2018 (9) TMI 877 - HC - Income Tax

Provision for warranty - whether a contingent liability or an allowable expense - Held that - As stated by the AO in the assessment order, the table reveals that there was substantial increase and jump in sales year after year in the Assessment Years 2002-03, 2003-04, 2004-05 and 2005-06, from ₹ 58.97 crores to ₹ 830.51 crores to ₹ 2408.01 crores, and then to ₹ 4729.14 crores, respectively. The provision for warranty would accordingly increase in numerical terms. Pertinently, the percentage of closing provision of warranty with reference to quantum of sales had decreased and came down as is reflected in the figure in the column (h) of the table above. In the present case, we are only concerned with the Assessment Year 2003-04 in which the percentage of closing provision to sales was only 0.81%. Variation in figure would indicate that no thumb rule was applied. Moreover in case of doubt and debate, Income Tax Authorities should have asked for the basis and the formula/criteria applied by the respondent/assessee to compute provision for warranty. On the other hand without disputing the computation, disallowance was made by holding that actual expenditure on warranty claims and not provision for warranty was allowable as expenditure. This proposition is wrong and incorrect. Improvement in technology would not justify disallowance of claim/expenditure on account of provision for warranty, though in a given case on basis of data it could be relevant factor in making the calculations. Thus in view of the decision of the Supreme Court in Rotork Control India Pvt. Ltd. 2009 (5) TMI 16 - SUPREME COURT OF INDIA no good ground or reason to accept the aforesaid contention of the Revenue. Capitalization of marketing expenses - Held that - Finding regarding capitalization or business expenditure is a finding of fact. Obviously, assessee could not have claimed title and depreciation, once the mobile phones etc. had been given and ownership had been transferred to the employees, dealers, sales personnel and after-sales-service centres. In the absence of any material and evidence to show that the findings of fact are perverse, we do not see any reason to interfere with the impugned order on the said aspect. Addition on account of stocks damaged during transportation etc., which had not been included in the closing stock - AO held that value of the mobile phones damaged in transit should be included the closing stock affirmed by CIT-A - Held that - Assessee, at this stage, states that this issue may be remanded to the Tribunal for fresh decision as the reasoning given by the Tribunal is not correct and not germane to the issue in question. He states that the question of law need not be framed. Recording the said concession, this issue with regard to the damaged handsets and their inclusion in the closing stock is remitted to the Tribunal for fresh decision. Disallowance of the claim on account of obsolescence - Held that - In the present case, after noticing the factual matrix the Tribunal observed that the closing stock has to be valued on the basis of net realisable value. The said issue has been remanded to the Assessing Officer to determine and decide afresh the cost of obsolete items with reference to net realizable value. In view of the said direction for remand, we do not think that any substantial question of law arises for consideration. Recording the aforesaid including the concession made by the assessee on the issue of damaged stock, the present appeal is disposed of without any order

Issues:
1. Disallowance of provision for warranty
2. Capitalization of marketing expenses
3. Addition of damaged stocks in closing stock
4. Disallowance on account of obsolescence

Issue 1: Disallowance of provision for warranty

The primary issue in this case pertains to the disallowance of the provision for warranty amounting to ?5.48 crores by the Assessing Officer. The contention was that the provision was an unascertained liability and should not be allowed as an expense. However, the Tribunal ruled in favor of the respondent-assessee, stating that the provision was made on scientific and actuarial principles. The Tribunal referred to previous judgments and upheld the appeal, emphasizing that the provision was made on a mercantile basis and was justifiable. The High Court concurred with the Tribunal's decision, noting the significant increase in sales over the years and the decrease in the percentage of closing provision to sales, indicating a reasonable approach in calculating the provision for warranty.

Issue 2: Capitalization of marketing expenses

The second issue raised by the Revenue concerned the capitalization of marketing expenses amounting to ?39.98 lakhs. The Assessing Officer argued that mobile handsets provided to dealers and employees should be considered capital assets. However, the Tribunal disagreed, stating that once ownership of the mobile handsets was transferred to employees and dealers, they ceased to be assets of the respondent-assessee. The Tribunal deemed the cost of the mobile phones as business expenditure and not subject to capitalization. The High Court upheld the Tribunal's decision, emphasizing that the ownership transfer precluded any claim for depreciation on the mobile handsets.

Issue 3: Addition of damaged stocks in closing stock

The third issue revolved around the addition of over ?2.68 crores for stocks damaged during transportation, which were not included in the closing stock. The Assessing Officer insisted on including the value of damaged mobile phones in the closing stock, a decision affirmed by the Commissioner of Income Tax (Appeals). However, the Tribunal reversed this addition, citing potential double counting and lack of justification for the inclusion. The High Court remanded this issue back to the Tribunal for a fresh decision due to the inadequacy of the reasoning provided.

Issue 4: Disallowance on account of obsolescence

The final issue concerned the addition of ?8.50 lakhs due to the disallowance of a claim for obsolescence. The Assessing Officer made an ad hoc disallowance of 25% from the claimed amount, alleging insufficient justification. The Commissioner of Income Tax (Appeals) upheld this addition, referencing similar decisions in previous assessment years. The Tribunal, however, differentiated this case from previous judgments and remanded the issue to the Assessing Officer for a reassessment based on net realizable value. The High Court accepted this decision and disposed of the appeal without costs, noting the direction for parties to appear before the Tribunal for the issue of damaged stocks.

This detailed analysis covers the key issues addressed in the judgment, providing a comprehensive overview of the legal proceedings and decisions made by the authorities involved.

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