2019 (3) TMI 1782 - AT - Income Tax

Disallowance of Provision for Warranty - provision made is on estimate basis and the reliability and correctness of the basis cannot be ascertained - CIT-A deleted the addition - HELD THAT - When the year under assessment is first year of operation of the assessee who is manufacturer and trader of tyres of heavy vehicles sold along with warranty and was under obligation of replacement of the tyre sold during the warranty period on free of cost if any component is found to be suffering from manufacturing defect the basis for creating provision for warranty is scientific one. So when the provision of warranty expenses has been made on the basis of actual warranty expenses met out during the period 01.04.2010 to 25.09.2010 qua the product sold during the year under assessment the entire estimate is based on the scientific basis. Moreover the provision for warranty made by the assessee has been duly audited at the time of auditing the financials of company. So in these circumstances we are of the considered view that Ld. CIT(A) has rightly deleted the addition made by AO on account of disallowance of provision for warranty. - Decided against revenue Disallowance of Technical Know-How / Royalty - As alleged section 32(1)(ii) provides for depreciation @ 25% in case of intangible assets where the Technical know-how is specifically included under this category - HELD THAT - Following the ratio of the judgment CIT vs. Sharda Motor Industries Ltd. CIT vs. Hero Honda Motors Ltd 2015 (2) TMI 368 - DELHI HIGH COURT we are of the considered view that assessee company satisfied the test that transfer of technical know how / royalty by the continental AG to the assessee company was non-exclusive and non-transferable licence for the use of technology for manufacturing of tyres in India which was only a production licence and for limited purpose for use for manufacturing of tyres. Even the termination clause 11.8 is very categoric as Even the termination clause 11.8 is very categoric. Expenditure incurred by the assessee in accordance with TEA agreement pertaining to the technical know-how is quantified on the basis of sale / production effected by using such technical know-how is of revenue nature and as such allowable as business deduction. CIT(A) has also relied upon Circular no. 21 of 1969 issued by CBDT / clarified that when a licence is obtained for user of technical knowledge from a foreign participant for a limited period together with or without the right to use the patents and trademarks of the foreign party the payment would not bring into existence an asset of enduring advantage to the Indian party. - Decided against revenue.

Summary

Issues Involved:
1. Deletion of addition on account of Disallowance of Provision for Warranty.
2. Deletion of addition on account of Disallowance of Technical Know-How / Royalty.

Issue-wise Detailed Analysis:

1. Deletion of addition on account of Disallowance of Provision for Warranty:

The Assessing Officer (AO) disallowed the provision for warranty amounting to Rs. 2,13,40,735, arguing that it was based on estimates and lacked reliability and correctness. The AO's decision was challenged by the assessee, who argued that the provision was necessary to meet future obligations arising from warranty clauses in sales agreements. The year under assessment was the first year of operation, and no historical data was available to calculate warranty expenses accurately.

The assessee relied on the Supreme Court judgment in Rotark Controls India Ltd. Vs. CIT 314 ITR 62 (SC), which clarified that a provision is a liability measured by estimation and recognized when there is a present obligation due to a past event, a probable outflow of resources, and a reliable estimate of the obligation. The provision for warranty was made based on a fair and scientific approach, considering past sales events and calculated at 0.55% of the total turnover.

The Tribunal found that the provision for warranty was made scientifically and based on actual warranty expenses incurred during the period 01.04.2010 to 25.09.2010 for products sold during the assessment year. The provision was also audited. The Tribunal concluded that the CIT(A) rightly deleted the addition made by the AO, determining the ground against the revenue.

2. Deletion of addition on account of Disallowance of Technical Know-How / Royalty:

The AO disallowed Rs. 2,97,93,143 on account of technical know-how, classifying it as intangible assets and granting depreciation at 25%. The assessee contended that the payment for technical know-how was revenue expenditure, as the technical assistance agreement (TAA) with Continental AG, Germany, provided a non-exclusive and non-transferable license for manufacturing tyres in India. The payment was fixed at Euros 4,00,000 per annum, with additional payments for production beyond 4,00,000 units.

The assessee argued that the license was for limited use, without the right to transfer or make copies, and upon termination, the use of technology had to be discontinued. The assessee relied on Delhi High Court judgments in CIT vs. Sharda Motor Industries Ltd. 319 ITR 109 (Del. HC) and CIT vs. Hero Honda Motors Ltd. 372 ITR 481 (Del.HC), which classified similar payments as revenue expenditure.

The Tribunal agreed with the assessee, noting that the technical know-how was for a limited purpose and did not confer any proprietary rights. The expenditure was quantified based on production and sales, making it revenue in nature. The Tribunal found no illegality in the CIT(A)'s decision to delete the addition, determining the ground against the revenue.

Conclusion:

The Tribunal dismissed the revenue's appeal, upholding the CIT(A)'s decision to delete the additions on account of Disallowance of Provision for Warranty and Disallowance of Technical Know-How / Royalty. The order was pronounced in open court on March 19, 2019.