9911796707
TMI Blog2001 (4) TMI 870X X X X Extracts X X X X X X X X Extracts X X X X ..... a. In other words, in respect of long-term contracts the profit was shown by adopting the following method : Value of invoices raised Contractor value X Estimated profit from the contract as a whole Following break-up of the provisions of cost of jobs were furnished before the Assessing Officer : Provision for job cost on estimated material cost and percentage completion basis Rs. 55,36,000 Provision for rectification to be carried out on Deepak Fertilizers FM Boiler Unit assembled in shop Rs. 5,00,000 Rs. 60,36,000 The assessee contended before the Assessing Officer that the provision of Rs. 60,36,000 was liable to be allowed as the company regularly followed percentage of completion method and amount of revenue recognized is determined by reference to stage of completion at the end of the accounting period. It was further stated that for convenience of execution of job and supplies of various components required for assembly of boiler at site, a price break up is preferred and approved by the client before commencement of the supply. Material costs were booked against the job and same were also recognized at job level. It was also stated that provisions were made for a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Institute of Chartered Accountants of India for arriving at the portion of the profit of the long-term contract for the assessment year 1990-91, whose execution spread over more than one accounting period based upon the extent of work performed during the year as measured in the assessee-company's case with reference to the value of the invoices raised during the previous year against despatches to the site of the components, equipment and material in terms of the billing schedule agreed to between the assessee-company and the client. According to learned counsel for the assessee, the Commissioner of Income-tax (Appeals) has further erred in mistaking the simple surplus per se (invoice-cost price of the despatches) such profit for the year, without understanding the central fact that there is only one profit of an indivisible long-term contract, a portion of which is to be disclosed for the year as envisaged by the percentage of completion method and as such annual profit is a representative of the estimated profit of a longterm contract as a whole, necessitating provision in the accounts to ensure that the surplus disclosed during the year referred to above is brought in line with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the contract is at least 1/4 complete, a certain proportion of realised profit, that is profit revealed by the contract less the percentage of retention money, should be transferred to the profit and loss account and the balance left as reserve. The proportion is, usually : (i) 1/3rd in case the completed (certified) work is less than half the total contract, and (ii) 2/3rd in case the certified work is completed up to 50% or more. Or, the profit may be transferred to the profit and loss account by using the formula : Realised profit X Work certified Total value of contract This practice is becoming popular. If the contract account reveals loss, the whole of it should be transferred to the profit and loss account." On the legal side, learned counsel submitted that the method of accounting regularly followed by the assessee for the year under appeal and for subsequent years is as per the provisions of law. In support of this contention, relied upon the following authorities : 1. Aruna Mills Ltd. v. CIT [1957] 31 ITR 153 (Bom) ; 2. CIT v. Guttoffnungashutto Sterkrado [1992] 197 ITR 66 (Orissa) ; 3. M. N. Dastur and Co. Ltd. v. Deputy CIT [1997] 61 ITD 167 (Cal) ; 4. M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commercial accounting is that a notional profit or a notional loss cannot enter into the computation of profits in a year. That principle is subject to exception in regards to stock-in-trade and this aspect of the case has been dealt with in the said decision (B. S. C. Footwear Ltd. v. Ridgway (Inspector of Taxes) [1972] 83 ITR 269 (HL)). He also placed reliance on the decision in the case of Badridas Daga v. CIT [1958] 34 ITR 10 (SC) and the decision of the Gujarat High Court reported as CIT v. Gujarat State Warehousing Corporation [1976] 104 ITR 1. Coming to the last question, whether accountancy principle would overrule the provisions of income-tax and whether shifting of the profit as has been done by the assessee is permitted, the learned Departmental Representative again referred to the decision of the Madras High Court in the case of CIT v. Indian Overseas Bank [1985] 151 ITR 446. He also relied upon the decision of the Orissa High Court in the case of Tripty Drinks (P.) Ltd. v. CIT [1978] 112 ITR 721. The learned Departmental Representative also again placed reliance on the judgment of the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -7), it had no relevance for the year under operation. We have considered the rival submissions and perused the facts on record. It is well accepted that it is open to an assessee to decide/adopt a regular method of accounting. If such a method is an acceptable method of accounting, it will follow that the profits can be properly ascertained therefrom. In the case before us, the assessee has followed constantly for this year (which is first year of operation) and for the subsequent years a method which is one of the accepted accounting principles and practices sanctified by usage and in line with Institute's recommended standard which is known as AS-7. No doubt, AS-7 was issued in the year 1983, but AS-7 is merely a codification of existing accounting practices for which evidence of commentaries of various authors have already been referred to in paragraph 5 (page 32). Further, AS-7 has been made mandatory from April 1, 1991. From the chart reproduced on para. 4 (page 31), it is noted that the books of account, especially trading account has been accepted, save and except the addition of provisioning. As pointed above, the assessee is engaged in long-term contracts and the provisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rial Development Corporation [1997] 225 ITR 703 (SC). In Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1, the Supreme Court has held that the long-term indivisible contract spread over more than one accounting period, the profit from the contract as a whole is determined with reference to the entire value of the contract against the cost already incurred and the estimated cost yet to be incurred for its completion. This decision of the Supreme Court is of direct help to the assessee and this was also accepted by the Departmental Representative, but he tried to distinguish it. According to the Departmental Representative in the said case, the assessee had offered for taxation the total receipts and claimed for deduction on account of liability, which the assessee had to incur in subsequent years in order to fulfil the contractual agreement. According to the learned Departmental Representative under these particular circumstances, the Supreme Court allowed the deduction on account of liabilities to be incurred in subsequent year. However, according to the learned Departmental Representative, in the instant case the receipts have been received by the assessee during the assessment year and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the purpose of computing the chargeable income. In the present case, the assessee as pointed above, has adopted one of the acceptable accounting principles and practices sanctified by usage and in line with institute's recommended standard AS-7 and such method does not result in a distorted picture of the true state of business for the purpose of computing the chargeable income. Reliance placed by learned Departmental Representative on the judgment of the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 227 ITR 172 is also of no assistance to the Revenue. This decision of the apex court nowhere falls foul of the accounting principles which have found acceptance in several cases. Here, in this case, the business was not started, yet the company earned income by way of interest from the available surplus fund. Accounting practice is such that when the project is in construction stage, interest should be set off against the capital cost of the project. However, the Institute's guidelines of pre-construction accounting clearly states that even that income earned during the construction period is to be set off against the project cost yet in the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... obligation. The Assessing Officer holding that the amount claimed was in the nature of a provision and the provisioning had been made on estimated basis, disallowed the claim of the assessee. The assessee appealed to the Commissioner of Income-tax (Appeals). Detailed submissions were made before the Commissioner of Income-tax (Appeals) and he has reproduced the same verbatim in para. 10 of his order. Not convinced by the arguments put forth by the representative of the assessee, the Commissioner of Income-tax (Appeals) confirmed the addition. According to the Commissioner of Income-tax (Appeals)-"a mere provision in the accounts for a liability which is not ascertained, cannot be considered for a deduction. The provision is generally made in respect of a known liability for which the quantification cannot be made in the accounting year. In the instant case, warranty liability has been provided on estimate basis at two per cent. of the billing amount, considering it as charge on the profit and as a known liability. To my mind such unascertained liabilities cannot be allowed on estimate basis". Shri B. K. Khare, learned counsel for the assessee submitted that in the case of the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts attributable to the contract include expected warranty costs. Warranty costs are provided for when such costs can be reasonably estimated (page 147 of AS-7). Learned counsel concluded that such provision is allowable deduction in view of the following authorities : (1) Commissioner of Inland Revenue v. Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697 (PC) ; (2) ITO v. Wanson (India) Ltd. [1983] 5 ITD 102 (Pune) ; and (3) Voltas Ltd. v. Deputy CIT [1998] 64 ITD 232 (Mum). Shri Naresh Kumar, the learned senior Departmental Representative strongly supported the orders of the authorities below. He strongly articulated on para. 11 of the order of the Commissioner of Income-tax, where the latter held that a mere provision in the accounts for the liability which is not ascertained, cannot be considered for deduction. He pointed out that the Commissioner of Income-tax (Appeals) denied the claim of the assessee on the ground that the said liability is not an ascertainable liability. As per the contract, the warranty liability would start from the date of delivery of project boiler and thereafter for a period between 18 to 24 months. However, provision for warranty liability has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... working, then, for certain period, the suppliers will undertake, free of cost, to remove such deficiencies or infirmities which prevent the promised working by the capital asset. This is very important as offending unit could put into dis-array the whole working of the enterprises. In the case of the assesseecompany, as explained above, the guarantee is given in respect of supply of every project boiler which enjoins the company to make the boiler operational as per the specification, after removing the deficiencies found during the warranty period. This warranty period lasts from 12 to 18 months from handing over the project boiler or from the date the project has become operational. The contract value will necessarily include the cost required to be incurred in the warranty period. Such cost is estimated based upon the experience in the industry, and on the experience of the company's collaborators, and accordingly provided for. Thus, therefore, in our considered opinion, warranty provision is not a stray provision. It has been provided after scientific analysis based on the assessee's experience and experience of collaborators and the assessee assessed on total liability up to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erience in the earlier years. The assessee knew for certain that some expenditure had to be incurred and as a prudent businessman, had to make a provision which approximated to the amount of expenditure. The method followed was consistent and therefore, there was justification for allowing the assessee's claim. The case of the assessee is on all fours and accordingly, we hold that the above case clearly comes to the assistance of the assessee. The distinguishing factor pointed out by the learned Departmental Representative that the provision for warranty has been created by the assessee even before the product has come into existence is of no relevance because it is the principle of accounting which is of vital importance. We further find that the case of the assessee stands supported by the decision of the Income-tax Appellate Tribunal in the case of Voltas Ltd. [1998] 64 ITD 232 (Mum). Coming to the decision of the Bombay High Court in the case of Rajkumar Mills Ltd. [1971] 80 ITR 244 relied upon by the learned Departmental Representative we find that the same is not applicable for the following reasons : (a) No evidence in respect of any standard accounting practice brought on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tributable to employees out of the total lunch expenses of Rs. 1,47,523. Shri B. K. Khare, learned counsel for the assessee, stated that the claim of the assessee at 50 per cent. was in accordance with the judgment of the Karnataka High Court in the case of CIT v. Mysore Minerals Ltd. [1986] 162 ITR 562 (Karn). The learned Departmental Representative, Shri Naresh Kumar relied upon the orders of the authorities below. We have considered the rival submissions and perused the facts on record. It is noted that out of the total entertainment expenses of Rs. 1,86,702, the assessee had incurred a sum of Rs. 1,47,523 on business lunches. The business lunches were also attended by the employees of the company who accompanied the guests for such lunches. In accordance with the ratio of the Karnataka High Court in the case of Mysore Minerals Ltd. [1986] 162 ITR 562, we direct the Assessing Officer to allow 50 per cent. of the total expenditure as on business lunches attributable to employees. This ground accordingly succeeds. Ground No. 4 reads as under : "The learned Commissioner of Income-tax (Appeals) failed to appreciate that interest income in the sum of Rs. 11,07,085 was earned by d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... facts of the case of the assessee. In the matter of claim made by an assessee for deduction of provision made towards warranty obligations, a question often arises as to whether admission of such a claim will run counter to the fundamental postulate that an expenditure which is not actually incurred by the assessee and which is only of a contingent nature cannot be allowed under section 37(1) of the Income-tax Act. Among others, the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 and in the case of Madras Industrial Investment Corporation Ltd. [1997] 225 ITR 802, 808 (SC) has observed that an expenditure which is of a contingent nature cannot be admitted into the limited confines of section 37(1) which allows deduction for an expenditure which is incurred by an assessee. In fact, this proposition is self-evident and way back in the year 1959, the Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 held that the term "expenditure" is equal to "expense", i.e. actual laying out of money. Looked at differently, expenditure means "spending" in the sense of "paying out or away" in an irretrievable manner. Thus, there cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of the judgment, the apex court dealt with the provisions of section 37 and reiterated the principles laid down in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 (SC) to the effect that the expenditure deductible for income-tax purpose is towards the liability which actually exists. However, setting apart money which might become an expenditure on the happening of an event is not expenditure. To repeat, these observations were made in the context of section 37 at page 598 of the judgment. The court also noticed the decision of Metal Box Co. of India Ltd. [1969] 73 ITR 53 (SC) and reaffirmed its validity at page 599 of the judgment. Some very pertinent observations came to be made by the court on page 600 of the reported judgment in the following words : "As there were several methods which the assessee might choose to adopt in meeting his liability to pay gratuity, the treatment which he would receive under the Income-tax Act would depend upon the method adopted by him. The assessee is only under an obligation to pay gratuity when it becomes due and payable. The other methods adopted by the assessee for meeting the liability for gratuity as and when it arose ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... three tests enumerated supra and, accordingly, in my view, the claim of warranty is an allowable deduction. K. C. Singhal (Judicial Member).-After going through the order proposed by my learned Brother and having discussion at length with him, I have not been able to persuade myself to agree with the conclusion arrived at by him in para. No. 26 of his order regarding deduction on account provisions made for warranty liability. Therefore, I proceed to express my dissenting view. The issue for our consideration is whether the assessee is entitled to deduction in respect of the provisions made for warranty liability in respect of goods being manufactured/constructed by the assessee. The facts regarding this issue are in short compass and have been set out in the proposed order in para. 20. However, it would be useful to refer to few more facts, which, in my opinion, are relevant for disposal of this issue. Though the production commenced in the assessment year 1989-90, but the actual and effective business was started in this year. So, for all practical purposes, the year under consideration is the first year of the business. The assessee had obtained six contracts for construction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, the contention on behalf of the Revenue is that warranty liability is contingent in nature and therefore not allowable at all in view of the Supreme Court decision in the case of Shree Sajjan Mills Ltd. [1985] 156 ITR 585. According to learned senior Departmental Representative, it makes no difference whether such claim of the assessee is tested under section 28 or 37. It is also the contention of the senior Departmental Representative that the claim of the assessee is pre-mature since the occasion for such liability has not arisen. According to him, the boilers were in the stage of construction as only a part of construction was completed in the year under consideration while according to the terms of warranty, the assessee is liable only from the date of delivery or from the date of commission as the case may be. Since the boilers were in the construction stage itself, the claim of the assessee was thus premature and therefore, not allowable. According to the proposed order, the claim of the assessee regarding warranty liability is allowable for the following reasons : (a) That starting point of computation of taxable income is the commercial profits derived on the basis of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s that income referred to in section 28 shall be computed in accordance with the provisions of sections 30 to 43C. Similar provisions were on the statute in the form of section 10(1) and section 10(2) of the 1922 Act. These old provisions were the subject matter of the consideration before the Supreme Court in the case of Badridas Daga [1958] 34 ITR 10. In that case the question arose whether the loss on account of embezzlement by an employee could be allowed as deduction. The Supreme Court held that such deduction could not be allowed either under section 10(2)(xi) or under section 10(2)(xv). It then proceeded to observe that deductions and allowances enumerated in section 10(2) are not exhaustive of all the allowances which could be made in ascertaining the profits of the business taxable under section 10(1) which are to be understood according to the ordinary commercial principles. It is in this context, it was observed that if any deduction cannot be allowed under section 10(2), then it can be allowed under section 10(1) since tax is to be levied on true profits provided such deduction springs directly from the carrying on of the business and is incidental to it. The relevant p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 10(2)(xv). The court had held that the claim of the assessee in those two cases did not fall under the specific provisions of section 10(2) and, therefore, the same could be considered under section 10(1) itself because ultimately it is the true profits of the business which are to be taxed. Therefore, it is very much clear that starting point of computation is not under section 10(1) (corresponding to section 28 of the 1961 Act) as has been held by my learned Brother. Therefore, the profits are first to be computed in accordance with the provisions of sections 30 to 43C and if any claim of the assessee cannot be considered under these sections, then it can be considered under section 28 and for that purpose, the aspect of commercial profits would arise. If the contention of the assessee is accepted, then the scheme of the Act would become redundant. The reason is that all the expenditures referred to in sections 30 to 40C are generally deductible in accordance with the principle of commercial accountancy. For example, general expenses of business, i.e., the salary and wages, bonus, interest on borrowings, telephone, electricity, repairs, rent, rates and taxes etc., are allowabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ITR 649 (SC) and consequently cannot be applied in the present case. Even assuming for the sake of argument, the claim of the assessee can be considered under section 28. Still, such claim in my opinion, cannot be allowed. The contingent liabilities are not allowable either under section 28 or section 37 unless it falls within the exception laid down by the Supreme Court in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53. In order to appreciate this contention, it would be useful to refer the decision of the Court of Appeal in the case of Peter Merchant Ltd. v. Stedeford (Inspector of Taxes) [1948] 30 T C 496, the facts of which are similar to the present case. That case was relied on by the Revenue before the Supreme Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 in support of the contention that future liability cannot be allowed as deduction. The Supreme Court has discussed the facts of that case and the ratio laid down by the court of appeal at page 5 of the report as under : "Reliance was placed on behalf of the Revenue on the case of Peter Merchant Ltd. v. Stedeford (Inspector of Taxes) [1948] 30 TC 496 (CA), in which a distinction was drawn between ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has made a distinction between a liability which has accrued during the year though to be discharged at a future date and a liability which is contingent in the year, but may become a accrued liability in future upon the happening of an event. In the former case, deduction was held to be allowable while in the latter case held to be not allowable. It is to be noted that the Supreme Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 was considering the claim of the assessee under section 10(1) of the 1922 Act corresponding to section 28 of the 1961 Act. Therefore, it follows that even under section 28, contingent liability cannot be allowed while computing the profits in the commercial manner. Having held that the contingent liability cannot be allowed under section 28, there is no scope of argument that such liability can be allowed on estimate basis if it is based on past experience of the assessee or the industry. Even otherwise, the decision of the Supreme Court in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53 does not help the assessee. What has been held in that case is that the contingent liability, if it is a properly ascertainable and it is possible t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the income-tax provisions would prevail over the accounting principles. Reference may also be made to a recent decision of the Tribunal Bombay Bench in the case of Deputy CIT v. Associated Capsules Pvt. Ltd. [1995] 65 TTJ 774, wherein it has been held vide para. 17 at page 779 : "The Institute of Chartered Accountants of India has recommended the provision of such a liability on grounds of prudence. Now prudent accounting is one thing and determination of income for tax purposes is another. One may be almost sure that a certain liability will arise on the happening or nonhappening of an event, and from the viewpoint of the management, it may be prudent to set apart a specified amount, but undoubtedly, the liability has not arisen till the happening or non-happening of the event." In view of the above, the claim of the assessee cannot be allowed on the principle of accounting. Lastly, even on facts, in my opinion, the claim of the assessee is pre-mature. According to the guarantee clause, the assessee is liable to remove defects notified by the customer within a period of 12 months from the date of commissioning or 24 months from the date of despatch whichever is earlier. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ddition of Rs. 31,51,000 on account of warranty provision made in the accounts. The facts and arguments of both sides are identical to those discussed by us in I.T.A No. 157/Pune/1995 for the earlier assessment year, i.e., 1990-91. As such the decision given by us in the aforesaid order will apply mutatis mutandis to the facts of the present case. For the reasons discussed therein we hold that there is no justification for the impugned addition of Rs. 31,51,000 on account of provision made in respect of warranty in the accounts. The same is accordingly deleted. This ground accordingly succeeds. Ground No. 3 raised by the assessee reads as under : "The learned Commissioner of Income-tax (Appeals) erred, while working out the disallowance under section 37(2A), in restricting the company's claim for deduction on account of participation of the company's officials in the business lunches extended to the customers in the normal course of the company's business to 20 per cent. of such expenditure of Rs. 1,41,138 against the claim of the appellant at 50 per cent. based upon the fact that in the company's business of selling sophisticated capital goods evolved with the state of the art t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d facts in issue. The deduction under section 32A is admissible in respect of machinery or plant acquired or installed or put to use in the previous year. In the instant case, the plant and machinery including computers had been put to use in the assessment year 1989-90 and 1990-91 and as such cannot be considered for deduction in the assessment year 1991-92. The mere fact that the assessee could not claim deduction due to losses in the earlier years does not mean that it is eligible for such claim in later years. There is no material to show that computers or other plant and machinery for which disallowance is made had been installed or put to use in the previous year relevant to assessment year 1991-92 or in the immediately succeeding year. Considering these facts, the disallowance of Rs. 3,60,096 is confirmed." Shri B. K. Khare, learned counsel submitted that in the return of income, the assessee had sought deduction of investment allowance of Rs. 3,60,096 under section 32A of the Act as per the details given on para. 9 of the paper book. The investment allowance reserve of Rs. 2,71,000 was created in the accounts of the previous year relevant to the assessment year 1991-92. He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... option to create such reserve in the year the deduction is to be allowed under sub-section (3) of section 32A or in any earlier year not being earlier to the year in which the the machinery is installed or put to use. [Section 32A(4)(ii)]. Learned counsel further submitted that the assessee has no right of first appeal under section 246 if the claim for investment allowance is rejected where such claim is outside the scope of total income assessed. There is no specific clause under section 246 conferring right of appeal in such a case unless the allowance affects the amount of income assessable [sec. 246(1)(a)]. Unlike section 157 providing for intimation of loss there is no procedure for intimating to the assessee the investment allowance to be carried forward for set off. It is therefore, in effect submitted that the assessee is compulsively called upon in asserting his right to deduction under section 32A only in the year in which the total income is sufficient to contain and absorb the allowance. In support of his contention, learned counsel relied upon the following decisions : (1) CIT v. Dalmia Cement (Bharat) Ltd. [1995] 216 ITR 79 (SC) ; (2) CIT v. Arjun Prasad [1991] 190 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... installed in earlier years as can be seen from the annexure. Therefore, the primary condition for the claim of the investment allowance has not been fulfilled by the assessee. The learned Departmental Representative relied upon the judgment of the Calcutta High Court in the case of CIT v. J. Thomas and Co. Pvt. Ltd. [1977] 110 ITR 566, wherein it has been held that for claiming any concession the assessee must strictly comply with the requirements of the section. According to the learned Departmental Representative the decision of the Patna High Court in the case of Arjun Prasad [1991] 190 ITR 179 relied upon by learned counsel for the assessee is distinguishable from the facts of the case. He submitted that in Arjun Prasad's case [1991] 190 ITR 179 (Patna) the assessee had made the claim in the relevant assessment year. The assessee fulfilled all the conditions including creation of statutory reserve. However, no valid assessment was completed since the return was filed beyond statutory limit. Hence, it was held by the Patna High Court that the assessee was entitled to deduction under section 33(2) since the assessee fulfilled all the conditions for becoming entitled to deduction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss account is finally drawn up. The Supreme Court has clearly held that this is a condition for securing the benefit of development rebate and if the condition is not satisfied, the deduction on account of development rebate cannot be claimed at all. (emphasis supplied). In the case of the assessee, it is an admitted fact that in the earlier two assessment years 1988-89 and 1989-90 when the machinery was first installed and put to use, neither any reserve was created nor claim for deduction of development rebate was made before the Assessing Officer on the ground that in those years, the assessee-company had suffered losses. The assessee did not make any book entries for creating a reserve fund. The finding of the Supreme Court on the issue is very clear and is reproduced as follows (page 196) : "That (creation of reserve) is a condition for securing the benefit of development rebate and if that condition is not satisfied, we fail to see how the deduction on account of development rebate can be claimed at all." The reliance placed by learned counsel on the judgment of the Supreme Court in the case of CIT v. Dalmia Cement (Bharat) Ltd. [1995] 216 ITR 79 is of no assistance because ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar (Judicial Member).-The following question has been referred to me under section 255(4) for decision : "Whether, on the facts and in the circumstances of the case as well as in law, the assessee is entitled to deduction in respect of the provisions made for warranty liability ?" The assessee is a public limited company and is engaged in the business of designing, engineering, fabrication, procurement and assembly, erection, installation and commissioning of ground boilers with the help of sophisticated technology for petrochemical, fertiliser, sugar and other industries. During the relevant years (assessment years 1990-91 and 1991-92), it made provisions for warranty in its accounts in the amounts of Rs. 11,64,000 and Rs. 31,51,000 respectively and claimed deduction in the assessments in respect of them. It was explained before the Assessing Officer that the assessee was under an obligation to replace defective components of the boilers during the warranty period and that the amounts provided represented the estimated liabilities in respect of the obligation. As per clause 1.11 of the guarantee, the assessee "shall guarantee the equipment for design, workmanship and material fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntions of the assessee. He held that the contract value would necessarily include the warranty costs, that such costs were properly estimated on the basis of the past experience, that the provisions made in the accounts were approved by AS-7 and standard textbooks on accountancy and that such practice was being followed by the assessee consistently in the following years. He further held that it is the principle of accountancy which is of vital importance and the fact that the assessee made a provision even before the delivery of the boiler was of no relevance. He, therefore, allowed the assessee's claim for both the years. The learned Judicial Member ("JM", for short) could not agree with the view proposed by the learned Accountant Member and would appear to have requested the latter to reconsider his proposed order in the light of the judgment of the Supreme Court in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585. The learned Accountant Member thereafter passed a sort of an appendix to his proposed order, wherein he gave reasons as to why he was unable to accede to the request of the learned Judicial Member. These are contained in paragraphs 36 to 44. In short, he reasoned th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 649. He held that the later judgment of the Supreme Court in Metal Box Co. of India Ltd. [1969] 73 ITR 53, on which reliance was placed by the learned Accountant Member, was contrary to the above two earlier judgments rendered by larger Benches and therefore cannot be applied to the present case. He further held that even assuming that the claim must be considered under section 28, still it was not allowable because according to him even under this section the liability must be an ascertained liability and not a contingent liability. According to him, in the present case, the warranty liability had not become an ascertained liability during the relevant years, that it was merely estimated at 2 per cent. of the billing amount, that even this estimate had no basis, that the claim that it was based on past experience was not established and therefore it was not an ascertained or properly evaluated liability. He further observed that the "very possibility that there may not be any defect in the boilers constructed by the assessee itself indicates that such liability is not ascertainable property" and therefore the case of the assessee cannot be brought under the principle laid down in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctive of other relevant principles or considerations under the income-tax law, is unacceptable. That would open the floodgates and even claims that are made on the basis of conservative accounting or commercial practices/policies or on grounds of accounting or commercial prudence, which have no grounding under the established principles of income-tax law, would become allowable, a consequence that can hardly be countenanced. In the present case, it is not disputed that the warranty period starts only when the boilers are delivered. The relevant clause in the contract has been quoted by the learned Judicial Member. It is only when the warranty period starts that the assessee becomes liable to replace or remove the defects and is under an obligation to do whatever has been agreed upon under clause 1.11 of the contract. There is also no dispute that during the relevant accounting years no boilers were delivered or commissioned by the assessee. This is supported by note 6 to the printed accounts, to which my attention was drawn on behalf of the Department. Thus, during the relevant accounting years, the liability under the warranty clause did not accrue at all. There was just a possib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew Metal Box Co. of India Ltd.'s case [1969] 73 ITR 53 (SC) is distinguishable not only because the quantum of the provision made has no established basis but because-and mainly because-the provision made by the assessee in the present case is not on the basis of any statute, as in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53 (SC), wherein the liability has already been fastened on the assessee and only the quantification thereof remained to be done ; but in the present case, the provision is based on a clause in the contract but the clause is yet to come into operation. Whereas in Metal Box Co. of India Ltd.'s case [1969] 73 ITR 53 (SC) it was case of a statutory liability arising under the Payment of Gratuity Act, 1972, in the present case it is a case of a contractual "liability", where the liability has not accrued to the assessee. It would be commonsense to expect that the assessee would resist, with all the resources it could muster, if any claim is made by its customers under the warranty clause during the years under appeal. The argument of the assessee, if confronted with such a claim, would certainly be that no boilers have been supplied and therefore the warr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oes not satisfy the conditions imposed by the income-tax law. The rule in Badridas Daga's case [1958] 34 ITR 10 (SC), cited by the learned Judicial Member in a slightly different context, is applicable to the present claim. According to the rule, it is necessary for the assessee to show that the claim arises out of the carrying on of the business and is incidental thereto and if that is established, the claim must be allowed "provided of course there is no prohibition against it, express or implied, in the Act". The first part of the rule is satisfied in the sense that the warranty liability is incidental to the carrying on of the business and arises out of the same. But the second part of the rule, viz., that there should be no prohibition against the claim, express or implied, under the Income-tax Act, is not satisfied since in my view, the very scheme of the Act prohibits the allowance of a contingent liability as a deduction in computing the profits of the business. I also accept the contention of the Department that even the decision of the Bombay High Court in the case of Tata Iron and Steel Co. Ltd. v. D. V. Bapat, ITO [1975] 101 ITR 292 does not lay down the proposition th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nto account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account . . ." These observations were heavily relied upon by the assessee before me. But, in my view, these observations have to be understood in the context in which they were made. The assessee in that case had claimed to deduct its liability under two gratuity schemes while arriving at the profits for the purpose of the Payment of Bonus Act. There was an actuarial valuation. It was in this context that the observations relied on by the assessee were made by the Supreme Court. Even from these observations, it would be clear that the liability should be "properly ascertainable" and that the contingent liabilities should be "sufficiently certain" so as to be capable of valuation. In the present case, the liability is neither properly ascertainable nor is it sufficiently certain. It is entirely in the realm of contingency. As the learned Members have found and as is not also disputed by the assessee, no boilers have been delivered or commissioned during the relevant accounting years and therefore there is no material with r ..... X X X X Extracts X X X X X X X X Extracts X X X X
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