Case Law Details
RELEVANT PARAGRAPHS:
6. On the issue as to whether the provisions for warranty liability is deductible for income-tax purposes, a useful reference may be made to a decision of the Hon’ble Kerala High Court in the case of CIT v. Indian Transformers Ltd. (2004) 270 ITR 259, where the Hon’ble Kerala High Court found that the provision for after sales services of transformers on the facts of that case was a reasonable one in view of the actual expenses, which materialized in a latter year, so that it was also allowable, following the decision of the Hon’b;e Supreme Court in the case of Bharat Earth Movers (2000) 245 ITR 428 which, however, related to a case of leave encashment but the rational of the Hon’ble Supreme Court decision in the case of Bharat Earth Movers (2000) 245 ITR 428 on leave encashment but also a decision of the Hon’ble Supreme Court in the case of Calcutta Co. Ltd. (1959) 37 ITR 1 (Supreme Court) in support of the principle that certain liability in future is not a contingent liability. The Privy Council in the case of IRC v. Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697 specifically on the subject of warranty has also taken a similar view by observing thus (headnote): “The taxpayer’s liability under the warranty for each vehicle sold was contingent on a defect appearing and being notified to the dealer within the warranty period so that no liability was incurred by the taxpayer until those conditions were satisfied, regard could be had to its estimation of warranty claims based on statistical information, which showed that as a matter of existing fact not future contingency 63 per cent, of all vehicles sold by the taxpayer contained defects likely to be manifested within the warranty period and require work under warranty; that since theoretical contingencies could be disregarded, the taxpayer was in the year of sale under an accrued legal obligation to make payments under those warranties and, even though it might not be required to do so until the following year, it was definitely committed in the year of sale to that expenditure; and that, accordingly, in computing the profits or gains derived by the taxpayer from its business in the year in which the vehicles were sold, the taxpayer was entitled under section 104 to deduct from its total income the provision which it had made for the costs of its anticipated liabilities under outstanding warranties in respect of vehicles sold in that year.” Regarding the warranty liability, the Privacy Council further 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 painwork. Sometime 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 make a reasonably accurate forecast, based on previous experience, of what will be the total cost of remedial work for all the vehicles sold in a given year. Normal commercial practice therefore requires that this amount should be brought into account as ad deduction from income in estimating the profits or gains of the business in the year in which the vehicles were sold”. The aforesaid decision of the Privacy Council in the case of Mitsubishi Motors New Zealand Ltd. [1996] 222 ITR 697 was followed by the hon’ble Delhi High Court in the case of CIT v. Vinitec Corporation P. Ltd. [2005] 278 ITR 337 where it was observed that when it was not disputed that warranty clause is part of the sale document and imposes a liability upon the assessee to discharge its obligation under that clause for the period of warranty, it is a liability which is capable of being construed in definite terms, which had arisen in the accounting year, may be actual quantification and discharge is deferred to a future date. Once the assessee is maintaining its account on the mercantile system, the liability accrued, though to be discharge at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. The hon’ble Delhi High Court has also taken note of the principles laid down by the hon’ble Supreme Court in the cases of Calcutta Co. Ltd. [1959] 37 ITR 1 and Bharat Earth Movers (2000) 245 ITR 428. On the question of allowing the deduction towards warranty liability, the fact that the assessee has been following the mercantile system of accounting where actual liability accrues or arises during the previous year can be considered as an expenditure deductible for income-tax purposes has been emphasized. It has also taken into consideration that a liability which is dependent on fulfillment of a condition cannot be allowed as a deduction unless the dependent condition is fulfilled during the previous year. In the case of warranty liability, it is found that the assessee when it sold the goods manufactured by it, conferred on the purchasers the benefit of a warranty, and thereby the assessee undertakes to provide free maintenance or replacement of its parts within a particular period on sale of the goods. The contention of the Revenue that the liability was contingent upon a defect appearing and being notified within the warranty period and till such time there was no liability in law and, therefore, the claim for deduction on account of estimated liability could not be allowed has not been accepted by the courts by holding and observing that once the liability arising on account of warranty claims is in-built in the sale mechanism itself, it cannot be viewed that it is contingent in nature. It was further held by the court, that a contingent liability is to be understood as one, which is not only dependent on the happening of a future event but is also incapable of ascertainment or even estimation with a fair degree of precious. In contrast, a liability whose happening and valuation is possible to be made with reasonable certainty and would arise continually so as to be conterminous with the carrying on of the business of the assessee, cannot be construed as a contingent liability. It was further emphasized by the court that as the assessee was in the year of sale under an accrued legal obligation to make payment under the warranty clause and, even though it might not be required to do so until the following year, it was definitely committed in the year of sale to that expenditure, and that, accordingly, in computing the profits or gains derived by the assessee from its business in the year in which the goods were sold, the assessee was entitled to deduct from its profit the provision which it had made for the costs of its anticipated liabilities under outstanding warranties in respect of the goods sold in that year, the quantification thereof
being based on statistical information. It was further held there that occurrence of the warranty claim has to be viewed from an overall perspective so as to match the costs vis-à-vis the sales revenue of a given period. In this sense and the issue being considered in this background the court held that the warranty liability of the assessee cannot be construed to be a contingent liability in nature. On analysis of the judgments referred to above, the position of law emerging therefrom is that once the assessee is maintaining its accounts on the mercantile system, the liability accrued in a year, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of business, regard had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in the case of amounts actually expended or paid. The expression `the liability already accrued in a year’ signifies that a business liability must have definitely arisen in that accounting year. In other words, for allowing the deduction of a liability while working out the profits and gains of business, a business liability should have definitely arisen in that accounting year. What should be certain is the incurring of the liability. The definite liability must be in prasenti and not de futuro. The liability must have arisen under a definite obligation. The obligation of the trader must not be of a purely contingent in nature for it to be a permissible outgoing or allowance or deduction in the year of account, it is further clear that the putting aside of money, which may become expenditure on the happening of an event, is not admissible expenditure. The expenditure which is deductible for income-tax purpose is one which is towards a definite and certain liability actually existing at the relevant time. Therefore, a pure contingent liability distinguished from a definite and actual liability arising in paresnti, do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. The other condition to be satisfied is that the definite liability to prasernti should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these conditions are satisfied, it does not make any difference if the liability may have to be discharged at a future date, and the future date, on which the liability shall have to be discharged, is not certain. It is also clear that a condition subsequent, the fulfillment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that definite liability into a contingent one. However, an answer to the question as to whether the liability, in respect of which a deduction is claimed by the taxpayer, had definitely arisen, under a definite obligation of a trader, in any accounting year, depends on the facts of each and every case.
7. In the case before us, we are concerned with regard to the assessee’s claim of deduction towards warranty liability under a condition or stipulation made in the sale document imposing a liability upon the assessee to discharge its obligation under warranty clause for the period of warranty, and thus, in the light of the discussion made above, the liability so accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of assessee’s business from sale of the commodity in question. The assessee had made the provision of warranty liability having regard to the past factor of actual expenses incurred by the assessee towards warranty. The assessee has worked out the amount of liability by applying a multiplying factor on the total sale made during the year on the basis of past result. This method has been followed by the assessee in uniformly right from the first year of commencement of the production as so noted by the Commissioner (Appeals) in his order.
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Wether replacements made under warranty claim be treated as part of sales and wether vat is payable