ITAT Delhi allows provision for warranty expenses despite lack of past experience & scientific basis

Grey Orange India Pvt. Ltd. Vs ACIT (ITAT Delhi)

Introduction: The Income Tax Appellate Tribunal (ITAT) Delhi has recently passed a noteworthy judgment in the case of Grey Orange India Pvt. Ltd. vs. Assistant Commissioner of Income Tax (ACIT). The case revolved around the allowability of deductions for expenses incurred on warranty claims. The ITAT’s decision has significant implications for businesses concerning the treatment of warranty expenses in their financial statements. This article delves into the details of the case, the arguments presented, and the implications of the ITAT’s ruling.

Background of the Case: Grey Orange India Pvt. Ltd. filed its return of income for the assessment year 2016-17, declaring a loss of INR 10,49,61,711. The Assessing Officer (AO) selected the case for scrutiny and made several additions, including a disallowance of INR 23,51,396 for the provision of warranty expenses. Consequently, the assessed loss was reduced to INR 9,38,50,740. The company’s appeal to the Commissioner of Income Tax (Appeals) [CIT(A)] resulted in partial relief, but the disallowance of the warranty expense provision was upheld. Grey Orange India Pvt. Ltd. then appealed to the ITAT.

Arguments by the Assessee: The assessee argued that the provision for warranty expenses was calculated based on a reliable estimate, as required by accounting standards and the Supreme Court’s judgment in the case of Rotork Controls India (P) Ltd. v. CIT. The warranty clause was integral to the sales agreements, creating an obligation at the time of sale. They contended that disallowing these provisions violated the matching principle of accounting, where expenses should match the revenues they help generate. The assessee also highlighted that similar provisions had been allowed in subsequent years, indicating consistency in their accounting practices.

Contentions by the Revenue: The Revenue opposed the deduction, arguing that the provision for the unexpired period of warranty did not pertain to the current financial year. They asserted that the method used by the assessee lacked scientific basis due to the company’s limited operational history, rendering the provision unreliable. The Revenue maintained that the provision for future expenses should not be allowed in the current year’s financial statements.

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