2022 (1) TMI 878 - AT - Income Tax

Disallowance of claim of provision for losses - AO has disallowed the provision made by the assessee on the ground that it is not an actual expenditure and not in conformity with the prudent accounting principles - CIT(A) upholding the disallowance of provision for losses holding the same as contingent in nature even though the provision was made following Accounting Standard - 7 - whether CIT(A) has failed to appreciate that disallowance of provision for losses results in taxability of income which does not exist thereby ignoring the principle of taxability and real income - HELD THAT - Assessee has not given any scientific basis for the provision made either before the Assessing Officer or before the ld. CIT(A) or even before the Tribunal. The main argument of the assessee is that due to various unforeseen events which occurred during the course of project execution, certain unplanned costs had to be incurred by the assessee to complete the project. These costs including significant increases in material, labour and other costs to address these unplanned events, the provision of loss has been created. This is the only submission made before us. The above submission was neither placed before AO nor before the ld. CIT(A). In so far as the above statement is concerned, the ld. Counsel has not explained any basis as to how the material cost and labour cost are increased. Except stating the above, the ld. Counsel for the assessee has not explained any scientific basis for which the assessee is going to incur such huge expenditure as a loss. There is no change in the terms and conditions of the contract entered into and subsequently executed and same amount has been received. The assessee has not placed any material on record to show that any increase in the cost of material and cost of labour and other services to anticipate future loss. Apart from the above, the assessee has not incurred any loss and the assessee gain profit much more in the subsequent years. In fact, the assessee reversed the provision made in this year under consideration in subsequent two financial years. Therefore, the above facts clearly show that there is no basis for the assessee to make the provision and it is only an estimation made by the assessee. Thus estimation of future loss was neither based on any actuarial or any scientific method of determination of its liability and thus, we confirm the orders of authorities below that the losses could not be allowed on a projected basis unless they are actually incurred and verifiable with proper accounting methods. Thus, the ground raised by the assessee stands dismissed.

Summary

Issues Involved:
1. Disallowance of claim of provision for losses.

Detailed Analysis:

Issue 1: Disallowance of claim of provision for losses

The assessee, a company, filed its return of income for the assessment year 2012-13 declaring a total income of ?1,25,40,710/-. During the scrutiny, the Assessing Officer (A.O) noted that the assessee had debited ?12,31,40,818/- to the Profit & Loss (P&L) statement as a provision for losses. The A.O questioned the nature of this provision, emphasizing that it was not an actual expenditure but merely a provision, thus not conforming to prudent accounting principles. Consequently, the A.O disallowed this amount and added it back to the income of the assessee.

On appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] upheld the A.O's decision, stating that the provision was contingent and not an actual expenditure. The CIT(A) noted that the losses claimed were projected and contingent, not actual or verifiable, thus confirming the A.O's disallowance.

The assessee then appealed to the Tribunal, arguing that the provision was made following Accounting Standard-7 (AS-7) due to unforeseen costs incurred during a fixed-price contract for a roofing project at the Mumbai International Airport. The assessee contended that these costs, including significant increases in material and labor, justified the provision for losses. The assessee also cited various judicial precedents and a CBDT circular supporting the provision for known liabilities and losses.

However, the Tribunal found that the assessee did not provide a scientific basis for the provision made. The Tribunal noted that the assessee's main argument was unforeseen events leading to unplanned costs, but no detailed explanation or evidence was provided to substantiate the increased costs. Furthermore, the Tribunal observed that there was no change in the contract terms and no material evidence of increased costs. The Tribunal also highlighted that the assessee had reversed the provision in subsequent years, indicating that the provision was merely an estimation.

The Tribunal reviewed the cited case laws and found them inapplicable to the present case. For instance, in the case of Rotork Controls India Private Limited, the provision for warranty was made using a scientific method and was consistently followed, unlike the present case where no such method was adopted. Similarly, other cited cases, such as Bharat Earth Movers and Woodward Governor India, involved specific liabilities or foreign exchange fluctuations, which were not comparable to the assessee's situation.

Ultimately, the Tribunal upheld the orders of the lower authorities, stating that the losses could not be allowed on a projected basis unless they were actually incurred and verifiable with proper accounting methods. Thus, the appeal filed by the assessee was dismissed.

Conclusion:

The Tribunal dismissed the appeal, confirming that the provision for losses claimed by the assessee was not based on a scientific method or actual incurred losses, and thus, could not be allowed as a legitimate business expenditure. The decision emphasized the necessity for actual and verifiable losses rather than projected or contingent ones.