Commissioner Of Income Tax Salem v. M/S. Luk India P. Ltd. Post Box

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED : 05.07.2010 CORAM :- THE HON'BLE MR.JUSTICE F.M.IBRAHIM KALIFULLAandTHE HON'BLE MR.JUSTICE M.M.SUNDRESH Tax Case (Appeal) Nos.489 to 494 of 2010 Commissioner of Income TaxSalem. .. Appellant in all/Appellantthe appeals.vs. M/s. Luk India P. Ltd.Post Box No.20Royakottah Road, Hosur 635 109. .. Respondent in/Respondent all the appeals Tax Case Appeals filed under Section 260A of the Income Tax Act,1961, against the common order of the Income Tax Appellate Tribunal,Madras 'C' Bench, dated 28.08.2009 passed in I.T.A.Nos.472 to477/Mds/2009 for the assement years 1989-2000,2000-2001, 2001-2002,2002-2003 2003-2004 and 2004-2005 against the order of Commissionerof Income-Tax (Appeals) No.3, Gandhi Road, Salem, dated 20.1.2009 andmade in 1) ITA.NO.222/06-07, for the Assessment year 1999-2000. 2. ITA.NO.223/06-07, for the Assessment year 2000-01. 3. ITA.NO.224/06-07, for the Assessment year 2001-02.4. ITA.NO.238/07-08, for the Assessment year 2002-03.5. ITA.NO.239/07-08, for the Assessment year 2003-04.6. ITA.NO.225/06-07, for the Assessment year 2004-05.respectively.R1 against the order of Deputy Commissioner of Income Tax, Incometax Department, Company circle, Salem, dated 15.12.06, and 27.12.07in PAN/G.I.No.1) IDCL0017, 2)IDCL0017, 3)IDCL0017, 4) AAAC6817D/IDCL0017, 5) AAACL6817D/IDCL0017, 6) IDCL0017, for theAssessment year. 1. 1999-2000, 2. 2000-01, 3. 2001-02, 4. 2002-03, 5. 2003-04, 6. 2004-05 respectively. For Appellant : Mr.K.Subramaniam Sr. Standing Counsel for Income-taxFor Respondent : Mr.R.Venkatanarayan for M/s.Subbaraya Aiyar Padmanabhan COMMON JUDGMENT(JUDGMENT OF THE COURT WAS DELIVERED BY F.M.IBRAHIM KALIFULLA,J.) The Revenue has come forward with these appeals raising thefollowing substantial questions of law: "1. Whether on the facts and in thecircumstances of the case, the Income TaxAppellate Tribunal was right in holding that theprovision for warranty was an allowable deduction,even though the provision had not been made on anyscientific basis ensuring a fair degree ofaccuracy, thereby resulting in huge deferment ofrevenue and tax liability thereon?2. For Assessment Year 2003-04 and 2004-05: Whether on the facts and in the circumstancesof the case, the Income Tax Appellate Tribunal wasright in holding that the provision made by theassessee should be allowed as a deduction for thepurpose of 115JB on the I.T. Act, even though suchprovision has not been made on any scientificbasis and huge excess provision had been maderesulting in deferment of revenue? 2. The question concerns the provision for warranty claims madeand it is allowable. 3. Mr.K.Subramanian, learned senior standing counsel for theappellant, vehemently contended that no scientific method was adoptedby the respondent/assessee while making the provision for warrantyclaims and therefore, the Tribunal went wrong in allowing the saiddeduction. Learned standing counsel however fairly brought to ournotice a recent decision of the Hon'ble Supreme Court reported in(2009) 314 ITR 62 (SC) (Rotork Controls India Pvt. Ltd. v.Commissioner of Income-tax), wherein the Hon'ble Supreme Court dealtwith this issue in depth and has laid down the principles whileexamining a claim for warranty provision by way of allowablededuction. Paragraph 14 of the said decision, where the principlehas been laid down, reads as under: "14. In this case, we are concerned with productwarranties. To give an example of product warranties, https://hcservices.ecourts.gov.in/hcservices/ "14. In this case, we are concerned with productwarranties. To give an example of product warranties, https://hcservices.ecourts.gov.in/hcservices/ a company dealing in computers gives a warranty for aperiod of 36 months from the date of supply. The saidcompany considers following options: (a) account forwarranty expense in the year in which it is incurred;(b) it makes a provision for warranty only when thecustomer makes a claim; and (c) it provides forwarranty at 2 per cent. of turnover of the companybased on past experience (historical trend). The firstoption is unsustainable since it would tantamount toaccounting for warranty expenses on cash basis, whichis prohibited both under the Companies Act as well asby the Accounting Standards which require accrualconcept to be followed. In the present case, theDepartment is insisting on the first option which, asstated above, is erroneous as it rules out the accrualconcept. The second option is also inappropriate sinceit does not reflect the expected warranty costs inrespect of revenue already recognised (accrued). Inother words, it is not based on the matching concept.Under the matching concept, if revenue is recognisedthe cost incurred to earn that revenue includingwarranty costs has to be fully provided for. Whenvalve actuators are sold and the warranty costs are anintegral part of that sale price then the appellant hasto provide for such warranty costs in its account forthe relevant year, otherwise the matching conceptfails. In such a case the second option is alsoinappropriate. Under the circumstances, the thirdoption is most appropriate because it fulfils accrualconcept as well as the matching concept. Fordetermining an appropriate historical trend, it isimportant that the company has a proper accountingsystem for capturing the relationship between thenature of the sales, the warranty provisions made andthe actual expenses incurred against it subsequently.Thus, the decision on the warranty provision should bebased on past experience of the company. A detailedassessment of the warranty provisioning policy isrequired particularly if the experience suggests thatwarranty provisions are generally reversed if theyremained unutilised at the end of the period prescribedin the warranty. Therefore, the company shouldscrutinise the historical trend of warranty provisionsmade and the actual expenses incurred against it. Onthis basis a sensible estimate should be made. Thewarranty provision for the products should be based onthe estimate at year end of future warranty expenses.Such estimates need reassessment every year. As onereaches close to the end of the warranty period, theprobability that the warranty expenses will be incurred is considerably reduced and that should be reflected inthe estimation amount. Whether this should be donethrough a pro rata reversal or otherwise would requireassessment of historical trend. If warranty provisionsare based on experience and historical trend(s) and ifthe working is robust then the question of reversal inthe subsequent two years, in the above example, may notarise in a significant way. In our view, on the factsand circumstances of this case, provision for warrantyis rightly made by the appellant enterprise because ithas incurred a present obligation as a result of pastevents. There is also an outflow of resources. Areliable estimate of the obligation was also possible.Therefore, the appellant has incurred a liability, onthe facts and circumstances of this case, during therelevant assessment year which was entitled todeduction under Section 37 of the 1961 Act. Therefore,all the three conditions for recognising a liabilityfor the purposes of provisioning stands satisfied inthis case. It is important to note that there are fourimportant aspects of provisioning. They are —provisioning which relates to present obligation, itarises out of obligating events, it involves outflow ofresources and lastly it involves reliable estimation ofobligation. Keeping in mind all the four aspects, weare of the view that the High Court should not haveinterfered with the decision of the Tribunal in thiscase." 4. A perusal of the principles stated therein shows that whilethere could be three broad options available to a company whilemaking a provision viz., (a) account for warranty expense in the yearin which it is incurred; (b) it makes a provision for warranty onlywhen the customer makes a claim; and (c) it provides for warranty at2 per cent. of the turnover of the company based on past experience(historical trend), the Hon'ble Supreme Court while holding the firsttwo options would not be appropriate, the third option would be moreappropriate as that would fulfil the accrual concept as well as thematching concept. The Hon'ble Supreme Court appreciated the decisionof the Company that while making a warranty provision based on pastexperience of the company, it held that there should be a warrantyprovisioning policy based on a scientific method and that if suchprovisions are made on experience and historical trend and if theworking is robust, then the question of reversal in the subsequenttwo years, in the said case, may not arise significantly. The fourimportant aspects of provisioning have also been highlighted by theHon'ble Supreme Court and keeping those aspects in mind, when a caseis analysed and the facts involved therein satisfied thoseprinciples, no interference should be made. 5. Keeping the above legal principles in mind, when we examinethe order of the Tribunal impugned in these appeals and the questionsof law raised before us, we find that the Tribunal has in effectapplied the principles and has held that the assessee herein made ascientific approach while making a provision for warranty account forthe relevant years and therefore, there was no scope to disallow theclaim made by the assessee. The assessment years related to 1999-2000 to 2004-2005. Before the Tribunal, on behalf of the assessee,the provisions for warranty made in the books of accounts and theactual settlements of warranty claims for the assessment years 1997-1998 to 2009-2010 were furnished and the same has been set out inparagraph 7. Similarly, the details of the year-wise sales and thepercentage, at which the quantum of provision for warranty was workedout in each year by the assessee-company were also furnished. Afterreferring to those figures furnished in the form of statements andafter considering the stand of the Revenue as well as the assessee,the Tribunal has rendered its finding as under in paragraph 11. "11. It is seen from the chart reproduced inparagraph (8) above that the multiplying factor was 3.99in AY 2002-03 and that it came down to 0.67 in 2007-08.Since the basis of computation is the average of theimmediately preceding three year's actual settlements,the accumulated credit balance in the 'Provision forWarranty Account' will become self-limiting, as can beseen from the chart in paragraph (8) above. For A.Y.2007-08, the sale was more than three times the sale forAY 2002-03, whereas the provision for warranty was aboutone-half. Further, the genuineness of the figures ofthe actual settlements has not been doubted by the AO.In view of these facts, the method of computationadopted by the assessee cannot be said to be arbitraryand therefore, we see no reason to interfere with theconclusions reached by the CIT(A). His orders for AYs1999-2000 to 2002-03 are, accordingly confirmed." 6. We also perused the statements, which have been extracted bythe Tribunal in its order in paragraphs 7 and 8. In fact, on behalfof the assessee, a categoric stand was made that the assessee wasmaking a reasonable estimate of the provision for warranty claims andthat it was consistently adopting a method of taking the average ofactual settlements of the immediately preceding three years whileworking out the provision based on the percentage of current year'ssales. 7. Having regard to the figures furnished and the claim that ascientific approach was made while making a provision for warrantyclaim, which was based on the average of the previous years' warrantysettlements, it cannot be held that there was any error, much less anillegal error committed by the Tribunal while passing the impugned https://hcservices.ecourts.gov.in/hcservices/ order. In fact, a cursory glance of the figures set out in thestatements in paragraphs 7 and 8 disclose that depending upon thetrend of warranty settlements over a period of time corresponding tothe sales figures, the percentage of provisions made was notinconsistent and as rightly held by the Tribunal, there was noarbitrary approach made by the assessee while making the provisionfor warranty claims. Therefore, looked at from any angle, we do notfind any flaw in the order of the Tribunal in having decided toconfirm the order of the Commissioner of Income-tax (Appeals) for therelevant years. We are, therefore, not inclined to entertain theappeals, as we do not find any question of law, much less substantialquestion of law arising in these appeals. These appeals fail and thesame are dismissed. No costs. Consequently, M.P.Nos.1 of 2010 (5petitions) are also dismissed. ATR Sd/-Asst.Registrar /True Copy/ Sub.Asst.Registrar To1. The Assistant Registrar, Income Tax Appellate Tribunal 3rd floor, Rajaji Bhavan, Besant Nagar, Madras-90. 2. The Commissioner of Income Tax(Appeals) No.3, Gandhi Road, Salem 636 007. 3. The Deputy Commissioner of Income Tax, Company Circle, Salem. 4. The Commissioner of Income Tax Salem.+ 1 cc to Mr. R. Venkatanarayanan, Advocate SR.48021+ 1 cc to Mr.K. Subramaniam SR.47966 PKB(CO)EU 22.07.2010. TC (A) Nos.489 to 494 of 2010