Section 198 of the income tax act 1961

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CA Shobha Karmakar (Querist)
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08 December 2016 My assessee is a works contractor. He received certain advance payment after deduction of Tds. I termed the advance received as ''income received but not accrued'' and neither showed the amount as income nor claimed any expenditures in that particular year. The same was shown as income in next financial year.

Further, during scrutiny the Income tax officer added back the whole advance amount received during the year declaring it contravention of Section 198. Kindly guide me how and on what grounds relief can be plead for?

Thanks in advance.

CA Suresh Jain

CA Suresh Jain (Expert)
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08 December 2016 You have to file an appeal but correct answer can only be given after going through the Assessment order

CA Shobha Karmakar

CA Shobha Karmakar (Querist)
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16 December 2016 Thanks Mam
Pls provide your mail id so that i can send you the Assessment Order.

Aashok Kumar Sharma

Aashok Kumar Sharma (Expert)
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23 July 2025 Issue at Hand:
The issue revolves around the advance payment received by your client (a works contractor) and how it was treated under Section 198 of the Income Tax Act, 1961, during scrutiny assessments. The Income Tax Officer (ITO) has added back the entire advance payment as income in the year it was received, citing non-compliance with Section 198.

Key Provisions of Section 198:
Section 198 of the Income Tax Act, 1961, defines the "income" to be considered for the purposes of computing the total income under the provisions of the Act. Section 198 specifically provides that:

Income received or receivable shall be considered as income in the year in which it is received, irrespective of whether it has been accrued or not.

In the case of works contractors or any other business where advances are received, the advance payment received during the year should typically be accounted for as income in that particular year, even though the work for which the advance was received may not have been completed.

Section 198(1) states that all sums received during the year are included in the total income and that the amount can only be claimed as income in the year the payment is actually received (i.e., cash basis).

Key Concern:
In your situation, the advance received by your client was not recognized as income in the year of receipt and was deferred to the subsequent year when it was actually accrued. However, according to Section 198, any income received (including advance payments) must be included in the income of the year it was received.

Guidance & Relief Strategy:
Advance Payment Must Be Included in the Year of Receipt:

According to Section 198, income received must be accounted for in the year it was received, even if it is not yet accrued.

The advance received by your client should have been included as income in the year of receipt, not the next financial year.

If the advance payment was shown as income in the next financial year, the ITO’s action of adding it back seems to be based on non-compliance with Section 198.

Relief through a Correct Declaration:

You can argue that the advance payment should have been included as income in the year it was received. However, if it was mistakenly not accounted for in the correct year, you can seek relief by filing a rectification request under Section 154 for correcting the assessment.

If the advance payment was intended to be used for future work, the income could have been shown as "income received but not accrued", but the issue is that it must still be declared in the year it was received under Section 198.

Proving Income on a Cash Basis:

If your client is following a cash basis of accounting, you can argue that the advance received, even though not accrued, should still be treated as income when received.

Under Section 145 of the Income Tax Act, taxpayers can follow the cash basis of accounting, in which case the advance would be accounted for as income in the year of receipt (regardless of whether it relates to work done or future liabilities).

Relief Through Section 154 (Rectification):

If the mistake was in the incorrect year of inclusion, you can request a rectification of the assessment under Section 154 of the Income Tax Act. In your request, you can state that the income was mistakenly omitted from the income in the relevant year and seek its inclusion in the correct year, as per Section 198.

The request should clearly highlight the correct treatment of advance income based on the cash basis and Section 198 provisions, explaining that the entire advance amount should not have been added back.

Argument for Consistency in Accounting:

If your client has consistently followed the practice of deferring the recognition of advance income (i.e., showing it in the next year), you can argue that this has been the consistent accounting policy and should be respected, provided it is aligned with the general principles of taxation and business accounting.

Appeal Mechanism:

If relief is not granted at the rectification stage, you may consider filing an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)) on the grounds that the income was mistakenly treated in the wrong financial year.

In Summary:
To address the scrutiny issue:

Recognize Advance Income: Under Section 198, the advance should have been included as income in the year it was received, even if not yet accrued.

Rectification Request: If the advance was omitted, you can apply for rectification under Section 154, as it is a procedural error in applying the provisions of Section 198.

Cash Basis Accounting: If applicable, argue that the income was received on a cash basis and hence should be included in the year of receipt.

Appeal: If rectification fails, consider filing an appeal before the CIT(A) to explain the accounting policy and seek relief.

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