2023 (1) TMI 177 - HC - Income Tax

Provision for estimated loss on contracts - Allowable business expenditure under Section 37 - as per assessee provision for estimated loss on contracts is created on a scientific basis in accordance with the Accounting Standard (AS) 7 and as such it is an ascertained liability allowable as deduction under Section 37 - appellant had claimed the aforesaid estimated loss on the strength of Accounting Standards (AS) 7 of the Institute of Chartered Accountants - whether the provision made by the appellant in its books of account regarding the estimated loss on the ongoing project can be allowed or not by applying Paras 21 and 35 of the Accounting Standard (AS) 7? - HELD THAT - The appellant has not explained how the total contract costs will exceed total contract revenue despite being specifically asked to explain. The appellant has neither explained the same before the lower authority nor before the first appellate authority nor before the Income Tax Appellate Tribunal. The only explanation that was given by the appellant before the Assessing Officer in its reply dated 24.02.2015 before the Assessment Order was passed u/s 143(3) of the Income Tax Act, 1961 on 24.03.2015, was a mere reiteration of the contents of paragraph 21 of Accounting Standard (AS) 7 which has been extracted above. No further explanation has been given by the appellant. A reading of paragraph 5 of the order passed by the Appellate Commissioner also indicates that the appellant has not demonstrated its case despite specific opportunity being given and has merely relied on the Judgments settling the substantial questions of law. Barring reference to Accounting Standard (AS) 7 for recognition of estimated loss there is no explanation on the facts by the appellant. Therefore, the decisions allowing deductions in the peculiar facts of the case cited by the Hon ble Supreme Court in Rotork Controls India (P) Ltd. 2009 (5) TMI 16 - SUPREME COURT as held therein would not come to the rescue of the appellant. In the light of the above discussion, the substantial questions of law is answered against the appellant. We therefore, do not find any merits in the above appeal filed by the appellant. The appeal filed by the appellant therefore is liable to be dismissed.

Summary

Issues Involved:

1. Allowability of provision for estimated loss on contracts as a business expenditure under Section 37 of the Income Tax Act.
2. Applicability of Accounting Standard (AS) 7 for recognizing estimated loss as an ascertained liability.
3. Consistency in following the Tribunal's own order from a previous assessment year.
4. Consideration of alternative ground regarding deduction of reversal/utilization of such provisions in subsequent years.

Issue-Wise Detailed Analysis:

1. Allowability of Provision for Estimated Loss on Contracts as a Business Expenditure under Section 37 of the Act:

The appellant claimed an estimated loss of Rs.1,14,45,495/- as a permissible deduction under Section 37 of the Income Tax Act, which was disallowed by the Assessing Officer. The Tribunal upheld this decision, stating that the provision made by the appellant was not an ascertained liability but a simple provision, which is not allowable under Section 37. The Tribunal emphasized that the appellant failed to substantiate the necessity of the provision and did not provide sufficient material to demonstrate that the liability was ascertained.

2. Applicability of Accounting Standard (AS) 7 for Recognizing Estimated Loss as an Ascertained Liability:

The appellant relied on Accounting Standard (AS) 7, which stipulates that an expected loss on a construction contract should be recognized as an expense immediately. However, the Assessing Officer and the Tribunal held that Accounting Standards are binding for the preparation of books but not for Income Tax purposes. The Tribunal noted that the appellant did not demonstrate how the provision for estimated loss was an ascertained liability as per AS-7, and merely quoting the standard without factual substantiation was insufficient.

3. Consistency in Following the Tribunal's Own Order from a Previous Assessment Year:

The appellant argued that the Tribunal should follow its own order from the assessment year 2005-06, where a similar issue was remitted back to the Assessing Officer. However, the Tribunal distinguished the current case from the previous one, noting that the earlier case dealt with a provision for warranty, not an estimated loss on contracts. Therefore, the Tribunal decided not to remit the matter back to the Assessing Officer.

4. Consideration of Alternative Ground Regarding Deduction of Reversal/Utilization of Such Provisions in Subsequent Years:

The appellant contended that if the provision for estimated loss on contracts is disallowed in the year of creation, the reversal/utilization of such provisions should be allowed as a deduction in the years of reversal/utilization. The Tribunal did not explicitly address this alternative ground in the judgment. However, it was noted that the appellant could claim deduction on the actual loss incurred during succeeding financial years, subject to the right to reopen the assessment in accordance with law.

Conclusion:

The High Court dismissed the appeal, affirming the decisions of the Assessing Officer, Appellate Commissioner, and the Tribunal. The Court concluded that the appellant failed to demonstrate that the provision for estimated loss was an ascertained liability. The Court also clarified that while Accounting Standards may guide financial reporting, they do not override the provisions of the Income Tax Act. The appellant was advised to claim deductions for actual losses incurred in subsequent years, subject to the legal provisions for reopening assessments.