Income-tax---

----Reference---Accounting---Rejection of accounts---Estimate of income-- Contractor---Finding by Tribunal that assessee had consistently followed a particular method of accounting---Tribunal considering difficulties of contractors and deciding that no addition could be made towards work-in progress---Tribunal was justified in deleting additions---No question of law arises---Indian Income Tax Act, 1961, S.256.

Held, dismissing the application for reference, that the question was purely one of fact. The two authorities below had found that there was no justification for rejection of the books of account. For the assessment years 1982-83 to 1985-86, the assessee continued to maintain the same system of accounting, accounting for receipts on cash basis and accounting for expenditure on mercantile basis. It also recorded that the book results without work-in-progress were accepted in the assessment year 1981-82 and the assessee was following the same system of accounting. It found that the very nature of the activity of the contractor had its own situational peculiarities making it difficult for justifiable resort to estimation. It observed that the value of the work-in-progress has necessarily to be understood as nil basis with regard to ongoing contracts because there were always inherent risks faced by the contractor implicit in the very contracting process requiring re-doing the work, rectifying the defects for which there had to be a provision and realisation requiring retention of the required amount. The Tribunal was right in law and fact in holding that the addition towards work-in-progress was rightly deleted by the Commissioner of Income-tax (Appeals). No question of law arose from its order.

CIT v. Central India Industries Ltd. (1971) 82 ITR 555 (SC); Deepnarain Nagu & Co. v. CIT (1986) 157 ITR 37 (MP) and G. Padmanabha Chettiar and Sons v. CIT (1990) 182 ITR 1 (Mad.) ref.

P.K.R. Menon, Senior Advocate and N.R.K. Nair for Petitioner.

P. Balachandran for Respondent.

JUDGMENT

V.V. KAMAT, J.---The Revenue has prayed under section 256 of the Income Tax Act, 1961, for a direction for reference of the following two questions:

"(1) Whether, on the facts and in the circumstances of the case, was the Tribunal right in law and fact in holding that the addition towards work-in-progress was rightly deleted by the Commissioner of Income-tax (Appeals)?

(2) Whether, on the facts and in the circumstances of the case, was the Tribunal right in law and in fact in holding that it is not necessary to take the stock of work-in-progress for ascertainment of profits in the case of a non-trading concern like the assessee?"

Reading the questions, firstly, we have to determine as to whether deletion of the addition towards work-in-progress was proper and correct as done by the Commissioner of Income-tax (Appeals), and, secondly, whether it is necessary or not to take the stock of work-in-progress for the purpose of ascertainment of profits as far as the assessee is concerned.

The assessee is a contractor for practical purposes carrying on in the name of "geo Tech Construction Corporation", principally engaged in multi -storeyed buildings for the assessment year 1981-82 ending on March 31, 1981. The accounts as kept by the assessee are factually accepted by the Department. The system of accounting shows that the receipts are accounted on cash basis and at the other end expenses on mercantile basis.

The business activity of the firm mainly engaged in the construction of multi-storeyed buildings has peculiarities of its own in relation to the work-in-progress. The assessee has freedom to maintain his own accounts that are intelligible to him and others. What is required in the process is the internal consistency in regard thereto. There are two basic methods for arriving at the value of the work-in-progress. Generally one is called as the "direct cost method" and the other as "on cost method". Under the first one the cost of direct materials used and the wages of the labour directly employed are required to be taken into account. As regards the other, a proportion of indirect expenditure gets added to the direct cost. Even though these are the two known methods, they cannot be considered as water tight from each other. What is required to be considered is that it cannot be insisted or laid down as a rule that one is preferable to the other or there cannot be a method peculiar to an assessee himself. The ultimate purpose is to find out and to arrive at the ascertainment of value with regard to the work-in-progress. The approach pre-supposes as situation, which will help the authority to ascertain and arrive at the value of the work-in-progress. This may not be at a given point of time with reference to the year in question. Nor are we required to consider a situation in the context that with regard to the work-in-progress in relation to a situation of a -long-term or short-term contract, there would be no possibility of ascertaining the value of the work in-progress at any time. In other words, it will have to be seen clearly that there would be no occasion that ascertainment of the value would escape assessment altogether for all times. It may be that for a year in question by reason of the work being in progress, it may not be proper to arrive at the value of the work-in-progress.

The approach takes a realistic shape by reason of the very nature of the work being in progress in continuation. Often it is considered more appropriate to spread over the period of the contracts on properly determined basis. In other words, it is taken into consideration that it is only when the contracts are completed from the point of view of their performance, not only that the profits expected to be earned get properly determined at that point of time, but the determination becomes feasible at the mint of completion. This is in view of the position that it is only at that stage it becomes reasonably clear from the state of the work to know that what amount of profit would ultimately be earned. From this point of view it has always been felt that it is inappropriate to include any profit element when at the material time under consideration the work under the contract shows this character of progress creating practical difficulties in the matter of ascertainment of profits in regard thereto. There is yet another aspect which discourages this attitude of haste because foreseeable losses and provisions and allowances in regard there to are also required to be taken into consideration. This is all because there has to be a clear basis for inclusion of the profit amount which becomes difficult by reason of the activity being in progress and continuous.

In this aspect overriding consideration is required to be anticipated. This is as to whether the profit to be valued in the process could be ascertained and foreseen with a reasonable degree of certainly which can only be to sight at the point of completion of the contract.

The accounting process is the individual function of the assessee to know his position of accounts and in this context if it is found that the assessee has maintained accounts according to his system, may be based on convenience to adopt one known system with an admixture and intermixture with the other known system, it has always been understood that the assessee who maintains his own accounts has the liberty to employ his system for the purpose of maintaining accounts in respect of his transactions. The Courts and even those engaged in the ancillary field have sought to introduce and stamp labours in regard thereto and, as is common, a ready phrase from the field of horticulture gets introduced to describe such system as a hybrid system of accounting, really leading to one fundamental fact of life that account consciousness gets reflected in the process of system of keeping accounts which have to be understood and appreciated in the context of the person or assessee concerned. The consistency or continuance in the process are factors of assurance in regard thereto.

It would be necessary to appreciate these basic aspects of intrinsic consistency and continuance in relation to the situations, which are again basic in the approach of the dynamics of change. A person lives to learn and seeks to modify his behaviour, may be in the context of management of his finances. He may feel that even the method of keeping accounts may justifiably require a change. The process would require appreciation and understanding in the context. The general situation requires appreciation not in a static way, but requires the situation to be understood.

Normally, if a person resorts to a change in the process, that by itself cannot be said to smack the situation. Similarly also, if the system in the course of time and experience is found to be inconvenient, unsatisfactory, may be even erroneous, that would not justify its continuance. The Courts have and had occasions to make observations of stray character to meet factual situational exigencies which would not have any effect of a binding nature essentially because of requirement which was special to the factual situation governing the process of decisions in regard thereto.

As stated at the outset, for the year 1981-82 ending on March 31, 1981, the assessee submitted the return and was assessed, in regard to which there are no difficulties whatsoever. For the subsequent years, covered by these petitions, the original returns are filed valuing the work-in-progress. Revised returns were felt necessary. Obviously, it was for the year 1982-83 because for the subsequent years the returns obviously were filed without valuing the work-in-progress. This was done by the assessee under section 139(5) of the Act. On discovering, it is submitted, a wrong statement with regard to valuation of the work-in-progress which, if not legitimately done, would considerably reduce the total income of the return. Obviously, this was before the time of the completion of the assessment. Needless to state that for the subsequent years 1983-84 up to 1985-86 (independent subject-matter of these petitions) the additions are made in the following manner:

Rs.

The appellate authority---Commissioner of Income-tax (Appeals) considered the question in paragraph 5 of its order (Annexure "B"). The appellate authority took into consideration that the assessee is the successor of the original firm in the name and style of "United Builders" which did not maintain any books of account. It is then observed that the present firm "Geo Tech Construction Corporation" emerged on the basis of a fresh and new partnership-deed. The firm started maintaining books of account from the year April 1, 1980. It is obvious that the accounts came to be closed for the first year on March 31, 1981. It is observed that in regard to this year the assessment was completed without making any addition on account of work in-progress. It is further observed that in spite of these, as far as the next assessment year 1982-83, there is no material change perceptible in any way and the firm was showing consistently a profit without taking into account the work-in-progress. It is emphasised that for the year 1982-83, 8.7 per cent. is the profit shown whereas for the year 1983-84, 11.23 per cent. is the profit and the profit shown for the year 1984-85 is 13.84 per cent. Factually, it is observed by the appellate authority that even during all these years without showing the work-in-progress, it cannot be observed that the disclosure of the profit was grossly low or below the expected standards. It is also observed that even in spite of the situation reflecting from the books of account, if any addition is made with regard to the value of the work in- progress, it would amount to rejecting the result depicted by the books of account.

In the process of reasoning, it is observed that it is necessary to 'show, to reject the book result that from the method of accounting employed by the assessee, the result is such that the income cannot be properly deduced therefrom. It is in this process, it is observed that the assessee is at liberty to adopt any system of accounting which would facilitate computation of income from profits or gains from business or profession and, if that can be properly deduced, no fault could be placed at the doors of the assessee concerned. In support of this situation, if necessary, the appellate authority has referred to the decisions of the Supreme Court as well as that of the Gujarat High Court. It is also observed that the assessee is at liberty to have his own understandable system of accounting and if the books of account are acceptable, contrary thereto it would not be possible to include the value of the work-in-progress.

The Revenue took up the question before the Appellate Tribunal. The Tribunal also proceeds on the factual basis that for the assessment years 1982-83 to 1985-86, the assessee continued to maintain the same system of accounting, showing that accounting for receipts are shown on cash basis and accounting for expenditure is shown as on approval basis. It also recorded that the books results without work-in-progress were accepted in the assessment year 1981-82 and the assessee was following the same system of accounting. In the process it is further re-emphasised that even though there is no dispute that the assessee was adopting his own system of accounting (described as hybrid), so long as the profits disclosed was reasonable, the system cannot be discarded.

It is in this situation the Tribunal has considered the question observing that the value of the stock on hand should be taken into account to ascertain the true profits. It is observed that in the case of a contractor it would not be necessary to take the stock of work-in-progress for ascertainment of profit. The Tribunal has recorded the reason for this approach especially emphasising that the work-in-progress represents incomplete work as distinguished from the true, correct and legal meaning of a contract which is understandable feasibly only as a completed work. As a corollary it is observed that unless the work done reaches the stage of completion, measured that certified, the assessee cannot be reasonably expected to be certain in the matter of payments and consequent profits.

The Tribunal proceeds to observe that the value of the work-in- progress has necessarily to be understood on "nil" basis with regard to on -going contracts because there are always inherent risks faced by the contractor implicit in the very contracting process requiring redoing the work, rectifying the defects for which there has to be a provision and realisation requiring retention of the required amount. Even the experience of the Tribunal is found to have been recorded as having come across a number of instances of the accounts of contractors having been required to be usually assessed on estimate basis.

The Tribunal felt that unless a situation emerges that profits disclosed by the assessee as a result of his own method of accounting are so unreasonable and patently unacceptable leading to the situation of rejection of books of account, estimation and its consequent addition on the basis of valuation of work-in-progress would not get any justification on factual basis. The Tribunal held that there is no basis for resort to the estimate and in the process affirmed the decision of the appellate authority referred to above.

On the basis of the above factual prologomena we feel the situation is purely a' question of fact. The two authorities below have found that there is no justification for rejection of the books of account. They have also found that the very nature of the activity of the contractor has its own situational peculiarities making it difficult or justifiable resort to estimation. The two authorities below have not found anything wrong with the system of books of account and have unequivocally observed that the assessee has ample liberty to follow his own system of accounting if he knows the income and the resultant profit. The two authorities have also considered the nature of the work, its pending character and continuance over a long period. In this connection, we also find that there is no escape for the assessee with regard to the income or profit even with reference to the work-in-progress. We also appreciate the various difficulties in the process of estimation apart from the situation that resort to estimation requires justification for rejection of the books of account, which have been consistent and has already received acceptance. No authority has even suspected the correctness of the books of account. No authority has also even by whisper smelt that the system of accounting was wrong or erroneous. The system of accounting may have its own peculiarities, which is perfectly within the normal notions of liberty in regard thereto.

Additionally our experience is not different from that of the Tribunal as recorded, that the accounts of the contractors have situational peculiarities, uncertain expectations and requirement of precautions of retention, making it more than difficult to resort to valuation of work-in -progress.

Learned senior counsel for the Department relied on G. Padmanabha Chettiar & Sons v. CIT (1990) 182 ITR 1 (Mad) to contend that the assessee is not permitted to adopt mercantile system to claim deduction of amounts payable and cash system in respect of amounts due to it. In other words, the change of work or inherent inconsistencies are not permissible. Having gone through the decision cited, we find that the facts before us are completely at tangent. There is no question of there being internal inconsistency, but on the contrary as we have emphasised, factually the accounts have been accepted and are not even contended to be wrong or erroneous on the factual matrix before us.

Learned counsel relied on another decision of the Supreme Court in CIT v. Central India Industries Ltd. (1971) 82 ITR 555 to place reliance on really a stray observation (page 560 of the report) do urge that no one gets a vested right in an erroneous order. None can dispute the strength and application of the proposition but it is not applicable in any way to the disputes raised before us in these proceedings.

Learned senior counsel sought to rely on the decision of the Madhya Pradesh High Court in Deepnarain Nagu & Co. v CIT (1986) 157 ITR 37 on the basis of the factual observations as described by the assessing authority. The decision is for the proposition that if it is a situation of commission to mention something or mention of a wrong statement in the original return, section 139(5) could be invoked. But under the guise a legitimisation as if to rewrite the accounts would not be under contemplation. As stated above, we have already observed that consistently no error was even whispered in regard to the system of accounts. We have already observed that the factual records and findings in regard thereto show that there is intrinsic consistency and continuance with regard to the system of accounting. The provisions of section 139(5) of the Income Tax Act, if considered in relation to the factual findings accepted by the fact-finding authorities, would show that it is a case for review as it relates to a wrong statement.

In our judgment for all the above reasons no case for any kind of direction is seen by us. The petitions, therefore, stand dismissed.

M.B.A./1237/FCPetition dismissed.