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Receipt of retention money by furnishing bank guarantee is not chargeable to
tax since it accrues onl y on a successful completion of a contract
31 January 2012




Background
Recently, the Mumbai Bench of the Income-tax Appellate
Tribunal (the Tribunal) in the case of Ballast Nadam
Dredging
1
(the taxpayer) held that payments received on
account of retention money by furnishing of bank
guarantee are not chargeable to tax since it accrues only
on a successful completion of a contract.
Facts of the case
The taxpayer is a foreign company engaged in
execution of a contract for construction of breakwaters
and the associated dredging and land reclamation
works awarded by the Government of India. As per
contract the retention money at the rate of 5 percent
had been withheld. The agreement further provides
that whenever retention money reaches to 2 percent
of the contract price, the contractor could ask for
release of 1 percent of the contract price by furnishing
of bank guarantee.

__________

1
ADIT v. Ballast Nadam Dredging [ITA No. 999/Mum/2008, dated 30 December
2011]




Accordingly, in the Assessment Year (AY) under
consideration, the taxpayer received payment towards
release of retention money against bank guarantee.

The taxpayer did not offer the said payment for
taxation on the ground that it would become taxable in
the year when contractor satisfactorily completed the
work and removed defects if any it would be taxable at
that stage. However, the Assessing Officer (AO)
brought the said amount to tax on the ground that it
had accrued to the taxpayer during the year and is
therefore taxable.

The Commissioner of Income-tax Appeals [CIT(A)]
relying on various decisions
2
held that the taxpayer
does not have an absolute right over the amount paid
against bank guarantee out of retention money and
therefore the said amount could not be assessed to
tax.
___________________

2
CIT v. Associated Cables Pvt Ltd[2006] 286 ITR 596 (Bom)

DCIT v. Spirax Marshall Ltd [2007] 109 TTJ 593 (Pune)

CIT v. Yatindra and Co [2005] 149 Taxman 281 (ALL)


2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.
































Issue before the Tribunal
Whether payments received by the taxpayer on account of
retention money by furnishing of bank guarantee are
chargeable to tax?
Taxpayers contentions
The taxpayer contended that it had received retention
money on furnishing of a bank guarantee. Therefore, the
release of retention money against bank guarantee did
not result in conferring an unfettered right on it. It can be
considered as financing arrangement for smooth
completion of the work by the taxpayer. Further it was
following consistently to offer for taxation the part
released of retention money against bank guarantee in
the AY in which right to receive the said release of
retention money accrued unconditionally.
Even if it could not fulfill obligations expressed in the
contract, the contractee has right to recover the retention
money from the bank on the basis of the bank guarantee
given. The bank has also undertaken unconditionally
and irrecoverably to pay the contractee on demand by
invoking bank guarantee. Further the income has
accrued to it in which the right to receive particular
income accrued unconditionally.
The taxpayer contended that this particular contract was
completed in AY 2006-07 and it had recognised the
retention money as income in AY 2006-07. The similar
issue has been considered by third member Bench of
the Mumbai Tribunal in the case of Associated Cables
Pvt. Ltd
3
. Thereafter, the Bombay High Court in the case
of Associated Cables Pvt. Ltd confirmed the above
decision of the Tribunal.
The taxpayer contended that the decisions cited by the
tax department are not relevant to the facts of the case,
as in those cases the bank guarantee was given to fulfill
warranty obligations only and the taxpayer received full
amount which is not a case of retention money.
Tax departments contentions
The tax department contended that the Government of
India released 1 percent of the contract price out of the
retention money withheld by it by furnishing bank
guarantee. The amount received was to be assessed in
the year in which the amount has been received by the
taxpayer as the income had accrued to it. Further the
taxpayer had already claimed expenditure incurred in
respect of contract executed and therefore, when the
amount is released, the same has to be taken into
consideration in the year in which it is received.
_________________________

3
Associated Cables Pvt. Ltd v. DCIT [1994] 48 ITD 141(Mum)






The tax department relied on the decision of Amarshiv
Construction (P) Ltd
4
where it was observed that the
amount was deducted from running bills of
construction work as additional security deposit for
satisfactory performance of contract. It was released
on furnishing bank guarantee. Therefore the payment
had accrued in the AY in which bills were raised. This
decision was squarely applies to the case of the
taxpayer and therefore retention money received
against bank guarantee was the income of the
taxpayer.
The tax department contended that the Bombay High
Courts decision in the case of Associated Cables Pvt.
Ltd was not applicable as in that case no retention
money was received by the taxpayer but a part of that
retention money was withheld by the contractee.
Therefore, it was held that no income accrued in the
year in which the amount was retained. Further this
decision of Bombay High Court was also considered
by Chandigarh Tribunal in the case of Punjab
Communications Ltd
5
.
The tax department contended that the income which
has actually accrued cannot be reduced with the
probable obligations which may arise under the
warranty clause. The AO was justified to include the
amount received by the taxpayer in the AY under
consideration out of retention money as the said
income has accrued to the taxpayer.

Tribunals ruling

Similar issue had been considered by third member of
the Tribunal in the case of Associated Cables Pvt. Ltd
wherein the third member was observed that as long
as the performance guarantee remains and is
enforceable without notice to the taxpayer, the income
from the retention money cannot be recognised.
Consequently, the retention money of 10 percent has
to be excluded in computing the total income until the
period of guarantee is over.

The Tribunal observed that the Bombay High Court in
the case of Associated Cables Pvt. Ltd in subsequent
AY has affirmed the Mumbai Tribunals decision and
held that retention money withheld by the contractee
pending completion of a contract work does not
accrue to the contractor in the year in which the
amount was retained.

__________________

4
DCIT v. Amarshiv Construction (P) Ltd [2004] 88 ITD 381(Ahd)

5
Punjab Communications Ltd v. DCIT 87 TTJ 440 (Chd)




2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.






















































Similar issue was also considered by the Pune Tribunal in
the case of Spirax Marshall Ltd where it was held that the
receipt of retention money against furnishing of bank
guarantee cannot partake the character of income as it
cannot be apportioned until guarantee period was over.
The retention money may be received by the taxpayer.
However, it cannot be apportioned until expiry of warranty
period.

Further the Allahabad High Court in the case of Yatindra
and Co has held that an amount received by taxpayer
against bank guarantee was not accrued during the year
as no absolute right to receive the amount at that stage
vested. Thus, no income had accrued on account of such
retention payment.

Our comments

The Mumbai Tribunal has followed various decisions and
held that payments received on account of retention money
by furnishing of bank guarantee are not chargeable to tax,
since it accrues only on successful completion of a contract.

In the present case even though the taxpayer had received
the amount of retention money, the bank guarantee for
performance clearly shows that the receipt was at the risk of
losing the amount if there was any defect in the goods.
Therefore, the release of retention money does not partake
the character of income unless contract is successfully
completed.





2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative
(KPMG International), a Swiss entity. All rights reserved.




























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endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue
to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
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(KPMG International), a Swiss entity. All rights reserved.
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