2002 (7) TMI 220 - AT - Income Tax

Warranty provision in product sales and cost allocation for 80-IA/80HHE/80-O deductions; major tax deductions allowed, some disallowances upheld.

Provision for warranty was held to be an accrued and certain liability embedded in sale price; only quantification was estimated on past experience, so it ... Deduction of provision for warranty and office expenses - towards provision for warranty expenses in its profit and loss account - Disallowance under r. 6D in respect of travelling expenses - Deduction under s. 80-IA - Levy of interest under s. 234B - Deduction under s. 80-IA - Payments made to IGE - HELD THAT:- In our view, the warranty liabilities are inbuilt in the sale price since all sales are with warranty liabilities. The liability towards warranty liabilities is certain and has accrued on the date of sale and only the ascertainment could be said to be contingent which the assessee has estimated based on its past experience and in our opinion, the claims made by the assessee in this regard are most reasonable and are supported by some plausible material. In our view, the Department is not justified in treating the liability as contingent. Following the principle laid down by several decisions of the Tribunal including that of the apex Court in [1968 (8) TMI 53 - SUPREME COURT], we hold that the claim of the assessee is in order and should be accepted. The AO shall ensure that the assessee shall not claim the deduction again based on the expenditure in respect of warranty and after sales in the books of account maintained. With these observations, the assessee's ground on this issue is to be treated as allowed. Disallowance under r. 6D in respect of travelling expenses - The claim of the assessee before us is that the working of disallowance under r. 6D would involve substantial time and processing of the back records and it is very difficult to provide per trip details in every case. This only shows that the assessee prays for ad-hoc disallowance on per trip basis. The assessee has provided some of these details in pages 47 to 51 of the paper book. The assessee has himself substantially worked out a disallowance take care of the plausible omissions and commissions. We direct the disallowance to be maintained at a sum. The Rules providing for enhanced limits have been made specifically effective from asst. yr. 1993-94 and subsequent years meaning thereby that the claim of the assessee for total collection of the disallowance is not tenable for the year under consideration. Deduction under s. 80-IA - The direct expenses and depreciation in respect of manufacturing activity, royalty, amortisation and technical knowhow fees on the basis of treating them as direct cost of the respective units based on these services directly used by these units. In other words, in our opinion, there is no need for allocation of any expenses when the expenses are directly connected with period. What is required is the allocation of common expenses or indirect expenses which the assessee has shown the allocation at p. 20. The salaries wages, bonus and commission have been allocated. For e.g., the assessee adopted wages as the basis for allocating salaries, wages, bonus, commission, contribution to PF, gratuity, bonus, staff welfare, recruitment training expenses etc. In our view, wages is the proper base for allocating the indirect expenses of manufacturing. Similarly, transportation, insurance, repairs and maintenance of the building, advertisement and sales promotion and such other expenses have been apportioned on the basis of sales which in our opinion, is perfectly in order. This very basis adopted by the assessee in the asst. yr. 1995-96 has not been questioned in the asst. yrs. 1996-97 and 1997-98. We, therefore, direct the AO to accept the assessee's working in relation to the deduction under s. 80-IA of the Act. Levy of interest under s. 234B - The assessment for the asst. yrs. 1993-94 was completed only on 25th March, 1996, by which date the interest was withdrawn. So the assessee should offer to tax in that assessment year, but has requested the AO to reduce the income to that extent in view of the subsequent development of the Departmental action in withdrawing the deduction. The AO was therefore, not right in ignoring the claim of the assessee. We, therefore, direct the AO to allow the deduction as claimed by the assessee for the asst. yr. 1993-94 itself. The CIT(A) in para 15 of his order has given a direction to consider it as deduction for the asst. yr.1995-96. In view of the fact that we have accepted the assessee's claim for asst. yr. 1993-94, this direction of the CIT(A) for asst. yr. 1995-96 need not be followed by the AO. Compensation payment - benefit of an enduring nature - In our opinion, this payment is part of regular business expenditure incurred by the assessee for the purpose of its business. The payment paid by the assessee is just like recruitment cost. The cost of recruiting the rest of the employees was necessary for the purpose of business. We, therefore, consider the compensation payment as revenue expenditure. As regards the payment made towards access to information base and for transition of customer order filing, this payment again, is for business consideration and we do not agree with the CIT(A) that the amount was paid for obtaining information useful for a long period and that the same could be treated as plant. There is no question of acquisition of any asset when the assessee made the payments and acquire the information about the customer base. That will help the assessee to carry on its business very efficiently and in a more profitable manner. The payment, in our view, is, therefore, a proper business expenditure allowable as deduction. Payments made to IGE - Bombay Bench of the Tribunal in the case of Voltas Ltd. vs. Dy. CIT [1998 (1) TMI 514 - ITAT MUMBAI], while dealing with the recipients case of IGE, has held 50 per cent to be treated as capital and the balance of 50 per cent to be treated as revenue in nature. Following the same reasoning and keeping in view the principles laid down in the case laws relied upon by the learned counsel for the assessee, which are more elaborately discussed in the order of the Tribunal, we direct the AO to allow 50 per cent of the said payment to IGE as part of the revenue expenses and the balance of 50 per cent has to be created as capital in nature. Deduction under s. 80HHE of the Act - The total turnover for the purpose of s. 80HHE can only mean the total turnover of the computer software both in India and outside India. Under the scheme of the said section, it is not correct to include any other turnover not connected with the computer software business. We are, therefore, of the opinion, that the denominator adopted by the Department is wrong and is not in accordance with the scheme of deductions under s. 80HHE of the Act. If we approve the calculation of the Department, the very object of intending and giving deduction under s. 80HHE is likely to be defeated if the assessee is having other turnover not connected with the computer software. The total turnover under s. 80HHE can only mean the turnover of the software business alone and the same should not be treated as to include the turnover of the company totally unconnected with the business of computer software. When the numerator speaks of turnover of software business alone, the denominator should also be of similar nature, i.e., the turnover of the company from the business of computer software. In other words, the computer software business should be treated as an independent unit for the purpose of computing deduction under s. 80HHE of the Act. If the Department's computation is accepted, it would only result in manifest anomalies and arbitrariness. Therefore, in our view, for the purpose of deduction contemplated by s. 80HHE, the total turnover for the said section should not include turnover on account of manufacturing, trading etc. which is totally unconnected with the public software business. Therefore, in our considered view, the total turnover, for the purpose of s. 80HHE consists of turnover from computer software business and providing of technical services. Accordingly, we direct computation of deduction under s. 80HHE on the total turnover of the assessee which, in accordance with the view we have expressed, should be the basis as a denominator. Sundry income from the profit - What s. 80AB requires is that for the purpose of computing deduction under s. 80-O the amount of income of that nature computed in accordance with the provisions of the Act shall alone be deemed to be the amount of income of that nature which is derived or received by the assessee. Thus, in our opinion, only the direct expenses incurred by the assessee in earning the income of the nature referred to in s. 80-O is required to be deducted. There is no scope for reducing the income by estimating certain expenses as would have been incurred for earning such income. We, therefore, hold that the direct expenses alone are required to be reduced from the gross receipts stated to be amount realized in convertible foreign exchange and, on the balance amounts, the amount is eligible for deduction at 50 per cent of such income. No estimated expenditure relatable to off shore revenue is to be deducted from such receipts for computation of deduction under s. 80-O. The AO is directed accordingly. In the result, all the appeals are to be treated as partly allowed. Issues: (i) Whether provision for warranty and office expenses is allowable as revenue deduction; (ii) Whether travelling expenses disallowance under r.6D was correctly determined; (iii) Whether deduction under s.80-IA for 1995-96 as computed by assessee is allowable; (iv) Characterisation of payments to IGE/FIL (capital or revenue) for years 1991-92 to 1994-95; (v) Computation of deduction under s.80HHE for 1997-98 (treatment of denominator and profits); (vi) Whether deduction under s.80-O for 1991-92 to 1996-97 should be computed on receipts less only direct expenses and validity of CIT(A) enhancement proceedings; (vii) Consequential interest and other incidental adjustments.Issue (i): Allowability of provision for warranty and office expenses as deduction.Analysis: Accounting practice showed scientifically estimated provisions based on past experience and neutralisation by actual debits in subsequent years; Tribunal and precedents accept that where liability accrues on date of sale and only quantum is estimated, such provision under mercantile accounting is allowable as trading expense.Conclusion: In favour of Assessee.Issue (ii): Correctness of travelling expenses disallowance under Rule 6D for 1992-93.Analysis: Rule 6D requires per-trip computation; assessee had already computed an ad hoc disallowance and provided some trip details; amendment increasing per diem limit applied from assessment year 1993-94 and not applicable to year under consideration.Conclusion: Partly against Assessee; disallowance maintained at Rs. 1,50,000.Issue (iii): Validity of deduction under Section 80-IA for 1995-96 as computed by assessee.Analysis: Materials consumed and direct expenses were allocated directly to eligible units; indirect/common expenses were apportioned on proper bases (wages for personnel costs, sales for certain expenses); same method accepted in subsequent years.Conclusion: In favour of Assessee; AO directed to accept assessee's working.Issue (iv): Nature of payments to IGE/FIL (including amounts for access to information, transition assistance and voluntary retirement contribution) revenue or capital.Analysis: Tripartite agreement payments considered in commercial context; certain payments (compensation towards voluntary retirement and transition assistance) treated as revenue where they represented recruitment/operational expenses and did not create enduring asset; following recipient-bench treatment and precedents, part of larger payment apportioned between revenue and capital.Conclusion: Mixed 50% of payments to IGE to be allowed as revenue expense (in favour of Assessee) and remaining 50% to be treated as capital (against Assessee on that portion); payment of Rs. 28.8 lakhs for transition assistance treated as revenue (in favour of Assessee); Rs. 22.5 lakhs contribution for voluntary retirement treated as revenue (in favour of Assessee).Issue (v): Computation of deduction under Section 80HHE for 1997-98 scope of 'total turnover' and treatment of sundry income.Analysis: Section 80HHE pertains to profits from computer software business; denominator 'total turnover' must be limited to turnover of software business (domestic and export) and exclude turnovers unconnected with software; sundry income from other activities should not be excluded from software profits if not connected.Conclusion: In favour of Assessee; AO directed to compute deduction using software business turnover and profits as per assessee's figures.Issue (vi): Computation of deduction under Section 80-O and procedural validity of CIT(A) enhancement.Analysis: Section 80-O deduction computed with reference to income of that nature; Tribunal precedent supports allowing deduction on receipts after reducing only direct expenses incurred abroad in earning such income; CIT(A) issued preliminary letters seeking details and proposed recomputation, but merits favour the assessee on the proper method of computation.Conclusion: In favour of Assessee; deduction under s.80-O to be computed after reducing only direct expenses incurred to earn the specified receipts. Procedural irregularity in CIT(A) noted but not decided against the revenue since assessee succeeds on merits.Issue (vii): Consequential interest and incidental adjustments (s.234B, s.244A, s.115JA).Analysis: Interest consequences are directed to follow the substantive reliefs granted; where amounts were withdrawn/allowed, corresponding deductions/adjustments to be made in the appropriate assessment year; computation under s.115JA to be done after giving effect to this order with opportunity of hearing.Conclusion: Consequential adjustments to be given effect as directed (in favour of Assessee as to adjustments ordered).Final Conclusion: The appeals are partly allowed; specified substantive issues are allowed in favour of the assessee while certain disallowances are sustained or apportioned as directed, and consequential interest and assessment computations are to follow the substantive rulings.Ratio Decidendi: Where a liability in respect of warranties or similar obligations accrues on the date of sale and the amount is estimated on a consistent, experience-based mercantile accounting method that neutralises actual outgoings over time, such provision constitutes an allowable revenue deduction; for statutory export-related deductions (s.80HHE, s.80-O) the relevant denominator and income must be confined to the turnover and profits of the specific business activity to which the provision relates.