2024 (9) TMI 479 - AT - Income Tax

Disallowance of provision for contract losses - CIT(A) and AO erred in concluding that the provision for anticipated loss is an unascertained liability not allowable as a deduction u/s 37 - as argued provision represents the excess of estimated contract expenditure over the estimated contract revenues - HELD THAT - The provision of this year would be nothing but an ascertained liability / probable loss for the assessee. It could not be said that the provision was not made on a scientific basis. In our considered opinion, both the lower authorities have erred in appreciating the fact that revenue from the contract has also been recognized on percentage of completion basis only. The case laws as cited by Ld. AR duly support our view. The case law of FLSmidth v DCIT 2023 (1) TMI 177 - MADRAS HIGH COURT is distinguishable on facts. Upon perusal of Para-28, it is clear that in that case the assessee could not explain as to how the total contract costs would exceed total contract revenue despite being specifically asked to explain. The assessee merely relied on AS-7. However, in the present case, the assessee has recognized the revenue as well as expenses on same methodology. The claim is supported by computations / workings. The provision has been reversed in subsequent years as per estimation made in subsequent year. Therefore, this case law would not render any assistance to the case of the revenue. The case law of Hon'ble Delhi High Court in Triveni Engg Industries Ltd 2010 (11) TMI 90 - DELHI HIGH COURT is on similar facts. The assessee recognized the income from the projects and also made provision for expenses to be incurred up-to the stage of completion. AO termed the provision as contingent liability and accordingly, disallowed the same. However, Hon ble Court confirmed the order of Tribunal allowing such deduction. Therefore, we would hold that the impugned provision would be an allowable deduction. The question of adding the same to Book-Profit do not arise. Assessee appeal allowed.

Summary

Issues:
Assessment of provision for contract losses under section 37 of the Income Tax Act, disallowance of provision for expected loss under section 115JB, recognition of provision as a contingent liability, applicability of Accounting Standard - 7, and potential double taxation due to disallowance of provision.

Analysis:

Assessment Proceedings:
The appellant, a corporate assessee engaged in dredging services, claimed a provision for expected losses on a contract. The Assessing Officer disallowed the provision as the basis was not furnished. The provision was disallowed under normal provisions and while computing Book Profits u/s 115JB.

Appellate Proceedings:
During the appellate proceedings, the appellant submitted that the provision was made as per Accounting Standard-7 (AS-7) and was based on the percentage of completion method. The CIT(A) considered the provision as a contingent liability, citing precedents. The CIT(A) held that the provision was unascertained and contingent, not qualifying as expenditure under the IT Act. The disallowance was upheld, leading to further appeal.

Findings and Adjudication:
The appellant provided detailed financial statements and explained the methodology used for recognizing losses on the project. The appellant followed AS-7, recognizing losses immediately when total costs exceed total revenue. The appellant incurred an actual loss during the year and made a provision for the expected balance loss. The provision was reversed in subsequent years. The Tribunal found that the provision was an ascertained liability and not contingent. The revenue and expenses were recognized based on the percentage of completion method. Precedents were cited to support the deduction of the provision. The Tribunal allowed the appeal, stating that the provision was an allowable deduction, and there was no need to add it to Book Profits.

In conclusion, the Tribunal allowed the appeal, emphasizing that the provision for contract losses was a legitimate deduction, supported by accounting standards and recognized revenue and expenses. The judgment highlighted the importance of recognizing liabilities based on reasonable estimations and following accounting principles.