2022 (11) TMI 228 - AT - Income Tax

Revision u/s 263 by CIT - Disallowance of liquidated damages - disallowance was upheld on the basis that the liability would arise only on actual supply and therefore the provision made for the year under consideration is an unascertained liability. - HELD THAT - The provision is made up to the last date of the financial year, i.e. 31.03.2012. The assessee has considered the delivery date as per the purchase order/clause in the contract and calculated the delay up to 31.03.2012. It is also noticed that the amount of liquidated damages is calculated as a percentage of the basic value of the purchase order/contract. This would mean that the provision for liquidated damages is created for the period relevant to the year under consideration. Though the actual damages would be paid only on delivery of lubrication systems or products, the liability, in our view, has to be provided for under the mercantile system of accounting. We see no merit in the contention that the provision made is an unascertained liability on the basis that the liability to pay would arise on a future date.. The CIT(A) relied on the decision of FFE Minerals 2018 (9) TMI 357 - MADRAS HIGH COURT while upholding the disallowance. In our view this case is distinguishable from assessee s case since the fact of the said case is different to the extent that only negotiations and discussion took place and the final amount of liquidated damages was computed much later. In assessee s case, however, the provision is made based on the terms agreed with the customer and it relates to the period relevant for the year under consideration. In view of the above discussion we hold that the provision made for liquidated damages is an ascertained liability and should be allowed as a deduction. The disallowance made by the AO in this regard is deleted. Appeal filed by the assessee is allowed.

Summary

Issues Involved:
1. Whether the assessment order passed by the Assessing Officer (AO) was erroneous and prejudicial to the interest of Revenue.
2. Whether the provision for liquidated damages amounting to Rs. 49,20,000/- is an unascertained liability and should be disallowed.

Issue-wise Detailed Analysis:

1. Assessment Order's Validity:

The assessee contended that the Commissioner of Income-tax (Appeals) [CIT(A)] erred in dismissing the appeal and confirming the AO's assessment order. The assessee argued that the original order was passed with proper application of mind and after considering all issues, thus the impugned assessment order was merely a change of opinion. The assessee further claimed there was no erroneous order causing prejudice to the Revenue's interest, and hence, the assessment order under Section 143 r.w.s 263 of the Income Tax Act, 1961 (the Act) should be quashed. The Principal Commissioner of Income Tax (PCIT) issued a notice under Section 263, stating the order was erroneous and prejudicial to Revenue due to the allowance of deduction for provision for liquidated damages, which was deemed an unascertained liability. The PCIT directed the AO to verify the claim and redo the assessment, resulting in the AO disallowing the provision for liquidated damages.

2. Provision for Liquidated Damages:

The assessee argued that the provision for liquidated damages was based on contractual obligations, where the purchase orders or contracts contained clauses for payment of liquidated damages if delivery schedules were not met. The provision was accrued for the financial year ending on 31.03.2012, even though actual payment would occur later. The assessee, following the mercantile system of accounting, claimed the liability accrued during the year under consideration and should be provided for in the books of account. The AO disallowed the provision, stating it was based on future delivery dates and thus an unascertained liability. The CIT(A) upheld this disallowance, relying on the decision of the Hon'ble Madras High Court in FFE Minerals India (P.) Ltd. vs. JCIT.

Upon review, the Tribunal noted that the provision was calculated based on the percentage agreed upon in the purchase orders/contracts and up to the financial year-end date. The provision was thus related to the period relevant to the year under consideration. The Tribunal distinguished the case from FFE Minerals, noting that in the current case, the provision was based on agreed terms with customers and related to the relevant period. The Tribunal concluded that the provision for liquidated damages was an ascertained liability and should be allowed as a deduction, thereby deleting the disallowance made by the AO.

Conclusion:

The Tribunal allowed the appeal filed by the assessee, holding that the provision for liquidated damages was an ascertained liability and should be allowed as a deduction. The disallowance made by the AO was deleted. The judgment was pronounced in the open Court on 26th September 2022.