2015 (1) TMI 702 - HC - Income Tax

Accrual of Income - Inclusion of particular income in the assessment year - what is the system of accountancy adopted by the assessee? - year in which the amount representing 2.5% had accrued to the respondent - Held that - In the instant case, the clause in the contract provided for deduction of 7.5% from each bill. Out of this, 5% would be payable on successful completion of the work and balance 2.5% after the expiry of the defect free period. For instance, if the value of the contract is ₹ 1.00 crore and the amounts are paid under four bills of ₹ 25.00 lakhs each. From each of the first 3 bills, sums representing 7.5% are deducted. On successful completion of the work, the amounts representing 5% deducted from the first three bills, would become payable along with the final bill. However, even from the final bill, 2.5% would be deducted. This amount of 2.5%, which stood deducted from all the four bills, becomes payable, only on expiry of the defect free period. If such period is one year, the amount becomes payable only when no defects whatever are found or noticed, during that period. It is, no doubt, true that in all the bills, reference was made to these amounts and corresponding entries were made in the books of account. However, the right to receive that amount was contingent upon there not being any defects in the work, during the stipulated period. It is then, and only then, that the amount can be said to have accrued to the respondent. It is represented by the learned counsel for the respondent that the amount was received by his client in the subsequent assessment year on expiry of the defect free period and that the amount has been brought under the tax. - Decided against revenue.

Summary

Issues:
Interpretation of accrual of income under the mercantile system of accounting.

Detailed Analysis:
The High Court of Andhra Pradesh heard an appeal under Section 260A of the Income Tax Act, 1961, where the Revenue challenged an order passed by the Income Tax Appellate Tribunal. The case involved a Civil Contractor who had a contract with the Hyderabad Municipal Water Supply and Sewerage Board, which included a provision for deduction of 7.5% from each bill. The contractor did not include the 2.5% deduction in their returns for the assessment year 1996-97, arguing that it should only be shown as income when received. The Assessing Officer disagreed, stating that under the mercantile system of accounting, the amount accrued and should be treated as income for that year.

The appellant contended that under the cash system, income is reflected when received, while under the mercantile system, it should be shown in the year it was entered in the books, regardless of actual receipt. The respondent argued that income accrues only when the right to receive it arises. The High Court discussed Section 145 of the Act, which allows the choice between cash and mercantile accounting systems. They cited two landmark Supreme Court judgments, emphasizing that income accrues when the right to receive it is established, regardless of actual receipt.

The Court highlighted the distinction between the right to receive income and the actual receipt, particularly in cases of contingent conditions. In this specific case, the 2.5% deduction was contingent upon the absence of defects during a specified period. The respondent received the amount in a subsequent year after the defect-free period, and it was included in their tax returns. The Court upheld the Tribunal's decision, stating it aligned with Supreme Court precedents, and dismissed the appeal without costs.

Overall, the judgment clarifies the principles of income accrual under the mercantile system, emphasizing the importance of the right to receive income and the timing of accrual based on contractual terms and conditions.