By TIOL News Service

AHMEDABAD, APR 07, 2014: THE issue before the Bench is - Whether the retention money would be the income accrued to the assessee when it is received from the contractee in order to have more liquidity but against a bank performance guarantee on a condition that the guarantee will be released only after satisfactory completion of the work upon being certified by the Engineer-In-charge and in case of any non satisfactory completion of work, it would be recovered from bank guarantee. And the answer favours the assessee.

Facts of the case

Assessee is a civil contractor. It was awarded a construction contract by SSNNL. Out of running bills raised by assessee for construction work, SSNNL would retain a portion for satisfactory completion of the work upon being certified by the Engineer-In-charge. Such terms were later on modified to permit greater liquidity to the contractors and an option was given to receive such completion warranty amounts also in cash, subject to providing bank guarantee of a matching sum.

In the return of income filed, assessee claimed debit of retention money in computation of income. It was stated that as per the terms of the contract, the money was withheld by the Government pending verification of satisfactory completion of the work, for which the payment was related. The retention money did not arise or accrue to the assessee in the year in which the work was executed or the bills were raised.

AO observed that in the present case, assessee had credited receipt in its Profit & Loss account. This cannot be stated to be hypothetical income. The amount was received on furnishing the bank guarantee. This, therefore, was not a case of withholding of retention money but a case where the amount was already released. Thus, AO taxed the said amount.

CIT (A) allowed the appeal of assessee stating that the right to receive the retention money had yet not accrued. Such right would accrue only after satisfactory completion of the contract and after defect liability period is over and the Engineer-in-charge certifies that no liability attaches to the assessee.

ITAT reversed the order of CIT (A) and held that the assessee had received the amount on which TDS was deducted. ITAT held that though indisputably income would accrue only where there is a right to receive income but on the premise that the assessee had actually received the said sum, the said receipt must be taxed during the year under consideration. The income had accrued to assessee and thereafter it was retained by way of an additional security. The liability to return the amount may arise in future, if there was insufficient performance of contract. In the present case, no such liability arose, even at a later date. As per AS 9, revenue recognition should not be postponed. The assessee had claimed full expenditure and not deferred a portion thereof relatable to the retention money.

Assessee contended that as per modified terms of contract the right to receive such amount had not accrued till the end of warranty period and the release of the bank guarantee upon certification by the Engineer-in-Charge. The assessee had offered the said receipt to tax in later year and thus the assessee was subjected to tax in both the years ie., in the present year when the amount was received and at a later point of time, when the amount was released unconditionally by the SSNNL.

Revenue contended that the amount was actually received by the assessee. It was, therefore, not a case of deferred payment. Tax was deducted at source on such receipts also. Accounting standards would require that the assessee must show the said amount in the Profit and Loss account and cannot defer the revenue recognition. Right to receive such amount thus clearly accrued.

After hearing both the parties, the High Court held that,

++ in the modified terms of agreement, from a maximum additional security deposit which could earlier be accumulated upto a 7.5% of the tender amount, the ceiling was reduced to 5%. Simultaneously, the contractor was given an option to receive the security deposit in cash on giving the bank guarantee. Since withholding of 10% of the running account bills upto a maximum of 7.5% of the tender amount for the entire warranty period of twelve months would cause considerable hardship to the contractors, more lenient terms were offered. These modifications, were subject to other conditions providing that the security deposit minus the amount due would only be returned to the contractor at the end of the defects liability period. This would be subject to Engineer-in-Charge certifying that no liability attaches to the contractor. Any such recovery of the amount due to SSNNL from the contractor would be made from the bank guarantee offered by the contractor in lieu of the security deposit.

++ whenever the retention money of a contractor for performance guarantee was actually held back by the employer of the contract, the Courts have taken a view that the right to receive such income not having accrued, the same cannot be taxed at the point of time when the bills are raised. In our opinion, merely because in the present case, the amount was realized, would not change this situation.

++ it is undisputed that every receipt is not an income. Whether a receipt is an income or not would depend on whether the right to receive the same had accrued to the assessee. Before the amendment, the assessee had to surrender a portion of the running bill amount towards additional performance guarantee deposit. The assessee could request the employer of the contract to convert such amount into interest bearing securities or deposits. The amount would still remain with SSNNL. After amendment, the assessee had an additional option of receiving the amount but converting the security deposit into a bank guarantee. In other words, the assessee would receive the full running bill amount; including 10% to be set apart by way of additional security deposit, upon furnishing the bank guarantee of a matching sum. In either case, namely as in the preamendment scenario where the assessee would not receive 10% of the running bill amount or post amendment, when such amount would be received by the assessee upon furnishing the bank guarantee, the general conditions remained unchanged. As per the said condition, the security deposit or the security deposit converted into bank guarantee would be returned to the contractor after defects liability period is over. This would be subject to two conditions – firstly, that the employer of the contract would deduct from such amount, any amount due to it and that the Engineer-in-Charge certifies that no liability attaches to the contractor. It can thus be seen that in either of the two cases, SSNNL would recover from the assessee, the amount due to SSNNL and release the rest of the amount out of the security deposit only upon completion of the defects liability period and upon certification by the Engineer-in-Charge. In case of the preamendment period, such recovery would be from the security deposit/interest bearing securities or deposits; as the case may be. In the post amendment period, if the assessee had so opted and furnished bank guarantee to receive the amount, such recovery would be from the bank guarantee so furnished.

++ as the assessee’s right to receive the said amount is concerned, there has been no change by virtue of the amendment in the general conditions contained in the contract. SSNNL retained the right to make recovery. Only the source of such recovery changed. Earlier, such recovery could be made from the security deposits of the assessee lying with SSNNL. Post amendment, such recovery could be made from the bank guarantee furnished by the assessee. The same uncertainty of receiving the full amount of additional security deposit remained the same, either before or after the amendment in the conditions. The character of the amount did not change. Its temporary release to the assessee on furnishing the bank guarantee cannot be equated with the right to receive such amount and resultantly with accrual of income because the dominant control over the said amount still remained with SSNNL. Mere fact that in the present case no recoveries were made from the bank guarantee or security deposit is of no consequence.

++ the fact that tax was deducted at source on said amount also would be of no consequence. Tax was deducted by SSNNL. The assessee had no control over such deduction. Merely whether tax was deductible or not would not decide the taxability of certain receipts. Assessee claiming entire expenditure and not excluding expenditure relatable to the withheld security deposit also would not be fatal to the interest of the assessee. The expenditure in toto was incurred. The expenditure incurred by the assessee could not be proportionately divided into that covering the assessee’s ninety per cent of the bill amount and relatable to the rest ten percent.

(See 2014-TIOL-437-HC-AHM-IT)