TaxTMI 
TaxTMI 
2011 (1) TMI 1608
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.... provision for warranty in the sum of Rs. 3,09,42,798 which was disallowed. (ii) The claim of royalty paid to the tune of Rs. 70.66 lacs which was disallowed by the AO under s. 40(a)(i) of the Act. 3. The assessee herein preferred appeal against the assessment order challenging all the additions including the aforesaid two additions made by the AO whereby certain other additions were deleted but both the aforesaid additions were confirmed. However, in respect of deduction for royalty payments, the CIT(A) allowed this deduction and deleted the addition made by the AO. Both the assessee as well as the Revenue approached the Tribunal against this order of CIT(A). Insofar as the assessee is concerned, in its appeal, both the aforesaid additions were challenged. The Tribunal has sustained the challenge thereby deleting these additions. This is how the Revenue is in appeal before us. 4. It is in this factual background that the present appeal was admitted on the following two substantial questions of law : "(a) Whether the Tribunal was correct in law in deleting the addition of Rs. 3,09,42,798 made by the AO on account of disallowance of provision for warranty cla....
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....entific method considering number of products sold under warranty provisions of Rs. 3.09 crores was made in the year in question. As per the assessee, the variation/shortfall in the warranty provision on account of different years has arisen due to various reasons like increase between the time of provision and the time of actual repair of the machines, the failure rate of machines, available power factor at the disposal of the customers, handling of products by the customers etc., all of which were beyond the control of the assessee but routine in the nature of appellant's business. Another justification given for making this provision was that the compressor division has been sold by the assessee during the previous year relevant to the asst. yr. 1998-99 resulting in the repair work of compressor under warranty being carried out from outside parties and, therefore, expenses on this account were expected to rise. The main reason for disallowing this additional warranty provision by the AO was that it was a contingent liability, ad hoc in nature and having no connection with the sale affected in the year in question. The CIT(A) had accepted this reasoning of the AO observing that t....
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....ction. The decision of Hon'ble Delhi High Court in the case of CIT v. Vinitec Corporation (P.) Ltd. (supra) relied upon by the learned Departmental Representative laid down that provision for future liability under warranty which is under the warranty clause of sale document is a current liability though actual quantification is deferred to the future date and though to be discharged at a future date. However, this will not help the case of the Revenue. In the present case, it is seen that the provision is made for additional liability on the basis of actuarial valuer appointed for the purpose. Thus the same cannot be disallowed by holding that either the liability pertained to the past years or that the liability will be discharged in the subsequent years. The liability has accrued during the year as the assessee carried on an exercise to evaluate its present liability as on the last day of the financial year and came to the conclusion that the provision was short to the extent claimed. We accordingly delete the disallowance of Rs. 3,09,42,798." 8. Whereas, Mr. Sahni, learned counsel for the Revenue challenged the line of action taken by the Tribunal and supported the view of t....
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.... paid was claimed as deduction from the profits. The Supreme Court held that such payment could not be treated as expenditure. Not only payment was contingent but even the liability itself was contingent as it would have accrued only in the eventuality Mr. Harvey attained the age of 55 years, had he died attaining the age of 55 years, the trustees were to receive the capital value of the deferred annuity policy. It is thus to be borne in mind that on the facts of that case the Court had found that there was no ascertained liability which was contingent on happening of certain event and even the payment made was merely contingent. Following discussion in the judgment would bring forward this aspect: "These cases may help to determine the nature of the contract with the insurance company but cannot help in the solving of the question whether the payments to the insurance company were expenditure. That insurance of human lives involves a contingency relating to the duration of human life is a very different proposition from the question whether the payment in the present case to the trustees was towards a contingent liability depending on a contingency. In our opinio....
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....titled to receive the payment during the year, the amount being a large one in one year and a small one in another year, the employer often finds it desirable and/or convenient to set apart for future use, a sum every year to meet the contingent liability as a provision for gratuity or a fund for gratuity. He might create an approved gratuity fund for the exclusive benefit of his employees under an irrevocable trust and make contributions to such fund every year. Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which was deductive for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure. [See in this connection, the observations of this Court in Indian Molasses Co. Ltd. v. CIT [1959] 37 ITR 66 (SC)]. A distinction is often made between an actual liability in praesenti and a liability de future, which for the time being is only contingent. The former is deductible but not the latter." 12. One has, however, to keep in mind that the assessee had claimed....
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....ng 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 v. CIT [2000] 162 CTR (SC) 325 : [2000] 245 ITR 428 (SC) 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 Earth Movers (supra) has a direct bearing on the issue in controversy before us. Dealing with the proposition whether the assessee would be allowed deduction in the accounting year, although the liability m....
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...., 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 s. 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 squarely applicable to the facts of the present case. It is not disputed that the warranty clause is part of the sale document and imposes a liability upo....
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....e that is recognized 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. 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 s. 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 having no alternative to settling that obligation." 16. The Court also discussed the manner in which provision for product warranties can be made and various options which are available, highlighting the options which are more suitable in the cases of 'product warranties'. This discussion is as follows : "In th....
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....re 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 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....
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....e had paid royalty to the tune of Rs. 70.66 lacs which was disallowed by the AO under s. 40(a)(i) of the Act. The CIT(A) had allowed the deduction and deleted the addition for which order of the CIT(A) is confirmed by the Tribunal. 22. The facts of the case are not in dispute. The assessee had entered into foreign technical collaboration agreement with M/s Whirpool Corporation, USA on 24th Feb., 1995 which was duly approved by the Government of India. Under this agreement, the assessee was to pay to its foreign collaborator royalty @ 5 per cent on the domestic sales and 8 per cent on export proceeds subject to taxes for a period of ten years. The royalty accrued from the date of agreement i.e. from 24th Feb., 1995. Royalty, however, was paid for sales made from 1st March, 1995 onwards and entire royalty of Rs. 70.66 lacs made during the period from 1st March, 1995 to 31st March, 1995 was accounted for the captioned assessment year which was claimed in this assessment year on the ground that tax had been deducted on the said royalty and deposited only on 10th May, 1996 in this assessment year and this deposit was made within the time prescribed in r. 30 of the IT Rules, 1962. ....
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....g provided under ss. 30 to 38 of the Act. Where in the case of an assessee any interest or royalty which is payable outside or in India to the non-residents and at which tax is deductible at source under Chapter XVII-B of the Act and if such tax is not deducted or after deduction has not being paid during the previous year or in the subsequent year before the expiry of the time prescribed under sub-s. (1) of s. 200 shall not be deducted. The section has three ingredients (a) royalty which is payable outside India or in India to a non-resident; (b) the tax is deductible at source under Chapter XVII-B and has not been deducted; or (c) after deduction has not been paid during the period specified. In the section it is a composite performance and a satisfaction of these ingredients which would take the amount indicated in the section beyond the mischief of s. 40(a) (i). If the language of these ingredients are not satisfied, the obvious result thereof would be that the specified amount shall not be liable to be deducted." 25. The question is as to whether deduction is to be claimed in the year in which tax is deducted at source or in the year in which it is deposited, though within ....