Provision Of Warranty Expenditure Under Income Tax Act Landmark Judgment (2023)
1. A landmark judgment has been pronounced by the Hon’ble Jharkhand High Court in the case of Principal Commissioner of Income-tax v. Heavy Engineering Corporation Ltd (2023). It is held that deduction under section 37(1) could not be disallowed in respect of provision made for warranty expenditure.
2. In this article, an attempt has been made to simplify the facts of the case and the judgment thereof.
3. Brief Fact of the Case: Heavy Engineering Corporation Ltd is a government of India undertaking and has engaged in the business of manufacturing, project works, reconditioning, Execution, and Commissioning of machinery, Equipment for Steel plants, Mining sector, Railways, Defense, etc. and is registered under the provisions of Companies Act, 1956.
3.1 In compliance with its contractual obligations’ “warranty” for the replacement of spare parts and maintenance for a certain specified period free of cost has been provided.
3.2 Defects existed in some of the sophisticated goods manufactured in the past and sold and the Company was making provisions in respect thereof. Based on past experience and technical estimates for warranty, expenses are provided in accounts on an accrual basis. The Company provides for 0.5% on sale for liabilities under the contract towards obligations/warranties.
3.3 This is done by crediting the profit and loss account for its sales revenue and along with this manufacturing and other expenses and Warranty expenses are charged to the account as expenses.
3.4 The provision of after-sales service is then reverted by the company on the expenditure of the guarantee/warranty period and the amount of such expiration is then offered for taxation of income.
3.5 The procedure followed is as per clause 6 of the statement of Accounting Policies of the Company. This policy is being followed uniformly and consistently every year in the preparation of the Balance Sheet and Profit and Loss Account.
4. On 28-9-2012 the Company filed its return and the same was processed under section 143 (1). On 26-8-2013, the return was selected for scrutiny. Notice under section 143(3) was issued.
4.1 Assessment order was passed wherein the amount claimed as business expenses under the head of “Provision for Warranty Expenses” amounting to Rs. 3,93,07,000/- was disallowed.
4.2 The Company preferred an Appeal before the Commissioner of Income-tax (Appeal) and the same was allowed. All additions made by the Assessing Officer were deleted. However, the Revenue preferred an Appeal before learned ITAT and the matter went to the Court.
5. Legal Decision: It is held by the Hon’ble HIGH COURT OF JHARKHAND that where defects existed in some of the sophisticated goods manufactured in the past and sold and the assessee was making provisions in respect thereof, deduction under section 37(1) could not be disallowed in respect of such provision made for warranty.
5.1 It further transpires that on the expiration of the warranty period, the balance amount is offered for tax as income by the Company. This goes to show that there is no tax evasion.
6. Legal Decision 2: The issue about the provision of warranty has been settled in the case of Rotork Controls India (P.) Ltd. v. CIT (2009) wherein it was held that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate is possible of the amount of obligation. If the facts established show that defects exist in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deductions.
7. Conclusion: The principle which emerges from these decisions is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and if the facts established show that defects existed in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts’ u/s 37 of the 1961 Act. It would all depend on the data systematically maintained by the assessee.
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Disclaimer: This article is provided for educational purposes only. For specific tax-related matters and legal advice, it is advisable to consult with qualified professionals. The author can be contacted at caanitabhadra@gmail.com for further inquiries.
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