Income Tax Appellate Tribunal - Pune
Ashoka Buildcon Ltd., Nashik vs Department Of Income Tax on 31 December, 2014
IN THE INCOME TAX APPELLATE TRIBUNAL
PUNE BENCH "B", PUNE
BEFORE SHRI G.S. PANNU, ACCOUNTANT MEMBER
AND SHRI R.S. PADVEKAR, JUDICIAL MEMBER
ITA No.394/PN/2007
(Assessment Year : 2003-04)
Asstt. Commissioner of Income Tax,
Circle-2, Nashik. .... Appellant
Vs.
Ashoka Buildcon Ltd.,
S.No.861, Ashoka Marg,
Wadala, Nashik - 422 011.
PAN : AABCA9292J .... Respondent
Department by : Shri P. S. Naik
Assessee by : Shri Sunil Pathak
Date of hearing : 10-11-2014
Date of pronouncement : 31-12-2014
ORDER
PER G. S. PANNU, AM
The captioned appeal by the Revenue is directed against an order of the Commissioner of Income Tax (Appeals)-II, Nashik dated 22.12.2006 which, in turn, has arisen from an order dated 28.03.2006 passed by the Assessing Officer u/s 143(3) of the Income-tax Act, 1961 (in short "the Act") pertaining to the assessment year 2003-04.
2. In this appeal, Revenue has raised the following Grounds of Appeal :-
"1. That the learned CIT(A) erred in law and facts in allowing relief of Rs.1,24,85,000/- to the assessee by holding it that the foreseeable losses claimed by the assessee represent ascertained liability ignoring the fact that these expenses admittedly pertain to period April 2003 to November 2006.
2. That the learned CIT(A) erred in law and facts in allowing relief of Rs.1,24,85,000/- to the assessee ignoring the fact that these expenditure represent contingent liability and admittedly pertain to period April 2003 to November 2006.
3. That the learned CIT(A) erred in law and facts in allowing relief of Rs.1,24,85,000/- to the assessee relying on AS-7 of accounting standards ignoring the fact that these accounting standards are not notified u/s 145 of the I.T. Act."2 ITA No.394/PN/2007
3. Briefly put, the relevant facts and background of the dispute can be summarized as follows. The respondent-assessee is a company incorporated under the provisions of Companies Act, 1956 and is, inter-alia, engaged in the business of civil construction, contracting, implementation of infrastructure project, etc.. The Assessing Officer noted that assessee had undertaken a project for construction and maintenance of East Coast Road for Tamilnadu Road Development Corporation (in short "TNRDC"). The stated project was awarded to the assessee in the year 2000-01 and it was a composite contract which involved improvement work/construction and maintenance of road. During the previous year relevant to the assessment year under consideration, assessee completed the construction of the road and it was under an obligation to maintain the road for five years as per the terms and conditions of the contract awarded by TNRDC. Since the work of maintenance of road was for a period of five years and construction was completed during the year under consideration, assessee anticipated losses on account of maintenance work. The assessee determined such future foreseeable losses at Rs.1,24,85,000/- and made a Provision of such amount. The Provision so made was debited to the Profit & Loss Account and claimed as a deduction while computing income for the year under consideration. The Assessing Officer treated such Provision for foreseeable losses as a contingent liability and disallowed the same while finalizing the assessment u/s 143(3) of the Act dated 28.03.2006. The aforesaid action of the Assessing Officer is the subject-matter of controversy before us.
4. The CIT(A), however, disagreed with the Assessing Officer and held that the foreseeable loss was not a contingent liability but it was liable to be considered while determining the income of the assessee for the period under consideration. As per the CIT(A), such losses were ascertained losses on the maintenance portion of the contract though it was an estimation made in the light of the available information. The CIT(A) also noted that as per the 3 ITA No.394/PN/2007 judgement of the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. vs. CIT, 37 ITR 1 (SC), where an assessee was following the mercantile system of accounting, it was entitled to deduct expenditure which is incidental to the business and such expenditure was deductible on accrual basis though it may not have been actually incurred during the relevant assessment year. In nutshell, the CIT(A) held that the future foreseeable losses of Rs.1,24,85,000/- claimed by the assessee represented an ascertained liability which was allowable as deduction while computing income for the assessment year under consideration. Against such a decision of the CIT(A), Revenue is in appeal before us.
5. Before us, the Ld. Departmental Representative has referred to the assessment order and in-particular paras 8 (iv) and (v) to point out that the impugned Provision for foreseeable losses was merely an estimation and therefore the claim was justifiably disallowed by the Assessing Officer. According to the Ld. Departmental Representative, the expenses for maintenance work of the road was required to be considered by the assessee on actual basis in the respective years and the impugned Provision towards future losses of five years on account of maintenance expense was only an estimate and therefore it was a contingent liability. In this manner, the Ld. Departmental Representative contended that the CIT(A) erred in allowing the claim of the assessee.
6. On the other hand, Ld. Representative for the respondent-assessee has defended the conclusion drawn by the CIT(A). At the time of hearing, the Ld. Representative referred to the Paper Book filed wherein is placed a copy of the contract entered into with TNRDC, which is placed at pages 1 to 45 of the Paper Book. The Ld. Representative explained that the contract with TNRDC was a composite contract inasmuch as it involved improvement/construction and maintenance of the East Coast Road of 113 4 ITA No.394/PN/2007 Kilometers between Pondicherry to Chennai. In this context, our attention was invited to the terms and conditions of the contract which shows that it was a composite contract. In-particular, reference was made to page 8 of the Paper Book wherein the expressions used in the contract have been defined. In terms of the said definition of the expressions "improvement works contract value"; "improvement works period"; and, "improvement works completion date", etc. it is sought to be established that it was a composite contract inclusive of the construction of the road and its maintenance for a specified period thereon. It was pointed out that in terms of the contract, assessee was required to carry out the necessary improvement/construction of the road and to maintain it for the period stipulated thereon which was five years. A reference has also been invited to pages 110-111 of the Paper Book, wherein the relevant clauses of the agreement are reflected which show the schedule of payments for improvement works as well for the portion of maintenance work. In terms thereof, it is submitted that the value of the improvement work was Rs.42,01,07,171/- and the same was required to be executed between September, 2000 to July, 2001. The detailed scope of work in the improvement category has also been referred to which is placed as Annexure- 1 to the contract at page 143 of the Paper Book. Thereafter, in terms of the contract, assessee was required to maintain the road from October, 2001 to July, 2006 and the total amount payable to the assessee in installments for maintenance of the road was Rs.1,77,15,800/- during the aforesaid period. The details of the maintenance work to be carried out is also reflected in Appendix-1 of the contract, which is also placed in the Paper Book.
7. The Ld. Representative submitted that during the year under consideration, assessee had completed the improvement work of the road and its liability to maintain the contract for the next five years had started. The assessee realized, it might incur loss on maintenance of the road as it anticipated that the expenses likely to be incurred on maintenance would 5 ITA No.394/PN/2007 exceed the amounts receivable over the years for the maintenance as stipulated in the contract. Accordingly, assessee made a Provision for losses on maintenance of road amounting to Rs.1,24,85,000/-. Justifying the basis of estimation of loss, a reference has made to the pages 245 to 255 of the Paper Book, wherein a detailed working in this regard has been placed. The Ld. Representative emphasized that the working of such losses have not been disputed by the Assessing Officer but the same have been rejected merely on the ground that it was a contingent liability.
8. At the time of hearing, the Ld. Representative submitted that a similar situation had arisen before the Mumbai Bench of the Tribunal in the case of ACIT vs. ITD Cementation India Ltd., (2014) 146 ITD 59 wherein a Provision made for foreseeable losses was allowed as a deduction. Apart therefrom, reliance has also been placed on the decision of the Mumbai Bench of the Tribunal in the case of Mazagon Dock Ltd. vs. JCIT, (2009) 29 SOT 356 in support of the case of the assessee. In the course of hearing, reference has also been made to the following decisions : (i) judgement of the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. vs. CIT, 37 ITR 1 (SC); (ii) Bharat Earth Movers vs. CIT, 245 ITR 428 (SC); and, (iii) Rotork Controls India P. Ltd. vs. CIT, (2009) 314 ITR 62 (SC).
9. We have carefully considered the rival submissions. The respondent- assessee is engaged in the execution of an infrastructure development project which was awarded by the TNRDC. The work related to improvement of work and its maintenance for a period of five years. The job has been done on a contractual basis. Factually speaking, the contract for improvement of the road and its maintenance for a period of five years is a composite contract. The Assessing Officer, however, has observed that TNRDC has awarded separate contracts, i.e. one for construction of road and second for its maintenance for a specified period. The Assessing Officer has observed so 6 ITA No.394/PN/2007 on the ground that TNRDC has specifically quantified the amount payable for the two components of the work separately. For this reason, the Assessing Officer held that the impugned losses calculated by the assessee are only relating to the maintenance portion of the work and therefore maintenance expenses should be allowed only to be considered in the period corresponding to the period for which maintenance is being effected.
10. In our considered opinion, though the TNRDC has quantified the contract payments separately with regard to the improvement work and the maintenance work, so however, it would be inappropriate to say that the two works were different. In-fact, it was a composite work awarded by TNRDC which involved improvement of road and its maintenance thereof for a specified period. At page 115 of the Paper Book is placed a communication addressed by the assessee to TNRDC wherein the performance guarantee has been furnished which is for the composite work relating to improvement of road and its maintenance thereof. Apart therefrom, a perusal of the various terms and conditions of the contract awarded by TNRDC makes it quite clear that the obligation of the assessee was a composite one i.e. involving improvement of the road and its subsequent maintenance for the specified period. Therefore, we are unable to agree with the Assessing Officer that the works of improvement and maintenance of road were separate. In-fact, factually speaking, the work carried out by the assessee was a composite fixed contract work involving improvement of road and its maintenance thereof for a fixed period.
11. The Assessing Officer has disallowed the impugned Provision on the ground that it is liable to be allowed in the year when it is actually incurred, and because assessee had shown the total income of Rs.41,92,05,032/- from TNRDC for road construction on receipt basis. This aspect of the matter has been challenged before the CIT(A), who held that the Assessing Officer was 7 ITA No.394/PN/2007 wrong in inferring that the assessee has offered income on receipt basis. The CIT(A) has recorded in para 12 (ii) of his order that assessee company is following mercantile system of accounting and is recognizing income from contracts on percentage of completion method. In our considered opinion, there is nothing to disagree with the CIT(A) on this aspect of the matter. In- fact, the financial statements of the assessee company which are placed at pages 206 to 220 of the Paper Book also point out that the assessee company is maintaining its accounts on a mercantile system. In so far as the issue of allowability of future foreseeable losses is concerned, a similar situation had come up before the Mumbai Bench of the Tribunal in the case of ITD Cementation India Ltd. (supra). In the case before the Mumbai Bench, assessee was carrying on the business of infrastructure development and the work was executed on a contractual basis. The assessee therein was executing a fixed price contract and in terms of Accounting Standard-7 issued by Institute of Chartered Accountant of India (ICAI) made a Provision for future foreseeable losses and claimed deduction of such a Provision. The Revenue disallowed the Provision made for such foreseeable losses. The Tribunal concurred with the stand of the assessee that such a Provision was an allowable deduction. The relevant portion of the order of the Tribunal is reproduced as under :-
"14. We have considered the rival submissions and perused the orders of the lower authorities. We have also the benefit of going through the AS-7 issued by ICAI. At the very outset, it would not be out of place to consider the provisions of Sec. 145 of the Act. Sec. 145(2) of the Act provides that the Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. It is a fact that AS-7 has not been notified by the Central Government. This does not mean that the assessee is precluded from following AS-7. A perusal of the provisions of Sec. 145 show that Accounting Standards which have been notified by the Central Government have to be mandatorily followed by the assessee. But this does not mean that the assessee cannot follow the other Accounting standards issued by ICAI. ICAI being the highest accounting body of the country, created by an Act of Parliament, Accounting Standards issued by it cannot be brushed aside lightly. On the contrary, if an assessee is following the Accounting Standards issued by ICAI, it would give more credibility and authenticity to its account. AS - 7 , inter alia , provides :8 ITA No.394/PN/2007
"When the outcome of a construction contract cannot be estimated reliably"
(a) Revenue should be recognized only to the extent of contract costs incurred of which recovery is probable and
(b) Contract costs should be recognized as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognized as an expense immediately in accordance with paragraph 35."
15. It is not in dispute that the assessee is executing fixed price contract which means that the contractor has agreed to a fixed contract price or rate in some cases subject to cost escalation prices. As per AS-7, the assessee is entitled to make provision for foreseeable losses.
16. A perusal of the accounting statement of the assessee for the year under consideration shows that at para-1.6 to the notes to the financial statement, the auditors have provided as under:
"Revenue recognition on contracts Contract prices are either fixed or subject to price escalation clauses. Revenue from contracts is recognized on the basis of percentage completion method, and the level of completion depends on the nature and type of each contract including :
Unbilled work-in-progress valued at lower of cost and net realizable value upto the stage of completion. Cost includes direct material, labour cost and appropriate overheads; and Amounts due in respect of the price and other escalation, bonus claims and/or variation in contract work approved by the customer/third parties etc. where the contract allows for such claims or variations and there is evidence that the customer/third party has accepted it. In addition, if it is expected that the contract will make a loss, the estimated loss is provided for in the books of account. Contractual liquidated damages, payable for delays in completion of contract work or for other causes, are accounted for as costs when such delays and causes are attributable to the company or when deducted by the client."
17. A similar issue has been considered by the Tribunal in the case of Mazagoan Dock (supra) wherein the Tribunal has held as under:
"The question that came up for consideration was as to whether the anticipated loss on the valuation of fixed price contract in view of the mandatory requirements of the AS-7, was to be allowed in the year in which the contract had been entered into or it was to be spread over a period of contract, as was done by the assessee in earlier years. As far as the change in the method of valuation of work-in-progress was concerned, it could not be disputed that in view of mandatory requirements of the AS-7, it was a bona fide change in the method of valuation of work-in-progress, particularly in view of the qualification made in this regard by statutory auditors as well as by the Comptroller & Auditor General of India. Therefore, the observation of the Commissioner (Appeals) that the assessee had booked bogus loss was not correct. As far as the basis of estimation was concerned, the same was done on technical estimation basis and, therefore, merely because there were some variations in the figures furnished by the assessee at different stages, it could not be said that the estimated loss was not allowable. It was not disputed that the department in 9 ITA No.394/PN/2007 earlier years had allowed the loss on estimated basis having regard to the expenditure actually incurred in various years. Therefore, in principle, it was not disputed that the estimated loss under the present circumstances was an allowable deduction. However, merely because the change in method of accounting was bona fide, it could not lead to the inference that the income was also deducible property under the Act. This aspect is very evident from the first proviso to section 145 as it stood prior to the amendment by the Finance Act, 1995 with effect from 1/4/1997. It could not be disputed that from the method adopted by the assessee, the assessee's income could not be deducted property in the year in which the loss had been anticipated. As a matter of fact this aspect was not disputed by the Assessing Officer also. He had swayed more by the revenue loss than by the correct principle to be applied. The matching principle of accounting was not of much significance in the present context because if the loss had been properly estimated in the year in which the contract had been entered into, then it had to be allowed in that very year and could not be spread over the period of contract. The matching principle is of relevance where income and expenditure, both are to be considered together. However, in the instant case, the effect of valuation of WIP would automatically affect the profits of subsequent years accordingly. Therefore, there was no reason for not accepting in principle the assessee's claim as being allowable. However, in view of discrepancies pointed out by the Commissioner (Appeals) for correct estimation of loss, the matter was to be restored to the file of the AO to examine the correctness of amount claimed."
18. A similar view has been taken by the Tribunal in the case of Jacobs Engineering India Pvt. Ltd. (supra) wherein the assessee's claims of foreseeable losses were allowed irrespective of method of accounting in terms of AS-7. In the case of Dredging International (supra), the issue before the Tribunal was whether u/s. 37(1) of the Act provision for foreseeable loss made in accordance with guidelines of AS-7 and duly debited in audited accounts of company is an allowable expenditure. The Tribunal decided the case in favour of the assessee and held that 'yes' it is an allowable expenditure. The Tribunal while deciding this issue has also considered the decision of Mazagaon Dock (supra).
19. Considering the facts of the case in the light of the accounting standards and the decisions of the Tribunal (supra), and as no distinguishing cases have been brought on records by the revenue , reversing the findings of the Ld. CIT(A) ,we direct the AO to re-compute the business profits by allowing the losses provided by the assessee in its books. The appeal filed by the assessee is allowed."
12. To the similar effect is the decision of the Mumbai Bench of the Tribunal in the case of Mazagaon Dock (supra) which has also been relied upon by the Tribunal in the case of ITD Cementation India Ltd. (supra). Therefore, in view of the aforesaid precedents in-principle, it has to be inferred that where an assessee is executing an infrastructure development fixed price contract, the 10 ITA No.394/PN/2007 foreseeable losses of future years can be recognized following the rationale of AS-7 issued by ICAI, and such a Provision is an allowable deduction.
13. The other aspect to be considered is the efficacy of the provision estimated by the assessee at Rs.1,24,85,000/-. In this context, the Ld. Representative for the assessee clarified that the estimation of the provision is based on the maintenance expense rates on roads issued by the PWD, Government of Maharashtra. A Circular of the PWD is placed at page 253 of the Paper Book which contains the rates prevailing for the year 1989-90 wherein the PWD has estimated maintenance expenses of Rs.25,600/- to Rs.38,200 per Km., which is likely to be incurred on maintenance of State Highways every year. The Ld. Representative explained that the road contract in question is also for a State Highway and based on the rates of the PWD for 1989-90, estimate of likely expenses to be incurred by the assessee during the financial years 2003-04 to 2006-07 came to Rs.3,00,91,193/-, which is higher than the amount estimated by the assessee at Rs.2,72,57,400/-, as per the working placed in the Paper Book at page 255. It has been pointed out that after giving credit for the amount receivable for maintenance work as per the contract, the Provision required to be made as per the PWD rates came to Rs.1,53,18,793/-, which is even more than the Provision of Rs.1,24,85,000/- made by the assessee. In this manner, it is sought to be pointed out that the Provision made by the assessee for foreseeable losses was reasonable and justified.
14. At this stage, the Ld. Representative has also referred pages 242 to 243 of the Paper Book, wherein certain Notes to account of some of the stock- exchange listed companies engaged in execution of contracts have been placed to show that such companies were also making Provisions for foreseeable losses in execution of contracts. It is sought to be pointed out on 11 ITA No.394/PN/2007 the basis of the aforesaid material that creation of an adequate Provision for future losses is a generally accepted commercial policy.
15. We have considered the working of the Provision made and find that the same is neither irrational and nor irrelevant to the kind of business operations under consideration. In any case, we find that the Assessing Officer has not disputed the working of the Provision submitted by the assessee. An aspect which has been raised by the Ld. Departmental Representative is to the effect that in the subsequent assessment year of 2007-08 when the maintenance period was over assessee has written-back an amount of Rs.76,00,000/- out of a Provision of Rs.1,24,85,000/- and that such an action indicated that estimation made by the assessee is not justified. The aforesaid approach of the Revenue, in our view, is not justified. The efficacy of the Provision has to be examined in the light of the circumstances prevailing at the time when the estimate was made. In any estimation, certain degree of guesswork is invariably present, but the same would not make it unreasonable, so long as the basis adopted for making the estimate is rationale and is acceptable. In the present case, the estimate made by the assessee has been benchmarked against PWD notified rates and it appears to be reasonable. The fact that in the subsequent year, assessee has written- back only a portion of the Provision does not indicate its unreasonableness, rather the facts indicate that assessee indeed incurred expenditure on maintenance work which is more that the receipts due to it as per the contract. Therefore, the judgement of the assessee that it was likely to incur loss on maintenance work after five years was indeed justified, as the factum of incurrence of such loss is not disputed. In sum and substance, we are in agreement with the CIT(A) that the Provision for foreseeable losses debited by the assessee in the Profit & Loss Account, is not a contingent liability so as to be disallowed while computing business income for the year under 12 ITA No.394/PN/2007 consideration. As a consequence, we hereby affirm the order of the CIT(A) and Revenue fails in its appeal.
16. In the result, appeal of the Revenue is dismissed.
Order pronounced in the open Court on 31 st December, 2014.
Sd/- Sd/-
(R.S. PADVEKAR) (G.S. PANNU)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Pune, Dated: 31 st December, 2014.
Sujeet
Copy of the order is forwarded to: -
1) The Assessee;
2) The Department;
3) The CIT(A)-II, Nashik;
4) The CIT-II, Nashik;
5) The DR "B" Bench, I.T.A.T., Pune;
6) Guard File.
By Order
//True Copy//
Assistant Registrar
I.T.A.T., Pune