2009 (1) TMI 525 - AT - Income Tax

Provision for warranty expenses - obligation of providing after sale service - Whether the CIT(Appeals) was justified in deleting the addition of provisions of service warranties without appreciating the fact that as per the provisions of section 37(1) only those expenses which have been incurred wholly and exclusively for the purpose of business are allowed as deduction - HELD THAT - We are concerned with regard to the assessee s claim of deduction towards warranty liability under a condition or stipulation made in the sale document imposing a liability upon the assessee to discharge its obligation under warranty clause for the period of warranty, and thus, in the light of the discussion made above, the liability so accrued, though to be discharged as a future date, would be a proper deduction while working out the profits and gains of assessee s business from sale of the commodity in question. The assessee had made the provision of warranty liability having regard to the past factor of actual expenses incurred by the assessee towards warranty liability. The assessee has worked out the amount of liability by applying a multiplying factor on the total sale made during the year on the basis of past result. This method has been followed by the assessee in uniformly right from the first year of the commencement of the production as so noted by the CIT(Appeals) in his order. We are, therefore, in the full agreement with the view taken by the CIT(Appeals) in allowing the assessee s claim of deduction towards warranty liability, a provision thereof was made in the books of account on actuarial basis. The order of CIT(Appeals) is thus upheld. In the result, the appeal filed by the revenue is dismissed.

Issues Involved:
1. Justification for deleting the addition of provisions of service warranties amounting to Rs. 11,24,04,000 under section 37(1) of the Income-tax Act.
2. Justification for deleting the addition without appreciating the unpredictability and non-ascertainability of sales.

Issue-wise Detailed Analysis:

1. Justification for Deleting the Addition of Provisions of Service Warranties Amounting to Rs. 11,24,04,000 under Section 37(1) of the Income-tax Act:

The revenue contested the deletion of the addition of Rs. 11,24,04,000 made by the Assessing Officer (AO) under section 37(1) of the Income-tax Act, which allows deductions for expenses incurred wholly and exclusively for business purposes. The AO argued that the provision for service warranties was unpredictable and not ascertainable, thus not meeting the criteria for deduction under section 37(1).

The CIT(Appeals) countered this by citing the Supreme Court's decision in Bharat Earth Movers Ltd. v. CIT [2000] 245 ITR 428, which established that if a business liability has definitely arisen in the accounting year, it should be allowed as a deduction, even if the liability is to be discharged in the future. The CIT(Appeals) also referenced the Delhi High Court's decision in CIT v. Vinitek Corpn. (P.) Ltd. [2005] 278 ITR 337, which supported the deduction of warranty liabilities as they are part of the sale document and impose a definite obligation on the assessee.

The Tribunal upheld the CIT(Appeals)'s decision, agreeing that the liability for warranty expenses, calculated based on past statistical data and scientific methods, was a definite liability and not contingent. The Tribunal emphasized that the liability was capable of being estimated with reasonable certainty, even though the actual quantification might occur later. This approach aligns with the principles of commercial practice and accountancy, which allow for the matching of costs with the corresponding revenue in the year of sale.

2. Justification for Deleting the Addition Without Appreciating the Unpredictability and Non-ascertainability of Sales:

The revenue argued that the provision for service warranties was based on sales, which are unpredictable and not ascertainable, thus questioning the validity of the deduction.

The CIT(Appeals) and the Tribunal dismissed this argument by highlighting that the assessee had consistently followed a method of calculating warranty provisions based on historical data and experience. This method, which had been applied since the commencement of the business, involved calculating a multiplying factor from past expenses and applying it to the current year's sales to estimate the liability. This systematic approach provided a reasonable basis for estimating the warranty liability, making it a legitimate business expense.

The Tribunal further referenced several judicial precedents, including the Kerala High Court's decision in CIT v. Indian Transformers Ltd. [2004] 270 ITR 259, which supported the view that warranty provisions based on past statistical data are not contingent liabilities but ascertainable ones. Additionally, the Tribunal noted the Privy Council's decision in IRC v. Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697, which endorsed the deduction of warranty liabilities based on reasonable estimates derived from statistical information.

Conclusion:

The Tribunal concluded that the CIT(Appeals) was justified in deleting the addition of Rs. 11,24,04,000 towards service warranty provisions. The provision was deemed a legitimate business expense, calculated based on scientific and historical data, and consistent with accepted accounting principles. The Tribunal upheld the CIT(Appeals)'s order, dismissing the revenue's appeal.

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