2016 (7) TMI 270 - AT - Income Tax

Disallowance toward provision for loss on contracts - reporting profit on the basis of proportionality as per AS-7 - Held that - It is the profit (or loss) for the relevant year that is to be assessed and brought to tax for that year each year being an independent unit of assessment. The decline in the market price, even where relevant and material, i.e., with reference to the price obtaining as at the year-end, would therefore fall to be considered as and form part of the profit (or loss) of the subsequent year. This also explains the standard prescription for valuing raw material at historical cost (refer AS-2 issued by ICAI). The project/s in the instant case, on the other hand, spread over 2-3 years, and it is on account of this that the loss thereon, the enterprise following percentage completion method (for recognizing income), the profit (or loss) on the entire project, estimating the costs yet to be incurred, is required to be reckoned, booking the same proportionately. AS-7, on the other hand, clearly provide for reporting profit on the basis of proportionality when the project is likely to yield a profit, while booking the loss where not so, and which in the present case, as we understand, has been provided for on a proportionate basis. The reliability of the estimate is indeed very relevant and crucial to the claim for loss, lest any amount could be claimed under the garb of the likely loss, and which brings us to the next aspect of the matter. We uphold the assessee s claim in principle, i.e., qua the provision for loss on contracts likely to arise on its ongoing projects, which though would have to be substantiated. Further, the fact that the assessee did not contest the claim for loss, similarly made, while computing its book profit, though surprising, cannot by itself prevail so as to be regarded as conclusive of the matter, and can at best provide a clue to the Revenue that the assessee s claim with regard to cost escalation/s may require a closer examination, which the AO is even other obliged to, even as to be fair to the assessee the loss stands provided for in the audited accounts, so that it has been subject to both internal as well as external scrutiny. The same though cannot bind the A.O. We decide accordingly. The appeal is accordingly disposed on the above said terms. - Decided in favour of assessee for statistical purposes.

Summary

Issues:
Confirmation of disallowance towards provision for loss on contracts.

Analysis:
The appeal concerns the confirmation of the disallowance towards the provision for loss on contracts made by the assessee in its accounts. The assessee, a domestic company engaged in manufacturing and installation of industrial machinery, changed its accounting system to align with Accounting Standards. The provision for loss was made based on technical assessments of individual projects. The Revenue disputed the claim, citing that the Accounting Standards were notified after the assessee's accounting system change. The Revenue argued that recognizing the estimated loss on uncompleted projects would lead to skewed results. The Revenue also emphasized the need for reliable estimates based on verifiable data. The assessee contended that the provision was made in accordance with the principle of prudence and AS-7, which mandates recognizing expected losses immediately when total costs exceed total revenue.

The Tribunal analyzed the case, highlighting the importance of reliable estimates and the principle of prudence in accounting. It noted that the provision for loss should be made if, based on available information, a project is likely to incur a loss upon completion. The Tribunal emphasized that estimates may change over time as more work is undertaken, necessitating continuous assessment based on available data. The Tribunal rejected the Revenue's reliance on previous judgments, stating that the present case involved different circumstances and principles. It upheld the assessee's claim in principle, subject to substantiation, and suggested a closer examination of cost escalations and contract clauses. The Tribunal concluded that the provision for loss, though not contested by the assessee while computing book profits, requires further scrutiny by the Revenue.

In summary, the Tribunal allowed the assessee's appeal for statistical purposes, acknowledging the validity of the provision for loss on ongoing projects but emphasizing the need for verification and substantiation of estimates. The decision highlighted the importance of reliable data, adherence to accounting standards, and thorough examination of cost-related aspects in assessing provisions for expected losses on contracts.