Sankar Prasad Mttra, C.J.
1. This is a reference under Section 256(1) of the I.T. Act, 1961. The assessee is a company. Its entire share capital, it is stated, has been acquired by the Govt. of India with effect from April 19, 1960.
2. Before the acquisition, the assessee's business consisted mainly of repairing ships. The assessee has now extended its activities to the manufacture of rollers, cranes, river craft and sea-going vessels.
3. The assessee was all along following the mercantile system of accounting. At the end of each accounting year it had some work-in-progress in respect of the contracts it had undertaken.
4. Up to the accounting year September 30, 1956, the assessee had been valuing its work-in-progress at 'cost'. From the accounting year ended September 30, 1957, it changed its method of valuation. The work-in-progress, according to the changed method, was being valued at ' cost or realisable value, whichever is less '.
5. In all subsequent years, the assessee was adopting the changed method mentioned above. Under the changed method when the assessee found that its expenditure in the execution of any contract exceeded the amount realisable under the contract, the assessee was writing off the difference in its accounts at the end of the year.
6. The ITO was not accepting this changed method of valuation. He was adding back in the relevant assessments the amounts written of in the accounts. He was not allowing the claim on the ground that the change which the assessee had made amounted to a change in the method of accounting and such a change was not permissible. He was not allowing the claim also on the ground that actual losses could be allowed on completed contracts but losses anticipated in contracts remaining incomplete at the end of the year could not be allowed.
7. The AAC was upholding the additions from year to year which the ITO had made in the aforesaid assessments.
8. For the assessment year 1957-58, the Tribunal decided against the assessee. The Tribunal held that the method which the assessee regularly followed and which the department accepted till the preceding year was that only losses on completed contracts were allowed and the assessee could not be permitted to deviate from the method of accounting which it had regularly followed.
9. The ITO made similar additions in the assessments for the assessment years 1959-60 and 1960-61, but the assessee did not go up on appeal.
10. The assessee again went up on appeal before the Tribunal in the assessment year 1961-62. In that appeal it was contended before the Tribunal, on the authority of the decisions in Indo-Commercial Bank's case : 44ITR22(Mad) and Forest Industries Travancore Ltd.'s case : 51ITR329(Ker) , that an assessee might be permitted to change his method of accounting, if such change was done in a bona fide manner-It was contended further that the Tribunal's earlier decision for the assessment year 1957-58 should not be followed, as the principle of res judicata did not apply to income-tax proceedings. In any event, in that year, namely, 1957-58, the assessee merely claimed the benefit of change in the method of accounting without actually effecting such a change. The Tribunal dealt with these contentions by the following observations :
'It is true that there is no res judicata in income-tax proceedings. It does not mean, however, that the past should be entirely ignored. It may be mentioned here that the assessee has been regularly assessed on completed contract basis and that no profit or loss has been assessed for this year or other years. What remains to be done in the assessee's case was only to value the work-in-progress according to the principles of accounting. '
11. The Tribunal then observed, after referring to Batliboi's views in Advanced Accountancy, 14th Edn., as follows :
'Therefore, it would be clear that the method of valuing work-in-progress adopted by the assessee was also not in consonance with the recognised principles of accountancy. Appart from that, it would not be proper to allow anticipated losses on incomplete contracts as realisable work-in-progress when the assessee had not been assessed on profit or loss on incomplete work otherwise. In these circumstances, we uphold the additions made by the Income-tax Officer. '
12. Similar additions made for the assessment years 1963-64, 1964-65, 1965-66 and 1966-67 were also challenged before the Tribunal, out of which the present reference has arisen. The particulars of the additions are as follows:
Assessment yearAddition Rs.
13. Apart from repeating the contentions made on behalf of the assessee for the assessment year 1961-62, certain other arguments were also advanced by the assessee's representative in the appeals which were the subject-matter of the present reference. For the sake of convenience we intend to place those arguments on record, at this stage, inasmuch as, more or less, the same arguments have been advanced before us.
14. The assessee's contention that the method of valuing the closing work-in-progress at 'cost or realisable value, whichever is less', which the assessee has adopted, accords with the well-recognised principles of accountancy. The opinions of some recognised authorities and accountancy institutions were cited before the Tribunal. The same opinions have also been cited before us. For instance, our attention has been drawn to statements of standard accounting practice issued by the United Kingdom Chartered Accountancy Institute in May, 1975. We have also been taken through a booklet issued by the International Accounting Standards Committee on Accounting for Construction Contracts. The assessee submitted before the Tribunal that it did not write off any anticipated further losses by adopting the changed method of valuation of the closing work-in-progress. It had merely written off actual losses in contracts in which the expenses exceeded the proportionate contracted price realisable. It was stated before the Tribunal that if the valuation had been done on the basis of actual cost incurred in such cases, the assessee's profits would have been inflated and its accounts would not have exhibited a true and fair view of the company's state of affairs. The assessee would have violated the provisions of the Companies Act.
15. The Tribunal's order it was contended, for the assessment year 1957-58, should not be taken into consideration in deciding the present issue inasmuch as the said order was made at a time when several High Court decisions, already referred to, were not available. Further, the Tribunal's order was based on the fact that the disputed amount was not actually written off in the relevant accounting year ending on September 30, 1956.
16. The departmental representative relied on the Tribunal's order for the assessment year 1961-62. The Tribunal found no reason to take a view different from the one which it had taken for the year 1961-62. By a common order, the Tribunal upheld the ITO's additions in the assessment years under reference towards under-valuation of the work-in-progress as at the end of the relevant accounting years.
17. At the time of hearing of the reference application before the Tribunal, a copy of the High Court's order on the assessee's application under Section 256(2) of the I.T. Act, 1961, in respect of the assessment year 1961-62, was placed before it. That is why the Tribunal has referred to this court for the year under reference the following questions;
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in rejecting the assessee's method of valuation of the work-in-progress on the alleged ground that such method was not in consonance with the recognised principles of accountancy ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified is not accepting for taxation purposes the appellant's change in the method of valuation of the work-in-progress from the basis of ' cost' to the basis of ' cost or realisable value ', whichever is less ?'
18. On behalf of the assessee, learned counsel has argued before us that the change in the method of valuation referred to in question No. (2) above was made long ago in the year relevant to the assessment year 1957-58. But the tax authorities did not accept those methods and chose to impose taxes with reference to the completed contracts only. In the years under reference there is no finding by the Tribunal that the method which the assessee had employed was such that the income could not properly be deduced therefrom. There was no finding that the change of method was mala fide. According to learned counsel, in cases where there are completed contracts as well as incomplete contracts, foreseeable losses with regard to incomplete contracts are always provided for in the accounts. This is also a recognised principle of accountancy. Anticipated losses are always admissible for tax purposes. The Tribunal, therefore, should have accepted the assessee's method of valuation and given relief to the assessee on that basis. A large number of decisions were cited before us but it would not be necessary to disclose those decisions in this judgment, as we propose to rely on the views expressed by authors, whose books on accountancy are recognised throughout the world. We find from those books that for the valuation of long-term contracts a particular method has been consistenly prescribed. Let us refer to that method as expressed by the authors in question.
19. In Spicer and Pegler's Book Keeping and Accounts, 16th Edn., at p. 301, extracts from the recommendations and memoranda made by the Institute of Chartered Accounts in England and Wales as to the value at which, inter alia, work-in-progress should be included in final accounts have been referred to. So far as 'long-term' contracts are concerned the observation made at p. 301 are as follows :
' In businesses which involve the acceptance and completion of long-term contracts it is often appropriate to spread over the period of the contracts on a properly determined basis, the profits which are expected to be earned when the contracts are completed. This procedure takes up in each period during the performance of the contract a reasonable amount as representing the contribution of that period towards the eventual profit; it thus recognises to a prudent extent the value of the work done in each period and restricts the distortion which would result from bringing in the whole of the profit in the period of completion. The principles which determine whether an element of profit is to be included are :
(a) profit should not be included until it is reasonably clear from the state of the work that a profit will ultimately be earned; it is, therefore, inappropriate to include any profit element where at the balance-sheet date the contract has been in progress for a comparatively short time or to include an amount in excess of the profit element property attributable to the work actually done;
(b) provision should be made for foreseeable losses and allowance should be made as far as practicable for penalties, guarantees and other contingencies;
(c) a clear basis for including a profit element should be established and adhered to consistently.'
20. In Yorston, Smyth and Brown's Advanced Accounting, 6th Edn., at pp. 475 to 476, the same principles as in Spicer and Pegler's Book-keeping and Accounts have been reiterated.
21. In Brown and Howard's Principles and Practice of Management Accountancy, 3rd Edn., at p. 419, we find the following passage :
' Long-term contract work-in-progress.
The method by which profit may be taken into account needs to take into consideration the type of business concerned. In all businesses, however, it is normal to define the point before which no profit should be taken. The overriding consideration is that of the profit which in the light of all the circumstances can be foreseen with a reasonable degree of certainty to arise on completion of the contract; there is regarded as earned to date only that proportion which prudently reflects the amount of work carried out to date. The method adopted for taking up profits needs to be consistently applied.
Other facts to be considered before taking any anticipated profit are:
(a) any future costs of rectification and guarantee work ;
(b) likely increases in wages and salaries;
(c) increases in prices of raw materials and overheads, where such increases are not recoverable from the customer.
When practical, separate parts of the contract may be treated as separate contracts where costs can be matched against performance. In relation to long term contracts the following additional information should be given:
(i) the separate amounts included in respect of cost and attributable profit;
(ii) the amount deducted in respect of anticipated losses ;
(iii) the further amount provided for anticipated losses on those contracts where the total anticipated losses exceed the costs to date ;
(iv) cash received and receivable at the accounting date as progress payments on account of contracts.
(b) Profit and loss account the amount of profit or loss arising from long term contracts distinguishing between ;
(i) the net amount provided in the year for anticipated losses ;
(ii) the profits less losses relating to contracts which had been treated as completed at the close of the preceding financial year ;
(iii) other profits and losses on long term contracts.
In Wittctt's Current Accounting Law and Practice 1977 at p. 391 we have come across the following passage :
' Long-term contract work-in-progress:
The amount at which long-term contract work-in-progress is stated in periodic financial statements should be cost plus any attributable profit, less any foreseeable losses and progress payments received and receivable. If, however, anticipated losses on individual contracts exceed cost incurred to date less progress payments received and receivable, such excesses should be shown separately as provisions.'
22. In the passages we have quoted above the method of valuation of long-term contracts recognised in accountancy has been elaborately discussed. We do not find from the statement of the case that the assessee contended before the Tribunal that it had adopted this method since the assessment year 1957-58. All that we find is that the Tribunal was invited to consider whether the valuation of the work-in-progress on the basis of ' cost -or realisable value, whichever is less,' should be accepted. Confronted with the above passage Mr. Poddar, learned counsel for the assessee, submitted to us that there was no difference between the method which the assessee had adopted and the method described in these passages. He says that the principle of net realisable value is applicable to long-term work-in-progress also. The foreseeable losses, according to Mr. Poddar, which are required to be provided for, are computed with reference to the net realisable value. And the Tribunal has not challenged the figure of the net realisable value. The Tribunal's challenge is to the system itself. There is no finding by the Tribunal also that correct profits or gains cannot be computed in the case of the assessee by following the changed method of valuation.
23. The method followed by the assessee in keeping its books or in preparing its balance-sheet or profit and loss accounts requires detailed examination of facts which can be done only by the tax authorities or the Tribunal. Sitting here, in the reference court, we are not entitled to express any opinion on those facts. The Tribunal's findings in this regard have to be accepted by us. In none of the recognised text books have we discovered any direct support for the principle that the valuation of work-in-progress of long-term contracts has to be made on the basis of 'cost or realisable value, whichever is less' ; on the contrary, these text books have given detailed information as to how accounts in respect of long-term contracts have to be maintained and there is scope, we find, for taking into consideration foreseeable losses and various other factors, if any. It is for the assessee to convince the Tribunal, so far as the subsequent years are concerned, that its method of valuation of these long-term contracts is the same as those described above on the basis of facts to be placed before the Tribunal.
24. In the instant case, in making assessments, no profit or loss on incomplete contracts has been taken into account. The assessments have proceeded on profit or loss on completed contracts only. The closing work-in-progress has been valued at cost. The expenditure from year to year is allowed to be accumulated and in the year of completion the entire expenditure has been allowed and the ultimate result ascertained. On the facts available to us at the moment, we can only express the view that the assessments have been made on a fair, direct, clear-cut and reasonable basis. But this observation of ours should be treated as confined to the cases which have been referred to us.
25. In Minister of National Revenue v. Anaconda American Brass Ltd. 0043/1955 : 30ITR84(SC) Viscount Simonds, delivering the judgment of the Privy Council, has observed that new theories of accountancy, though they may be accepted and put in practice by businessmen, do not finally determine a trading company's income for tax purposes. In a later judgment of the Court of Appeal in Duple Motor Bodies Ltd. v. Ostime : 43ITR65(Cal) , Lord Evershed M.R. has said:
'The duty of the directors is to make their decision on this matter in the best interests of the company, looking at it as a business entity ; and quite plainly it could not be said that their conclusion, quite properly come to as responsible for the company's management, was decisive of the matter for income-tax purposes. '
26. This decision of the Court of Appeal was upheld by the House of Lords ( 39 TC 537, 565).
27. In the present case, we find that consistently over a long period the tax authorities have made assessments on the basis of profits earned on or losses sufferred in completed contracts only. The position with regard to incomplete contracts was never taken into account. It is open to an assessee to change its method of valuation. Likewise, it is open to the revenue not to adopt a basis of valuation, which had been accepted by it consistently in the past, provided there are overriding reasons for effecting a change: See Kanga and Palkhivala's The Law and Practice of Income Tax, 7th Edn., p. 879.
28. The Tribunal, in the present case, has not found 'any overriding reason for effecting a change of method from the one consistently followed in the past. And, in the absence of non-availability of material facts, we are unable to state that the Tribunal has taken an erroneous view.
29. For all the reasons aforesaid, our answers to both the questions referred to us are in the affirmative.
30. We make no order as to costs.