2015 (10) TMI 181 - AT - Income Tax

Disallowance of foreseeable losses - whether represent ascertained liability - whether these expenses admittedly pertain to period April 2003 to November 2006? - CIT(A) held that the Assessing Officer was wrong in inferring that the assessee has offered income on receipt basis - Held that - There is nothing to disagree with the CIT(A) on this aspect of the matter. Infact, the financial statements of the assessee company. 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 in the case of ITD Cementation India Ltd. (2013 (11) TMI 223 - ITAT MUMBAI) wherein 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. 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 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. 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 writtenback 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 consideration. As a consequence, we hereby affirm the order of the CIT(A) and Revenue fails in its appeal. - Decided against revenue

Issues Involved:
1. Whether the foreseeable losses claimed by the assessee represent ascertained liability or contingent liability.
2. The applicability of Accounting Standard-7 (AS-7) in determining the allowability of the provision for foreseeable losses.
3. The method of accounting followed by the assessee and its impact on the recognition of foreseeable losses.

Detailed Analysis:

1. Foreseeable Losses: Ascertained vs. Contingent Liability

The primary issue revolves around whether the foreseeable losses claimed by the assessee represent an ascertained liability or a contingent liability. The Assessing Officer (AO) disallowed the provision for foreseeable losses, treating it as a contingent liability. The CIT(A) disagreed, holding that the foreseeable losses were not contingent but ascertained liabilities. The CIT(A) referenced the judgment of the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. vs. CIT, which established that expenditure incidental to business is deductible on an accrual basis under the mercantile system of accounting, even if not actually incurred during the relevant assessment year. The Tribunal upheld the CIT(A)'s view, emphasizing that the provision for foreseeable losses was based on a rational estimate and was therefore an allowable deduction.

2. Applicability of AS-7

The Revenue contended that the CIT(A) erred in allowing the relief based on AS-7, arguing that these accounting standards are not notified under Section 145 of the Income-tax Act. However, the Tribunal noted that while AS-7 is not notified by the Central Government, it does not preclude the assessee from following it. AS-7, issued by the Institute of Chartered Accountants of India (ICAI), is considered credible and authentic. The Tribunal cited the case of ITD Cementation India Ltd., where the Mumbai Bench allowed the provision for foreseeable losses under AS-7. The Tribunal concluded that the foreseeable losses of future years could be recognized following the rationale of AS-7, making the provision an allowable deduction.

3. Method of Accounting

The AO inferred that the assessee offered income on a receipt basis, which was challenged by the CIT(A). The CIT(A) recorded that the assessee followed the mercantile system of accounting and recognized income from contracts on a percentage of completion method. The Tribunal agreed with the CIT(A), noting that the financial statements of the assessee confirmed the mercantile system of accounting. The Tribunal further referenced the case of Mazagon Dock Ltd., where the Tribunal held that the estimated loss under a fixed price contract was an allowable deduction. The Tribunal also considered the working of the provision made by the assessee, which was based on the maintenance expense rates issued by the PWD, Government of Maharashtra. The Tribunal found the provision reasonable and justified, as it was benchmarked against PWD notified rates.

Conclusion:

The Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s order that the provision for foreseeable losses was not a contingent liability and was allowable as a deduction while computing business income for the year under consideration. The Tribunal emphasized the rational basis of the estimate and the adherence to AS-7, supporting the assessee's claim for the provision for foreseeable losses.

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