2009 (10) TMI 640 - AT - Income Tax

Disallowance of expenditure u/s 40(a)( ia) - Computation of income chargeable under the head Profits and gains of business or profession - Methods of accounting - nature of business activities - Whether the AO can make any addition in total income on account of disallowing expenditure u/s 40(a) in a case where assessee follows completed contract method - AO noticed from audit report that the assessee made late payment of TDS - AO made the addition as same is not allowable u/s 40(a)( ia) - CIT(A) confirmed the action of the AO. HELD THAT - We find that certain expenditures are not allowable if the assessee failed to deduct tax or after deduction same was not paid in time. Basically income chargeable under the head Profits 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. 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. 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 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). In the case under consideration we find that 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 ). The correct procedure in completed contract method is that instead of making addition AO should correct the amount of work-in-progress by reducing or enhancing work-in-progress as the case may be. 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 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 ld 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. 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. In the result the appeal of the assessee is partly allowed for statistical purposes.

Issues Involved:
1. Disallowance under section 40(a)(ia) of the Income Tax Act.
2. Deductibility of expenses transferred to closing work-in-progress.
3. Allowability of expenses in the subsequent year when TDS was paid.
4. Applicability of retrospective amendment to section 40(a)(ia) by the Finance Act, 2008.

Detailed Analysis:

Issue 1: Disallowance under section 40(a)(ia) of the Income Tax Act
The primary issue in this case is whether the disallowance of Rs. 63,22,988 under section 40(a)(ia) of the Income Tax Act was justified. The Assessing Officer (AO) disallowed this amount because the assessee failed to pay TDS on certain expenses within the prescribed time. The CIT(A) confirmed this disallowance.

Issue 2: Deductibility of expenses transferred to closing work-in-progress
The assessee argued that the disallowed expenses were not effectively claimed as deductions since they were transferred to the closing work-in-progress. The assessee followed the project completion method, capitalizing the expenses under 'Work-in-progress'. The AR contended that since the expenses were included in the work-in-progress, they should not be disallowed as they would be accounted for in the subsequent year when the work-in-progress is transferred to the profit and loss account.

Issue 3: Allowability of expenses in the subsequent year when TDS was paid
The assessee claimed that the expenses should be allowed in the subsequent year when the TDS was paid. The AR submitted that section 40(a) provides that such expenditures are allowable in the year of payment. Since the TDS was paid in the subsequent year, the expenses should be added to the work-in-progress of the subsequent year, resulting in no net addition.

Issue 4: Applicability of retrospective amendment to section 40(a)(ia) by the Finance Act, 2008
The assessee argued that the disallowance for expenses where TDS was deducted in March 2005 and paid before the due date under section 139(1) was not justified. The retrospective amendment to section 40(a)(ia) by the Finance Act, 2008, should apply, making the provisions of section 40(a)(ia) not attracted in these cases.

Judgment Analysis:

Disallowance under section 40(a)(ia)
The Tribunal examined whether the AO could make any addition to the total income by disallowing expenditure under section 40(a)(ia) when the assessee follows the 'completed contract method'. The Tribunal noted that section 40(a) disallows certain expenditures if the assessee fails to deduct tax or pay it in time. However, such expenditures are allowable in the year the tax is paid.

Deductibility of expenses in work-in-progress
The Tribunal agreed that under the 'completed contract method', costs are accumulated under 'work-in-progress' until the contract is completed. When the project is completed, the profit and loss account is prepared, and the work-in-progress is transferred to the profit and loss account. The Tribunal stated that if certain expenditures are not allowable, they should be excluded from the work-in-progress.

Allowability of expenses in the subsequent year
The Tribunal emphasized that the correct procedure under the 'completed contract method' is to adjust the work-in-progress rather than making an addition to the total income. The AO should correct the work-in-progress by reducing or enhancing it based on the allowable expenses. The Tribunal directed the AO to delete additions made to the total income for incomplete projects and to confirm the additions for completed projects after verifying the calculations.

Applicability of retrospective amendment
The Tribunal acknowledged the assessee's argument regarding the retrospective amendment to section 40(a)(ia) by the Finance Act, 2008. The Tribunal noted that the AO should consider this amendment while verifying the calculations for disallowance.

Conclusion:
The Tribunal partially allowed the appeal for statistical purposes. It directed the AO to delete additions made to the total income for incomplete projects and to confirm the additions for completed projects after verifying the calculations. The AO was also instructed to correct the work-in-progress for incomplete projects in accordance with the Tribunal's discussion and after providing an opportunity for the assessee to be heard.

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