Assessee entitled to claim deduction in respect of the provision for warranty made on the basis of past experience

Acer India Pvt. Ltd. Vs. DCIT (ITAT Bangalore) – Provision for warranty stood crystallised as soon as the sale was made which a customer would like to be fulfilled within the warranty period and is at the cost of an assessee ‘Goodwill Therefore, the residual amount purported to have been held by the AO as an excess provision cannot be considered as a contingent provision and not an ascertained liability.

The warranty period continues beyond an year which fact was rightly considered by the ld. CIT(A) confining to the various decisions such as IBM India Ltd. (Supra) reported in 290 ITR (AT) 183 = (2007-TIOL-22- ITAT-Bang). Similar view has been taken by other coordinate Benches of the Tribunal therefore requires no further deliberation. In the light of the above, we hold the view that the decision of the ld. CIT(A) requires no further interference on the issue. The revenue’s appeal stands dismissed.

Decided by – ITAT Bangalore

Decided on- 25.02.2011

ITA No. 784/Bang/2010

(Assessment year- 2005- 06)

PER GEORGE GEORGE K:

This appeal preferred by the assessee is directed against the order of learned CIT(A)-I, Bangalore dated 2/2/2010. The asst. year concerned is 2005-06.

2. The assessee has raised 8 grounds in this appeal. The first ground is general in nature and no specific adjudication is called for. Hence, the same is dismissed.

3. Ground nos. 2 to 7 relate to the issue as to whether the CIT(A) is justified in confirming the dis allowance made by the A.O. on account of provision for warranty amounting to Rs. 2,26,05,903/-.

The assessee is a company. It is engaged in the manufacture and trading of computer systems and components. For the relevant asst. year, return of income was filed on 31/10/2005 declaring a total income of Rs. 3,28,93,910/-. The case was selected for scrutiny and assessment u/s 143(3) of the Act was completed vide order dated 26.12.2008 by making the following adjustments to the returned income:-

a)  disallowance of provision for warranty amounting to Rs. 2,26,05,903/- and

b) Exclusion of the interest income of Rs. 25,83,813/- from the profit derived by the Pondicherry unit (^DUnit”) for the purpose of computation of deduction u/s 80-IB(4) of the Act.

6.  Aggrieved by the assessment, the assessee carried the matter in appeal before the first appellate authority.

7. The CIT(A) dismissed the appeal of the assessee vide his impugned order dated 2/2/2010.

8. Aggrieved by the order of the CIT(A), the assessee is in second appeal before us.

9. The learned AR reiterated the submissions made before the authorities below.

10. The learned bR, on the other hand, supported the impugned orders of the Income Tax Authorities.

11. We have heard the rival submission and perused the material on record.

Provision for Warranty

The assessee had debited a sum of Rs. 8,24,29,136/- in the P&L account on account of provision for warranty. The assessee had actually incurred an expenditure of Rs. 4,92,32,936/- during the year. At the time of scrutinising the assessment, a sum of Rs. 5,98,23,233/- was expended by the assessee. The assessment was completed by disallowing the unexpended portion of the provision for warranty amounting to Rs. 2,26,05,903/-[Rs.8,24,29,136 – Rs. 5,98,23,233], being the excess amount debited to the P&L account over the actual expenditure incurred.

11.1 The action of the AO was upheld by the CIT(A). The CIT(A), we are of the view, has misdirected himself that the assessee had claimed different amounts towards provisions by comparing the amount of provision debited to the P&L account Rs. 8,24,29,136/-, dis allowance made by the AO being Rs. 2,26,05,903/- and the amount of Rs. 12,16,75,204/-, being the closing provision of warranty appearing in the books of account.

 11.2 The assessee creates provision for warranty based on the estimation of expenditure likely to be incurred on the past sales made on yearly basis at then prevailing market prices for spares and labour. For the relevant previous year, the assessee estimated the warranty liability at Rs. 12,76,77,530/- and created a provision only for Rs.12,16,75,204/- in the books of account by charging a provision of Rs. 8,24,29,136/- to the debit in the P&L account and claimed it as 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 adhoc 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 Honourable 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 Honourable 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 dealing in computers gives warranty for a period of 36 months from the date of supply. The said company considers following options : (a) account for warranty expense in the year in which it is incurred; (b) it makes a provision for warranty only when the customer makes a claim; and (c) it provides for warranty at 2Z of turnover of the company based on past experience (historical trend)………

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“………

If warranty provisions are based on experience and historical trend(s) and if the working is robust then the question of reversal in the subsequent two years, in the above example, may not arise in a significant way’.

11.4 In the assessee’s own case in identical facts for the immediately preceding year, the Tribunal in ITA No.774 & 877/Bang/2008 vide order dated 30.1.2009 has decided the issue in favour of the assessee. The relevant finding of the Tribunal at para 5 of its order reads as follows:-

“We have heard the rival contentions and perused the material available on record. We are of the considered view that the assessee ‘s case clearly falls in line with the legal ratio set out by the various appellate decisions cited at Bar in so far as the provision for warranty stood crystallised as soon as the sale was made which a customer would like to be fulfilled within the warranty period and is at the cost of an assessee ‘sgoodwili Therefore, the residual amount purported to have been held by the AO as an excess provision cannot be considered as a contingent provision and not an ascertained liability. The warranty period continues beyond an year which fact was rightly considered by the ld. CIT(A) confining to the various decisions such as IBM India Ltd. (Supra) reported in 290 ITR (AT) 183 = (2007-TIOL-22- ITAT-Bang). Similar view has been taken by other coordinate Benches of the Tribunal therefore requires no further deliberation. In the light of the above, we hold the view that the decision of the ld. CIT(A) requires no further interference on the issue. The revenue’s appeal stands dismissed.”

11.5 In view of the above facts and the decision referred above, we hold that dis allowance of provision of warranty is to be deleted and it is ordered accordingly.

12. In the result, ground nos. 2 to 7 raised herein are allowed.Exclusion of interest for the purpose of computing  the deduction u/s 80-IB of the Act

13. The AO has disallowed a sum of Rs.25,83,813/- from the profits derived by the Unit for the purpose of computation of deduction u/s 80IB of the Act. The CIT(A) has decided the issue against the assessee company by following the ratio of the decision of the Honourable Supreme Court in the case of Pandian Chemicals (262ITR 278). Before us, the learned AR submitted that the interest claimed for the purpose of computing of deduction u/s 80IB is to be bifurcated as follows:-

Sr No.	Particulars	Amount (Rs.)
1.	LC Margin Money deposits with Bank	Rs. 15,53,186/-
2.	Fixed deposits with bank	Rs. 10,30,627/-
	Total	Rs. 25,83,813/-

13.1 It was conceded that with reference to interest on fixed deposit with the bank amounting to Rs.10,30,627/-, the assessee does not have a case for claiming deduction u/s 80IB, since it was the surplus money of the assessee, which was deposited in the bank. It was contended that the interest earned from deposit made for opening the letter of credit with the banks for the purpose of availing credit facility was for the purpose of carrying on the business and there is a direct nexus with the business activity carried on by the industrial undertaking of the assessee company. He relied on the decision of the Hon’ble belhi High Court in the case of CIT v Eltek SGS Pvt. Ltd. (300 ITR 6) and also the unreported decision of the Mumbai Bench of Tribunal in the case of Bajaj Healthcare P. Ltd.

13.2  The relevant provisions of section 80IB(1) of the Act reads as follows:-

“Section 80IB-(1) Where the gross total income of an assessee includes any profits and gains derived from any business referred to in sub­sections (3) to [(11), (11A) and(11B)](such business being hereinafter referred to as eligible business), there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income ofthe assessee, a deduction from such profits and gains of an amount equal to such percentage and for such number of assessment years as specified in this section ….. (Emphasis supplied)’.

13.3 The decision of the Honourable Delhi High Court in the case of C1T v Eltek SGS (P) Ltd. (300 1TR 6) is most appropriate in the present case. The Delhi High Court has held that the language used in section 80HH of the Act is different from the language used in 801~ of the Act. The relevant extract is provided below for reference:

“13. A perusal of the above would show that there is a material difference between the language used in section 80HH of the Act and section 8018 of the Act. While Section 80-HH requires that the profits and gains should be derived from the industrial undertaking, section 8018 of the Act requires that the profits and gains should be derived from any business of the undertaking. 1n other words, there need not necessarily be a direct nexus between the activity of an industrial undertaking and the profits and gains………..

20. 1t is crucial to appreciate the difference in language in section 80HH and section 801~. While the language used in section 80HH and 801 are similar, there is a clear departure in the language used in section 8018 and it is this choice of words that makes allthe difference’.

Hence, for the purpose of section 80IB of the Act, the expression “profits and gains from any business of the undertaking” has to be interpreted in a wider sense. There need not be any direct nexus between the activity of the industrial undertaking and profits and gains. Further, the Hon’ble belhi High Court in this case, has distinguished the principles laid down by the Apex Court in the case of Pandian Chemicals. The Hon’ble Mumbai Bench of the Tribunal in the case of Bajaj Healthcare P Ltd. (Unreported) has allowed interest on deposits made for availing bank facilities by following the decision of the Hon’ble belhi High Court in the case of CIT v Eltek SGS (P) Ltd. (300 ITR 6). The relevant finding of the Mumbai Bench of the Tribunal in the case of Bajaj Healthcare P. Ltd. (supra) is reproduced below:-

“We have perused the records and considered the matter carefully. The dispute raised is regarding allow ability of deduction u/s 80IB in respect of DEPB licenses and income from interest and dividend. The authorities below have not allowed the claim on the ground that there is no direct nexus between the aforesaid receipts and the industrial undertaking following the judgement of Hon’ble Supreme Court in the case of Sterling Foods Ltd. (Supra) and in case of Pandyan Chemicals Ltd. (supra). It has been pointed out that above judgement have been delivered in connection with the deduction u/s 80HH in which the deduction was allowable in respect of profit derived from the undertaking whereas the language used in section 80IB is profit arrived from the business of undertaking. The Hon’ble High Court of belhi in case of SGS Pvt. Ltd. (300 ITR 6) after noting the said difference have allowedthe deduction in respect of duty drawback and following the said judgement the Tribunal in assessee ‘s own case in assessment year 2001-02 allowed the deduction in respect of export incentives and term deposits as well as dividend income from the bank. The Tribunal held that term deposit had been used as a collateral security for the purpose of business and dividend had been received from the bank in respect of shares which had been purchased with a view to secure loan from the bank and therefore the interest and dividend income was inextricably linked with the business of the assessee. We have to follow the decision of the Coordinate Bench ofthe Tribunal in assessee ‘s own case and respectfully following the same, we allow the deduction in respect of DEPB licenses, interest on term deposits and dividend from bank. However, this year the assessee has also claimed deduction in respect of interest on short term deposits which has not been used as collateral security for the business. Therefore, the assessee will not be entitled to deduction in respect of interest from short term deposit. We hold accordingly’.

13.4 In view of the above decisions, the interest income earned from deposits made for opening letter of credit with the banks for the purpose of availing credit facilities to carry on the business must be treated as income from business, since it has direct nexus with the business activity carried on by the industrial undertaking of the assessee firm. However, since the break-up of interest claimed for the purpose of computing deduction u/s 80IB of the Act was not before the Income Tax authorities, this issue is restored back to the file of the AO with the specific direction to allow the claim of deduction u/s 80IB in respect of LC Margin money deposits with bank. Therefore, ground no.8 raised herein is allowed for statistical purposes.