TaxTMI 
TaxTMI 
1991 (2) TMI 177
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....salvage operation, the assessee engaged the services of three specialised vessels on hire which are fitted with necessary diving gears, namely 'Malacca', 'Orinoco' and 'Monsoon' all through M/s. Smith International of Singapore, shipping agent. The assessee has followed a Hybrid system of account for this salvaging business insofar as it has followed mercantile system for expenses and cash system for income. " "New Business :-- As already stated in para 2, the assessee entered into a contract with the BPT for salvaging operation during the year. The BPT contract is peculiar in nature as it is strictly a time-bound contract, technically known as 'time is the essence of the contract'. it is also bound by a technical qualification on 'no cure no pay basis'. The whole meaning of such technicalities boils down to the basic principles that :-- (1) The contractor shall be bound to perform the work within a fixed time limit. (2) The contractor shall operate against a lump sum consideration agreed as per tender. (3) The contractor shall be entitled to the lump sum only if the contract is discharged successfully and in case of failure nothing shall be payable. These, in short, are the ....
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....ssee has chosen a hybrid system of accounting for this new line of business. It has treated the expenditure incurred by it for salvaging works on mercantile basis but has chosen to account for the income on receipt basis. This method adopted by the assessee suffers from glaring lacunae. Any business venture in the nature of a project which is expected to continue for a considerable period of time is generally accounted for in one of two long accepted basis. A contractor may choose to offer the work done by it from time to time on percentage of completion basis weighing it against the billing made or partial payments received against such work. This is generally known as work-in-progress method. The other way is to offer the work on a completed contract method. The rationale of this second method is that income or loss arises only on ultimate completion of the project and not from year to year before the completion. In general contract business there is no third method followed for arriving at true income or loss of the project. The work-in-progress method allows the contractor to charge all its expenses to the trading account against the value of work-in-progress. This method is ba....
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....ystem by "Compendium of Statements and Standards on Accounting". The considerations in the selection of the Accounting Policies are discussed in para 16 of Accounting Standard--1 (AS-1). The primary consideration in the selection of Accounting Policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as at the Balance Sheet date and of the profit or loss for the period ended on that date. Accordingly, to conclude that the business has resulted in a huge loss where the work is not yet complete and the income has not yet been received cannot be said to be a true and fair view of the state of affairs. Para 18 of the AS-1 makes it obligatory that to ensure proper understanding of the financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Para 26 of the AS-1 dealing with the disclosure of the accounting policies states that any change in the accounting policies which has a material effect in the current period or which is reasonably ....
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....f the observation of the Auditors, the verification of such consumption of spares and utilisation of labour comes immediately to question. A query was raised before the assessee relating to the maintenance of stock and the closing stock of spares available at the end of the year. No stock register could be produced by the assessee in respect of spares. Vide their letter dated 23-2-1989, M/s. P.P. Katdhare has stated further "As already explained vide our letter dated 6th February, 1989, there is no stock on hand since all stores are purchased against work as and when required. The company does not maintain stock register or other documentary evidence for consumption of stores because these are controlled through the personal supervision of the Management. In the circumstances, it is not by any means difficult to conclude that the expenses incurred by the assessee are not fully verifiable and, therefore, not fully ascertainable. Hence such debit of unascertainable expenses to the accounts on accrual basis against some incomplete and immeasurable work cannot be allowed. Motive of the Assessee : The main business of the assessee is that earning income by hiring out its ship "Ocean Pea....
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....nbsp; Rs. Rs. Rs. ----------------------------------------------------------------------------------- 1985 1,53,79,867 2,12,99,587 Nil 59,19,549 1986 2,81,21,686 3,59,22,858 Nil 78,01,172 1987 2,48,97,069 2,91,96,838 Nil 42,83,335 The motive of the assessee in embracing this hybrid system of accounting comes out ....
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....ss at the definite completion of the project. Expenses on Incomplete Projects : From the details filed, the following expenses shall be fully attributable to the 'Incomplete Projects of the assessee, that is the salvage contracts performed through the three vessels hire through M/s. Smith International namely Malaca, Orinoco and Monsoon. Rs. (i) Charter hire charges to Smith International 1,02,98,682 (ii) Tender fees 799 (iii) Stores consumed (* @ 75% of total expenses)....
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....; 1,00,000 ----------- 1,33,40,340 ----------- Thus it can be seen that the assessee has incurred a sum ....
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....nt of contract Rs. 71 lakhs (3) CHERRY CHENTAK: The first phase of the contract was to locate the ship and the contract amount was Rs. 20,00,000 for this. Wreck could not be located till 30-11-1985 and B.P.T. refused further extension vide their letter dated 22-5-1986. There was no question of further salvage work. (4) SUN RISE : Work started 15-2-1985 Due date of completion of work 20-9-1986 Work completed Not yet. It will be seen from the above facts that none of the contracts was completed during the accounting period relating to the Assessment year 1986-87 which ended on 31-12-1985. Payments of all these contracts was based on "No Cure No Pay" basis and no estimate of the amount receivable could, be made until the contract was completed. A....
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....expenditure and tender fees expenses were spent exclusively on these contracts. The rest of the expenses have by and large been divided in the ratio of vessels used for these contracts and other services and the allocation appears to be justified. The estimate of Rs. 1 lac out of Head Office and other Misc. expenses allocable to these contracts also appears to be in order and does not need any interference.' 3. The assessee is aggrieved, hence this second appeal and we have heard the parties at length. The grievance of the assessee stands summarised as under :-- (i) The assessee is agitated and aggrieved with the action of the learned lower authorities in treating 75% of the expenditure incurred as the expenses incurred on marine salvage operation, which the revenue claims to be new business. The assessee claims that this expenditure is allowable as in the nature of revenue one in computing the total income of the assessee. (ii) The assessee is aggrieved against the action of the learned lower authorities in not allowing the claim for investment allowance on new machinery purchased during the year. The assessee has placed on our file paper books containing 1 to 40 pages, 1 to 46....
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....bsp; Time allowed - 6 months Work actually started - 7-8-1985 Work completed - 1-6-1986 Amount/Date of billing - Rs. 71 lakhs on Amount received/ Date - Rs. 70.09 lakhs on 28-6-1986 - Rs. 0.91 lakhs Remarks - Work started in Assessment year &nbs....
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.... Assessment year 1986-87 and was completed in assessment year 1989-90 Amount received in Assessment year 1989-90. (3) SUNRISE -SALVAGING &n....
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....nbsp; Amount received - -- Remarks - Whether conditions prevented resumption after 7-6-1985. Extension allowed  ....
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.... mercantile basis. About one of the contracts mentioned above at SI. No. 4, the learned Senior Departmental Representative contended that it was only survey and no other services. The motive is attributed to the assessee for claiming expenses to neutralise the hire charges/chartering income and claimed that assessee's business this year is distinctly new. Indermani Jatia v. CIT [1959] 35 ITR 298 (SC) at page 299, CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC) at page 123, Ganga Ram Balmokand v. CIT [1937] 5 ITR 464 (Lahore) at page 465, CIT v. Sarangpur Cotton Mfg. Co. Ltd. [1938] 6 ITR 36 (PC), Jamna Das Rameshwar Das v. CIT [1952] 21 ITR 109 (Punjab) CIT v. McMillan & Co. [1958] 33 ITR 182 (SC), Sundaram & Co. Ltd. v.CIT [1959] 36 ITR 162 (Mad.) S.N.Namasivayam Cheitiar v. CIT [1960] 38 ITR 579 (SC) Royal Medical Hall v. CIT [1962] 46 ITR 748 (AP), P.M. Mohammed Meerakhan v. CIT [1969] 73 ITR 735 (SC), Sree Shanmugar Mills Ltd. v. CIT [1974] 96 ITR 411( Mad.), Dhondiram Dalichand v.CIT [1971] 81 ITR 609 (Bom.), Sukhdeodas Jalan v. CIT [1954] 26 ITR 617 (Pat.), Tirath Ram Ahuja (P.) Ltd. v. CIT [1990] 186 ITR 428 (SC), Fancy Corpn. Ltd. v. CIT [ 1986] 162 ITR 827 (Bom.), E....
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....resentative and additionally for the reasoning that the finding of the learned lower authorities that the machinery had not been utilised for assessee's business, viz. manufacturing purposes inasmuch as, according to the revenue, the assessee is engaged in hiring out the ship and providing diving services and salvage operations. No case has been made out on behalf of the assessee. The ground stands rejected. 5. As regards the main grievance, in the context of 'Fact Sheet on 4 Contracts' as reproduced in the body of the order above, we will take each contract individually for discussion here. Now first contract was dated 5-6-1985. The work was completed on 1-6-1986. Amount was received on 28-6-1986 and it relates to assessment year 1987-88, i.e., the payment part. The second contract is dated 21-1-1985. It was billed on 5-12-1988. Payment was received in the accounting period relevant to assessment year 1989-90. The third contract is dated 15-2-1985 and it was pending till assessment year 1989-90. The fourth is dated 15-2-1985. Time involved was two months. Work started on 19-4-1984, i.e., after the time allowed but it was stopped on 7-6-1985 and weather conditions are claimed to h....
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....se to him in India during such year. Explanation 1 : Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India. Explanation 2 : For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.' Needless to mention that these two sections are said to be substantive sections in the Act and others are said to be procedural. 7. Under the charging section, viz., section 4 of the Act, the subject matter of charge is the total income of a previous year and the same is to be worked out in accordance with and subject to the provisions of the Act. Under section 5, the scope of total income of a previous year is subject to the provisions of the Act but it includes all incomes from whatever source derived, which is received or is deemed to be received in India or, else, has accrued or arisen or ....
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.... Simply because the assessee had incurred expenditure and the income has resulted in the subsequent accounting periods, the claim for expenses could not have been disallowed. In fact, the learned CIT (Appeals) in para 11 of the impugned order has observed that the Assessing Officer has not made any extra disallowance for the reasoning that the expenses were not fully verifiable and ascertainable. He has observed that the finding was used to make an estimate of expenses relating to incomplete contracts. This reasoning of the Assessing Officer, as such, also goes. The Hon'ble Supreme Court in the case of CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 has laid down the ratio that materialising of income in the accounting period is not a pre-requisite to qualify the expenditure for deduction since it has held that the expenditure shall be deducted only if any income is made or earned is an incorrect proposition of law. In that case, the assessee borrowed moneys for the purposes of making investment in certain shares and paid interest thereon during the accounting period relevant to the assessment year but did not receive any dividend on the shares purchased with those moneys. The Hon'....
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....) of section 145, hence the method of accounting in view of the above facts is not at issue. The reasoning of the learned lower authorities is that each contract has to be treated as a distinct and separate project and expenditure is allowable only when the contract results in income, i.e., when the contract is completed. This is not the correct method inasmuch as once an assessee is in business and the regular activity is what is being carried on this year also, then whether or not the contracts result in income, the expenditure has got to be allowed and it cannot be disallowed for the only reasoning that there has been no income this year but that income has been received in subsequent assessment years. Earning of income is not a pre-requisite for allowance of expenditure and in this view of the matter, on the facts of the assessee's case, the motive cannot be attributed because the details of the 'facts sheet of 4 contracts' reproduced above and the resultant income returned by the assessee in the subsequent assessment years belie the stand of the revenue. 10. To summarise, on the facts and in the circumstances of the case, we do hold that claim of the assessee made as expendit....
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....down is that where amounts have neither been received nor could be deemed to have been received, it could not be taxed as income. 12. In A. Krishnaswami Mudaliar's case at page 13, the Hon'ble Supreme Court held that section 13 does not compel the Income-tax Officer to accept a balance sheet of cash receipts and outgoings prepared from the books of account ; he has to compute the income in accordance with the method of accounting regularly employed by the assessee. Further, that, whereas under the cash system no account of what are called the outgoings of the business either at the commencement or at the close of the year is taken, according to the mercantile method actual cash receipts during the year and the actual cash outlays during the year are treated in the same way as under the cash system but to balance thus arising, there is added the amount of the outstandings not collected at the end of the year and from this is deducted the liabilities incurred or accrued but not discharged at the end of the year. In Ganga Ram Balmokand's case at page 465, the Lahore High Court has held that the only section under which the method of computing income for the purposes of sections 10, 1....
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....results of that system and to deduce the true income of the assessee. In S.N. Namasivayam Chettiar's case at page 580, the Hon'ble Supreme Court has held that the power to compute profits under the proviso to section 13 arises only where no method of accounting has been regularly employed by the assessee and where the method is such that the income, profit and gains cannot properly be deduced therefrom. It means that the method adopted by the assessee must prima facie prevail where it is regularly employed, that the Income-tax Officer can resort to the proviso if the method is such that the true profits cannot be correctly determined therefrom. In other words, even if the assessee has regularly employed a method of accounting, it can be discarded under the proviso if the method does not show the correct profits of the year. In Royal Medical Hall's case the Hon'ble Andhra Pradesh High Court has laid down the same ratio as above, viz. that even if the assessee has employed a regular method of accounting, if the Income-tax Officer comes to the opinion on proper materials that the income, profits and gains cannot be properly deduced from assessee's accounts, the Income-tax Officer can ....
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....the assessee that profits should be ascertained on the completion of the contract and assessment of the profit should take place after the completion of the contract. But section 3 imposes a charge of income-tax upon the profits and gains of the assessee for the accounting period and it is the duty of the Income-tax Authorities to ascertain the profits and gains accruing to the assessee in respect of the payment received during the accounting period. It cannot be said that merely because a contract was completed after the accounting year, no profits arose or accrued to the assessee in the accounting year. In the case of an incomplete contract, there is a well established method of calculating profits accruing in the accounting year, which is set out at page 917 of Batliboi's Advanced Accounting. Mathematical certainty is not demanded in a case of this description. In that case, the assessee had contracts with two Departments of the Government, viz. the Public Works Department and the Defence Department. In Tirath Ram Ahuja (P.) Ltd.'s case the Hon'ble Supreme Court while holding that the decision of the Income-tax Appellate Tribunal will not give rise to a question of law since wha....