1978 (10) TMI 2 - SC - Income Tax

Supreme Court: Govt-supplied materials not part of contractor profits. Appeals allowed.

The Supreme Court held that the cost of materials supplied by the Government (M.E.S. Department) should not be included in the estimation of the ... Estimation of contractor's profits excluding cost of governmentsupplied materials - Best judgment assessment - requirement of honest and fair estimate - Works contracts - governmentsupplied stores remaining government property - Turnover of a works contract - exclusion of nonprofit embedded suppliesEstimation of contractor's profits excluding cost of governmentsupplied materials - Works contracts - governmentsupplied stores remaining government property - Turnover of a works contract - exclusion of nonprofit embedded supplies - Cost of materials supplied by the Government for use in execution of works is not to be included in the turnover on which a flat rate is applied to estimate a contractor's profits where no element of profit is embedded in such supplies. - HELD THAT: - The Court examined the terms of the M.E.S. lumpsum contracts (including Schedule B and General Conditions Nos. 10 and 33) and held that the department's supplies are issued at fixed rates, remain the property of the Government, are to be used, fixed or incorporated in the works and surplus materials are returnable to the department with adjustments for wear and tear. On those contractual terms there is no theoretical or real possibility of any element of profit being embedded in the turnover represented by the cost of such materials. While ordinarily profits under a works contract are assessed on the value of the contract as a whole, where specified materials are supplied by the Government on terms that exclude transfer of beneficial ownership and do not permit the contractor to realise a profit on those supplies, the real value of the contract for assessing the contractor's income is the contract value less the cost of such governmentsupplied materials. Applying the established principle that a bestjudgment assessment must be an honest and fair estimate related to available material (not capricious or wild guesswork), the Court concluded that the taxing authorities erred in including the cost of such governmentsupplied materials in the assessable receipts and approved the contrary view of the Appellate Tribunal and the High Courts which excluded such cost.The cost/value of stores/materials supplied by the M.E.S. for incorporation in works is not includible in the turnover for estimating a contractor's profits; the Appellate Tribunal's view excluding such cost is restored.Final Conclusion: Appeals allowed; the orders of the Punjab and Haryana High Court are set aside and the Appellate Tribunal's orders restored, holding that governmentsupplied materials (used, fixed or incorporated under the contracts and remaining government property) are not to be included in the contractor's turnover for profit estimation; revenue to pay costs. Issues Involved:1. Whether the cost of materials supplied by the Government (M.E.S. Department) should be considered while estimating the profits of a contractor.2. Whether the Income Tax Officer (ITO) made a fair and honest estimate in the best judgment assessment.Detailed Analysis:Issue 1: Cost of Materials Supplied by the GovernmentThe primary issue in these appeals was whether the cost of materials supplied by the Government (M.E.S. Department) to contractors should be included in the estimation of the contractor's profits. The facts of the cases were similar, with the assessees being M.E.S. contractors who received materials like cement, coal, and steel from the Government at fixed rates specified in Schedule B of the contract. These materials remained the property of the Government and had to be returned if surplus remained after the contract's completion.The Income Tax Officer (ITO) estimated the cost of these materials at 50% of the cash payments received by the contractors and added this to the total receipts to estimate the profits. The Appellate Assistant Commissioner (AAC) reduced this estimate to 25%, but the Income Tax Appellate Tribunal (ITAT) held that the cost of materials supplied by the Government should not be included while estimating the profits. The Tribunal reasoned that these materials were never sold to the contractor and remained the property of the Government, thus no profit could be said to have arisen from them.The Punjab and Haryana High Court, however, disagreed and held that the cost of materials supplied by the military authorities should be included before applying the flat rate to the contractor's receipts. This decision was challenged in the Supreme Court.Issue 2: Best Judgment AssessmentThe second issue was whether the ITO made a fair and honest estimate in the best judgment assessment. The Supreme Court reiterated that while making a best judgment assessment, the ITO must make an honest and fair estimate of the income of the assessee. The estimate should not be capricious but should have a reasonable nexus to the available material and the circumstances of the case.The Supreme Court referred to the principles laid down by the Privy Council and previous decisions of the Court, emphasizing that the assessment must be based on some evidence or material and not mere suspicion.Supreme Court's Decision:The Supreme Court held that the cost of materials supplied by the Government should not be included in the estimation of the contractor's profits. The Court noted that the materials supplied by the Government remained its property and were merely handled and used by the contractor. There was no element of profit embedded in these materials.The Court emphasized that the real total value of the contract should be the value minus the cost of such materials supplied by the Government. Therefore, the income or profits derived by the contractor should be determined based on the cash payments received from the Government, exclusive of the cost of the materials supplied.The Supreme Court approved the views taken by the Kerala High Court, Madras High Court, Gujarat High Court, and Andhra Pradesh High Court, which held that the cost of materials supplied by the Government should not be included in the contractor's profits.Conclusion:The appeals were allowed, and the impugned orders of the Punjab and Haryana High Court were set aside. The orders of the Appellate Tribunal were restored, and the revenue was directed to pay the costs of the appeals to the assessee-firms.Appeals Allowed.