2011 (1) TMI 657 - HC - Income Tax

Disallowance - provision for warranty claims & royalty - It is claimed by the assessee that on the basis of the report undertaken by the independent agency applying the scientific method considering number of products sold under warranty provisions of Rs. 3.09 crores was made in the year in question - assessee has obtained a report of an Actuary for making the provision - It is settled law that even though there is some difficulty in estimation it would not convert the accrued liability into an additional one or a contingent liability - It is thus to be borne in mind that on the facts of that case the Court had found that there was no ascertained liability which was contingent on happening of certain event and even the payment made was merely contingent -

Summary

Issues Involved
1. Disallowance of provision for warranty claims.
2. Disallowance of royalty payments under Section 40(a)(i) of the Income-Tax Act.

Detailed Analysis

Provision for Warranty Claims

Facts and Background:
The assessee, engaged in manufacturing and selling refrigerators and deep freezers, offered an optional service contract (OSC) for seven years. The warranty for the first year covered the entire machine, while from the second to the seventh year, it covered only the compressor. The amounts received from OSC were included in the income in the year of sale, and the provision for warranty was made based on actuarial valuation. This practice was consistently followed and accepted by the Income Tax Department from the financial year 1989-90 to 1994-95.

Dispute:
In the assessment year 1996-97, the assessee made an additional provision for warranty claims amounting to Rs. 3,09,42,798/-, which was disallowed by the Assessing Officer (AO) and the CIT (A) on the grounds that it was a contingent liability and not related to the sales of the year in question. However, the ITAT allowed this provision, stating that it was made on a scientific basis using an actuarial report.

Legal Analysis:
The Tribunal held that at the year-end, the assessee is required to make provision for all known liabilities, even if they are to be discharged in subsequent years. The liability must be scientifically estimated, and the provision in question was made based on an actuarial report. The Tribunal referenced the Supreme Court decisions in Calcutta Co. Ltd. and Bharat Earth Movers Ltd., which supported the notion that even if there is difficulty in estimation, it does not convert an accrued liability into a contingent one.

Judgment:
The High Court upheld the ITAT's decision, agreeing that the provision for warranty claims was justified and legally entitled. The court emphasized that the provision was made based on a scientific study and actuarial basis, fulfilling the accrual and matching concepts. The court referenced the Supreme Court's decision in Rotork Controls India P. Ltd., which clarified that a provision for warranty, based on historical trends and actuarial valuation, is a present obligation and not a contingent liability.

Royalty Payment

Facts and Background:
The assessee entered into a foreign technical collaboration agreement with M/s Whirpool Corporation, USA, approved by the Government of India. Under this agreement, the assessee was to pay royalty @ 5% on domestic sales and 8% on export proceeds. The royalty accrued from 24th February 1995, but the payment for sales made from 1st March 1995 to 31st March 1995 was accounted for in the assessment year 1996-97, as the tax deducted at source was deposited on 10th May 1996.

Dispute:
The AO disallowed the royalty payment of Rs. 70.66 lacs under Section 40(a)(i) of the Act, arguing that it should have been claimed in the assessment year 1995-96 when the payment was made. The CIT (A) and the ITAT, however, allowed the deduction in the assessment year 1996-97, as the tax was deposited within the time prescribed by Rule 30 of the Income Tax Rules, 1962.

Legal Analysis:
Section 40(a)(i) of the Act stipulates that payments to non-residents are not deductible if tax is not paid or deducted under Chapter XVII-B. The proviso to this section allows the deduction in the year in which the tax is paid or deducted. The High Court referenced its own decisions in CIT Vs. Nestle India Ltd. and CIT Vs. Oracle Software India P. Ltd., which held that the deduction should be allowed in the year when the tax is deposited, provided it is within the statutory time limit.

Judgment:
The High Court concluded that the assessee should have claimed the deduction in the assessment year 1995-96, as the tax was deducted in that year and deposited within the stipulated period in the next assessment year. The court answered the question against the assessee, allowing the deduction in the assessment year 1995-96 and not in 1996-97.

Conclusion
The High Court upheld the ITAT's decision regarding the provision for warranty claims, allowing it as a legitimate deduction based on actuarial valuation. However, the court disagreed with the ITAT on the royalty payment issue, ruling that the deduction should have been claimed in the assessment year 1995-96 when the tax was deducted, even though it was deposited in the next assessment year.