TMI Blog2011 (1) TMI 657X X X X Extracts X X X X X X X X Extracts X X X X ..... . 1. Before pointing out the questions of law which were framed while admitting this appeal and to answer those questions, we deem it appropriate to take note of the facts under which these questions have arisen for consideration. 2. In the assessment year 1996-97 relevant to financial year 1995-96, the respondent/assessee had filed its return of income on 30th November, 1996 declaring a loss of Rs. 48.71 crores. This income was assessed under Section 143 (3) of the Income-Tax Act (hereinafter referred to as the Act‟) making various additions. The Assessing Officer assessed the loss at Rs. 45.25 crores instead of Rs. 48.71 crores as declared by the assessee. We are concerned here with only two such additions which are as under:- (i) The assessee had made 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 Assessing Officer (AO) under Section 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tain years, the provision for warranty amount had depleted sharply and in two years it had been reduced to Nil‟. The position during the year ending 31st March, 1996 i.e. previous year relevant to the assessment year was as under:- Financial Year Balance Available Remaining Years of Warranty 1989-90 21,99,424 1 1990-91 0 2 1991-92 0 3 1992-93 38,40,204 4 1993-94 71,71,092 5 1994-95 2,38,72,473 6 3,70,83,193 7. The assessee thus felt shortages in warranty liability account. It entrusted the matter to a qualified independent actuary to study all the invasions and undertake actuarial valuation of warranty provisions. It is claimed by the assessee that on the basis of the report undertaken by the independent agency applying the scientific 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 variations/shortfall in the warranty provision on account of different years has arisen due to various reasons l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d law that even though there is some difficulty in estimation, it would not convert the accrued liability into an additional one or a contingent liability. Reference can be made to the decision of Hon‟ble Supreme Court in the case of Calcutta Co. Ltd. 37 ITR 1 and that of Bharat Earth Movers Ltd. 245 ITR 428. The Hon‟ble Karnataka High Court in the case of Motor Industries Co. Ltd. (supra) held that where the assessee is required to make provision for additional gratuity liability pertaining to the past services, the same is held to be an allowable deduction. Thus the ration laid down can help the case of the assessee in the sense that even if the sales were affected in the past, the additional liability on the re-appreciation of the material on hand will acquire the assessee to make provision for additional liability if the situation so demand and can be claimed as deduction. The decision of Hon‟ble Delhi High Court in the case of CIT Vs. Vinitec Corporation Pvt. Ltd. (supra) relied upon by the learned DR laid down that provision for future liability under warranty which is under the Warranty Clause of sale document is a current liability though actual quantifica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deferred longest life policy, with the said insurance company in their names, but in favour of Harvey and Mrs. Harvey for an annuity of Pound 558-1-0 per annum payable during their joint lives from the date of Harvey's superannuation and during the lifetime of the survivor, provided further that if Harvey died before attaining the age of 55 years, the annuity payable to Mrs. Harvey would be Pound 611-12-0 during her life. It was further provided that if Harvey dies before attaining the age of 55 years, the trustees would stand possessed to the capital value of the deferred annuity policy, upon trust to purchase therewith an annuity for Mrs. Harvey with the above insurance company or with any other insurance company of repute. In furtherance thereof, the trustees took out a policy on January 12, 1949 and paid early premia for few years before Harvey died. The premium 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etirement or termination of their services and the liability to pay gratuity became the accrued liability of the assessee, when the employees retired or their services were terminated. Until then the right to receive gratuity is a contingent right and the liability to pay gratuity continues to be contingent liability qua the employers. An employer might pay gratuity when the employee retires or his service is terminated and claim the payment made as an expenditure incurred for the purpose of business under Section 37. He might, if he followed the mercantile system, provide for the payment of gratuity which became payable during the previous year and claim it as an expenditure on accrued basis under Section 37 of the said Act. Since the amount of gratuity payable in any given year would be a variable amount depending upon the number of employees who would be entitled 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the surplus staff must depend upon several hypothetical contingencies and denied the deduction of the aforesaid provision. 14. We may take note of a decision of this Court in CIT Vs. Vinitec Corporation (P) Ltd. 278 ITR 337 which is referred by the Tribunal also. In that case the assessee had claimed deduction under Section 37 of the Act, inter alia, on the provision made by it in the year against future claims by customers under the warranty clause which was part of the sale. The AO disallowed the claim on the ground that it was a contingent liability. The Tribunal, however, accepted the assessee‟s claim holding that the liability was definite and certain quantification was done on estimate basis after taking into consideration the data for past years of the percentage of warranty expenses. The High Court affirmed the decision of the Tribunal holding 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, i.e. in favor of the assessed and against the Revenue." It will be useful for us to make a reference to the judgment of the Privy Council in the case of Commissioner of Inland Revenue (supra) where the Privy Council dealing with a taxpayer who was selling new motor vehicles to the dealers to indemnify them against warranty claims which, in turn, resulted in providing of warranty clause for 12 months from the date of delivery to the purchaser by the dealer, held as under :- "Held, dismissing the appeal, that, although the taxpayer's liability under the warranty for each vehicle sold was contingent on a defect appearing and being notified to the dealer within the warranty period so that no liability was incurred by the taxpayer until those conditions were satisfied, 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Court then proceeded to determine as to what would be the most appropriate method for making a provision for product warranty‟, based on historical trend and held that:- (a) It should be based on historical trend and for determining a proper historical trend, the company should have proper accounting system for capturing of sales, warranty provisions made and the actual expenses incurred subsequently. (b) 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 based on past experience. (c) The warranty provision for the product should be based on estimate at year end of future 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 asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see no reason as to why the assessee could be precluded from revising this provision after taking into consideration that warranty period of the goods sold under warranty was existing provision already provided in a particular is falling short of the expected claims that may be received. It is, however, to be kept in mind that such a provision is based on scientific study and actuarial basis that is precisely done by the assessee in the instant case and, therefore, we see no reason to differ with the view taken by the Tribunal in the impugned order. We, therefore, answer this question no. (a)‟ in the affirmative. RE: ROYALTY PAYMENT 21. The assessee had paid royalty to the tune of Rs. 70.66 lacs which was disallowed by the AO under Section 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 February, 1995 which was duly approved by the Government of India. Under this agreement, the assessee was to pay to its foreign co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the payment was made but paid in this year. This Court in CIT Vs. Nestle India Ltd. 275 ITR 1 analysed and explained the aforesaid provision in the following manner:- It is a settled canon of interpretation of law that wherever a provision uses plain and simple language free of ambiguity such provision should be given its plain meaning without addition or subtraction of any expression into the language of the provisions. The scope of Section 40 spells out what amounts are not deductible from the income charged to tax under the profits and gains of business or profession. Thus, the Section indicates what ought not to be excluded despite anything provided under Section 3 to 38 of the Act where in the case of an assessed any interest 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-Section (1) of Section 200 shall not be deducted. The Section has three ingredients (a) Royalty which is payable outside India or in India to a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ur in the same financial year that does not even appear to be the legislative intent inasmuch as Section provides in the situation where deduction is made in one year and is deposited/paid in another year. In our view, the most significant aspect of this provision is its payment within the time specified in law. We have already noticed that the authorities had found it as a matter of fact that the payments of the tax deducted at source were made within the prescribed time . 26. Same approach was adopted by this Court in CIT Vs. Oracle Software India P. Ltd., 293 ITR 353. That was also a case where the assessee paid royalty in the assessment year 1994-95 and tax deducted thereof was deposited in the year 1995-96 i.e. within the time provided by the statute. The Court held that the assessee would be entitled to claim deduction in the assessment year 1994-95. 27. Following these judgments, we are of the view that the assessee should have claimed the deduction in the assessment year in question i.e. 1995-96. It is more so, when proviso itself stipulates that the same shall be allowed as deduction in the year in which it is either paid or deducted under Chapter XVII-B of the Act. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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