Provision For Liquidated Damages is an Ascertained Liability and Allowable

SKF Engineering & Lubrication India Pvt. Ltd Vs JCIT (ITAT Bangalore)

The assessee during the year under consideration has made a provision for liquidated damages for an amount of Rs. 49,20,000/-. The AO during the revision proceedings has disallowed the said amount on the basis that the calculation of liquidated damages is based on percentage agreed upon the time of purchase order and at the time of making the provision the assessee would not be aware of the date of delivery which a future date. Against the appeal filed by the assessee before the CIT(A) the disallowance was upheld on the basis that the liability would arise only on actual supply and therefore the provision made for the year under consideration is an unascertained liability.

On perusal of the workings it is noticed that the provision is made up to the last date of the financial year, i.e. 31.03.2012. The assessee has considered the delivery date as per the purchase order/clause in the contract and calculated the delay up to 31.03.2012. It is also noticed that the amount of liquidated damages is calculated as a percentage of the basic value of the purchase order/contract. This would mean that the provision for liquidated damages is created for the period relevant to the year under consideration. Though the actual damages would be paid only on delivery of lubrication systems or products, the liability, in our view, has to be provided for under the mercantile system of accounting. We see no merit in the contention that the provision made is an unascertained liability on the basis that the liability to pay would arise on a future date.. The CIT(A) relied on the decision of the Hon’ble Madras High Court in the case of FFE Minerals (supra) while upholding the disallowance. In our view this case is distinguishable from assessee’s case since the fact of the said case is different to the extent that only negotiations and discussion took place and the final amount of liquidated damages was computed much later. In assessee’s case, however, the provision is made based on the terms agreed with the customer and it relates to the period relevant for the year under consideration. In view of the above discussion we hold that the provision made for liquidated damages is an ascertained liability and should be allowed as a deduction. The disallowance made by the AO in this regard is deleted.

FULL TEXT OF THE ORDER OF ITAT BENGALURU

This appeal is against the order passed by the National Faceless Appeal Centre (NFAC), Delhi in appeal No. CIT(A), Bengaluru-4/10071/2018-19 dated 29.04.2022 for AY 2012-13.

2. The assessee raised the following grounds of appeal: –

“1.1 The learned Commissioner of Income-tax (Appeal) has erred in dismissing the appeal filed by the appellant and in confirming the assessment order passed by Assessing Officer. On proper appreciation of facts and law, the learned Commissioner of Income tax (Appeals) should have quashed the order passed by the Assessing Officer.

1.2. The Assessing Officer having passed the original order on proper application of mind and after considering all the issues, the present impugned assessment order passed by the learned assessing officer and as confirmed by the learned CIT(A) is only on account of change of opinion and therefore also the orders of lower authorities deserves to be quashed.

1.3. There was no erroneous order at all so as to cause any prejudice to the interest of revenue. There being no earlier erroneous order, the impugned assessment order passed U/s. 143 r.w.s 263 of I.T. Act, 1961 has no legs to stand and is to be quashed. The learned CIT(A) has erred by upholding the order of the learned assessing officer which under applicable law and facts of the case deserves to be quashed.

[Tax effect of above ground : Rs 33,84,980/-

Without prejudice:

2.1. The learned Commissioner of Income tax (Appeals) has erred in upholding the addition of Rs. 49,20,000/- as made by Assessing Officer by holding provision for liquidated damages as unascertained liability.

2.2. On proper appreciation of facts of the appellant’s case and applicable legal provisions, the addition of Rs. 49,20,000/- is erroneous and is liable to be deleted.

2.3. The addition as made in the assessment order resulting only in timing differences without resulting in any additional revenues to the exchequer ought to have been deleted by the learned CIT(A).

[Tax effect of above ground : Rs 33,84,980/-1

Without further prejudice,

3. Alternatively and without acceding, the lower authorities upon holding provision for current year as unascertained liability ought to have at least

a) allowed deduction in current year in respect of provisions made in the preceding year.and

b) allowed deduction for current year’s provisions in the income computation of subsequent year.

[Tax effect of above ground : Rs 33,84,980/-]

4. In view of the above and on other grounds to be adduced at the time of hearing, it is requested that impugned assessment order be quashed or at least disallowance of Rs. 49,20,000/- be deleted.

[Tax effect of above ground : Rs 33,84,980/-]”

3.The assessee is in the business of automated lubrication systems, manual lubrication equipment and industrial pumping systems. The assessee returned total income of Rs.37,18,54,400/- for AY 2012-13 vide revised return of income. The case was selected for scrutiny and an assessment order was passed under Section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (the Act) on 16.02.2015 wherein the assessee company’s income was assessed at Rs.37,74,93,367/-. Subsequently notice under Section 263 of the Act dated 26.12.2017 was issued by the PCIT stating that the order under Section 143(3) r.w.s. 144C(13) of the Act dated 16.02.2016 is erroneous and prejudicial to the interest of Revenue because the assessee has been allowed deduction for provision for liquidated damages on Rs.49,20,000/- which was an unascertained liability. The PCIT did not accept the submissions made by the assessee with regard to the allowability of liquidated damages and proceeded to pass an order under Section 263 of the Act dated 06.02.2018 setting aside the assessment order and directed the AO to verify the claim of the assessee with regard to the provision of liquidated damages and redo the assessment. Accordingly the AO passed an order under Section 143(3) r.w.s. 263 of the Act dated 05.06.2018 disallowing the provision for liquidated damages stating that it is in the nature of unascertained liability.

4. On further appeal the CIT(A) confirmed the order of the AO. Aggrieved the assessee is in appeal before the Tribunal.

5. Before us the learned A.R. submitted that the assessee is under contractual obligation to pay liquidated damages since the purchase orders raised by the customers or the contracts entered into by the assessee with its customers contain a clause for payment of liquidated damages by the assessee if the assessee fails to deliver the lubricating systems/products on or before the schedule delivery date. The learned A.R. also submitted that the provision for liquidated damages is accrued for the financial year ended on 31.03.2012 on the basis that the liability has accrued for the year ended, though the actual payment would happen on a later date. According to the learned A.R. the assessee is following mercantile system of accounting and therefore the liability to pay liquidated damages which is accrued during the year under consideration has to be provided for in the books of account and the fact that liquidated damages are payable on a later date will not dilute the liability that has accrued to the assessee. The learned A.R. further submitted that the PCIT has claimed that the details of the provisions for liquidated damages was not submitted by the assessee which is not factually correct since the assessee has submitted the detailed working of the provision made towards liquidated liability before the lower authorities (pages 65 & 66 of paper book).

6. The learned D.R., on the other hand, submitted that the liability to pay the liquidated damages is arising at future date and therefore it cannot be stated to be an ascertained liability. The learned D.R. therefore supported the orders of the lower authorities.

7. We have heard the rival contentions and perused the material on record. The assessee during the year under consideration has made a provision for liquidated damages for an amount of Rs. 49,20,000/-. The AO during the revision proceedings has disallowed the said amount on the basis that the calculation of liquidated damages is based on percentage agreed upon the time of purchase order and at the time of making the provision the assessee would not be aware of the date of delivery which a future date. Against the appeal filed by the assessee before the CIT(A) the disallowance was upheld on the basis that the liability would arise only on actual supply and therefore the provision made for the year under consideration is an unascertained liability. The CIT(A) in this regard relied on the decision of the Hon’ble Madras High Court in the case of FFE Minerals India (P.) Ltd. vs. JCIT (2018) 98 com 170 (Madras). We perused the working submitted by the learned A.R. with regard to calculation of liquidated damages which is extracts as below: –

–

On perusal of the above workings it is noticed that the provision is made up to the last date of the financial year, i.e. 31.03.2012. The assessee has considered the delivery date as per the purchase order/clause in the contract and calculated the delay up to 31.03.2012. It is also noticed that the amount of liquidated damages is calculated as a percentage of the basic value of the purchase order/contract. This would mean that the provision for liquidated damages is created for the period relevant to the year under consideration. Though the actual damages would be paid only on delivery of lubrication systems or products, the liability, in our view, has to be provided for under the mercantile system of accounting. We see no merit in the contention that the provision made is an unascertained liability on the basis that the liability to pay would arise on a future date.. The CIT(A) relied on the decision of the Hon’ble Madras High Court in the case of FFE Minerals (supra) while upholding the disallowance. In our view this case is distinguishable from assessee’s case since the fact of the said case is different to the extent that only negotiations and discussion took place and the final amount of liquidated damages was computed much later. In assessee’s case, however, the provision is made based on the terms agreed with the customer and it relates to the period relevant for the year under consideration. In view of the above discussion we hold that the provision made for liquidated damages is an ascertained liability and should be allowed as a deduction. The disallowance made by the AO in this regard is deleted.

8. In the result, the appeal filed by the assessee is allowed.

Pronounced in the open Court on 26^th September, 2022.