2006 (1) TMI 77 - HC - Income Tax

Accural of Income - on the date when the bills were submitted, having regard to the nature of the contract, no enforceable liability has accrued or arisen and, accordingly, it cannot be said that the assessee had any right to receive the entire amount on the completion of the work or on the submission of bills. The assessee had no right to claim any part of the retention money till the verification of satisfactory execution of the contract - Tribunal was right in holding that moneys retained by the contractee, as a percentage of the bills raised to be paid after the contract is completed is to be treated as income only when the moneys are actually received, even though the appellant is following mercantile system of accounting

Summary

Issues: Interpretation of the treatment of retention money in income tax assessment under the mercantile system of accounting.

Analysis:
The High Court of Madras addressed the issue of whether retention money retained by a contractee, to be paid after contract completion, should be treated as income when billed or when actually received, considering the mercantile system of accounting. The assessee, a construction company, had 10% of contract amounts retained as retention money. The Assessing Officer included this retention money in total income, stating that under the mercantile system, accrued income is taxable even if not received. The Commissioner of Income-tax (Appeals) upheld this decision. However, the Income-tax Appellate Tribunal ruled in favor of the assessee, stating that retention money accrues only after contract completion and should not be included in total income until then.

The Revenue argued that retention money accrues upon completion of work and billing, following the mercantile system of accounting. They contended that under this system, amounts accrued, regardless of receipt, should be treated as income. On the other hand, the respondent argued that retention money is only realized upon customer satisfaction with completed work, thus should be taxed on a receipt basis. The High Court noted that the retention money is payable only after contract completion and inspection, and the assessee has no enforceable right until then. Referring to a similar case, the Court emphasized that no enforceable liability arises until the customer is satisfied, supporting taxation on a receipt basis.

Considering the precedents and the specific circumstances of the case, the High Court agreed with the Tribunal's decision. They found no error in the Tribunal's order and dismissed the tax cases in favor of the assessee, against the Revenue. The Court's decision aligned with the principle that retention money should be taxed only upon actual receipt, based on the completion and satisfaction of the contract terms.