JUDGMENT judgment of court was delivered by N. Kumar J.-This appeal is preferred by assessee challenging order passed by lower authorities disallowing its claim for expenditure under section 37(1) of Income-tax Act, 1961. assessee-company was awarded contract by Madhya Pradesh Electricity Board (for short "the MPEB") for rehabilitation job for Amarkantak Thermal Power Station near Jabalpur in Madhya Pradesh. amount of Rs. 9,29,20,000 was paid as advance. assessee gave bank guarantee for said amount. assessee commenced work and incurred expenditure on project. total amount of expenditure incurred on project is Rs. 6,64,01,149. case of assessee is, MPEB arbitrarily terminated contract and invoked bank guarantee. said contract was terminated by letter dated October 8, 2002. assessee invoked arbitration clause and put forth claim. amount of Rs. 6,64,01,149 included money spent on raw materials like tubes and pressure parts, consumables, freight and carriage and also bank charges, professional charges, etc., in addition to expenses on personnel, transport and communication and administrative expenses. However, more than 50 per cent. of total amount was debited towards material consumed for contract work. assessee debited said amount being cost of abandoned project towards profit and loss account. In notes appended, it is stated that said amount has been charged as expenditure on abandoned project. assessee also mentioned that assessee has contested invocation of bank guarantee by MPEB before court of Jabalpur. On date of assessment order arbitration award also had been passed on September 23, 2004, under which assessee was granted substantial damages for illegal invocation of bank guarantee, cancellation of contract, etc. However, no amount has been paid by MPEB in terms of award as they were contesting award in appeal before court of Jabalpur. assessing authority was of view that assessee has been following mercantile method of accounting. As and when any expenditure is incurred on contract, it should either result in corresponding receipts from contract or it should be represented as work-in- progress. assessee has neither received any amount from MPEB nor is showing any work-in-progress. expenditure on particular project cannot be merely allowed as expenditure unless there is corresponding credit in form of contract receipt or work-in-progress. assessee is claiming entire expenditure as deductible expenditure since contract has been abandoned. Although assessee has abandoned contract, fact remains that they have made claim in arbitration in respect of expenditure incurred and has also claimed damages for termination of contract. This being case, it cannot be said that assessee is not entitled for any amount from MPEB. In fact, amount spent should have been shown as work-in-progress which is recoverable from MPEB on arbitration award. assessee-company has only debited expenditure. assessee has not shown said amount as expenditure towards work-in-progress. debit of expenditure was disallowed since there is no corresponding credit either by way of contract receipts or at least equivalent amount of work-in-progress. Aggrieved by said order, assessee preferred appeal before Commissioner of Income-tax (Appeals)- I, Bangalore. In course of appeal proceedings, assessee has furnished statement showing year-wise cost of project from April 1, 2000, to March 31, 2002, and treatment of same in books of account. appellate authority was of view, though assessee has shown in accounts amount spent towards expenditure for assessment years 1999-2000, 2000- 2001 as work-in-progress for concerned years yet cost to tune of Rs. 2,57,74,199 incurred during previous year 2001-02 relevant to assessment year in question has not been reflected as work- inprogress. Instead entire cumulative expenditure incurred up to March 31, 2002, on impugned project amounting to Rs. 6,64,01,150 inclusive of expenditure of Rs. 2,57,74,199 incurred towards previous year relevant to assessment year in question has been written off/charged off as expenditure on abandoned project. This, according to appellate authority, is improper. assessee is not following any specific method of accounting. In any case non-reflection of expenditure incurred on said project as work-in-progress during previous year relevant to assessment year in question is not in accordance with mercantile system of accounting, thus resulting in distorted disclosure of profit/income from said project. Therefore, it dismissed appeal. Aggrieved by said order, assessee preferred appeal before Tribunal. Tribunal was of view that expenditure on particular project cannot be merely allowed as expenditure unless there is corresponding credit in form of contract receipt or work-in-progress. assessee has claimed that since contract has been abandoned, entire expenditure is deductible expenditure. Although assessee has abandoned contract, fact remains that they have made claim in arbitration case in respect of expenditure incurred and has also claimed damages for termination of contract. This being case, it cannot be said that assessee is not entitled for any amount from MPEB. In fact, amount spent should have been shown as work-inprogress which is recoverable from MPEB on basis of arbitration award. assessee- company has only debited expenditure. contractor can be taxed either on project completed or on billing method. In respect of this particular contract, assessee has followed neither of methods. true profits of assessee in respect of this project cannot be ascertained as assessee has not disclosed any receipts or workin-progress from this contract and has only debited expenditure. More so, since assessee has made claim for damages from MPEB in regard to contract work done and in regard to invocation of bank guarantee on termination of contract, assessee ought to have shown expenditure as work-in-progress. termination of contract in middle of its tenure would have opened claims and counter- claims for receipt which can never be lost sight of as assessee has not been able to specify reasonableness of recovering amount including said project having won at arbitration stage. We see no reason why assessee should maintain claim in subsequent years also till such claim resulted in receipt. By writing off this amount in impugned assessment year, assessee appears to have washed its hands off by claiming loss on account of its business activity by placing reliance on various citations which facts are not applicable to facts of assessee's case before us. assessee was required to carry forward total amount incurred for project as claim because it was contractee who terminated contract and assessee was rendering business services. Therefore, it could not be said that by invoking bank guarantee for amount given as advance to assessee had been agitated in year of amount written off itself. When issue is sub judice, it is more reason that amount incurred as business activity for contractee by assessee for particular contract agreed upon with contractee, amount remains as amount owed by contractee. In so far as writing off, this amount cannot be said to have been written off against any particular business activity carried out by assessee because contract amount lying with bank against bank guarantee was sought to be invoked by contractee which contractor was awarded by arbitration court. Therefore, Tribunal was of view assessee has not met its own consistent system of accounting to be followed for rightfully becoming claimant for loss of three years in one year without incorporating corresponding receivables to become entitled for write off under provisions of section 36(1)(vii) and not under section 37(1) of Act. Aggrieved by said order, assessee has preferred this appeal. This appeal came to be admitted on September 28, 2010, to consider following substantial questions of law: "1. Whether, on facts and in circumstances of case, Appellate Tribunal was right in holding that deduction of expenditure/loss incurred by appellant towards abandoned project was not allowable since appellant had not recorded any corresponding credit either as contract receipts or as work-in-progress? 2. Whether, on facts and in circumstances of case, Appellate Tribunal is right in holding that appellant had not disclosed true profits in respect of abandoned project as appellant has not disclosed any receipts or work-in-progress but only debited expenditure/loss? 3. Whether, on facts and in circumstances of case, Appellate Tribunal is right in confirming orders of authorities below to effect that appellant had not followed consistent system of accounting and, hence, appellant is not eligible to claim deduction of trading loss? 4. Whether, on facts and in circumstances of case, Appellate Tribunal is right in holding that appellant had enforceable right to receive damages once arbitration proceeding commences irrespective of result of such adjudication?" learned counsel for assessee assailing impugned order contended that facts are not in dispute. assessee has spent in all sum of Rs. 6,64,01,149 towards expenditure under contract. Admittedly, it has not raised any bills nor payment is made. MPEB terminated contract illegally invoked bank guarantee and received back entire amount given as deposit. amounts spent for assessment years 2000- 01 and 2001-02 was shown as work-in-progress. But in year 2002-03 when contract was terminated including amount spent during said period entire amount was claimed as expenditure. Though assessee has succeeded in getting award before arbitrator, as it is under challenge before High Court, it has not received any money even in terms of award. It is only when assessee gets amount in that assessment year, it could be taxed. Therefore, all three authorities committed serious error in not realising that when assessee has not received any payments and payment made was taken back by encashment of bank guarantee, contract was terminated, assessee was entitled to claim amounts spent towards contract as expenditure in law under section 37(1) read with section 28 of Act and, therefore, he submits that impugned orders are unsustainable. Per contra, learned counsel for Revenue submitted unless assessee shows in his books of account expenditure incurred in terms of contract "as work-in-progress" it is not entitled to claim said amounts as expenditure and, therefore, he submits order passed by authorities is strictly in accordance with law and do not call for interference. As could be seen from orders passed by authorities, assessing authority and Tribunal proceeded on assumption that assessing authority has not shown in its accounts expenditure incurred as representing work-in-progress. However, first appellate authority has looked into profit and loss account and was convinced that for first two years expenditure is shown as "work-in-progress" but for year in question as expenditure was not shown as work-in-progress and entire expenditure was shown as expenditure assessee is not entitled to said benefit. statement filed by assessee before first appellate court showing year-wise cost of Amarkantak project from April 1, 1999, to March 31, 2002, and statement of books of account is as under: Year-wise cost of Amarkantak project from 1st April, 2000, to 31st March, 2002, and treatment in books of account Cost Cumulative Treatment incurred for cost incurred for Reference Sl.N. F. Y. in books of Amarkantak Amarkantak to account head account Project Project Treated 1999- Refer 1 21,585,906 21,585,906 as work-in- 2000 annexure I. progress 2000- 2 19,041,045 40,626,951 do. do. 01 Written off Refer 2001- as cost of sales profit and loss 3 25,774,199 66,401,150 02 work bills and account for services FY 2001-02 Annexure I Break-up of work-in-progress Work-in-progress account heads F. Y. Amarkantak Samalkot Neyveli Akrimota Total work- Project (MPEB) project (BSES) Contract (NLC) project (GMDC) in-progress 1999- 21,585,906 1,172,494 22,758,400 2000 2000- 40,626,951 23,816,169 64,443,120 01 2001- 13,956,228 13,483,410 27,439,638 02 said statement is not disputed. Therefore, it clearly shows that for years 1999-2000, 2000-2001 amount spent towards expenditure is shown as "work-in-progress" in books of account. It is only for previous year 2001-02 expenditure incurred is not shown as work-inprogress. reason is contract was terminated. bank guarantees had been invoked. No doubt claim was put forth before arbitrator. But in near future there was no chance of getting any amount in that particular previous year and amount paid had been taken away. Therefore, assessee in that previous year has shown entire amount incurred as expenditure and sought for writing off as business expenditure. This aspect has been missed by first appellate authority. It is only in relevant year assessee has not shown amount spent towards expenditure as work-in-progress. It is during that year contract was terminated and he put forth present claim. He could not have shown it as work-in-progress. Therefore, finding that he is not entitled to benefit is ex facie illegal and cannot be sustained. Punjab and Haryana High Court in case of Laxmi Ginning and Oil Mills v. CIT reported in [1971] 82 ITR 958 (P&H) in some what similar situation has held as under (page 960): "The pendency of litigation about loss suffered cannot militate against fact that loss was suffered by assessee-firm during accounting year in question. amount of that loss cannot be postponed in view of pendency of litigation referred to above." Madras High Court in case of George Maijo and Co. v. CIT [2003] 261 ITR 231 (Mad) held when there is direct intimate connection between business operation of assessee and loss that has fallen on assessee, though loss was occasioned by act done by seller since assessee is not stated to be party to fraud committed by foreign seller, loss would be allowable as deduction as loss is incidental to business carried on by assessee. Supreme Court in case of Ramchandar Shivnarayan v. CIT [1978] 111 ITR 263 (SC) has held that it is open to assessee to claim loss if it has proximate connection with its business. Similarly, it was held by apex court in case of Madras Industrial Investment Corporation Ltd. v. CIT reported in [1997] 225 ITR 802 (SC) that, where liability was incurred which has to be discharged in future date it will be liability but, however, contingent liability which may have to be discharged in future cannot be considered as expenditure. Therefore, if assessee incurs liability and when contract under which that liability was incurred was terminated and when no amounts under contract or in pursuance of claim is receivable, he is entitled to claim said amount incurred as expenditure in implementing contract as set off under section 37(1) read with section 28 of Act. In fact section 41(1)(a) of Act reads as under: "41. (1) Where allowance or deduction has been made in assessment for any year in respect of loss, expenditure or trading liability incurred by assessee (hereinafter referred to as firstmentioned person) and subsequently during any previous year,- (a) first-mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, amount obtained by such person or value of benefit accruing to him shall be deemed to be profits and gains of business or profession and accordingly chargeable to income-tax as income of that previous year, whether business or profession in respect of which allowance or deduction has been made is in existence in that year or not; or" In view of aforesaid provision, though assessee has incurred expenditure during assessment years 2000-01, 2001-02 and 2002-03 during which period he has not received any amount as against expenditure, if and when he receives money in pursuance of award which is already passed, if it is upheld by High Court, said amount is chargeable to income-tax as income of that previous year in which he receives said amount whether business in respect of which deduction has been made is in existence in that year or not. Therefore, interest of Revenue is fully protected. All three authorities have not applied their mind to factual aspects of case and have not kept in mind statutory provisions and, thus, committed serious illegality in passing impugned orders. orders are not sustainable. Therefore, substantial questions of law raised in this appeal are answered in favour of assessee and against Revenue. In that view of matter, we pass following order: appeal is allowed. impugned orders passed by three authorities are hereby set aside. assessing authority is directed to allow aforesaid amount as set off. *** Asia Power Projects P. Ltd. v. Deputy Commissioner of Income-tax