TMI Blog2019 (3) TMI 1782X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... same to P L Account. Declining the contention raised by the assessee, AO proceeded to disallow the amount of ₹ 2,13,40,735/- created and charged to P L Account by the assessee on the ground that the provision is made merely on estimated basis, and as such reliability and correctness of basis cannot be ascertained. 3. Assessing Officer also noticed that the assessee has debited an amount of ₹ 2,97,93,143/- to its P L Account on account of technical know-how. Declining the contention raised by the assessee that expenses on technical know-how is in the nature of revenue expenditure disallowed the same u/s 37 of the Act, However, classified the technical know-how as an intangible assets and granted depreciation at 25% and thereby made addition of ₹ 2,23,44,857/-. 4. Assessee carried the matter before the Ld. CIT(A) by way of filing the appeal who has deleted the addition by partly allowing the appeal. Feeling aggrieved the revenue has come up before the Tribunal by way of filing the present appeal. 5. We have heard the ld. DR for the revenue and gone through the order passed by the lower revenue authority. Ground no. 1 : 6. Undis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 the case of a manufacture and sale of one single item the provision for warranty could constitute a contingent liability not entitled to deduction under Section 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative to settling that obligation. In the present case, the appellant has been manufacturing and selling Valve Actuators. They are in the business from assessment years 1983- 84 onwards. Valve Actuators are sophisticated goods. Over the years appe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ranty costs in its account for the relevant year, otherwise the matching concept fails. In such a case the second option is also inappropriate. Under the circumstances, the third option is most appropriate because it fulfills accrual concept as well as the matching concept. 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 assessment of the warranty provisioning policy is required particularly if the experience suggests that warranty provisions are generally reversed if they remained unutilized at the end of the period prescribed in the warranty. Therefore, the company should scrutinize the historical trend of warranty provisions made and the actual expenses incurred against it. On this basis a sensible estimate should be made. The warranty provision for the products should be based on the estimate at year end of future warrantyexpenses. Such estimates need reassessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also brought on record relevant extract of claim inspection register / claimed defect identification qua the complaint filed by the purchasers of the tyre as Annexure 6 and also brought on record letter issued for replacement reward in respect of aforesaid complaint as annexure 7 , copy of relevant ledger extract qua aforesaid warranty reward and copy of new invoice issued post warranty award reducing the warranty claim for product price as annexure 9 . 12. Ld. CIT(A) on the basis of account ledger, complaint register, sale invoice qua sales made to Avatar Tyres, relevant extract of claim inspection register / claim defect identification, copy of letter issued for replacing reward copy of new invoice issued post aforesaid warranty award etc. reached the conclusion that the provision for warranty expenses made by the assessee in the books of accounts qua the year under assessment was created out of actual warranty expenses on scientific basis in view of ratio of Rotark Controls India Ltd. Vs. CIT 314 ITR 62 (SC) (supra). 13. So when the year under assessment is first year of operation of the assessee who is manufacturer and trader of tyres of heavy vehicles sold alo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n CIT vs. Sharda Motor Industries Ltd. 319 ITR 109 (Del. HC), CIT vs. Hero Honda Motors Ltd. 372 ITR 481 (Del.HC). 18. The Ld. DR supported the assessment order by relying upon decision rendered by Hon ble Supreme Court Honda Siel Car India Ltd., And decision rendered by co-ordinate bench of Tribunal in case cited as Semoco Electrical Pvt. Ltd. 19. Hon ble Delhi High Court in case of Sharda Motors Industries Ltd. (Supra) decided the identical issue of transfer of technical knowhow and allowed the payment of the same as revenue expenditure by relying upon decision rendered by Hon ble Delhi High Court in case cited as CIT vs. J.K.Synthetics Ltd. [2009] 309 ITR 371 (Delhi) by returning following findings :- 5. In CIT v. J. K. Synthetics Ltd. : [2009] 309 ITR 371 (Delhi), after elaborately discussing the entire case law on the subject, the court culled out the broad principles to determine as to whether expenditure in a particular case would be capital or revenue expenditure. One of the principles enumerated therein reads as under (pages 412413): (v) expenditure incurred for grant of licence which accords 'access' to technical knowledge, as against ' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of facts and circumstances, Hon ble Delhi High Court in case cited as Hero Honda Motors Ltd (supra). held the payment made by the assessee for using technology licensed by Hero Honda Motors as revenue expenditure by returning following findings :- Section 37(1) of the Income tax Act, 1961- Business expenditure-Allowability of (Royalty)- Assessment years 2000-01 to 2002-03- Assessee was joint venture between Hero Group and Honda, Japan, for manufacture and sale of motorcycle using technology licenced by Honda Assessee and Honda thereupon entered into an agreement called licence and technical assistance agreement in terms of which assessee paid royalty to Honda- Assessee claimed deduction of said payment under section 37(1) Assessing Officer rejected assessee s claim holding that it was in nature of capital expenditure- Tribunal, however, allowed assesssee s claim Whether since payment in question was for acquiring rights to use technical know how and ownership of intellectual property rights in know how remained with Honda Japan, Tribunal was justified in holding that said payment was to be allowed as revenue expenditure Held, yes [Paras 16 and 21] [In favour of ..... 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