TaxTMI 
TaxTMI 
2024 (6) TMI 153
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....e order of the Income Tax Appellate Tribunal [ITAT] dated 10 May 2023 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 "unset....
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....asis of actual communication received from the policy holders, it can by no stretch of imagination be considered 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 g....
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....y the Ld CITA before us. Hence, we find no infirmity in the order of the Ld. CITA in this regard and accordingly dismiss the Ground No. l raised by the revenue." 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 i....
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....iples and methods detailed in clause 4 below (b) The IBNR shall be estimated using appropriate actuarial principles and shall be certified by the Appointed Actuary. (c) The Appointed Actuary shall estimate IBNR on both net of reinsurance and 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 method....
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.... the aforesaid matter, the Supreme Court was concerned with whether a standard warranty which had been provided by the assessee in respect of claims likely to arise could be construed to be a contingent liability and thus not allowable as a deduction under Section 37. 12. While expounding upon the concept of a provision being made in the books of 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 o....
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....t, all three conditions for recognition of a provision are satisfied in this case." 13. As is evident from the principles enunciated above, the Supreme Court explained the concept of provisioning for liabilities as being based upon a present obligation which may come to be owed by an enterprise as a result of a past event and the probability of an outflow of resources that may be required to settle that 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) ....
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....the 1961 Act. This has been reiterated in Shree Sajjan Mills [(1985) 4 SCC 590 : 1986 SCC (Tax) 82 : (1985) 156 ITR 585]. The position got altered only after 1-4-1973. Before that date, provision made in the profit and loss account for the estimated present value of the contingent liability properly ascertained and discounted on an accrued basis could be deducted either under Section 28 or Section 37 of the 1961 Act. This has been 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 judgm....
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....med by the judgment of the Supreme Court in Shree Sajjan Mills [(1985) 4 SCC 590 : 1986 SCC (Tax) 82 : (1985) 156 ITR 585] up to 1-4-1973." 14. What follows from the above is the right of an enterprise to make provisions for a liability which could be measured by and as the Supreme Court described a "substantial degree of estimation". It was thus held that as long as a liability is properly ascertainable on the basis of empirical data or a known methodology, 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 ....
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....r, the High Court has failed to notice the "reversal" which constituted part of the data systematically maintained by the assessee over last decade." 16. A lucid explanation of the concept of contingent liabilities is then found in The Commissioner of Income Tax vs. Whirpool of India Ltd. Neutral Citation: 2011 DHC:394-DB. In the facts of that case, this Court found that the assessee there had been consistently making provisions on the basis of actuarial valuation in respect of machines sold and 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....
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....to the facts of the case at hand we are satisfied that the provision made by the appellant-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. 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....
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.... that:- (a) It should be based on historical trend and for determining a proper historical trend, the company should have proper accounting system for capturing of sales, warranty provisions made and the actual expenses incurred subsequently. (b) 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 based on past experience. (c) The warranty provision for the product should be based on estimate at year end of future warranty expense. 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....