2009 (2) TMI 31 - HC - Income Tax

Allowance of provision for Long Service Award payable by assessee to employees - if a liability arises within the accounting period the deduction should be allowed though it may be quantified & discharged at a future date - fact that the provision was estimated based on actuarial calculations deduction claimed is allowed in respect of capitalization of cost of emergency/insurance spares since spares are emergency spares required for plant & machinery depreciation can be claimed thereon

Summary

Issues Involved:
1. Allowance of provision for "Long Service Award" payable to employees.
2. Depreciation on emergency/insurance spares.

Issue-wise Detailed Analysis:

1. Allowance of Provision for "Long Service Award" Payable to Employees:

Facts and Background:
The assessee, engaged in manufacturing spray dried silica, had a scheme to award employees for long service. Employees completing 10, 15, and 20 years of service were eligible for awards equivalent to 2, 3, and 4 months' salary, respectively. The assessee made a provision of Rs 47,15,782/- based on actuarial calculations, considering factors like probable future withdrawals and salary increases.

Assessing Officer's View:
The Assessing Officer disallowed the provision, arguing it was at the discretion of the management and thus not an ascertained liability.

CIT(A)'s Decision:
The CIT(A) reversed the Assessing Officer's order, citing that under the mercantile system of accounting, provisions for liabilities, even if payable in the future, must be made. The CIT(A) referenced Supreme Court judgments in Shree Sajjan Mills Ltd vs CIT, Bharat Earth Movers Ltd vs CIT, and Metal Box Company of India Ltd vs Their Workmen, and CBDT Circular No. 47 dated 21.09.1970. The CIT(A) concluded that the provision was akin to gratuity and thus an ascertained liability.

Tribunal's Decision:
The Tribunal upheld the CIT(A)'s decision, agreeing that the provision for liability, if ascertained during the accounting period and payable in the future, is admissible under the mercantile system of accounting.

High Court's Analysis:
The High Court found no fault with the CIT(A) and Tribunal's reasoning. The court emphasized that a liability arising within the accounting period, even if quantified and discharged later, is deductible if it is certain and reasonably estimable. The court referenced the Supreme Court's decisions in Bharat Earth Movers and Metal Box Company, affirming that such provisions are not contingent liabilities.

Conclusion:
The High Court upheld the allowance of the provision for "Long Service Award," finding it to be an ascertained liability and deductible under the mercantile system of accounting.

2. Depreciation on Emergency/Insurance Spares:

Facts and Background:
The assessee had capitalized emergency spares worth Rs 1,41,64,495/- and claimed depreciation of Rs 35,41,123/-. The change in accounting treatment was due to the revised Accounting Standard (AS) 2 by the ICAI, effective from 01.04.1999.

Assessing Officer's View:
The Assessing Officer allowed depreciation only on the cost of spares actually consumed (Rs 31,76,187/-), amounting to Rs 5,49,806/-, rejecting the claim for the entire capitalized amount on the grounds that the spares were not "put to use."

CIT(A)'s Decision:
The CIT(A) sustained the Assessing Officer's decision but allowed the alternative claim for deduction of the cost of spares consumed during the period.

Tribunal's Decision:
The Tribunal allowed the assessee's appeal, noting that the emergency spares were ready for use and referencing the Madras High Court's decision in CIT vs Southern Petrochemicals Industries Corporation Ltd, which allowed depreciation on critical spare parts kept as standby.

High Court's Analysis:
The High Court framed the question of law: "Whether ITAT was correct in law in allowing depreciation of Rs 35,41,123/- to the assessee on spare parts u/s 32 of the Act as against Rs 5,49,806/- allowed by the Assessing Officer." The court analyzed the revised Accounting Standards (AS) 2 and (AS) 10, which mandated capitalization of emergency spares. The court also referenced various judgments supporting the concept of "passive user" for depreciation purposes, including CIT vs Viswanath Bhaskar Sathe, CIT vs Vayithri Plantations Ltd, and CIT vs Southern Petrochemical Industries Corporation Ltd.

Conclusion:
The High Court concluded that the entire cost of emergency spares should be capitalized and depreciated, as these spares, though not actively used, were ready for use and specific to fixed assets. The court upheld the Tribunal's decision, allowing depreciation on the entire capitalized amount of Rs 1,41,64,495/-.

Final Judgment:
The appeals were dismissed, and the High Court ruled in favor of the assessee on both issues, with no substantial question of law arising for consideration. No orders as to cost were made.