2025 (5) TMI 1157 - AT - Income Tax

Application of ICDS III to assessee being a civil contractor - Scope of Percentage of Completion Method (POCM) for revenue recognition in construction contracts - HELD THAT - Assessee is mandated to follow ICDS III and has rightly followed the same and accounted the entire revenue as required by ICDS III in computing its total income. We also hold that the assessee paying GST on the basis of invoices raised and not on the basis of POCM will have no implication on the computation of total income of the assessee. We also find merits in the argument of assessee has by itself has returned a total income of Rs. 9, 79, 75, 000/- on a gross POCM of Rs. 42, 26, 67, 000/- which itself amount to a net income of 23.18% and that if the addition made by the AO is also taken into account the net margin of the assessee would be 48.64% which appears to be improbable in the assessee s line of business. Having found that the income has been correctly accounted as per POCM and that the manner of paying GST has no implication on the quantum of income to be offered and which has been correctly offered and that there is no conflict between the ICDS and the Income Tax Act we are of the considered view that no interference is warranted with the findings and the order of the Ld. CIT(A) in deleting the additions made by the AO. Appeal of the revenue stands dismissed.

Summary

The core legal questions considered in this appeal revolve around the proper recognition of income by a civil contractor under the Income Tax Act, specifically:

(i) Whether the assessee has correctly complied with Income Computation and Disclosure Standards (ICDS) III, which mandates the use of the Percentage of Completion Method (POCM) for revenue recognition in construction contracts;

(ii) Whether the Assessing Officer (AO) was justified in making an addition of Rs. 10,76,23,212/- on the ground that the assessee understated revenue by not fully recognizing income as per POCM;

(iii) Whether the Work-in-Progress (WIP) balances, representing unbilled revenue, were properly accounted for and whether ignoring WIP led to double taxation;

(iv) Whether the difference in treatment of revenue recognition for Goods and Services Tax (GST) purposes and Income Tax purposes is permissible;

(v) Whether any conflict exists between ICDS and the Income Tax Act, and if so, which prevails;

(vi) Whether the assessee altered WIP without adequate documentary evidence as required under ICDS III;

(vii) Whether the Commissioner of Income Tax (Appeals) [CIT(A)] erred in deleting the addition made by the AO.

Issue-wise Detailed Analysis

1. Compliance with ICDS III and Application of Percentage of Completion Method (POCM)

The legal framework is governed by Section 145(2) of the Income Tax Act empowering the Central Government to notify ICDS, including ICDS III applicable to construction contracts. ICDS III mandates revenue recognition based on POCM, which requires recognizing income proportionate to the percentage of work completed, typically calculated by cost-to-cost method.

Precedent from the Jaipur bench of the Income Tax Appellate Tribunal (ITAT) in Vastukar Township Pvt. Ltd. was relied upon, affirming that revenue recognition must be in line with POCM, including advances received, to avoid premature or deferred recognition.

The AO found discrepancies between revenue recognized by the assessee and revenue computed as per POCM, leading to an addition of Rs. 10,76,23,212/-. However, the assessee contended that the AO failed to consider WIP, which represents unbilled revenue valued at contract price, and that when WIP is added to revenue recognized in the Profit and Loss account, the total matches the revenue computed under POCM.

The CIT(A) accepted the assessee's explanation, noting that the difference between the AO's addition and the WIP plus recognized revenue was only Rs. 18,367/-, a negligible amount.

The Court examined the reconciliation tables submitted, showing detailed project-wise computations where revenue recognized plus WIP closely matched the revenue as per POCM, thereby confirming compliance with ICDS III.

2. Treatment of Work-in-Progress (WIP) and Alleged Alteration Without Documentary Evidence

The revenue alleged that the assessee altered WIP without satisfactory documentary evidence or computation as mandated by ICDS III. ICDS III requires that WIP be valued at contract price and properly accounted for as closing stock of unbilled work.

The assessee demonstrated that WIP was credited to the Profit and Loss account at contract price and reconciled with revenue recognized, showing no alteration but legitimate accounting treatment consistent with ICDS III. The Court found no evidence of arbitrary alteration but rather a correct application of accounting principles.

The Court emphasized that WIP valuation at contract price ensures that revenue is neither understated nor overstated, preventing double taxation.

3. Difference in Revenue Recognition for GST and Income Tax Purposes

The revenue challenged the CIT(A)'s acceptance that the assessee recognized revenue on invoice value for GST but deferred revenue recognition for Income Tax purposes as per POCM.

The Court noted that GST is payable on invoiced amounts, which may not align with the percentage of work completed. The Income Tax Act, however, requires revenue recognition as per ICDS III and POCM.

The Court held that differing treatments for GST and Income Tax purposes do not conflict legally, as they serve different statutory purposes. The assessee's method of paying GST on invoice value while recognizing income for tax purposes as per POCM was found to be valid and not prejudicial to revenue.

4. Conflict Between ICDS and Income Tax Act

The revenue contended that in case of conflict between ICDS and the Income Tax Act, the provisions of the Act should prevail.

The Court observed that ICDS are notified under Section 145(2) of the Income Tax Act and are thus subordinate legislation meant to provide uniform accounting standards. ICDS III is not in conflict with any substantive provisions of the Act.

Therefore, ICDS III is binding and must be followed. The Court found no conflict in the present case and upheld the application of ICDS III.

5. Validity of Addition Made by AO and Deletion by CIT(A)

The AO's addition was based on ignoring WIP and considering only select projects where revenue recognized was less than POCM-based revenue.

The assessee demonstrated that when all projects and WIP are considered, the revenue recognized matches POCM computations.

The CIT(A) deleted the addition, and the Court found this deletion justified based on detailed reconciliation and accounting principles.

The Court also considered the improbability of the net margin increasing from 23.18% to 48.64% if the AO's addition were accepted, reinforcing the reasonableness of the assessee's accounting.

6. Treatment of Advance Receipts

The assessee explained that advances received are credited to sales for GST purposes but revenue recognition for Income Tax is restricted to the percentage of completion, consistent with POCM and ICDS III.

The Court accepted this treatment, referencing the precedent that revenue recognition must be aligned with work completion, not merely receipt of advances.

Conclusions

The Court concluded that:

- The assessee has complied with ICDS III and recognized income correctly under POCM;

- WIP has been properly accounted for at contract price, preventing double taxation;

- The difference in GST and Income Tax revenue recognition methods is permissible and does not conflict with the Act;

- No alteration of WIP without evidence was established;

- The addition made by the AO was unsustainable and rightly deleted by the CIT(A);

- There is no conflict between ICDS III and the Income Tax Act in this case;

- The appeal filed by the revenue was liable to be dismissed.

Significant Holdings

"The percentage of completion method basically indicates that revenue from performance obligations recognized over a period of time should be based on the percentage of completion of the contract undertaken... The difference between the contract price and the amount recognized as revenue in the Profit and Loss Account is reckoned as WIP in respect of each of the contract. This is equivalent to reckoning year end stock at selling price. It does not make a difference in terms of profit whether the product is reckoned as sold or in stock since the valuation is on contract price."

"Addition of the differential without considering that the WIP has been valued at contract price and the revenue has actually been reckoned would lead to double taxation of the same amount which has been already reckoned as WIP since the billing event has not occurred."

"We hold that the assessee is mandated to follow ICDS III and has rightly followed the same and accounted the entire revenue as required by ICDS III in computing its total income. We also hold that the assessee paying GST on the basis of invoices raised and not on the basis of POCM will have no implication on the computation of total income of the assessee."

"There is no conflict between ICDS and the provisions of the Act and that the ICDS is to be followed... there is no alteration made to the WIP but only that a credit has been made to the WIP and recognised in the profit and loss account to be compliant with ICDS III."

"The addition made on account of revenue recognition is not sustainable and deleted the same."