2017 (10) TMI 1246 - AT - Income Tax

Disallowance of Provision towards recovery of cost of repairs - as per AO assessee failed to file any documentary evidence for making such provision and also the working of such provision - Held that - As on completion of repair contracts, advance received from customers and other collections after completion of repair contracts are credited to income from services in the profit and loss account and expenses incurred on repair contract and debited to Work In Progress (WIP) are transfer to the debit of profit and loss account. At the year-end, a review on progress of repair contracts is undertaken. During such an exercise, it is found that there are some contracts which are dormant in nature. These are the contracts, on which work was done long back and no further work is expected to be done. In such circumstances, expenses incurred on such dormant repair contracts and debited to WIP account are transferred to profit and loss account. Similarly, advances received from customers in respect of such contracts and credited to advances from customers account are also transferred to profit and loss account. Both these amounts are transferred to miscellaneous expense under the sub head provision for repair expense . Thus the above the word provision is a misnomer as, in reality, it is not a provision but write off of actual repair expenses (net of recovery). In view of the above, the disallowances made by the AO in AY 2009-10 and AY 2010-11 are deleted. - Decided in favour of assessee. Disallowance of provision for maintenance and free service warranty - Held that - We find that as the expenses relating to warranty are the expenses for the year in which the elevator is sold, in accordance with the concept of matching revenue with cost, the assessee-company is making provision for the cost of warranty in the year in which the elevator are sold. In Rotork Controls India (P) Ltd. (2009 (5) TMI 16 - SUPREME COURT OF INDIA), it has been held that (i) for a provision to qualify for recognition, there must be a present obligation arising from past events, settlement of which is expected to result in an out flow of resources and in respect of which reliable estimate of amount of obligation is possible and (ii) if historical trend indicates that in past large number of sophisticated goods were being manufactured and defects existed in some of items manufactured and sold, then provision made for warranty in respect of army of such sophisticated goods would be entitled from gross receipts u/s 37(1), provided data is systematically maintained by the assessee. In view of the factual matrix narrated above, we delete the disallowance - Decided in favour of assessee. Addition u/s 40(a) on the basis of tax audit report - Held that - As gone through the relevant record and found that documents relating to the above claim were not filed by the assessee-company before the AO or the Ld. CIT(A). Therefore, we set aside the order of the Ld. CIT(A) on the 3rd ground of appeal for the AY 2009-10 and restore the same to the file of the AO to make a fresh assessment after verifying the documents and giving reasonable opportunity of being heard to the assessee - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Disallowance of Provision towards recovery of cost of repairs
2. Provision for Maintenance and Free Service/Warranty
3. Disallowance of expenditure under section 40(a)(ia)

Issue-wise Detailed Analysis:

1. Disallowance of Provision towards recovery of cost of repairs
For both AY 2009-10 and AY 2010-11, the Assessing Officer (AO) disallowed provisions towards recovery of cost of repairs amounting to ?66,66,881 and ?51,73,107 respectively. The AO found that the assessee had included these amounts in miscellaneous expenses without providing documentary evidence or the working of such provisions. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the disallowance, stating that the provision was made against future income and lacked original bills and vouchers.

Before the Tribunal, the assessee argued that these were actual expenses incurred, similar to bad debts, and debited to the Profit and Loss account when further recovery was deemed impossible. The Tribunal found that the provision was a misnomer and represented a write-off of actual repair expenses. Consequently, the disallowances of ?66,66,881 and ?51,73,107 were deleted, and the first ground of appeal for both years was allowed.

2. Provision for Maintenance and Free Service/Warranty
For AY 2009-10, the AO disallowed provisions for maintenance and free service/warranty amounting to ?1,29,59,645 and ?3,24,48,624. The AO noted that the assessee failed to provide details and that the amounts were not reflected in the profit and loss account. The CIT(A) upheld the disallowance, stating that there was no convincing basis for the estimation and that the terms referred to future responsibilities.

The assessee argued that the provision was based on a scientific method and was allowable as per the Supreme Court judgment in Rotork Controls India (P) Ltd. vs. CIT. The Tribunal found that the expenses related to warranty were for the year in which the elevator was sold, and the provision was made accordingly. The Tribunal referred to the financial statements and found the provision to be in line with the matching revenue with cost principle. Therefore, the disallowance of ?4,54,08,269 was deleted, and the second ground of appeal was allowed.

3. Disallowance of expenditure under section 40(a)(ia)
The AO disallowed ?5,44,27,004 under section 40(a)(ia), which the assessee had initially disallowed in the original return but later realized was erroneously considered. The AO was not convinced by the tax auditor's letter provided by the assessee and made the disallowance. The CIT(A) upheld this disallowance.

Before the Tribunal, the assessee relied on the tax auditor's certificate, which stated that the expenses were not for sub-contractors but for employees. The Tribunal found that the letter did not substantiate the claim and that relevant documents were not filed before the AO or CIT(A). Therefore, the Tribunal set aside the order of the CIT(A) on this issue and restored it to the AO for fresh assessment after verifying the documents. The third ground of appeal was allowed for statistical purposes.

Conclusion:
- The appeal for AY 2009-10 was partly allowed, and the appeal for AY 2010-11 was fully allowed.
- Disallowances towards recovery of cost of repairs and provision for maintenance and free service/warranty were deleted.
- The issue of disallowance under section 40(a)(ia) was remanded back to the AO for fresh assessment.