2024 (7) TMI 1437 - HC - Income Tax

Disallowance of Provision of Liquidated Damages - said amount was on account of unascertained liability for which there did not exist a probability of outflow of resources - ITAT deleted addition - HELD THAT - There is a concurrent finding which has come to be recorded by both CIT(A) as well as the ITAT that the liquidated damages upon being waived were written off after the same had been waived in the subsequent year. As correctly held by ITAT provision is arising out of a contractual obligation and the basis of providing the provision is based on past experience and such a reasonable basis of estimation has been regularly followed by the assessee in the past, then ostensibly it cannot be held that the basis of estimation of working of the provision is not correct. - once it is brought on record that assssee on the year of reversal has paid taxes on excess provision and similar feature appeared in the earlier years and assesee had payments for liquidated damages on delay of deliverables, then no adverse view can be taken, because it is not the charge of the AO that assessee has made some kind of excessive provision in this year in relation to past. Decided against revenue. Provisioning for warranty - To give an example of product warranties, a company dealing in computers gives warranty for a period of 36 months from the date of supply. The said company considers following options (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 turnover of the company based on past experience (historical trend). The first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis, which is prohibited both under the Companies Act as well as by the Accounting Standards which require accrual concept to be followed. In the present case, the Department is insisting on the first option which, as stated above, is erroneous as it rules out the accrual concept. The second option is also inappropriate since it does not reflect the expected warranty costs in respect of revenue already recognized (accrued). It is not based on matching concept. Under the matching concept, if revenue is recognized the cost incurred to earn that revenue including warranty costs has to be fully provided for. When value actuators are sold and the warranty costs are an integral part of that sale price then the appellant has to provide for such warranty costs in its account for the relevant year, otherwise the matching concept fails. In such a case the second option is also inappropriate - Thus third option is most appropriate because it fulfils accrual concepts as well as the matching concept. Validity of rectification order by TPO - TP Adjustment - ITAT concluded services provided by the AE were not stewardship services - HELD THAT - ITAT has essentially taken into consideration, the undisputed fact that there was a failure on the part of the Transfer Pricing Officer TPO to provide an opportunity to the assessee of being heard before enhancing income. As per Section 154(3) of the Act amendment/rectification which has the effect of enhancement of an assessment or reducing a refund or otherwise increasing the liability of the assessee shall not be made unless the authority concerned gives notice to the assessee of its intention to do so. Therefore, it is obligatory under the statute to issue notice by the tax authority to give a reasonable opportunity of being heard to the Assessee. This is clearly set out u/s 154 of the Income Tax Act and it has to be followed by the tax authorities at the initial stages. If this procedure of issuing the notice and giving reasonable opportunity of being heard is not followed, any further exercise will be non est. Therefore, the order itself becomes void ab initio. In the circumstances, we have no other option to set aside the impugned rectification order as being void ab initio. No justification to take a view contrary to what was expressed by the ITAT. Question nos. 2.5 and 2.6 are concerned, Appellant has sought time to address submissions in that respect. Consequently, re-notify on 07.03.2024.

Summary

Issues:
1. Disallowance of Provision of Liquidated Damages
2. Allowance of claim of warranty
3. Discrepancy in value of contracts executed and warranty expenses
4. Addition on account of provisions for warranty and liquidated damages
5. Deduction on account of suspended contracts
6. Claim of suspended contract without revised return
7. Validity of rectification order by TPO

Issue 1 - Disallowance of Provision of Liquidated Damages:
The Commissioner challenged the ITAT's order regarding the disallowance of Provision of Liquidated Damages. The ITAT upheld the provision made by the assessee for liquidated damages based on contractual obligations and past experience. The ITAT found that the provision was made reasonably and in accordance with the contractual terms. The ITAT confirmed the CIT(A)'s order dismissing the Revenue's appeal on this issue.

Issue 2 - Allowance of claim of warranty:
The ITAT also addressed the claim of warranty made by the assessee. It was noted that the assessee had provided warranty based on past experience and contractual obligations. The ITAT cited a relevant case law to support the provision made by the assessee for warranty expenses. The ITAT concluded that the provision for warranty was made appropriately, considering past expenses and contractual obligations.

Issue 3 - Discrepancy in value of contracts executed and warranty expenses:
The ITAT highlighted a discrepancy in the value of contracts executed and warranty expenses claimed by the assessee. The ITAT found that the provision for warranty was made based on actual expenses and past experience. The ITAT referred to a specific case law to support the provision for warranty made by the assessee. Consequently, no substantial question was raised in this regard.

Issue 4 - Addition on account of provisions for warranty and liquidated damages:
The ITAT confirmed the provision made by the assessee for both warranty and liquidated damages based on contractual obligations and past experience. The ITAT found that the provision was made reasonably and in accordance with the terms of the agreements. The ITAT upheld the CIT(A)'s order on this issue.

Issue 5 - Deduction on account of suspended contracts:
The ITAT allowed the deduction on account of suspended contracts, which was challenged in the appeal. The ITAT considered the absence of the claim in the return of income filed by the assessee. The matter was set for further consideration, and the appellant was given time to address submissions on this issue.

Issue 6 - Claim of suspended contract without revised return:
The ITAT's decision to allow the claim of suspended contract was questioned in the appeal. The absence of the claim in the original return and the violation of a previous court decision were raised as issues. The matter was scheduled for further review, with the appellant given an opportunity to present arguments.

Issue 7 - Validity of rectification order by TPO:
The ITAT examined the validity of a rectification order passed by the TPO, focusing on the failure to provide an opportunity to the assessee before enhancing income. The ITAT concluded that the rectification order was void ab initio due to the violation of principles of natural justice. The ITAT set aside the rectification order as it was passed without giving the assessee a chance to be heard. The decision of the ITAT was upheld, emphasizing the importance of following procedural requirements in such cases.