INCOME TAX APPELLATE TRIBUNAL
On the facts and in the circumstances of the case and in law, the Ld. CIT (A) erred in deleting the addition of Rs.78,84,241/- being the excess amount of unexpired service contracts holding that since the service contract is spread over 2 accounting years the receipts, actually received during the year, also should be taxed in 2 accounting years despite the fact the assessee is following mercantile system of accounting
Central Circle 29, Room No.411,4th Floor, Aayakar Bhavan,M.K. Road,Mumbai -400 020 .....…. Appellant Vs M/s. Pest Control (I) Pvt. Ltd.,5th Floor, Jagdamba House,Peru Baug, Goregaon East, Mumbai -400 062 .....… Respondent
IN THE INCOME TAX APPELLATE TRIBUNAL
“C” BENCH: MUMBAI
BEFORE SHRI R.S. SYAL, ACCOUNTANT MEMBER
AND SHRI R.S. PADVEKAR, JUDICIAL MEMBER
(Assessment Year: 2007-08)
Asst Commissioner of Income-tax,
Central Circle 29,
4th Floor, Aayakar Bhavan,
Mumbai -400 020 .....…. Appellant
M/s. Pest Control (I) Pvt. Ltd.,
5th Floor, Jagdamba House,
Peru Baug, Goregaon East,
Mumbai -400 062 .....… Respondent
PAN: AAACP 5994 K
Appellant by: Shri N.K. Mehta
Respondent by: Shri G.S. Pikale
Date of Hearing: 25.01.2012
Date of Pronouncement: 14.03.2012
O R D E R
PER R.S. PADVEKAR, JM:
In this appeal the revenue has challenged impugned order of the Ld. CIT (A)-40, Mumbai dated 15.04.2010 for the A.Y. 2007-08. Ground no.a reads as under:
“1. On the facts and in the circumstances of the case and in law, the Ld. CIT (A) erred in deleting the addition of Rs.78,84,241/- being the excess amount of unexpired service contracts holding that since the service contract is spread over 2 accounting years the receipts, actually received during the year, also should be taxed in 2 accounting years despite the fact the assessee is following mercantile system of accounting.”
2. The issue in controversy is in respect of denying the benefit of spread over to the assessee and making addition of Rs.78,84,241/-. The assessee is in the business of rendering pest control services and manufactures and formulates products for its own captive consumption and also markets some of its products as trading activity. The assessee filed the return of income for the A.Y. 2007-08 declaring income of Rs.8,70,98,073/-. The return filed by the assessee was selected for scrutiny and assessment was completed u/s.143(3) of the Act. In the balance sheet the assessee has shown the liability of Rs.15,14,60,717/- on account of value of unexpired services contract. The A.O. sought the explanation of the assessee in respect of the said liability. The assessee stated that the assessee company undertakes various types of service contract like household disinfection service, Termite control-pre & post treat, General Pest Control, Rodent Control, Mosquito Control etc. which are required to be executed either as periodical contracts or as a single service depending upon the customers requirement and nature of disinfectant. The assesse further stated that the performance of service formerly spills over the next financial year in some cases and there is liability on the assessee company till the performance of the contract is complete. The assessee stated before the A.O. that method adopted by the assessee for determination of the value of unexpired service contract is in consonance of the Accounting Standard-29 issued by the Institute of Chartered Accountants of India (ICAI) and the assessee is also consistently following the said standard, which has been accepted by the A.O. in past. The assessee explained that at the beginning of the financial year 2006-07 the last year’s unexplained service contract value was of Rs.132,49,29,511/- which was added back to the Service Sales Account and appropriate provision was made at the end of the accounting year 2006-07 for Rs.15,14,60,717/-. The assessee stated that since effect has already been given to the Sales Account, it cannot, therefore, be treated as unclaimed liability within the meaning of sec.41(1) of the Income-tax Act. The assessee also filed the working of value of unexpired services contract as on 31.03.2007. As per the chart filed by the assessee HHD Goldseal/ Pestseal and Termiseal Service were worked out at Rs.78,84,241/- (Rs.17,84,76,956/-) out of which Rs.3,56,95,391/- being 20% has been offered for tax. Out of rest 80%, Rs.14,27,81,563/- and Rs.4,75,93,855/- have been retained to be declared as sales in the next year respectively. Likewise, in respect of the Termiseal Service post Treat the total receipts for one year was Rs.5,89,15,516/-, out of which Rs.1,96,38,505/- being 33% have been retained to be offered in subsequent year as income. The assessee also stated that for the annual contract the assessee has to provide four services to the customers and in most of the cases the annual contract covers two to three services in a financial year and one to two services in the next financial year. The A.O. was not convienced with the explanation of the assessee. In his opinion since the assessee has received the entire amount in the financial year and the assessee was following the mercantile system of accounting and hence, the assessee should have recorded or considered the entire amount for the purpose of working out the profit. At the same time, the A.O. held that looking to the nature of the business of the assessee at least 75% of the receipt received in respect of annual contract should have been credited to the profit and loss account and rest of 25% should have been carried forward in the next year. In sum and substance, though the A.O. agreed that the entire receipts should not have been recorded in this year but to the extent of 25% only assessee should have deferred receipts of pest control services treating the same as an income in the subsequent year. The A.O. worked out the excess over 25% and made addition of Rs.78,84,241/-. The assessee carried the issue before the Ld. CIT (A) and found favour. The Ld. CIT (A) deleted the addition. The operative part of the order of the Ld. CIT (A) is as under:
“2.3 I have considered the assessment order and the submissions of the appellant. Looking into annual service contracts, the Accounting Standards of the ICAI, the treatment of the unexpired service contracts in the appellant’s accounts, the trend analysis of the ratio of single service contract to annual service contracts, the inevitability of services spilling over to the next year and
surrounding facts and circumstances, I agree with the appellant that there is no case for the addition. To this end, in the first place, I do not find any fault in the accounting treatment given to the unexpired service contracts. As I see, the preceding year’s value of the unexpired service contracts is added back to the sales (service account:) at the beginning of the next financial year for the full value of the last year’s provision of the unexpired service contracts. This being so, I do not find any sufferance of revenue on account of this treatment when the accounts of two years are seen together. Importantly, I also find that the appellant has been consistently following this method, which has also been accepted by the Income-tax Department in the earlier years. The fact of the company following the proportionate completion method has also been noted in schedule 15(1)(g)(ii) under the section Significant Accounting Policies of the Annual Report and the Assessing Officer has not brought on record any information or basis to find fault with this. Taking all these signature features of the treatment of the unexpired service contracts, I do not see anything of note to warrant modification in this accounting treatment.
“2.3.1 I also find the treatment in order from the point of view of the nature of the services provided under the annual service contracts. To this end, as I find, since the requisite quarterly services are not possible to be fully executed in course of one financial year in all cases, a spill over of the services to the next year is inevitable and this being so, the full contract having been only partially executed during a financial year, the liability to discharge the non-performed contractual obligation remains with the appellant till the performance of contracts in full. In view of this, I do not find any infirmity in the way the liability on account of value of unexpired service contract has been created. In this respect, I find that the Assessing Officer is of the view that the liability is in the nature of an estimate. As the accounting treatment has been consistently followed and accepted by the Department, and as the treatment is based on historical trend analysis, I do not find any substantial merit In the Assessing Officer’s argument, particularly, when nothing new has been brought into play. Besides, I also find that in the assessment, the Assessing Officer has himself accepted the method of accounting in principle and has only modified the percentage of the contracts carried over to the next year. In this process, the Assessing Officer has held that the percentage of receipts to be credited during the year to the Profit & Loss Account and receipts to be carried forward to the next year would be in the ratio of 75% to 25% respectively. Here also, he has made an estimate and has not given any basis.
Accordingly, since the apportionment by the Assessing Officer is also based on estimate, without any new fact emerging, I do not find any reason to disturb an accounting method historically followed and accepted. Further, I find that accepting the Assessing Officer’s working will necessitate simultaneous adjustment to the value of unexpired service contracts at the beginning of the year. In this respect, I agree with the appellant that disturbing the closing valuation of the unexpired service contract, without a corresponding effect to the value of the service contract at the beginning of the year would give a distorted picture for inflated profits for the current accounting year. As I see, if the valuation of contracts at the end of the year is to be disturbed then by the same logic, the value of the contracts at the beginning of the accounting year should also be required to be modified. In absence of any new finding or fact, this would be an unnecessary complication.
“2.3.2 In Line with the foregoing, I do not find any merit in the addition. It is deleted and the ground of appeal is allowed.”
3. Now the revenue is in appeal before us. We have heard the rival submissions of the parties and perused the records. We find that the A.O. himself has accepted that the service contracts in many cases are spill over to two financial years. In view of the A.O., at the most, the assessee can carry forward 25% of the receipts for recognising the income in the next year and the assessee should have recognized to the extent of 75% of its receipts in the present assessment year. The Ld. Counsel demonstrated that where all the services are over in a financial year, entire income is recognized and only in the cases where the contracts are spill over in those cases only the pro rate revenue is recognized in the next year. We further find that in the past the assessee has consistently following this method and even in the assessment completed u/s.143(3) the method followed by the assessee has been accepted. We find that there is no logic in the approach of the A.O. We find no reason to interfere with the order of the Ld. CIT (A) on this issue accordingly the same is confirmed. Accordingly, issue in ground ‘a’ stands dismissed.
4. Ground no.b reads as under:
“b. On the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in deleting in entirety the disallowance of Rs.101,74,000/- made by the A.O. on account of commission payment made to the directors.
5. The issue in respect of commission payment to the Executive Directors of the assessee company. The assessee has claimed deduction to the extent of Rs.1,01,74,000/- which was on account of profit commission. The assessee stated that from A.Y. 1992-93 company is providing for performance awards on ad-hoc basis and Department has also accepted the said payment. The A.O. rejected the claim of the assessee and made the addition to the total income. To the extent of commission paid to the Director amounting to Rs.1,01,74,000/-. The assessee carried the issue before the Ld. CIT (A) who deleted the addition by giving following reasons:
“3.3 I have considered the assessment order and the submissions of the appellant. As I find, the main ground of the disallowance of the payment as pointed out by the Assessing Officer is the appellant’s inability to prove that any special services had been rendered by the Directors to deserve the receipt of the commission. As against this, the appellant has backed up its justification by referring to the credentials of the Directors, their contribution, Mr. Anil S. Rao, the increased sales, profits and exports over the years, acceptance of the payments in the past assessments and adherence to the Companies Act, 1956 while making the payment. Weighing these two positions, I find myself in agreement with the appellant. To this end, on the question of special services rendered, I find the Directors to be key functionaries of the company with very distinguished credentials. This is particularly so In the case of Mr. Ani1 S. Rao. When the credentials and key role of the Directors in the functioning of the company are seen against the backdrop of the increased sales, profits, exports and expansion of the appellant’s business, it becomes clear that the Directors have played a key role in the process. The following chart of the growing turnover profit and exports is illustrative of this.
Financial Year 2002-03 2003-04 2004-05 2005-06 2006-07
Turnover 64.53 71.99 81.90 93.64 116.03
Profit before tax 5.25 5.64 5.69 7.20 9.18
Exports 0.36 0.45 0.72 0.84 1.56
Significantly, I also note that the commission being related to profit is performance and merit based and is not in the nature of gratis. Being so, I do not find any element of excessiveness or unreasonableness in the payments as it is based on the very transparent parameter of profit. This is particularly so in the case of Mr. Anil S. Rao. As I find in the appellant’s submissions, Mr. Anil S. Rao has been in the company since 1987 and his father is the founder Chairman of the company since 1954. It is clear that Mr. Anil S. Rao has a key role to play in expanding the business of the company, in training the staff and managers and in the Research and Development activities of the company. As I find, the company has received national awards for the best R & D, s is evident from the letter dated 8.10.2007 from the Ministry of Science and Technology, Government of India to Mr. Anil S. Rao. I also find that the payment of the commission to the Directors is not discriminatory to the other managers and staff as the company has a separate performance awards scheme for them for achievements in different areas. In this respect, I find that the contribution of Mr. Anil S. Rao to the Joint Venture of the Company is also significant as I find that over the years the company’s income towards consultancy has also shown steady increase and during the year in terms of consultancy fees/commission, the company’s income was Rs.14,84,9761- as against Rs.12,99,309/- during the preceding year. In this respect, I also find that out of the total receipts by Mr. Anil S. Rao, the emolument by way of salary is smaller than the profit commission which underlines the fact that Mr. Anil S. Rao will be entitled to a larger amount only in the event of profit and accordingly, the payment is purely performance based. I also find that similar payment has been accepted in the earlier years and the Assessing Officer has not brought out anything new on record to justify the departure from assessments. Interestingly, I find that In the assessment order, the Assessing Officer has made the appellant’s explanation on the performance awards given to managers and staff as the basis of his decision on the completely different payment of profit commission paid to the Directors. Accordingly, I find the premise of the disallowance misplaced. In this respect, I find that the Assessing Officer’s reliance on the decision quoted by him as misplaced. As may be seen, in this decision, the Hon’ble Supreme Court had the occasion to observe that work of the assessee company was done by the managing agents and the Directors did not render any additional services in the accounting year to justify payment of additional remuneration. The appellant’s case stands on a completely footing in that the profit commission was not a payment which was made for the first time during the year but it had been consistently paid in the past. Further, in the
appellant’s case the Directors are closely and regularly involved in the functioning of the company. In the appellant’s case, the contribution of the Directors in effecting increased sales and profits is very clear on account of the key functions performed by them. Besides, in the appellant’s case, the managers and staff have also been separately rewarded for their performance. As against this, I find the reliance by the appellant on the decisions quoted by it as apt and appropriate. As I see, in essence, in these decisions, the commission underlining point is that the disallowance in the matter should be backed up by evidence and findings. As I See, in the appellant’s case, the Assessing Officer has not based his decision on concrete findings or evidence. In line with the foregoing, I do not find the disallowance justified. It is deleted and the ground of appeal is allowed.”
Now, the revenue is in appeal before us.
6. We have heard the parties and perused the records. The Ld. Counsel submits that company has been paying the Directors remuneration as a profit commission as per the provisions of the Companies Act, 1956, after determination of the profits. The assessee-company also is performance incentives to the Managers. He submitted that Mr. S. Rao was Chairman & Managing Director of the assessee company who withdrew from the active participation of the company’s business and Mr. Anil S. Rao was paid a commission of Rs.81,39,200/- @ 8% of the profit which as per the resolution passed by the Board. We have also heard Ld. D.R. We find that the profit commission which is paid to the Director is approved in the general meeting (G.M.) of the shareholders and required evidence was filed before the Ld. CIT (A). we further find that assessee has been paying profit commission to the Managing Director in past also. Earlier, Mr. S. Rao was paid same commission and after his withdrawal from business of the assessee, Mr. Anil Rao has been paid, enhancing his percentage to 8%, that is merging percentage of commission earlier paid to his father. In past A.O. has allowed said deduction and never raised any objection. After giving our anxious consideration to the facts on records, in our opinion there was no justification to the A.O. to disallow the commission payment to the Directors and the Managers. We find no reason to take a different view from that of Ld. CIT (A), we accordingly confirm the same and accordingly issue in round ‘b’ also stands dismissed.
7. So far as ground no.’c’ & ‘d’ are concerned, these are argumentative ground to support ground no.’b’. As we have dismissed ground no.’b’, ground no. ‘c’ & ‘d’ does not survive and accordingly, we dismiss the same.
8. In the result, revenue’s appeal is dismissed.
Order pronounced in the open court on 14th day of March, 2012.
(R.S. SYAL) (R.S. PADVEKAR)
ACCOUTANT MEMBER JUDICIAL MEMBER
Mumbai, Date: 14th March, 2012
1) The Appellant.
2) The Respondent.
3) The CIT (A)-40, Mumbai.
4) The CIT-Central-II, Mumbai.
5) The D.R. “C” Bench, Mumbai.
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