2011 (7) TMI 573 - HC - Income Tax

Provision for warranty - whether allowable as expenditure - Held that - Warranty provision needs to be recognized because the appellant is an enterprise having a present obligation as a result of past events resulting in an outflow of resources - Lastly a reliable estimate can be made of the amount of the obligation- In short all three conditions for recognition of a provision are satisfied in this case - As decided in Rotork Controls India (P.) Ltd. v. CIT 2009 (5) TMI 16 - SUPREME COURT OF INDIA allowing the claim of provision for warranty stating that with making of provision on the basis of estimated present value of contingent liability holds good during the assessment years in question qua warranty claims . No substantial question of law arises for consideration in this appeal.

Summary

Issues:
- Allowability of provision for warranty as expenditure

Analysis:
The primary issue in this case revolves around the allowability of the provision for warranty as expenditure. The Assessing Officer initially allowed the provision for warranty amounting to Rs. 2.83 crores, but the Commissioner, in his revisional jurisdiction, held that it was not allowable as expenditure. The Commissioner considered the provision as a contingent provision, stating that it would not constitute expenditure unless the liability on account of warranty was certain and capable of being estimated with reasonable certainty.

The assessee contended that the provision for warranty was created on an accrual basis at the end of each quarter, based on earlier customer experience, sale of similar equipment, and scientific analysis. The provision was adjusted against actual warranty-related expenses incurred, generally kept for one year, and any balance was written back. The Tribunal, relying on a previous High Court judgment, held that the provision for warranty was an allowable expenditure and not contingent. The Tribunal's decision was based on the premise that the provision for warranty satisfied the conditions for recognition as a provision, as outlined by the Apex Court in the case of Rotork Controls' India (P.) Ltd. v. CIT.

The Apex Court in the Rotork Controls' India case clarified the conditions for recognizing a provision, emphasizing that it should arise from a present obligation due to a past event, with a probable outflow of resources to settle the obligation, and a reliable estimate of the obligation amount. The Court highlighted that for liabilities to qualify for recognition, there must be both a present obligation and a probability of resource outflow for settlement. In the present case, the Court found that the provision for warranty met all three conditions for recognition as a provision, considering the nature of the enterprise's business and the integral role of warranty in the sale price of the product.

Based on the Apex Court's judgment and its application to the facts of this case, the High Court concluded that no substantial question of law arose for consideration. Consequently, the appeal challenging the finding of the Tribunal, which approved the provision for warranty as expenditure, was dismissed.