2023 (4) TMI 519 - AT - Income Tax

Disallowance of Provision for foreseeable loss - Claim was made as per Accounting Standard 7 relating to Construction Contracts - AO held it to be a contingent liability and accordingly disallowed the claim - CIT(A) also confirmed the disallowance - HELD THAT - When the onshore supply portion of the revenue in the contract was fixed at Rs.44.56 crores, the assessee would have estimated the cost lesser than the above said revenue. However, the cost has been claimed to have been escalated to Rs.110.39 crores within a period of 18 months, which is almost 300%. The claim that the cost has escalated by 300% within a period of eighteen months is unheard and accordingly, shall raise doubt in the minds of any prudent person, though it may be probable also. Accordingly, it is the obligation of the assessee to explain before the AO as to how the cost has escalated by 300% from the original estimate. The burden of the assessee is further increased on the reason that the contract has been obtained by the assessee from its promoter, a related concern. As noticed earlier, there was no occasion for the AO to examine these factual aspects, as he had disallowed the claim holding it as contingent liability. This issue needs to be restored to the file of AO for examining the computation of the loss claimed by the assessee. Accordingly, we restore this issue to the file of the AO with the direction to examine the claim of the assessee by calling for the relevant details. Appeal filed by the assessee is treated as allowed for statistical purposes.

Issues Involved:
1. Disallowance of "Provision for foreseeable loss" claimed by the assessee.
2. Applicability and adherence to Accounting Standard 7 (AS-7).
3. Examination of the claim on merits and the escalation of costs.

Detailed Analysis:

Disallowance of "Provision for Foreseeable Loss":
The core issue in this case is the disallowance of the "Provision for foreseeable loss" amounting to Rs. 45.83 crores claimed by the assessee for the assessment year 2010-11. The assessee, a joint venture engaged in the manufacture of supercritical steam turbines and generators, had entered into a contract for supply of turbines. During the financial year 2009-10, the assessee estimated a loss from the onshore supply portion of the contract, which was offset by savings in the offshore supply portion, leading to the provision for a foreseeable loss. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] disallowed this provision, categorizing it as a contingent liability.

Applicability and Adherence to Accounting Standard 7 (AS-7):
The assessee argued that the provision for foreseeable loss was made in compliance with AS-7, which mandates recognizing expected losses immediately when it is probable that total contract costs will exceed total contract revenue. The relevant provisions of AS-7 were cited, emphasizing that such losses should be recognized irrespective of the stage of completion of the contract or the commencement of work. The Tribunal referred to several precedents where similar claims were allowed based on AS-7, such as:
- Mazgaon Dock Ltd vs. JCIT
- Jacobs Engineering India P Ltd vs. ACIT
- Dredging International N V vs. ADIT
- ACIT vs. ITD Cementation India Ltd

The Tribunal highlighted that the principle of prudence under AS-1 also supports the recognition of expected losses. It was noted that the Tribunal in previous cases consistently held that the deduction of expected loss is required to be provided for in the books of accounts and is allowable as a deduction.

Examination of the Claim on Merits and the Escalation of Costs:
Despite acknowledging the principle of recognizing foreseeable losses, the Tribunal found that the AO had not examined the claim on its merits, as the disallowance was based on the classification of the loss as contingent. The Tribunal observed several critical points requiring further examination:
- The assessee obtained the contract from a related concern, necessitating a thorough examination of the transactions.
- The contract revenue for the onshore supply was initially fixed at Rs. 44.56 crores, but the cost escalated to Rs. 110.39 crores within 18 months, leading to a visualized loss of Rs. 65.83 crores.
- The escalation of costs by approximately 300% within a short period raised doubts, necessitating a detailed explanation from the assessee.

The Tribunal directed the AO to re-examine the computation of the loss claimed by the assessee, considering the relevant details and explanations. The matter was restored to the AO for a fresh assessment, ensuring that the claim is scrutinized based on the actual facts and adherence to the applicable accounting standards.

Conclusion:
The appeal filed by the assessee was allowed for statistical purposes, with the Tribunal directing a re-examination of the claim by the AO. The Tribunal emphasized the need for a detailed scrutiny of the cost escalation and the transactions with the related concern, ensuring compliance with AS-7 and the principles of prudence under AS-1. The order by the CIT(A) was modified accordingly, and the AO was instructed to take an appropriate decision based on the reassessment.

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