TMI Blog2001 (4) TMI 870X X X X Extracts X X X X X X X X Extracts X X X X ..... tracts the profit was shown by adopting the following method : Value of invoices raised Contractor value X Estimated profit from the contract as a whole Following break-up of the provisions of cost of jobs were furnished before the Assessing Officer : Provision for job cost on estimated material cost and percentage completion basis Rs. 55,36,000 Provision for rectification to be carried out on Deepak Fertilizers FM Boiler Unit assembled in shop Rs. 5,00,000 Rs. 60,36,000 The assessee contended before the Assessing Officer that the provision of Rs. 60,36,000 was liable to be allowed as the company regularly followed percentage of completion method and amount of revenue recognized is determined by reference to stage of completion at the end of the accounting period. It was further stated that for convenience of execution of job and supplies of various components required for assembly of boiler at site, a price break up is preferred and approved by the client before commencement of the supply. Material costs were booked against the job and same were also recognized at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... now formally recognized as accounting standards 7 (AS-7) of the Institute of Chartered Accountants of India for arriving at the portion of the profit of the long-term contract for the assessment year 1990-91, whose execution spread over more than one accounting period based upon the extent of work performed during the year as measured in the assessee-company's case with reference to the value of the invoices raised during the previous year against despatches to the site of the components, equipment and material in terms of the billing schedule agreed to between the assessee-company and the client. According to learned counsel for the assessee, the Commissioner of Income-tax (Appeals) has further erred in mistaking the simple surplus per se (invoice-cost price of the despatches) such profit for the year, without understanding the central fact that there is only one profit of an indivisible long-term contract, a portion of which is to be disclosed for the year as envisaged by the percentage of completion method and as such annual profit is a representative of the estimated profit of a longterm contract as a whole, necessitating provision in the accounts to ensure that the surplus dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s in the Books of Advanced Accounting, 6th edition by Yorsten, Smyth and Brown, pages 475 and 476 (page 135 of the paperbook). He specially drew our attention to the extract from the Advanced Accountancy by Shukla/Grewal, page 606, which reads as under : In case the contract is at least 1/4 complete, a certain proportion of realised profit, that is profit revealed by the contract less the percentage of retention money, should be transferred to the profit and loss account and the balance left as reserve. The proportion is, usually : (i) 1/3rd in case the completed (certified) work is less than half the total contract, and (ii) 2/3rd in case the certified work is completed up to 50% or more. Or, the profit may be transferred to the profit and loss account by using the formula : Realised profit X Work certified Total value of contract This practice is becoming popular. If the contract account reveals loss, the whole of it should be transferred to the profit and loss account. On the legal side, learned counsel submitted that the method of accounting regularly followed by the assessee for the year under appeal a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, in the present case, profits have accrued to the assessee. In this connection, in support of this contention he placed reliance on the decision of the Madras High Court in the case of CIT v. Indian Overseas Bank [1985] 151 ITR 446 (in particular on page 451). He pointed out that according to the learned judges in that case, the principle of commercial accounting is that a notional profit or a notional loss cannot enter into the computation of profits in a year. That principle is subject to exception in regards to stock-in-trade and this aspect of the case has been dealt with in the said decision (B. S. C. Footwear Ltd. v. Ridgway (Inspector of Taxes) [1972] 83 ITR 269 (HL)). He also placed reliance on the decision in the case of Badridas Daga v. CIT [1958] 34 ITR 10 (SC) and the decision of the Gujarat High Court reported as CIT v. Gujarat State Warehousing Corporation [1976] 104 ITR 1. Coming to the last question, whether accountancy principle would overrule the provisions of income-tax and whether shifting of the profit as has been done by the assessee is permitted, the learned Departmental Representative again referred to the decision of the Madras High Court in the case of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... correct position of accounts and the correct profits cannot be deduced therefrom. The learned Departmental Representative further submitted that Accounting Standards (AS-7) of the Institute of Chartered Accountants of India was not issued in the relevant assessment year and accordingly, even if the assessee has followed Accounting Standards (AS-7), it had no relevance for the year under operation. We have considered the rival submissions and perused the facts on record. It is well accepted that it is open to an assessee to decide/adopt a regular method of accounting. If such a method is an acceptable method of accounting, it will follow that the profits can be properly ascertained therefrom. In the case before us, the assessee has followed constantly for this year (which is first year of operation) and for the subsequent years a method which is one of the accepted accounting principles and practices sanctified by usage and in line with Institute's recommended standard which is known as AS-7. No doubt, AS-7 was issued in the year 1983, but AS-7 is merely a codification of existing accounting practices for which evidence of commentaries of various authors have already been referre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and gains, the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes . In the case of Madras Industrial Investment Corporation Ltd. v. CIT [1997] 225 ITR 802, the Supreme Court reiterated the same principle as enunciated in the case of U. P. State Industrial Development Corporation [1997] 225 ITR 703 (SC). In Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1, the Supreme Court has held that the long-term indivisible contract spread over more than one accounting period, the profit from the contract as a whole is determined with reference to the entire value of the contract against the cost already incurred and the estimated cost yet to be incurred for its completion. This decision of the Supreme Court is of direct help to the assessee and this was also accepted by the Departmental Representative, but he tried to distinguish it. According to the Departmental Representative in the said case, the assessee had offered for taxation the total receipts and claimed for deduction on account of liability, which the assessee had to incur in subsequent years in order to fulfil the contractual agreement. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... old that the ratio does not apply to the facts of the present case because in that case, the system of accounting adopted was such which excluded, for valuation of stocks in trade, all costs other than the cost of raw-material, for the goods in process, finished products and same was likely to result in a distorted picture of the true state of business for the purpose of computing the chargeable income. In the present case, the assessee as pointed above, has adopted one of the acceptable accounting principles and practices sanctified by usage and in line with institute's recommended standard AS-7 and such method does not result in a distorted picture of the true state of business for the purpose of computing the chargeable income. Reliance placed by learned Departmental Representative on the judgment of the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 227 ITR 172 is also of no assistance to the Revenue. This decision of the apex court nowhere falls foul of the accounting principles which have found acceptance in several cases. Here, in this case, the business was not started, yet the company earned income by way of interest from the availabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The Assessing Officer called upon the assessee to explain the nature of this provision. The assessee submitted that contracts with customers imposed warranty obligation. The company had to replace defective components during the warranty period. The assessee had made provision on account of services/replacements required to be made in terms of the warranty obligation. The Assessing Officer holding that the amount claimed was in the nature of a provision and the provisioning had been made on estimated basis, disallowed the claim of the assessee. The assessee appealed to the Commissioner of Income-tax (Appeals). Detailed submissions were made before the Commissioner of Income-tax (Appeals) and he has reproduced the same verbatim in para. 10 of his order. Not convinced by the arguments put forth by the representative of the assessee, the Commissioner of Income-tax (Appeals) confirmed the addition. According to the Commissioner of Income-tax (Appeals)- a mere provision in the accounts for a liability which is not ascertained, cannot be considered for a deduction. The provision is generally made in respect of a known liability for which the quantification cannot be made in the accou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2% (approx) (b) No FOAK 0.5% (approx) (c) Exactly repetitive jobs, viz. sugar boilers, FM 0.25% (approx) Even though the warranty period starts after handing over the boiler, the provision for liability on account of warranty is to be made in respective years of the progressive execution of the contract as per the Accounting Standard 7 where it is stated that the costs attributable to the contract include expected warranty costs. Warranty costs are provided for when such costs can be reasonably estimated (page 147 of AS-7). Learned counsel concluded that such provision is allowable deduction in view of the following authorities : (1) Commissioner of Inland Revenue v. Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697 (PC) ; (2) ITO v. Wanson (India) Ltd. [1983] 5 ITD 102 (Pune) ; and (3) Voltas Ltd. v. Deputy CIT [1998] 64 ITD 232 (Mum). Shri Naresh Kumar, the learned senior Departmental Representative strongly supported the orders of the authorities below. He strongly articulated on para. 11 of the order of the Commissioner of Income-tax, where the latter held that a mere provision in the accounts for the liability whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew Zealand and income-tax in India, the said decision has no relevance. The learned Departmental Representative accordingly, concluded that the action of the authorities below deserves to be upheld. We have considered the rival submissions and perused the facts on record. In the case of manufactured capital goods, invariably, a provision is made in the contract that should any deficiencies and infirmities be found in its working, then, for certain period, the suppliers will undertake, free of cost, to remove such deficiencies or infirmities which prevent the promised working by the capital asset. This is very important as offending unit could put into dis-array the whole working of the enterprises. In the case of the assesseecompany, as explained above, the guarantee is given in respect of supply of every project boiler which enjoins the company to make the boiler operational as per the specification, after removing the deficiencies found during the warranty period. This warranty period lasts from 12 to 18 months from handing over the project boiler or from the date the project has become operational. The contract value will necessarily include the cost required to be incurred in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en back in the accounts for the next year. The Assessing Officer did not allow such excess provision on the ground that it was only an estimate amounting to contingent liability and the same basis given by the Assessing Officer in the case of present assessee before us. On appeal, the Tribunal held that no doubt, the provision made was contingent at the time when it was made, but such estimate was based on the assessee's experience in the earlier years. The assessee knew for certain that some expenditure had to be incurred and as a prudent businessman, had to make a provision which approximated to the amount of expenditure. The method followed was consistent and therefore, there was justification for allowing the assessee's claim. The case of the assessee is on all fours and accordingly, we hold that the above case clearly comes to the assistance of the assessee. The distinguishing factor pointed out by the learned Departmental Representative that the provision for warranty has been created by the assessee even before the product has come into existence is of no relevance because it is the principle of accounting which is of vital importance. We further find that the case of the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In the computation of total income, it had claimed 50 per cent. business lunch expenses incurred by employees accompanying the guests and had shown Rs. 1,12,941 as disallowed. The Assessing Officer held that the entire expenses of Rs. 1,47,523 incurred on business lunches were in the nature of entertainment and accordingly, he applied the provisions of section 37(2A). On appeal, the Commissioner of Income-tax (Appeals) gave partial relief inasmuch as he directed the Assessing Officer to treat 20 per cent. of the expenditure to be attributable to employees out of the total lunch expenses of Rs. 1,47,523. Shri B. K. Khare, learned counsel for the assessee, stated that the claim of the assessee at 50 per cent. was in accordance with the judgment of the Karnataka High Court in the case of CIT v. Mysore Minerals Ltd. [1986] 162 ITR 562 (Karn). The learned Departmental Representative, Shri Naresh Kumar relied upon the orders of the authorities below. We have considered the rival submissions and perused the facts on record. It is noted that out of the total entertainment expenses of Rs. 1,86,702, the assessee had incurred a sum of Rs. 1,47,523 on business lunches. The busine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lowed in part ... The above draft order was placed before the Judicial Member who, after perusing the same, vide his Note dated January 11, 2000, requested me to reconsider the issue of guarantee, in view of the ratio laid down by the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585, 598, 599. After going through the judgment of the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 I find that the ratio laid down by the Supreme Court in the said case is not applicable to the facts of the case of the assessee. In the matter of claim made by an assessee for deduction of provision made towards warranty obligations, a question often arises as to whether admission of such a claim will run counter to the fundamental postulate that an expenditure which is not actually incurred by the assessee and which is only of a contingent nature cannot be allowed under section 37(1) of the Income-tax Act. Among others, the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 and in the case of Madras Industrial Investment Corporation Ltd. [1997] 225 ITR 802, 808 (SC) has observed that an expenditure which is of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ree Sajjan Mills Ltd. [1985] 156 ITR 585 (SC) sought to reduce the taxable income by contending that it had in fact not made any provision for gratuity in the books of account and, therefore, the provisions of section 40A(7) which frown upon only provisions made in the accounts, should not come in the way of the assessee's claim. The apex court declined to bless this contention which, though was the result of the working of a clever mind but could be said to be guilty of making mockery of a clearly intended provision of a statute. In the course of the judgment, the apex court dealt with the provisions of section 37 and reiterated the principles laid down in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 (SC) to the effect that the expenditure deductible for income-tax purpose is towards the liability which actually exists. However, setting apart money which might become an expenditure on the happening of an event is not expenditure. To repeat, these observations were made in the context of section 37 at page 598 of the judgment. The court also noticed the decision of Metal Box Co. of India Ltd. [1969] 73 ITR 53 (SC) and reaffirmed its validity at page 599 of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of section 37. In other words, if the assessee can satisfy the authorities that : (a) a provision for warranty has been fairly estimated, (b) such provision finds acceptance from the accounting standpoint or rather making of such a provision is considered mandatory in arriving of nature of true commercial profits, (c) the provision so made is as per the regular method of accounting, then there cannot be any objection for the admissibility of such a claim as discussed by me in para. 24 (page 42). In my view, the assessee's case satisfies all the three tests enumerated supra and, accordingly, in my view, the claim of warranty is an allowable deduction. K. C. Singhal (Judicial Member).-After going through the order proposed by my learned Brother and having discussion at length with him, I have not been able to persuade myself to agree with the conclusion arrived at by him in para. No. 26 of his order regarding deduction on account provisions made for warranty liability. Therefore, I proceed to express my dissenting view. The issue for our consideration is whether the assessee is entitled to deduction in respect of the provisions made for warranty liability in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business must be determined first in accordance with commercial practice and then, such profits should be further computed in accordance with the provisions of sections 30 to 43C. Therefore, it was argued by him that warranty liability, even though not deductible under section 37 being contingent liability, is deductible under section 28 itself in accordance with the accounting principles. Reference was made to Accounting Standards 7 issued by the Institute of Chartered Accountants of India as well as the International Standard of Accounting. On the other hand, the contention on behalf of the Revenue is that warranty liability is contingent in nature and therefore not allowable at all in view of the Supreme Court decision in the case of Shree Sajjan Mills Ltd. [1985] 156 ITR 585. According to learned senior Departmental Representative, it makes no difference whether such claim of the assessee is tested under section 28 or 37. It is also the contention of the senior Departmental Representative that the claim of the assessee is pre-mature since the occasion for such liability has not arisen. According to him, the boilers were in the stage of construction as only a part of construct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n been disputed by the learned counsel for the assessee. Further, there is no dispute between us on the point that such claim of the assessee cannot be allowed under section 37 (see para. 42 (page 46) of the proposed order). So, the only short question for consideration remains is whether such claim can be allowed under section 28 itself, despite the fact that it is not allowable under section 37. In my considered view, the legal position is the other way around. Section 28 provides that the profits and gains of the business are chargeable to tax. Section 29 provides that income referred to in section 28 shall be computed in accordance with the provisions of sections 30 to 43C. Similar provisions were on the statute in the form of section 10(1) and section 10(2) of the 1922 Act. These old provisions were the subject matter of the consideration before the Supreme Court in the case of Badridas Daga [1958] 34 ITR 10. In that case the question arose whether the loss on account of embezzlement by an employee could be allowed as deduction. The Supreme Court held that such deduction could not be allowed either under section 10(2)(xi) or under section 10(2)(xv). It then proceeded to obse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in finding out the true assessable profits or gains. This was laid down by the Privy Council in CIT v. S. M. Chitnavis [1932] 2 Comp Cas 464 and has been accepted by this court. In other words, section 10(2) does not deal exhaustively with the deductions, which must be made to arrive at the true profits and gains. The perusal of the relevant observations in the aforesaid two Supreme Court decisions clearly shows that the claim of the assessee could not be considered under section 10(1) if the claim could be considered under specific provisions of sections 10(2)(i) to 10(2)(xv). The court had held that the claim of the assessee in those two cases did not fall under the specific provisions of section 10(2) and, therefore, the same could be considered under section 10(1) itself because ultimately it is the true profits of the business which are to be taxed. Therefore, it is very much clear that starting point of computation is not under section 10(1) (corresponding to section 28 of the 1961 Act) as has been held by my learned Brother. Therefore, the profits are first to be computed in accordance with the provisions of sections 30 to 43C and if any claim of the assessee cannot be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore the Supreme Court in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53. Had these judgments been referred to, such observations might not have been made by that Bench. In view of the above discussion, the ratio of the Supreme Court decision in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53 that a claim though not allowable under section 36(1)(v) could be allowed under section 28 is not binding and therefore to be ignored in view of the decisions of the larger Benches in the case of Badridas Daga [1958] 34 ITR 10 (SC) and Mysore Sugar Co. Ltd. [1962] 46 ITR 649 (SC) and consequently cannot be applied in the present case. Even assuming for the sake of argument, the claim of the assessee can be considered under section 28. Still, such claim in my opinion, cannot be allowed. The contingent liabilities are not allowable either under section 28 or section 37 unless it falls within the exception laid down by the Supreme Court in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53. In order to appreciate this contention, it would be useful to refer the decision of the Court of Appeal in the case of Peter Merchant Ltd. v. Stedeford (Inspector of Taxes) [1948] 30 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aim was made, the liability had to be regarded as contingent and not deductible. The aforesaid decision of the Court of Appeal was distinguished by the Supreme Court in the following words (page 6) : It is clear from the above that on the facts and circumstances of that case the court held that it was not an accrued liability but was merely a contingent one and if that was the case only the sums actually expended could be deducted and not those which the company was liable to expend in the future. By distinguishing the decision of the Court of Appeal, the Supreme Court has made a distinction between a liability which has accrued during the year though to be discharged at a future date and a liability which is contingent in the year, but may become a accrued liability in future upon the happening of an event. In the former case, deduction was held to be allowable while in the latter case held to be not allowable. It is to be noted that the Supreme Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 was considering the claim of the assessee under section 10(1) of the 1922 Act corresponding to section 28 of the 1961 Act. Therefore, it follows that even under section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... determined for the purpose of distribution of dividends. If there is any possibility of certain liability being accrued in future in respect of the business carried on by the assessee, then it would be prudent for a trader to make provisions for such liability in the accounts, but on that account, it cannot be allowed as deduction if it is not allowable under the provisions of the Income-tax Act. In this connection, reference may be made to the Supreme Court decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT [1997] 227 ITR 172 wherein it has been held that the income-tax provisions would prevail over the accounting principles. Reference may also be made to a recent decision of the Tribunal Bombay Bench in the case of Deputy CIT v. Associated Capsules Pvt. Ltd. [1995] 65 TTJ 774, wherein it has been held vide para. 17 at page 779 : The Institute of Chartered Accountants of India has recommended the provision of such a liability on grounds of prudence. Now prudent accounting is one thing and determination of income for tax purposes is another. One may be almost sure that a certain liability will arise on the happening or nonhappening of an event, and f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No. 157/Pune/1995 for the earlier assessment year, i.e., 1990-91. As such the decision given by us in the aforesaid order will apply mutatis mutandis to the facts of the present case. For the reasons discussed therein, we hold that there is no justification for the impugned addition of Rs. 96,37,000 on account of provision made on account of revenue recognition on percentage of completion method. The same is accordingly deleted. This ground accordingly succeeds. The next grievance of the assessee is that the learned Commissioner of Income-tax (Appeals) is not justified in confirming the addition of Rs. 31,51,000 on account of warranty provision made in the accounts. The facts and arguments of both sides are identical to those discussed by us in I.T.A No. 157/Pune/1995 for the earlier assessment year, i.e., 1990-91. As such the decision given by us in the aforesaid order will apply mutatis mutandis to the facts of the present case. For the reasons discussed therein we hold that there is no justification for the impugned addition of Rs. 31,51,000 on account of provision made in respect of warranty in the accounts. The same is accordingly deleted. This ground accordingly succeeds. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubmitted before the Assessing Officer that in the earlier year the claim could not be claimed in view of the losses. The Assessing Officer disallowed the claim on the ground that in the returns for the earlier years, i.e., 1989-90 and 1990-91, neither investment allowance had been claimed nor allowed. The Assessing Officer further held that incurring of losses is no criteria for not claiming investment allowance. He further held that the investment allowance on computer is not allowable. He accordingly disallowed the claim of the assessee in toto. On appeal, the Commissioner of Income-tax (Appeals) confirmed the addition observing as under : I have considered the submission of the appellant, and facts in issue. The deduction under section 32A is admissible in respect of machinery or plant acquired or installed or put to use in the previous year. In the instant case, the plant and machinery including computers had been put to use in the assessment year 1989-90 and 1990-91 and as such cannot be considered for deduction in the assessment year 1991-92. The mere fact that the assessee could not claim deduction due to losses in the earlier years does not mean that it is eligible for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otal income unless there is sufficient total income to contain such allowance, such total income being computed after making all the deductions other than the deduction under section 32A itself and the deductions available under Chapter VI-A. In other words, the amount of investment allowance is not allowed to convert income into a negative total income. At best it is allowed to enter into the computing mechanism so as to reduce the total income to nil and no further. In this respect, he drew our attention to sub-section (3) of section 32A. Learned counsel further submitted that the deduction for investment allowance is further constrained by the conditions of creation of appropriate reserve with an option to create such reserve in the year the deduction is to be allowed under sub-section (3) of section 32A or in any earlier year not being earlier to the year in which the the machinery is installed or put to use. [Section 32A(4)(ii)]. Learned counsel further submitted that the assessee has no right of first appeal under section 246 if the claim for investment allowance is rejected where such claim is outside the scope of total income assessed. There is no specific clause under sect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of U. B. S. Publishers Distributors Ltd. v. IAC [1991] 41 TTJ 499 (Delhi-A Bench) held that no investment allowance is allowable on computers. Therefore, if the present issue is to be decided in favour of the assessee, the matter may be restored to the file of the Assessing Officer for finding out whether or not the assessee fulfils the other conditions. The learned Departmental Representative further submitted that as per section 32A the assessee can claim investment allowance only in the assessment year relevant to the previous year in which the machinery was acquired or was installed or was first put to use immediately succeeding the assessment year. In the instant case, the machineries have been installed in earlier years as can be seen from the annexure. Therefore, the primary condition for the claim of the investment allowance has not been fulfilled by the assessee. The learned Departmental Representative relied upon the judgment of the Calcutta High Court in the case of CIT v. J. Thomas and Co. Pvt. Ltd. [1977] 110 ITR 566, wherein it has been held that for claiming any concession the assessee must strictly comply with the requirements of the section. According to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it entries on the profit and loss account and the credit entry in a reserve account should be made in the relevant previous year in which the machinery or plant is installed or first put to use. It has further been held that in view of the Explanation added with retrospective effect from the commencement of the Act, to clause (a) of section 34(3) it is clear that what is contemplated is the creation of a reserve fund in the relevant previous year irrespective of the result of the profit and loss account disclosed by the books of the assessee. Mere book entries will suffice for creating such a reserve fund. The debit entries and the entries relating to the reserve fund have to be made before the profit and loss account is finally drawn up. The Supreme Court has clearly held that this is a condition for securing the benefit of development rebate and if the condition is not satisfied, the deduction on account of development rebate cannot be claimed at all. (emphasis supplied). In the case of the assessee, it is an admitted fact that in the earlier two assessment years 1988-89 and 1989-90 when the machinery was first installed and put to use, neither any reserve was created nor claim f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... claim of the assessee has been allowed by my learned Brother following his order in the assessee's own case in I. T. A. No. 157/Pune of 1995 for the assessment year 1990-91. For the reasons given by me in the dissenting order in paras. 45 to 62 (pp. 47-55) in that case it is held that the Commissioner of Income-tax (Appeals) was justified in confirming the disallowance of Rs. 31,51,000 on account of warranty provisions made in the accounts. Accordingly, the order of the Commissioner of Income-tax (Appeals) is upheld on this issue. However, the A would be entitled to deduction in respect of actual expenditure. Except as stated above, I agree with the rest of the proposed order. Order of Third Member R. V. Easwar (Judicial Member).-The following question has been referred to me under section 255(4) for decision : Whether, on the facts and in the circumstances of the case as well as in law, the assessee is entitled to deduction in respect of the provisions made for warranty liability ? The assessee is a public limited company and is engaged in the business of designing, engineering, fabrication, procurement and assembly, erection, installation and commissioning of ground ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the contentions. On behalf of the Department, it was contended that the liability in respect of the warranty was not an ascertained liability in the relevant years, that it was merely contingent, that the liability was to commence only after the boilers were delivered, that even before the delivery the assessee had created a provision in anticipation which is not permissible, that till the delivery of the boilers the liability in respect of warranty was a contingent liability which was not allowable as a deduction while computing the assessee's income. Strong reliance was placed on the orders of the departmental authorities and several decided cases. The learned Accountant Member ( AM , for short) accepted the contentions of the assessee. He held that the contract value would necessarily include the warranty costs, that such costs were properly estimated on the basis of the past experience, that the provisions made in the accounts were approved by AS-7 and standard textbooks on accountancy and that such practice was being followed by the assessee consistently in the following years. He further held that it is the principle of accountancy which is of vital importance and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of section 28 come into play and if a claim for deduction was not allowable under those provisions there was no question of allowing the same under section 28. He noted that there was no dispute that the liability was contingent and that even the learned Accountant Member had accepted this to be the position and had also held in paragraph 42 that such a contingent liability cannot be allowed as deduction under section 37(1). If that is so, it cannot be allowed as deduction even under section 28, because of the prohibition under section 37(1). In support of this view, the learned Judicial Member cited the judgments of the Supreme Court in Badridas Daga v. CIT [1958] 34 ITR 10 and in CIT v. Mysore Sugar Co. Ltd. [1962] 46 ITR 649. He held that the later judgment of the Supreme Court in Metal Box Co. of India Ltd. [1969] 73 ITR 53, on which reliance was placed by the learned Accountant Member, was contrary to the above two earlier judgments rendered by larger Benches and therefore cannot be applied to the present case. He further held that even assuming that the claim must be considered under section 28, still it was not allowable because according to him even under this section the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laim is examined under section 28, despite the fact that being a contingent liability the same is not allowable under section 37(1), still it is not allowable as deduction thereunder, for, in my view, a contingent liability does not merit deduction, under the very scheme of the Income-tax Act, while computing the profits of the business. It is no doubt true that the profits have to be ascertained on commercial principles and further that accounting principles and standards have to be given due respect or weight in computing the profits, but to hold that a claim which is sound or prudent on commercial or accounting principles must be, ipso facto, allowed as a deduction also under the income-tax law and must be so allowed irrespective of other relevant principles or considerations under the income-tax law, is unacceptable. That would open the floodgates and even claims that are made on the basis of conservative accounting or commercial practices/policies or on grounds of accounting or commercial prudence, which have no grounding under the established principles of income-tax law, would become allowable, a consequence that can hardly be countenanced. In the present case, it is not d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the other hand, the learned Judicial Member, with respect, has examined this aspect in paragraph 58 of his order. In this paragraph, he has also attempted to distinguish the decision of the Supreme Court in Metal Box Co. of India Ltd. [1969] 73 ITR 53. He has contrasted the present case with the facts in Metal Box Co. of India Ltd. [1969] 73 ITR 53 (SC) by observing that in the present case the warranty liability cannot be properly ascertained and even the estimate of 2 per cent. of the billing amount arrived at by the assessee had no basis. I am in agreement with the view expressed by the learned Judicial Member that Metal Box Co. of India Ltd. s case [1969] 73 ITR 53 (SC) is distinguishable. I would, however, add that in my view Metal Box Co. of India Ltd. s case [1969] 73 ITR 53 (SC) is distinguishable not only because the quantum of the provision made has no established basis but because-and mainly because-the provision made by the assessee in the present case is not on the basis of any statute, as in the case of Metal Box Co. of India Ltd. [1969] 73 ITR 53 (SC), wherein the liability has already been fastened on the assessee and only the quantification thereof remained to be d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y, which the provision seeks to represent, has not accrued. The fact that the claim is entered in the accounts is not conclusive of its allowability. The accounting standards or accounting or commercial principles cannot control the legal position. The correct position, in my humble view, would be that if the claim is in accordance with the legal position under the income-tax law, the fact that there are no entries made in the accounts would not be fatal to its allowability and the fact that entries have also been made in the accounts would undoubtedly support the claim ; but under no circumstances can a deduction be allowed solely on the ground that it is in accordance with the accounting or commercial principles, if the claim does not satisfy the conditions imposed by the income-tax law. The rule in Badridas Daga s case [1958] 34 ITR 10 (SC), cited by the learned Judicial Member in a slightly different context, is applicable to the present claim. According to the rule, it is necessary for the assessee to show that the claim arises out of the carrying on of the business and is incidental thereto and if that is established, the claim must be allowed "provided of course there is n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 53 (SC), which is a judgment rendered by a smaller Bench, cannot be applied to the present case. In Metal Box Co. of India Ltd. s case [1969] 73 ITR 53 (SC) it was held by the Supreme Court (pages 64-65 of the Report) that a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees and this he can do, if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. It was further held that even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account . . . These observations were heavily relied upon by the assessee before me. But, in my view, these observations have to be understood in the context in which they were made. The assessee in that case had claimed to deduct its liability under two gratuity schemes while arriving at the pro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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