Accrual of conditional retention arises on expiry of defect-liability, not on contract completion, so taxation deferred.

Retention sums under contract with a defect-liability period accrue only when the contractual condition (expiry free of defects) is fulfilled; therefore such retained amounts do not become taxable on mere contract completion, favouring the assessee. Findings of a prior Settlement Commission order that permitted capitalisations and adjustments must be given consequential effect in subsequent assessments while that order stands, limiting departmental additions. Loss on contract termination is allowable in the year of actual loss despite pending arbitration, with any future recovery to be adjusted when received. Penalties arising from additions are set aside where the Settlement Commission's order eliminates those additions, subject to reconsideration if that order is later declared void.

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Issues: (i) Whether retention amounts retained by the awarder under contract terms accrue and become taxable on completion of the contract where the assessee follows the mercantile system of accounting; (ii) Whether adjustments/additions relating to work-in-progress and bills receivable must conform to the Settlement Commission's earlier order for prior years and its consequent effect on subsequent assessments; (iii) Whether loss on termination of contract can be allowed while arbitration proceedings are pending; (iv) Whether penalties under income tax arising from additions should be sustained where the Settlement Commission's order produces consequential effects for subsequent years.

Issue (i): Whether retention amounts retained by the awarder under contract terms accrue and become taxable on completion of the contract where the assessee follows the mercantile system of accounting.

Analysis: The contract terms show a defect liability/retention period after completion during which the awarder is entitled to retain specified amounts to meet possible defects. The assessee's right to those retained sums is conditional on the expiry of the retention period without defects; accrual depends on the existence of an unconditional right to receive. The concepts of accrual and receipt are distinct, but accrual must be determined by contract terms. On the facts, the right to the retained amounts does not vest on completion but upon expiry of the retention period free of defects.

Conclusion: Answered in favour of the assessee and against the Revenue; retention amounts do not accrue on completion and are not taxable in the year of contract completion.

Issue (ii): Whether adjustments/additions relating to work-in-progress and bills receivable must follow the Settlement Commission's earlier order for prior years and its consequent effect on subsequent assessments.

Analysis: The Settlement Commission's earlier block assessment order created consequences for subsequent years by permitting certain capitalisations and adjustments. Where the Settlement Commission's order remains in force, its findings must be reckoned by the Department in making assessments for subsequent years. Issues concerning work-in-progress and bills receivable largely turn on facts and adjustments by the AO; some were remanded by the Accountant Member but the Tribunal majority and third member adhered to the consequences of the Settlement Commission's order.

Conclusion: Answered in favour of the assessee and against the Revenue, subject to the reservation that if the Settlement Commission's order is subsequently declared void the Revenue may approach the Tribunal to reopen the questions.

Issue (iii): Whether loss on termination of contract can be recognised while arbitral proceedings are pending.

Analysis: The assessee suffered cancellation of contract and encashment of bank guarantee resulting in actual loss in the relevant year; any future recovery pursuant to arbitration can be adjusted in the year of receipt. The present loss is not speculative merely because arbitration is pending.

Conclusion: Answered in favour of the assessee and against the Revenue; the loss allowed by the Tribunal is upheld.

Issue (iv): Whether penalties under income tax arising from additions should be sustained where the Settlement Commission's order produces consequential effects for subsequent years.

Analysis: If the Settlement Commission's order operates to validate the adjustments accepted for the years in question, then no additions remain for which penalty can be imposed; however, if the Settlement Commission's order is thereafter set aside, the Revenue retains the right to have additions and penalties reconsidered in accordance with sustained assessments.

Conclusion: Answered in favour of the assessee and against the Revenue; penalties set aside, subject to the reservation that penalties may be reconsidered if the Settlement Commission's order is declared void (with a further carve-out that issues independent of the Settlement Commission ruling, e.g., the retention-amount holding, remain favourable to the assessee).

Final Conclusion: The appeals are allowed overall: the legal questions on retention amounts, treatment of work-in-progress/bills receivable in light of the Settlement Commission's order, recognition of loss pending arbitration, and consequential penalty issues are decided for the assessee; the Department retains the limited right to seek review before the Tribunal if the Settlement Commission's order is set aside.

Ratio Decidendi: Where contract terms condition entitlement to retained sums on a defect-liability period, accrual occurs only upon fulfilment of those conditions; accordingly, conditional retention amounts are not taxable on contract completion, and a binding Settlement Commission order that affects prior years must be given consequential effect in assessments for subsequent years unless set aside.

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