2024 (9) TMI 281 - AT - Income Tax

Disallowance of warranty provision expenses - reasonableness of the provision - eligibility of deduction u/s 37 - HELD THAT - We observe that the AO allowed similar provisions in subsequent assessment years, including AY 2018-19 and AY 2021-22. This consistent tax treatment across different years indicates that the department accepted the reasonableness of the provision, further validating the assessee's approach in AY 2017-18. We also take note of the fact that the warranty provision made in AY 2017-18 was reversed in AY 2021-22, and the reversal amount was offered as income in AY 2022-23. This reversal demonstrates that the provision was prudently and accurately estimated and adjusted based on actual warranty claims, further supporting its legitimacy. We rely on the Hon ble Supreme Court s decisions in Rotork Controls India (P) Ltd. 2009 (5) TMI 16 - SUPREME COURT and Bharat Earth Movers 2000 (8) TMI 4 - SUPREME COURT which support the deduction of provisions for future liabilities when they are based on reasonable estimates and comply with recognized accounting standards. We also consider other judicial precedents cited by the assessee, which consistently uphold the admissibility of such provisions when made on a scientifically sound and consistent basis. Provisions based on scientific methods, consistent business practices, and compliance with AS-29 should be recognized as allowable deductions. The consistent application of these principles is essential to ensuring that business liabilities are accurately reflected in the financial statements and tax assessments. Disallowance is directed to be deleted, and the provision for warranty expenses is allowed as a deduction under Section 37 of the Act. Assessee appeal allowed.

Issues Involved:
1. Disallowance of warranty provision expenses.
2. Compliance with Accounting Standard 29 (AS-29).
3. Application of judicial precedents regarding provisions for future liabilities.
4. Consistency of tax treatment across different assessment years.

Issue-wise Detailed Analysis:

1. Disallowance of Warranty Provision Expenses:
The core issue was the disallowance of Rs. 1,14,19,990/- claimed by the assessee as warranty provision expenses. The assessee, engaged in manufacturing engineering goods, included this provision in its e-return for AY 2017-18. During scrutiny, the Assessing Officer (AO) disallowed this provision, deeming it a contingent liability as per AS-29, due to the lack of historical trends or scientific estimation. The AO categorized the provision as an ad-hoc estimate without a scientific basis, thus disallowing it.

2. Compliance with Accounting Standard 29 (AS-29):
The assessee argued that the warranty provision complied with AS-29, which requires a present obligation, probability of an outflow of resources, and a reliable estimate of the obligation. The provision was based on the sale of solar photovoltaic (SPV) pumps with a five-year warranty, creating an unavoidable obligation. The provision was calculated using the discounted cash flow (DCF) method, resulting in a reliable estimate of future warranty costs.

3. Application of Judicial Precedents:
The assessee referenced several judicial decisions to support the claim that the provision for warranty expenses, even when made for the first time, is admissible if based on reasonable and scientific estimation. Notable cases included:
- Rotork Controls India Ltd. v. CIT [2009] 314 ITR 62 (SC): The Supreme Court allowed a provision for warranty expenses based on past data and reliable estimation.
- Bharat Earth Movers vs. CIT [2000] 245 ITR 428 (SC): The Supreme Court held that a business liability, if based on a reasonable estimate and historical data, should be allowed as a deduction even if the exact outflow occurs in a future period.

4. Consistency of Tax Treatment Across Different Assessment Years:
The assessee highlighted that similar provisions were allowed in subsequent assessment years (AY 2018-19 and AY 2021-22) during scrutiny, indicating the department's acceptance of the provision's reasonableness. The provision made in AY 2017-18 was reversed in AY 2021-22 and offered as income in AY 2022-23, demonstrating prudent estimation and adjustment based on actual warranty claims.

Judgment:
After reviewing the submissions, compliance with relevant accounting standards, and judicial precedents, the tribunal acknowledged that the provision for warranty expenses was scientifically sound and consistent. The provision was calculated using the DCF method, considering the inflow from the solar project, the five-year warranty period, and a discount rate of 14%. This approach aligned with the principles established in Rotork Controls India (P) Ltd. v. CIT and Bharat Earth Movers v. CIT. The consistent use of this method across multiple years further supported the provision's legitimacy.

The tribunal found that the provision complied with AS-29, recognizing it as a liability due to a present obligation from past events, probability of an outflow of resources, and a reliable estimation process. The consistent tax treatment in subsequent years validated the provision's reasonableness. The tribunal emphasized the importance of recognizing provisions based on scientific methods, consistent business practices, and compliance with AS-29 as allowable deductions.

Conclusion:
The disallowance of Rs. 1,14,19,990/- was directed to be deleted, and the provision for warranty expenses was allowed as a deduction under Section 37 of the Income Tax Act. The appeal of the assessee was allowed.

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