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1978 (10) TMI 2 - SC - Income TaxContractors who undertake works on behalf of the Government - whether the cost of materials supplied by the Government (M. E. S. Department) for being used in the execution of works is liable to be taken into consideration while estimating the profits of a contractor - since ownership lies with the Government, there is no element of profit in its value.
Issues Involved:
1. Whether the cost of materials supplied by the Government (M.E.S. Department) should be considered while estimating the profits of a contractor. 2. Whether the Income Tax Officer (ITO) made a fair and honest estimate in the best judgment assessment. Detailed Analysis: Issue 1: Cost of Materials Supplied by the Government The primary issue in these appeals was whether the cost of materials supplied by the Government (M.E.S. Department) to contractors should be included in the estimation of the contractor's profits. The facts of the cases were similar, with the assessees being M.E.S. contractors who received materials like cement, coal, and steel from the Government at fixed rates specified in Schedule B of the contract. These materials remained the property of the Government and had to be returned if surplus remained after the contract's completion. The Income Tax Officer (ITO) estimated the cost of these materials at 50% of the cash payments received by the contractors and added this to the total receipts to estimate the profits. The Appellate Assistant Commissioner (AAC) reduced this estimate to 25%, but the Income Tax Appellate Tribunal (ITAT) held that the cost of materials supplied by the Government should not be included while estimating the profits. The Tribunal reasoned that these materials were never sold to the contractor and remained the property of the Government, thus no profit could be said to have arisen from them. The Punjab and Haryana High Court, however, disagreed and held that the cost of materials supplied by the military authorities should be included before applying the flat rate to the contractor's receipts. This decision was challenged in the Supreme Court. Issue 2: Best Judgment Assessment The second issue was whether the ITO made a fair and honest estimate in the best judgment assessment. The Supreme Court reiterated that while making a best judgment assessment, the ITO must make an honest and fair estimate of the income of the assessee. The estimate should not be capricious but should have a reasonable nexus to the available material and the circumstances of the case. The Supreme Court referred to the principles laid down by the Privy Council and previous decisions of the Court, emphasizing that the assessment must be based on some evidence or material and not mere suspicion. Supreme Court's Decision: The Supreme Court held that the cost of materials supplied by the Government should not be included in the estimation of the contractor's profits. The Court noted that the materials supplied by the Government remained its property and were merely handled and used by the contractor. There was no element of profit embedded in these materials. The Court emphasized that the real total value of the contract should be the value minus the cost of such materials supplied by the Government. Therefore, the income or profits derived by the contractor should be determined based on the cash payments received from the Government, exclusive of the cost of the materials supplied. The Supreme Court approved the views taken by the Kerala High Court, Madras High Court, Gujarat High Court, and Andhra Pradesh High Court, which held that the cost of materials supplied by the Government should not be included in the contractor's profits. Conclusion: The appeals were allowed, and the impugned orders of the Punjab and Haryana High Court were set aside. The orders of the Appellate Tribunal were restored, and the revenue was directed to pay the costs of the appeals to the assessee-firms. Appeals Allowed.
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