TMI Blog2003 (9) TMI 11X X X X Extracts X X X X X X X X Extracts X X X X ..... Commissioner of Income-tax (Appeals) has filed these three appeals against the separate orders of the Income-tax Appellate Tribunal, Cochin Bench (for short "the Tribunal"), in the case of the same respondent-assessee for different assessment years 1991-92, 1992-93 and 1993-94, respectively. Since the question involved in all the three cases is one and the same, these appeals are disposed of by this common judgment. The matter arises under the Income-tax Act, 1961 (for short "the Act"), in respect of a claim made by the respondent-assessee under section 37 of the Act. The respondent-assessee is a company engaged in the business of manufacture and sale of electrical transformers. In the assessment for the years 1991-92, 1992-93 and 1993-94, the assessee claimed deduction of Rs. 3,50,000, Rs. 4,01,000 and Rs. 4,78,000, respectively, representing provision for after sales services based on the warranty issued at the time of sale of the transformers. The Assessing Officer disallowed the claim and added back the provision mainly on the ground that the provision is made in respect of a contingent liability and not in respect of a definite and ascertained liability. However, the said c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ananthakrishnan for the respondent, submitted that the assessee had made the provision for after sales services based on the warranty issued to the customers in the accounting period during which the sales of transformers were effected to the customers from its experience and on a reasonable basis which is a permissible deduction. Senior counsel took us to the order of the Commissioner of Income-tax (Appeals) where the said authority has noted the submission of the authorised representative of the appellant that the claims made towards repairs and after sales service charges during the warranty period were being allowed year after year and that the first appellate authority has clearly noted that in the case of MES, Goa, the appellant had made a provision for Rs. 42,000 towards replacement of HF/LV coils and leak repeated failure of the transformers and had obtained excise permission for warranty and that in the case of BHEL a provision for Rs. 90,000 has been made based on the claim made by them during the previous year. Senior counsel further pointed out that the BHEL had sent a letter dated October 20,1990, to the appellant wherein it was H mentioned that they had purchased te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... swered. In the above circumstances, we will refer to the findings of the three authorities on this question. The Assessing Officer in the assessment order (annexure A) has dealt with the issue thus: "The assessee had debited the profit and loss account with Rs. 3,50,000 representing provision for after sales service. The assessee was asked to file the correspondences to come to the conclusion that the repairs or defects were intimated to the assessee on or before March 31, 1991, and also working sheets as to how the provision for after sales service was worked out for each item of defect. The assessee filed a list in which only the name of the machinery and the amount of provision is mentioned. The assessee has not filed the intimation received from the purchase parties of transformers intimating the defect. In case the defect is intimated to the assessee only after March 31, 1991, this will be allowed only in the next year. Some of the correspondences filed by the assessee shows that it relates to subsequent years. Further, the exact working as to how each amount was arrived was also not filed. As seen from Schedule 11 of the balance-sheet, the assessee has written back Rs. 12,2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessment years 1991-92 to 1995-96 and against the actual expenditure on repairs in respect of machines sold by the assessee and pointed out that as against the provision of an amount of Rs. 3,50,000 created for the previous year relevant to the assessment year 1991-92, the actual expenditure incurred was Rs. 7,98,958 debited to the accounts in the subsequent year. The Tribunal also observed that the authorised representative had clarified that a sum of Rs. 12,23,381 brought back to the accounts as provision no longer required did not represent expenses for repairs under warranty. It is also observed that the details furnished showed that the said amount represented pro forma credits, sales tax provision for various years and various expenses like legal charges, advertisement charges, etc. The Tribunal thereafter considered the matter thus: "Considering the submissions on both sides and on verifying the facts, we are of the view that the Commissioner of Income-tax (Appeals) was justified in holding that the assessee was entitled to deduct the sum of Rs. 3,50,000 representing the provision for repairs. It is not disputed that the provision was created for repairs/replacement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessment year 1991-92 itself defects in the transformers supplied were brought to the notice of the assessee and that the second transaction referred to in the appellate order is in respect of ten transformers supplied to BHEL and that all the ten transformers failed within a year of operation which resulted in serious dislocation of production at Rourkela. It is also relevant to note that the BHEL itself had brought this fact to the notice of the chairman of the GEC and requested him to give serious attention to the quality. The Tribunal considered the further fact that the actual expenses incurred for the assessment year 1991-92 was Rs. 7,98,958 as against the provision made for Rs. 3,50,000. The Tribunal had also noted that the amount of Rs. 12,23,381 written back as the provision did not relate to the warranty claim. Thus it is clear that the Tribunal has found as a fact that the claim of deduction for the amount of Rs. 3,50,000 made towards after sales services is an ascertained liability. We do not find any illegality in the said finding of the Tribunal. As already noted if the finding of the two appellate authorities that the provision made is for an ascertained liability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns would show that if the provision made is towards a contingent liability and not for a liability in praesenti, such provision is not deductible under section 37. In other words if the provision made is towards an actual liability in praesenti it is deductible. The decision of the Privy Council in Mitsubishi Motors New Zealand Ltd.'s case [1996] 222 ITR 697, relied on by senior counsel for the assessee is relevant. In that case the taxpayer sold new motor vehicles to dealers undertaking to indemnify them against warranty claims. On selling a vehicle to a purchaser the dealer gave the purchaser a warranty in respect of defects in materials or workmanship appearing within 12 months after delivery, subject to the purchaser returning the vehicle to the dealer with notification of the defect. Based on statistical information the taxpayer estimated that 63 per cent, of all vehicles sold would contain defects requiring repair under warranty. In calculating its assessable income for the year ending December 31, 1988, the taxpayer claimed as a deduction the amount of a reserve for its anticipated liabilities under unexpired warranties in respect of vehicles sold in that year. In assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... committed" to the expenditure. Regarding the warranty liabilities the Privy Council observed as follows: "The evidence of accounting practice adduced before Doogue J. left no doubt about the proper treatment of the outstanding warranty liabilities. They were part of the cost of the vehicle sales and therefore, so far as capable of reasonable estimation, should be matched against the corresponding revenue. The evidence satisfied the judge that a reasonable estimate could be placed upon the anticipated liabilities. All vehicles which leave the taxpayer's assembly plant at Porirua have been tested and examined for defects. So far as the taxpayer is aware, there is nothing wrong with them. Nevertheless, experience shows that in many cases, a defect will be discovered during the warranty period. Often it is no more than a blemish in the paintwork. Sometimes it is more serious. Sixty three per cent, of the vehicles sold by the taxpayer in the year 1988 were returned to the dealers for some kind of work to be done under the warranty. Although it cannot of course be predicted whether any particular vehicle will turn out to be defective or how serious the defect will be, the taxpayer can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mate to have regard to the evidence establishing that 63 per cent., would in fact have had defects. This, however, is not in itself enough to show that a liability was incurred. As has been said, their Lordships agree with the Court of Appeal that the language in which the warranty was expressed made liability dependent upon the manifestation and notification of the defect within the 12 months period. But the Australian authorities show that the question of whether the taxpayer is 'definitively committed' to an expenditure or whether it is merely 'impending, threatened or expected' (to adopt the language used in the leading case of Federal Commissioner of Taxation v. James Flood Pty. Ltd. [1953] 88 CLR 492, 506-507) does not depend simply upon whether future events which may determine liability are expressed in the language of contingency or defeasance. Their Lordships think it would be strange if a concept so eminently practical as the computation of profits for income-tax depended upon theoretical distinctions more appropriate to the rule against perpetuities. The question is rather whether, in the light of all the surrounding circumstances, a legal obligation to make a payment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain". The decision of the Privy Council is almost on the point. Even though the warranty provides for that the purchaser returning the vehicle to the dealer with notification of the defect within 12 months after delivery, the taxpayer had made provision on an estimated basis even before any such event on the basis of the statistical information that 63 per cent, of all vehicles sold would contain defects requiring repair under warranty. The provision made based on this experience was held to be deductible. In the present case also, as we have already noted, the two instances of defects came to the notice of the assessee of which one was with respect to ten numbers of transformers sold to BHEL and as per the complaint all the transformers failed within one year of such purchase. This gave a clear picture that a major portion of the transformers sold were defective and therefore a reasonable provision has to be made. We have noted that for the assessment year, the assessee had made ..... X X X X Extracts X X X X X X X X Extracts X X X X
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