2009 (12) TMI 51 - HC - Income Tax

Future Warranty expenses Deduction u/s 37 - The assessee is engaged in manufacture and supply of cement plant, engineering and structural drawings, goods and services. The assessing officer did not allow the deduction in respect of provision for warranty of a sum of Rs.9,79,68,895 Held that - warranty became an integral part of the sale price; in other words, the warranty stood attached to the sale price of the product. Warranty provision had to be recognised because the assessee had a present obligation as a result of past events resulting in an outflow of resources and a reliable estimate could be made of the amount of the obligation. The value of the contingent liability like the warrant expense, if properly ascertained and discounted on accrual basis, can be an item of deduction under section 37 of the Act. The principle of estimation of the contingent liability is not the normal rule. It would depend on the nature of the business, the nature of sales, the nature of the product manufactured and sold and the scientific method of accounting adopted by the assessee. It would also depend upon the historical trend and upon the number of articles produced. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation and held that the provision made for warranty in respect of such sophisticated goods would be entitled to deduction from the gross receipts under section 37 of the Act. decided in favor of assessee

Summary

Issues:
- Appeal against the order of the Income Tax Appellate Tribunal regarding the provision for future warranty expenses for the assessment year 2001-02.

Analysis:
1. Substantial Question of Law: The appeal raised the question of whether the provision for future warranty expenses should be considered a contingent liability or allowable under section 37 of the Income Tax Act, 1961.

2. Facts and Background: The assessee, engaged in manufacturing and supply, had a provision for warranty expenses disallowed by the assessing officer. The Commissioner of Income Tax (Appeals) directed modification of the order, leading to an appeal by the department before the Tribunal. The Tribunal allowed the provision for warranty as a deduction, considering it a liability on the contingency of goods becoming defective within the warranty terms, following previous court decisions.

3. Supreme Court Judgment: The Supreme Court's ruling in Rotork Controls India P. Ltd. v. CIT, (2009) 314 ITR 62, established that warranty provision is an integral part of the sale price, attaching to the product's price. The Court emphasized the need for recognizing warranty provisions as they represent present obligations from past events, with reliable estimates of the obligation amount. The judgment allowed for the deduction of contingent liabilities like warranty expenses under section 37 of the Act, based on proper estimation and accrual basis.

4. Application of Precedents: Citing the Supreme Court's decision, the High Court in a similar case, CIT III v. M/s. FL Smedth Ltd., ruled in favor of the assessee, aligning with the principles outlined in the Rotork Controls case. Given the similarity of facts between the current case and the precedent, the Court upheld the allowance of the provision for warranty expenses as a deduction, following the apex court's guidance and previous decisions of the Division Bench.

5. Final Decision: Considering the settled legal position established by the Supreme Court and previous High Court rulings, the Court answered the questions of law in favor of the assessee and against the revenue department. The appeal was dismissed, with no costs imposed on either party, maintaining consistency with the interpretation of warranty provisions as deductible business expenditures under section 37 of the Income Tax Act.