2020 (5) TMI 375 - AT - Income Tax

Recognition of contract revenue under Accounting Standard (AS) 7 - Construction Contracts - whether the costs and expenses pertaining to O M Phase are includable or not while calculating percentage completion method as per the provisions of AS 7 (accounting standard relating to construction contract)? - HELD THAT - The payment pattern reveals that the assessee has raised separate invoices for O M phase on a regular basis as per Section 5 of TOR Clause 8.3 and the same have been duly accounted in the years in which it has been received. On going through the entire facts of the case, we find that the three different phases of the work which are totally separate in execution. Keeping in view the fact, that the O M phase cannot be a part of the construction activity as the O M phase involves the supply of water to the residence giving connections and monitoring the connections which is clearly a post construction activity, we hold that the amount allotted for O M phase cannot be included in determining the percentage of completion method in recognition of the revenue. The amounts of O M phase have been duly offered to tax in the year of receipts. We also find that the Phase-I and the Phase- II are the preparatory construction phases over a period of 18 months whereas the operations maintenance ( O M phase) of such constructed project is of 60 months. Maintenance activities cannot be clubbed with the construction activity. Having gone through the accounting standards (AS-7 and AS-9 ), we find that application of the standard to separately identifiable components of single contract is allowable while determining the percentage completion of the project. Since, the O M phase commences after the construction of activity of rehabilitation phase, we hereby hold that the amount pertaining to O M phase needs to be separately considered while determining the profits out of the construction activities. C onsideration of VAT for recognizing the revenue under AS-7 - HELD THAT - AO has considered this amount for calculating the revenues of the year. CBDT Circular No. 4 /2008 dated 04.04.2008 clarified that service tax doesn t partake the nature of income. The Circular was issued while dealing with Section 194-I. Since, the sum and substance of the circular is that the service tax doesn t form a part of the income of the assessee, the same need not be considered for calculating the profits of the assessee for the year. Similarly, the Value Added Tax which do not form the part of the income of the assessee also needs to be excluded while determining the revenues of the year in the instant case. As a result, appeal of the assessee on ground is hereby allowed.

Summary

Issues Involved:
1. Short recognition of contract revenue under Accounting Standard (AS) 7.
2. Misapplication of AS 7 to revenue from Operation and Maintenance (O&M) services.
3. Inclusion of Value Added Tax (VAT) and Service Tax in the construction contract value for revenue recognition under AS 7.

Issue-wise Detailed Analysis:

1. Short Recognition of Contract Revenue under AS 7:
The assessee contested the order of the CIT(A) for sustaining the action of the AO, which alleged short recognition of contract revenue under AS 7 by incorrectly treating the 'revised work order value' of ?27,70,60,188 for Project Demo Zone as the 'contract value' instead of the construction contract value of ?21,94,78,821. The AO held that the entire contract value, including the O&M phase, should be considered while calculating the percentage of completion method. The CIT(A) upheld this view, considering the O&M phase as part of the composite contract.

2. Misapplication of AS 7 to Revenue from O&M Services:
The assessee argued that the CIT(A) erred in applying AS 7 to an income/revenue item amounting to ?4,15,26,000 related to O&M services, which should be considered only during the period when the O&M activity actually takes place. The O&M phase, which involves post-construction activities like volumetric billing, collection of payments, and monitoring connections, was argued to be separate from the construction contract. The tribunal examined the terms of the contract and payments made by the Nagpur Municipal Corporation (NMC) to the assessee, finding that the O&M phase is distinct and should not be included in the percentage of completion method for construction activities. The tribunal held that the amount allotted for the O&M phase cannot be included in determining the percentage of completion method in recognition of revenue. The appeal on grounds 2 and 2.1 was allowed.

3. Inclusion of VAT and Service Tax in Construction Contract Value:
The assessee contested the inclusion of amounts aggregating to ?2,68,39,975 towards VAT and Service Tax in the construction contract value for revenue recognition under AS 7. The tribunal referred to CBDT Circular No. 4/2008, which clarified that service tax does not partake the nature of income and should not be considered for calculating profits. Similarly, VAT should also be excluded while determining the revenues of the year. The tribunal allowed the appeal on ground 2.2, excluding VAT and Service Tax from the construction contract value for revenue recognition purposes.

Conclusion:
The tribunal allowed the appeal of the assessee, holding that:
1. The amount related to the O&M phase should not be included in the percentage of completion method for construction activities.
2. VAT and Service Tax should be excluded from the construction contract value for revenue recognition under AS 7.

Order Pronounced in the Open Court on 27/04/2020.