2009 (2) TMI 31 - HC - Income Tax

Deduction allowed for long service award provision; emergency spare parts treated as assets under Section 32 with full depreciation

HC allowed the assessee's deduction for a provision under a long service award scheme, finding the liability sufficiently certain and not merely ... Allowance of provision for “Long Service Award” payable by assessee to employees - business of manufacturing of spray dried silica in technical collaboration with a German company - Depreciation on Emergency/Insurance parts u/s 32 - words 'used for the purposes of the business' - applicability of the principles of accountancy - HELD THAT:- In our view, the issue raised by the Revenue before us that the liability under the 'long service award' scheme of the assessee is contingent as the payment under the same scheme is dependent on the discretion of the management is a submission which deserves to be rejected at the threshold. It is well settled that if a liability arises within the accounting period, the deduction should be allowed though it may be quantified and discharged at a future date. Therefore, the provision for a liability is amenable to a deduction if there is an element of certainty that it shall be incurred and it is possible to estimate the liability with reasonable certainty even though the actual quantification may not be possible as such a liability is not of a contingent nature. See Bharat Earth Movers [2000 (8) TMI 4 - SUPREME COURT]. The principles enunciated above have been applied by the Supreme Court also in the case of Metal Box Company [1968 (8) TMI 53 - SUPREME COURT], wherein the Supreme Court was considering the question whether estimated liability under gratuity schemes were amenable for deduction from gross receipts shown in the profit and loss account. Thus, we are of the opinion that the deduction claimed by the assessee had to be allowed. We find no fault with the reasoning of the Tribunal. No substantial question of law arises for our consideration. Depreciation on spare parts u/s 32 - HELD THAT:- It is not disputed that the assessee is maintaining the accounts based on a mercantile system. Under sub-section (1) of Section 145 of the Act the assessee‟s income which is chargeable under the head 'profits and gains of business or profession' is required to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. The assessee has been maintaining a mercantile system of accounting, therefore, the treatment of emergency spares in accordance with the revised Accounting Standard (AS) 2 and (AS) 10 would be in consonance with the mercantile system of accounting which under the Act the Revenue is required to look at for computing income of the assessee chargeable under the head 'profits and gains' from business. The submission of the learned counsel for the Revenue that the accounting treatment to be meted out to a transaction in accordance with the Accounting Standard has no relevance for the purposes of the Income Tax Act, 1961 is a submission which does not commend to us. We are of the considered opinion that the expression 'used for the purposes of business‟ appearing in Section 32 of the Act also takes into account emergency spares which even though ready for use are not as a matter of fact consumed or used during the relevant period, as these are spares specific to a fixed asset and will in all probability be useless once the asset is discarded. In that sense, the concept of passive user which is applied by the aforementioned cases to standby machinery will be applicable to emergency/insurance spares. In our opinion, the Assessing Officer misdirected himself in law by limiting the depreciation to the aforementioned amount. Similarly, the CIT(A) also erred in rejecting the claim of the assessee for capitalization of the cost of spares amounting to Rs 1,41,64,495/- by ignoring the crucial issue that it was not disputed by the Revenue that the spares in issue were 'emergency spares'. The only point in issue before the CIT(A) was whether depreciation could be allowed in respect of spares which had not been put to use. It is on account of this finding that the learned counsel has confined her submissions only to a limited issue as to whether depreciation under Section 32 could be allowed in respect of emergency spares on the basis of passive use. Once spares are considered as emergency spares required for plant and machinery as found by the Tribunal, the assessee was entitled to seek capitalization of the entire cost of spares amounting to Rs 1,41,64,495/- and claim depreciation thereon. Though as a matter of fact, in the instant case, there was not much of a difference between depreciation claimed by the assessee which amounted to Rs 35,41,123/-as against actual consumption of spares during the relevant period which amounted to Rs 31,76,187/-; nevertheless on principle, in our view, the assessee was right as found by the Tribunal in claiming depreciation on the entire capitalized cost of spares. In the result, the question of law framed by us is answered in favour of the assessee and against the Revenue. The appeals are dismissed. Issues Involved:1. Allowance of provision for 'Long Service Award' payable to employees.2. Depreciation on emergency/insurance spares.Issue-wise Detailed Analysis:1. Allowance of Provision for 'Long Service Award' Payable to Employees:Facts and Background:The assessee, engaged in manufacturing spray dried silica, had a scheme to award employees for long service. Employees completing 10, 15, and 20 years of service were eligible for awards equivalent to 2, 3, and 4 months' salary, respectively. The assessee made a provision of Rs 47,15,782/- based on actuarial calculations, considering factors like probable future withdrawals and salary increases.Assessing Officer's View:The Assessing Officer disallowed the provision, arguing it was at the discretion of the management and thus not an ascertained liability.CIT(A)'s Decision:The CIT(A) reversed the Assessing Officer's order, citing that under the mercantile system of accounting, provisions for liabilities, even if payable in the future, must be made. The CIT(A) referenced Supreme Court judgments in Shree Sajjan Mills Ltd vs CIT, Bharat Earth Movers Ltd vs CIT, and Metal Box Company of India Ltd vs Their Workmen, and CBDT Circular No. 47 dated 21.09.1970. The CIT(A) concluded that the provision was akin to gratuity and thus an ascertained liability.Tribunal's Decision:The Tribunal upheld the CIT(A)'s decision, agreeing that the provision for liability, if ascertained during the accounting period and payable in the future, is admissible under the mercantile system of accounting.High Court's Analysis:The High Court found no fault with the CIT(A) and Tribunal's reasoning. The court emphasized that a liability arising within the accounting period, even if quantified and discharged later, is deductible if it is certain and reasonably estimable. The court referenced the Supreme Court's decisions in Bharat Earth Movers and Metal Box Company, affirming that such provisions are not contingent liabilities.Conclusion:The High Court upheld the allowance of the provision for 'Long Service Award,' finding it to be an ascertained liability and deductible under the mercantile system of accounting.2. Depreciation on Emergency/Insurance Spares:Facts and Background:The assessee had capitalized emergency spares worth Rs 1,41,64,495/- and claimed depreciation of Rs 35,41,123/-. The change in accounting treatment was due to the revised Accounting Standard (AS) 2 by the ICAI, effective from 01.04.1999.Assessing Officer's View:The Assessing Officer allowed depreciation only on the cost of spares actually consumed (Rs 31,76,187/-), amounting to Rs 5,49,806/-, rejecting the claim for the entire capitalized amount on the grounds that the spares were not 'put to use.'CIT(A)'s Decision:The CIT(A) sustained the Assessing Officer's decision but allowed the alternative claim for deduction of the cost of spares consumed during the period.Tribunal's Decision:The Tribunal allowed the assessee's appeal, noting that the emergency spares were ready for use and referencing the Madras High Court's decision in CIT vs Southern Petrochemicals Industries Corporation Ltd, which allowed depreciation on critical spare parts kept as standby.High Court's Analysis:The High Court framed the question of law: 'Whether ITAT was correct in law in allowing depreciation of Rs 35,41,123/- to the assessee on spare parts u/s 32 of the Act as against Rs 5,49,806/- allowed by the Assessing Officer.' The court analyzed the revised Accounting Standards (AS) 2 and (AS) 10, which mandated capitalization of emergency spares. The court also referenced various judgments supporting the concept of 'passive user' for depreciation purposes, including CIT vs Viswanath Bhaskar Sathe, CIT vs Vayithri Plantations Ltd, and CIT vs Southern Petrochemical Industries Corporation Ltd.Conclusion:The High Court concluded that the entire cost of emergency spares should be capitalized and depreciated, as these spares, though not actively used, were ready for use and specific to fixed assets. The court upheld the Tribunal's decision, allowing depreciation on the entire capitalized amount of Rs 1,41,64,495/-.Final Judgment:The appeals were dismissed, and the High Court ruled in favor of the assessee on both issues, with no substantial question of law arising for consideration. No orders as to cost were made.