Itr/264/1997 Of The Commissioner Of Income Tax v. Bhageeratha Engineering Ltd

IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT THE HONOURABLE MR.JUSTICE S.V.BHATTI & THE HONOURABLE MR. JUSTICE BECHU KURIAN THOMASTHURSDAY, THE 24 DAY OF JUNE 2021 / 3RD ASHADHA, 1943 ITR NO. 264 OF 1997 AGAINST THE ORDER/JUDGMENT IN ITA 997/1989 OFI.T.A.TRIBUNAL,COCHIN BENCH, ERNAKULAM PETITIONER/S: THE COMMISSIONER OF INCOME TAX,COCHIN.BY ADVS.SRI.P.K.R.MENON,SR.COUNSEL, GOI(TAXES)SRI.JOSE JOSEPH, SC, FOR INCOME TAXCHRISTOPHER ABRAHAM, INCOME TAX DEPARTMENT RESPONDENT/S: BHAGEERATHA ENGINEERING LTD.,COCHIN. BY ADVS.SMT.P.ANITHASMT.P.ANITHASMT.R.S.GEETHASRI.V.B.UNNIRAJSRI.T.M.SREEDHARAN (SR.) THIS INCOME TAX REFERENCE HAVING COME UP FOR HEARING, THECOURT ON 24.06.2021 DELIVERED THE FOLLOWING: S.V. Bhatti, J. O R D E R The Commissioner of Income Tax, Cochin (for short 'Revenue') and M/s.Bhagheeratha Engineering Limited (forshort 'the assessee') are the petitioner and the respondentrespectively in the instant I.T.R. The reference is made by theIncome Tax Appellate Tribunal (ITAT) on the application madeby the Commissioner of Income Tax (Appeals), Cochin, underSection 256(1) of Income Tax Act, (for short 'Act'). Thereference deals with the controversies and the consequentquestions of law arising in the finalisation of assessment for theAssessment Year 1986-87. 2.The assessee, as a contractor, is engaged in thebusiness of construction of dams, bridges, railway lines, canalembankment etc. The assessee, as part of its business, had The assessee, as a contractor, is engaged in the I.T.R. No.264/1997 undertaken the construction of a branch railway line for acement factory in Iraq. The standing of assessee in theexecution of work is that of a sub-contractor and the principalcontractor was Indian Railway Construction Company (for short'Ircon Ltd.') It is an admitted circumstance that the assesseehad entered into back to back contract with Ircon Ltd. Theassessee had completed a portion of the contract work duringthe previous year ending 1985-86. The completed portion ofcontract during the previous year ending on 31.03.1986, billswere submitted and the quantum of executed work wascertified at Rs.13,14,66,919/-. The assessee, as against the saidcertified amount of Rs.13,14,66,919/-, received Rs.3,27,60,321/-.The expenses booked during the year against execution of thesaid work was Rs.6,21,90,197/-. The assessee was following themercantile system of accounting and has been filing the returnsaccordingly. But, the assessee for the subject assessment year I.T.R. No.264/1997 adopted completed contract method of accounting standard and asper the adopted accounting standard did not reflect entries forrecognition of revenue from the work executed by the assesseein the previous year 1985-86. The assessee had taken a standthat Iraq was at war with Iran and in these conditions thecompletion of contract work would either take long time, thetime schedule are not certain, and the balance of work whethercould be executed by the assessee/sub-contractor in the nearfuture. The assessee, compelled by the circumstances, enteredinto supplementary agreement dated 05.09.1984 with Ircon Ltdfor deferred payment of contract dues. The assessee, keeping inperspective these singular circumstances faced in the executionof sub-contract in Iraq, had chosen to adopt completed contractmethod of accounting for determination of income from thework executed by the assessee in Iraq. Due to deferred paymentagreement between the contractor and the sub-contractor, no I.T.R. No.264/1997 part of the contract amount was receivable during the relevant I.T.R. No.264/1997 part of the contract amount was receivable during the relevant previous year. Therefore, no income from the contract could beassessed for income tax purposes. The assessee places relianceon 'accountancy standards for accounting for constructioncontracts' (for short 'AS'). In the professional parlance ofaccountancy, the completed contract method is a standardaccountancy method and not inconsistent with the provisionsof the Act. 3.The Deputy Commissioner of Income Tax/AssessingOfficer issued notice under Section 143(3) of the Act and takingnote of the quantum of work/bills certified by Ircon for thework executed in Iraq and the expenses incurred in this behalffor executing the work in the previous year 1985-86, addedRs.6,92,96,722/- being the difference between amount certifiedand expenses incurred. The reference deals with the questionsof law arising out of completed contract accounting method I.T.R. No.264/1997 adopted by the assessee and whether the assessee has discretion to do so, and/or curtailed by the Act and finally the adoption ofcompleted contract method fails the requirement of bona fidesin selecting the completed contract method. On appeal, at theinstance of assessee, the Commissioner of Income Tax (Appeals)rejected the addition of Rs.6,92,96,722/-. On the appeal filed bythe Revenue, the Tribunal confirmed the view taken by theCommissioner of Income Tax (Appeals). Under thesecircumstances the following questions are referred for ouropinion: 1)“Whether on the facts and in the circumstances of thecase and also in view of the fact that the assessee was followingmercantile system of accounting with regard to theexpenditure with reference to the sub-contract with Ircon Ltd.should not the contract receipt or the right to contract receiptbe considered under the mercantile system of accounting forassessment purpose? 2)Whether, on the facts and in the circumstances of thecase and considering the method of accounting followed by the I.T.R. No.264/1997 assessee with regard to the expenditure incurred, should not bethe bills certified as relating to the work completed during theyear be brought to tax in the assessment year 1986-87? 3)Whether on the facts and circumstances of the case theTribunal is right in law in holding that the mere fact that thework was executed or the progress bills were presented andapproved does not create an enforceable right in the assesseeto receive payment? 4.Learned Standing Counsel Mr.Christopher Abraham adverted to the undisputed circumstances in the case, namelythat the assessee, prior to the subject previous year, wasfollowing mercantile system of accounting. The departure frommercantile system of accounting to completed contractaccounting system for the works under execution in Iraq isrightly noted as an incidence to avoid or evade tax by theassessee. The Assessing Officer rightly added the differencebetween the amount for which works are certified and theexpenses booked by the assessee against the works in Iraq, as I.T.R. No.264/1997 4.Learned Standing Counsel Mr.Christopher Abraham adverted to the undisputed circumstances in the case, namelythat the assessee, prior to the subject previous year, wasfollowing mercantile system of accounting. The departure frommercantile system of accounting to completed contractaccounting system for the works under execution in Iraq isrightly noted as an incidence to avoid or evade tax by theassessee. The Assessing Officer rightly added the differencebetween the amount for which works are certified and theexpenses booked by the assessee against the works in Iraq, as I.T.R. No.264/1997 income derived from the contract under execution in Iraq,amounting to Rs.6,92,96,722/-. The assessee should haveconsistency in adopting accounting standard and departurefrom consistent practice is not bona fide adding of income,hence, is within the discretion and jurisdiction of the AssessingOfficer under the Act, particularly having regard to the scopeand purpose of Section 145 of the Act. According to argument,the mercantile system of accounting ought to be accepted asconsistent to the business practice of the assessee and since noexception to the details of these entries is taken in the longspells of examination by the Department etc, the naturalconsequence is to add the difference amount to the total incomeof the assessee. Therefore, stated summarily, the adoption ofcompleted contract is not acceptable. Thereby the recognitionof revenue takes place as per mercantile system of accountancyand the certified work therefore is treated as enforceable right I.T.R. No.264/1997 and receipt in the books of account of the assessee and theinclusion of the amount is valid and correct. 5.Per contra, learned Senior Advocate Mr. T MSreedharan prefaces the circumstances in which the assesseewas positioned, are singular and could be limited to, by way ofillustration to similarly situated unfortunate contractors whowere executing contracts in Iraq, when Iraq went to war withIran. He invites the attention of the Court to the deferredpayment agreement dated 05.09.1984 and argues that theassessee, compelled by circumstances beyond its control, hadrealised the difficulty of completing the work at any time in thenear future from the previous year ending 31.03.1986. Theassessee shall not be compelled to opt for a system ofaccountancy which is not suitable or compatible to thecircumstances of the case. While arguing, even in retrospect, itis stated that even today it cannot be said that Iraq is peaceful I.T.R. No.264/1997 and good atmosphere is present for execution of work by theforeign agencies. Therefore, the uncertainty was looming largeand the option taken by the assessee conforms to the certifiedaccounting standards followed and verified by the Institute ofChartered Accountants. According to him, the assessee hasdiscretion to opt for a particular accounting system unless anduntil the system so adopted by the assessee is established as aruse conceived to evade payment of tax and a finding to the saideffect is recorded by the Assessing Officer. In the instant case,no such finding is recorded by the Assessing Officer. Thereasons of Assessing Officer were independently examined byboth CIT (Appeals) and the Appellate Tribunal, and have beendisapproved. Therefore, for the sake of asking, the assesseeshall not be compelled to revert to mercantile system and adoptthe tax planning as per the wish of Revenue. Alternatively themercantile system does not reflect the actual state of affairs of I.T.R. No.264/1997 assessee/Company, much less the taxable income of theassessee for the Assessment Year. 5.1To convince the Court with an illustration he has I.T.R. No.264/1997 assessee/Company, much less the taxable income of theassessee for the Assessment Year. 5.1To convince the Court with an illustration he has drawn our attention to the outflow from the books of account,certified bills, actual receipt from the principal contractor, ifare treated as receivable and after deducting expenses incometax is levied, the assessee would be paying tax on amount whichis not certain in any manner as on the date of filing of incometax return but further outflow of cash reserves would occasion.According to him, the circumstances leading to thesupplemental agreement and limited options in which theassessee had accepted the proposal of Ircon and Union of Indiaare independently considered both by the Commissioner ofIncome Tax (Appeals) and the Income Tax Appellate Tribunal.The findings of fact are pure and simple, recorded by theauthorities having jurisdiction in this behalf. The questions of law are to be answered in favour of the assessee in the facts and circumstances and no exception to the findings recorded in thisbehalf would be taken. The learned Senior Counsel finallyargues that the questions substantially compel the assessee tofollow mercantile system of accounting, in spite of suchaccounting system being impracticable and unworkable in thecircumstances of the case. He prays for dismissing the appeal. 6.The learned counsel on both sides have made theabove submissions by drawing our attention to various findingsrecorded by the authorities in Annexures A to C, judicial orbinding precedent on the questions for decision are not placedbefore us. According to them, the questions are substantiallyformulated in the facts and circumstances of the case on handand are decided. 6.1Stated succinctly, question no.1, taking note of theaccounting standard practiced by the assessee for the previous I.T.R. No.264/1997 assessment years, whether the contract receipt or the right tocontract receipt, be considered under mercantile system ofaccounting for assessment purpose. Question no.2 deals withbills certified as amounting to work completed for the previousyear ending 31.03.1986 and revenue recognition should havebeen carried out. Question no.3 deals with the enforceability ofcertified bills and entitlement of assessee to receive payment.The questions, though are stated in three dimensions, we wouldlike to deal with the questions referred to us as two parts.Question nos.1 and 2 as forming the first part and question no.3as the second part and the questions substantially depend onassessee’s discretion in choosing accounting standard. 6.2It is useful to preface a few circumstances admittedby the parties and the findings recorded by the threeauthorities. Annexure D is agreement dated 27.08.1981 enteredinto between Ircon and the assessee. Under the said agreement Ircon has sub-contracted a portion of the work for execution in favour of assessee. On 05.09.1984 the assessee entered intosupplementary agreement for defferment of payment. Theassessee, for the subject year recorded work completed asamounting to Rs.13,14,66,919/-, expenses incurred as Rs.6,21,90,197/- and actual receipts amounting toRs.3,27,60,321/-. The assessee by resorting to completedcontract accounting standard, did not include the details of Iraqcontract in the subject return. 6.3The Assessing Officer accepts that an assessee mayfollow different kinds of accounting system, according toassessees' convenience. The Revenue is concerned with thereflection of fair and reasonable declaration of income asarising out of business carried on during subject year by theassessee. The assessee has completed a part of the work. Thecontractor has approved the work executed by the assessee. I.T.R. No.264/1997 Rs.6,21,90,197/- and actual receipts amounting toRs.3,27,60,321/-. The assessee by resorting to completedcontract accounting standard, did not include the details of Iraqcontract in the subject return. 6.3The Assessing Officer accepts that an assessee mayfollow different kinds of accounting system, according toassessees' convenience. The Revenue is concerned with thereflection of fair and reasonable declaration of income asarising out of business carried on during subject year by theassessee. The assessee has completed a part of the work. Thecontractor has approved the work executed by the assessee. I.T.R. No.264/1997 The assessee received a portion of the payment as well.Therefore, the completed contract method would not reflectfair and reasonable picture of the profit earned by the assesseefrom year to year or for the subject assessment year. Thesupplementary agreement for deferred payment postponesreceipt of payment and not otherwise. The circumstances inIraq may not take away the right of assessee to receive contractamount for the completed work. The assessee since has beenfollowing mercantile system of accounting, should havefollowed the same accounting standard for the subjectassessment year as well. Therefore, the difference betweencertified work and the expenses incurred in this behalf has beentreated as income assessable to tax in the assessment year andadded accordingly. 6.4The Commissioner of Income Tax (Appeals) in detailreferred to the contentions, totality of circumstances and has I.T.R. No.264/1997 concluded that the assessee will finalise the profit or loss onaccount of this particular contract when the entire payment isreceived and it will be offered to taxation in the year ofcompletion of contract. Therefore, as stated above, there willnot be revenue loss on account of this completed contractmethod of accounting system adopted by the appellant. Stateddifferently, the CIT (Appeals) records a finding that by resort tocompleted contract method, the revenue is not adverselyaffected. The CIT(Appeals), thereafter examined whether theincome has accrued to the appellant during the accounting yearrelevant to the assessment year. By referring to a few decisionsit is noted that “even if there is a change in the methods ofaccounting in respect of the source of income and it is in goodfaith changed the method of accounting and it has to beaccepted”. It has been decided by the Kerala High Court in thecase reported in Forest Industries Travancore Ltd v. Commissioner of I.T.R. No.264/1997 Income Tax[1]: which reads “that the assessee was entitled to change his method of valuation of stock in this manner even though therevenue may be affected adversely by such change”. Finally heldthat: “"16. It may be noted that the agreement in respect of thecontract in the appellant's case is similar to that of the case ofRecondo Ltd. (Bombay). The important factor whichnecessitated the change of method of accounting in the case ofRecondo Ltd. was the war between Iran and Iraq and as a result,all the receipts were postponed at the Government'sintervention to a later year. Therefore, the dictum that anincome is taxable only when it has become due, applies to boththe cases. After analysing various case laws mentioned above, Ihave come to a conclusion that the amount of Rs.6,92,96,722/-included by the Assessing Officer is the income of the appellanthad not accrued to the appellant during the accounting yearrelevant to the assessment year. Hence, this addition has to bedeleted." 7 The Income Tax Appellate Tribunal in appeal filed by the Revenue held that: 11964 51 ITR 329 Ker 7 The Income Tax Appellate Tribunal in appeal filed by the Revenue held that: 11964 51 ITR 329 Ker “The learned CIT (Appeals) saw merit in the contention of theassessee that having regard to the special features of thiscontract and the difficulties faced by the assessee in executingthe work in a war-torn country facing financial and economiccrisis, the assessee was well advised to follow the completedcontract method. He also noticed the contention of theassessee that no part of the income has accrued during theaccounting year relevant to the assessment year under appealon account of the specific provision contained in clause 19 ofthe agreement which releated to the payment. As per thatclause payment was to be made by IRCON Ltd. to the assesseeonly when the money was received by IRCON Ltd., from theIraqi authorities. Further, it was noticed that such paymentswere deferred upto July, 1989 by an agreement entered intowith the Iraqi Government. He also noticed the decisions reliedon by the assessee viz., 46 ITR 144(SC), 56 ITR 42(SC); 57 ITR624(SC), 89 ITR 266(SC) and also 105 ITR 627 (Ker.). He alsonoticed the contention of the assessee that amounts thus farexpended on the contract in a total of Rs.6,21,90,197 were to betreated as work-in-progress as the assessee had adoptedcompleted contract method of accounting for arriving at theprofit in respect of this contract. …....….... I.T.R. No.264/1997 As the receipts were postponed to later years at theintervention of the Iraqi Government in respect of the contract,the learned CIT(Appeals) held that the amount ofRs.6,29,96,722/- included by the assessing officer as the incomeof the assessee had not accrued to the assessee during theaccounting year relevant to the assessment year 1986-87. Thus,he deleted the addition.” In the aforementioned conclusion recorded by the CIT (Appeals) and ITAT, let us examine the questions referred forour opinion: Questions 1 and 2 7.1The conspectus of judicial precedence suggests to an axiomatic view, however, subject to a few exceptions, that theassessee has discretion to follow a particular accounting system, namely mercantile system, completed contract etc formaintenance of accounts. The books of account are maintainedin the format of accounting system adopted by the assessee.The Act does not stipulate adherence to one particular I.T.R. No.264/1997 accounting standard to be followed by a particular set ofassessees, depending upon the nature of business the assesseesdo. There is no prohibition under the Act to change from oneparticular accounting standard to another accounting standardby the assessee. The object of the Act is therecognition/identification of income liable to tax under the Actand is definitely attained by several methods of accounting. 7.2. The same results in recognition/identification ofincome are attained by following any one of the acceptedaccounting methods. From accounting parlance, completedcontract method is one of such methods adopted to recognisethe revenue and profit associated with the project only after theproject has been completed. The completed contract method isresorted to when there is uncertainty about the collection offunds due from a customer under the terms of a contract. Inaccounting parlance, this method yields same results as the I.T.R. No.264/1997 percentage of completion method, but only after the project hasbeen completed. The completed contract method, prior tocompletion, does not yield any useful information and the delayin income recognition allows the business to defer therecognition of related income tax issues. In the saidaccountancy pattern, the revenue and accounts recognitiondefer till the end of the project, consequently the timing ofrevenue recognition is delayed. I.T.R. No.264/1997 percentage of completion method, but only after the project hasbeen completed. The completed contract method, prior tocompletion, does not yield any useful information and the delayin income recognition allows the business to defer therecognition of related income tax issues. In the saidaccountancy pattern, the revenue and accounts recognitiondefer till the end of the project, consequently the timing ofrevenue recognition is delayed. 7.3The completed contract method is resorted to whenit is not possible to derive dependable estimates about thepercentage of completion of the project or when there areinherent hazards that may interfere with completion of aproject or when contracts are of such a short-term nature thatthe results reported under the completed contract method andthe percentage of completion method would not varymaterially. In completed contract accounting method, I.T.R. No.264/1997 recognition of revenue is avoided during the execution of thecontract. The adoption of this accounting system, in effect,facilitates the drawing of profit or loss at the end of completionof project. There is no prohibition under the Act againstchanging the account method by an assessee. The change in oraccountancy method, as long as, held not to be bona fideintended to avoid/evade payment of tax of income received bythe assessee, the assessee is free in its discretion to change theaccounting procedure in a year. Section 145 of the Act enablesthe Assessing Officer to determine whether or not the incomededuced by the accounts maintained by the assessee is correct,a computation is proffered, and conform to the circumstancesof the case. In this case, we are proposing to examine thediscretion available to the assessee and the legal obligationsread with functions conferred on the Assessing Officer underSection 145 of the Act. We would like to conclude that normally I.T.R. No.264/1997 the choice of the method of accounting remains with theassessee. It is open to the assessee to follow one system ofaccounting in respect of one source and another system inrespect of another source. Likewise, it is also open to theassessee to change its method of accounting regularly employedby it, in any assessment year. However, we hasten to add thatthe change should be bona fide and the change is not a casualdeparture from the regular method which has hitherto beenadopted by the assessee with a view to avoiding or evadeingincome tax. Now reverting to the case on hand, we notice thatit is not the case of Revenue, much less the consideration by theAssessing Officer, that the case on hand attracts any of theexceptions by referring to which the accounting system nowadopted by the assessee warrants to be disregarded and theaccounts should have been finalised as per mercantile system ofaccounting. I.T.R. No.264/1997 8.The first question deals with the obligation to followmercantile system of accounting, record expenditure, contractreceipt etc. For the view in the particular facts andcircumstances of this case and upon considering the findingsrecorded by CIT(Appeals) and Tribunal, we are of the view thatthe argument of Revenue that mercantile system of accountingshould have been adopted for the work executed in Iraq, doesnot arise and the assessee had rightly adopted completedcontract system for the work under execution in Iraq in thecontemporary period. The answer to second question isdependent on the findings we have recorded in the firstquestion. Once this Court holds that the completed contractmethod adopted by the assessee in the current facts andcircumstances is right, the bills certified as relating to workcompleted cannot be recognised as receipts and brought to taxin the Assessment Year 1986-87. The question that mercantile I.T.R. No.264/1997 system of accounting should be directed would curtail thediscretion available to the assessee. For the above reasons and consideration, we answer the I.T.R. No.264/1997 system of accounting should be directed would curtail thediscretion available to the assessee. For the above reasons and consideration, we answer the points in favour of assessee and against the Revenue. Question No.3 9.The question deals with a finding of fact recorded by the Tribunal. From the findings recorded, it is not brought to our notice that the bills certified are gone that far in gettingapproval from the Iraq Government and an enforceable right inthe Assessment Year. The bills are stated as certified. It isdefinitely an enforceable right in the realm of contract. Theassessee since is subjected to vagaries and uncertainties offluctuation, preferred to have completed contract method forthe entire project. The effect of these transaction, recognitionof revenue etc would arise either upon completion of thecontract and/or rescission of contract, other foreseen and I.T.R. No.264/1997 unseen eventualities, that means, arising in the course of the execution of the contract. By keeping in view the finding of factrecorded by the Tribunal, we answer the issue by holding thatthe bills certified in the case on hand having regard to thedeferred payment agreement entered by the assessee did notcreate an enforceable right even in the subsequent AssessmentYear. The point is answered in favour of the assessee and againstthe Revenue. ITR No.264/1997 is answered as indicated above. Registry shall send the certified copy of this judgment to the Income TaxAppellate Tribunal, Cochin. Sd/- S.V.BHATTIJUDGESd/- BECHU KURIAN THOMASJUDGE I.T.R. No.264/1997 APPENDIX OF ITR 264/1997 PETITIONER ANNEXURE ANNEXURE D COPY OF THE AGREEMENT BETWEEN INDIAN RAILWAY CONSTRUCTING COMPANY LTD. AND BHAGEERATHA ENGINEERING LTD. ANNEXURE ECOPY OF THE AGREEMENT BETWEEN INDIAN RAILWAY CONSTRUCTING COMPANY LTD. AND BHAGEERATHA ENGINEERING LTD. ANNEXURE ACOPY OF THE ASSESSMENT ORDER DATED 31/03/1988. ANNEXURE BCOPY OF THE ORDER OF THE COMMISSIONER OF INCOMETAX (APPEALS) DATED 14/09/1989. ANNEXURE C COPY OF THE ORDER OF THE TRIBUNAL DATED 30/09/1994.