation cables to the specification of the customers. The contract provided that 10% of the price shall be paid on acceptance of the contract, 80% of the price on presentation or the despatch of documents of the goods and the balance 10% on receipt and acceptance of the goods subject to a performance and workmanship bank guarantee for that 10%. The guarantee bond stipulated that if there was any shortcoming in the workmanship or performance of the materials supplied, the purchaser shall be at liberty, without reference to the assessee-company, to recover the amount from the bank. Therefore, even though the amount was received, the assessee has referred to this 10% of the price as "retention money" as the assessee was of the view that it could not be appropriated until the period of guarantee was over. Therefore, the assessee contended that this retention money had to be excluded in computing the total income of the assessee. On the other hand, the Revenue contended that under the terms of the contract the assessee had the right to receive the amount and, therefore, it could not be excluded in computing the total income.
When the appeal was heard, the learned Judicial Member accepted the case of the Revenue. But the learned Accountant Member differed from him and held that until the guarantee period was over, the assessee had no right to the 10% of the amount and hence it should be excluded from the total income. Consequently, the following question has been referred to me for adjudication as a Third Member under Section 255(4) of the Income-tax Act, 1961 :
"Whether, on the facts and circumstances of the case, the sum of Rs. 52,80,660 could be said to accrue or arise to the assessee as its income during the relevant accounting year ?"
62. Before me, both sides presented elaborate arguments with reference to the principles relating to the accrual of income and in particular the right to receive the amounts. It was pointed out on behalf of the Revenue that this claim has been made by the assessee for the first time in this year even though the assessee had been taking into account 100% of the receipt in the earlier years and thus there was a change in the method of accounting which could not be allowed. The Revenue relied on the decision in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC). On the other hand, it was contended on behalf of the assessee that there was no change in the method of accounting which remained the mercantile method of accounting. According to the assessee, it had not correctly understood the concept of accrual of income and on proper advice it was taking the position that the retention money had not accrued and had therefore to be left out of the total income. The assessee relied on the following decisions:
CIT v. Simplex Concrete Piles (India) Pvt. Ltd. [1989] 179 ITR 8 (Cal).
E. D. Sassoon and Co, Ltd. v. CIT [1954] 26 ITR 27 (SC) at pages 50, 51.
Indian Molasses Co. (Pvt.) Ltd. v. CIT [1959] 37 ITR 66 (SC). CIT v. Ashokbhai Chimanbhai [1965] 56 ITR 42 (SC).
CIT v. Hindustan Housing and Land Development Trust Ltd. [1986] 161 ITR 524 (SC).
Jehangir P. Vazifdar v. ITO [1992] 42 ITR 67 (Bom).
CIT v. Palakol Co-operative Agricultural and Industrial Society [1988] 171 ITR 607 (AP).
CIT v. Govind Prasad Prabhu Nath [1988] 171 ITR 417 (All).
CIT v. A. Gajapathy Naidu [1964] 53 ITR 114 (SC).
63. I have considered the submissions of both sides and the decisions cited. It is not in dispute that the assessee had been maintaining its accounts under the mercantile method of accounting. The only dispute is whether the retention amount could be regarded as income not accruing to the assessee even though it was actually received. The conflict between the two Members appears to have arisen because the focus was on the right to receive the 10 per cent. of the price without keeping in mind the distinction between receipt and income. The learned Judicial Member was right in saying that under the terms of the contract the assessee had a right to receive the balance 10 per cent. on furnishing the bank guarantee. The learned Accountant Member was also right, in his view that because of the bank guarantee the assessee did not have an unconditional right to appropriate the sum even though it would receive the amount. I find that this situation was anticipated by the accounting standards of the Institute of Chartered Accountants of India. In Revenue Recognition (AS-9), paragraphs 10 and 11 state the principle as follows :
" 10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.
11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled :
(i) the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership ; and
(ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods."
(See Compendium of Statements and Standards--As on December 31, 1985, issued by the Institute of Chartered Accountants of India)
64. In the present case, even though the assessee had received the balance of 10 per cent., the bank guarantee for performance clearly shows that the receipt was at the risk of losing the amount if there was any defect in the goods. It would appear that this situation was a contingency and it is possible to view this as a contingent expenditure. But as held by the Supreme Court in the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53, contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account. In my opinion that would probably be the correct method, viz., to take into account 100 per cent. of the price and provide as against that an estimated amount as a provision for performance guarantee. However, as a Third Member hearing the appeal, I have no jurisdiction to resolve the issue in a manner different from that made by the other two Members. I have perforce to agree either with the learned Judicial Member or with the learned Accountant Member. Keeping in mind the principle of income recognition which is a basis of the mercantile method of accounting, I have to agree with the learned Accountant Member that as long as the performance guarantee remains and is enforceable without notice to the assessee, the income from the retention money cannot be recognised. Consequently, I have to agree with the learned Accountant Member that the retention money of 10 per cent. has to be excluded in computing the total income until the period of guarantee is over. The appeal will now be placed before the Bench for passing an order conformably with the majority of the Members who heard the appeal.