2010 (7) TMI 82 - HC - Income Tax

Provision for warranty allowable deduction scientific basis of making provision deduction of provisions for the purpose of section 115JB Held that - there could be three broad options available to a company while making a provision viz. (a) account for warranty expense in the year in which it is incurred; (b) it makes a provision for warranty only when the customer makes a claim; and (c) it provides for warranty at 2 per cent. of the turnover of the company based on past experience (historical trend) - Hon ble Supreme Court while holding the first two options would not be appropriate the third option would be more appropriate as that would fulfil the accrual concept as well as the matching concept - a categoric stand was made that the assessee was making a reasonable estimate of the provision for warranty claims and that it was consistently adopting a method of taking the average of actual settlements of the immediately preceding three years while working out the provision based on the percentage of current year s sales. - the assessee herein made a scientific approach while making a provision for warranty account for the relevant years and therefore there was no scope to disallow the claim made by the assessee decided in favor of assessee

Summary

Issues:
1. Allowability of provision for warranty claims without scientific basis ensuring accuracy.
2. Allowability of provision for warranty claims under Section 115JB of the Income Tax Act.

Issue 1:
The main issue in this judgment revolves around the allowance of provision for warranty claims without a scientific basis ensuring accuracy. The appellant contended that the provision for warranty claims made by the respondent/assessee was not based on a scientific method, leading to a deferment of revenue and tax liability. However, the Tribunal upheld the deduction, citing a recent Supreme Court decision emphasizing the need for a scientific approach in making warranty provisions. The Supreme Court highlighted the importance of historical trend analysis and experience-based estimation for warranty provisions. It rejected the options of accounting for warranty expenses on a cash basis or only when a claim is made, favoring a provision based on past experience and turnover percentage. The court stressed the accrual and matching concepts in recognizing warranty liabilities, emphasizing the necessity of reliable estimation based on past trends.

Issue 2:
The second issue pertains to the allowability of provision for warranty claims under Section 115JB of the Income Tax Act for Assessment Year 2003-04 and 2004-05. The Tribunal analyzed the provision made by the assessee and affirmed its allowance as a deduction for the purpose of Section 115JB, despite the absence of a scientific basis and excess provision resulting in revenue deferment. The Tribunal considered the method of computation adopted by the assessee, which involved averaging actual settlements of the preceding three years to determine the provision based on the current year's sales percentage. It found the method reasonable and not arbitrary, as evidenced by the consistency in provision percentages over time. The Tribunal concluded that the assessee's approach was not arbitrary, and there was no error in confirming the Commissioner of Income-tax (Appeals) order for the relevant years. The court upheld the Tribunal's decision, stating that no substantial question of law arose, leading to the dismissal of the appeals.

This comprehensive analysis of the judgment highlights the key legal principles, arguments presented, and the court's reasoning in addressing the issues raised regarding the provision for warranty claims and its allowability under the Income Tax Act.