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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 ..... and poses the following questions for our consideration:- "A) Whether on the facts and circumstances of the case and in law, the Hon'ble ITAT has erred in deleting the disallowance of provision for unsettled claims outstanding as on March 31st ignoring that the amount is shown as a provision in books of account of the assessee and can be allowed in the year when it is materialised and not in the year under consideration. B) Whether on the facts and circumstances of the case and law, the Hon'ble ITAT erred in deleting the disallowance on account of the provision for unlogged claim ignoring that this provision was purely on ad-hoc basis and 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 q ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be ad-hoc in nature as alleged by the Ld. AO. The appellant has submitted that incurrence of liability and its quantification are two separate aspects and merely because some claims are rejected subsequently being fraudulent/ erroneous in nature, the same cannot be considered to be an ad-hoc provision against contingent liability resulting in disallowance of the said liability. The principle enunciated in the case of Kerela Transport Company vs Assistant Commissioner of Income Tax [1994] 50 TTJ 435 supra squarely applies to the facts on hand, In the light of above, I do not find any merit in the addition made by the AO in this case. Accordingly, ground no 3 is 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 co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e." Thus, as said provision has been created by it to meet ascertained liabilities, the Company is entitled to claim a deduction of the same while computing its income under the head 'profits & gains from business and profession'. Therefore, respectfully following the decision of the Hon'ble ITAT in the case of National Insurance above, I do not find any merit in the addition made by the AO in this case. Hence, this ground of appeal is allowed." 14. We have heard both the parties and perused the records. In the light of the assessee's submissions herein above, we find that ld. CIT (A) has taken correct decision, which does not need any interference on our part. The case law 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 sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gross of reinsurance basis. (d) The Appointed Actuary shall estimate the provision for IBNR for each year of occurrence and the figures shall be aggregated to arrive at the total amount to be provided. (e) If estimate of IBNR provision for any year of occurrence is negative, the Appointed Actuary shall reexamine the underlying assumptions. Even after re-examination, if the mathematics produces negative value, the Appointed Actuary shall ignore the IBNR provision for that year of occurrence. (f) The estimation process shall not discount the estimated future development of paid claims to the current date." 9. While dealing with IBNR claims reserve, Clause 3(3) of Schedule II provides that IBNR would be estimated by usage of 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f account, the Supreme Court pertinently observed as follows:- "22. What is a provision? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognised when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognised. 23. Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. 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 prese ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat obligation. One of the crucial aspects which was highlighted in this regard was of the enterprise being entitled to make a reliable estimate and whether such an estimation could be made of the amount that may be ultimately owed on account of the obligation. Apart from obligations flowing from past events, the Supreme Court also recognized the concept of historical trends and those justifying the making of an appropriate provision. Historical trend was acknowledged to be a study of defects detected over a period of time and the data collated in respect thereof. The concept of historical trends was explained as under:- "35. In the present case, the High Court has principally gone by the judgment of the Supreme Court in Shree Sajjan Mills [(1985) 4 SCC 590 : 1986 SCC (Tax) 82 : (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 unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... explained in Shree Sajjan Mills [(1985) 4 SCC 590 : 1986 SCC (Tax) 82 : (1985) 156 ITR 585] at p. 599. 39. Section 40-A(7) deals only with the case of gratuity. Even in the case of gratuity but for insertion of Section 40-A(7), provision made in the profit and loss account on the basis of present value of the contingent liability properly ascertained and discounted on an accrued basis was entitled to deduction either under Section 28 or under Section 37 of the said Act. This aspect, therefore, indicates that the present value of the contingent liability like the warranty expense, if properly ascertained and discounted on accrued basis, could be an item of deduction under Section 37 of the said Act. This aspect is not noticed in the impugned judgment. 40. We may add a caveat. As stated 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 sta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , the same cannot possibly be held to be a contingent liability. 15. The Supreme Court ultimately in Rotork Controls held as follows:- "47. At this stage, we once again reiterate that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate is possible of the amount of obligation. As stated above, Indian Molasses Co. [AIR 1959 SC 1049 : (1959) 37 ITR 66] is different from the present case. As stated above, in the present case we are concerned with an army of items of sophisticated (specialised) goods manufactured and sold by the assessee whereas Indian Molasses Co. [AIR 1959 SC 1049 : (1959) 37 ITR 66] was restricted to an individual retiree. On the other hand, Metal Box Co. of 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 estimate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... warranty claims lodged. Both the AO as well as the CIT(A) in that case had taken the view that claims pertaining to unexpired periods of warranty could be considered only when actual claims may arise and that the assessee would not be justified in estimating a warranty liability. 17. While dealing with this aspect, the Court observed:- "14. We may take note of a decision of this Court in CIT Vs. Vinitec Corporation (P) Ltd. 278 ITR 337 which is referred by the Tribunal also. In that case the assessee had claimed deduction under Section 37 of the Act, inter alia, on the provision made by it in the year against future claims by customers under the warranty clause which was part of the sale. The AO disallowed the claim on the ground that it was a contingent liability. The Tribunal, however, accepted the assessee's claim 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The High Court was not right in taking the view to the contrary. The appeal is allowed. The judgment under appeal is set aside. The question referred by the Tribunal to the High Court is answered in the affirmative, i.e. in favor of the assessed and against the Revenue." It will be useful for us to make a reference to the judgment of the Privy Council in the case of Commissioner of Inland Revenue (supra) where the Privy Council dealing with a taxpayer who was selling new motor vehicles to the dealers to indemnify them against warranty claims which, in turn, resulted in providing of warranty clause for 12 months from the date of delivery to the purchaser by the dealer, held as under :- "Held, dismissing the appeal, that, although the taxpayer's liability under the warranty for each vehicle sold was contingent on a defect appearing 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ense. This becomes clear from the following discussion in the said judgment:- "For determining an appropriate historical trend, it is important that the company has a proper accounting system for capturing relationship between the nature of the sales, the warranty provisions made and the actual expenses incurred against it subsequently. Thus, the decision on the warranty provision should be based on past experience of the company. A detailed assessment of the warranty provisioning policy is required particularly if the experience suggests that warranty provisions are generally reversed if they remained unutilized at the end of the period prescribed in the warranty. Therefore, the company should scrutinize the historical trend of warranty provisions made and the actual expenses incurred against it. On this basis a sensible estimate should be made. The 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 c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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