Unpaid TDS embedded in work-in-progress cannot be disallowed if expenditure is not claimed in profit and loss.

ORDER

Makarand Vasant Mahadeokar, Accountant Member.- This appeal is directed against the order passed by the Learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi, under section 250 of the Income Tax Act, 1961, dated 06.11.2025, arising out of the assessment order passed by the Assessing Officer under section 143(3) read with section 144B of the Act dated 19.04.2021 for Assessment Year 2018-19.

2. The assessee, a partnership firm, filed its return of income on 31.10.2018 declaring total income at (-) Rs. 19,13,36,376/-. The case was selected for complete scrutiny under the EAssessment Scheme, 2019 on issues relating to income from real estate business, default in TDS and disallowance for such default, and investments/advances/loans. Notices under section 143(2) dated 23.09.2019 and under section 142(1) dated 16.12.2020, 03.01.2021 and 31.03.2021 were issued and served upon the assessee.

3. During the course of assessment proceedings, the Assessing Officer observed that the assessee had shown TDS payable of Rs. 6,08,51,784/- in its balance sheet and called upon the assessee to furnish challans evidencing payment thereof. It was further observed that as per the audit report, TDS was not deducted on certain expenditures amounting to Rs. 47,72,650/-, whereas the assessee had disallowed only Rs. 34,80,352/- under section 40(a)(ia), thereby resulting in a difference. The assessee was also required to furnish copies of sale deeds in respect of properties sold during the year. However, the Assessing Officer recorded that the assessee failed to furnish the requisite information.

4. A show cause notice along with draft assessment order dated 08.04.2021 was issued proposing disallowance of TDS liability under section 43B and further disallowance under section 40(a)(ia).In response, the assessee submitted that provisions of section 43B are not applicable to non-payment of TDS and that such disallowance is governed by section 40(a)(ia). It was further submitted that the assessee had already disallowed Rs. 10,44,106/- under section 40(a)(ia) in the return of income and any further disallowance would result in double disallowance. The Assessing Officer did not accept the explanation of the assessee and observed that as per the audit report, the assessee had deducted TDS amounting to Rs. 6,08,51,784/- but failed to deposit the same before the due date of filing of return under section 139(1). Accordingly, the Assessing Officer held that there was contravention of section 40(a)(ia) and disallowed expenditure amounting to Rs. 1,82,85,535/- being 30% of the unpaid TDS and added the same to the total income. Further, on account of non-deduction of TDS on certain payments aggregating to Rs. 46,56,850/-, the Assessing Officer observed that the assessee had disallowed a lesser amount and therefore made an additional disallowance of Rs. 3,52,949/-under section 40(a)(ia). Accordingly, the total income was assessed at a loss of Rs. 17,26,97,892/- as against returned loss of Rs. 19,13,36,376/-.Penalty proceedings under section 270A were also initiated.

5. Aggrieved, the assessee preferred an appeal before the Learned CIT(A).Before the CIT(A), the assessee reiterated that it was engaged in redevelopment activities and that the expenditure incurred during the year was debited to work-in-progress and carried to the balance sheet as per ICAI guidelines. It was submitted that since the expenditure was not claimed in the profit and loss account, provisions of section 40(a)(ia) were not applicable. The assessee also brought on record that subsequent to the assessment order, rectification orders under section 154 dated 29.12.2022 and 09.03.2023 were passed by the Assessing Officer modifying the quantum of disallowance and brought forward losses. It was contended that the original assessment order stood merged with the rectification order and therefore the appeal had become infructuous.

6. The CIT(A), after considering the submissions, held that rectification under section 154 does not result in merger of the original assessment order, and therefore the appeal against the assessment order remains maintainable.

7. The Learned CIT(A) also noted that the core issue in appeal pertains to disallowance of expenditure under section 40(a)(ia) of the Act. The first contention of the assessee was that the Assessing Officer initially proposed disallowance under section 43B in the show cause notice but ultimately made the disallowance under section 40(a)(ia), rendering the disallowance invalid. On this aspect, the Learned CIT(A) held that the substance and intent of the show cause notice clearly indicated that the proposed disallowance was on account of non-deposit of TDS and was in the nature of disallowance under section 40(a)(ia). The reference to section 43B in the show cause notice was held to be inadvertent. It was further observed that section 292B of the Act cures such defects and that mere incorrect mention of a statutory provision would not invalidate the proceedings if the action is otherwise in accordance with law. The Learned CIT(A) recorded that the assessee was fully aware of the nature of the proposed disallowance and was afforded adequate opportunity of being heard. Accordingly, the contention of the assessee was rejected as being devoid of merit.

8. With regard to the second contention of the assessee that section 40(a)(ia) is not applicable to expenditure debited to workin-progress, the Learned CIT(A) examined the factual position and observed that the assessee had deducted tax at source amounting to Rs. 6,08,51,784/- but had failed to deposit the same within the prescribed time. The Assessing Officer had initially disallowed 30% of the said amount, which was subsequently found to be erroneous and rectified under section 154 by applying the disallowance on the total expenditure of Rs. 91,72,13,274/-. The Learned CIT(A), therefore, proceeded to examine the disallowance of Rs. 27,51,63,982/- being 30% of such expenditure. The Learned CIT(A) further considered the submission of the assessee that the expenditure was incurred in relation to an incomplete project and was capitalised to work-inprogress in accordance with the ICAI Guidance Note on real estate projects, and hence not claimed in the profit and loss account. After analysing the provisions of section 40(a)(ia), the Learned CIT(A) observed that the section operates to deny deduction in computation of business income where tax is not deducted or not paid within the prescribed time. It was noted as an undisputed fact that the assessee had deducted TDS but failed to deposit the same within the due date and no evidence was furnished to establish subsequent compliance. However, on the applicability of section 40(a)(ia) to expenditure capitalised as work-in-progress, the Learned CIT(A) placed reliance on the decision of the Co-ordinate Bench in the case of Savala Associates v. ITO [2010] 35 SOT 148 (Mumbai), wherein it was held that under the completed contract method, if any expenditure is found to be not allowable, the appropriate course is to adjust the work-inprogress rather than making a direct addition to income. Following the said judicial precedent, the Learned CIT(A) held that where the assessee follows the completed contract method and the expenditure is debited to work-in-progress, the disallowance under section 40(a)(ia) should not be made by way of addition to income in the year under consideration, but the correct approach would be to adjust or reduce the work-inprogress. It was further held that if the project is completed and the expenditure is ultimately routed through the profit and loss account, then the disallowance under section 40(a)(ia) would be attracted in the relevant year.

9. In view of the above, the Learned CIT(A) restored the matter to the file of the Assessing Officer with a limited direction to verify whether the expenditure in question pertains to an incomplete project as claimed by the assessee. It was directed that if the expenditure relates to an incomplete project, the adjustment should be made only by reducing the work-in-progress. However, if it is found that the expenditure pertains to a completed project, then disallowance under section 40(a)(ia) is warranted in computing the income.

10. Aggrieved by the order of CIT(A), the Revenue is in appeal before us raising following grounds of appeal:

11. The Learned Departmental Representative (DR), inviting our attention to para 7.1 and 7.2 of the order of the Learned CIT(A), submitted that the appellate authority has erred in law and on facts in not adjudicating the issue on merits and in restoring the matter to the file of the Assessing Officer. It was contended that the Learned CIT(A) has wrongly held that the disallowance under section 40(a)(ia) is dependent upon the completion or otherwise of the project and has directed that the impact of non-compliance of TDS provisions be dealt with by merely reducing the work-inprogress. The Learned Departmental Representative further invited our attention to the accounting policy placed in the paper book at page No. 20 and submitted that the assessee is, in fact, following the Percentage Completion Method for recognition of revenue and not the Completed Contract Method as assumed by the Learned CIT(A).The Learned DR further submitted that the Assessing Officer has computed the disallowance strictly in accordance with the details furnished by the assessee itself in the tax audit report in Form 3CD.The Learned DR submitted that in such circumstances, the findings of the Learned CIT(A) in setting aside the disallowance for verification are unwarranted, since the primary facts stand admitted and duly supported by the tax audit report. It was thus contended that once the assessee’s own audit report evidences non-compliance with the provisions relating to deduction and deposit of tax at source, the disallowance under section 40(a)(ia) follows as a statutory consequence and does not call for further factual verification.

12. Per contra, the Learned Authorised Representative for the assessee supported the order of the Learned CIT(A) and submitted that the appellate authority has passed a well-reasoned order after duly appreciating the facts of the case as well as the applicable legal position. The Learned AR invited our attention to the consequential order passed by the Assessing Officer dated 25.02.2026 pursuant to the directions of the Learned CIT(A) and submitted that the directions issued by the Learned CIT(A) have already been given effect to by the Assessing Officer. It was contended that the Learned CIT(A) had correctly appreciated that the applicability of section 40(a)(ia) in the present case is intrinsically linked to the method of accounting followed by the assessee and the treatment of the expenditure as work-in-progress. The Learned AR further invited our attention to the reliance placed by the Learned CIT(A) on the decision of the co-ordinate Bench in the case of Savala Associates (supra).

13. In rebuttal, the Learned Departmental Representative submitted that the reliance placed by the Learned CIT(A) and the Learned AR on the decision of the co-ordinate Bench in the case of Savala Associatesis misplaced and not applicable to the facts of the present case. It was contended that the said decision pertains to a situation where the assessee was following the Completed Contract Method. The Learned DR submitted that in the present case, as already demonstrated from the accounting policy for revenue recognition placed in the paper book, the assessee is following the Percentage Completion Method.

14. We have carefully considered the rival submissions, perused the orders of the lower authorities, the material placed on record including the accounting policy at paper book pages 20-21, the order passed by the Assessing Officer dated 25.02.2026 giving effect to the directions of the Learned CIT(A), and the judicial precedent relied upon.

15. The primary grievance of the Revenue, as emanating from the grounds of appeal, is that the Learned CIT(A) erred in not sustaining the disallowance under section 40(a)(ia) and in restoring the matter to the file of the Assessing Officer, and further erred in holding that the consequence of non-compliance with TDS provisions should be reflected by way of adjustment to work-in-progress instead of direct disallowance. The Revenue has also assailed the reliance placed by the Learned CIT(A) on the decision in Savala Associates (supra) and has contended that the assessee is following Percentage Completion Method and not Completed Contract Method.

16. The core controversy lies in determining whether disallowance under section 40(a)(ia) is to be made in the year under consideration or whether the same is to be reflected through adjustment in work-in-progress. From the record, the following facts are not in dispute:

17. The Learned DR has contended that the assessee follows Percentage Completion Method. From the accounting policy placed on record, it is evident that the revenue from the project is recognised by applying Percentage Completion Method’. Thus, it is correct that the assessee is following the Percentage Completion Method. However, this finding alone does not conclude the issue. What is relevant is not merely the method of accounting in abstract, but whether the impugned expenditure has actually entered the computation of income for the year under consideration.

18. Section 40(a)(ia) disallows expenditure while computing income under the head “Profits and gains of business or profession”. Therefore, the pre-condition for its application is that the expenditure must be claimed as deduction in computation of income. If an expenditure has not been claimed in the profit and loss account and is merely carried forward as WIP, the question of disallowance in the current year does not arise, as there is no deduction claimed.

19. The Learned CIT(A) has relied on the decision in Savala Associates (supra), wherein it was held:

6.1 On plain reading of above section, we find that certain expenditures are not allowable if the assessee failed to deduct tax or after deduction same was not paid in time. However, such expenditures are allowable:

6.2 The above provision is related to amount not deductible while computation of income chargeable under the head ‘Profits and gains of business or profession’. Basically, income chargeable under the head ‘Profits and gains of business or profession’ or ‘Income from other sources’, be computed in accordance with cash or mercantile system of accounting regularly employed by the assessee. Recognition/identification of income under the Income-tax Act is attainable by several methods of accounting considering the nature of business activities. It may be noted that the same result could be attained by any one of the accounting methods. “Completed contract method” is one such method. Similarly, “percentage of completion method” is another such method. Under the “completed contract method”, the revenue is not recognized until the contract is complete. Under the said method, costs are accumulated during the course of the contract period. As per the accepted accounting principle, it is accumulated under one head of account, work-in-progress’. The project constituted the stock-in-trade of the assessee. The project did not constitute a fixed asset of the assessee. In the last accounting period when work is completed, the profit and loss account is prepared, that ‘work-in-progress’ account is to be transferred in profit &loss account. Thus, the “completed contract method” determines profits/loss only when contract is completed. Now question arises how the profit is to be calculated in case of ‘completed contract method’. One of the important aspects to be seen is Cost incurred by a contractor which can be divided into Cost that relate directly to a specific contract; Cost that can be attributed to the contract activity in general and can be allocated to specific contracts and Costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts. Examples of costs that relate directly to a specific contract include: site labour costs, including supervision; materials used for project construction; depreciation of plant and equipment required for a contract; costs of moving plant and equipment to and from a site. Examples of costs that can be attributed to the contract activity in general and can be allocated to specific contracts include: insurance; design and technical assistance; construction overheads. Examples of costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts, include: general administration and selling costs; finance costs; research and development costs; depreciation of plant and equipment that cannot be allocated to a particular contract. In case of “completed contract method”, the above expenses related to individual project have to be capitalized in work-in-progress which is similar to stock-in-trade, of respective individual project. Opening balance of work-in-progress of individual project will go up in the relevant year. When these projects were completed, in that year, income has to be computed after considering increased opening work-in-progress and receipts of the relevant project. Accordingly, in the year when these projects were completed, income on account of those projects is be computed after considering increased opening balance of work-in-progress due to addition of expenses for the period of project in work-in-progress. Contrary, if certain expenditures are not allowable under the Act, the work-in-progress will not increased by that amount. Such expenses are to exclude from the work-in-progress if same were included by the assessee. For the above purposes, the Assessing Officer has to examine the work-in-progress account in each assessment year. If on examination the Assessing Officer did not find any mistake in work-inprogress account then said work-in-progress is to be carried forward in the next year and so on till completion of project. If on examination, the Assessing Officer found that the work-in-progress shown in books of account is not correct, the Assessing Officer is empowered to correct the same. In other words, it can be said that work-in-progress is just like one side of profit & loss account, i.e., debit side, the Assessing Officer can have all powers to examine this debit side of profit & loss account including the power of examination of allowability/disallowability of expenditure under section 40(a) of the Act. In the case under consideration, we find that the Assessing Officer has rightly noted that the expenditure claimed by the assessee which are subject to TDS liability but TDS was no paid in time; therefore, these were disallowable under section 40(a). In principle we agree with above view of revenue that in case of “completed contract method” the Assessing Officer is empowered to examine the expenditures incurred during the year which increases the opening work-in-progress or addition in work-in-progress. But we do not agree with the view of revenue that addition is to be made in total income, if some expenditure were found not allowable. The correct procedure in “completed contract method” is that instead of making addition, the Assessing Officer should correct the amount of work-in-progress by reducing or enhancing workin-progress as the case may be. Such corrected WIP will be finally considered in profit and loss account/contract account for the year in which work is completed. The result of calculation of correct profit in case of “completed contract method” could be attained by this procedure. In the case under consideration, the Assessing Officer made addition in all the projects including incomplete projects, which is not warranted. Such addition in total income is warranted only in respect of project which is completed during the year. The learned AR has conceded the additions in respect of completed works. Necessary calculation is required after verification from original record. The original record is not readily available at this stage under the circumstances we send back this matter to the file of the Assessing Officer with direction to delete the additions made in total income in respect of incomplete projects. However, the addition in respect of completed project is to confirm subject to verification of calculation of the amount. The Assessing Officer is further directed to correct the amount of work-inprogress of incomplete works/projects in accordance with the above discussion and after providing opportunity of hearing to the assessee.

20. The Revenue has contended that this decision applies only to Completed Contract Method and not to Percentage Completion Method.

21. We find that the ratio of the decision is not confined to the nomenclature of the accounting method, but is based on a broader principle, namely:

disallowance under section 40(a)(ia) operates only where the expenditure is claimed in computation of income.

22. Even under Percentage Completion Method (PCM) only that portion of expenditure which is charged to Profit & Loss Account is considered for computing income. The balance portion remains embedded in WIP. Thus, even under PCM, the principle remains the same “Expenditure not claimed cannot be disallowed. It can only be adjusted in WIP and carried forward.” Therefore, the distinction sought to be made by the Revenue is not determinative.

23. The most crucial aspect of the matter is the subsequent order dated 25.02.2026 passed by the Assessing Officer. The Assessing Officer, after detailed verification, has recorded:

“substantial portions of the impugned expenditure formed part of project cost/WIP. and were not wholly claimed in the Profit & Loss account for A.Y. 2018-19.”

Further:

“where the assessee has demonstrated that the impugned amount stood debited to WIP and. did not survive as a deduction claimed….disallowance u/s 40(a)(ia) is not warranted for that component for this year.”

24. The Assessing Officer has also accepted the proportionate allocation:

“80.75%. remaining in closing WIP and. 19.25%. charged/claimed during the year. found to be reasonable and acceptable.”

25. Thus, even the Assessing Officer, after verification, has accepted that a substantial portion of the expenditure was not claimed in the current year, hence, no disallowance can be made for such portion in the current year.

26. The Learned DR has argued that the disallowance is based on Form 3CD.We are unable to accept this contention. The Assessing Officer himself has recorded in the OGE:

“figures in clause 34(a) of Form 3CD were aggregate reporting figures and not. the exact base for disallowance.”

Thus, Form 3CD cannot override actual computation of income or accounting treatment.

27. The Revenue has challenged the direction of the Learned CIT(A) that non-compliance should result in reduction of WIP. We find that this direction is legally sound, because if expenditure is disallowable, it cannot form part of cost. Hence, WIP must be adjusted. Otherwise, it would lead to double deduction in subsequent years. The Learned CIT(A) has also safeguarded this by directing verification in year of completion.

28. The Revenue has objected to restoration. However, we find that the issue involved factual verification regarding segregation of WIP and claimed expenditure and the Learned CIT(A) has restored the matter with specific and limited directions. The Assessing Officer has already given effect after verification. Thus, no prejudice is caused to the Revenue.

29. In view of the above, we find no infirmity in the order of the Learned CIT(A). The same is upheld and the grounds raised by the Revenue are dismissed.

30. In the result, the appeal of the Revenue is dismissed.