1. In this case, at the instance of the assessee, the following question has been referred to us for our opinion by the Income-tax Appellate Tribunal
'Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the value of the materials supplied by the railway authorities was to be taken into consideration in estimating the total receipts of the assessee ?'
2. In the instant case we are concerned with the assessment year 1965-66, the relevant previous year being the financial year 1964-65. The assessee is a Hindu undivided family and carries on business of constructing buildings and doing the work of maintenance of buildings, inter alia, for railways. This work was being done in Ratlam Division of Western Railway. The assessee did not maintain books of accounts. In the absence of the books of accounts, the Income-tax Officer estimated net profit at the rate of 15 per cent. on total receipts for the assessment year 1965-66. In the total receipts of the assessee, the Income-tax Officer included the value of materials such as cement, iron, etc., supplied by the railway authorities and after arriving at the total figure, he calculated the net profits at the rate of 15 per cent. He worked out the net profit at Rs. 1,02,149 and the total taxable income was computed at Rs. 93,270.
3. Against the decision of the Income-tax Officer, the assessee carried the matter in appeal and the Appellate Assistant Commissioner reduced the rate of net profit to 12.5 per cent. of the total receipts and held that the Income-tax Officer was not justified in including the value of the materials supplied by the railway authorities in the total receipts for the purpose of calculating the net profit by application of the rate.
4. Against the decision of the Appellate Assistant Commissioner, the assessee went in appeal before the Tribunal and contended that the net profit should be calculated at 10 per cent. of the total receipts and this basis of 10 per cent. should have been adopted by the Income-tax Officer and the Appellate Assistant Commissioner. The Revenue filed cross-objections contending that the rate of net profit adopted by the Appellate Assistant Commissioner was low and it further contended that the value of the materials supplied by the railway authorities should have been included in the total receipts of the assessee. The Tribunal by its order partially allowed the appeal filed by the assessee and also partially allowed the cross-objections filed by the revenue. The Tribunal held that the value of the materials supplied by the railway authorities should be included in the receipts for the purpose of ascertaining the net profits by applying the percentage rate. The Tribunal also held that instead of 12.5 per cent. the profit should be calculated on the basis of 10 per cent. Thereafter, at the instance of the assessee, the above-mentioned question has been referred to us for our opinion.
5. In the instant case, the Appellate Assistant Commissioner has observed in paragraph 6 of his order :
'The contention of the appellant, on the other hand, is that as per the specific terms of the contract entered into with the railway authorities, cement and iron had to be supplied by them for execution of the work and no accounting of the cost of these materials was to be done while making the bill in respect of contract payment. The appellant further urges that for the assessment years 1963-64 and 1964-65 the Appellate Assistant Commissioner had already held that the fictitious receipts in respect of the cost of cement and iron could not be included in the estimated contract receipts for the purpose of arriving at the total income and in view of this decision of the Appellate Assistant Commissioner the estimate of the Income-tax Officer is obviously erroneous.'
6. Mr. Kaji appearing for the revenue has after referring to the orders of the Appellate Assistant Commissioner for assessment years 1963-64 and 1964-65 very fairly stated that those orders go to show that in these contracts with the railway authorities, the assessee before us was entering into the contracts in specific terms that the cement and iron had to be supplied by the railway authorities for the execution of the work and that no accounting of the cost of the work was to be done by it. Under these circumstances, it is obvious that the main question that we have to consider has to be decided in the light of this particular aspect of the matter. The Income-tax Officer noted in his order that cement and iron constituted one-third of the total cost of receipts and, hence, he took one-third of the total receipts for iron and cement which the railway supplied free to the assessee and on that basis taking the figure of Rs. 5,10,744 as the total receipts, he added one-third, namely, Rs. 1,70,248, in respect of the cement and iron as discussed above and then ascertained the amount of net profits on the basis of calculation at the rate of 15 per cent. of Rs. 6,80,992.
7. Before we go on to discuss the authorities cited at the bar, before us, we must make it clear that the question referred to us has to be decided in the light of clear perception and appreciation of what is generally provided in building contracts of the type before us. From the point of view of the question referred to us, contracts for building construction or of similar type can be divided into two broad categories. Category No. (1) will cover contracts where, at the time of entering into the contract, the contractor is told that some of the materials required for construction work will be supplied by the person or authority who entrusts the construction work to him and it is on that footing of such construction materials being supplied by the authorities or the other party to the contract, that the contractor enters into the contract for the constructions quoting a particular figure for the entire contract. A sub-category of this first category of contract is the type of contract where, for notional purposes, a total figure is mentioned for the construction contract inclusive of materials an on the footing that the contractor is to supply all the materials for the construction work. However, at the time when the contract is entered into, it is clearly agreed between the contracting parties that some of the building materials will be supplied by the other party to the contract, that is, the person or authority entrusting the construction work to the contractor, and that credit will have to given by the contractor for the materials thus received and the rates at which the credit is to be given is also agreed upon between the contractor and the other party to the contract. We have designated this as sub-category of category No. (1) because though notionally and on the face of it the contract has been entered into for a much larger amount and on the footing that the contractor is to supply all the materials, because of the clear agreement between the parties about the materials to be supplied by the other party to the contract and also about rates at which those materials are to be supplied, it is clear that in fact and in substance the parties have entered into the contract where certain specified materials are to be supplied not by the contractor but by the other party to the contract and the contractor right form the beginning enters into the contract on this footing and puts forward his quotation and ultimately gets the contract for the amount where he does not take in to consideration supply of those particular materials or rates for those materials. Category No. (2) of contracts is the type where, right form the beginning, the contractor enters into the construction contract on the footing that he has to supply all the materials but while the contract is being executed, the other party to the contract supplies some of the materials and when the bill is finally paid, the other party to the contract is claims credit for the price of the materials supplied to the building contractor. In the eventuality, it is really the total figure of the original contract or figure worked out in accordance with the terms of the original contract which will constitute the original receipts of the building contractor and the fact that, instead of going into the market and purchasing the materials for himself, the contractor gets these materials for himself, the party to the contract, does not enter into the picture so far as this aspect of the case is concerned. The question as to under which particular category, category, No. (1) or category No. (2) set out above, a particular contract falls, will have to be decided looking to the substance of the transaction between the parties in each individual case. If the case falls under the first category, then it is obvious that the cost of the materials supplied by the other party to the contract be taken into consideration in arriving at the figure of the total receipts of the contractor in respect of the particular contract for building construction. On the other hand, if the case falls, on the facts and circumstances of the particular case, in the second category, then the total receipts of the building contractor in the respect of that particular contract will be total amount of the contract not withstanding the fact that the other party to the contract has supplied some of the materials required for building construction work. When we examine the cases of the different High Courts and of the Supreme Court dealing with one or the other categories which we have to consider, this division into two categories which we have mentioned above will be the correct test to be applied in cases of this kind.
8. In Chowringhee Sales Bureau P., Ltd. v. Commissioner of Income-tax, the facts before the Supreme Court were that the appellant before the Supreme Court was a private company dealing in furniture and it is also acted as an auctioneer. In respect of the sales effected by it as auctioneer, the appellant realised during the relevant period, in addition to the commission, Rs. 32,986 as sales tax. This amount was credited separately in its account books under the head 'Sales tax collection account'. The appellant did not pay the amount of sales tax to the actual owner of the goods. Nor did it deposit the amount realised by it as sales tax in the State exchequre, because it took the position that the statutory provision creating that liabity upon it was not valid, nor did it refund the amount to the persons from whom it had been collected. In the cash memos issued by the appellant to the purchasers in the auction sales, the appellant was shown as the seller and, on the facts, the Supreme Court held that the amount of Rs. 32,986 realised as sales tax by the appellant in its character as an auctioneer formed part of its trading or business receipts and it was further held that the fact that the appellant credited the amount received as sales tax under the head 'Sales tax collection account.' did not make any material difference. AT page 548 of the report, Khanna J., Delivering the judgment of the Supreme Court, observed :
'It is the true and the quality of the receipt and not the head under which it is entered in the account books as would prove decisive. If a receipt is a trading receipt, the fact that it is not so shown in the account books of the assessee would not prevent the assessing authority form treating it as trading receipt.'
9. It is, therefore, clear that in matters of this kind, when deciding whether a particular amount should or should not be considered to be trading receipt, it is true nature and quality of the receipt, either actual or deemed, which has to be considered and to the outward form or the head under which the amounts is entered in the account books of the assessee concerned.
10. In Commissioner of Income-tax v. Bijli Cotton Mills (P.) Ltd., the Allahabad High Court was concerned with the collection of a sum of Rs. 74,261 which was received by the assessee before the Allahabad High Court under the expectation that it might be required to pay additional excise duty on the yarn supplied by it to a party in Bombay. The assessee agreed to refund it to the party if the additional excise duty was not collected. Additional excise duty was not in fact paid and the assessee refunded the amount of Rs. 7,239 only to the party from whom this amount was received. The amount was received in March, 1948, and in the calendar year 1950, the assessee credited the balance of Rs. 67,125 to the capital reserve fund account of the assessee. The question was regarding the inclusion of this amount of Rs. 67,125 in the assessee's income for assessment year 1951-52. On these facts the Allahabad High Court held that though there might be some force in the contention that there was a trading receipt in 1948, there was no receipt by the assessee during teh calender year 1950, and thus there was no incoem if tge assessee for the previous year relevant to the assessment year 1951-52. At page 627 for the report, Oak C.J., delivering the judgment of the court, observed :
'The question remains whether this was a trading receipt during the previous year relevant to the assessment year 1951-52. In Morley v. Tallersall, Sir Wilfrid Greene M.R. observed on page 65 that the quality and nature of a receipt for income-tax purposes is fixed once and for all when it is received.'
11. We are inrespectful agreement with this approach of the Allahabad High Court to the question of determination of the real character of a receipt, actual or deemed.
12. In Commissioner of Income-tax v. K. S. Guruswami Gounder & K. S. Krishnaraju, the Madras High Court held that the cost of materials supplied to the contractor by the Government for the purpose of constructions on their behalf undertaken by him cannot be included in his total receipts for the purpose of computing the income of the contractor. Such income has to calculated only on the actual receipts from the Government. At page 91 Ramanujam J., delivering the judgment of the Madras High Court, observed :
'It is not the case of the revenue that the obligation to supply the materials like cement, steel, etc., was not undertaken by the Government even at the time of calling for the tenders. If the assessee gave its tender on the definite understanding that the department concerned is to supply the required materials for the construction of the buildings, the rates quoted by him would have been adjusted on that basis. Therefore, there is no question of the assessee purchasing the materials required for the buildings from outside and putting itself to a disadvantage. Admittedly, the materials supplied by the departments had been used in the construction of the buildings and the assessee did not, in fact, earn any profit in relation thereto. We are not, therefore, in a position to say that the turnover represented by the cost of the materials supplied, in any manner, contributed to the profit of the assessee.'
13. The Madras High Court noted that in the decision of the Kerala High Court in M. P. Alexander & Co. v. Commissioner of Income-tax, which is printed as an Appendix to this dicision of the Madras High Court, the same view was taken on similar facts by the Kerala High Court.
14. At page 92, Govindan Nair J., as he then was, in Kerala High Court, mentioned that the assessee's contention was that the cost of the materials supplied by the government should not be taken into consideration while considering the total receipts of the assessee while arriving at the figure of the net profits. He observed :
'We may state at the outset that these amounts have been included for applying the percentage on the basis that these amounts representing the cost of the materials has contributed to the profies made. This is clear from the Tribunal's order as well as from the statement of the case. In the statement of the case, in paragraph 3, it is stated : 'The assessee was asked as to why the cost of materials and the hire charges had not been taken into account. The assessee's explanation was that, while tendering the cost of materials supplied the hire charges were not considered, as no profit was made thereon'.'
15. The Kerala High Court pointed out (page 93) :
'It is clear that the Tribunal has proceeded on the basis that there is an element of profit involved even in the supply of materials by the State Government. Even so they were prepared to say that there was no such element involed in the hire charges. We are unable to discern any difference between these. Further, we are unable to see any material on the basis of which it was possible to postulate that the turnover represented by the cost of materials in any manner contributed to the profit of the assessee.'
16. The Kerala High Court pointed out that two certificates had been produced by the assessee, one issued by the Executive Engineer, Building Division, Alwaye, and the other issued by the Executive Engineer, Panniar Division, Kallarkutty, clearly stating that for estimating purposes the percentage of profit was calculated on the labour charges alone and that it was not calculated on the cost of departmental materials supplied for the work.
17. It is thus clear that the contract before the Madras High Court in Commissioner of Income-tax v. K. S. Guruswami Gounder & K. S. Krishnaraju, and before the Kerala High Court in M. P. Alexander & Co. v. Commissioner of Income-tax fall within the first category that we have mentioned above and we are in respectful agreement with the conclusion reached by the Madras and the Kerala High Courts regarding contracts of this type which we have referred to as the contract in the first category.
18. In Brij Bushan Lal v. Commissioner of Income-tax, the facts before the Punjab High Court were that the assessee, who did building work on contract for the M.E.S. department, was assessed on the basis of net profits determined at 10 per cent. 12.5 per cent. 12.5 per cent. and 10 per cent.of the amount received by the assessee from the M.E.S. department in the four years in question. Subseqently, on the ground that the cost of materials supplied by the military authorities to be used in the building works by the assessee had not been disclosed, the Income-tax Officer issued notices to the assessee under seciton 34 of the Indian Income-tax Act, 1922, and made orders of reassessment by adding profits at the same rates on the cost of the building materials supplied to him. Question No. (3) referred to the High Court at the instance of the assessee was : 'Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the price of the stores supplied by the military authorities was to be included before applying the flat rate to the assessee's receipts ?' The Punjab High Court held that if an assessee does not produce his accounts to satisfy the Income-tax Officer as to the true profits or income made by him from a contract and leaves it to him to determine, on the best judgment basis, the profits or income made by the assessee, the Income-tax Officer naturally will calculate and determine the net income assessable on the basis of the value of the contract as a whole and not on the value of the contract after deducting the cost of the materials supplied by the department. With respect, we are unable to asgree with this conclusion of the learned judges of the Punjab High Court. The question that has to be determined these profits, the main question is what was in substance the contract between the parties. It is that substance of the contract which matters and it, as we have pointed out in sub-cat gory if catrgory No. (1), the agreement between the parties right from the beginning is that certain materials are to be supplied by the other party to the contract, that is, the Government department, or the authority concerned, then it is obvious that the contract was entered into the footing that no profit would be made by the building contractor in respect of the supply of those materials.
19. It may be pointed out that in a subsequent decision in Commissioner of Income-tax v. Brij Bhusan Lal, Ramesh Kumar, the Punjab High Court followed its earlier decision and held that the cost of materials supplied by the Government must be included while estimating the profit of the contractor.
20. In V. D. Rajarathanam v. Commissioner of Income-tax, the Andhra Pradesh High Court was concerned with the contract undertaken by the assessee for carrying out certain items of renovation and repairs to 'Rashtrapathi Nilayam' in Andhra Pradesh. Question No. (2) referred to the Andhra Pradesh High Court was : 'Whether, on the facts and in the circumstances of the case, estimation of profit on the gross amount instead of estimating on the net amount received by the assessee after deduction of cost of material supplied by the Government is justified in law ?' Jaganmohan Reddy C.J., as he then was observed at page 22 :
'There is, however, an indication in the finding of the Appellate Assistant Commissioner that the latter is the case (that the contract was for the whole of the work including the materials and the Government gave a rebate of the cost of materials). In the statement of the case, the following observations of the Appellate Assistant Commissioner were extracted, which we may also usefully give below :
'The contention that profit rate should be adopted only in respect of the net receipts cannot be accepted because admittedly the appellant had received the gross amount and had to furnish the materials himself. A profit ratio had been adopted. The materials supplied by the departmental authorities were of such a nature that they could not be obtained by the appellant in the open market at the rates at which the Government supplied them, even if he could obtain them in the open market. It is not also the case of the appellate that he had enough funds that he could stock those materials when the prices were low and utilise them when prices were high. the percentage of net profit of 12.5 per cent. adopted by the Income-tax Officer also is quite reasonable. In fact, in respect of the contract relating to Rashtrapathi Nilayam, the income-tax Officer himself adopted the net profit at 10 per cent. accepting the appellant's plea that the appellant had been allotted only a part of the work and that more profitable items of the contract were given to other contractors.' This above extract gives a indication that the assessee was to receive the gross amount and had to furnish the materials himself but since the Government furnished the materials, an inference would arise that they must have deducted those amounts from the payments, in which case the basis cannot be challenged.'
namely, the basis of estimation of profits on the gross amount instead of estimating on the net amount received by the assessee after dedcution of cost of materials.
21. It is thus clear from the passage that we have quoted above that, on the facts and circumstances of the particular case before the Andhra Pradesh Higth Court, it was a contract of the second category which we have set out hereinabove. The contract was as a whole and the contractor had to supply the materials but while the contract was being executed, some of the materials required for executing the contract were supplied by the Government. Under these circumstances it is but obvious that the Andhra Pradesh High Court proceeded on the footing that the profits had to be determined after taking into consideration the gross amount of the contract and not on the net amount actually received from the Government.
22. In Commissioner of Income-tax v. K. S. Reddy, the Andhra Pradesh High Court was concerned with the case of an assessee, a contractor, who produced no accounts to satisfy the authorities as to the true profit or income derived by him from the contract works. The Andhra Pradesh High Court relying upon the decision of the Punjab High Court in Brij Bushan Lal v. Commissioner of Income-tax held that the profit or income had to determined on the basis of the contract after deducting the cost of materials supplied to him by the Government. It seems from the report that the decision of the Andhra Pradesh High Court which came to be subsequently reported in V. D. Rajarathanam v. Commissioner of Income-tax, was cited and the passages which we have extracted from the judgment of Jagamohan Reddy C.J. have actually been quoted in the judgment of Obul Reddy C.J. in this particular case of K. S. Reddy. With respect, we are unable to agree with the reasoning which appealed to the learned judges of the Andhra Pradesh High Court in Commissioner of Income-tax v. K. S. Reddy. The distiction on the facts of the case which Jaganmohan Reddy C.J. had pointed out in V. D. Rajarathanam's case has not been taken into consideration and we are unable, therefore, with respect, to agree with that reasoning in K. S. Reddy's case.
23. It is, clear, therefore, that in the light of the principles which we have called out above and in the light of the two categories in which the contracts of this kind can be divided for the purpose of answering questions of the type referred to us, in each case the question that has to be asked in : in which out of these two categories, the contract would fall. In the instant case, as pointed out above, the contract between the parties, namely, the assessee and the railway authorities, was that cement and iron had to supplied by the railway authorities for the execution of the work and no accounting of the cost of these materials was to be done while making out a bill in respect of the contract payment. Under these circumstances it must be held that since this particular contract falls in the first category where at the time of entering into the contract the quotation did not take into account the materials like iron and cement which were to be supplied by the railway authorities, all calculations at the time of entering into the contract were made on the footing that iron and cement were to be supplied by the railway authorities and it is obvious that these items could not be included in the total receipts of the assessee for the purpose of arriving at the figure of net profits by working out the percentages of that total figure.
24. We find from the order of the Tribunal that the Tribunal fixed the figure of 10 per cent. of the total receipts only in view of the fact that the cost of materials supplied by the railway authorities was to be taken into consideration at the time of fixing the receipts. Since we are holding in the instant case that the cost of these materials supplied by the railway authorities is not to be taken into consideration at the time of determining the receipts in the light of the facts and circumstances of this particular case, it is but fair that the matter should be left on to the Tribunal to decide as to which particular percentage it would apply to the total receipts in order to arrive at the net profits earned by the assessee before us.
25. We, therefore, answer the questions referred to us in the negative, that is, in favour of the assessee and against the revenue. It will be open to the Tribunal to fix the amount of percentage total receipts, namely, 10 per cent. or any other percentage, in light of the facts and circumstances of the case for the purpose of arriving at the amount of net profits. Under section 260, sub-section (1) of the Income-tax Act, 1961, the Tribunal will work out this percentage in order to give effect to this judgment of ours.
26. The question is answered accordingly. The Commissioner will pay the costs of this reference to the assessee.