TMI Blog2008 (1) TMI 417X X X X Extracts X X X X X X X X Extracts X X X X ..... ICAI. In the type of contract that assessee had with M/s IOC, no doubt recognition of revenue on percentage completion basis is itself an estimation, since such profits are so estimated even before a project is complete. Therefore, it is only prudent that all possible expenditures are also taken into account. Since accrual system has to be followed by a company, it is very much necessary that liabilities that are crystallised though difficult to be quantified are accounted for. It is true that there are inter-head variations between the technical estimates and actual spending, but that is well explained from the fact that one is an estimate and the other actual. Thus, assessee has been able to justify the provisioning and its quantum in a reasonable manner. The Madras High Court decision in CIT vs. Rotork Controls [ 2007 (2) TMI 200 - MADRAS HIGH COURT] what can be discerned is that warranty provisioning is allowable, if supported by sufficient data to justify such provisioning and is based on statistical or other relevant data. We have no hesitation in the facts of the case to hold that 5 per cent of the warranty provisioning done by the assessee was made against ascertain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed revenue expenditure written off by the assessee, made by the AO in the relevant previous year for computing book profit I for the purpose of s. 115JB. Hence, Grounds 1 and 2 of the Revenue are dismissed. In the result, appeal of the Revenue is dismissed. To sum-up, assessee's appeal is partly allowed for statistical purposes and Revenue's appeal is dismissed. - K. C. Singhal Judicial Member And Abraham P. George Accountant Member For the Assessee : Percy J. Pardiwalla For the Revenue : Rajeev Nabar ORDER ABRAHAM P. GEORGE, A.M.: These are cross-appeals arising from the order of CIT(A)-X, Mumbai. Assessee's appeal and Revenue's appeal are taken up in that order for disposal. ITA No. 7729/Mum/2004 2. In its ground number one assessee is aggrieved that CIT(A) confirmed AO's disallowance of performance warranty provision of Rs. 4,83,72,135 for computing income under normal income-tax provisions. In its second ground, assessee is aggrieved that for the purpose of computing book profits as per s. 115JB also, AO made addition of the above provision. Ground number three of the assessee is against CIT(A) not deleting interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. (ii) Onus of ensuring satisfactory performance of the facility rested with the appellant since the contracts with M/s IOC had a defect liability period of twelve months from the date of completion or commissioning of the facility. (iii) Provision of 5 per cent on progressive billings was made after a detailed technical assessment carried out by qualified technical engineers to, determine the nature and type of defects performance failures which could arise under the various components of the construction work. (iv) Para 17.4 of AS-7, which is the Accounting Standards for Construction Contracts promulgated by the ICAI requires appropriate allowance to be made for future unforeseeable factors either on a specific or a percentage basis, and hence this provision was made in strict compliance with such Accounting Standards. 2.4 While making the above submissions before learned CIT(A) reliance was also placed by the assessee on the following cases: (a) Voltas Ltd. vs. Dy. CIT (1987) 64 ITR 232 (Bombay); (b) ITO vs. Warson (India.) Ltd. (1994) 51 ITD 102 (Pune); (c) IRC vs. Mitsubishi Motors New Zealand Ltd. (1996) 222 ITR 697 (PC). 2.5 Assessee's submission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nite and ascertained liability and confirmed the order of the AO on this aspect. Addition, of this amount for computation of book profit under s. 115JB was also sustained by learned CIT(A), since according to him such provisions were contingent and not ascertained. However, for the purpose of computing book profit under s. 115JB, CIT(A) directed the AO not to make the addition of Rs. 1,00,18,189 on account of differential amount of preliminary and deferred revenue expenses written off, accepting the contentions of the assessee that s. 115JB did not allow such addition. 2.7 For sustaining the AO's order, disallowing the provision for performance warranties in the normal computation as well as for the MAT computation under s. 115JB, learned CIT(A) gave the following reasoning: (i) The liability has been estimated by applying the principle of probability of happening of some event, which mayor may not occur, as could be made out from the technical assessment prepared by technical engineers appointed by the assessee itself. According to the CIT(A), terminology used by the technical engineers in such assessment tended to rely on certain terms which only point to the likely def ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... already stated, ground Nos. 1 and 2 relate to the same issue of addition of Rs. 4,83,72,135 on account of provisions for performance warrantee, first for computing the income under the normal provisions and second for computing the book profit under s. 115JB. 2.10 In the submissions before us, the learned Authorised Representative reiterated all the grounds raised before the AO as well as the CIT(A), with gusto. He further submitted as follows: (i) As per the contract with Indian Oil Corporation (in short IOC), the assessee had given a security deposit of 10 per cent of contract value. The learned Authorised Representative brought to our notice paper book pp. 68 to 238 which is a copy of the relevant clauses as contained in the agreement between the assessee and M/s IOC (hereinafter referred to as the agreement). At p. 84 the clause captioned 'Security deposit' clearly states that the security deposit of 10 per cent of contract value had to be given to IOC, which would be released by them only on completion of 12 months from the date storage facility is completed by the assessee, in line with its bid package. (ii) As per cl. 15 of the agreement as it appears at pap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng practice. (viii) Assessee is supported by the decision of Hon'ble Bombay High Court in CIT vs. Associated Cables (P) Ltd. (2006) 206 CTR (Bom) 580 : (2006) 286 ITR 596 (Bom), wherein it was held that even retention money withheld by contractees pending completion of contract work does not accrue to the assessee contractor in the year in which the amount is retained. (ix) Assessee is also supported by the following decisions: (a) Bharat Earth Movers vs. CIT (2000) 162 CTR (SC) 325 : (2000) 245 ITR 428 (SC); (b) IRC vs. Mitsubishi Motors New Zealand Ltd.; (c) CIT vs. Indian Transformers Ltd. (2004) 192 CTR (Ker) 216 : (2004) 270 ITR 259 (Ker) (d) CIT vs. Vinitec Corpn. (P) Ltd. (2005) 196 CTR (Del) 369 : (2005) 278 ITR 337 (Del) 2.11 The learned Departmental Representative made his reply submissions as follows: (i) The technical assessment cited point out to only certain common problems that could arise in the future and did not give rise to an ascertainable or ascertained liability. (ii) Actual expenditure incurred by the assessee against the provision when compared to the head-wise provisioning made by the technical experts varied substantially. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... had followed percentage completion method for accounting its income, which is a prudent one as evident from AS-7 of ICAI and no doubt vide s. 211(3) of the Companies Act, 1956, a company is bound to follow the Accounting Standards promulgated by ICAI. Assessee company was thus having no option but to follow this Accounting Standard. This Accounting Standard itself is based on the 'principle of prudency' in maintenance of accounts, whereby an entity is prevented from projecting excessive profits without considering all possible outgoes. In the type of contract that assessee had with M/s IOC, no doubt recognition of revenue on percentage completion basis is itself an estimation, since such profits are so estimated even before a project is complete. Therefore, it is only prudent that all possible expenditures are also taken into account. Since accrual system has to be followed by a company, it is very much necessary that liabilities that are crystallised though difficult to be quantified are accounted for. 2.14 In the case of Bharat Earth Movers, the Hon'ble Supreme Court has given a guiding principle, where such liabilities have arisen though not quantifiable with cert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ning for warranty based on past data which showed that: (i) Ten transformers sold by the concerned assessee to M/s BHEL had failed and (ii) Actual expenses on account of warranty period repairs for the preceding year were Rs. 7.99 lakhs against provision of Rs. 3.5 lakhs. 2.18 The common vein running through all the above cases is that there was sufficient past data with the assessee to justify the reasonableness of the warranty provisioning done. 2.19 On the necessity of past data for determining whether provisioning was justified in the case of CIT vs. Rotork Controls India Ltd. decided by Hon'ble Madras High Court is very relevant. In this case, assessee could not adduce data on actual incidence of liability under warranty, based on any past data as a percentage of turnover. Hon'ble High Court came to a conclusion in this case that the existence of elements of certainty was not there and that the liability could not be substantiated by the party concerned. The dictum evolving out of the judgment of Hon'ble High Court is that unless actual expenses incurred against provisioning could be substantiated for justifying the quantum or unless a basis for the pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,06,79,133, as against the warranty provisioning of Rs. 4,83,72,135. Revenue has not controverted these figures except for that heads under which actual expenses for rectification for damages were spent and the heads under which technical assessment were done varied. It is true that there are inter-head variations between the technical estimates and actual spending, but that is well explained from the fact that one is an estimate and the other actual. Thus, assessee has been able to justify the provisioning and its quantum in a reasonable manner. 2.21 In all the cases referred to supra, including the Madras High Court decision in CIT vs. Rotork Controls what can be discerned is that warranty provisioning is allowable, if supported by sufficient data to justify such provisioning and is based on statistical or other relevant data. We have no hesitation in the facts of the case to hold that 5 per cent of the warranty provisioning done by the assessee was made against ascertained liability, very much reasonable and made on relevant data. Hence, we hereby set aside the CIT(A)'s order confirming non-allowance of deduction of performance warranty of Rs. 4,83,72,135 in computing the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... granted prior to 1st June, 2003, being the date on which the said section was enacted, has already been referred to the Special Bench of this Tribunal. Hence, we feel it appropriate to set aside the CIT(A)'s order on this aspect so that the AO can decide it afresh. Therefore, this ground of the assessee is allowed, CIT(A)'s order is set aside, and matter remitted back to AO for deciding the matter afresh, taking into consideration the Special Bench's directions in this regard. 3.2 Hence, Ground 3 of the assessee is allowed, to the extent stated above. 4. In the result, appeal of the assessee is partly allowed for statistical purpose. ITA No. 7412/Mum/2004 5. Revenue has raised two grounds against CIT(A)'s order. Both are confined to the same issue and relate to CIT(A) deleting an addition of Rs. 1,00,18,189 for computing the net profit under s. 115JB of the Act. This amount was preliminary and deferred revenue expenditure written off by the assessee during the relevant previous year. 5.1 Facts relating to this issue run as follows. Assessee company had in its P L account, fully written off, what was remaining in balance under the head 'Pre1imina ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .4 Learned CIT(A) accepted the contentions of the assessee and deleted this addition. For coming to this conclusion learned CIT(A) based himself on the following: (i) Use of the words in accordance with provisions of Parts II and III of Sch. VI of the Companies Act in s. 115J was made for the limited purpose of empowering the AO to rely on the authentic statement of accounts of the company as decided by Hon'ble Supreme Court in Apollo Tyres. (ii) Sub-s. (1A) of s. 115J does not empower the AO to embark upon a fresh enquiry in regard to the entries made in the books of accounts by a company. (iii) By changing its accounting policy, in writing off the balance in 'preliminary and deferred revenue expenses', assessee had not violated any of the Accounting Standards or guidelines of ICAI. (iv) Explanation to s. 115JB has not prescribed any adjustment of like nature to be made to the net profit for computing book profit and in view of the Hon'ble Supreme Court's decision, cited supra, AO was prohibited from making and such adjustment to the book profit. 5.5 Before us the learned Departmental Representative relied on assessment order and submitted that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch accounts laid before its AGM. There has been no finding by the AO that assessee had not followed this mandate regarding accounting policies/standards. Accounting Standards and policies of ICAI nowhere state that there cannot be a change in an accounting policy by a company. What the auditors have done is to give in their note the effect of such change in assessee's profit, in the instant case. This in no way means that the assessee had not followed provisions of Parts II and III of Sch. VI to the Companies Act. 1956 in preparation of its accounts. There is no case for the Revenue that assessee had adopted any different set of standards or policies vis-a-vis the accounts laid by it before the AGM. By writing off the balance remaining under its head 'Preliminary and deferred revenue expenditure' assessee was only doing what was prudent, in that, it was removing from the asset side of its balance sheet a non-productive item, and which in any case was not an asset at all. Therefore, it was not doing anything contrary to any ICAI guidelines. CIT(A) was very much right in following the law laid down by Hon'ble Supreme Court in Apollo Tyres, referred supra, according t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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