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 relevant previous year. Under the contract terms, only 90% of the bill amount accrued upon execution of work; the balance 10% or 5%, as retention money, was contingent upon satisfactory completion, removal of defects and adjustment of damages, if any. Until such conditions were fulfilled, no enforceable liability arose on the contractee and no corresponding right to receive accrued to the assessee. Consequently, the retention money could not be brought to tax for A.Y. 1965-66. The reference was answered in favour of the assessee.

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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 Gains
The 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 Accounting
The 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 Money
The 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.

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