ITAT, MUMBAI BENCHES `L’, MUMBAI
DDIT (Int’l Taxation)
v.
Stock Engineer & Contractors B. V.
ITA No. 2169/Mum/2004
RELEVANT EXTRACTS:
9. We have heard the rival submissions in the light of material placed before us. There is no controversy on the fact that the sum of Rs.78.88 lakhs represents the expenditure incurred by the assessee in the immediately preceding year in relation to the contract which was awarded to the assessee on 24.2.1998. The learned CIT (A) has recorded a 
categorical finding that the assessee was following Percentage completion method. A copy of the letter dated 23.1.2002 addressed [o the Assessing Officer during the course of assessment proceedings is placed on record. As per para 4 of this letter, the calculation of Closing work in progress at Rs. 19,56,87,000 was divulged and it was also made clear that percentage completion method of contract accounting as prescribed in Accounting Standard-7 was being followed by the assessee. It is further mentioned in this letter that the work in progress was valued on the basis of proportion of actual costs incurred to the total estimated costs. The Assessing Officer has not disagreed with this calculation. His only point of view for disallowance is that since this expenditure relates to the prior period and hence cannot be allowed as deduction in this year and further the assessee had not filed its return of income for the earlier year.
10 Thus there remains no doubt about the fact that the assessee was following project completion method in respect of the instant contract. It had opening work in progress representing the expenditure incurred up to 31.3.1998 amounting to Rs.78.89 lakhs. Since this project was not concluded in the instant year as well, the closing work in progress was recognized at Rs. 19.56,87.000 and carried forward to the next year According to the AS-7, two methods of accounting for contracts commonly followed by the contractors arc the percentage of completion method’ and the completed contract method’, “the costs incurred on year to year basis are taken into consideration for determining the profit of the contract as a whole on year to year basis or at the end of the project depending upon the method of contract accounting followed by the assessee. The difference between the Project completion and Percentage of completion methods is that where as in the latter case the revenue is recognized on annual basis as the contract activity progresses based on the completion reached, subject to determination of the ultimate profit or loss from the project on its completion, in the former case, no revenue is recognized till the project is fully or substantially completed. To exemplify suppose the total contract value is Rs. 1000. The contractor has incurred expenditure of Rs.30() in the first year and he estimates 35% of the contract as having been completed, the profit of the first year, in the case o\’ percentage of completion method, will be Rs.50 [i.e. 35% of Rs.1000 minus cost of Rs.300 incurred). Similarly if further sum of Rs. 200 is incurred in the second year with 60% completion, then the profit of the second year will be Rs.100 (i.e. 65% of Rs. 1000 minus costs incurred in both the years aggregating to Rs. 500 minus the profit of Rs.50 offered for taxation in the first year). In the like manner in the third year w hen the project is completed with the further cost of Rs.200, the profit to be offered will be accordingly computed at Rs. 150 {i.es. Rs. 1000 minus the cost incurred in three years at Rs.700 and profit of Rs. 150 declared in the earlier two years). In contrast to it, under the project completion method, there is no requirement for computing the income periodically but the entire Profit of Rs. 300 will be offered for taxation only in the third year i.e. when the project is completed.
11. Thus it is evident that under both the above referred methods, the costs incurred in the project are accumulated on year to year basis till the project is finally completed. In other words the costs incurred in the first year are carried forward to as work in progress in the second year. Then the costs incurred in the second year are further added to the costs incurred in the first year and then further carried forward to the third year as the opening work in progress and so on till the project is finally completed and the profit is ultimately determined. It is wrong to disallow the first year’s brought forward expenditure in the second year by branding it as prior period expenditure’ because unless the entire expenditure is considered at the end of the project, the correct amount of profit cannot be finally determined) Further in the percentage of completion method, the income on the basis of the estimate of the completion of the project is also shown on cumulative basis. That is if in the first year the contract is complete by 35% income is deduced accordingly by considering the expenses incurred in relation to that. Though in the second year the further progress is 25%, but the income is computed by taking the 60% of the total contract value as reduced by the total expenditure incurred including that of the first year. If the figure of the opening working in progress is not reckoned, as don e by the AO. then the resultant figure o{‘ the profit will be fully distorted because of the receipts being considered on the basis of the percentage completion of the project including that part which was completed in the earlier year. And further if revenue as well as expenditure are considered for the current year alone, then there wiil arise difficulty in computing the ultimate profit on the completion of project as a whole. Thus it is manifest that the opening work in progress has to be taken into consideration in computing the income from the project. Coming back to the facts of our case for this year, we find that the assessee had rightly considered the sum of Rs.78.88 lakhs as opening work in progress in the second year which is eligible to be considered in the computation of the profit for the second year,
12. A great deal of emphasis has been laid by the AO on the fact that the assessee had not furnished any return of income for the A.Y. 1998-99. According to section 139(1), prevalent at the material time, every person including a company is liable to file return if its total income assessable under the Act during the previous year exceeds the maximum amount which is not chargeable to income tax. Thus the requirement for filing the return is activated only when there is some income chargeable to tax. If there is no income, then the law does not cast a duty upon a person to file the return of income. The obligation to file the loss return u/s 139(3) arises if the assessee has sustained loss in any previous year under the head ‘Profits and gains of business or profession’ or under the head Capital gains’ and claims that the loss or am part thereof should be carried forward for set off in the subsequent years. In such a situation the loss return is required to be filed on or before the due date as prescribed u/s 139(1). But for claiming the benefit of carry forwards of “loss etc., there is no requirement to file return” if the assessee has “incurred a loss.
13. The assessee claims that it did not file any return for the preceding year because there was no income chargeable to tax. The reason for not showing any profit in the immediately preceding year from the contract is that a very small part of it was completed. It is evident from the fact that the opening work in progress of Rs.78.88 lakhs which represents around 4% of the closing work in progress at Rs. 19.56 crores. As per the above referred Accounting Standard-7. No profit is to be recognized unless the work on contract has progressed to a reasonable extent. Para 9.8 of the Accounting Standard states that “ordinarily this test is not considered as Having been satisfied unless 20 to 25% of the work is completed”. It is, therefore, palpable that under the percentage of completion method, the income is to be recognized on year to year basis as the contract activity progresses based on the stage of completion reached} However if the work is not completed up to 20 to 25%, till that stage, no income need be identified and offered for taxation. As the assessee had only completed a very small percentage of the total work in the preceding year, which is far below the prescribed percentage, there was no requirement for it to offer any income for taxation in that year. Apart from this contract, the assessee had not earned any income which is taxable in India. It is further not a case of loss return for the preceding year which would have merited filing as per due date prescribed u/s 139(1) as a pre-condition for allowing its carry forward. The assessee is not claiming any carry forward of loss but only claiming the opening work in progress in respect of the contract underway in this year. In our view the AC) was not justified in attributing non filing of the return for the earlier year as a reason for not allowing the opening work-in-progress by characterizing it as “prior period expenditure”.
