TMI Blog1991 (2) TMI 177X X X X Extracts X X X X X X X X Extracts X X X X ..... r carrying out this salvage operation, the assessee engaged the services of three specialised vessels on hire which are fitted with necessary diving gears, namely 'Malacca', 'Orinoco' and 'Monsoon' all through M/s. Smith International of Singapore, shipping agent. The assessee has followed a Hybrid system of account for this salvaging business insofar as it has followed mercantile system for expenses and cash system for income. " "New Business :-- As already stated in para 2, the assessee entered into a contract with the BPT for salvaging operation during the year. The BPT contract is peculiar in nature as it is strictly a time-bound contract, technically known as 'time is the essence of the contract'. it is also bound by a technical qualification on 'no cure no pay basis'. The whole meaning of such technicalities boils down to the basic principles that :-- (1) The contractor shall be bound to perform the work within a fixed time limit. (2) The contractor shall operate against a lump sum consideration agreed as per tender. (3) The contractor shall be entitled to the lump sum only if the contract is discharged successfully and in case of failure nothing shall be payable. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he work on a completed contract method. The rationale of this second method is that income or loss arises only on ultimate completion of the project and not from year to year before the completion. In general contract business there is no third method followed for arriving at true income or loss of the project. The work-in-progress method allows the contractor to charge all its expenses to the trading account against the value of work-in-progress. This method is based on the simple principle that income accrues as the work progress. For this method the essential ingredient is that there shall be a measurable progress made in the discharge of the contract and the progress thus made can be valued rationally. Then only the contractor shall be entitled to debit the expenses incurred by it thus for in discharge of the contract. In the instant case of the assessee this method is palpably inapplicable and the assessee has admitted it too. Vide their reply dated 23-2-1989, M/s. P.P. Katdhare has submitted that in case of salvaging operation quantification of work done is not possible. So the application of work-in-progress method is to be ruled out in the instant case and that leaves one w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e state of affairs. Para 18 of the AS-1 makes it obligatory that to ensure proper understanding of the financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Para 26 of the AS-1 dealing with the disclosure of the accounting policies states that any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. In the case of a change in accounting policies which has a material effect in the current period, the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. In the instant case of the assessee, the Auditors have not indicated anything to suggest that the assessee has chosen a different accounting policy in respect of the salvage work. The absence of any such indication or disclosure on the Auditor's Report can only point to one conclusion--that the assessee offers a non-existent change ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e personal supervision of the Management. In the circumstances, it is not by any means difficult to conclude that the expenses incurred by the assessee are not fully verifiable and, therefore, not fully ascertainable. Hence such debit of unascertainable expenses to the accounts on accrual basis against some incomplete and immeasurable work cannot be allowed. Motive of the Assessee : The main business of the assessee is that earning income by hiring out its ship "Ocean Pearl". It also earns substantial income by rendering diving services. The assessee started its business in a very small way in the Calendar Year 1981. Its real business started during the Calendar Year 1984 when it acquired the "Ocean Pearl". The ship was acquired by the assessee on 19-12-1984 and was immediately used for charter hire. The total billing shown by the assessee for calendar year 1984 was Rs. 31,47,405. The total billing for the subsequent calendar years kept on increasing, Rs. 1,53,79,887 for 1985, Rs. 2,81,21,686 for 1986, and Rs. 2,48,97,069 in 1987. Since the main source of income by way of billing was the charter hire charges of "Ocean Pearl", the assessee ran the risk of incurring heavy taxation as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en before its contract was complete. We have already examined the peculiar nature of this contract and how it is impractical and unscientific to treat this otherwise than by the 'completion of contract method'. Because only on the completion of the contract it would be known whether the whole venture results in a complete loss or otherwise. For that the assessee has to wait till the expiry of the contract period, or the extended period as allowed by the B.P.T. But the assessee has not found it convenient to wait to that extent. In fact, the conduct of the assessee shown that its main concern has been to incur expenditure to set it off against legitimate income. This is illustrated by the fact that the assessee willingly did not avail the extended period allowed by the B.P.T. for salvage work in respect of "Cherry Chantak" and allowed the whole contract result in a loss. This fact is borne out of the letter of the B.P.T. addressed to the assessee dated 22-5-1986 which is attached to this order as Annexure 'A'. In view of the motive adopted by the assessee as narrated hitherto, it can be safely concluded that this system of accounting cannot be allowed to the assessee so as to enable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sons discussed in earlier paras, this expenditure on incomplete contracts shall not be set off against this year's income. 2. The learned first appellate authority upheld the reasoning of the Assessing Officer, inter alia, observing that as regards the quantification of the expenses incurred on these projects, it was not possible to verify the consumption of its spares and utilisation of labour on account of the absence of stock register and other documentary evidence and allocated the expenses between the incomplete projects and other business activities, i.e., the learned Commissioner of Income-tax (Appeals) upheld the reasoning of the Assessing Officer as is mentioned in para 10 of the assessment order. The learned first appellate authority further held that all the expenses of the contracts have been debited this year by the assessee to wipe out the income earned by hiring of ship and diving services and reduced its taxable income to Nil. He further held that the correct procedure and practice should be to treat each contract as one project for determining income/loss at the definite completion of the project. His reasoning in nutshell is as under :-- 'I have, heard the lea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... puty Commissioner made any departure from the old practice. As regards the contract relating to "Cherry Chentak", since its termination was intimated to the appellant by the B.P.T. only by its letter dated 22-5-1986 when even the accounts relating to this year had been finalised, it cannot be said that the contract terminated in the year 1985 just because the work had been discontinued on the same on 13-11-1985. In fact the appellant continued to pursue its attempts for further extension of this contract beyond 13-11-1986 and it was only by the letter dated 22-5-1986 that the contract was terminated. Therefore the expenditure in respect of these contracts also could not have been allowed in the assessment year 1986-87. In view of these facts, I endorse the decision of the Deputy Commissioner in holding that the expenses of these contracts were not allowable as deduction during this year. As regards the allocation of expenses to incomplete projects, the Deputy Commissioner has given detailed working in para-10 of the assessment order. As the expenses relating to the hire charges to Smith International were exclusively for these four contracts, the amount of Rs. 1,02,98,682 actuall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , on the facts and in the circumstances of the case, the expenditure was incidental to and in the course of the carrying on of the assessee's business, which the assessee contends to be 'services'--salvage and maintenance services. Yet further it has been contended that in the context of the provisions in the Income-tax Act, 1961 and on the basis of concept of real income, once no income has accrued to the assessee or, else, there has been no receipts from the contracts, disallowance of expenditure could not be made on those basis. The assessee has expended the expenditure and the expenditure is connected with, relatable to and for the purpose of carrying on the assessee's business activity, hence total expenditure should have been allowed. About investment allowance also, the orders of the learned lower authorities have been assailed. The learned Senior Departmental Representative, Shri A. Mansukhani, has taken us to the factual aspect of the contracts, a resume of which has been placed on our file and which reads as under :-- 'FACT SHEET ON 4 CONTRACTS (1) GULF-STAR SALVAGING Date of Contract - 5-6-1985 Time allowed - 6 months ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... after 7-6-1985. Extension allowed till 30-11-1985 When assessee requested more time in April 1986, BPT refused by letter of May 1986.' He has, in the context of above facts, contended that although the assessee was engaged in maintenance services, he was also chartering/on hire and was in receipt of hire charges and the contracts were of two types, viz. salvage of ships and survey/salvage. Salvage activity has been started this year. He has placed strong reliance on the reasoning of the Assessing Officer as is contained in paras 6, 7, 7.3, 8, 8.1, 9, 9.1 and 9.2. He has contended that the motive was to defer tax liability and neutralise the hire charges so that there was no taxable income and no tax. Yet further he has contended that system of accounting employed by the assessee was such that real income could not be deduced. Expenses were not verifiable. Para 8 of the order of learned first a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... horities. The assessee, on its turn, pleaded that assessee's system of accounting is accepted in earlier years and it is hybrid system. The finding of the learned lower authorities and the contention of the learned Senior Departmental Representative are misconceived inasmuch as it is not a new line of business and the assessee is already in this line of business, viz., rendering of under-water services. The learned authorised representative contended that, in fact, as an observation the learned CIT (Appeals) has accepted this stand of the assessee. About expenses/income, he contended that it is to be allowed on accrual basis and in the face of 'no cure no pay', the income having not accrued, the expenditure has to be allowed. Concludingly, he contended that a service contract cannot be said to be a project like that of a construction company, since no capital asset comes into being or is involved. The Assessing Officer as also the learned CIT (Appeals) has not applied either proviso to sub-section (1) of section 145 or, else, sub-section (2) of section 145 and the disallowance is made on misconceived basis. Concludingly he prayed that de hors the method of accounting, the expenditu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with, and subject to the provisions of, this Act in respect of the total income of the previous year or previous years, as the case may be, of every person : Provided that where by virtue of any provision of this Act income-tax is to be charged charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly. (2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act. Scope of total income: 5. (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which-- (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or (c) accrues or arises to him outside India during such year : Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h one of the services of survey. Services cannot be said to be projects as has been contended on behalf of the assessee rightly, since the business activity of the assessee is providing services in terms of salvaging and survey and, as the name of the assessee depicts, it is under-water services. These services are a normal feature of assessee's business activity and a regular line of activity since earlier years. The learned CIT (Appeals), in fact, has rightly held in para 9 of the impugned order that the question as to whether the business is new or old becomes immaterial as all the contracts in the past had been taken up and completed with in the same accounting period. The learned CIT (Appeals) has reasoned that since in the earlier years contracts were taken and completed in the same accounting period and since, for the assessment year under appeal, there is a spill-over of the contracts to subsequent accounting periods, the income has to be each contractwise and not the activitywise. This reasoning of learned CIT (Appeals) cannot be upheld inasmuch as if, for reasons beyond the assessee's endeavours and resources, the spill-over of the contract was there and out of four contr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pect of the two has arisen and accrued to the assessee in the assessment years 1987-88 and 1989-90 respectively. In respect of the third, up to assessment year 1989-90, the issue was pending finality and in respect of the fourth contract, the contract itself got frustrated. On the basis of the concept of real income and the scope of total income within the meaning of section 5, the method of accounting becomes irrelevant to that context only, since the concept of real income speaks of income received or, else, deemed to be received--income which has accrued or arisen to an assessee or can be deemed to be so. In the case of the assessee vis-a-vis all the four contracts, no income has been received and nothing can be deemed to be so. No income has accrued or arisen and so is the case with the deeming provision. The contracts were on the basis of 'no cure no pay', which means that if there is a cure, there is a payment and in this view of the matter, the arising of the income as also the accrual is with the cure. The assessee has expended expenditure, which cannot be said to be in the nature of capital expenditure or the personal expenditure of the assessee, and these have been laid o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ars when the contracts were taken and finished in the same accounting period they resulted in income; that earning of income is not a pre-requisite for allowance of expenditure in view of the ratio of the decision of the Hon'ble Supreme Court mentioned in the body of the order, viz., Rajendra Prasad Moody's case that since disallowance has not been made for the reasoning that the expenditure was not verifiable but has been made for partial apportionment/disallowance of the expenditure, that reasoning no longer holds good and the claim has to be allowed as made by the assessee. 11. Before parting, we like to discuss the case law relied upon by the parties before us. In Indermani Jatia's case at page 299, the Hon'ble Supreme Court has laid down the following ratio :-- 'It is well known that the mercantile system of accounting differs substantially from the cash system of book-keeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits; whereas, under the mercantile system, credit entries are made in respect of amounts due immediately they become legally due and before they are actually received ; similarly, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ounting-- 'held that for assessment purposes a method of accounting has to be compulsory and the income has to be computed on those bases and the income-tax authorities can invoke that section where income otherwise cannot be properly deduced. In Jamna Das RameshwarDas's case the Punjab High Court (as it then was) has held that the Income Tax Department is entitled to judge the accounts of an assessee each year on their merits. The fact that they accepted a particular form of accounts as sufficient in one year does not debar them from holding later that particular items or particular claims made by the assessee in later years have not been established since there is no question of estoppel in such a case and it is for the assessee claiming to offset a particular amount of loss to establish that he has incuffed such amount of loss. In McMillan Co.'s case the Hon'ble Supreme Court was again dealing with section 13 of the 1922 Act and Their Lordships held that whether the income, profit and gains, can properly be deduced from the assessee's method of accounting is undoubtedly a matter which rests with the income-tax authorities and non-exercise of powers under proviso to section 13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nting -- rejection of account books -- rejection of method of accounting -- distinction between right of Officer to reject accounts books -- proviso to section 13 and estimate of income. The Hon'ble Madras High Court held that proviso to section 13, of the Indian Income-tax Act, 1922 can be invoked only if a finding is recorded as to the unacceptability of the method and in irregularity of the accounts kept. Before invoking the proviso to section 13, the Officer must give a specific finding that the method of accounting adopted by the assessee is not acceptable and the account books are not reliable. In the absence of such a finding, the proviso cannot be invoked. In Dhondiram Dalichand's case the Hon'ble jurisdictional High Court -- Bombay High Court -- has held that before exercising his powers under proviso to section 13, it is necessary that an Income-tax Officer should find that the method of accounting employed by the assessee is such that the profits made cannot be properly deduced therefrom. The Income-tax Officer need not, however, make an explicit statement to that effect. It is sufficient if his order has the effect of impliedly recording such a finding. In Sukhdeodas Ja ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cloth. The assessee-company attempted to instal a borewell at its new factory side. The attempt failed. The assessee claimed deduction of the expenditure incurred. The Assessing Officer and the ITAT rejected the claim. The Hon'ble Bombay High Court upheld the findings with the reasoning that if the well had been successfully bored, it would have added to the fixed capital of the assessee and would have become a part of its capital assets. The expenditure was held to be in the nature of capital expenditure. So far as good, nobody can find fault with the ratio laid down by the various Hon'ble High Courts and the Hon'ble Supreme Court under proviso to section 13 of the 1922 Act (which is in perfect pari materia with proviso to section 145 of the 1961 Act) that the Income Tax Authorities are justified on facts and in law in applying the same if the method of accounting employed by the assessee is such that real income cannot be deduced therefrom. But, on the facts and in the circumstances of the assessee's case, the Assessing Officer has neither applied proviso to sub-section (1) of section 145 nor sub-section (2) of section 145. What the Assessing Officer has done and which stands up ..... 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