Brief of the Case
Delhi High Court held In the case of Seagram Distilleries Pvt. Ltd. vs. CIT that in the current case there is no reasonable scientific method adopted by the Assessee to estimate the transit breakages to justify such provision. The provision would, in the circumstances, be a provision for a contingent liability and, therefore, in terms of the AS- 29 ought not be recognised. The actual transit breakages as and when they occur are allowable as revenue expenditure in the accounting year in which such breakages occur.
Facts of the Case
The Seagram Distilleries Private Limited was a 100% subsidiary of Seagram India Private Limited engaged in the business of manufacture and sale of Grain Neutral Spirit (GNS) and India Made Foreign Liquor (IMFL) from its Nasik plant. The parent company, originally incorporated under the Companies Act, 1956 on 3rd September, 1993 under the name and style of Seagram India Private Limited, changed its name to Pernod Ricard India Private Limited (PRIPL) and obtained a fresh certificate of incorporation on 23rd April, 2007. Thereafter, Seagram Distilleries Private Limited was merged into the parent company, PRIPL by a scheme of amalgamation which received sanction from this Court vide an order dated 8th October 2010.
Assessee’s products are transported in glass bottles by roads to various states in the country. According to him, since the bottles are prone to breakages, he while dispatching the goods make a provision for breakages on the basis of the past history of the region to which the goods are transported. Once the goods reach their intended destination he reverses the provision and debits the actual breakages to the profit and loss account. The AO held that in case of breakage and pilferage the liability is not certain. Consequently, the provision made was treated as a contingent liability and, therefore, not allowable. It was added back to the total income of the Assessee.
Contention of the Assessee
The ld counsel of the assessee relied on the decisions in Bharat Earth Movers v.CIT 245 ITR 428 (SC), Commissioner of Income Tax v. Vinitec Corporation P. Ltd. 278 ITR 337 (Del), Commissioner of Income Tax v. Insilco Ltd. 179 Taxman 55 (Del), Commissioner of Income Tax v. Sony India Pvt. Ltd.  160 Taxman 397 (Del), Commissioner of Income Tax v. Beema Manufactures Pvt. Ltd.  130 Taxman 162 (Del) and Commissioner of Income Tax v. Hewlett Packard (P) Ltd.  173 Taxman 162 (Del) to urge that the provision for transit breakages, having been calculated on a scientific basis, was an allowable deduction under Section 37(1) of the Act.
Relying on the decision in Commissioner of Income Tax v. Balaji Distilleries Ltd. 126 Taxman 264 (Madras) and Commissioner of Income Tax v. Brindavan Beverages (P) Ltd. 335 ITR 163 (Karn), he submitted that transit breakages were normal to the bottling business and, therefore, allowable as a revenue expenditure. By the same analogy, the provision for said breakages should also be allowed particularly since the provision was reversed on the opening day of the following year. Thereby, there was no loss to the Revenue. He placed reliance on the decision of the Commissioner of Income Tax v. Excel Industries Ltd. 358 ITR 295 (SC).
Referring to the Accounting Standards 29 (AS 29), he submitted that it was incumbent on the Assessee to make a provision for known liabilities failing which the balance sheet would not reflect the true and fair picture of the accounts. He also referred to the Notification No. SO 69(E) dated 25th January 1996, issued by the CBDT which required that “provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.” The CBDT had highlighted the need for the Assessee to adopt such accounting policies “so as to represent a true and fair view of the state of affairs of the business, profession or vocation in the financial statements prepared and presented on the basis of such accounting policies.” It is accordingly submitted that the ITAT erred in holding the provision for the known liabilities for transit breakages made by the Assessee to be a contingent liability and, therefore, not allowable as a revenue expenditure. Reliance was also placed on the decision of the Supreme Court in Rotork Controls India P. Ltd. v. Commissioner of Income Tax  314 ITR 62 (SC).
Contention of the Revenue
The ld counsel of the revenue pointed out that the nature of business of the Assessee was such that the breakages would be known within 15 to 30 days of the dispatch or at the latest on the delivery of the goods. The matching of the breakages by debiting it to the P&L Account would occur soon thereafter within that financial/accounting year itself. Therefore, there was no occasion for making any provision for the contingent liability of transit breakages likely to take place during the ensuing financial year. Further pointed out that the estimates of transit breakages made by the Assessee for the AYs in question were off the mark and in fact in excess of the actual breakages, which in any event were allowed as revenue expenditure in the year in which such breakages occurred. They submitted that the ITAT‟s impugned orders do not call for any interference.
Held by CIT (A)
CIT (A) allowed the appeal of the assessee and allowed the provision. It was held that the provision had been made on a scientific basis and that the method of accounting for transit breakages had been followed by the Assessee year after year. The CIT (A) held that the decision of the Supreme Court in Bharat Earth Movers v.CIT 245 ITR 428 (SC) supports the case of the Assessee.
Held by ITAT
ITAT allowed the appeal of the revenue and disallowed the provision for breakages. It was held that the provision made was without “any basis much less scientific one”. It was noted that this was evident by the fact that the Assessee itself had reversed the provision on the first day of the following year. Analysing the chart submitted by the Assessee on the provision made on the actual breakages for each of the AYs, the ITAT noted that in each year the provision made was excessive. The first Assessee did not have enough experience of its own to enable it to make provision of expenditure on scientific basis. It appeared to have been made on ad hoc basis depending on the places of destination.
Held by High Court
It is not in dispute that as and when transit breakages do occur the resultant losses are allowable as revenue expenditure, given the nature of the business of the Assessee. The decision in Commissioner of Income Tax v. Balaji Distilleries Ltd. 126 Taxman 264 (Madras) and Commissioner of Income Tax v. Brindavan Beverages (P) Ltd. 335 ITR 163 (Karn) recognised this. In fact, for AYs 2002-03 to 2004-05 the AO has allowed transit breakages as revenue expenditure in the year in which the breakages occurred.
The issue, however, is the justification for creating a provision for such breakages anticipating them in advance of the occurrence of the actual breakages. If such transit breakages cannot be estimated with a reasonable degree of certainty then the liability on that score would be considered ‘contingent’ in terms of the definition of that expression in AS 29 i.e. “a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise”. AS 29 itself makes it explicit that no provision for a contingent liability would be recognised.
In the case of Bharat Earth Movers, it was decided by the Supreme Court that “The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied, the liability is not a contingent one. The liability is in prasenti 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 Court further summarised the decision in Metal Box Co. of India Ltd. v. Their Workmen  73 ITR 53 (SC). Also In Commissioner of Income Tax v. Vinitec Corporation P. Ltd., 278 ITR 337 (Del) it was held that a liability accrued, though discharged at a future date would be a proper deduction.
In Rotork Controls India P. Ltd. v. Commissioner of Income Tax  314 ITR 62 (SC), the Assessee sold valve actuators and at the time of sale provided a standard warranty whereby in the event of the product or a part thereof becoming defective within the periods specified there under, the Assessee had an obligation to rectify or replace the defective part free of charge. It was noticed that although the AYs in question were 1991-92 to 1994-95 the claim of such allowance had been allowed since AY 1983-84 itself. It was held that the warranty became an integral part of sale price and, therefore, warranty provision has to be recognised because “the Assessee had a present obligation as a result of past event resulting in an outflow of resources and a reliable estimate could be made of the amount of obligation.” The Assessee was held entitled to a deduction in respect of the warranty provision under Section 37 of the Act.
Facts of the current case
The Court is unable to discern any uniform scientific method followed by the Appellant in making provision for the breakages. As noticed by the ITAT, the explanation offered by the Appellant was that on an ad hoc basis it fixed a rate per case of bottles. In the case of Andhra Pradesh, the rate was Rs.10 per case, for Goa and Karnataka it was Rs.15 per case. Also the breakages are known within a period of 15 to 30 days after despatch of the goods. The Court also concurs with the view of the ITAT that with the first Assessee having entered the line of business only from AY 2001-02, it cannot be said to have gathered sufficient experience to have reasonably estimated such breakages for the AYs in question. In the circumstances, the ‘liability’ on that score could at best be described as a ‘contingent liability’ as defined in AS-29.
Extensive reference has been made to AS-29 since one of the submissions of the Assessee is that its failure to make a provision for transit breakages would violate the applicable accounting standards. However, as has been discussed hereinbefore, the AS is clear that “an enterprise should not recognise a contingent liability”. Therefore, a provision made by the Assessee for transit breakages in future which cannot be reasonably estimated would not adhere to the AS-29 and the balance sheet so prepared would not present a true and fair view of the state of its business affairs.
Accordingly, appeal of the assessee dismissed.