TMI Blog2018 (6) TMI 1732X X X X Extracts X X X X X X X X Extracts X X X X ..... ia (P) Ltd. [ 2009 (5) TMI 16 - SUPREME COURT ] - The Hon'ble Supreme Court in the aforesaid case, discussed in detail how the accounting entries for product warranty are to be made by the Assessees. We are, therefore, satisfied that both the Appellate Authorities below were justified in returning the proper findings of facts on the relevant material before them and have rightly found that the provisions of warranty made by the Respondent-Assessee Company was on the basis of the scientific and consistent method and therefore, the present appeal of the Revenue does not give rise to any substantial question of law and the same deserves to be dismissed and is accordingly dismissed. - I.T.A. No. 243/2012 - - - Dated:- 25-6-2018 - Dr. Vineet Kothari And S. Sujatha, JJ. For the Appellant : K.V. Aravind, Adv. For the Respondent : T. Suryanarayana, Adv. JUDGMENT Dr. Vineet Kothari, J. 1. The Revenue has filed this appeal u/s. 260-A of the Income Tax Act, 1961 ['Act' for short] raising purported substantial questions of law arising from the order of the Income Tax Appellate Tribunal ['Tribunal' for short] dated 16.03.2012 in ITA No. 22( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on yearly basis at then prevailing market prices for spares and labour. For the relevant previous year, the assessee estimated the warranty liability at ₹ 12,76,77,530/- and created a provision only for ₹ 12,16,75,204/- in the books of account by charging a provision of ₹ 8,24,29,136/- to the debit in the P L account and claimed it as ITA 22(Bang)/2011 Page 5 of 7 deduction. The assessee company had created the provision based on the estimation of warranty liability, which is based on failure rates of the past year data/experience and industry trends and not on ad hoc basis. The assessee has not changed the method of computing the warranty provision and it has been followed consistently. 11.3 The decision of the Hon'ble Supreme Court in the case of Rotork Controls India Pvt. Ltd.,: 314 ITR 62 would be squarely applicable to the facts of the case. The Hon'ble Supreme Court has held that provision made on past experience is a scientific method and is the most appropriate method. The relevant extract of the decision is provided below: 'In this case, we are concerned with Product Warranties. To give an example of Product Warranties, a company deali ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CIT(A) requires no further interference on the issue. The revenues's appeal stands dismissed.' 11.5 In view of the above facts and the decision referred above, we hold that disallowance of provision of warranty is to be deleted and it is ordered accordingly. Following the above decisions, we hold that the CIT(A) is not justified in upholding the disallowance of provision for warranty and accordingly allow the ground of appeal of the assessee on this issue. 3. The Assessing Authority in the present case disallowed the entire amount of such provision of warranty of ₹ 10,16,76,422/- [Rupees Ten Crores Sixteen Lakhs Seventy six Thousand Four Hundred and Twenty Two only) by holding in para 5 of the impugned Assessment Order, Annexure-A dated 18.12.2009. that the system of making of the provision for warranty by the Assessee-Company was not scientific and the reversal of the provision at the year end in view of the actual claims made by the customers was huge, varying from 23% to 100% and therefore, since the Assessee has not followed the scientific system of making a provision in this regard, the entire amount of provision deserves to be disallowed and the same ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase I have held that if the expenditure is above 66% of the provision made it should be treated to have a scientific basis. In this case the provision made is ₹ 1,01,676,472/- whereas the expenditure is ₹ 4,09,123/- i.e., 40%. Hence on facts I hold that the AO is justified in making the disallowance and also justified to restrict the same to ₹ 6,06,97,349/- vide order passed u/s. 154 dated 18-02-2010. 8. Result: Appeal is dismissed. 5. The Second appeal filed by the Revenue before the Tribunal also failed. Hence, the present appeal before us by the Revenue. 6. The Learned Counsel for the Revenue Mr. K.V. Aravind submitted that the Assessing Authority had followed the decision of the Hon'ble Supreme Court and finding that the Respondent-Assessee company had not adopted the scientific basis for creating provision for warranty and therefore, the provision in this regard was rightly disallowed by the Assessing Authority. 7. On the other hand, the Learned Counsel for the Respondent-Assessee Mr. T. Suryanarayan, brought to our notice that the initial provision created after ascertaining the actual amount spent out of such provision, taking into account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... order. 9. We are absolutely at a loss to understand how the Assessing Authority has found the said consistent practice of the Assessee-Company to be unscientific and untenable and then proceeded to disallow the entire claim of provision made by the Assessee-Company in this regard. Neither allowing the provision made for warrantees nor the actual expenses incurred by the company to be deducted from the profits of the company during the year is absolutely arbitrary and unscientific on the part of Assessing Authority, to say the least. There was absolutely no basis for the Assessing Authority to make both the disallowances of provision for warranty as well as actual expenses at the same time in the hands of the Respondent-Assessee. In view of the comparison of actual expenses and provisions made for warranty, the details of which are given in the Assessment Order itself, we do not find any abnormal fluctuation or excess provision made by the Assessee-Company on this account. 10. We express our concern and dissatisfaction at the manner in which the Assessing Authority in the present case has very casually disallowed the said claim in the hands of the Respondent-Assessee. Moreover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eates 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alve Actuators are sold and the warranty costs are an integral part of that sale price then the appellant has to provide for such warranty 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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