TaxTMI 
TaxTMI 
2008 (1) TMI 417
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.... the relevant previous year, construction of terminals was also started by it. It was awarded construction and operation of petroleum terminals of M/s IOC at Dumad and Mathura. Two contracts were entered into for this purpose with M/s IOC. Under these contracts, the appellant was required to design and construct storage facilities and also to provide services relating to handling, storage and despatch of petroleum products. Return of income was filed by assessee on 30th October, 2001 declaring a loss of Rs. 14,73,34,669 as per normal provisions of the IT Act and Rs. 13,44,98,910 under s. 115JB of the IT Act. Refund was also claime4 and received by the assessee. During the assessment proceedings AO made an addition of Rs. 4,83,72,135 being provision made by the assessee in its accounts for performance warranties, while computing its income/loss under the normal provisions. For computation of book profits under s. 115JB, AO, in addition to the provision for performance warranties Rs. 4,83,72,135 also added Rs. 1,00,18,189 charged to the P&L a/c as 'preliminary and deferred revenue expenses'. 2.2 AO disallowed the provision of Rs. 4,83,72,135 for performance warranties citi....
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....by AO on the book profit for computation of MAT under s. 115JB were as follows: (i) That under cl. (c) of Explanation to s. 115JB, only liabilities which cannot be ascertained are to be added to the book profit and the provisioning for performance warranty was not unascertained liability, but made on the basis of a detailed technical assessment. (ii) The assessee was following AS-7 as mandated by ICAI, and prudent accounting principle of matching cost with revenue required such provisioning, (iii) Expert advisory committee of ICAI had opined that provisions made to meet obligations resulting from warranty or guarantee did not represent contingent liability. (iv) That a security deposit of 10 per cent of contract value was given to M/s IOC and such security deposit was indicative of M/s IOC's own assessment as regards costs that could arise during the warranty period. (v) That with respect to the inclusion of preliminary and deferred revenue expenses of Rs. 1,00,18,189 in the net profit, such addition goes against the Explanation to s. 115JB which does not specifically provide that any difference on account of change in method of acco....
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....ts which may arise during the defect liability period. In other words according to CIT(A) the technical assessment was based on a general terminology whereby only certain probable events like tendency to develop cracks, replacement of seals, etc. were noted. Hence, according to learned CIT(A) such liabilities were not ascertained or crystallised. (ii) Such liabilities are only contingent and do not give rise to any definite obligation, and hence it cannot fall within the expression "expenditure laid out or expended wholly or exclusively for the purpose of business". No enforceable liability had accrued or arisen to the assessee on account of warranty. (iii) Mercantile system can never be stretched so as to embrace all sorts of provisions, notional or contingent payment. Projects at Dumad and Mathura had not yet been completed and were under execution. Therefore, according to him, the liability, on the basis of which the deduction has been claimed, did not exist as on the last date of the relevant previous year. 2.8 For deleting the addition of differential amount of Rs. 1,00,18,189 written off as preliminary and deferred revenue expenses by the assessee, in com....
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....15 of the agreement as it appears at paper book page No. 222, for a period of 6 months, after the work was completed, assessee had to maintain and uphold the same in efficient condition and was also bound to remedy any omission or defects discovered or appearing in the works as directed by the Dy. GM (Project) of M/s IOC. It is also specified in this clause that security deposit would be released only after the expiry of the said period and subject to it being ascertained that there was no defective work or material requiring repairs or maintenance. Therefore, assessee was responsible for the smooth working after completion during the warranty period. (iii) Assessee had adopted percentage completion method which is the approved methodology for accounting construction contracts, as per AS-7 of ICAI. Though, this is not an Accounting Standard which has been notified under s. 145(2) of the Act, assessee applied it for prudent accounting. This Accounting Standard mandates that when profit is recognised under percentage of completion method an appropriate allowance for future unforeseeable factors should be made on either specific or a percentage basis. Assessee being a company....
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....ainst the provision when compared to the head-wise provisioning made by the technical experts varied substantially. (iii) Hon'ble Madras High Court in the case of CIT vs. Rotork Controls India Ltd. (2007) 209 CTR (Mad) 297 : (2007) 293 ITR 311 (Mad) after considering all the decisions cited by the learned Authorised Representative, had held that where the nature of the liability was yet to be crystallised and was loaded with uncertainty of the event which can give rise to a liability, there is no justification to accept such a claim of the assessee. (iv) In none of the cases cited by the learned Authorised Representative, has the liability under the warranty clause determined based on a fixed percentage of the turnover and, therefore, accepting the claim of a percentage on turnover for the provisioning could not be sustained. 2.12 We have considered the order of the AO, the CIT(A)'s order, the submissions and grounds made before the AO as well as before the CIT(A), the relevant pages of the paper book referred to by learned Authorised Representative, and learned Departmental Representative as also the submissions and case law brought to our notice, The ....
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.... the Hon'ble Supreme Court has given a guiding principle, where such liabilities have arisen though not quantifiable with certainty. According to Hon'ble Supreme Court deduction is allowable once business liability has arisen, though it could be quantified and discharged only at a future date. However, that case dealt with provisioning for liability on account of encashment of earned leave of employees. Since such liability had already arisen and could reasonably be quantified in proportion to the entitlement of each employee and their length of service, subject to the outer-limit of eligibility, Hon'ble Supreme Court held provisions thereof as reasonable. To be specifically noted is that, here, there was a methodology available for making a reasonable estimate of such liability. 2.15 Hon'ble Delhi High Court in CIT vs. Vinitec Corporation (P) Ltd. held that even where actual quantification and discharge of a liability are deferred to a future date, once an assessee is maintaining its accounts in mercantile system, a liability so accrued, though to be discharged on a future date would be a proper deduction while working out the profits and gains of his business, ....
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....t is that unless actual expenses incurred against provisioning could be substantiated for justifying the quantum or unless a basis for the provisioning was given such provisioning could not be done. 2.20 Here, the assessee was for the first time executing the work of the type. Hence, no past data was available with it to justify the quantum. In fact, furnishing of such past data was impossible for the assessee. A warranty clause for maintaining the facility it was setting up, for a period of 12 months, was very much there in the agreement and M/s IOC had the power to make good expenses incurred by it, in case assessee failed to meet its warranty obligations, out of the 10 per cent security deposit with it. Since past data was not available, assessee did the best it could do in such circumstances for estimating its liability. It made a technical assessment and had it vetted by an independent agency. Against 5.73 per cent arrived at by such technical evaluators, which was vetted by independent contractors, as possible warranty expenses, assessee in fact had made only a 5 per cent provisioning. Though the cited cases, supra, were not on warranties in any construction projects, neve....
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...., we hereby set aside the CIT(A)'s order confirming non-allowance of deduction of performance warranty of Rs. 4,83,72,135 in computing the income of the assessee under the normal provision of the IT Act. AO is directed to allow the deduction of the provision for warranty as claimed by the assessee for computing its income under normal provisions of the Act. 2.22 As regards the addition of the same amount in computing the book profits as per s. 115JB, it is necessary to see the type of addition allowed under cls. (a) to (f) of Explanation to cl. (2) of s. 115JB. These Explanations run as follows: "(a) the amount of income-tax paid or payable. and the provision therefor; or (b) the amounts carried to any reserves, by whatever name called (other than a reserve specified under s. 33AC) or (c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or (d) the amount by way of provision for losses of subsidiary companies; or (e) the amount or amounts of dividends paid or proposed; or (f) the amount or amounts of expenditure relatable to any income to which [other than the ....
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....ear. 5.1 Facts relating to this issue run as follows. Assessee company had in its P&L account, fully written off, what was remaining in balance under the head 'Pre1iminary and deferred revenue expenditure'. In note No. 5 of Sch. 17 to its audited P&L a/c and balance sheet it is stated that such write off, as against its earlier accounting policy of amortising such expenses over a period of 10 years and 5 years, had resulted in the profit for the year being lower by Rs. 1,00,18,189. Assessee was required by the AO to explain why this amount should not be added back for computation of book profit in accordance with s. 115JB of the Act. Assessee replied that book profit vide s. 115JB means net profit as per P&L a/c as increased by certain provisions and liabilities as per cls. (a) to (f) of the Explanation to cl. (2) of s. 115JB. Assessee also cited the decision of Hon'ble Supreme Court in Apollo Tyres Ltd. vs. CIT and submitted before the AO that in the light of this decision, such addition ought not be made. AO however did not accept these contentions since according to him Hon'ble Supreme Court in the case of Apollo Tyres Ltd. was concerned with addition made by ....
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....39;s decision, cited supra, AO was prohibited from making and such adjustment to the book profit. 5.5 Before us the learned Departmental Representative relied on assessment order and submitted that the adjustment was correctly carried out by AO since the preliminary and deferred revenue expenditure written off, actually pertained to earlier years and there was specific qualification made by the auditors vide note No. 3 of Sch. 17 to the audited account for year ended 31st March 2001. Learned Authorised Representative on the other hand strongly supported the order of the CIT(A) and the reasoning given by him. 5.6 We have perused the mentioned orders as also the submissions made. It is an undisputed fact, as emanating from Note 3 to Sch. 17 of assessee's audited account that it had made a write off of the preliminary and deferred revenue expenditure which had resulted in the profit for the year being lower by Rs. 1,00,18,189. AO has proceeded to make an addition of this amount, based on this audit note, to the net profit of the assessee, for the purpose of computing book profits under s. 115JB. Under Explanation to s. 115JB, as it stood at the relevant time book profit for ....