2013 (7) TMI 144 - HC - Income Tax

Provision of warranty and Rectification expenses - unascertained liabilities - assessee had made provision for liquidated damages under two heads viz., one towards delay in delivery and other towards non performance. - The rectification expenses is mainly for repairs and replacements - Deduction u/s 37 - Held that - provision is recognised when an enterprise has a present obligation as a result of a past event; that it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate can be made on the amount of the obligation. If these conditions are not met, no provision could be recognized. - when the company made reliable estimate based on the performance capacity and the quality therein and the materials relating thereto, we do not find any justifiable ground to reject the plea of the assesee on the provision made. - Decided in favor of assessee. Commissioner of Income Tax (Appeals) committed an error in his finding on the ground that the amount claimed in the nature of warranty was not stated so, but described as provision towards the liquidity damages. We do not find that the description of the claim would govern the claim on the provision for warranty when the terms of the agreement specifically provided that the liquidated damages was for non performance. Given the above fact, one can not reject the claim for provision made towards the warranty on the performance of the machineries supplied - Following the decision of ROTORK CONTROLS INDIA P. LTD v. CIT 2009 (5) TMI 16 - SUPREME COURT OF INDIA - Decided in favour of assessee. Regarding rectification expenses - Held that - it was stated that the said provision was based on the information that some of the equipments supplied by the company required repair and replacement and that technical team estimated such expenses for making provision in the account. The claim thus based on materials and the information of the technical team - Deduction allowed - Decided in favor of assessee.

Summary

Issues:
1. Disallowance of provision for warranty.
2. Addition of write back of the provision.

Issue 1: Disallowance of Provision for Warranty
The case involved an appeal by the assessee against the Income Tax Appellate Tribunal's order regarding the disallowance of Rs.40 lakhs for the provision for warranty claims for the assessment year 2003-04. The assessee, engaged in designing and engineering, claimed the deduction based on scientific data and past experience. The Revenue contended that the provision was unascertained liabilities and thus not allowable. The Tribunal confirmed the disallowance, leading to the appeal. The Court considered previous decisions and held that a provision is a liability measurable by estimation. It noted the nature of the business, sales, and accounting method. The Court allowed the deduction for the provision made for warranty, similar to earlier cases, rejecting the Revenue's argument against scientific working on the provision.

Issue 2: Addition of Write Back of the Provision
Regarding the addition of Rs.87,74,691/- on account of the write back of the provision, the Court analyzed the clauses related to liquidated damages for delay and non-performance in the contract. The Court observed that the provision for liquidated damages was more in the nature of a warranty for machinery performance rather than damages for shortfall in production. The Court differentiated between liquidated damages for delayed performance and warranty for defective parts requiring repairs. The Court held that the provision for rectification expenses based on technical team estimates and information fell within the criteria set by the Apex Court. Consequently, the Court set aside the Tribunal's order, allowing the claim for the provision towards warranty and write back.

In conclusion, the High Court of Madras allowed the Tax Case Appeal, overturning the Tribunal's decision on both issues of disallowance of provision for warranty and addition of write back of the provision. The Court emphasized the nature of the provision, the scientific estimation involved, and the distinction between warranty and liquidated damages, ultimately ruling in favor of the assessee based on the provided evidence and legal principles.