L AND T MHPS TURBINE GENERATIORS PRIVATE LIMITED,MUMBAI vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 2(2), MUMBAI

The assessee has filed this appeal challenging the order dated 07.04.2017 passed by Ld CIT(A)-5, Mumbai and it relates to the assessment year 2010-11. The assessee is aggrieved by the decision of Ld CIT(A) in confirming the disallowance of “Provision for foreseeable loss” of Rs. 45.83 crores claimed by the assessee during the year under consideration.

2 L&T MHPS Generators Pvt. Ltd. project of the assessee. During the year ending 31.3.2010, i.e., in the very next year of the contract, the assessee expected loss from the “onshore supply” portion of the contract. It is stated that the assessee also could make saving of Rs.20 crores in the “Offshore supply” portion of the contract by way of sub-contracting the work. Accordingly, the assessee estimated the loss from the project as under:-

Total estimated cost for “Onshore supply” 110.39 crores Less:- Contract value 44.56 crores ------------------- 65.83 crores Less:- Savings in cost from Offshore supply 20.00 crores ------------------- Resultant foreseeable loss 45.83 crores ============ The assessee provided in the books of account of the Financial Year 2009-10 relevant to the assessment year 2010-11. The claim was made as per Accounting Standard 7 relating to Construction Contracts. The AO, however, held it to be a contingent liability and accordingly disallowed the claim. The Ld CIT(A) also confirmed the disallowance.

4. We heard the parties on this issue and perused the record. The case if the assessee is that it has followed the Accounting Standard 7 and accordingly provided for foreseeable loss. The relevant provisions of the Accounting standard are extracted below:-

“21. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35. …………………….

25. Under the percentage of completion method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually

3 L&T MHPS Generators Pvt. Ltd. recognised as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 35. …………………………… Recognition of Expected Losses

36. The amount of such a loss is determined irrespective of: (a) whether or not work has commenced on the contract; (b) the stage of completion of contract activity; or (c) the amount of profits expected to arise on other contracts which are not treated as a single construction contract in accordance with paragraph 8.”

Identical views have been taken in the above said cases by the co-ordinate benches. For the sake of convenience, we extract below the relevant observations made by the co-ordinate bench in the case of Dredging International N V (supra):-

“24. We have considered the issue and examined the various arguments and papers placed on record. The assessee justified its claim of future losses not only before the A.O. but also before the DRP by giving detailed factual position as well as legal arguments. We are surprised to note that instead of countering all these arguments and submissions the DRP rejected the entire explanation with a single sentence that assessee did not file proper reply. However, the DRP failed to explain what is 'proper reply' and how it expects the 'proper reply'. Since no reasons were given in rejecting assessee's explanation, we are unable to understand what the DRP meant by stating that assessee did not file proper reply. As far as the factual position is concerned assessee has given detailed explanation for estimating the future losses which in fact it had suffered and the final loss

4 L&T MHPS Generators Pvt. Ltd. was already determined by the A.O. in the next assessment year, the order of which does not contain any disallowance. There is evidence on record that assessee has suffered loss and loss claimed in that year on completion of the project stood allowed. No adjustments have been made to the loss claimed in later year. In view of this we are of the opinion that as far as quantification of loss is concerned assessee has made a justifiable claim in arriving at the future loss for this year.

"35. When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognised as an expense immediately.

"Having regard to the above legal and factual discussions, and following the decision of the ITAT in the case of Mazagaon Dock Ltd. (supra) and Metal Box Co. of India Ltd. (supra) and decision of the Hon'ble Delhi High Court in the case of CIT v. Woodward Governor India Pvt. Ltd. [2007] 294 ITR 451 (Delhi), the contention of the assessee regarding allowability of foreseeable loss is accepted in principle."

The decision of Mumbai Tribunal in the case of Mazagaon Dock Ltd. (supra) was also in favour of allowing future losses. In this case, assessee, as per method of accounting in case of contracts where loss was anticipated reckoned the entire loss, based on estimated realizable values

5 L&T MHPS Generators Pvt. Ltd. and estimated cost of contracts in the first year itself. The A.O. disallowed assessee's claim observing that this being only a provision made on estimated basis, cannot be allowed. The Tribunal held as below: -

"He seems to have swayed more by revenue loss than by the correct principle to be applied. The matching principle of accounting is not of much significance in the present context because if the loss has been property estimated in the year in which the contract has been entered into then it has to be allowed in that very year and cannot be spread over the period of contract. The matching principle is of relevance where income and expenditure, both are to be considered together. However, in the present case, the effect of valuation of WIP will automatically affect the profits of subsequent years accordingly. We, accordingly, do not find any reason for not accepting in principle assessee's claim as being allowable."

Assessee also placed reliance on the decision of Thermax Babcock & Wilcox Ltd.'s case (supra) wherein the ITAT had upheld the percentage completion method of Accounting followed by assessee as prescribed by AS-7. The Tribunal held that where assessee is following constantly the same method adopted in the first year of operation, also in subsequent years and where the method is one of the accepted accounting principles and practices sanctified by usage and is also in line with recommended standard AS-7 prescribed by ICAI, then the said method did not violate the provisions of charging section and addition on account of provisioning is not justified.

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Industrial Investment Corporation Ltd., i.e. allowability of discount on debentures. The Court held that while the entire amount of discount was not allowable deduction, the discount had to be spared out proportionately over the number of years for which the bonds were issued and the proportionate amount of discount would be allowed expenditure. iv. In Mysore Kirlosker Ltd.'s case (supra), the issue which was raised before the Court was whether donation given by the assessee can be claimed under section 37(1). In this case, assessee-company had promoted a trust which had constructed school to provide education for the children of the employees and ex-employees of the assessee company. During the year, assessee company donated Rs. 62,000/- to meet the expenditure of the school. Assessee claimed deduction of this expense under section 37(1) of the Act. The Court observed that sections 37(1) and 80G are not mutually exclusive. In other words, the Court observed donation if laid out wholly and exclusively for the purpose of business should be allowed under section 37(1) of the Act. Accordingly, the Court in the present case allowed deduction of Rs. 62,000/- to assessee.

instance, for computation of income from civil construction in cases where the accounts have not been maintained as required under section 44AA(2)(i) and the turnover does not exceed Rs. 40.00 lacs, there is special provision under section 44AD to compute the income @8% of turnover or gross business receipts. Similarly there is special provision for computation of profit from retail business under section 44AF. There are also special provisions for computation of income for certain specified businesses in respect of non-residents. For instance, the income from shipping business in case of a non-resident is required to be computed under the provisions of section 44AB under certain conditions which are not satisfied. There are no special provisions for computation of income from construction projects. It is no where provided in the Act that income from construction projects has to be completed in the manner prescribed in AS-7. Therefore, the income from rehabilitation projects is required to be computed under the normal provisions of the Act. The Accounting Standard, AS-7 has also not been notified by the Government. Therefore, there is no case for computation of income for the purpose of taxation to be made as per Accounting Standard AS-7. When pointed out, the ld. A.R for the assessee submitted that even the Accounting Standard AS-1 notified by the Government provides for allowance of loss in respect of all known liabilities and therefore, provisions for losses has to be allowed as per the notified AS-1. ………………..

2.11.3 A careful perusal of the Accounting Standards AS-1 & AS-2 notified above shows that these are only regarding disclosure of accounting policies and disclosure of prior period expenses and extraordinary items and changes in accounting policies. These provide that the assessee should disclose all significant accounting policies or any changes in accounting policies. It further provides that the accounting policy should be such so as to represent a true and fair view of the state of affairs of the business, profession or vocation. In this context it has been mentioned that the provisions should be made for all known liabilities. The Accounting Standard notified no where provides that the provisions for known liabilities should be allowed as deduction while computing total income. Whether the provision made can be allowed as deduction or not will depend on facts and circumstances of the case. It is a settled legal position that provisions in respect of liabilities which had been incurred during the year have to be allowed as deduction even if liabilities are required to be discharged at a future date if they can be estimated with reasonable certainty. This legal position has been declared by the Hon'ble Supreme Court in several cases such as in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC); in case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53; and in case of Bharat Earth Movers v. CIT [2000] 245 ITR 428/112 Taxman 61 (SC). It has been made clear in these cases that for claiming deduction on account of any provision for liability, the incurring of liability during the year must be certain. In case of Calcutta Co. Ltd. (supra), the assessee had sold land with an undertaking to develop it within six months. The sale deed had been executed and on the sale deed date, the assessee had received part of the sale consideration

8 L&T MHPS Generators Pvt. Ltd. and balance was to be received in installments in future. The assessee had also to develop the land within six months from the sale deed date. It was held that on the date of sale deed, income had accrued as per mercantile system even if part consideration was to be received later. Similarly on execution of sale deed, assessee incurred the liability to incur expenses to develop the land in future and therefore estimated expenditure on development of the land on a reasonable basis was held allowable as deduction. Precisely because of these reasons and the rulings mentioned above, the Accounting Standard AS-1 notified by the government provides that provisions shall be made in respect of all known liabilities so that AO could allow deduction in respect of liabilities which had been incurred during the year. ………………………..

2.11.6 Reliance has also been placed on the decision of the Tribunal in the case of Mazagon Dock Ltd. ( supra) and decision of the Tribunal in the case of Jacobs Engineering India (P.) Ltd. (supra), in which the previous decision of the Tribunal has been followed. Thus reliance is basically on the decision of the Tribunal in the case of Mazagon Dock (P.) Ltd. (supra). In that case also, the deduction had been claimed on account of anticipated loss as per Accounting Standard AS-7. The assessee had claimed the loss by switching over the method of accounting of income to AS-7. The Tribunal observed in the order that merely because change in method was bona fide, it could not lead to the inference that income was also deductible properly under the Act. Thus, even in that case the Tribunal held that income has to be computed under the provisions of the Act. However, Tribunal had also observed that there was no dispute in principle that estimated losses were allowable. The Tribunal therefore, held that the loss could not be considered as bogus as held by CIT(A) because the same had been computed as per the Accounting Standard AS- 7. The Tribunal had restored the issue to the AO for properly estimating the loss. It thus appears that the Tribunal even though observing that income has to be computed under the provisions of the Act allowed the claim in the understanding that there was no dispute about allowability of the losses. In the present case, the claim of the assessee has been strongly disputed and therefore, in our view, the issue has to be decided under the provisions of law and not as per Accounting Standard AS-7 which has not been notified by the Government. The cases cited by the assessee are, therefore, of no help. The assessee had also not pressed the application of AS-7 before CIT(A), as the same has not been notified by the government. Even before us emphasis was placed only on AS-1 as notified by the government, which we have already dealt with in para 2.11.3.”

A careful perusal of the above said decision rendered by the co-ordinate bench would show that the Tribunal has rendered its decision on the principle that AS-7 has not been notified by CBDT; that the AS-1 mentions about making of provision for liabilities and not for deduction; that the mere making of provision as per AS-1 will not entitled to claim deduction, unless

9 L&T MHPS Generators Pvt. Ltd. the liability is incurred. The co-ordinate bench has further distinguished the decisions rendered by earlier benches of the Tribunal by observing that “the Tribunal even though observing that income has to be computed under the provisions of the Act allowed the claim in the understanding that there was no dispute about the allowability of the losses. The Tribunal further held that “in the present case, the claim of the assessee has been strongly disputed and therefore, in our view, the issue has to be decided under the provisions of law and not as per Accounting Standard AS-7 which has not been notified by the Government.

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(b) When the contract was awarded on 5th September, 2008, the contract revenue for “onshore supply” portion was determined as Rs.44.56 crores.

(c) However, by 31.3.2010, i.e., within a period of 18 months, the cost has been claimed to have escalated to Rs.110.39 crores and a loss of Rs.65.83 crores was visualized. It is stated that the assessee could make a saving of Rs.20 crores in “offshore supply” portion of contract and hence the net loss visualized was Rs.45.83 crores.

When the onshore supply portion of the revenue in the contract was fixed at Rs.44.56 crores, the assessee would have estimated the cost lesser than the above said revenue. However, the cost has been claimed to have been escalated to Rs.110.39 crores within a period of 18 months, which is almost 300%. The claim that the cost has escalated by 300% within a period of eighteen months is unheard and accordingly, shall raise doubt in the minds of any prudent person, though it may be probable also. Accordingly, it is the obligation of the assessee to explain before the AO as to how the cost has escalated by 300% from the original estimate. The burden of the assessee is further increased on the reason that the contract has been obtained by the assessee from its promoter, a related concern.

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