A CONSTRUCTION CO. PVT. LTD. v. INCOME TAX OFFICER
[Citation -1986-LL-0807-4]

Citation 1986-LL-0807-4
Appellant Name A CONSTRUCTION CO. PVT. LTD.
Respondent Name INCOME TAX OFFICER
Court ITAT
Relevant Act Income-tax
Date of Order 07/08/1986
Assessment Year 1982-83
Judgment View Judgment
Keyword Tags manufacture or production • business of construction • private limited company • industrial undertaking • system of accounting • investment allowance • method of accounting • plant and machinery • accounting standard • industrial company • accounting method • contract business • foreign exchange • work in progress • contract work • notional loss • special bench • rate of tax
Bot Summary: The business consists of undertaking contracts in respect of constructing buildings and during the year it also undertook work of affluent channel project for CIDC. It is the claim of the assessee that it has prepared the accounts on the basis of standard accounting practices and has followed the recognised method of accounting in respect of the contract work. Two methods of accounting for contracts commonly followed by contractors are the percentage of completion method and the completed contract method. Under the completed contract method, revenue is recognised only when the contract is completed or substantially completed, that is, when only minor work is expected other than warrantly obligation. In the case of fixed price contracts, this degree of reliability could be provided if the following conditions are satisfied: total contract revenues to be received can be reliably estimated, both the costs to complete the contract and the stage of contract performance completed at the reporting date can be reasonably estimated, and the costs attributable to the contract can be clearly identified so that actual experience can be compared with prior estimates. Profit in the case of fixed price contracts, normally should not be recognised unless the work on a contract has progressed to a reasonable extent. The costs included in amount at which construction contract work is stated should comprise those costs that relate directly to a specific contract activity in general and can be allocated to specific contracts. The above usual methods and approach are emerging from the clear nature of the business of the contracts with regard to construction especially because the property does not pass unless and until the contract is over of project is completed depending upon the terms of the contract.


grounds raised in this appeal are as under: ld. CIT erred in reopening assessment under s. 263 and setting aside order of ld. ITO. ld. CIT erred in fact and in law in holding that company is not industrial company as decided by ld. ITO and in directing ITO to recompute tax accordingly. ld. CIT erred in fact and in law in rejecting method of accounting followed by your appellant in ascertaining profit and loss on incomplete contracts according to standard accounting bodies for such business and in setting aside order of ITO accepting said method and in directing ITO to revise income of assessee on such basis. assessee is private limited company registered on 31st March, 1980 under Companies Act, 1956. first accounting year of company ended on 30th June, 1983. business consists of undertaking contracts in respect of constructing buildings and during year it also undertook work of affluent channel project for CIDC. It is claim of assessee that it has prepared accounts on basis of standard accounting practices and has followed recognised method of accounting in respect of contract work. After going into details in respect of various accounting practices that should be followed in respect of contract job undertaken by assessee, it was submitted, ITO completed assessment. CIT invoked jurisdiction under s. 263 of IT Act on following two grounds mentioned in notice issued by him: assessee company was engaged mainly in construction work. It is not engaged in manufacturing activities, and so it was not Industrial Company but ITO erroneously treated same as Industrial Company. From P & L A/c, and material available on record it is seen that receipt of Rs. 11,78,950 were not included in certified work A/c as per R.A. Bills on ground that same were provision for contingencies. provisions for contingencies are not permissible deduction. assessee-company represented that work of construction of buildings, roads, dams, etc. is included in term manufacturing and processing of goods and therefore, company was industrial company, in respect of ground No. 2 various details submitted to ITO were brought to his notice. In short, it was claimed that there was not question of any deduction not question of deduction in respect of provision for contingency, receipt of Rs. 11,78,950 was not taken into consideration because assessee had followed system of accounting recognised by accountants all over world in respect of contract business because of peculiar features of business and in support various authorities from various books were cited before him. Commissioner, however, rejected both contentions. In respect of first ground relying upon in case of CIT vs. . Shan Constructions Co. Ltd. (1982) 30 CTR (Bom) 245: (1983) ITR 142 ITR 692 (Bom) he held that assessee- company could not be said to be company which is either wholly or mainly engaged in manufacturing or processing of goods. In respect of second ground relevant portion of his order is extracted below: "Regarding non-inclusion of receipt of Rs. 11,68,960 assessee s main contention is that as construction work is not completed so estimate of probable loss in profitability may be claimed. Assessee s contention is not acceptable because loss which is not computed during year, cannot be allowed as deduction. commentaries on which reliance is placed by assessee, are opinion in respect of percentage of profit to be arrived at, in case of uncompleted work. in case of assessee, assessee is claiming anticipatory loss which has not accrued during year of account. Madras High Court in recent case of CIT vs. . Indian Overseas Bank (1984) 41 CTR (Mad) 212, had occasion to examine allowability of loss in contract due to anticipated fluctuation in foreign exchange rate. Their Lordships in that case in CIT vs. . Indian Overseas Bank (1984) 41 CTR (Mad) 212 at 216 observed as under: "On facts, we have to find that amount claimed by assessee represented deduction in notional value of outstanding foreign exchange contracts which were yet to be settled and, therefore, it is only notional loss that is claimed by assessee. It outstanding contracts wee determined by parties, as per terms of contract by either of parties, it will stand on different footing. Then loss or profit accruing or arising on such foreign exchange contracts will come into computation of profits for that year. But where contract has not yet been settled whether contracts actually resulted in profit or loss can not be known during assessment year. We do not see how assessee could claim said amount as loss actually arisen during accounting year. above observations of Hon ble Madras High Court have decided issue that loss which is not known during year of account cannot be allowed as deduction." Before us, ld. counsel for assessee after submitting paper book containing 59 pages reiterated submissions made before authorities below and in respect of rate of tax required to be adopted it was fairly conceded that certain factual aspects of nature of business of assessee company were not properly brought to notice of authority below and unnecessarily assessee took stand that construction of building etc. could be said to be manufacturing activity etc. Highlighting aspects of nature of business of assessee it was submitted that it was also manufacturing bricks, steel windows, doors etc. In support of this contention some evidence was laid. Bringing to our notice ground on which notice under s. 263 was issued it was submitted that Commissioner s objection was with regard to company not being engaged in manufacturing activity and in fact considering evidence laid before us company was certainly engaged in manufacturing activity. In respect of ground No. 2 grievance was raised stating that detailed material and notice were submitted to CIT and it appeared that probably mind was not applied to material laid before him. It is never case of assessee that any deduction was sought for in respect of any liability or provision but it has always been case of assessee that it followed recognised method of accounting and in support of contention notes from various books of accountancy were submitted together with illustrations based on various methods that could be adopted in respect of illustrations based on various methods that could be adopted in respect of contract business. Commissioner has not at all appreciated issue involved and therefore, obviously did not rebut material laid before him or material was such that there cannot be any opinion other than that arrived at by assessee because assessee adopted accounting system as per standard books of accounting accepted all over world. case relied upon by Commissioner has no bearing to issue involved here and it was commented that it was not proper to apply any decision of High Court to any facts so as to arrive at desired conclusion. It was further submitted that CIT had probably no time to took into material submitted and that is why decision of Madras High Court which was dehors issue was simply applied. ld. Department representative submitted that assessee constructed certain factory sheds and construction was main activity and manufacturing of doors etc. was only subsidiary activity. Therefore, decision in case of Shan Construction Co. Ltd. (supra) was rightly applied. With regard to manufacturing of brick and steel windows and doors, etc. ITO did not go into details and it was fresh evidence. Even if same is there ultimate use was required to be seen. With regard tot he receipts it was submitted that some tenements were completed and profit in respect of which was not included either in work in progress or in accounts. We have gone through materials placed before us to which our attention was drawn. In our opinion, there is no error in order passed by ITO and therefore, jurisdiction under s. 263 was not legally invoked. reasons are as follows: "From copy of assessment order placed before us we notice that ITO has not given any finding with regard to method of accounting. Therefore, initially while perusing records of assessment inquiry should have been made as to why such finding is not given. Had it been done so probably sand taken by Commissioner in respect of receipts would not have been basis for invoking jurisdiction under s. 263". In respect of ground No. 1 we find from assessment order passed by ITO that he has allowed investment allowance of Rs. 87,803 while computing income of assessee. No grievance is raised by CIT in respect of this particular aspect of deduction claimed by assessee and granted by ITO. Sub-cl. (iii) of cl. (b) of sub-s. (2) of s. 32A of IT Act allows investment allowance in respect of machinery or plant installed in any industrial undertaking for purpose of business of construction, manufacture or production of article or thing. test required to be satisfied for purpose of grant of investment allowance is more severe than one required for purpose of claim as industrial company for purpose of lower rate of tax. Therefore, it can safely be concluded for purpose of revisional jurisdiction that once assessee is granted investment allowance in respect of plant and machinery engaged in same business it cannot be said that assessee is not engaged in business of manufacturing activity or processing of goods while deciding upon status of assessee-company. Further issue involved, in our opinion, is also covered by decision of Special Bench of Tribunal in case of CIT vs. . Hydel Construction Pvt. Ltd. (1984) 41 CTR (Trib) 17 (Del) SB: (1984) 20 TTJ (Del) 578: (1983) 6 ITD 575 (Del) (SB). Coming to aspect regarding provisions for contingency, we are in agreement with assessee that issue is not concerned with claim of any deduction but it springs from nature of method of accounting followed by assessee. decision relied upon by CIT is distinguishable on facts though in printed accounts of company receipts are shown as provision for contingency on liability side of balance-sheet. In fact, same is because of method of showing income in respect of contract business and therefore, part and parcel of method of accounting rather than independent provision, Since ITO has considered this aspect and allowed deduction accordingly, there is no error. Even on merits, we accept stand taken on behalf of assessee that assessee has followed standard accounting method and this being first year of business it was sole choice of assessee to adopt particular method of accounting contemplated under s. 145 of Act. Certain extracts from text of accounting Standard 7 (AS 7) issued by Institute of Chartered Accountants of India on accounting for construction contracts would be not only decisive of issue but educative to some extent. Para 7 of text runs as under: "Accounting Treatment of Construction Contract Costs and Revenue. Two methods of accounting for contracts commonly followed by contractors are percentage of completion method and completed contract method. Under percentage of completion method revenue is recognised as contract activity progresses based on stage of completion reached. costs incurred in reaching stage of completion are matched with this revenue, resulting in reporting of results which can be attributed to proportion of work completed. Although (as per principle of prudence) revenue is recognised only when realised, under this method, Revenue is recognised as activity progress even though in certain circumstances it may not be realised. Under completed contract method, revenue is recognised only when contract is completed or substantially completed, that is, when only minor work is expected other than warrantly obligation. Costs and progress payments received are accumulated during course of contract but revenue is not recognised until contract activity is substantially completed. Under both methods, provision is made for losses for stage of completion reached on contract. In addition, provision is usually made for losses on reminder of contract." Para 17 of same text gives following guide lines: percentage of completion method can be used if customs of contract can be reliable estimated. In case of fixed price contracts, this degree of reliability could be provided if following conditions are satisfied: (i) total contract revenues to be received can be reliably estimated, (ii) both costs to complete contract and stage of contract performance completed at reporting date can be reasonably estimated, and (iii) costs attributable to contract can be clearly identified so that actual experience can be compared with prior estimates. Profit in case of fixed price contracts, normally should not be recognised unless work on contract has progressed to reasonable extent. In case of cost plus contracts, this degree of reliability would be provided only if both following conditions are satisfied: (i) costs attributable to contract can be clearly identified, and (ii) costs other those that are specifically estimated. While recognising profit under percentage of completion method, appropriate allowance for further unforeseeable factors should be made on either specific or percentage basis. costs included in amount at which construction contract work is stated should comprise those costs that relate directly to specific contract activity in general and can be allocated to specific contracts. foreseeable loss on entire contract should be provided for financial statements irrespective of amount of work done and method of accounting followed." above usual methods and approach are emerging from clear nature of business of contracts with regard to construction especially because property does not pass unless and until contract is over of project is completed depending upon terms of contract. This aspect of such business distinguishes transactions of sale of goods etc. profit i n which is instantly recorded form those of amounts received in advance pending completion of project of contract which may or may not include or involve element of profit. We therefore, set aside order passed by CIT under s.263 of IT Act. In result, appeal is allowed. *** CONSTRUCTION CO. PVT. LTD. v. INCOME TAX OFFICER
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