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TMI Blog2005 (9) TMI 235X X X X Extracts X X X X X X X X Extracts X X X X ..... direct materials consumed in each of the contract is charged to the respective contract by way of works billing. The direct labour costs incurred on each contract are charged by way of hourly rates depending on the labour mix for each of the contract on the basis of time sheets maintained at the factory at standard rate. Various standard materials purchased and consumed at the site of installations are charged to the said contract directly on the basis of the expense vouchers prepared by the various sites and/or the regional offices. 4. In addition to the aforesaid direct expenses/costs, various indirect costs namely, salaries and wages, freight and forwarding, insurance charges, sales cost, commission payable to the business agents on the respective contracts, if any, excise duty paid/incurred at the time of removal of goods from the factory to the sites of installation, octroi duty, free OTIS services, administrative burden, etc., are allocated to the various contracts that executed during the year. However, the expenses like interest, bad debts/advances written off and provisions for doubtful debts and advances are not allocated between contracts since these are not items of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceding year to the losses provided for the loss-making contracts, the same were reversed only to the extent of the contracts which are still in progress as at the end of this previous year by a set of journal entries in the books of account in this year. Once again losses incurred on the loss-making contracts as at the end of this year are provided for at the end of this year by another set of journal entries. This is other words means the profit and loss account is charged only to the extent of fresh losses incurred on loss-making contracts during this previous year. (ii) As regards the contracts which were closed during the year and for which losses were provided up to the end of the preceding year, the same were reversed in order to arrive at the actual cost of the contract and sales are also taken into the revenues of the year and this is accounted by a set of journal entries. This is in other words mean profit and loss is charged only with the amounts of fresh losses incurred during the previous year while accounting for the entire sales value. This is how it is reflected by the term 'losses reversed on completion' in Annexure-A to our letter dated March 19, 1993. Though app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fits or losses could be said to accrue by unilateral transaction such as valuation of closing stock. It was also observed that loss claimed by the assessee was merely provisions in the book since such loss is reversed in the next year. In view of these observations, he held that such loss on incomplete contracts could not be allowed. 11. On appeal, the learned CIT (Appeals) allowed the loss by observing as under:- "13. In the appellant's case, it cannot be denied that the incomplete contracts have been executed by way of payment or receipt of goods during the year. The work-in-progress of incomplete contracts cannot also be regarded under the Income-tax Act as anything else apart from stock-in-trade. It is also true that the provisions for loss is based on valuation of such stock-in-trade at market price, which is lower than the cost. The contention of the Assessing Officer that such a loss cannot be allowed as work-in-progress (stock-in-trade) of incomplete contracts cannot be taken into account for computation of profit under computed contract method is in my opinion a criticism of the accounting standard only. Such is also the view of Board of Inland Revenue (U.K.) as it wil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th by the Hon'ble Bombay High Court in the case of Taparia Toob Ltd. v. Jt. CIT [2003] 260 ITR 102. According to him, the expenditure must match with the income. Therefore, expenditure incurred cannot be allowed as deduction unless matched with the connected income. Since the assessee had not shown any income by way of receipts, the question of allowing any loss does not arise. Proceeding further, he drew our attention to escalation clause in the contract and submitted that loss claimed was contingent or premature till the escalation price is received by the assessee. Accordingly, it was pleaded by him that order of the Assessing Officer may be restored. 13. On the other hand, the learned counsel for the assessee has vehemently supported the order of the learned CIT (Appeals). According to him, the assessee is entitled to adopt any of the methods of accounting. It was further submitted that the assessee had been maintaining such method of accounting since decades and consistently being followed and also accepted by the department. Therefore, the Assessing Officer could not deviate from such method from disallowing the losses. Reliance was placed on Bombay High Court judgment in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The answer to this question would depend on the interpretation of the provisions of section 145 of the Act, which gives option to assessee to adopt any method of accounting. Section 145 as applicable to the years under consideration, reads as under:- "145. Method of accounting.-(1) Income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee: Provided that in any case where the accounts are correct and complete to the satisfaction of the Assessing Officer but the method employed is such that, in the opinion of the Assessing Officer, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Assessing Officer may determine: Provided further that where no method of accounting is regularly employed by the assessee, any income by way of interest on securities shall be chargeable to tax as the income of the previous year in which such interest is due to the assessee: Provided also that nothing contained in this sub-section shall preclude an assessee from being charg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e mercantile system of accounting for debiting interest to the accounts of the parties and crediting the same to the profit and loss account, no fault as such can be found with the system followed by the assessee. The only power the Income-tax Officer has in such cases is the power under the proviso to section 145(1) of the Act which permits him, on being satisfied that the method employed by the assessee is such that his income cannot be properly deduced therefrom, to compute his income upon such basis and in such a manner as he may determine. Evidently this is not a case falling under the proviso to section 145(1) in view of the categorical finding of the Tribunal in this regard. Besides, the Income-tax Officer himself has been accepting this system which had been followed by the assessee throughout in the past as a proper method of accounting and profits had in fact been determined on the basis thereof in the past as well as in two of the three assessment years under consideration. The fact that the assessee, for its convenience, kept a separate note of all those parties in whose case the mercantile system of accounting had not been followed and the interest on the amounts due f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be mercantile or cash basis or even Hybrid System of accounting. However, if the system followed by assessee does not show the true picture of profits of business carried on by assessee then certainly, Assessing Officer can invoke the provisions of the proviso to section 145 though such powers are to be exercised judiciously. 20. In the above backdrop, let us examine the system followed by the assessee. Assessee being a contractor can adopt either percentage completion method or contract completion method, which are duly recognized by the Institute of Chartered Accountants. It can also employ any other method provided which shows true profits of its business. In the present case, the assessee has adopted contract completion method in general. According to this method, the assessee goes on accumulating the expenditure year after year in respect of each contract and the contract price is credited in the year in which contract is completed and the d resultant profit is shown in the books in that year. However, there is an exception to such system of accounting. In some cases, where, during the pendency of contract, the expenditure incurred exceeds the contracted price, the excess am ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ------- ---------- 20,70,000 20,70,000 ----------------------------------------------------- Year IV - P L A/c ----------------------------------------------------- Rs. Rs. To Opening 20,30,000 By Sales A/c 20,30,000 Balance To Raw Material 5,000 By Losses on To Direct Labour 5,000 completed 20,000 To Direct contracts Overheads 5,000 To Indirect 5,000 Overheads ---------- ---------- 20,50,000 20,70,000 ----------------------------------------------------- 22. The reasoning given by assessee in adopting the above system is that contract price is fixed and, therefore, where the expenditure incurred already exceeds the realizable price, the losses are incurred which are ascertained and, therefore, can be booked to Profit Loss Account. Therefore, the assessee is entitled to set off the same against profits of business of that year. However, where expenditure incurred is less than the realiz ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly recognized by the Apex Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1. Therefore, we hold that system of accounting employed by assessee consistently since decades cannot be rejected. 26. Before parting with this order, we may mention that judgment of Hon'ble Supreme Court in the case of Chainrup Sampatram relied upon by the assessee's counsel, in support of the proposition that closing stock is to be valued at cost or market price, cannot be applied in the case of contractor. Such method is applicable only where the closing stock is sold as a trader or manufacturer since profits are to be determined on year to year basis in respect of sales affected by the assessee during the year. When the assessee, as a contractor, chooses the completion method, the question of valuing the stock does not arise since work-in-progress is to be computed on the basis of accumulated expenditure. Hence, such contention of the assessee is rejected. 27. In view of the above discussions, the issue is decided in favour of the assessee. The orders of the learned CIT (Appeals) are, therefore, upheld on this issue. 28. The next common issue pertaining to assessment years 1990-91 to 19 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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