1988 (12) TMI 52 - HC - Income Tax

Retention money under works contracts not taxable until conditions met, despite mercantile accounting; income accrual deferred for assessee

HC held that, though the assessee maintained accounts on a mercantile basis, retention money under works contracts did not accrue as income in the ... Exemptions - Whether, the assessee follows the mercantile system of accounting, the Tribunal was right in holding that the retention money in respect of the jobs completed by the assessee during the relevant previous year should not be taken into account in computing the profits and gains of the assessee's business for the assessment year 1965-66 ? - HELD THAT:- The assessee follows the mercantile system of accounting and, therefore, it must credit its accounts as and when the right to receive any sum accrues. There cannot be any dispute that only in respect of 90 per cent. of the bills, in the first instance, when the job is done accrues to the assessee and the remaining 10 or 5 per cent. becomes due in accordance with the terms of the respective contract. In some cases, as per the contract, the right to receive payment of 5 per cent. accrues on completion of work and only the remaining 5 per cent. is deferred for a further period. The payment of retention money is deferred and is contingent on the satisfactory completion of the work and removal of defects and payment of damages, if any. Till then, there is no admission of liability and no right to receive any part of the retention money accrues to the assessee. Accordingly, the Tribunal was right in directing the Income-tax Officer to examine the question of retention money from this angle and make adjustments regarding the same, if necessary. We are of the view that on the terms and conditions of the contract as examined by the Tribunal, it cannot be held that either 10 per cent. or 5 per cent., as the case may be, being the retention money, became legally due to the assessee on the completion of the work. Only after the assessee fulfils the obligation under the contract, that the retention money would be released and the assessee would acquire the right to receive such retention money. Therefore, on the date when the bills were submitted, having regard to the nature of the contract, no enforceable liability has accrued or arisen and, accordingly, it cannot be said that the assessee had any right to receive the entire amount on the completion of the work or on the submission of bills. The assessee had no right to claim any part of the retention money till the verification of satisfactory execution of the contract. We answer this question in this reference in the affirmative and in favour of the assessee. Issues Involved:1. Whether the retention money should be taken into account in computing the profits and gains of the assessee's business.2. Whether the assessee had changed its method of accounting.3. When the right to receive the retention money accrues to the assessee.Summary:Issue 1: Retention Money in Computing Profits and GainsThe primary issue was whether the retention money in respect of jobs completed by the assessee during the relevant previous year should be taken into account in computing the profits and gains of the assessee's business for the assessment year 1965-66. The Tribunal held that the retention money did not arise or accrue in the years in which the job was executed but at a later date depending on the completion of the contract and the certificate of the architect/engineer that the work had been satisfactorily completed. The Tribunal directed the Income-tax Officer to examine the question of retention money in light of their observations and make necessary adjustments in the assessment order.Issue 2: Change in Method of AccountingThe Revenue contended that the assessee had changed its method of accounting, as noted in the auditor's report, which stated that approximately Rs. 21,00,000 representing retention money becoming due after December 31, 1964, had not been taken into the accounts. The Tribunal, however, did not find any reason to hold that the entire amount became due immediately upon the submission of bills but that 5 or 10 percent of the bills, as the case may be, was withheld as security.Issue 3: Accrual of Right to Receive Retention MoneyThe Tribunal examined various contracts and concluded that the right to receive 90 percent payment would arise or accrue immediately on completion of the work, but the right to receive the remaining 10 percent would be deferred and contingent on the satisfactory completion of the work, the architect's certificate, removal of defects, and payment of damages, if any. The Tribunal referred to the Supreme Court decision in CIT v. A. Gajapathy Naidu [1964] 53 ITR 114, which stated that the right to receive an amount accrues when the work is satisfactorily completed and certified. The Tribunal upheld the Appellate Assistant Commissioner's order and directed the Income-tax Officer to examine the question of retention money from this perspective and make necessary adjustments.Conclusion:The High Court affirmed the Tribunal's decision, stating that the assessee had no right to claim any part of the retention money until the verification of satisfactory execution of the contract. Therefore, the retention money should not be included in the profits and gains of the assessee's business for the relevant assessment year. The question was answered in the affirmative and in favor of the assessee, with no order as to costs.