2004 (6) TMI 282 - AT - Income Tax

Disallowance u/s 37 - entertainment expenses - Manufacturing of mini-computers/micro-processor based systems - Treatment of expenditure as capital or revenue - Provision for warranties - Provision for royalty - Disallowance of income-tax paid on salary of managing director - excessive and unreasonable payments u/s 40A(2)(b) - HELD THAT - As regards the relevance of accounting method followed by the assessee we have already observed that the treatment given by the assessee to the impugned expenditure as deferred revenue expenditure cannot be considered as different from the one followed for the purpose of computing the total income under the IT Act. In any case as held by the Supreme Court in the case of Kedarnath Jute Manufacturing Co. Ltd. vs. CIT 1971 (8) TMI 10 - SUPREME COURT the allowability of a particular deduction depends on the provisions of law relating thereto and not on the basis of entries made in the books of account which are not decisive or conclusive in this regard. The expenditure in question was incurred towards advertisements in launching of a new product and was revenue in nature. The action of the Revenue authorities in treating the same as capital expenditure and disallowing the claim for deduction was not proper. We direct the AO to delete the addition made to the total income. Thus grounds No. 1.1 1.2 and 1.4 are allowed while ground No. 1.3 does not require any adjudication in view of the decision on grounds No. 1.1 1.2 and 1.4. Provision for warranties - The basis of computation of the warranty for the asst. yr. 1990-91 was 1.5 per cent of the total cost of sales. In the asst. yr. 1991-92 which is the year in dispute in the present appeal the provision has been made @ 1.5 per cent of the cost of sales in respect of goods sold within the country and 5 per cent on export sales. The assessee also wrote back the provision made for the asst. yr. 1990-91 from the estimated liability for asst. yr. 1991-92 and the difference alone is sought to be claimed as a deduction while determining the income for asst. yr. 1991-92. Even for the subsequent assessment year the provision on account of liability under warranty has been made on a scientific basis. Whatever provisions have been made for a particular assessment year in excess the actual expenses incurred in the subsequent assessment year the difference is again written back in the subsequent assessment year. Thus a legal obligation to make a payment in future can be said to have accrued. It is not required to wait for the contingency to occur. We can infer that a business liability has definitely arisen in the accounting year though the quantification or discharge of this liability was at a future day. The estimation by the assessee of its liability is reasonably certain. In the circumstances it can be said that the liability is in presenti to be discharged at a future date and not a contingent one. We therefore direct the AO to allow a sum claimed as deduction by the assessee. Provision for royalty - It is clear from the perusal of the provisions of s. 40(a)(i) that if royalty is payable outsideIndia tax has to be deducted or paid under Chapter XVII-B and only then the deduction can be claimed in computing the income chargeable under the head profit and gains of business and profession. In the present case the liability to pay the royalty had accrued and it was not contingent as held by the AO. The quantification had taken place at later point of time and this was not the event by which the liability became ascertained. As already observed by us while making the provision the assessee had also made book entries in respect of tax deductible. The condition under s. 40(a)(i) was either deducting tax at the time of payment or making actual payment. If one of the conditions is fulfilled then the deduction is allowable. Thus we are of the view that the Revenue authorities were not justified in disallowing the provision made for royalty. The addition made by the AO in this regard is directed to be deleted. The 3rd ground of the appeal of the assessee is allowed. Salary of managing director - The nature of payment made by the assessee cannot assume the character of remuneration paid to the managing director. As observed by the Hon ble Supreme Court in the case of Malayalam Plantations 1964 (4) TMI 9 - SUPREME COURT the fact that it was paid under an agreement will not make the payment an expenditure in connection with the business of the assessee. Payment of rent for accommodation of managing director and payment of his club fees - These payments were approved even by the Department of Electronics which approved the appointment of foreign technician. The annexure to the approval by the Department of Company Affairs also specifies that housing and club fees will be paid subject to certain limitations. The club fees paid is therefore to be allowed as a deduction. As far as house rent paid is concerned the case of the AO is that it is excessive and unreasonable. The AO has not brought enough material on record to prove this allegation and it was incumbent upon him to do so before making any disallowance. The deduction towards house rent and club fees is therefore directed to be allowed while the tax liability of the employee claimed as a deduction cannot be allowed as a deduction. Thus ground No. 5 is dismissed while ground No. 6 is allowed. In the result the appeal by the assessee is partly allowed. Disallowance under s. 40A(2)(b) - The AO has made a sweeping statement that the payment made is excessive. There is absolutely no record to justify his calculation. The CIT(A) was therefore justified in deleting the addition made by the AO by taking note of the other circumstances namely the allegation of under-invoicing by customs authorities and orders of the Asstt. Collector of Customs concluding that the value determined by the assessee is correct. Consequently the first ground of the appeal of the Revenue is dismissed. In the result the appeal of the Revenue is dismissed.

Summary

Issues Involved:
1. Disallowance of advertisement expenses.
2. Disallowance of provision for warranties.
3. Disallowance of provision for royalty.
4. Disallowance of income-tax paid on managing director's salary.
5. Disallowance of excessive payments to foreign collaborator.
6. Disallowance of entertainment expenses.

Summary of Judgment:

1. Disallowance of Advertisement Expenses:
The assessee claimed Rs. 77,16,120 as advertisement expenses, treating it as revenue expenditure. The AO disallowed this amount, arguing it was capitalized in the balance sheet. The CIT(A) upheld this disallowance, stating that the expenditure was shown as deferred revenue expenditure. The Tribunal held that the expenditure was revenue in nature and directed the AO to delete the addition of Rs. 77,16,120, emphasizing that the concept of deferred revenue expenditure does not apply under the IT Act.

2. Disallowance of Provision for Warranties:
The assessee provided Rs. 33,77,573 for warranties, estimating future liabilities. The AO disallowed this, considering it contingent. The Tribunal, referencing the Supreme Court's decision in Bharat Earth Movers vs. CIT, held that the liability was ascertained and should be allowed as a deduction, directing the AO to allow the claimed amount.

3. Disallowance of Provision for Royalty:
The assessee made a provision for royalty amounting to Rs. 49,37,042, including R&D cess. The AO disallowed this, considering the liability unascertained. The CIT(A) confirmed the disallowance under s. 40(a)(i) since the tax was paid in the subsequent year. The Tribunal directed the AO to allow the provision, stating that the liability had accrued and the tax was deducted and paid within the stipulated time.

4. Disallowance of Income-Tax Paid on Managing Director's Salary:
The AO disallowed Rs. 2,62,394 paid as income-tax on the salary of the managing director. The CIT(A) confirmed this disallowance. The Tribunal upheld this decision, stating that discharge of tax liability of others is not a business expenditure. However, the Tribunal allowed deductions for house rent and club fees paid for the managing director, as these were approved by the Department of Electronics.

5. Disallowance of Excessive Payments to Foreign Collaborator:
The AO disallowed Rs. 80 lakhs, considering payments to the foreign collaborator excessive. The CIT(A) deleted this addition. The Tribunal upheld the CIT(A)'s decision, noting that the AO failed to provide evidence of excessive payment and that the customs authorities had accepted the valuation by the assessee.

6. Disallowance of Entertainment Expenses:
The AO disallowed 25% of entertainment expenses, attributing them to employee participation. The CIT(A) directed that 25% be considered for disallowance under s. 37(2A). The Tribunal upheld this decision, following its previous ruling in the assessee's case for the asst. yr. 1990-91 and the Delhi High Court's decision in CIT vs. Expo Machinery Ltd.

Conclusion:
The appeal by the assessee was partly allowed, and the appeal by the Revenue was dismissed.