2007 (2) TMI 200 - HC - Income Tax

Provision for Warranty - Warranty charges as a contingent liability - future requirements - Tribunal held that warranty provision is an allowable deduction and in respect of future claims that may not rise at all is a deductible expenditure in the current year? - HELD THAT - We agree with the submission made by learned counsel for the Revenue, that considering the nature of the liability, which is yet to crystallise but loaded with uncertainty of the event to cause a liability, there is no justification to accept the plea of the assessees to uphold the order of the Tribunal. Ld counsel for the assessees reiterated the fact that under the terms of sale, warranty clause is a committed liability and, as such, the claim is reasonable as to the particular percentage in the total turnover. We do not agree with the submission of ld counsel that they could be granted some ad hoc percentage. Considering the fact that the liability, as such, being a contingent one and not a certainty, we fail to understand the reasoning of the Tribunal in accepting the case of the assessee on the strength of decisions, which certainly are based on definite data. Thus, the decision of the Tribunal deserves to be reversed. It may be noted that the assessee was providing warranty for the repair for a period of one year, when they were paying Rs. 150 per set to another company, by name, T. D. Electronics Service Company. That apart, there was another five years warranty and the expenditure on this account was estimated at Rs. 68 lakhs and this expenditure was to be incurred only when there arose a liability, to be borne. The facts herein are no different from that of the earlier cases. We do not find any justification to accept the plea of the assessee that the provision merited a deduction. Appeals preferred by the Revenue, on the question of warranty charges as a contingent liability, are allowed, holding that the same as not deductible.

Issues Involved:
1. Deductibility of warranty provision as an allowable deduction.
2. Deductibility of provision made for future claims under warranty.
3. Disallowance under section 40A(2)(b)(iv) of the Income-tax Act regarding payment of corporate service charges to a closely connected company.

Issue-wise Detailed Analysis:

1. Deductibility of Warranty Provision:
The primary issue was whether the Tribunal was correct in holding that the warranty provision is an allowable deduction. The court examined whether the provision made for future claims under warranty, which may not materialize, qualifies as a deductible expenditure in the current year. The assessee had made a provision for warranty charges payable under the terms of sale, but the liability had not crystallized against the assessee. The court noted that the claims were not based on any particular data available from earlier years. The court referred to the Supreme Court's distinction between "provision" and "reserve" and emphasized that contingent liabilities, by their nature, cannot have a provision for purposes of deduction. The court concluded that the warranty provision, being an uncrystallized and uncertain liability, does not qualify for deduction.

2. Provision for Future Claims Under Warranty:
The court addressed whether a provision made for future claims under warranty, which may not arise, is a deductible expenditure. The court highlighted that for a liability to be deductible, it must be certain and not contingent. The court referred to various judgments, including Bharat Earth Movers v. CIT, which established that a liability must be certain to be deductible, even if its quantification is postponed to a future date. The court found that the assessee had not provided any proof of previous patterns of expenditure to justify the provision. Consequently, the court held that the provision for future claims under warranty, being contingent, is not deductible.

3. Disallowance Under Section 40A(2)(b)(iv):
In T.C. No. 94 of 2004, the issue also involved the disallowance under section 40A(2)(b)(iv) regarding payment of corporate service charges to a closely connected company. The assessee claimed that payment at 2% required a revision due to increased turnover. The assessing authority rejected the claim as excessive and unreasonable. The first appellate authority upheld a partial allowance of Rs. 10 lakhs, disallowing Rs. 15 lakhs. The Tribunal, however, accepted the assessee's claim, noting that the expenditure was warranted by commercial exigencies and the assessee would have spent more if it maintained branches instead of taking services from the holding company. The court found that the Tribunal had accepted the assessee's claim without sufficient details of the services rendered. Therefore, the court remanded the matter to the assessing authority for fresh consideration, requiring the assessee to furnish details justifying the payment over and above the 2% service charges.

Conclusion:
The court concluded that the warranty provision, being a contingent liability, is not deductible. The court also remanded the issue of disallowance under section 40A(2)(b)(iv) for fresh consideration by the assessing authority, requiring the assessee to provide detailed justification for the additional service charges paid. The appeals preferred by the Revenue on the question of warranty charges as a contingent liability were allowed, and the Tribunal's decision was reversed.

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