Income Tax Appellate Tribunal - Delhi
Frederic R. Harris (India) (P.) Ltd. vs Deputy Commissioner Of Income-Tax on 23 August, 2001
Equivalent citations: [2002]81ITD227(DELHI)
ORDER
K.C. Singhal, Judicial Member
1. The only issue arising out of this appeal relates to the disallowance of Rs. 83,58,500 being the amount of provisions for expenses.
2. The brief facts giving rise to this appeal are these. The assessee is engaged in the business of providing engineering consultancy services mainly in the areas of development of infrastructure relating to ports and harbours, bridges and highways etc. During the year under consideration, the assessee had claimed a deduction of Rs. 83,58,500 for the expenses incurred corresponding to the revenue earned during the period. This amount has been simultaneously credited under the head "Provisions for expenses" and shown in the balance sheet. The Assessing Officer noticed that in the balance sheet, it was shown under the head "Provisions for tax" amounting to Rs. 88,46,304, details of which were given in Schedule 8 to the balance sheet. The details as mentioned in Schedule 8 are being reproduced as under :
Rs. Rs.
Provision for duty and taxes 58,963
Provisions for expenses 83,58,500
Salaries payable 1,94,831
Tax payable 2,34,010
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87,88,341.
3. After considering the explanation of the assessee in this regard, the factual position was summarised by Assessing Officer as under :
The facts found by me hitherto arc summarised as under :
(i) Classification for the provision for taxes made in the balance sheet was misleading. The provision mainly related to expenses.
(ii) On 31-3-1997, provision made for the expenses was nullified next day by passing reverse entries, and as per assessee, the provision for expenses is nullified and treated like a dummy account in books in the next year.
(iii) Reversal entry was passed to the professional receipt amount on 31-3-1997 on the ground that the other party refused to entertain payment. Under Cochin Port Trust, there were two projects. Invoices were raised for 45% and 40% respectively. In both these cases, the revenue recognition is 40% by the assessee.
The principal argument of the assessee was that the method of accounting followed by it was in conformity with the accounting standards issued by the Institute of Chartered Accountants of India (in short ICAI) and accordingly, the claim 6f the assessee could not be rejected. After discussing the accounting standards, the Assessing Officer observed as under:
I have broadly reproduced accounting standards relied upon by the assessee. It nowhere suggests, even remotely, that the assessee cannot create dummy account for creation of provisions for expenses and nullify the entry on the next day. In effect there was no liability in existence at the end of the year for which a provision has been created. The conduct of the assessee is clearly indicative of this.
Further revenue recognition has not been in consonance with these accounting standards. Once the assessee claims to follow mercantile system of accountancy and thereunder percentage of completion project method, there was no occasion to reverse professional fees receipts on the ground that the same has not been accepted by the other party. Even otherwise there were two projects under Cochin Port Trust. For one project, bill was preferred at the rate of 45% of the completed project and in another case it was 40% of the completed project. These bills were preferred by the assessee on 19-2-1997. Thereafter, certain inputs on these project has undertaken. Ignoring these inputs in the revenue recognition, the assessee has only recognised revenue of 40% of the project. What about remaining 5% and the input after February, 1997? There is no explanation for this.
This is not the end of the matter. Under Accounting Standards-9, it was obligatory on the assessee to disclose the circumstances under which the revenue recognition has been postponed. This has not been done. The Auditor in his report has also not made any reference to the reversal of the entries in this year as well as on the 1st day of the next financial year.
Reference to notification under Section 145(2) issued by the CBDT is wholly misplaced. Nowhere in the notification, it is permissive to create a dummy account at the end of the year and nullify in the next year to claim deduction for liability. Vague liability debited in the dummy account cannot be said to have been incurred.
In view of the above discussion, it was held by him that claim of provisions for liabilities shown in the books in the guise of "provision for taxation" could not be sustained. According to him, it was only inserted to reduce the incidence of tax. The claim of Rs. 83,58,500 on account of "provision for expenses" was, therefore, disallowed and the assessment was completed. The CIT(A) has also confirmed the disallowances for the reasons given by the Assessing Officer. Hence, the assessee has preferred this appeal before the Tribunal.
4. The ld. counsel for the assessee Mr. R. Ganeshan has assailed the order of CIT(A) by raising various contentions. Firstly, it was submitted by him that the head "Provisions for taxation" in the balance sheet was due to typographical mistake and in fact it was "provision for expenses" and, therefore, no adverse inference, can be drawn from this factual aspect. In this connection, he drew our attention to the balance sheet and Schedule 8 enclosed thereto to point out that provision for tax was only for Rs. 2,34,010 out of total provisions of Rs. 87,88,341. Rest of the provisions were for expenses. Therefore, according to him, the head given in the balance sheet should be considered as "provisions for expenses". Thereafter, it was contended by him that the books of accounts maintained by the assessee were in accordance with the accounting standards issued by ICAI and also the Notification No. 9949, dated 25-1-1996 issued by the CBDT under Section 145(2), copy of which has been placed on the record. He also drew our attention to the written submissions furnished before the Assessing Officer, copy of which is placed at pages 200 and 201 of the paper book to point out that assessee was following the percentage completion method as per ICAI AS-7 and AS-9. He also drew our attention to the amended provisions of Section 145, according to which the assessee is bound to follow the mercantile system of accounting in accordance with the accounting standards issued by the Central Government, in the Official Gazette. He also drew our attention to Section 209 of the Companies Act according to which the costs incurred in order to perform the service upto the revenue stage are to be treated as expenses for earning those revenues. He also drew our attention to para 4 of the Notification No. 9949, dated 25-1-1996 issued by the Central Government which provides "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." In view of the aforesaid materials, it was contended by him that assessee was entitled to deduction in respect of the expenses incurred upto the stage of revenue earned by the assessee since it was following percentage completed method as recognised by ICAI and notified by the Central Government. According to him, since invoice had not been received during the year under consideration, the assessee was bound to make provisions for the same and claimed the deduction for the said amount. Regarding the reversal of entry in the next year it was argued by him that both the lower authorities had not properly appreciated the accounting system adopted by the assessee. According to him, the provisions for expenses account had to be nullified after the receipt of bills from the sub-contractors to whom the payment was due. According to the accounting system, whenever such invoices are received the provisions for expenses account is debited and the account of the respective parties are credited. If there is any excess or deficiency in the provisions for expenses account, the same has to be taken to the Profit and Loss A/c. If the entries are made in this manner, the liabilities claimed as deduction in the year under consideration cannot be said to be nullified in the next year. What is nullified only is the account of provisions for expenses. It was clarified by him that instead of adopting the provisions for expenses and crediting the parties account as and when the invoices are received, the assessee reversed the entry in first go on the first day of April, 1997 and thereafter again debited the sub-contract account and crediting the parties account as and when invoices were received in the subsequent year. According to him, the net effect remained the same and, therefore, no adverse inference could be drawn by the lower authorities on this account. He drew our attention to the entries made by the assessee. Therefore, it was prayed by him that the disallowance made by Assessing Officer and sustained by CIT(A) should be deleted in toto. On the other hand, the ld. DR. has strongly relied on the orders of lower authorities.
5. Rival submissions of the parties and the materials placed before us have been considered carefully. In our opinion, both the lower authorities had failed to appreciate the accounting system followed by the assessee. Admittedly, the assessee is following mercantile system of accounting according to which entries relating to the income as well as expenditure, arc to be made on accrual basis. Reference can be made to the well celebrated judgment of Supreme Court in the case of Kesha v Mills Ltd. v. GT[1953] 23 ITR 230 at page 239. If a particular expenditure has been incurred, the entries are made in the books of account irrespective of the payment and the assessee is entitled to claim a deduction on that account. When the invoices are received in respect of expenses incurred, the expenses accounts are debited and respective parties accounts are credited since payments are not made by that time. However, where the invoice arc not received in respect of such expenditure from the parties then at the end of the year the expenses accounts are debited and a corresponding amount is credited under the head "Provision for expenses". This principle is well recognised in all the accounting systems of mercantile. Reference can be made to Accounting Standards notified under Section 145(2) by the Central Government vide Notification No. 9949, dated 25-1-1996. In para No. 4, it has been stated "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." So the assessee is entitled to the deduction if the liability is a known liability. That means if the liability is accrued then the assessee is entitled to debit such expenses and credit the same under the head "Provisions for Expenses" and claimed the deduction thereof. The only thing to be seen is that onus lies on the assessee to establish that the expenses represented by the "provisions" related to the year in which the deduction is claimed.
6. In the present case, the assessee is engaged in the business of providing engineering consultancy services in the area of development of infrastructure relating to ports, bridges and highways etc. It is not in dispute that the mercantile or accrual system of accounting followed by the assessee is in consonance with the provisions of Section 209(3) of the Companies Act, 1956, read with Notification No. 9949, dated 25-1-1996 issued by the Central Government under Section 145(2) and the Accounting Standards prescribed by ICAI. Accounting Standard-7 as prescribed by the Institute allows the assessee to follow the percentage completion method in the case of contract activity. AS-9 allows the assessee to follow the proportionate completion method in the case of activity of rendering services. Relevant portion of AS-9, as stated by the assessee in the statement of facts before the CIT(A) is reproduced as under :
AS-9: In a transaction involving rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished, such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of consideration that will be derived from rendering the service ** ** ** In the accrual basis of accounting, cost arc matched either against revenues or against the relevant time-period to determine periodic income. Further costs which are not charged against income of the period are carried forward... .
Since the assessee has been following the above method and it was also bound to follow the guidelines given in the notification issued by the Central Government (supra), it is held that system of accounting adopted by the assessee could not be rejected. Even Assessing Officer has not specifically rejected such system.
7. The only ground for disallowing the claim of the assessee by the Assessing Officer appears to be that dummy entry had been passed inasmuch as the effect of entries made in the year under consideration was nullified by making reverse entries on the next day i.e., 1st day of next year. To appreciate the point of the assessee, it would be useful to refer to the entries made by the assessee. The total amount of Rs. 83,58,500 included the sum of Rs. 78,95,000 payable for the sub contract to three firms. For the sake of convenience, we are referring to entries in respect of such amount. The entry passed by the assessee on this account in the year under consideration was as under :
1996-97 Head of account - Subcontract Date Jv No. Description Amount (Rs.) 31-3-1997 J-324 Sub-contract. Dr. 78,95,000.00 Provision for expenses Cr. 78,95,000.00 (Being the provision for expenses made for month of March, 1997)
8. In the next year, the following entries were passed :
1997-98 Rs.
1-4-1997 J-337 Provision for expenses Dr. 78,95,000.00
Sub-contract Cr. 78,95,000.00
(Being the Provision for expenses
made for month of March, 1997).
4-4-1997 J-350 Sub-contract Dr. 45,50,000.00
Coastal Marine Con. & Engg. Ltd.
Cr. 43,05,437.00
TDS professional charges
payable, Cr. 2,44,563.00
(Being the Bill No. Com. 9606/RA-1,
dated 2-4-1997 of COMACOE of
Rs. 55,00,000 and Rs. 10,00,000
already booked in sub-contract at
the time of payment as advance).
J-351 Sub-contract Dr. 12,17,353.00
Engineers India Ltd. Cr. 11,51,920.00
TDS professional charges payable Cr. 65,433.00
(Being Bill No. ELC/3915/20.1
dated 18-3-1997 of EIL booked on
ADB-Madras Ennore job and TDs
deducted @ 5.375%).
6-5-1997 J-7 Sub-contract Dr. 1,05,680.00
Vam Management Service P. Ltd.
Cr. 1,00,000.00
TDS professional charges
payable Cr. 5,680.00
(Being the Bill No. Vam/02
dated 3-5-1997 of Vam Management
Services P. Ltd., towards
professional charges for
Gangavarm Port bid project.
14-7-1997 J-118 Subcontractor. 85,000.00
IIT Madras Cr. 85,000.00
[Being the Bill No. Nil (Ref./
IC/96-97/OEC/016/FRH/RSUN) for
consultancy charges for completion
of item No. 2 geotechnical investigation].
25-7-1997 J-135 Sub-contract Dr. 33,16,860.00
Coastal Marine Con. & Engg.
Ltd. Cr. 31,51,017.00
TDS professional charges
payable Cr. 1,65,843.00
(Being the professional services
Bill RA-2, dated 7-7-1997 passed for
Rs. 33,16,860 (Rs. 88,16,860)-
55,00,000, already accounted) for
GMB project.
When these entries were ledgerised, the sub-contract account appeared in the books of the assessee as under :
Sub-contract 1997-98 A/c Rs. Rs.
4-4-1997 Coastal Marine 45,50,000 1-4-1997 Provision for 78,95,000
Con. & Eng. Ltd. expenses
4-4-1997 EIL 12,17,353
6-5-1997 Vam Management
Services P. Ltd. 1,05,680
14-7-1997 IIT Madras 85,000
25-7-1997 Coastal Marine
Con. & Engg. Ltd. 33,16,860
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92,74,893 78,95,000
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The above entries clearly indicate that the sum of Rs. 78.95 lacs was charged to P&L account only in assessment year 1997-98 and it was only the excess amount which is charged in assessment year 1998-99 on the basis of the bills issued by the parties. The ledger account shows that actual expenses were to the extent of Rs. 92,74,813 against the estimated amount of Rs. 78.95 lacs for which the provisions were made in the year under consideration. The excess expenditure was of Rs. 13,79,893 which was charged to P&L account in the next year and not the entire amount of Rs. 92,74,893. So what is nullified is the account of provisions for expenses and not the liability itself. Therefore, in our opinion, the Assessing Officer as well as CIT(A) merely erred in not appreciating the accounting system followed by the assessee.
9. As already stated, the provisions for expenses are made normally when invoices are not received against the expenditure incurred. So such provisions for expenses cannot stand forever in the balance sheet and, therefore, assessee is bound to reverse such entry on the receipt of invoices. In such case the assessee normally debits "provisions for expenses" account and credit the accounts of respective parties. Instead of doing this, the assessee has first credited the expenses account i.e., subcontract account on the first day of the next year and then again debited the sub-contract account at the receipt of bills from the parties and simultaneously crediting the accounts of such parties. That does not mean that entries made in the year under consideration were incorrect. By making such normal entries, the liabilities of the assessee to the extent of Rs. 78.98 lacs was not nullified as would appear from the ledger entries mentioned above. It was only the excess amount, over and above Rs. 78.85 lacs, which go to the Profit and Loss account for assessment year 1998-99. It is only the entry for "provision for expenses" which is considered as dummy entry, as such, entry is bound to be reversed and not the liabilities itself. Therefore, in our considered opinion, the Assessing Officer as well as CIT(A) was not justified in rejecting the claim of the assessee merely on this ground.
10. However, it is seen that on account of outright rejection of the assessee's claim on the wrong appreciation of entries, the Assessing Officer had not considered the claim on merit. As already held, the onus is on the assessee to prove that the amount represented by these provisions related to the year under consideration considering the system of accounting followed by the assessee. A doubt has been created in our mind while reading the order of CIT(A) in para 6 of the order. It has been mentioned while stating the submissions of the assessee "A copy of the bills and list were also filed during appeal proceedings. It was contended that the list would show that out of the provisions made, Rs. 60,74,841 were for expenses billed in the beginning of the next financial year and, therefore, evidently relate to assessment year 1997-98 only". So it has to be clarified whether the entire expenses of Rs. 83,58,500 related to this year or the sum of Rs. 60,74,841. Accordingly, we set aside the order of CIT(A) and restore the matter to the file of Assessing Officer who shall re-adjudicate the matter after ascertaining the fact that the sum of Rs. 83,58,500 represented the expenditure related to the year under consideration. The assessee shall be given reasonable opportunity to lead the evidence in this regard.
11. In the result, appeal of the assessee is allowed pro tanto.