Court upholds reassessment notice, asks taxpayer to prove income recognition method.

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Case Name

M/s. Durr India Private Limited (Rep. by its Director Mr. Michael Berger) vs. Assistant Commissioner of Income Tax (OSD) and Anr. (High Court of Madras)

W.P.Nos.32797 & 32801 of 2018 and W.M.P.Nos.38008 & 38014 of 2018 and 6663 & 6666 of 2019

Date: 24th February 2021

Key Takeaways

• The court did not quash the reassessment notices under Section 148 of the Income Tax Act, 1961.
• The “percentage of completion” method for recognizing income in construction contracts is valid, but the taxpayer must provide supporting documents.
• The Income Tax Department can reopen assessments if there is a lack of full and true disclosure of material facts, even if the accounting method is generally accepted.
• The court emphasized that mere entries in the balance sheet and profit & loss account are not enough; supporting documents and certifications are required.
• The reassessment will focus only on the issue of income recognition and not on any other matters.

Issue

Was the Income Tax Department justified in reopening the completed assessments of M/s. Durr India Private Limited for the years 2011-12 and 2013-14, based on the method of income recognition used by the company?

Facts

• Parties: M/s. Durr India Private Limited (the petitioner) vs. Assistant Commissioner of Income Tax (the respondent).
• Background: The company, engaged in construction contracts (specifically, supply and installation of paint booths for automobile companies), used the “percentage of completion” method to recognize income, as per Accounting Standard AS-7.
• Dispute: The Income Tax Department issued notices under Section 148 to reopen assessments for AY 2011-12 and 2013-14, arguing that the company had not fully disclosed the basis for its income recognition and that certain billed amounts were not included in taxable income.
• Company’s Stand: The company argued that its method was accepted in other years and is recognized by law and accounting standards.
• Department’s Stand: The department claimed the company did not provide sufficient documentation to substantiate the percentage of work completed, justifying the reopening of assessments.

Arguments

Petitioner (M/s. Durr India Private Limited)

• Used the “percentage of completion” method, as per AS-7 (Accounting Standard by ICAI), which is recognized by law.
• The method was accepted by the department in other assessment years (2010-11, 2012-13, 2014-15).
• Section 5 and Section 145 of the Income Tax Act, 1961, allow both accrual and cash methods of accounting.
• The method is now statutorily recognized for AY 2017-18 onwards (S.O.3079(E) under Section 145(2)).
• Cited several Supreme Court and High Court decisions supporting the use of consistent accounting methods and against reopening assessments based on a mere change of opinion, including:
• Commissioner of Income-tax, Delhi Vs. Woodward Governor India (P.) Ltd.
• Commissioner of Income-tax Vs. Bilahari Investment (P.) Ltd.
• MKB (Asia) (P.) Ltd. Vs. Commissioner of Income-tax
• Commissioner of Income-tax Vs. Syndicate Bank
• Commissioner of Income-tax Vs. Margadarsi Chi Funds (P.) Ltd.
• Commissioner of Income-tax, Delhi Vs. Kelvinator of India Ltd.
• Income Tax Officer, Ward No. 16(2) Vs. TechSpan India (P.) Ltd.
• TANMAC India Vs. Deputy Commissioner of Income-tax, Circle I, Pondicherry
• Commissioner of Income-tax, Chennai Vs. Schwing Stetter India (P.) Ltd.
• M/s S P Mani and Mohan Diary Vs. The Assistant Commissioner of Income tax
• M/s Asianet Star Communications Private Limited Vs. Assistant Commissioner of Income Tax

Respondent (Income Tax Department)

• The company did not provide documents to substantiate the percentage of completion at the time of the original assessment.
• The audited balance sheet alone is not enough; supporting documents and certifications are required.
• The reopening was justified due to lack of full and true disclosure of all material facts necessary for assessment.

Key Legal Precedents

• Commissioner of Income-tax, Delhi Vs. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 (SC)
• Commissioner of Income-tax Vs. Bilahari Investment (P.) Ltd. [2008] 299 ITR 1 (SC)
• Commissioner of Income-tax, Delhi Vs. Kelvinator of India Ltd. [2010] 187 Taxman 312 (SC)
• Income Tax Officer, Ward No. 16(2) Vs. TechSpan India (P.) Ltd. [2018] 404 ITR 10 (SC)
• TANMAC India Vs. Deputy Commissioner of Income-tax, Circle I, Pondicherry [2017] 78 taxmann.com 155 (Madras)
• Commissioner of Income-tax, Chennai Vs. Schwing Stetter India (P.) Ltd. [2015] 378 ITR 380 (Madras)
• M/s S P Mani and Mohan Diary Vs. The Assistant Commissioner of Income tax, order dated 26.09.2019
• M/s Asianet Star Communications Private Limited Vs. Assistant Commissioner of Income Tax, order dated 16.04.2019

The court relied on these cases to affirm that:

• The method of accounting regularly employed by the assessee should be accepted unless it distorts profits.
• Reopening of assessment cannot be based on a mere change of opinion.
• Full and true disclosure of all material facts is required; otherwise, reassessment is justified.

Judgement

• The court did not quash the reassessment notices.
• The court held that while the “percentage of completion” method is valid, the company must provide supporting documents (like contract terms and certification of work completed) to substantiate its income recognition.
• The court directed the company to submit these documents within 30 days, and the tax authorities to complete the reassessment within 60 days thereafter.
• The reassessment will be limited to the issue of income recognition and not any other matters.
• The court emphasized that mere entries in the balance sheet and profit & loss account are not enough for full disclosure; supporting documents are necessary.

FAQs

Q1: Can a company use the “percentage of completion” method for recognizing income in construction contracts?

A: Yes, this method is recognized by accounting standards (AS-7) and has been approved by the Supreme Court. However, the company must provide supporting documents to prove the percentage of work completed.

Q2: Why did the court allow the reassessment to proceed?

A: The court found that the company had not provided all necessary documents to substantiate its income recognition method at the time of the original assessment, so the Income Tax Department was justified in reopening the assessment.

Q3: What documents does the company need to provide?

A: The company must provide contracts, certifications (by an in-house department or independent engineer), and other documents showing the percentage of work completed for each contract.

Q4: Does this mean the company will definitely owe more tax?

A: Not necessarily. The reassessment will depend on the documents the company provides and whether they substantiate the income recognition method used.

Q5: Will the reassessment cover other issues?

A: No, the court limited the reassessment to the issue of income recognition and the percentage of work completed.

Q6: What is the significance of this judgment?

A: It clarifies that while recognized accounting methods are valid, taxpayers must fully substantiate their claims with supporting documents. It also reinforces the principle that reassessment is justified if there is a lack of full and true disclosure.

By this common order, both the Writ Petitions are being disposed of.

2. In W.P.No.32797 of 2018, the petitioner has challenged the impugned notice dated 28.03.2018 issued under Section 148 of the Income Tax Act, 1961 and the consequential communication dated 26.11.2018 of the first respondent overruling the objection of the petitioner for reopening the assessment for the Assessment Year 2011-12.

3. In W.P.No.32801 of 2018, the petitioner has challenged impugned notice dated 26.03.2018 issued under Section 148 of the Income Tax Act, 1961 and the consequential communication dated 26.11.2018 of the first respondent overruling the objection of the petitioner for reopening the assessment for the aforesaid Assessment Year 2013-14.

4. The reasons furnished by the first respondent for reopening of the assessment for the respective Assessment Years are identical. It has been stated that the petitioner follows a mercantile system of accounting and therefore the income accrues the moment bills are raised by the petitioner.

5. Since the petitioner was reducing a part of the bill amount from its Profit and Loss Account as excess billing, it is submitted that such adjustment on the liability side of the balance sheet will not affect the

income already accrued as the accounting entries do not change or alter

the income which had accrued to it.

6. Under these circumstances, the petitioner was called upon to show cause why a sum of Rs.7,74,20,000/- for the Assessment Year 2011-12 and Rs.58,45,26,000/- for the Assessment Year 2013-14 shown as billing in excess of revenue under the current liabilities to the total income should not be added to the income.

7. It is the case of the petitioner that it was adopting and arriving at the correct income for the purpose of payment of income tax by adopting percentage method of completion work irrespective of the amount billed

to the client or the amount received by the petitioner.

8. The learned counsel for the petitioner submitted that the Institute

of Chartered Accountant of India had issued Accounting Standard A.S-7

as early as 1983 which came to be revised in 2002. It is submitted that as per the aforesaid Accounting Standard, a company engaged in construction contract is required to recognise income based on the reliable estimation, contract revenue and contract cost associated with the construction contract with reference to the stage of completion of contract activity at the reporting date.

9. The learned counsel for the petitioner submitted that under Section 5 and Section 145 of the Income Tax Act, 1961, both accrual/mercantile and the cash receipt method are recognised. The petitioner has been consistently following accrual method of accounting albeit percentage of work completed.

10. The learned counsel for the petitioner further submitted that the method followed by the petitioner has now been statutorily recognised by the Income Tax Department vide S.O.3079 (E) issued under Section 145(2) of the Income Tax Act, 1961 for the Assessment Year 2017-18 onwards.

11. The learned counsel for the petitioner further submits that a similar dispute for the Assessment Year 2009-10 is also pending before this Court in W.P.No.41845 of 2016. At the same time, the above method of accounting adopted by the petitioner for the Assessment Year 2010-11, Assessment Year 2012-13 and Assessment Year 2014-15 has been accepted by the Income Tax Department. He therefore submits that once there is a particular method of accounting is being followed, there is no justification for reopening the assessments.

12. The learned counsel for the petitioner further submits that the

respondent has invoked Section 148 of the Income Tax Act 1961 for the

Assessment Year 2011-2012 just three days prior to expiry of limitation

under the proviso to Section 147 of the Income Tax Act, 1961 and for the

Assessment Year 2013-2014 two days prior to the expiry of normal

period of limitation under proviso to Section 147 of the Income Tax Act,

1961. He submits that the entire exercise was arbitrary and smacks of

revenue bias.

13. The learned counsel for the petitioner further submits that prior

to 29.09.2016, under Section 145(2) of the Income Tax Act, 1961,

Accounting Standards was in force from 1996, as per which, if the

fundamental accounting assumption relating to Going Concern,

Consistency and Accrual are followed in financial statements, specific

disclosure in respect of such assumptions are not required. Only when

fundamental accounting assumption is not followed, such fact shall be

disclosed.

14. He further submitted that as per the above notification, accrual

refers to the assumption that revenue and cost are accrued, that is,

recognised as they are earned or incurred (and not as money is received

or paid) and recorded in the financial statements of the period to which

they relate.

15. He further submitted that as per AS-7 of the Institute of

Chartered Accountants of India revised in 2002, if the outcome of the

construction contract can be estimated reliably, contract revenue and

contract cost associated with construction contract should be recognised

as revenue and expenses respectively by reference to the stage of

completion of the contract activity at the reporting date.

16. The learned counsel for the petitioner relied upon the following

decisions of the courts:-

i. Commissioner of Income-tax, Delhi Vs. Woodward

Governor India (P.) Ltd., [2009] 312 ITR 254 (SC) :

[2009] 179 Taxman 326 (SC).

ii. Commissioner of Income-tax Vs. Bilahari

Investment (P.) Ltd., [2008] 299 ITR 1 (SC) : [2008]

168 Taxman 95 (SC).

iii. MKB (Asia) (P.) Ltd. Vs. Commissioner of Income-

tax, [2007] 294 ITR 655 (Gauhati) : [2008] 167

Taxman 256 (Gauhati).

iv. Commissioner of Income-tax Vs. Syndicate Bank,

[2003] 261 ITR 528 (Karnataka) : [2003] 127

TAXMAN 287 (KAR.).

v. Commissioner of Income-tax Vs. Margadarsi Chi

Funds (P.) Ltd., [1985] 155 ITR 442 : [1984] 19

Taxman 73 (Andhra Pradesh).

17. The learned counsel for the petitioner further submitted that the

Hon’ble Supreme Court has frowned upon reopening of the assessment

based on change of opinion and in absence of any failure to truly and

fully disclose material that were required for assessment. Invocation of

Section 148 and the proviso to Section 147 cannot be justified. In this

connection, the learned counsel for the petitioner, relied upon the

following decisions:-

i. Commissioner of Income-tax, Delhi Vs. Kelvinator

of India Ltd., [2010] 187 Taxman 312 (SC).

ii. Income Tax Officer, Ward No.16(2) Vs. TechSpan

India (P.) Ltd., [2018] 404 ITR 10 (SC) : [2018] 92

taxmann.com 361 (SC).

iii. TANMAC India Vs. Deputy Commissioner of

Income-tax, Circle I, Pondicherry, [2017] 78

taxmann.com 155 (Madras).

iv. Commissioner of Income-tax, Chennai Vs. Schwing

Stetter India (P.) Ltd., [2015] 378 ITR 380 (Madras) :

[2015] 61 taxmann.com 19 (Madras).

v. M/s.S.P.Mani and Mohan Diary Vs. The Assistant

Commissioner of Income tax, order dated 26.09.2019,

passed by this Court in W.P.No.3648 of 2018.

vi. M/s.Asianet Star Communications Private Limited

Vs. Assistant Commissioner of Income Tax, order

dated 16.04.2019, passed by this Court in

W.P.No.25328 of 2018 and batch.

18. These decisions were cited to state that once accounts were

maintained in the course of business, they are to be taken as correct

unless there are strong and sufficient reasons to indicate that they are

unreliable. The learned counsel for the petitioner further submitted that in

absence of any finding questioning the correctness or completeness of the

accounts of the assessee, the accounts cannot be reopened.

19. He has further submitted that the respondents have not

demonstrated any distortion in the accounts maintained by the petitioner

for the purpose of computation of income. He submitted that even in the

context of chit fund, the Hon’ble Supreme Court has recognised in

Bilahari Investments Private Limited case referred to supra the

revenue method of accounting in the case of chit fund business.

20. He submitted that there the Hon’ble Supreme Court has

categorically held that recognition/identification of income under the

Income Tax Act, 1961 is attainable by several methods of accounting. It

could be attained by one or more method. Completed contract method is

one of such methods and similarly, percentage of completion method is

another method.

21. He therefore prays for quashing of the impugned notices issued

under section 148 of the Income Tax Act, 1961 for the respective

Assessment Years and the respective communications overruling the

objection of the petitioner for reopening of the completed assessment for

the contentious Assessment Years.

22. Defending the impugned order, the learned counsel for the

respondents submitted that the petitioner has not filed any documents to

substantiate the percentage of completion of the work at the time of

respective assessments and therefore the respondents were justified in

reopening the respective assessments.

23. He submitted that though in the audited balance sheet the

petitioner had stated that it recognised the revenue from projects sales

under the percentage of completion method, the petitioner had not filed

any documents before the original Authority to substantiate the extent of

percentage of completed work at the time of respective assessments and

therefore the Department was justified in reopening the assessment.

24. I have considered the arguments advanced by the learned

counsel for the petitioner and the respondent. I have also considered the

decisions cited by the learned counsel for the petitioner.

25. Facts are not in dispute. The petitioner is engaged in supply

and installation of paint booth for automobile companies. The petitioner

has adopted mercantile method of accounting which is one of the

recognized method for the purpose of recognition of income under the

Income Tax Act, 1961.

26. The law on the subject is also clear. Every assessee is entitled

to arrange its affair and follow the method of accounting which the

department has earlier accepted. According to the petitioner, the method

adopted by the petitioner has been accepted for the Assessment Years

2010-11, 2012-13, 2014-15 and thereafter.

27. As per the decision of the Supreme Court, it is only in those

cases where the Department records a finding that the method adopted by

the assessee results in distortion of profits, the Department can insist on

substitution of the existing method. In this case, it is the contention of the

Income Tax Department that the method followed by the petitioner has

not disallowed the correct income.

28. The case laws also indicate that an ITO has liberty to examine

the system of accounting regularly employed by the assessee to determine

whether the system of accounting is defective and whether by following

such system of accounting, correct profits can be deduced from the

accounts book maintained by the assessee.

29. If on such scrutiny, an Income Tax Officer comes to a

conclusion that with reference to the method of accounting followed by

the assessee, correct profits cannot be deduced, it is open to him to apply

to the provisions of Section 145 and make the assessment in an

appropriate manner.

30. Even where advances are received (pre-paid amounts), if the

assessee fails to perform the service as promised, it would be obliged to

refund the advance payment received under the ordinary law of contract

or special enactments, like the Consumer Protection Act.

31. Though in the context of construction contracts, the Central

Government vide S.O.3079 (E) dated 29.9.2016 has officially recognized

the Percentage of Completion Method for the Assessment Years 2017-18

onwards, the Supreme Court has given the seal of approval to the said

method in Commissioner of Income Tax Vs. Bilahari Investments

Private Limited referred to supra.

32. This method was also recognised by the Institute of Chartered

Accountants of India in AS-7 which was originally issued in the year

1983 and later revised in the year 2002. As per the aforesaid Standard in

para 21 when the outcome of a construction contract can be estimated

reliably, contract revenue and contract cost associated with the

construction contract should be recognised as revenue and expenses

respectively by reference to the stage of completion of the contract

activity at the reporting date.

33. Thus, it cannot be said that the petitioner was not entitled to

adopt percentage method of recognition of income for computation of

income tax under accrual method of accounting. However, mere

qualification in the Annual Report of the company containing the balance

sheet and the profit and loss by itself is not sufficient to conclude that the

petitioner has disclosed the percentage of the work completed during

previous year relevant for the Assessment Year.

34. Further, the petitioner may have entered into several contracts

with different clients with varied terms and conditions. These documents

are required to be produced before the Assessing Officer at the time of

assessments. The purpose of accounting under the Income Tax Act, 1961

is to ascertain the taxable income and to determine the tax payable by an

assessee. Therefore, these documents and other ancillary documents are

required to be produced before an Assessing Officer or Income Tax

Officer during the assessment.

35. Further, a Proper Certification whether by an In-House

Department of the Assessee or by an Independent Chartered Engineer

certifying the percentage of work completed under the contract was

required to be produced by the assessee before the Income Tax Officer

for the purpose of assessment.

36. What was the term of the contract under which the revenue was

generated or the bill raised on a client or a customer cannot be certified in

the Audited Profit and Loss Account and the Balance Sheet. At best, they

can corroborate what is there in the contract. Therefore, unless those

supporting documents are produced, it cannot be said that there was full

disclosure.

37. The enclosures filed before the Assessing Officer at the time of

Section 143(3) Assessment do not indicate the same. Therefore, it cannot

be said that there was true and full disclosure of all materials that were

required for assessment before the Assessing Officer by the petitioner. At

the same time, it is to be noticed that the reasons given in the

communications dated 05.11.2018 for reopening the respective

assessment have merely questioned the method of accounting adopted by

the petitioner and show it was issued in a mechanical manner.

38. It is noticed that as per Explanation 1 to Section 147 of the

Income Tax Act, 1961, production before the Assessing Officer of the

account books or other evidence from which material evidence could

with due diligence have been discovered by the Assessing Officer will

not necessarily amount to disclosure within the meaning of Section 147

of the Act. In fact, Explanation incorporates the reasons given in the

decision of the Hon'ble Supreme Court in Calcutta Discount Co. Ltd.

Vs. Income Tax Officer, (1961) 41 ITR 191 (SC).

39. At the same time, the conclusions arrived in the impugned

communications dated 26.11.2018 overruling the objections of the

petitioner for the reopening of the assessments by the impugned notices

are not conclusive. They are only prima facie views of the Assessing

Officer. It is for the petitioner to establish that it has correctly followed

the accounting method by producing the supporting documents to

substantiate the percentage of work that was completed for the purpose of

proper determination of taxable turnover for payment of income tax.

Mere disclosure in the Profit and Loss Account and Balance Sheet is not

sufficient.

40. Therefore, I do not find any justifiable reasons to interfere at

this stage of the re-assessment proceedings. Therefore, the first

respondent is therefore directed to complete the re-assessment after

examining the documents to be produced by the petitioner and pass re-

assessment orders on merits.

41. The petitioner is therefore directed to file documents to

substantiate its cases before the first respondent within a period of thirty

days from date of receipt of a copy of this order. The first respondent

shall pass orders within a period of 60 days thereafter.

42. It is made clear that the orders to be passed shall be confined to

the issue relating to percentage of the work completed and the

recognition of income alone and no other issues other than the one in

respect of which notices under Section 148 have been issued shall be

considered by the first respondent.

43. The Writ Petitions stand disposed of with the above

observations. No cost. Consequently, connected Miscellaneous Petitions

are closed.