2009 (9) TMI 710 - HC - Income Tax

Whether on the facts and in the circumstances of the present case the Tribunal was right in law in deleting the addition made on account of provision for warranty charges holding the same to be definite business liability allowable as deduction during the year under consideration ? Held that - The assessee-company is entitled to make a provision for the warranty charges holding the same to be a definite business liability allowable as a deduction during the years under consideration since the same is based on a scientific basis and a consistent policy applied by the assessee- company throughout the world including India and that consistent application of the same principle over the years would remove any advantage which according to the Revenue the assessee may have by deferring of its income to the extent of warranty provision to the next year. The present appeals are accordingly dismissed.

Summary

Issues Involved:
1. Entitlement to make a provision for warranty charges as a definite business liability allowable as a deduction.
2. Whether the provision for warranty is a contingent liability or a liability in presentie.

Comprehensive, Issue-wise Detailed Analysis:

1. Entitlement to make a provision for warranty charges as a definite business liability allowable as a deduction:

The primary issue in these appeals under section 260A of the Income-tax Act, 1961, is whether the assessee/respondent was entitled to make a provision for warranty charges, holding the same to be a definite business liability allowable as a deduction during the relevant assessment years. The assessee-company, engaged in the business of installation/erection and setting up/commissioning of various telecommunications projects, included warranty clauses in its contracts, which is a normal industry practice. The company sought to make a provision for the anticipated costs of its liability under these warranties, based on technical evaluations and computed scientifically as a percentage of its total turnover. The actual payments made pursuant to the warranty clauses were met out of this provision. The provision was reversed after actual payments, with the balance amount credited to the profit and loss account and offered for taxation under section 41(1) of the Act.

The Tribunal was tasked with determining whether such a provision made for warranty is towards liabilities that are only contingent or are in presentie, though discharged at a future date. The respondent argued that the issue is covered by the Supreme Court's decision in Rotork Controls India P. Ltd. v. CIT [2009] 314 ITR 62, which held that warranty provisions must be recognized because the assessee had a present obligation as a result of past events, resulting in an outflow of resources, and a reliable estimate should be made of the amount of the obligation. The Supreme Court noted that a provision is recognized when:
(a) An enterprise has a present obligation as a result of a past event;
(b) It is probable that an outflow of resources will be required to settle the obligation;
(c) A reliable estimate can be made of the amount of the obligation.

The respondent further contended that the provisions made and actual loss in subsequent years showed that higher amounts of claims towards warranty took place, indicating that the provisions were made on a scientific basis. The Revenue, however, argued that the huge differences between the provisions made and the actual payments indicated a lack of scientific basis for the provision, relying on the Supreme Court's observations in Rotork Controls India P. Ltd.

2. Whether the provision for warranty is a contingent liability or a liability in presentie:

The court noted that the respondent-company commenced operations only in the year 1997-98, and in a period of 3 to 4 years, it cannot be said that a "historical trend" emerges. The respondent-assessee company is a multinational company with a consistent policy for making a provision for warranty claims applied globally. The policy directives for warranties are detailed and scientifically based, not ad hoc. The provision made in the first year is carried forward in subsequent years, with only the additional difference on account of higher turnover debited in the provision account. The consistency in applying this principle over the years removes any undue benefit to the assessee-company.

The court framed the question of law as: "Whether, on the facts and in the circumstances of the present case, the Tribunal was right in law in deleting the addition made on account of provision for warranty charges holding the same to be definite business liability allowable as deduction during the year under consideration?"

The court answered this question affirmatively, stating that the assessee-company is entitled to make a provision for warranty charges as a definite business liability allowable as a deduction during the years under consideration, as it is based on a scientific basis and a consistent policy applied globally, including in India. The consistent application of this principle over the years removes any advantage the Revenue claims the assessee may have by deferring its income to the extent of the warranty provision to the next year.

Conclusion:

The appeals were dismissed, with the court holding that the provision for warranty charges is a definite business liability allowable as a deduction, based on a scientific basis and consistent policy applied by the assessee-company globally.