Separate contract phases and indirect taxes excluded from AS-7 revenue recognition in a composite water supply contract.

Where a composite water supply contract contained separately identifiable study, rehabilitation, and post-construction operation and maintenance phases, only the construction component was to be recognised under the percentage completion method under Accounting Standard 7; the separate maintenance receipts were excluded from construction revenue and were to be accounted for independently. Service tax and value added tax collected under the contract did not form part of income and were excluded from contract revenue for income recognition. The tribunal therefore held both issues in favour of the assessee.

---

---

Issues: (i) Whether the operation and maintenance phase of a composite water supply contract, being a post-construction activity, could be included in computing revenue under the percentage completion method under Accounting Standard 7; (ii) Whether service tax and value added tax forming part of the contract invoices could be included in the contract revenue for recognising income under Accounting Standard 7.

Issue (i): Whether the operation and maintenance phase of a composite water supply contract, being a post-construction activity, could be included in computing revenue under the percentage completion method under Accounting Standard 7.

Analysis: The contract comprised distinct phases, namely study, rehabilitation, and a separate five-year operation and maintenance phase. The construction phases were completed before the operation and maintenance phase commenced. The maintenance phase involved separate post-construction services such as billing, collections, monitoring, and complaint handling, and the receipts for that phase were separately invoiced and offered to tax in the years of receipt. On these facts, the operation and maintenance component was not part of the construction activity for applying the percentage completion method.

Conclusion: The operation and maintenance phase was required to be separately considered and was not includable in the percentage completion computation; the issue was decided in favour of the assessee.

Issue (ii): Whether service tax and value added tax forming part of the contract invoices could be included in the contract revenue for recognising income under Accounting Standard 7.

Analysis: Service tax does not partake the character of income, and the same principle applied to value added tax, which also did not form part of the assessee's income. Amounts collected towards such taxes were therefore not part of taxable revenue for the purpose of computing profits of the year.

Conclusion: Service tax and value added tax were excluded from contract revenue for income recognition purposes; the issue was decided in favour of the assessee.

Final Conclusion: The separate post-construction operation and maintenance receipts were outside the construction revenue computation, and indirect taxes collected under the contract were not to be treated as income. The appeal was allowed in full.

Ratio Decidendi: Where a contract contains separately identifiable and independently performed phases, only the construction component is to be brought to account under the percentage completion method, and statutory levies collected under the contract do not form part of taxable income.

---