2009 (2) TMI 507 - AT - Income Tax

Disallowance of Provision for foreseeable loss - Claim was made as per Accounting Standard 7 relating to Construction Contracts - Method of accounting - difference in the figures of cost incurred shown at the time of assessment proceedings and shown at the time of hearing of the appeal - AO disallowed the assessee s claim observing that this being only a provision made on estimated basis cannot be allowed and loss actually incurred is to be allowed in the year in which it had taken place under the Income-tax Act - CIT held that the loss was bogus loss as the assessee had not been able to prove the genuineness in view of variation in different figures. HELD THAT - In view of mandatory requirements of AS-7 change in the method of valuation of work-in-progress was a bona fide particularly in view of the qualification made in this regard by statutory auditors as well as by Comptroller Auditor General of India. It is not disputed that the department in earlier years has allowed the loss on estimated basis having regard to the expenditure actually incurred in various years. Therefore in principle it is not disputed that the estimated loss under the present and circumstances is an allowable deduction. However merely because the change in method of accounting is bona fide it would not lead to the inference that the income is also deducible properly under the Income-tax Act. This aspect is very evident from 1st proviso to section 145 as it stood prior to amendment 1995 with effect from 1-4-1997 The matching principle is of relevance where income and expenditure both are to be considered together. However in the present case the effect of valuation of WIP will automatically affect the profits of subsequent years accordingly. We accordingly do not find any reason for not accepting in principle the assessee s claim as being allowable. However in view of discrepancies pointed out by CIT(A) for correct estimation of loss we restore the matter to the file of AO to examine the correctness of amount claimed. This ground is accordingly treated as allowed for statistical purposes. Disallowance on provision for leave encashment - HELD THAT - Assessee-company submitted before AO stated that the provision for leave salary encashment was on accrual basis and was in accordance with Accounting Standard 15 viz. accounting for retirement benefits in Financial Statements for employers issued by ICAI. The AO has not brought on record any facts from which it could be inferred that assessee had not complied with the requirements of AS-15. We therefore do not find any basis for not applying the ratio laid down in the case of Bharat Earth Movers 2000 (8) TMI 4 - SUPREME COURT held that the provision made by the assessee-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by the employees of the company inclusive of the officers and staff subject to the ceiling on accumulation as applicable on the relevant date was entitled to deduction out of the gross receipts of the accounting year during which the provision is made for the liability. It was further held that the liability was not a contingent liability. Respectfully following the decision of the Hon ble Supreme Court in the case we direct AO to allow the deduction as claimed by the assessee in respect of provision for leave encashment. This ground is accordingly allowed.

Issues Involved:
1. Addition of Rs. 491.48 lakhs due to undervaluation of work-in-progress.
2. Deduction of Rs. 26.55 lakhs for the decrease in the value of surplus material.
3. Disallowance of Rs. 5,45,00,000 being provision for leave encashment.
4. Disallowance of Rs. 56,21,774 out of Rs. 3,23,76,886 debited as prior period expenditure.

Detailed Analysis:

Issue 1: Addition of Rs. 491.48 lakhs due to undervaluation of work-in-progress
The assessee, a Government of India Undertaking, changed its method of accounting for fixed price construction contracts, leading to a lower profit and work-in-progress valuation by Rs. 491.48 lakhs. The Assessing Officer (AO) required details of the change and found that the new method, based on AS-7 by ICAI, anticipated entire losses upfront rather than on a pro rata basis. The AO disallowed the claim, stating it was a provision on an estimated basis and not actual loss incurred.

The CIT(A) confirmed the AO's decision, citing discrepancies in figures provided by the assessee and referencing case laws that disallowed anticipatory and notional losses. The Tribunal acknowledged the bona fide nature of the change due to AS-7's mandatory requirements but restored the matter to the AO to verify the correctness of the claimed amount due to discrepancies noted by the CIT(A).

Issue 2: Deduction of Rs. 26.55 lakhs for the decrease in the value of surplus material
The assessee claimed a deduction for the decrease in the value of surplus materials left over from completed projects. The CIT(A) confirmed the addition, noting the issue was pending before the ITAT. The Tribunal referred to its decision in the assessee's case for AY 1991-92, directing the AO to add the amount to the opening stock of subsequent years, thus confirming the addition for the year under consideration but allowing the benefit in subsequent years.

Issue 3: Disallowance of Rs. 5,45,00,000 being provision for leave encashment
The AO disallowed the provision for leave encashment, treating it as a contingent liability. The CIT(A) upheld the disallowance, stating the assessee did not provide evidence fulfilling the Supreme Court's criteria in Bharat Earth Movers v. CIT. The Tribunal, however, found that the assessee complied with AS-15 and followed the Supreme Court's ruling, allowing the deduction as the provision was not a contingent liability.

Issue 4: Disallowance of Rs. 56,21,774 out of Rs. 3,23,76,886 debited as prior period expenditure
The AO disallowed the prior period expenditure claim due to lack of evidence and auditor certification. The CIT(A) allowed part of the claim but confirmed the disallowance of Rs. 56,21,774. The Tribunal referred to its decision in the assessee's case for AY 1991-92, restoring the issue to the AO to verify if the expenses crystallized during the year under consideration and allowing them if they did.

Conclusion:
The Tribunal allowed the appeal for AY 1996-97 partly for statistical purposes, directing the AO to verify the correctness of the claimed loss and add the surplus material value to the opening stock of subsequent years. For AY 1997-98, the Tribunal allowed the provision for leave encashment and restored the prior period expenditure issue to the AO for verification, treating the appeal as allowed for statistical purposes.

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