Scope for making addition on a/c of disallowance of expenditure u/s 40(a) in a case where assessee follows ‘completed contract method’
The correct procedure in “completed contract method” is that instead of making addition, if some expenditure are found to be not allowable, the AO should correct the amount of work-in-progress by reducing or enhancing work-in-progress as the case may be
ITAT MUMBAI, BENCH ‘J’
Savala Associates
v.
ITO
ITA No. 4441/M/2008
October 27, 2009
RELEVANT EXTRACTS:
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6.1 On plain reading of above section, we find that certain expenditures are not allowable if the assessee failed to deduct tax or after deduction same was not paid in time. However, such expenditures are allowable Provided that where in respect of any such sum. Tax has been deducted in any subsequent year, or has been deducted—
(A) during the last month of the previous year but paid after the said due date; or
(B) during any other month of the previous year but paid after the end of the said previous year.
Such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.
6.2 The above provision is related to amount not deductible while computation of income chargeable under the head 'profits and gains of business or profession. Basically, income chargeable under the head 'profit and gains of business or profession' or 'income from other sources', be computed in accordance with cash or mercantile system of accounting regularly employed by the assessee. Recognition/ identification of income under the I.T. Act is attainable by several methods of accounting considering the nature of business activities. It may be noted that the same result could be attained by any one of the accounting methods. "Completed contract method'' is one such method. Similarly, "percentage of completion method" is another such method. Under the "completed contract method", the revenue is not recognized until the contract is complete. Under the said method, costs are accumulated during the course of the contract period. As per the accepted accounting principle, it is accumulated under one head of account, work-in-progress'. The project constituted the stock-in-trade of the assessee. The project did not constitute a fixed asset of the assessee. In the last accounting period when work is completed, the profit and loss account is prepared, that 'work-in-progress' account is to be transferred in profit & loss account. Thus, the "completed contract method" determines profits/loss only when contract is completed. Now question arises how the profit is to be calculated in case of 'completed contract method'. One of the important aspects to be seen is Cost incurred by a contractor which can be divided into Cost that relate directly to a specific contract; Cost that can be attributed to the contract activity in general and can be allocated to specific contracts and Costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts. Examples of costs that relate directly to a specific contract include :site labour costs, including supervision: materials used for project construction; depreciation of plant and equipment required for a contract; costs of moving plant and equipment to and from a site. Examples of costs that can be attributed to the contract activity in general and can be allocated to specific contracts include: insurance; design and technical assistance; construction overheads. Examples of costs that relate to the activitiesof the contractor generally, or that relate to contract activity but cannot be related to specific contracts, include: general administration and selling costs; finance costs; research and development costs; depreciation of plant and equipment that cannot be allocated to a particular contract. In case of ""completed contract method", the above expenses related to individual project have to be capitalized in work-in-progress which is similar to stock in trade, of respective individual project. Opening balance of work-in-progress of individual project will go up in the relevant year. When these projects were completed, in that year, income has to be computed after considering increased opening work-in-progress and receipts of the relevant project. Accordingly, in the year when these projects were completed, income on account of those projects is be computed after considering increased opening balance of work-in-progress due to addition of expenses for the period of project in work in progress. Contrary, if certain expenditures are not allowable under the Act the work in progress will not increased by that amount. Such expenses are to exclude from the Work in progress if same were included by the assessee. For the above purposes the AO has to examine the work in progress account in each assessment year. If on examination the AO did not find any mistake in work-in-progress account then said work-in-progress is to be carried forward in the next year and so on till completion of project. If on examination, the AO found that the work-in-progress shown in books of account is not correct, the AO is empowered to correct the same. In other words, it can be said that work-in-progress is just like one side of profit & loss account i.e. debit side, the AO can have all powers to examine this debit side of profit & loss account including the power of examination of allowability / disallowability of expenditure u/s 40(a) of the Act. In the case under consideration we find that the AO has rightly noted that the expenditure claimed by the assessee which are subject to TDS liability but TDS was no paid in time; therefore these were disallowable u/s 40(a). In principle we agree with above view of revenue that in case oi "completed contract method" the AO is empowered to examine the expenditures incurred during the year which increases the opening work in progress or addition in work in progress. But we do not agree with the view of revenue that addition is to be made in total income, if some expenditure were found not allowable/The correct procedure in "completed contract method” is.. that instead of making addition the AO should correct the amount of work-in-progress by reducing or enhancing work-in-progress as the case may be a such corrected WIP will be finally considered in profit and loss account/contract account for the year in which work is completed. The result of calculation of correct profit in case of "completed contract method" could be attained by this procedure. In the case under consideration, the AO made addition in all the projects including incomplete projects, which is not warranted. Such addition in total income is warranted only in respect of project which is completed during the year. The learned AR has conceded the additions in respect of completed works. Necessary calculation is required after verification from original record. The original record is not readily available at this stage under the circumstances we send back this matter to the file of the AO with direction to delete the additions made in total income in respect of incomplete projects. However the addition in respect of completed project is to confirm subject to verification of calculation of the amount. The AO is further directed to correct the amount of work-in-progress of incomplete works/projects in accordance with the above discussion and after providing opportunity of hearing to the assessee.
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