2019 (4) TMI 92 - AT - Income Tax

Allowability of the provision of warranty - scope of policy for warranty - concept of accrual and the matching concept - contractual obligation to make the payment in principle - HELD THAT - Sum of provision was calculated based on the policy adopted by the company. This policy has not been found erroneous by the authorities in any forum. Therefore, it is wrong infer that the assessee does not have a policy and the contractual obligation to make the payment in principle and the quantification is also not found erroneous and unscientific by the authorities. It is also seen that unutilised provision is carried forward to the subsequent years by maintaining the opening and closing balances. Therefore, without bringing any evidence on record, the allegation of the Assessing Officer and the Commissioner of Income-tax (Appeals) that the warranty expenses are not claimable is incorrect. We also find the assessee has been maintained this method in principle over the years and they are not disturbed conclusively. Therefore, we hold that the provisions created by the assessee are required to be allowed as claimed by the assessee. Accordingly, the grounds raised by the assessee in this appeal are allowed.

Summary

Issues Involved:
1. Disallowance of provision for warranty.
2. Methodology for creating warranty provisions.
3. Deduction of warranty expenses in the year of actual incurrence.

Issue-wise Detailed Analysis:

1. Disallowance of Provision for Warranty:
The primary issue in this appeal was the disallowance of ?3,96,03,899 on account of "provision for warranty" by the Assessing Officer (AO) and its subsequent confirmation by the Commissioner of Income-tax (Appeals) [CIT(A)]. The authorities held that the provision for warranty was not created using a scientific method and was against the matching principle, thereby not reflecting the true income of the appellant for the period. The CIT(A) noted that the provision was based on past averages and not linked to current year sales, and there was no evidence of reversal of excess provision if found excessive.

2. Methodology for Creating Warranty Provisions:
The appellant argued that the provision for warranty was based on a contractual obligation to bear warranty expenses for products sold. The methodology involved using past experience, specifically the average of the last four quarters' actual claims, multiplied by five quarters for certain products and seven quarters for others, representing half the warranty period plus one quarter. This method was detailed in the company's policy for warranty, which specified the warranty periods for different components and products.

3. Deduction of Warranty Expenses in the Year of Actual Incurrence:
The appellant contended that if the provision for warranty was not allowed, the CIT(A) should have directed the AO to grant deduction of warranty expenses in the year of actual incurrence. However, the CIT(A) did not provide such directions, leading to further appeal.

Judgment Summary:
The Income Tax Appellate Tribunal (ITAT) examined the submissions and documents provided by the appellant, including the policy for warranty and the methodology for creating provisions. The ITAT found that the appellant had a clear policy and contractual obligation to bear warranty expenses. The methodology used for calculating the provisions was based on actual claims and was consistently followed.

The ITAT disagreed with the CIT(A)'s findings that the provision was unscientific and not linked to current year sales. It was noted that the provision was based on a reasonable estimate of future claims, supported by historical data, and the unutilized provision was carried forward to subsequent years.

The ITAT concluded that the provision for warranty was allowable as it was based on a consistent and reasonable policy. The appeal of the assessee was allowed, and the grounds raised were accepted.

Conclusion:
The ITAT allowed the appeal, recognizing the appellant's methodology for creating warranty provisions as reasonable and based on a consistent policy. The disallowance of ?3,96,03,899 was overturned, and the provision for warranty was deemed allowable. The ITAT emphasized the importance of adhering to a consistent and reasonable method for estimating future warranty claims, aligning with the matching principle and reflecting true income.