Provision for Warranty Expenses allowed as business expense u/s 37

PCIT Vs Heavy Engineering Corporation Limited (Jharkhand High Court)

Jharkhand High Court held that ‘Provision for Warranty Expenses’ is allowable as business expense as large number of sophisticated goods were manufactured in past and if facts established show that defects existing in some of items manufactured and sold then provision for warranty is entitled to deduction.

Facts- The respondent Assessee is a government of India undertaking. On 28.09.2012 Assessee filed its return declaring total income to be “NIL”.

Return was processed u/s. 143(1). On 26.08.2013, case of the Assessee was selected for scrutiny. Notice u/s. 143(3) was issued. On 29.01.2015, assessment order was passed wherein amount claimed as business expenses under the head of “Provision for Warranty Expenses” amounting to Rs.3,93,07,000/-.

Respondent-Assessee preferred an Appeal before CIT(A). On 20.03.2017, appeal filed by the Respondent was allowed. All additions made by AO was deleted. The revenue preferred an Appeal before Learned ITAT. On 15.03.2019, appeal filed by the revenue was dismissed.

Conclusion- Held that we see that the Assessee company has not committed any error in making provisions inasmuch as large number of sophisticated goods were being manufactured in the past and if the facts established show that defects existing 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 receipt under Section 37 of 1961 Act. Consequently, the issue of provision of warranty in the facts and circumstances of the case goes in favour of the Assessee and against the Revenue.

FULL TEXT OF THE JUDGMENT/ORDER OF JHARKHAND HIGH COURT

T.A. 25 of 2019 has been preferred by the appellant Revenue praying therein for quashing of the order dated 15.03.2019 passed by the learned Income Tax Appellate Tribunal (ITAT); whereby the learned ITAT has dismissed the appeal of the Revenue being ITA No. 125/RAN/2017 for the Assessment Year 2012-13.

Likewise, Tax Appeal No. 37 of 2019 has been preferred by the appellant Revenue praying therein for quashing of the order dated 05.04.2019 passed by the learned I.T.A.T. in I.T.A. No. 95/RAN/2017 for the Assessment Year 2007-08.

Similarly, T.A. 38 of 2019 has been preferred by the revenue praying therein for quashing of the order dated 05.04.2019 passed by the learned I.T.A.T. in I.T.A. No. 223/Ran/2016 for the assessment year 2011-12. Since the respondent-assessee is common in all these appeals as such all are being heard together and being disposed of by this common judgment.

2. The respondent Assessee is a government of India undertaking and has engaged in the business of manufacturing, project works, reconditioning, Execution and Commissioning of machineries, Equipment for Steel plants, Mining sector, Railways, Defense etc. and is registered under the provisions of Companies Act, 1956.

5. Facts of T.A. No. 25 of 2019

On 28.09.2012 Assessee filed its return declaring total income to be “NIL”. Return was processed under Section 143 (1). On 26.08.2013, case of the Assessee was selected for scrutiny. Notice under Section 143(3) was issued. On 29.01.2015, assessment order was passed wherein amount claimed as business expenses under the head of “Provision for Warranty Expenses” amounting to Rs.3,93,07,000/-. Respondent-Assessee preferred an Appeal before CIT(A) being Appeal No. 159/Ran/Co/14-15. On 20.03.2017, appeal filed by the Respondent was allowed. All additions made by the Assessing Officer was deleted. The revenue preferred an Appeal before Learned ITAT being I.T.A. No. 125/Ran/2017. On 15.03.2019, appeal filed by the revenue was dismissed.

4. Facts of T.A. No. 37 of 2019

On 27.03.2008, Assessee filed its Return declaring total income to be “NIL”. Return was processed under section 143(1). Case of the respondent was selected for scrutiny. Notice under Section 143(3) was issued. On 26.12.2009, Assessment order was passed. Following additions were made by the Assessing officer to the total income of the Assessee:-

Assessee preferred an Appeal before CIT(A) being Appeal No. 165/Ran/Co/09-10. On 17.02.2017, appeal filed by the Respondent-Assessee was partly allowed. All additions except an addition of Rs. 4.79 Lacs towards Bad Debts, were deleted. The Revenue preferred an Appeal before Learned ITAT being I.T.A. No. 95/Ran/2017. On 05.04.2019, appeal filed by the revenue was dismissed.

3. Facts of T.A. No. 38 of 2019

On 26.09.2011, Assessee filed its Return declaring total income to be “NIL”. Return was processed under Section 143(1). On 01.08.2012, case of Respondent was selected for scrutiny. Notice under section 143(3) was issued. On 24.03.2014, assessment order was passed wherein amount claimed as business expenses under the head of “Provision for Warranty Expenses” amounting to Rs.3,65,51,000/- was disallowed. Respondent-Assessee preferred an Appeal before Commissioner of Income Tax (Appeal) [hereinafter referred to as “CIT(A)”] being Appeal No. 61/Ran/Oth/14-15. On 08.04.2016, appeal filed by the Respondent was allowed. All additions made by the Assessing Officer was deleted. The Revenue preferred an Appeal before learned ITAT being I.T.A. No. 125/Ran/2017. On 15.03.2019 appeal filed by the revenue was dismissed.

6. All these appeals were heard and admitted on 11.5.2022 and the following substantial question of law were formulated. “

Tax Appeal No. 25 of 2019:

1. Whether in the facts and circumstances of the case, the amount under the head of “Provision of Warranty Expenses” can be allowed as expenditure to the business income of the Respondent Assessee under the Income Tax Act, 1961?

2. Whether in the facts and circumstances of the case, the Respondent Assessee has complied with all the conditions laid down in the judgment of the Hon’ble Supreme Court, passed in the case of Rotork Controls India Private Limited v. CIT reported in (2009) 13 SCC 283, to be entitled to the amount of “Provision of Warranty Expenses” as an expenditure to the business income of the respondent Assessee under the Income Tax Act, 1961?

3. Whether in the facts and circumstances of the case, the finding of the Ld. ITAT in the Impugned Judgment that “the appellant company had made a reasonable estimate of claiming at 0.5% of sales based on past expenses and technical estimates” is perverse and not based on any material evidence?

4. Whether in the facts and circumstances of the case, the Impugned Judgment passed by Ld. ITAT is perverse?

Tax Appeal No. 37 of 2019

This appeal shall be heard on the following substantial questions of law:

1. Whether in the facts and circumstances of the case, the amount under the head of “Provision for Leave Assistance”, Provision for Liquidated Damages” and Miscellaneous Provision” respectively can be allowed as expenditure to the business income of the Respondent Assessee under the Income Tax Act, 1961?

2. Whether in the facts and circumstances of the case, the ratio laid down by the Apex Court in the case of Rotork Controls India Private Limited v. CIT reported in (2009) 13 SCC 283 would apply to the case of Respondent Assessee so far as his claim for entitlement of expenditure towards business income under “Provision for Leave Travel Assistance”, “Provision for Liquidated Damages” and “Miscellaneous Provision” is concerned under the Income Tax Act, 1961.

3. Whether in the facts and circumstances of the case, the Ld. ITAT is correct in holding that the expenditure made on sales promotion is allowable under Section 40(a) despite the fact that the assesse failed to discharge its onus of providing evidences in support of TDS made on the same?

4. Whether in the facts and circumstances of the case, the Impugned Judgment passed by Ld. ITAT is perverse?

Tax Appeal No. 38 of 2019

1. Whether in the facts and circumstances of the case, the amount under the head of “Provision of Warranty Expenses” can be allowed as expenditure to the business income of the Respondent Assessee under the Income Tax Act, 1961?

2. Whether in the facts and circumstances of the case, the Respondent Assessee has complied with all the conditions laid down in the judgment of the Hon’ble Supreme Court, passed in the case of Rotork Controls India Private Limited v. CIT reported in (2009) 13 SCC 283, to be entitled the amount of “Provision of Warranty Expenses” as an expenditure to the business income of the respondent Assessee under the Income Tax Act, 1961 ?

3. Whether in the facts and circumstances of the case, the findings of the Ld. ITAT in the Impugned Judgment that “Based on its past experience and technical estimate for warranty, expenses are provided in account” and also the finding that ‘the liability so accrued was estimated scientifically’ are perverse and not based on any material evidence?

4. Whether in the facts and circumstances of the case, the Impugned Judgment passed by Ld. ITAT is perverse?

7. Learned counsel for the appellant has submitted as follows:

(a) The amount under the head of “Provision of Warranty Expenses” cannot be allowed as expenditure to the business income of the Respondent Assessee as the Respondent has not complied with all the conditions laid down in the judgment rendered in the case of Rotork Controls India (supra) to be entitled to the amount of “Provision of Warranty Expenses” as an expenditure to the business income of the respondent Assessee.

(b) The finding of the Ld. ITAT in the Impugned Judgment that “the appellant company had made a reasonable estimate of claiming at 0.5% of sales based on past expenses and technical estimates” is perverse and not based on any material evidence.

(c) The amount under the head of “Provision for Leave Assistance”, Provision for Liquidated Damages” and Miscellaneous Provision” respectively cannot be allowed as expenditure to the business income of the Respondent Assessee.

(d) The Ld. Tribunal is incorrect in holding that the expenditure made on sales promotion is allowable under Section 40(a) despite the fact that the Assessee failed to discharge its onus of providing evidences in support of TDS made on the same.

8. Learned counsel for the respondent Assessee supported the impugned judgment and submits that no error has been committed by the learned tribunal, as such these appeals may be dismissed as no substantial question of law is involved in these appeals.

9. Having heard learned counsel for the parties and after going through the impugned judgment and the questions of law, we are proceeding to decide these appeals on the respective issues and questions of law.

In Tax Appeal No. 38 of 2019 and Tax Appeal No. 25 of 2019, the issue involved is provision of warranty. It appears that the Assessee company is a manufacturer and sell capital goods/heavy equipment for customer. In compliance with its contractual obligations’ “warranty” for replacement of spare parts and maintenance for certain specified period at free of cost has been provided. Further, providing after sales service is also an obligation under the contract of sale for the Assessee. Per se, incurring of liability is thus certain. It further appears that based on the past experience and technical estimate for warranty, expenses are provided in accounts on accrual basis. This is done by crediting the profit and loss account of the Assessee for its sales revenue and along with this manufacturing and other expenses and Warranty expenses are charged in account as expenses.

The Assessee provides for 0.5% on sale for liabilities under the contract towards obligations/warranties. This is as per clause 6 of the statement of Accounting Policies of the Assessee company. The Assessee has been following this policy uniformly and consistently every year in the preparation of its balance sheet and profit and loss account. This provision of after sales service is then revert back by the company on expenditure of guarantee/warranty period and the amount of such expiration is then offered for taxation of income.

It further transpires from the impugned order that the learned tribunal has categorically held at Paragraph 13 of the order dated 15.03.2019 passed in I.T.A. No. 176/Ran/15 that company on the expiration of warranty period, the balance amount is offered for tax as income. This clearly goes to show that there is no tax evasion. The issue with regard to provision of warranty has been settled down in the case of Rotork Controls India (P) Limited Vs. Commissioner of Income Tax, Chennai, reported in (2009) 13 SCC 283 wherein at Para-47-51 it has been held as under

“47. At this stage, we once again reiterate 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. As stated above, the case of Indian Molasses Co. (supra) is different from the present case. As stated above, in the present case we are concerned with an army of items of sophisticated (specialized) goods manufactured and sold by the assessee whereas the case of Indian Molasses Co. (supra) was restricted to an individual retiree. On the other hand, the case of Metal Box Company of India (supra) pertained to an army of employees who were due to retire in future.

48. In that case the company had estimated its liability under two gratuity schemes and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out its estimated liability on actuarial valuation. It had made provision for such liability spread over to a number of years. In such a case it was held by this Court that the provision made by the assessee-company for meeting the liability incurred by it under the gratuity scheme would be entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability.

49. The same principle is laid down in the judgment of this Court in the case of Bharat Earth Movers (supra). In that case the assessee company had formulated leave encashment scheme. It was held, following the judgment in Metal Box Company of India (supra). It was held, following the judgment in Metal Box Company of India (supra), that the provision made by the assessee for meeting the liability incurred under leave encashment scheme proportionate with the entitlement earned by the employees, was entitled to deduction out of gross receipts for the accounting year during which the provision is made for that liability.

50. The principle which emerges from these decisions is that if the historical trend indicates that large number of sophisticated goods were being manufactured in the past and in the past 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.

51. It may be noted that in all the impugned judgments before us the assessee(s) has succeeded except in the case of Civil Appeal Nos. of 2009 (Arising out of S.L.P.(C) Nos. 14178-14182 of 2007- Rotork Controls India (P) Ltd. v. Commissioner of Income Tax, Chennai, in which the Madras High Court has overrules the decision of the Tribunal allowing deduction u/s 37 of the 1961 Act. However, the High Court has failed to notice the “reversal” which constituted part of the data systematically maintained by the assessee over the last decade.”

Thus, we see that the Assessee company has not committed any error in making provisions inasmuch as large number of sophisticated goods were being manufactured in the past and if the facts established show that defects existing 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 receipt under Section 37 of 1961 Act. Consequently, the issue of provision of warranty in the facts and circumstances of the case goes in favour of the Assessee and against the Revenue.

10. So far as the issue involved in T.A. No. 37 of 2019 is concerned, the same is discussed hereinbelow.

(i) Provision of Liquidated Damages:-

Liquidated damages refer to an amount actually deducted by the customers for delayed supply of the equipment by the HEC. It is a prevalent trade practice and also a commercial term in the contract and agreement with the customers. The amount so deducted under the contractual obligation as a normal trade practice is charged to profit and loss account as liquidated damages by way of provision or otherwise. If any sum is subsequently refunded back to the Assessee by the customers, then the Assessee credit its profit and loss account with such refund. Since the liquidated damages provided in the accounts are based on allowances/expenditure/deduction allowed by the Assessee to its customer as a part of contract and this practice is being followed by the Assessee consistently, and such debits are based on actual deduction made by the customers, accordingly they are ascertained expenditure. Accordingly, looking to the facts and practice, the Assessee company has not committed any error in making the provisions of liquidated damages.

(ii) Miscellaneous Provisions:–

As per the accounting policy of the Assessee whereby the inventory of Raw materials, stores and spares, loose tools, work in progress are procured/manufactured as per the specifications of the customers but subsequently are not required due to cancellation of orders, change in technology, non-receipt of fresh order etc. Such items of inventory which are not moving for the above reasons are provided for in the profit and loss account. The Assessee is a manufacturer of capital goods which are consumer specific and other specific and therefore, items of inventory, work in progress and finished goods cannot be sold/used elsewhere easily where the orders get cancelled and stop orders do not materialize. Accordingly, the profit and loss account are charged for such losses. Having regard to the facts, no error has been committed by the Assessee in making of “Miscellaneous Provisions”

(iii) Provision for Leave Travel Assistance:-

LTA benefit is the benefit to the employee of the Assessee which is based on the Assessee’s rules which specifies Employee’s Emoluments and Benefit/Compensation policy; therefore, the Assessee is following this procedure consistently.

LTA is allowable to every employee as travel concession as stated in section 10(5) of the Act. It is not in the nature of ‘some payable by the Assessee as an employee in lieu of any leave at the credit office employee’ as mandated u/s 43 B (f) of the Act. Accordingly, the provision would not be governed by the provisions of section 43 B(f) of the Act.

(iv) Sales Promotion:-

The Assessee is a capital goods manufacturer and it is a trade practice prevalent in the line of business to provide after sales service on sale of such high-technology, high value capital goods. After sales service varies from 1 year to 3 years. The Assessee therefore incurs expenditure on account of after sales service which are booked under the head sales promotion.Furthermore, the Assessee also has to incur expenditure on account of sales and marketing of the product.

Expenditures on sale promotions like this playing its product at exhibition etc. have to be incurred.

Assessee deduct TDS whenever the provision of TDS calls applicable on payments made by it. In fact, the Assessee has added back the entire expenses in cases where the non-deduction of TDS has been reported by the Tax Auditor in their Tax Audit Report. In fact, the sales promotion expense of Rs. 2.29 lakhs include expenditure on account of after sales service. The provision for after sales service (warranty period) expenses of Rs. 152.36 lakhs are booked under the same head sales promotion.

11. Thus, we see that the Assessee has not committed any violation of the provisions of the I. T. Act and its Rules. As a matter of fact, learned I.T.A.T. has discussed each and every ground raised by the Revenue in detail and rejected the contentions of the Revenue and dismissed their appeal filed before it. We hold that no error has been committed by the learned tribunal in rejecting the claim of the respondent revenue and dismissing the respective appeals.

12. Having regard to the discussions made hereinabove, the question of law does not favour the Revenue and consequently, all these appeals are dismissed on contest. However, there is no order as to cost.