2011 (2) TMI 1554 - AT - Income Tax

Disallowance on account of provision for warranty - Whether the CIT(A) is justified in confirming the disallowance made by the A.O. on account of provision for warranty? - HELD THAT - The assessee creates provision for warranty based on the estimation of expenditure likely to be incurred on the past sales made on yearly basis at then prevailing market prices for spares and labour. For the relevant previous year, the assessee estimated the warranty liability at ₹ 12,76,77,530/- and created a provision only for ₹ 12,16,75,204/- in the books of account by charging a provision of ₹ 8,24,29,136/- to the debit in the P L account and claimed it as deduction. The assessee company had created the provision based on the estimation of warranty liability, which is based on failure rates of the past year data/experience and industry trends and not on adhoc basis. The assessee has not changed the method of computing the warranty provision and it has been followed consistently. The decision of the Hon ble Supreme Court in the case of M/S. ROTORK CONTROLS INDIA (P) LTD. VERSUS COMMISSIONER OF INCOME TAX, CHENNAI 2009 (5) TMI 16 - SUPREME COURT would be squarely applicable to the facts of the case. The Hon ble Supreme Court has held that provision made on past experience is a scientific method and is the most appropriate method. Thus, disallowance of provision of warranty is to be deleted and it is ordered accordingly. Deduction u/s 80-IB - Exclusion of the interest income from the profits of the eligible units - Whether the CIT(A) is justified in upholding the exclusion of the interest income from the profits of the eligible units for the purpose of computing deduction u/s 80-IB of the Act? - HELD THAT - For the purpose of section 80IB of the Act, the expression profits and gains from any business of the undertaking has to be interpreted in a wider sense. There need not be any direct nexus between the activity of the industrial undertaking and profits and gains. Further, the Hon ble Delhi High Court in ELTEK SGS (P) LTD 2008 (2) TMI 17 - DELHI HIGH COURT in this case, has distinguished the principles laid down by the Apex Court in the case of PANDIAN CHEMICALS LTD. VERSUS COMMISSIONER OF INCOME-TAX 2003 (4) TMI 3 - SUPREME COURT . The Hon ble Mumbai Bench of the Tribunal in the case of Bajaj Healthcare P Ltd. (Unreported) has allowed interest on deposits made for availing bank facilities by following the decision of the Hon ble Delhi High Court in the case of THE COMMISSIONER OF INCOME TAX VERSUS ELTEK SGS (P) LTD 2008 (2) TMI 17 - DELHI HIGH COURT . The interest income earned from deposits made for opening letter of credit with the banks for the purpose of availing credit facilities to carry on the business must be treated as income from business, since it has direct nexus with the business activity carried on by the industrial undertaking of the assessee firm. However, since the break-up of interest claimed for the purpose of computing deduction u/s 80IB of the Act was not before the Income Tax authorities, this issue is restored back to the file of the AO with the specific direction to allow the claim of deduction u/s 80IB in respect of LC Margin money deposits with bank - this ground is allowed for statistical purposes. The appeal filed by the assessee is allowed for statistical purposes.

Summary

Issues Involved:
1. Disallowance of provision for warranty amounting to Rs. 2,26,05,903.
2. Exclusion of interest income of Rs. 25,83,813 from the profits of eligible units for computing deduction under Section 80-IB of the Income Tax Act.

Detailed Analysis:

1. Disallowance of Provision for Warranty:

The assessee, a company engaged in the manufacture and trading of computer systems and components, had debited Rs. 8,24,29,136 in the Profit & Loss (P&L) account as provision for warranty. However, the actual expenditure incurred during the year was Rs. 4,92,32,936. The Assessing Officer (AO) disallowed the unexpended portion of the provision for warranty amounting to Rs. 2,26,05,903, which was upheld by the Commissioner of Income Tax (Appeals) [CIT(A)].

The Tribunal noted that the assessee created the provision for warranty based on the estimation of expenditure likely to be incurred on past sales, using historical data and industry trends. This method was consistent and not ad hoc. The Tribunal referenced the Supreme Court's decision in Rotork Controls India Pvt. Ltd., which validated the provision for warranty based on past experience as a scientific and appropriate method.

Additionally, the Tribunal cited its own previous decision in the assessee's case for the immediately preceding year, where it had ruled in favor of the assessee, recognizing the provision for warranty as an ascertained liability rather than a contingent one.

In conclusion, the Tribunal held that the disallowance of the provision for warranty should be deleted, and the appeal on this ground was allowed.

2. Exclusion of Interest Income for Deduction under Section 80-IB:

The AO had excluded Rs. 25,83,813 from the profits derived by the Pondicherry unit for computing the deduction under Section 80-IB of the Income Tax Act. The CIT(A) upheld this exclusion, referencing the Supreme Court's decision in Pandian Chemicals.

The assessee argued that the interest income should be bifurcated into:
- LC Margin Money Deposits with Bank: Rs. 15,53,186.
- Fixed Deposits with Bank: Rs. 10,30,627.

The assessee conceded that the interest on fixed deposits, being surplus money, was not eligible for deduction under Section 80-IB. However, it contended that the interest earned from deposits made for opening letters of credit (LC) was directly linked to the business activity and should be eligible for deduction.

The Tribunal referred to the Delhi High Court's decision in CIT v. Eltek SGS Pvt. Ltd., which distinguished between the language of Section 80HH and Section 80-IB, noting that the latter requires profits and gains from "any business of the undertaking," allowing for a broader interpretation.

The Tribunal also cited its own decision in Bajaj Healthcare P. Ltd., where it allowed interest on deposits made for availing bank facilities, following the Delhi High Court's rationale.

Given these precedents, the Tribunal ruled that the interest income from LC Margin Money Deposits should be treated as business income with a direct nexus to the business activity. However, since the specific break-up of interest was not available, the issue was remanded back to the AO for verification and appropriate allowance of the deduction.

In conclusion, the appeal on this ground was allowed for statistical purposes.

Final Judgment:

The appeal filed by the assessee was allowed for statistical purposes, with specific directions for the AO to reassess the interest income for deduction under Section 80-IB. The order was pronounced on February 25, 2011, in Bangalore.