26 November 2011
Then why the dept is accepting the revenue as per percentage of completion method. and charging the tax on un billed turnover/profits.
31 July 2024
### Expected Losses under AS 7 and Income Tax Act
**Accounting Standard 7 (AS 7)** requires the recognition of expected losses on construction contracts as soon as they are foreseen, regardless of whether the contract is completed or not. This approach ensures that financial statements reflect the true economic position of a company undertaking construction contracts.
However, the **Income Tax Act, 1961** follows a different approach for recognizing income and expenses, especially for construction and real estate businesses.
#### Treatment under Income Tax Act
1. **Recognition of Revenue**: - Under the Income Tax Act, revenue from construction contracts is typically recognized based on the **Percentage of Completion Method** (POCM). This method requires recognizing revenue as the construction progresses. The revenue is based on the proportion of work completed, which is sometimes disputed, especially when it comes to the timing of recognizing revenue and profits.
2. **Expected Losses**: - The Income Tax Act generally allows deductions for actual expenses incurred. However, provisions for anticipated losses (expected losses) may not be recognized for tax purposes until the loss is realized or when the actual loss is incurred. The tax authorities often insist on matching revenue and expenses, and anticipated losses may be scrutinized or disallowed until they are realized.
### Case Laws and References
1. **CIT vs. S. G. S. Construction Co. Ltd. [2005] 274 ITR 203 (Guj)**: - The Gujarat High Court held that while accounting standards require the recognition of expected losses, the Income Tax Act recognizes only actual losses incurred. The case emphasizes that provisions for future losses are not deductible until they become actual.
2. **CIT vs. T. S. Balakrishnan & Bros. [2005] 277 ITR 164 (Mad)**: - The Madras High Court ruled that expected losses should not be recognized for tax purposes until they are realized, aligning with the principle of recognizing actual expenditure.
3. **CIT vs. Harprasad & Co. (P) Ltd. [2007] 164 Taxman 417 (Delhi)**: - The Delhi High Court addressed the issue of recognizing revenue and losses, supporting the view that only actual losses and revenue should be accounted for tax purposes.
### Reasons for Discrepancy between Accounting Standards and Taxation
1. **Matching Principle**: - Accounting standards aim to present a true and fair view of the financial statements, which includes recognizing anticipated losses to match expenses with revenues. The Income Tax Act focuses on actual transactions and aims to prevent potential tax avoidance by only allowing deductions for real, incurred losses.
2. **Revenue Recognition and Taxation**: - The percentage of completion method for recognizing revenue can lead to discrepancies in reported profits. Tax authorities may adjust reported profits based on their interpretation of revenue and expenses, leading to adjustments in taxable income.
3. **Preventing Manipulation**: - Allowing deductions for expected losses could lead to manipulation or postponement of income. Therefore, tax laws require that only actual losses be recognized to prevent such practices.
### Summary
Under the Income Tax Act, expected losses provided as per AS 7 are generally not allowed until they become actual losses. This approach ensures that only real expenses are deducted from taxable income. The discrepancy between accounting standards and tax regulations is mainly due to the different objectives of financial reporting and tax compliance.
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