2025 (5) TMI 1571 - AT - Income Tax

Disallowing the provision for leave encashment invoking the provisions of section 43B(f) - HELD THAT - We find that this issue is covered against the assessee vide coordinate Bench 2018 (8) TMI 2169 - ITAT DELHI as held in view of the clear-cut provisions of the law that from 1 April 2002 leave salary payable by the assessee as an employer to his employees is brought within the purview of section 43B - However the relaxation contained in the 1st proviso is available. On further it is clarified that once deduction of the provision made in an earlier year s is allowed no deduction is permissible in respect of the same amount once again on payment basis. Therefore if the assessee has made the provision of leave salary which has not been paid on or before the due date prescribed under the income tax act for filing of the return of income then such provision cannot be allowed as deduction in the year in which the provision is made but the payment has not been made before the due date of filing of the return of income. In view of this we do not find any infirmity in the order of the lower authorities - Decided against assessee. Deduction for provision for warranty - whether appreciating that the provision was created on scientific basis and the same represents liability in praesenti allowable u/s 37(1)? - basis adopted by the company for calculating the provision for warranty expenses - HELD THAT - We observed that the issue under consideration is squarely covered by the decision of coordinate Bench in AYs 2003-04 2004-05 2018 (8) TMI 2169 - ITAT DELHI therefore we are inclined to direct the Assessing Officer to follow the directions and the relevant findings in OGE in AYs 2003-04 and 2004-05 may be followed. Accordingly this issue is allowed in favour of the assessee. Nature of expenses - software annual maintenance charges - HELD THAT - As decided in own case 2018 (8) TMI 2169 - ITAT DELHI assessee s major expenditure was also because of the annual renewal of the software licenses. Assessee has also made the software development expenditure for bringing up the relevant software used for the day-to-day business needs of the assessee. In view of this it cannot be said that the software has given any benefit of enduring nature to the assessee or are capital expenditure in nature. In view of this is the expenditure incurred by the assessee on software expenditure is day-to-day routine expenditure and annual renewal charges only we are of the opinion that it is revenue in nature. In view of this we direct the AO to delete the disallowance made by the learned AO because of software expenditure holding the same to be capital expenditure. He is also further directed to withdraw the allowance of the depreciation at the rate of 60% thereon. Liquidated Damages created on a scientific basis u/s 37(1) - HELD THAT - As brought to our notice by Revenue that in present assessment year the issue of two agreements involved is BSNL and TATA. We observed that the issue under consideration is decided in favour of the assessee based on the agreement entered by the assessee with TATA AIG. However BSNL issue is not verified by the lower authorities and therefore we are inclined to allow the liquidated damages claimed by the assessee with respect to the agreement with TATA AIG. With regard to BSNL we are inclined to remit the issue back to the file of Assessing Officer to verify the claim of the assessee in line of the directions of the coordinate Bench in AY 2007-08.

The core legal issues considered by the Appellate Tribunal (AT) in these appeals relate primarily to the allowability of various provisions and expenses claimed by the assessee under the Income-tax Act, 1961, the applicability of specific statutory provisions such as section 43B(f), the correctness of transfer pricing adjustments, and the initiation of penalty proceedings. The principal questions examined include:

1. Whether the provision for leave encashment is deductible in the relevant assessment year or is governed by the provisions of section 43B(f) of the Act, which restricts deduction until actual payment.

2. The allowability of provision for warranty expenses as a liability in praesenti under section 37(1) of the Act, including the adequacy and reasonableness of the estimation method employed by the assessee.

3. The characterization of computer software expenditure as capital or revenue expenditure, and the consequent tax treatment thereof.

4. The deductibility of provision for liquidated damages, including the scientific basis for the provision and whether the liability crystallized in the relevant year.

5. The validity of transfer pricing adjustments made by the Assessing Officer (AO) and Transfer Pricing Officer (TPO), including the methodology for selecting comparable companies, the use of contemporaneous data, application of quantitative and qualitative filters, and the allowance of working capital and risk adjustments.

6. The propriety of initiation of penalty proceedings under section 271(1)(c) for concealment of income and furnishing inaccurate particulars.

7. Miscellaneous issues including non-adjudication of additional grounds such as allowance of Tax Deducted at Source (TDS) credit.

Issue-wise detailed analysis is as follows:

Provision for Leave Encashment and Applicability of Section 43B(f)

The legal framework involves section 43B(f) of the Income-tax Act, which mandates that deductions for sums payable by an employer in lieu of leave at the credit of employees are allowable only in the year in which such sums are actually paid. The assessee contended that the provision for leave encashment is an accrued liability and not contingent, relying on the Supreme Court decision in Bharat Earth Movers Ltd. v. CIT, which held such provisions deductible in the year of creation.

The Court, however, distinguished the pre-2002 position from the statutory amendment effective from 1 April 2002, which brought leave salary payable within the ambit of section 43B(f). The Tribunal followed a coordinate Bench decision holding that the provision for leave encashment not paid before the due date of filing the return is not deductible in that year but only in the year of payment. The Court rejected the assessee's argument that the liability was not payable to current employees and upheld the disallowance under section 43B(f).

The Court treated the Revenue and assessee submissions equally but adhered to the coordinate Bench ruling, dismissing the grounds challenging the disallowance of leave encashment provision.

Provision for Warranty Expenses

The issue concerned the allowability of warranty provisions as deductible expenses under section 37(1), which permits deduction of any expenditure incurred wholly and exclusively for business purposes. The assessee claimed that the provision was made on a scientific basis and represented a liability in praesenti.

The coordinate Bench had remanded this issue back to the AO and CIT(A) for verification of the scientific basis and correlation between actual warranty expenses and provision made. The current Tribunal directed the AO to follow the directions and findings of the coordinate Bench in the earlier years, effectively allowing the provision subject to verification.

The Court emphasized the need for reasonable accuracy in estimation and adherence to judicial precedents, including the Supreme Court ruling in Rotork Controls India (P) Ltd. v. CIT, which recognized the allowability of such provisions if made on a scientific basis. The Tribunal granted relief by remitting the matter for fresh verification, thereby partially allowing the assessee's claim.

Computer Software Expenditure

The legal question was whether expenditure on computer software should be treated as capital expenditure or revenue expenditure. The assessee argued that the expenditure mainly pertained to annual maintenance and renewal charges, which are routine and revenue in nature. The Revenue contended that the expenditure was capital in nature due to software upgradation.

The Tribunal relied on the coordinate Bench decision which had held that software annual maintenance charges and renewal of licenses do not confer enduring benefits and thus qualify as revenue expenditure. The Tribunal directed deletion of disallowance and withdrawal of depreciation claimed on such expenses.

The Court rejected the Revenue's arguments and upheld the principle that routine software maintenance and renewal expenses are revenue in nature, allowing the deduction accordingly.

Provision for Liquidated Damages

The assessee claimed deductions for provisions made for liquidated damages under contracts with BSNL and TATA AIG, asserting that these provisions were created on a scientific basis and represented liabilities in praesenti. The Revenue disputed the claim, arguing that the liability crystallizes only upon actual delay and that the provisions were not supported by scientific calculation or contracts.

The Tribunal examined the coordinate Bench decision for AY 2007-08, which allowed such provisions where the contract contained specific clauses defining liquidated damages and where delay had occurred. The Tribunal observed that while the claim relating to TATA AIG was covered by this ruling, the BSNL-related claim lacked verification and documentation.

The Tribunal allowed the claim relating to TATA AIG and remitted the BSNL-related issue to the AO for verification, directing the AO to provide the assessee an opportunity of being heard. This approach balanced the need for scientific estimation with the requirement of verifying contractual liability.

Transfer Pricing Adjustments

The assessee challenged the transfer pricing adjustments made by the AO and TPO, raising issues such as the selection of comparable companies, use of contemporaneous data, rejection of loss-making comparables, absence of working capital and risk adjustments, and ignoring the arm's length price determined by the assessee's transfer pricing documentation.

The Tribunal noted that the assessee had filed a Mutual Agreement Procedure (MAP) request with the USA tax authorities covering the relevant assessment years, including the current years under appeal. In view of the MAP proceedings, the assessee sought to withdraw the transfer pricing grounds.

The Tribunal allowed the withdrawal of transfer pricing related grounds, effectively staying the issue in light of the MAP process. The Revenue's appeal on transfer pricing was dismissed as infructuous due to the MAP proceedings.

Penalty Proceedings under Section 271(1)(c)

The assessee challenged the initiation of penalty proceedings for concealment of particulars of income and furnishing inaccurate particulars. The Tribunal held that initiation of penalty proceedings at this stage was premature and dismissed the ground accordingly.

Other Grounds

Additional grounds such as non-adjudication of TDS credit claims and general challenges to the AO and CIT(A) orders were dismissed as either general or premature.

Significant Holdings and Core Principles Established

Regarding leave encashment provisions, the Tribunal preserved the principle that post-1 April 2002, section 43B(f) mandates deduction only upon actual payment, notwithstanding earlier Supreme Court rulings on accrued liability. The Tribunal stated:

"...from 1 April 2002 leave salary payable by the assessee as an employer to his employees is brought within the purview of section 43B of the act... if the assessee has made the provision of leave salary which has not been paid on or before the due date prescribed under the income tax act for filing of the return of income then such provision cannot be allowed as deduction in the year in which the provision is made but the payment has not been made before the due date of filing of the return of income."

On warranty provisions, the Tribunal emphasized the necessity of "estimation with reasonable accuracy" and adherence to judicial precedents, remitting the matter for verification to ensure the provision represents a liability in praesenti.

For software expenditure, the Tribunal affirmed that routine software maintenance and license renewal expenses are revenue in nature and deductible, rejecting their treatment as capital expenditure.

On liquidated damages, the Tribunal recognized that liability crystallizes upon occurrence of delay as per contractual terms, and provisions made on a scientific basis for such damages are allowable deductions. The Tribunal allowed the claim for TATA AIG and remitted the BSNL claim for verification.

Regarding transfer pricing, the Tribunal's acceptance of the assessee's withdrawal of grounds due to ongoing MAP proceedings underscores the procedural principle that transfer pricing disputes covered by MAP may be stayed to avoid double taxation and facilitate resolution.

The Tribunal also held that penalty proceedings under section 271(1)(c) should not be initiated prematurely without complete adjudication of facts.

In conclusion, the Tribunal partly allowed the assessee's appeals for the relevant assessment years on provisions for warranty expenses, software expenditure, and liquidated damages (subject to verification), upheld the disallowance of leave encashment provisions under section 43B(f), dismissed transfer pricing grounds due to MAP proceedings, and dismissed premature penalty challenges. The Revenue's appeal on transfer pricing was dismissed as infructuous.

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