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TMI Blog2024 (6) TMI 153X X X X Extracts X X X X X X X X Extracts X X X X ..... ported (IBNR) Claims Reserve - The computation of profits of general insurance business is undisputedly regulated by the provisions made in the First Schedule of the Act and which requires an entity engaged in the business of insurance to compute its profits and gains from business as per its profit and loss account prepared in accordance with the Insurance Act, 1938, the rules framed under the said enactment or the Insurance Regulatory and Development Authority Act, 1999 and the rules and regulations framed by the IRDA. We find that the provisioning for IBNR is based upon the Insurance Regulatory and Development Authority of India (Assets, Liabilities and Solvency Margin of General Insurance Business) Regulations, 2016 [Regulations]. The determination of amount of liabilities of a general insurer is regulated by Regulation 5 and which requires a general insurer to prepare a statement of liabilities in accordance with Schedule II of those Regulations. A lucid explanation of the concept of contingent liabilities is then found in Whirpool of India Ltd. [ 2011 (1) TMI 657 - DELHI HIGH COURT ] In the facts of that case, this Court found that the assessee there had been consistently mak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd the assessee was already allowed special provision in terms of rule 6E of the IT Act. C) The appellant craves leave to add, alter or amend any substantial question of law raised above at the time of the hearing. 2. Upon hearing, Mr. Meharchandani, learned counsel for the appellant and Mr. Vohra, learned senior counsel who appeared for the respondents, we find that the principal questions which arise pertain to the provisions made for unsettled outstanding claims and the Incurred But Not Reported [IBNR] claims. For the years in question, the Assessing Officer [AO] had held that both the provision for unsettled claims as well as IBNR would amount to contingent liabilities and thus could not be validly claimed under Section 37 of the Income Tax Act, 1961 [ACt]. 3. Insofar as outstanding or unsettled claims are concerned, the Tribunal took note of the contention of the respondent-assessee that the provision for unsettled claims cannot be viewed as being ad hoc or an estimate since they record all outstanding claims to the extent lodged by policy holders. It is on the basis of the claims so lodged that the respondent appears to have made appropriate provisions in its books of account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allowed in favour of the appellant. 12. Upon due consideration, we find that AO has erred in holding provision for unsettled claims as contingent liability. In the light of assessee's submissions noted above and case laws submitted, we find that ld. CIT (A) has passed correct order which does not need any interference from us. The liability in this regard is duly ascertained. Hence, this ground raised by the Revenue is dismissed. 5. In our considered opinion, the Tribunal was clearly justified in taking into consideration the indubitable fact of the distinction that must be borne in mind between the incurrence of a liability and its ultimate quantification. Before us it was not disputed by the appellant that the provision was made by the respondent-assessee on the basis of customer wise details of claims lodged. Merely because those claims ultimately came to be adjudicated subsequently would have no bearing on a provision being validly made. 6. Insofar as the question of IBNR is concerned, the Tribunal has essentially followed the view taken by its Kolkata Bench in Deputy Commissioner of Income Tax vs. National Insurance Co. Ltd. IT APPEAL NOS. 674, 982 983 (KOL.) OF 2012. Dea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w from Kolkata Bench of ITAT duly holds that these are ascertained liabilities. Hence, we uphold the order of ld. CIT (A). 7. The computation of profits of general insurance business is undisputedly regulated by the provisions made in the First Schedule of the Act and which requires an entity engaged in the business of insurance to compute its profits and gains from business as per its profit and loss account prepared in accordance with the Insurance Act, 1938, the rules framed under the said enactment or the Insurance Regulatory and Development Authority Act, 1999 and the rules and regulations framed by the IRDA. We find that the provisioning for IBNR is based upon the Insurance Regulatory and Development Authority of India (Assets, Liabilities and Solvency Margin of General Insurance Business) Regulations, 2016 [Regulations]. 8. The determination of amount of liabilities of a general insurer is regulated by Regulation 5 and which requires a general insurer to prepare a statement of liabilities in accordance with Schedule II of those Regulations. The subject of claims reserve is regulated by Clause 3 of Schedule II of the Regulation which reads as follows:- 3. CLAIMS RESERVE (1) T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appropriate actuarial principles. IBNR itself is to be estimated on the basis of a study undertaken by an appointed actuary. Clause 4 then prescribes the various actuarial methods that may be used for the estimation of IBNR reserves. The said Clause reads as follows:- 4. ACTUARIAL METHODS (1) The following Standard Actuarial Methods may be used for the estimation of IBNR reserves: (a) Basic Chain Ladder Method (both on incurred and paid claims) (b) Bornhuetter Ferguson Method (both on incurred and paid claims) (c) Frequency Severity Method (2) The Appointed Actuary shall use more than one method to arrive at an estimate that s/he believes is adequate to meet the future liabilities. (3) Appointed Actuary may use methods other than standard actuarial methods of IBNR estimation. (4) In his/her annual report submission to the Regulator, Appointed Actuary should provide an explanation of the rationale underlying the selection of a particular method over the other available methods along with the advantages and disadvantages of doing so. (5) Where the results of different methods or assumptions differ significantly, an Appointed Actuary must comment on the likely reasons for the differe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that is recognised as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole. 24. In this connection, it may be noted that in the case of a manufacture and sale of one single item the provision for warranty could constitute a contingent liability not entitled to deduction under Section 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... : (1985) 156 ITR 585]. That was the case of gratuity. For Assessment Year 1974-1975 the assessee Company sought to deduct a sum of Rs 18,37,727 towards the amount of gratuity payable to its employees and worked out actuarially. No provision was made for Rs 18,37,727. The claim for deduction was made on the ground that the liability stood ascertained by actuarial valuation and, therefore, was deductible under Section 37 of the 1961 Act. The Income Tax Officer allowed the deduction only in respect of the amounts actually paid by the assessee and the rest was disallowed on the ground of noncompliance with the provisions of Section 40-A(7) of the 1961 Act. This view of ITO was affirmed by CIT(A). 36. The Tribunal in Shree Sajjan Mills [(1985) 4 SCC 590 : 1986 SCC (Tax) 82 : (1985) 156 ITR 585] held that for the earlier assessment year relating to 1973-1974, actuarially ascertained liability for gratuity arising under the Payment of Gratuity Act, 1972 was an allowable deduction. However, for the assessment year in question, the Tribunal held that the increased liability claimed by the assessee for deduction was allowable on general principles of accounting. This view was taken by the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d above, the principle of estimation of the contingent liability is not the normal rule. As stated above, it would depend on the nature of business, the nature of sales, the nature of the product manufactured and sold and the scientific method of accounting being adopted by the assessee. It will also depend upon the historical trend. It would also depend upon the number of articles produced. As stated above, if it is a case of single item being produced then the principle of estimation of contingent liability on pro rata basis may not apply. 41. However, in the present case, it is not so. In the present case, we have the situation of large number of items being produced. They are sophisticated goods. They are supported by the historical trend, namely, defects being detected in some of the items. The data also indicates that the warranty cost(s) is embedded in the sale price. The data also indicates that the warranty is attached to the sale price. In the circumstances, we hold that the principle laid down by this Court in Metal Box Co. of India [AIR 1969 SC 612 : (1969) 73 ITR 53] will apply. 42. In Metal Box Co. of India case [AIR 1969 SC 612 : (1969) 73 ITR 53] this Court held tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f India [AIR 1969 SC 612 : (1969) 73 ITR 53] pertained to an army of employees who were due to retire in future. 48. In Metal Box Co. of India case [AIR 1969 SC 612 : (1969) 73 ITR 53] the company had estimated its liability under two gratuity schemes and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out its estimated liability on actuarial valuation. It had made provision for such liability spread over to a number of years. In such a case it was held by this Court that the provision made by the assessee Company for meeting the liability incurred by it under the gratuity scheme would be entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. 49. The same principle is laid down in the judgment of this Court in Bharat Earth Movers [(2000) 6 SCC 645 : (2000) 245 ITR 428]. In that case the assessee Company had formulated leave encashment scheme. It was held, following the judgment in Metal Box Co. of India [AIR 1969 SC 612 : (1969) 73 ITR 53], that the provision made by the assessee for meeting the liability incurred under leave encashment scheme p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... im holding that the liability was definite and certain quantification was done on estimate basis after taking into consideration the data for past years of the percentage of warranty expenses. The High Court affirmed the decision of the Tribunal holding that the warranty clause was a part of the sale document and imposed a liability upon the assessee to discharge its obligation under that clause for the period of warranty. It was a liability, which was capable of being construed in definite terms, which had arisen in the accounting year, although its actual quantification and discharge might be deferred to a future date. Once the assessee is maintaining his accounts on the mercantile system, a liability accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. In forming the aforesaid view, the Court applied the test laid down in Bharat Earth Movers, Vs. CIT, 245 ITR 428 and analyzed the said judgment and another judgment of Privy Council in the following terms:- In our opinion, the judgment of the Supreme Court in Bharat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ppearing and being notified to the dealer within the warranty period so that no liability was incurred by the taxpayer until those conditions were satisfied, regard could be had to its estimation of warranty claims based on statistical information, which showed that as a matter of existing fact not future contingency 63 per cent. of all vehicles sold by the taxpayer contained defects likely to be manifested within the warranty period and require work under warranty; that since theoretical contingencies could be disregarded, the taxpayer was in the year of sale under an accrued legal obligation to make payments under those warranties and even though it might not be required to do so until the following year, it was definitively committed in the year of sale to that expenditure; and that, accordingly, in computing the profits or gains derived by the taxpayer from its business in the year in which the vehicles were sold, the taxpayer was entitled under section 104 to deduct from its total income the provision which it had made for the costs of its anticipated liabilities under outstanding warranties in respect of vehicles sold in that year. The ratio decidendi of the above cases is sq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e warranty provision for the products should be based on the estimate at year end of future warranty expenses. Such estimates need reassessment every year. 18. Apart from other things, the Court highlighted that provision for warranty on turnover of the company based on past experience fulfills accrual concept as well the matching concept. The Court not only laid stress on the past experience based on historical trend of warranty provisions, it was also emphasized that this provided estimates under the assessment every year. 19. We may also point out at this stage itself that the Supreme Court distinguished the judgments in Sajjan Mills (supra) as well as Indian Molasses Co. (supra). We would also like to refer to the judgment of the Supreme Court in CIT Vs. Woodward Governor India P. Ltd. 312 ITR 254 wherein it was held that the accounting method followed by the assessee continuously for a given period of time has to be presumed to be correct till the AO comes to the conclusion for the reasons to be given that the estimate does not reflect to be true and correct profits . 19. Upon due consideration of the principles enunciated in the aforenoted decisions, we come to the firm concl ..... X X X X Extracts X X X X X X X X Extracts X X X X
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