1. These six appeals, three from the assessee and three from the Revenue, for assessment years 1981-82, 1982-83 and 1983-84, are combined for the sake of convenience.
2. We first take up the appeals from the assessee. The assessee is a company in which public are not substantially interested. In the years under consideration, it had undertaken a project of construction of a multi-storeyed building. For assessment years 1981-82 and 1982-83, the assessee had sold 11 flats in each year and had respectively realised amounts of Rs. 5,89,500 and Rs. 2,39,488. For assessment year 1983-84, the sale proceeds of flats realised by the assessee worked out to Rs. 8,20,833. For these three years, however, the assessee had not shown any profit. For assessment year 1981-82, the Assessing Officer had completed the original assessment on 24-2-1984 but it was reopened by issue of notice under Section 148 on 12-3-1986. Despite the service of notice on the assessee on 14-3-1986, no return was filed by the assessee and, therefore, the Assessing Officer, after issue of notice under Section 142(1), had completed the assessment under Section 144 of the IT Act. For assessment years 1982-83 and 1983-84, the assessee had filed the return of income but, however, the income for both the years was declared at nil. The contention of the assessee before the Assessing Officer was that the assessee was engaged in construction of flats and no profit accrued during these three years as the project was not complete. The assessee had taken a stand before the Assessing Officer that in the case of a building contractor, the profits should not be assessed on year-to-year basis and the ascertainment of the profit should be done at the end of the contract work. Thus, the assessee was of the view that the profit in its case should be assessed only after the contract work was completed. It was, therefore, accordingly, pleaded before the Assessing Officer that no profit for the years under consideration should be computed. Hence the assessee had requested the Assessing Officer to accept the returns for the assessment years under consideration.
3. The Assessing Officer was, however, of the view that the method of accounting followed by the assessee was defective and incomplete. The method of accounting followed by the assessee, therefore, did not lead to the correct computation of income. The Assessing Officer took cognisance of the note No. 4 in Schedule VII of the Annual Accounts forming part of the balance-sheet, in which the auditors had mentioned: "the work-in-progress has been not technically evaluated and is represented by the balance figure of profit and loss account". In other words, the Assessing Officer found that while preparing the profit and loss account for the years under consideration, the assessee-company had debited opening stock, work-in-progress (opening), purchase of construction material, salaries, labour charges and other incidental expenses. The credit side of the profit and loss account contained the amount of sales, closing work-in-progress and closing stock of construction material. However, the assessee had manupulated the closing work-in-progress. The closing work-in-progress in the opinion of the Assessing Officer, was not valued by the assessee by following any method. The assessee would put on credit side any amount which will bring the profit to 'Nil'. The'assessee had followed this method on the ground that the profit does not accrue to the assessee from year to year and it accrues only after the completion of the contract. The Assessing Officer was, therefore, of the view that the method of accounting followed by the assessee was defective and hence he rejected the same. With a view to arrive at the reasonable profit for the years under consideration, the Assessing Officer applied the provisions of Section 145 and computed the business income of the assessee at 8 per cent of the receipts mentioned above. This resulted in the assessment of profit of Rs. 47,160 for assessment year 1981-82, Rs. 19,160 for assessment year 1982-83 and Rs. 65,666 for assessment year 1983-84.
4. In addition to the estimate of profit mentioned above, the Assessing Officer also found that the interest payment to certain extent was also to be disallowed under the provisions of Section 40A(8) of the IT Act.
By applying the said provisions, the Assessing Officer added the interest of Rs. 44,473 for assessment year 1981-82, Rs. 86,798 for assessment year 1982-83 and Rs. 65,834 for assessment year 1983-84.
Thus, the total income of the assessee was computed at Rs. 91,630 for assessment year 1981-82, Rs. 1,25,370 for assessment year 1982-83 and Rs. 1,71,140 for assessment year 1983-84.
5. Being aggrieved, the assessee-company went in appeal before the first appellate authority. The assessee had objected to the estimate of profit at 8 per cent of the receipts for all the three years under consideration and also the disallowance of interest under Section 40A(8) of the IT Act. The Commissioner of Income-tax (Appeals) examined the issue on both the counts and was of the view that the estimate of business at 8 per cent of the receipts was justified. She, therefore, upheld the computation of business income. She also observed that the determination of business income at 8 per cent of the receipts was reasonable and therefore, she did not interfere with the assessment ordsrs of the Assessing Officer. Against this, the assessee has come up in appeals before us.
6. However, the assessee succeeded in respect of the addition of interest under Section 40A(8) of the IT Act. The CIT (Appeals) was of the view that the business profit of the assessee had been estimated under the provisions of Section 145 of the IT Act and, therefore, such estimate should be deemed to include the disailowable interest under Section 40A(8) of the IT Act. She accordingly deleted the interest of Rs. 44,473, Rs. 86,798 and Rs. 65,834 respectively for assessment years 1981-82, 1982-83 and 1983-84, Against this, the Revenue has filed the appeals before us.
7. Sri M.J. Swamy, learned counsel for the assessee, very strenuously addressed arguments before us and contended that in the case of a building contractor, no profit accrues from year to year. Unless the contract is complete and all the flats are sold, the Revenue cannot assess the assessee on notional income when as a matter of fact no income accrued to the assessee. Though the profit and loss account, balance sheet etc. were prepared in the case of the assessee, these were for the purpose of keeping control over the project and not for finding out the profit for the year under consideration. As a matter of fact, the closing work-in-progress was valued with a view to neutralise the debit side of the profit and loss account. He, therefore, urges that the CIT (Appeals) erred in confirming the estimate of the income at 8 per cent of the sale price of the flats during the relevant years under consideration. The CIT (Appeals), without any justifiable reason, failed to appreciate that the assessee is liable to pay the tax only after the completion of the entire project. In the opinion of the learned counsel, the profit on sale of flats registered in the accounting year under appeal cannot be ascertained and hence no profit on sale of flats can be included in any of the assessment year till the completion of the entire project since 'the expenditure incurred for each one of the flats sold cannot be ascertained to find out the profits on sale of individual flats or office accommodation.
8. Sri Swamy has also brought to our notice, the decisions of the Income-tax Appellate Tribunal, Hyderabad Bench 'B', in the case of Decent Builders for assessment years 1982-83 and 1984-85. In ITA No.952/ Hyd./1987, dated 22-3-1990 and ITA No.l806/Hyd./1987, dated 4-3-1993, the contention of the assessee, that the profit accrues after the completion of the contract, was accepted by the Tribunal. In the opinion of the learned counsel, therefore, the issue is fully covered in his favour by the aforesaid two decisions. He, therefore, prays that the orders of the CIT (Appeals) on this count should be vacated.
9. Alternatively, the learned counsel contends that, without prejudice to the contention that no part of the income on sale of flats registered in the accounting years is includible in the income of the assessee, the rate of 8 per cent adopted by the Assessing Officer and confirmed by the CIT (Appeals) is excessive. He, therefore, urges that the rate adopted by the Assessing Officer should be suitably reduced.
10. On the other hand, the learned departmental representative, Sri K.Vasanth Kumar, argued that the method of accounting followed by the assessee was incomplete and does not lead to the computation of true income. The assessee's Auditors themselves had mentioned that the closing work-in-progress has not been scientifically valued by the assessee. The books of account maintained by the assessee are not closed and adjusted and part of the expenses also cannot be verified.
The books also cannot lead to the deduction of the true profit and, therefore, as per the decision of the Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 188 ITR 44, the Assessing Officer has to apply Sub-section (2) of Section 145 and compute the reasonable profit. He also points out that in the case of a building contractor, the Revenue normally takes 12 1/2 per cent as rate of profit, but as the contract is not complete, the Assessing Officer has adopted only 8 per cent which is reasonable and should be upheld.11. The learned departmental representative has also taken us through our own decision in the case of Decent Builders (supra) and points out that the Tribunal has not laid down any ratio to support the case of the assessee. As a matter of fact, the decision of the Tribunal in the case of Decent Builders (supra) is distinguishable on facts. He, therefore, urges that the decision of the CIT (Appeals) on this issue should be maintained.
12. We have heard both the parties at length. The issue for adjudication before us is to see whether in a contract work the profit accrues from year to year or it accrues only after the completion of the contract. In this regard, we have taken assistance of certain accounting methods of long-term contracts and have perused certain books like Batlihoi's Advanced Accounting, to arrive at the conclusion.
After due consideration of all the facts of the case, we are of the view that the profit in a long-term contract should be taxed on year to year basis. It is a dangerous proposition to recognise, that the profit accrues only after the completion of a contract. Such a proposition is liable to be abused by dishonest tax-payers. We have also gone through certain judicial authorities to which we will advert later and find that it is a judicially recognised proposition that in the case of a contract, in order to ascertain the income, one need not wait till the contract is completed and that it is open to the Revenue to estimate the profit on the basis of receipts in each year of construction, although the contract is not complete. It is therefore, not necessary for the Assessing Officer to wait till the completion of the contract to tax the business profit in the case of an assessee. In this view, we are supported by the decision of the Delhi High Court in the case of Tirath Ram Ahuja (P.) Ltd. v. CIT [1976] 103 ITR 15. On the facts of that case, the High Court held that "in the case of a contract, one need not wait till the contract was completed in order to ascertain the income and it was open to the Revenue to estimate the profit on the basis of the receipts in each year of the construction although the contract was not complete....". Our view is also strengthened by the finding of the Patna High Court in the case of Sukhdeodas Jalan v. CIT [1954] 26 ITR 617. The brief facts of the case before their Lordships of the Patna High Court were that the assessee was a contractor and he took a contract from the Defence Department on 14-4-1943. The assessee's accounting year was from 1-4-1943 to 31-3-1944. The assessee did not show in his return any income from the contract business in the accounting period 1943-44 on the ground that the accounts in respect of this contract were closed only on 3-12-1944 and, therefore, the profit from that contract could be ascertained only on that date. This issue was examined by the Honourable High Court under Section 3 and proviso to Section 13 of the 1922 Act. On facts, it was laid down that the scheme and the structure of the Income-tax Act is to make the tax and annual tax for the purpose of assessment. Section 3 makes each previous year a distinct unit of time for the purpose of assessment and the profits made before or after that unit of time are entirely immaterial in assessing the profits of that year. If the provisions of Section 3 are read in the context of Section 13, it is clear that the accounts maintained by the assessee must correctly show the profit of the preceding year. If the method of accounting adopted by the assessee does not reflect the true profits of the preceding year, the proviso to Section 13 will apply and the ITO will be entitled to compute the profit upon such basis and in such manner as he may determine. In the case of contracts, if accounts are maintained and completed on contract basis, the profits or gains of the previous year cannot properly be extracted from the accounts, for a contract may take several years for being completed and payments in regard to it may also be received by the assessee in several years. It may be convenient from the point of view of the assessee that profit 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 year and it is the duty of the ITO to ascertain the profits and gains accruing to the assessee in respect of the payment received during the accounting year. It cannot be said that merely because a contract was completed after the accounting year, no profit 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. In such a contract, the long-term contract method is adopted in respect of contracts which have to be completed by stages over a course of years, such as, building contracts or building schemes by co-operative or private enterprise, or contracts entered into with public authorities such as public works, Military, etc. The ascertainment of the profit in the execution of such contracts cannot be deferred till the completion of the entire constructions which may take several years. Each year's profit shall have to be, in the nature of things, computed on an estimate, having regard to the work completed during the year. The method of valuation set out by Batliboi's Advanced Accountancy is as follows: If a contract is nearly complete and only a small portion of the work remains to be done, an estimate will be made of the further expenditure on the portion remaining to be done and an allowance will also be made for the margin of profit on that portion. This estimate should be added to the amount already expended to the contract and the total will represent the cost of finishing the whole work. This cost should be compared with the contract price, and, if the latter exceeds the former, the excess will represent profit on the completed portion of the work.
13. With a view to arrive at the reasonable profit on an incomplete work, we also can gainfully refer to the observations in Spicer and Pegler's Bookkeeping and Accounts, 16th edition, page 301. In the said book, the method of valuation of a long-term contract has been discussed. As per the learned author: Any business which involves the expedience and completion of long term contracts, it is often appropriate to spread over the period of contract on a properly determined basis, the profits which are expected to be earned when the contracts are completed. This procedure takes up in each period during the performance of the contract a reasonable amount as representing the contribution of that period towards the eventual profit, it thus recognises to a prudent extent the value of the work done in each period and restricts distortion which would result from the beginning in the whole of the profit in the period of completion. The principles which determine whether an element of profit as to be included are: (a) profit should not be until it is reasonably clear from the state of the work that a profit will ultimately be earned: it is, therefore, inappropriate to include any profit element whether at the balance-sheet date the contract has been in progress for a comparatively short term, or to include an amount in excess of the profit element properly attributable to the work actually done; (b) provision should be made for foreseeable losses and allowance should be made as far as practicable for penalties, guarantees and other contingencies; (c) a clear basis for including a profit element should be established and adhered to consistently.
14. Thus, there are recognised methods of estimating with reasonable accuracy the profits accrued from time to time on uncompleted contracts. The fact that the contracts have not been completed or the accounts thereof have not been closed, is not sufficient reason for not estimating the profit of each year though absolute accuracy may not be reached. Thus, in a contract running over several years, the entire profits cannot be attributed to a single last year in which the contract was complete. The fact that it is not convenient or easy to allocate receipts or expenditure as against various items of trading assets is no reason for upholding that profits emerge only after the entire expenditure on the assets has been recouped; the allocation of expenditure and receipts must somehow be made on a reasonable basis and the debts and trading assets valued on the closing date. In such cases, in our view, a workable method is for the Revenue to assess on the basis of gross receipts of each year at a flat rate of profit on such receipts. The assessment in the case of a building contractor, therefore, need not be postponed till the completion of the contract.
If the profits can reasonably be arrived at from year to year, such profit should be assessed from year to year only. We have already pointed out above that the assessee has not correctly valued the closing work-in-progress and, therefore, it is the duty of the Assessing Officer to correctly value the closing work-in-progress and arrive at the true picture of the profit for the years under consideration.
15. Though the decision of the Supreme Court in the case of British Paints India Ltd. (supra) is not directly applicable to the facts of the case, we take assistance from the decision for a limited purpose of valuation of the closing work-in-progress. In the case before us, the Assessing Officer has applied the provisions of Section 145 to compute the profit in the case of the assessee. In the said decision, while examining the provisions of Section 145, the Honourable apex court observes: Section 145 confers sufficient power upon the Assessing Officer-say, it imposes a duty upon him to make such computation in such manner as he determines for deducing the correct profits and gains. This means that where accounts are prepared without disclosing the real cost of the stock-in-trade, albeit on sound expert advice in the interest of efficient administration of the business, it is the duty of the Assessing Officer to determine the taxable income by making such computation as he thinks fit.
On this issue, therefore, we hold that in the case of a Building Contractor, the Revenue need not wait till the completion of the contract and the reasonable profit can be estimated from year to year and brought to tax.
16. Regarding the reliance of the assessee on the decision of the Income-tax Appellate Tribunal in the case of Decent Builders (supra), we are of the view that the facts of that case are distinguishable. For assessment year 1982-83, in the case of Decent Builders (supra) the assessee, which is a builder, had filed the return declaring an income of Rs. 40,000 representing 10 per cent of the work-in-progress of Rs. 4,00,000. The Assessing Officer, however, made an addition of Rs. 1,00,000 towards unexplained investment under the head "other sources".
When the matter was examined by the CIT (Appeals), he found that none of the flats was complete and the possession was not handed over by the assessee. The flats were found to be in varying stages of construction and, therefore, the CIT (Appeals) was of the view that the income could not be said to have arisen from the unfinished project. He, therefore, set aside the assessment and restored. it back to the Assessing Officer to refrarne the assessment in accordance with law after allowing due opportunity to the assessee- to represent its case. Against the order of the CIT (Appeals), the Revenue came up before the Tribunal only on the limited issue that the CIT (Appeals) was not justified in setting aside the matter. Having regard to the facts of that case, the Tribunal held: "We are of the opinion that the action of the learned Commissioner of Income-tax (Appeals) was perfectly in consonance with law. We do not find therefore it necessary to interfere with his order".
17. For assessment year 1984-85, in the case of the same assessee, the assessee had filed the return admitting an income of Rs. 37,975. While completing the assessment, the Assessing Officer had made an addition of Rs. 50,000 by estimating the work-in-progress at a higher figure.
The sum of Rs. 50,000 was treated as income from other sources. The assessee had filed appeal before the CIT (Appeals). The CIT (Appeals), like in the earlier year, had set aside the assessment and restored it back to the file of the Assessing Officer with a direction to recompute the income in accordance with law. Against the order of the CIT (Appeals), the Revenue came up in appeal before the Tribunal and agitated that the CIT (Appeals) was not justified in setting aside the assessment. For assessment year 1984-85, the Tribunal had followed its own order for assessment year 1982-83 and had upheld the action of the CIT (Appeals).
18. It is however, important to mention that in the case of Decent Builders (supra) the merits of the case were neither advocated nor discussed by the Tribunal. The issue before the Tribunal was only whether the CIT (Appeals) had rightly restored the matter back to the file of the Assessing Officer. The issue Whether the profit in the case of a building contractor arises or accrues from year to year or on the completion of the contract, was never examined by the Tribunal in the aforesaid orders. The decision in these two orders, therefore, does not support the contention of the assessee in the case before us.
19. It is also important to mention that normally the profit or loss of a trader should be computed with reference to the books of account maintained and the method of accounting followed by him. In the case of Decent builders [supra] the assessee itself had filed return of income disclosing income of Rs. 40,000 for assessment year 1982-83 and Rs. 37,975 for assessment year 1984-85. The assessee itself was, therefore, following a method of accounting according to which the profit was accruing year to year. It was only the CIT (Appeals) who made an attempt to change the method of accounting followed by the assessee and accepted by the Revenue. The CIT (Appeals) was of the view that the assessee should not have declared any income. Since the matter was set aside and remanded to the Assessing Officer for readjudication, the issue now before us was never either argued or decided in the case of Decent Builders (supra). The assessee, therefore, would not get any help from the decisions relied upon. On the contrary, we have been able to find out decision mentioned earlier which support the case that profit in a building contract accrues from year to year. On this count, therefore, we uphold the orders of the CIT (Appeals) and reject the contention of the assessee.
20. Regarding the estimate of profit at 8 per cent, we are of the view that there is no material on record to show that such an estimate is excessive or unreasonable having regard to the facts of the case. The learned counsel for the assessee has not brought any material on record to convince us that the estimate of profit at 8 per cent is in any way,excessive or unreasonable. One fact, however, should not be lost sight of, viz., that the profit at 8 per cent estimated for these three years is only a mere estimate and the true profit of the entire project will be arrived at when the contract is complete. The assessee is, therefore, entitled to the adjustment of profit or loss in the year of completion of the contract. We, therefore, find the estimate of profit at 8 per cent as reasonable and, therefore, the alternative plea of the assessee is also rejected.
21. In assessment year 1981-82, the assessee has objected to the levy of interest under Section 139(8) and Section 217 of the IT Act. In this regard, the assessee has to succeed in view of the fact that the Assessing Officer had completed the assessment under Section 144 read with Section 147 of the IT Act. The notice under Section 148 was issued on 12-3-1986 and served on the assessee on 14-3-1986. Thus, the assessment in question cannot be termed as a regular assessment as defined in Section 2(4) of the IT Act. The issue is, therefore, covered by the decision of the Jurisdictional High Court in the case of CIT v.Padma Timber Depot [1988] 169 ITR 646 (AP). The Revenue is, therefore, directed to exclude the interest under Sections 139(8) and 217 of the IT Act for assessment year 1981-82.
22. Coming to the appeals from the Revenue, the only issue is against the deletion of interest under Section 40A(8) of the IT Act. The facts of the case we have already mentioned above. The provisions of Section 40A(8) were brought on the statute book for a definite purpose. The objective behind the enactment of the said provisions was explained in the Notes in Clauses when the provisions of Section 40A(8) were introduced. As a result of general policy of credit restraint and enforcement of selective control measures by Reserve Bank of India, it was felt that non-banking, non-financial companies had been increasingly resorting to acceptance of deposits from the public to meet their financial requirements. With a view to curb this, it was provided that 15 per cent interest was to be disallowed under the provisions of Section 40A(8) of the IT Act even if nothing was found excessive or unreasonable as under Section 40A(2) of the Act. Thus, the disallowance under Section 40A(8) was made mandatory. However, the CIT (Appeals) has deleted the addition only on the ground that the income of the assessee was estimated under Section 145 and such estimated income is deemed to include the interest under Section 40A(8) also.
23. The Revenue has contended before us that the orders of the CIT (Appeals) are erroneous and bad in law. The provisions of Section 40A(8) are mandatory and, therefore, have to be applied while disallowing the part of the interest. The CIT (Appeals) was not justified in deleting the addition. The learned departmental representative, therefore, urges that the orders of the CIT (Appeals) on this issue should be vacated.
24. Sri Swamy, on the other hand, strongly opposes the contention of the learned departmental representative and points out that if the books of account of a contractor are not accepted and the provisions of Section 145 are applied, the estimate of income should be inclusive of all disallowables under the IT Act. The separate disallowance, therefore, is not justified. Sri Swamy, therefore, supports the decision of the CIT (Appeals).
25. Having regard to the rival submissions, we are of the view that the CIT (Appeals) was not legally justified in deleting the addition of interest made by the Assessing Officer under Section 40A(8) of the FT Act. The computation of income in the case of a contractor is normally made under Section 145 of the IT Act if the books of account are incomplete and the true profit cannot be deduced therefrom. Such an estimate of profit under the provisions of Section 145 cannot include all the other statutory disallowances like Section 40A(8), Section 40(b) or other such disallowances under the Act. The disallowance under Section 40A(8) was provided for a specific purpose and if such a disallowance is deemed to be included in the estimate of profit under Section 145 of the IT Act, this would defeat the very purpose for which the provisions of Section 40A(8) were enacted. Similar issue was examined by the Income-tax Appellate Tribunal, Hyderabad Bench 'B' (Special Bench), in the case of ITO v. Sri Ramakrishna Contractors [1983] 3 SOT 479. In the said case, the issue before the Tribunal was whether after estimating the profit under Section 145, separate addition under Section 40(b) could be made. The Special Bench had come to the conclusion that even if the profit has been estimated at a certain percentage, a separate addition under Section 40(b) can be made by the Revenue. The ratio of the said decision supports the case before us. We are, therefore, of the opinion that the interest under Section 40A(8) can be separately added even if the profit in the case of the assessee had been estimated under Section 145 of the IT Act. We are, therefore, of the view that the CIT (Appeals) was in error in deleting the addition. We, therefore, vacate the order of the CIT (Appeals).
26. In the result, the appeal of the assessee for assessment year 1981-82 is partly allowed, the appeals of the assessee for assessment years 1982-83 and 1983-84 are dismissed and the appeals of the Revenue for all the three years are allowed.