The Income-Tax Appellate Tribunal (ITAT) has held that anticipated losses on incomplete projects are allowable as a deduction, subject to that being calculated in accordance with Accounting Standard 7 (AS7). The ITAT passed the order in an appeal filed by assessee Jacobs Engineering, which is involved in the business of executing work contracts.
Jacobs Engineering claimed a deduction for foreseeable losses for FY03 and FY04, on incomplete projects that were disallowed by the assessing officer and the commissioner of income tax on the grounds that it was merely an anticipated loss based on an estimate.
Jacobs Engineering argued that accounting standards allow such a deduction. It further said that the Institute of Chartered Accountant of India (ICAI) has approved the provision and the company is following the said standard for regularly valuing its work-in-progress.
AS7 mandates that a foreseeable loss on an entire contract should be provided for in a companys financial statements irrespective of the progress made in the work. In some circumstances, the foreseeable losses may exceed the cost of work already done. The provision is, however, made for the entire contract.
Typically, when a contract is planned, an estimate is made based on various factors of production involved such as steel, cement, labour. These are subject to changes in the external economic environment that arent under the control of the company. The costs could, hence, increase while the revenue or business estimated from such a contract may not see a corresponding increase.
In contention to Jacobs Engineerings argument, the I-T department said that as a major part of the work was not completed, the losses could not be properly anticipated. It further pointed out to the appellate authority that the accounting standards are to be notified by the central government and the provision being relied upon by the assessee was not notified.
As far as the estimation was concerned, the same was based on a technical estimation and merely because there was some variation in the figures provided by the assessee at various stages, it could not be said that the estimated loss was not allowable, the ITAT said. The valuation of work-in-progress will affect the profit of subsequent years, it added in the order.
However, to confirm whether estimation of the foreseeable loss was accurate, the tribunal restored the matter to the assessing officer to examine the validity of the figure claimed.
Regarding the need for notification of the accounting standard applied, the ITAT said that it was approved by the ICAI and the Central Board of Direct Taxes.