KPMG Retention Money

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Receipt of retention money by furnishing bank guarantee is not chargeable to tax since it accrues only 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 Dredging1 (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 decisions2 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)


Issue before the Tribunal Whether payments received by the taxpayer on account of retention money by furnishing of bank guarantee are chargeable to tax?

Taxpayer’s 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. Ltd3. 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 department’s 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) Ltd4 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 Court’s 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 Ltd5.

• 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.

Tribunal’s 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 Tribunal’s 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)


• 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.


The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we 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 Retention Money

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