2021 (4) TMI 808 - AT - Income Tax

Disallowance being provision made for warranty expenses - AR pointed that Appellant had created the provision on the basis of past history and was based on a scientific and reliable method and as such, the disallowance sustained by the Ld. CIT(A) deserves to be deleted- HELD THAT - Variation in the methods adopted for the provision for warranty has not been clearly set out after 2010-11 by the assessee. CIT (Appeals) has rightly held that the assessee has not made a reliable estimate of amount of provision on the basis of past historical trend of warranty claimed. The assessee itself has admitted that due to up-gradation of technology, the defects in components were minimized and, therefore, warranty claim were substantially reduced. But in subsequent assessment year 2013-14, the assessee reversed the provision keeping in mind the quantum of brought forward of provision of warranty amount and which reduced the actual claim during the year. In assessment year 2013-14 the utilization of provision during the year from opening provision, balance figure also became a negative figure. Therefore, it clearly establishes that assessee had not been stick in making the provision for warranty at the end of financial year under consideration when it had all the available facts relating to warranty claim made and historical trend of available claim as laid down in the case of Rotork Controls India Pvt. Ltd 2009 (5) TMI 16 - SUPREME COURT The assessee s warranty provision equally lack in the proper accounting / calculating factors and, therefore, the claim of the assessee is not sustainable. The CIT (Appeals) has rightly rejected the set off of actual warranty expenses on payment basis as well as warranty expenses on payment basis. - Decided against assessee.

Issues Involved:

1. Sustaining the addition/disallowance made by the Assessing Officer (AO).
2. Disallowance of INR 7,37,150 in respect of provision for warranty.
3. Misinterpretation of the 'matching concept' by the CIT(A).
4. Alleged over-provisioning of warranty expense.
5. Revision of the basis of provisioning.
6. Alternate claim of actual warranty expenses incurred.
7. Initiation of penalty proceedings under section 271(1)(c) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Sustaining the Addition/Disallowance Made by the AO:
The assessee challenged the order of the CIT(A) which sustained the addition/disallowance made by the AO, arguing that the findings were erroneous on facts and in law. The Tribunal noted that the CIT(A) had dismissed the appeal of the assessee, thereby upholding the AO's assessment order which included the disallowance of INR 7,37,150 for warranty expenses.

2. Disallowance of INR 7,37,150 in Respect of Provision for Warranty:
The assessee argued that the provision for warranty was based on past history and a scientific method, making it a legitimate accrued liability. The Tribunal examined the basis of the provision, noting that the provision was made considering the percentage of warranty expenses/sales of the preceding year and the average of the last four years. However, the Tribunal found that the assessee failed to demonstrate the scientific method convincingly and that the provision was excessive given the substantial opening balance.

3. Misinterpretation of the 'Matching Concept' by the CIT(A):
The assessee contended that the CIT(A) misinterpreted the matching concept, which requires that if revenue is recognized, the cost incurred to earn that revenue, including warranty costs, must be fully provided for. The Tribunal referred to the Supreme Court's decision in Rotork Controls India Pvt. Ltd. Vs. CIT, which emphasized that a provision should be recognized if it is a present obligation resulting from a past event, probable outflow of resources, and a reliable estimate can be made. The Tribunal found that the assessee did not meet these conditions adequately.

4. Alleged Over-Provisioning of Warranty Expense:
The CIT(A) and AO observed that the assessee had been over-provisioning warranty expenses, leading to substantial opening balances that were not utilized. The Tribunal agreed with this observation, noting that the assessee's provision for warranty was not based on a reliable estimate and historical trends, thus justifying the disallowance.

5. Revision of the Basis of Provisioning:
The assessee claimed that it had been revising and reducing its estimates based on historical trends and technological improvements. However, the Tribunal found that the assessee frequently changed its provisioning basis without a clear scientific method, leading to inconsistencies. The Tribunal noted that the assessee's method lacked proper accounting and calculation factors, making the provision unreliable.

6. Alternate Claim of Actual Warranty Expenses Incurred:
The assessee argued that if the provision for warranty was not allowed, the actual warranty expenses incurred during the year should be allowed as a deduction. The Tribunal referred to Section 37(1) of the Income Tax Act, which allows expenses incurred wholly and exclusively for business purposes. However, the Tribunal found that the assessee did not separately debit the actual warranty expenses to the profit and loss account, and thus, the claim was not sustainable.

7. Initiation of Penalty Proceedings Under Section 271(1)(c):
The assessee contested the initiation of penalty proceedings under section 271(1)(c) of the Act. The Tribunal noted that this issue was consequential and did not require separate adjudication in this appeal.

Conclusion:
The Tribunal dismissed the appeal of the assessee, upholding the disallowance of the provision for warranty expenses and rejecting the alternate claim for actual warranty expenses. The Tribunal emphasized that the assessee failed to provide a reliable estimate and consistent method for provisioning warranty expenses, as required by the Supreme Court's decision in Rotork Controls India Pvt. Ltd. Vs. CIT. The order was pronounced in the open court on April 16, 2021.

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