Commissioner of Income Tax vs Azad Builders

This is a reference u/s 256(2) of the income tax Act, 1961 (''the Act''). The questions called for on reference to this Court are as follows:

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the value of the materials supplied to the assessee in execution of contract work should be excluded from the gross receipts in determining the net profit by application of rate?"

In this reference we are concerned with the assessment year 1970-71. The assessee is a partnership firm. The firm undertook the contract work during the assessment year in question. During the assessment year in question the firm received a sum of Rs. 9,16,384 as gross sum in satisfaction of its claim. The assessee returned a profit of Rs. 58,160. This sum was arrived at after charging depreciation to the tune of about Rs. 10,000. The ITO considered the profit to be very low. In his view there was some defect in the account. He also found that the expenses were not properly vouched and verified. He, therefore, adopted the rate of 10 per cent net profit of the gross receipt without deducting depreciation.

On appeal, the AAC held that out of the gross sum received by the assessee, Rs. 3,96,132 constitutes the cost of materials supplied by the Irrigation Department, Heavy Engg. Corpn. Ranchi and Ranchi University for whom the assessee has executed the work. In the view of the AAC, the rate of net profit should have been assessed on the basis of the net receipt and not on gross receipt. The view of the AAC was upheld by the Tribunal.

The revenue was not satisfied with the verdict of the Tribunal. An application u/s 256(1) having failed the petitioner moved this Court, on which, a reference was called for and the present reference has been received in the said circumstance.

The question thus falling for consideration is whether the cost of materials used in the contract should have been deducted from the gross receipt for the purpose of assessing the rate of profit. The law in this regard has been changing from time to time. For some years the law was that the cost of materials as a whole must be deducted in order to arrive at the rate of profit. That law underwent a change. The Supreme Court in the case of Brij Bhushan Lal Parduman Kumar Vs. Commissioner of Income Tax , Haryana Himachal Pradesh and New Delhi III, laid down that the question in regard to deducibility of the cost of materials supplied to the assessee would depend upon the facts of each case. If the supplies of materials involve element of profit to the assessee there would be no scope for deduction. If on the other hand, the materials were within the absolute control of the authority for whom the work was being done, the cost of materials must be deducted before calculating the rate of profit. The same question again fell for consideration before a Bench of this Court in the case of Ramesh Chandra Chaturvedi Vs. Commissioner of Income Tax, In this case their Lordships laid down law as follows:

"There cannot be a hard and fast rule to determine the question as to whether the value of the materials should or should not be included in the gross turnover of an assessee who is a contractor, for determining his net profits. It all depends upon the manner in which the materials have come to be used in the execution of the contract. Generally contracts partake three forms�

(1) an overall contract wherein the contractor undertakes to execute the contract wholly supplying the labour and material, himself;

(2) works contract in which the contractor undertakes to supply only the labour. The contractor is not at all concerned with the materials used in the contract. He just puts the materials in the form in which he is asked to do and charges only for labour; and lastly

(3) a lump sum contract.

The last form of contract can be sub-divided into further sub-heads, namely:�

(a) where the contractor is given to understand that the total value of the contract shall be of a certain amount and the materials to be used therein shall be roughly of so much value, a part of which is supplied by the department concerned to be exclusively used in the contract and part of which the contractor may himself acquire from his own resources;

(b) where the department itself supplies the entire materials in the execution of the contract and pays to the contractor only for his labour, but all the same, in order to complete its accounts the department calculates the value of the contract on a lump sum basis, namely, the value of the materials supplied as also the payment made towards labour cost in the execution of the contract." (p. 119)

After laying down as above, their Lordships observed that in an overall contract net profit would be ascertained upon the entire value of the contract including the value of the materials. Their Lordships also observed that in a works contract the value of the materials has to be wholly excluded because the contractor has no concern whatsoever with the materials except for the purpose of putting them into the shape as desired by the person giving the contract. In a lump sum contract, however, that part of the value of the materials which the assessee arranged himself, has to be included in determining his net profits from the contract. On the facts of that case, their Lordships further held that the assessee, the contractor, had failed to show that he had no control over the materials supplied to him and used by him.

The instant case must be decided by the Tribunal on the basis of the law laid down in the case of Ramesh Chandra Chaturvedi (supra). The Tribunal shall, therefore, consider in the instant case the agreement or agreements in relation to the contract and the extent of the assessee''s control over the materials supplied to him by the department. If the finding be that the assessee (contractor) had control over the materials the net profit must be reckoned on the basis of the gross receipts. If, on the other hand, the finding be that the assessee had no control over the materials supplied by the department, the rate of profit must be estimated on the basis of net receipt.

In the instant case there is nothing before us to throw any light whether the assessee had control over the materials supplied or the contracting departments had complete control over the materials supplied. In the absence of finding in that behalf the Tribunal was not right in holding that the value of the materials supplied to the assessee in execution of the contract work had to be excluded from the gross receipts.

The matter is, therefore, remanded back to the Tribunal to ascertain whether the assessee or the department had control over the materials supplied to him. If the department had the control the profit must be estimated on the net receipts. If on the other hand the materials were under the control of the assessee the rate of profit must be estimated on the basis of gross receipts. We are, therefore, of the view that without touching the question from the appropriate legal approach the Tribunal was not justified in holding that the value of the materials supplied in execution of the contract work should be excluded from the gross receipts in determining the net profit. The Tribunal must go through the exercise afresh in the light of the principles enunciated above. There shall be no order as to costs.