TRF Ltd. vs Commissioner of Income Tax, Ranchi

Narendra Nath Tiwari, J.—This batch of appeals was admitted for hearing on the following substantial questions of law :- (i) Whether under the mercantile system of accounting deduction has to be allowed in respect of a business liability in the year in which the same arises, even if not actually quantified, on the basis of a reasonable estimate?

(ii) Whether the Tribunal was justified in law in proceeding on the basis that it was required to examine the nature of the payments made by the appellant to the sub-contractor and in failing to address itself to the real question viz. As to whether the appellant was entitled to deduction in respect of the liability reasonably estimated to be due to the sub-contractor in the assessment years 1991-92 to 1995-96 notwithstanding its actual quantification in a subsequent year?

(iii) Whether the Tribunal misdirected itself in law in holding that the additional liability due to the sub-contractor was in suspense or was agreed to/accepted by the appellant or became a liability only in July, 1997, when it was actually quantified and its purported findings in this behalf are based on any material and/or have been arrived at by ignoring the relevant materials and/or by taking into consideration irrelevant and/or extraneous materials and/or are otherwise arbitrary, unreasonable and perverse?

(iv) Whether under the provisions of section 194C of the income tax Act, 1961 tax has to be deducted at source from all payments made to contractors even if they be on capital account?

(v) Whether under the mercantile system of accounting the expenditure incurred for earning the income should be considered for deduction in the year of accrual of the income so as to arrive at the true profits and postponement of deduction of such expenditure would result in distortion of profits?

(vi) Whether the Tribunal misdirected itself in law in holding that the appellant was not entitled to deduction of Rs. 15,39,181, Rs. 34, 27, 202, Rs. 19,98,021, Rs. 10,00,305 and Rs. 92,082 in the assessment years 1991-92, 1992-93, 1993-94, 1994-95 and 1995-96, respectively, towards liability for expenditure incurred for fulfilling its contract with Rourkela Steel Plant and its purported findings in this behalf are arbitrary, unreasonable and perverse?

The appellant has preferred these appeals against the common order dated 26-7-2001 passed by the income tax Appellate Tribunal (in short Tribunal) in ITA Nos. 22 to 26 (Pat.) of 2000, denying the deductions claimed by the appellant regarding additional payment made to its sub-contractor, namely, M/s. Pioneer Engineering Company (for short PECO) in the assessment years 1991-92 to 1995-96 and dismissing the said appeals. 2. It is pertinent to mention that the appellant made the said claim of deduction on accrual or mercantile basis of accounting, whereas the respondent-revenue seems to have refused the said deduction, on cash basis accounting.

The fact giving rise to the controversy is common in all the appeals and goes as under:

Fact

3.1 The appellant, a public limited company, is in the business inter alia of manufacturing and sale of material handling and processing, plant equipments and machineries.

3.2 The appellant was awarded a contract by the Rourkela Steel Plant of the Steel Authority of India Ltd., for modernization of the coal handling plant, the work related to structural fabrication, erection, dismantling and modification.

3.3 The appellant had given works to two sub-contractors, M/s. Pioneer Engineering Company (PECO) and one other. After commencement of the work, PECO and the other sub-contractor found that sub-contracts were not profitable and there was likelihood of increasing heavy losses. The other sub-contractor expressed inability and abandoned the work. PECO was also contemplating to do so. The project which was to be completed within 12 months was getting delayed for various reasons. It ultimately took 36 months, resulting in to cost escalation.

3.4 In order to retain PECO to complete the work, the appellant agreed to enhance the stipulated rates and assured to extend all possible assistance. The quantum of enhancement of rates was in absolute terms.

3.5 The appellant agreed to provide the following additional facilities to the PECO:

(a) Labour payment;

(b) Supply of consumables like gas and electrodes; and

(c) Repairing of machines.

3.6 The value of the said facilities was to be adjusted against the revised rates.

3.7 It was agreed that the said facilities would be provided on recoverable basis.

3.8 Accordingly, the appellant from time to time made payments towards the aforesaid facilities on actual basis of the work completed.

3.9 Out of such payments, the appellant deducted tax at source in accordance with the provisions of section 194C of the income tax Act, 1961 (hereinafter to be referred to as ''the Act'').

3.10 PECO had provided security of about Rs. 15 lakhs in respect of the initial advance paid by the appellant. No further security was stipulated in respect of the payments for the aforesaid facilities.

3.11 The appellant, following the mercantile system of accounting, raised bill on Rourkela Steel Plant for the work done during each year. The value of which was duly credited to the profit and loss account of that year. Since the appellant in principle had agreed to enhance PECO''s rates and had incurred the liability to pay PECO additional amount over and above the rates agreed to at the time of placement of the order, the appellant, in accordance with the mercantile system of accounting, made a provision in each year for such additional liability based on the extra payments made to PECO at actual for the work done.

3.12 The appellant, accordingly, claimed deduction for such additional liability for the previous years relevant to the assessment years 1991-92 to 1995-96, the aggregate of which amounted to Rs. 80,56,791. The deduction claimed for the assessment year 1994-95 was Rs. 10,00,305. True income from the contract with Rourkela Steel Plant was correctly arrived at in each of the said years.

3.13 The appellant had been carrying the said additional payment made to PECO in its books of account, pending quantification of the enhancement. In or about July, 1997, it was formally agreed between the parties that the additional amounts paid by the appellant from time to time would be taken as towards discharge of the enhanced rates demanded by PECO and nothing further was due to or payable by either of the parties.

3.14 According to the appellant, in the original assessments made in its case for the assessment years 1991-92 to 1994-95, the Assessing Officer duly allowed the deduction in respect of the said additional liability. Subsequently, in course of completing the income tax assessment of PECO for the assessment year 1995-96, the Assessing Officer found that the PECO had not treated the additional amount paid by the appellant, as its income in the relevant assessment year, but had claimed that the same accrued as its income in July, 1994 when the appellant agreed that the additional payments should be treated as the enhanced rates and no further amount was due to or payable by either party. The Assessing Officer accepted the stand taken by the PECO and sought to reopen the appellant''s assessment for the assessment years 1991-92 to 1994-95 taking the view that the additional liability could not have been claimed by the appellant as deduction in the said assessment years.

3.15 In the reopened assessments for the assessment years 1991-92 to 1994-95 and in the assessment for the assessment year 1995-96, the Assessing Officer disallowed the deduction of additional liability aggregating to Rs. 80,56,791 claimed by the appellant. The Assessing Officer assumed that the appellant was not liable to pay the PECO any amount over and above the rates stipulated in the original purchase orders.

3.16 Aggrieved by the refusal of claim of the deduction of the additional liability in the assessment years 1991-92 to 1995-96, the appellant preferred appeals before the Commissioner of income tax (Appeals) against refusal of deduction for each of the aforesaid assessment years. The Commissioner of income tax dismissed the appeals. The appellant then preferred appeal before the Tribunal. Learned Tribunal dismissed all the appeals of the appellant by the impugned common order dated 26-7-2001.

In the impugned order, learned Tribunal has held that the additional payment made by the appellant was only an advance payment and the same has become liability only on final settlement vide letter dated 28-7-1997. The appellant is required to deduct tax at source on payment to sub-contractors either on capital or revenue account and that the accounting entries in the books of account also give an impression that the additional payments made to PECO were in fact advance payment.

Mr. Biren Poddar, learned Senior Counsel, assailing the impugned order of the learned Tribunal, submitted that during subsistence of the contract, the appellant made additional payment on various facilities like labour, consumables and repair of machine. The appellant had made provision in its account for each of the year for such additional liability on a realistic basis having regard to the additional payments made for expenses incurred at actual, for the work done. There is no dispute between the appellant and PECO that the appellant was liable to enhance the rates, which is evident from the minutes of the meeting held on 25-5-1992. The exact enhanced compensation was formally agreed upon between the parties in July, 1997. It was agreed that the total additional payments at the enhanced rates would be paid by the appellant, as demanded by PECO. Learned counsel further submitted that the exact quantification of the liability in July, 1997 did not have the effect of postponing the accrual of the liability. Deduction on business liability is admissible in the year in which the same arises irrespective of the fact that the liability may be quantified and discharged at a future date.

Learned counsel submitted that the appellant had obligation to make the additional payment to PECO as per the agreement dated 25-5-1992. The appellant in order to ensure that the contract work awarded to it by Rourkela Steel Plant does not get hampered and since the other sub-contractors had abandoned the contract halfway, it had agreed in principle to revise the rates of contract with PECO.

Learned counsel urged that the Tribunal has erroneously interpreted the term ''Recoverable'' used in the minutes of the meeting held on 25-5-1992 and has held the said additional payment made by the appellant as an advance, recoverable by the appellant from PECO. The term ''Recoverable'' does not mean ''Refundable''. The amounts paid were not intended to be refunded. The recovery of the additional amount was to be made against the claim of PECO at the enhanced rates and it cannot be considered as temporary assistance in the form of advance or loan. The nomenclature used in the contract is not the criteria for testing the nature of the transaction, rather it has to be ascertained on the basis of the intention and acts of the parties. The substance of transaction has to be assessed from the businessman''s point of view and not on its nomenclature. Learned counsel submitted that under the provisions of section 194C of the Act, the assessee is liable to deduct tax at source for carrying out any work in pursuance of a contract. If the payments were made over and above the contract or were in the nature of loan, then there is no obligation on the assessee to deduct tax at source. But in the instant case, the appellant had deducted tax at source, considering the additional payments made in pursuance of the contract with PECO. The observation of the learned Tribunal that tax is to be deducted even if payment is made to sub-contractor on capital account is misconceived and untenable.

Stressing his point, learned counsel submitted that in the impugned order dated 26-7-2001 learned Tribunal has not considered that income from Rourkela Steel Plant was duly included in the Profit & Loss Account of the respective years according to the work done and in order to arrive at true income, expenditure incurred for earning such income had to be deducted even on an estimated basis. The expression ''profits and gains'' has to be understood in its commercial sense and in the light of the mercantile system accounting. In order to determine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed. That matching is required to be done on accrual basis irrespective of actual cash inflow and of actual cash outflow.

Mr. Poddar further contended that as regards the accounting and entry made by the appellant in respect of additional payments made to PECO by showing it under advance account and then transferring it to the expenditure account on the last day of the year and again reversing the entry on the first day of succeeding year, it is well settled legal position that accounting entries are not sine qua non in determining the taxability or otherwise of any income or deductibility or otherwise of any item of expenditure. It depends on the relevant provisions of law and not on the basis of the entries made by an assessee in his books of account. What is to be seen is the true nature of transaction and the relevant profit or loss to the assessee. Learned counsel submitted that the Tribunal has failed to take into account the relevant legal provisions in right perspective and has committed errors in dismissing the appellant''s appeals.

In support of the above contentions, learned counsel referred to and relied upon the following case laws:-

I. Bharat Earth Movers Vs. Commissioner of Income Tax, Karnataka,

II. Metal Box Company of India Ltd. Vs. Their Workmen,

III. Rotork Controls India (P) Ltd. Vs. Commissioner of Income Tax, Chennai,

IV. Commissioner of Income Tax Vs. Development Trust (P) Ltd.,

V. Tata Iron and Steel Co. Ltd. Vs. D.V. Bapat, Income Tax Officer, Companies Circle I(2), Bombay and Another,

VI. Commissioner of Income Tax Vs. Kelvinator of India Ltd.,

VII. NAGASURI RAGHAVESWAR RAO Vs. COMMISSIONER OF Income Tax, A. P.,

VIII. Commissioner of Income Tax Vs. State Bank of Indore,

IX. EX-SOLDIERS MOTOR TRANSPORT CO. Vs. COMMISSIONER OF Income Tax U. P.,

X. Commissioner of Income Tax, Punjab, Haryana, J. and K., H.P. and Union Territory of Chandigarh Vs. Panipat Woollen and General Mills Co. Ltd.,

XI. COMMISSIONER OF Income Tax, A. P. Vs. KRISHNA INDUSTRIAL CORPORATION LTD.,

XII. The Union of India Vs. Gosalia Shipping (Pvt.) Ltd.,

XIII. The Commissioner of Income Tax-TDS Vs. Glenmark Pharmaceuticals Ltd.,

XIV. Calcutta Company Ltd. Vs. The Commissioner of Income Tax, West Bengal,

XV. Taparia Tools Ltd. Vs. Joint Commissioner of Income Tax,

XVI. CIT v. Industrial Finance Corpn. of India Ltd. (2009) 185 Taxman 296 (Del.)

XVII. The Kedarnath Jute Mfg. Co. Ltd. Vs. The Commissioner of Income Tax, (Central), Calcutta,

XVIII. Sutlej Cotton Mills Limited Vs. Commissioner of Income Tax, Calcutta,

XIX. Commissioner of Income Tax, Bombay City I Vs. Shoorji Vallabhdas and Co.,

XX. Commissioner of Income Tax, West Bengal I Vs. India Discount Co. Ltd.,

XXI. Nagri Mills Co. Ltd. Vs. Commissioner of Income Tax, Gujarat,

The respondent-revenue, on the other hand, supported the impugned order. Mr. Deepak Roshan, learned counsel, appearing on behalf of the respondent, submitted that the plea of the assessee company that the rates of the PECO were enhanced is not supported by any document. The appellant used to pay substantial amount as advance over and above the payment made against the bill raised by PECO. Such payments were made on recoverable basis. The appellant''s contention that the value of the facilities given to PECO was to be adjusted against the revised rate is not supported by any fact or document. Further plea of the appellant that for the initial advance payment made by the appellant, PECO had given security of about Rs. 15,000 and no security was provided in respect of the payment for the facilities is not relevant for the payments made on recoverable basis. The appellant''s contention that in principle it had agreed to enhance rates of PECO and it had incurred the liability to pay the PECO additional amount over and above the rates agreed to at the time of placement of the order and as per mercantile system of accountancy made a provision in each year, is not correct. The same has been discussed in detail in Para 6(2) of the assessment order of the A.R. 1994-95. The parties had jointly admitted on 26-2-1997 that the principal contract between them was never revised. Thus, the extra payment by the appellant was not towards the revised rates of the original contract. According to learned counsel, learned Tribunal has duly considered the relevant facts on record and has rightly held that the payments were made by the assessee/appellant against the security by way of Bank Guarantee, Personal Guarantee or otherwise and that was admitted by the parties in course of the proceeding u/s 131. It would not have been done unless the payments were intended to be advance payment, as admittedly the assessee would have been interested in securing its interest, in case, the payments were not settled against their demands in July, 1997. Learned Tribunal has further held that the entries in books of account also give impression that the assessee at the first instance intended to record the payments as advance. They were transferable to revenue account at the end of the month/year and were again transferred back to the advance account in the beginning of the next month or the year. The enhanced claim of PECO was not in a fluid state of affair and the assessee was keeping its all option open in the settlement and it has taken a final shape by way of settlement in July, 1997 that the payments were adjusted as payments against the acceptance of enhanced claim of PECO in July, 1997.

Learned Tribunal has discussed every aspect and has rightly rejected the claim of the assessee for the aforementioned assessment years. There is, thus, no merit in these appeals and the grounds taken by the appellant are liable to be rejected.

Having heard the rival contentions of learned counsel for the parties, I find that the main issue for decision is as to what is the nature of the payment made by the appellant to the PECO. Whether the payment made by the assessee partakes the character of revenue expenditure or the same is by way of advance?

The real character of the revenue differs according to the mode of the accounting system. There are two recognized mode of accounting system; (1) Cash Basis of Accounting; and (2) Accrual Basis or Mercantile System of Accounting. Under cash basis accounting, revenues are recognized and earned only when cash is received irrespective of when and how the services were performed or goods delivered. To put it in different terms, in the cash basis of accounting what is to be considered are all those incomes which have been received in cash or other assets and expenses/losses that have been paid out in cash or other assets during the accounting period in consideration. Whereas under accrual or mercantile basis accounting, revenues are recognized and earned when they are realized or realizable irrespective of when the cash is received. That is to say, the accrual basis of accounting takes into consideration all those incomes/gains and expenses/losses pertaining to the accounting period for which the profit and loss is ascertained irrespective of whether the incomes are received in cash or not and the expenses are paid out in cash or not.

In the instant case, it is not in dispute that payments were made by the assessee to PECO from year to year, which were pending adjustment. According to the revenue, the payments made by the assessee are as advance payments, whereas according to the appellant, the payments were made pursuant to revision in the rates claimed by PECO. Learned Tribunal in its order has observed that unless and until the parties are addendum, the contract is not complete. It can be said so only when the payment made by the assessee is in recognition of the enhanced rates in terms of the agreement between parties. But in the instant case, the payments were made by the assessee for safeguarding its interest. The final decision on the demand raised by the PECO by letter dated 22-3-1991 was kept pending. It was in abeyance. It took a final shape of settlement in July, 1997. Till then the payment made by the assessee was only an advance payment and became the liability only on the final settlement in 1997. The deduction of tax at source from such payment u/s 194C of the Act could not determine the character of payment whether it was revenue or capital at the first instance. It has further observed that the impugned payments were made by the assessee against the security by way of bank guarantee, personal guarantee or otherwise and that was admitted by the either party in course of the proceeding u/s 131 which would not have been possible unless the payments were intended to be advance payments.

What has been said above by the learned Tribunal appears to be quite plausible and proper. If the same is tested on cash basis accounting, but it does not appeal to the reason, if the same is viewed on accrual or mercantile basis accounting under which a business liability is incurred in the year in which the same has arisen irrespective of the fact that the liability may be quantified and discharged on a future date.

In Bharat Earth Movers'' case (supra), the Apex Court has held as follows:-

If a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.

The Supreme Court has given similar verdict in Metal Box Co. of India Ltd.''s case (supra) and held thus:-

Contingent liabilities discounted and valued as necessary, can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if the profits cannot be properly estimated without taking them into account.

The same view has been taken in Rotork Controls India (P.) Ltd.''s case (supra).

The Allahabad High Court in the case of Development Trust (P.) Ltd. (supra) has held that the estimated liability of development expenses is not a contingent liability, but a liability in praesenti and is an allowable deduction.

In the case of Tata Iron & Steel Co. Ltd. (supra), the Bombay High Court has held that if the provision for expenditure is estimated on scientific basis then the same shall be allowed as deduction.

Now the question is as to whether the payments made by the appellant to the PECO was recoverable or refundable.

Though the term used as ''Recoverable'' in the minutes of the meeting held on 25-5-1992, the submission of the appellant that what is to be gathered is the intention of the parties and not the nomenclature is in the line of the settled principle of law. It is the intention of the parties, not the nomenclature, which is decisive. In this regard, reference may be made to the cases of Nagasuri Raghaveswara Rao (supra), State Bank of Indore (supra) and Ex-Soldiers'' Motor Transport Co.''s case (supra).

The submission of learned counsel for the appellant that regard should be had to the substance of the transaction from the business point of view rather than its form is supported by the decision in Panipat Woollen & General Mills Co. Ltd.''s case (supra), Krishna Industrial Corpn. Ltd.''s case (supra) and Gosalia Shipping (P.) Ltd.''s case (supra).

I find substance in the submission of learned counsel for the appellant that the Tribunal has failed to properly consider that since income from Rourkela Steel Plant was duly included in the Profit & Loss account in the respective years according to the work done, the expenditure incurred for earning such income is deductable even on estimated basis for arriving at true income.

In Calcutta Co. Ltd.''s case (supra), the Apex Court has held that the expression ''profits and gains'' has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted there from even if the expenditure is actually incurred or the liability in respect thereof has to be discharged at some future date.

The Bombay High Court in its decision in Taparia Tools Ltd.''s case (supra), has also held that under the mercantile system of accounting, in order to determine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed (expenses). This matching is required to be done on accrual basis. This matching concept, revenue and income earned during an accounting period, irrespective of actual cash inflow, is required to be compared with expenses incurred during the same period, irrespective of actual outflow of cash. The same view has been taken in Rotork Controls India (P.) Ltd.''s case (supra).

Further an entry made by an assessee in his books of account is not determinative of whether the assessee has earned any profit or suffered any loss, it is necessary to consider the nature of the transaction and as to whether, in fact, the same has resulted in profit or loss to the assessee. Reference may be made to the decision of the Apex Court in Sutlej Cotton Mills Ltd.''s case (supra), Shoorji Vallabhdas & Co.''s case (supra) and India Discount Co. Ltd.''s case (supra) as also to the decision in Nagri Mills Co. Ltd.''s case (supra).

Though learned counsel for the respondent-revenue tried to support the findings of the learned Tribunal, his submissions are not convincing in view of the settled legal principles and the aforesaid judicial pronouncements.

Learned Tribunal has not properly discussed the said legal and factual aspects and has erroneously rendered its decision applying the normal rule of cash basis accounting, as against the appellant''s claim based on accrual or mercantile basis accounting. The points raised by the appellant are, thus, required to be reconsidered by the Tribunal in the aforesaid perspective. On the facts of the case and contentions of the parties as also on proper appraisal of the relevant documents in order to come to a just and final conclusion on the claim of the appellant. In view of the above discussion, the impugned common order dated 26-7-2001 passed in ITA Nos. 22 to 26 (Pat.) of 2000 for the assessment years 1991-92 to 1995-96 are set aside. The matters are remitted to the income tax Appellate Tribunal to consider the appellants'' contentions and the points raised in these appeals afresh in the light of the above discussions and settled principles of law.

These appeals are allowed in the above term.