Commissioner Of Income Tax,Chennai-600 034 v. M/S.rotork Controls India Ltd

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED :: 05-02-2007 CORAM THE HONOURABLE MR.JUSTICE P.D.DINAKARAN AND THE HONOURABLE MRS.JUSTICE CHITRA VENKATARAMAN TAX CASE (APPEAL) Nos.163 of 2003,1 of 2004, 94 of 2004, 95 of 2004,229 of 2004, 565 of 2004 and 2203 of 2006 Commissioner of Income Tax,Chennai-600 034.... Appellant in all the Appeals -vs- M/s.Rotork Controls India Ltd.No.28-B, Ambattur Industrial Estate North(formerly Beacon Rotork Controls Ltd.)Chennai-98.... Respondent in T.C.Nos.163/2003,1/2004, 94/2004, 95 of 2004 & 565 of 2004 M/s.Beema Manufacturers Pvt. Ltd.,Chennai... Respondent in T.C.No.229/2004 M/s.Thompson Consumer Electronics,44, 1[st] Main Road,Gandhi Nagar,Adyar, Chennai-20... Respondent in T.C.No.2203/2006 * * *T.C.(A)No.163 of 2003 is against the order of the Income-taxAppellate Tribunal, Madras 'A' Bench, dated 28.2.2003 in ITA No.468/(Mds)/95. T.C (A)No.163 of 2003 as against the order dated 2.12.1994ITA.No.157/94-95 on the file of the Commissioner of Income Tax(Appeals 1) as against the order dated 30.3.1994 PAN/GIR No.47-056-CY-7043-9-B on the file of the Deputy Commissioner of Income TaxSpecial Range I, Madras. T.C.(A)No.1 of 2004 is against the order of the Income-taxAppellate Tribunal, Madras 'A' Bench, dated 7.7.2003 in ITANo.874/Mds/1996. https://hcservices.ecourts.gov.in/hcservices/ T.C (A)No.1 of 2004 as against the order dated 29.01.1996ITA.No.299/95-96 on the file of the Commissioner of Income Tax(Appeals) V, Madras 34, as against the order dated 22.11.1995GI.No.9-B/PAN/GIR No.47-056-CY-7043 on the file of the DeputyCommissioner of Income Tax Special Range I, Madras. T.C.(A)No.94 of 2004 and 95 of 2004 are against the commonorder of the Income-tax Appellate Tribunal, Madras 'C' Bench, dated28.4.2003 respectively in ITA Nos.276 and 1244/Mds/95. T.C (A)No.94 of 2004 as against the order dated 23.02.1994ITA.No.332/93-94/DC.SR.I on the file of the Commissioner of IncomeTax (Appeals) V, Madras 34, as against the order dated 29.10.1993PAN/GIR No.47-056-CY-7043/9-B on the file of the Deputy Commissionerof Income Tax Special Range I, Madras. T.C (A)No.95 of 2004 as against the order dated 2.12.1994IT/WT/GT.Appeal.No.137/94-95 on the file of the Commissioner ofIncome Tax (Appeals), Madras 34, as against the order dated30.03.1994 PAN/GIR No.47-056-CY-7043/9-B on the file of the DeputyCommissioner of Income Tax Special Range I, Madras. T.C.(A)No.229 of 2004 is against the order of the Income-taxAppellate Tribunal, Madras 'D' Bench, dated 30.9.2003 in ITANo.1285/Mds/2001. T.C (A)No.229 of 2004 as against the order dated 28.05.2001ITA.No.7,8 & 9/2001-2002 on the file of the Commissioner of IncomeTax (Appeals) V, 121 Mahatma Gandhi Road, Chennai 34, as against theorder dated 28.02.2001 PAN/GIR No.AAACB/2523N on the file of theDeputy Commissioner of Income Tax Company Circle - I (1) Chennai. T.C.(A) No.565 of 2004 is against the order of the Income-taxAppellate Tribunal, Madras 'B' Bench, dated 10.02.2004, in ITANo.1091/Mds/97. T.C (A)No.565 of 2004 as against the order dated 18.02.1997IT/WT/GT Appeal No. ITA 356/96-97 on the file of the Commissioner ofIncome Tax (Appeals) V, Chennai 34, as against the order dated15.11.1996 PAN/GIR No.47-056-CY-7043 on the file of the DeputyCommissioner of Income Tax Special Range, Madras. T.C.(A)No.2203 of 2006 is against the order of the Income-taxAppellate Tribunal, Madras 'B' Bench, dated 31.10.2005 in ITANo.1317/Mds/2001. T.C (A)No.2203 of 2006:- Order dated 20.06.2001 ITANo.56/2001-2002, on the file of the Commissioner of Income Tax(Appeals) IV, 121 Mahatma Gandhi Road, Chennai 34, as against theorder dated 21.03.2001 GIR No.397 on the file of the DeputyCommissioner of Income Tax Company Circle - III (2) Chennai.34. https://hcservices.ecourts.gov.in/hcservices/ * * * T.C.(A)No.2203 of 2006 is against the order of the Income-taxAppellate Tribunal, Madras 'B' Bench, dated 31.10.2005 in ITANo.1317/Mds/2001. T.C (A)No.2203 of 2006:- Order dated 20.06.2001 ITANo.56/2001-2002, on the file of the Commissioner of Income Tax(Appeals) IV, 121 Mahatma Gandhi Road, Chennai 34, as against theorder dated 21.03.2001 GIR No.397 on the file of the DeputyCommissioner of Income Tax Company Circle - III (2) Chennai.34. https://hcservices.ecourts.gov.in/hcservices/ * * * For appellant in all the T.Cs.: Mr.T.RavikumarFor respondents : Mr.R.Vijayaraghavan forin all the T.Cs. : N/s.Subbaraya Aiyar & Padmanabhan COMMON JUDGMENT (Judgment of the Court was delivered by CHITRA VENKATARAMAN,J.) All these appeals are clubbed together, for passing acommon order, considering the identity of the issues raised therein. 2. The common question that arises for consideration is,whether the Tribunal was right in holding that the warrantyprovision is an allowable deduction ? and, whether the Tribunal wasright in holding that a provision made in respect of future claimsthat may not rise at all is a deductible expenditure in the currentyear ? 3. In T.C.No.94 of 2005, apart from the warranty charges,there is yet another question relating to the disallowance underSection 40 A (2) (b) (iv) of the Income Tax Act, regarding paymentof corporate service charges paid to a closely connected company. 4. The facts in all these appeals centre on the questionof warranty charges. Taking T.C.No.163 of 2003 for consideration offacts, it may be seen that the assessee made a provision as regardswarranty charges payable under the terms of sale. It is stated thatsuch a provision is made in the accounts to mete out the futurerequirements arising on account of the warranty clause in the saleagreement. It is admitted by the assessee that the warrantyprovision made as against the liability had not crystalised againstthe assessee. Consequently, holding the provisions as unascertainedliability, the assessing authority rejected the plea of theassessee. The Assessing Officer followed the orders passed earlier,in respect of similar claims. Aggrieved of the same, the assesseepreferred an appeal before the first appellate authority, whofollowed the earlier orders of the Tribunal and allowed the claim.Aggrieved of this, the Assessing Officer further went on appeal,following the orders passed earlier under similar circumstances.Hence, these appeals. 5. It is a matter of fact that in all these cases, theclaims are not made on the basis of any particular data availablefor earlier years. https://hcservices.ecourts.gov.in/hcservices/ 6. Learned counsel appearing for the revenue referred tothe decision of the Supreme Court in Shree Sajjan Mills Ltd. v.Commissioner of Income-Tax, (1985) 156 ITR 585, and makes aparticular reference to the distinction between 'provision' and'reserve', dealt with by the Apex Court and to the extract from thedecision reported in Vazir Sultan Tobacco Co.Ltd. v. CIT [1981] 132ITR 559 (SC), which may be usefully extracted hereunder : "The distinction between a provision and areserve is in commercial accountancy fairly wellknown. Provisions made against anticipated lossesand contingencies are charges against profits and,therefore, to be taken into account against grossreceipts in the P.& L.account and the balancesheet. On the other hand, reserves areappropriations of profits, the assets by whichthey are represented being retained to form partof the capital employed in the business.Provisions are usually shown in the balance sheetby way of deductions from the assets in respect ofwhich they are made whereas general reserves andreserve funds are shown as part of theproprietor's interest." "The distinction between a provision and areserve is in commercial accountancy fairly wellknown. Provisions made against anticipated lossesand contingencies are charges against profits and,therefore, to be taken into account against grossreceipts in the P.& L.account and the balancesheet. On the other hand, reserves areappropriations of profits, the assets by whichthey are represented being retained to form partof the capital employed in the business.Provisions are usually shown in the balance sheetby way of deductions from the assets in respect ofwhich they are made whereas general reserves andreserve funds are shown as part of theproprietor's interest." 7. Based on the said decision, the learned Standing Counselsubmits that when there was no obligation cast as on the date ofsale except for an agreement and in the absence any comparison tomake a provision for an uncrystallised or uncertain liability, theassessee was not entitled to the benefit, as granted by theTribunal. He also placed reliance on the decisions in IndianSmelting and Refining Co.Ltd. v. Commissioner of Income-Tax, [2001]248 ITR 4 and Commissioner of Income-Tax v. Dynavision Ltd., [2004]265 ITR 289 and makes a reference to page 297, to impress on thefact that the contingency liability, by its very nature, cannot havea provision for purposes of deduction. He also made a specificreference to the decision in Bharat Earth Movers v. CIT, [2000] 245ITR 428, and submitted that the same is distinguishable on facts andin the absence of certainty of a liability and certainty of an eventto incur that liability, a provision cannot go for deduction. Thelearned counsel further submitted that the assessees in these caseshave not submitted any proof as regards previous pattern ofexpenditure, to maintain a provision. In this connection, he placedreliance on Commissioner of Inland Revenue v. Mitsubishi Motors NewZealand Ltd., [1996] 222 ITR 671 at 701; Commissioner of Income-Taxv. Vinitec Corporation Pvt. Ltd., [2005] 278 ITR 337 (Delhi) andCommissioner of Income-Tax v. Indian Transformers Ltd., [2004) 270ITR 259. 8. Per contra, Mr.Vijayaraghavan, learned counsel for theassessees, submits that a committed liability is an accruedliability and, hence, even though the exact quantification ispostponed to a future date, yet a provision in terms of theagreement undertaken has to be considered for deduction. In short,he submits that the determination of exactness of the liability on afuture date does not make a liability as on the date of agreement acontingency liability. In this connection, he placed reliance onSection 37 (1) and drew support from [2001] 248 ITR 4 and [2000] 245ITR 428. In the above circumstances, the learned counsel for theassessees prays that the order of the Tribunal be upheld. 9. We agree with the submission made by the learnedcounsel for the revenue, that considering the nature of theliability, which is yet to crystalise but loaded with uncertainty ofthe event to cause a liability, there is no justification to acceptthe plea of the assessees to uphold the order of the Tribunal. 9. We agree with the submission made by the learnedcounsel for the revenue, that considering the nature of theliability, which is yet to crystalise but loaded with uncertainty ofthe event to cause a liability, there is no justification to acceptthe plea of the assessees to uphold the order of the Tribunal. 10. The reliance placed on the decision of the SupremeCourt in (1985) 156 ITR 585 needs to be noted herein. It relates toa provision for future use for payment of gratuity to the employeeson retirement or on termination of their services. The Apex Courtheld that the liability to pay gratuity becomes an accrued liabilityof an assessee, when the employees retire or when their services areterminated and, until then, the right to receive gratuity is acontingent right and the liability to pay gratuity continues to be acontingent liability qua the employer. Taking note of the nature ofliability, the Supreme Court also made a reference to the decisionin Metal Box Co.of India Ltd. v. Their Workmen, [1969] 73 ITR 53,and held that it was permissible for an assessee, if he so chooses,to provide in his profit and loss account for the estimatedliability under a gratuity scheme, by ascertaining the present valueon accrued basis and claiming it as an ascertained liability, to bededucted in the computation of profits profits and gains of theprevious year. Referring to the provisions of Section 40 A (7) inthat case, the Supreme Court held that the requirements for gratuityto be deductible under the Act must be fulfilled under Section 40 A(7). It may be noted that though it relates to a gratuity payment,the fact remains, that, to qualify for a deduction, there must be aliability and it is a certainty. Although the quantification, assuch might be postponed to a future date, as long as the event is ofcertainty, the claim for deduction, as such, cannot be denied.However, where the liability itself is not held out with certainty,which may happen or may not happen, such liabilities, contingent incharacter, cannot be the subject matter of deduction, even under themercantile system of accounting. The eligibility or otherwise fordeduction hence depends on the certainty of the event, namely, theliability to occur even under the terms of sale agreement. Hence,with such uncertainty, the writ large on the occurring of an event,there is no justification to extend the benefit of deduction on theprovision on a contingent liability. The decision reported inhttps://hcservices.ecourts.gov.in/hcservices/ [2001] 248 ITR 4 relied on by the assessee is distinguishable to theeffect that the provision made for liability on the basis of showcause notice, which the assessee did not admit as a liability, wasnot deductible; that was only a contingent liability and, hence,could not constitute as an expenditure for the purpose of incometax. [2004] 265 ITR 289 is the decision of this Court, on thequestion of the character of a liability as the contingentliability. Referring to the decision in [1985] 156 ITR 585 (SC),this Court held that "the basic requirement is that the amountsought to be excluded should be an expenditure and the expenditure,which is deductible for income tax purposes, is one which is towardsa liability actually existing at the time, but the putting aside ofmoney, which may become expenditure on the happening of an event isnot an expenditure." 11. The Revenue as well as the assessees placed relianceon [2000] 245 ITR 428. This relates to a claim on leave encashment.The assessee, in that case, created a fund making provision formeeting its liability, arising on account of accumulatedearned/vacation leave. A certain sum was set apart in a separateaccount as provision for encashment of accrued leave. Assessee madea claim for deduction. The High Court reversed the view of theTribunal that provision for accrued leave salary was a contingentliability that was not a permissible deduction. Reversing the saidview, the Apex Court held that the provision made by the assesseetherein for meeting its liability was under the leave encashmentscheme proportionate with the entitlement earned by the employees ofthe company, subject to a ceiling on accumulation as applicable onrelevant date. Consequently, the Apex Court held that the liabilitywas not a contingent liability. 12. A perusal of the decision of the Supreme Court showsthat what should be certain is the incurring of the liability. Eventhough the actual quantification may not be possible, it should alsobe capable of being estimated with reasonable certainty. If theserequirements are satisfied, the liability is not a contingent one.The liability is in praesenti, though it will be discharged at afuture date. It makes no difference to the point of time when theliability shall have to be discharged. 13. The Supreme Court decision referred to above lays downthe law on the question of deductibility of a provision oncontingent liability and that the deduction to be allowable thereonmust be that liability existing with certainty to be called anaccrued liability. Hence, where there was no difficulty inascertaining the existence of a liability, mere existence ofdifficulty in actual quantification does not convert the accruedliability to that of a conditional one, to look upon to thehappening of an event. The settled principles, hence, emphasis onthe existence of element of certainty rather than on thequantification of the liability.https://hcservices.ecourts.gov.in/hcservices/ 14. A perusal of the facts in these cases makes it clearthat what has been projected in these cases is that under the termsof the agreement of sale, there is a warranty provision. Theaccounts of the assessee made a provision for warranty at apercentage on the turnover. 15. Learned counsel for the assessee could not deny thefact that considering the uncertainty of a liability, deductioncould still be a possibility under the law declared by the supremeCourt. 16. In none of these cases, the assessee could lay itshand on the actual incurring of a liability under the warrantyclause on the basis of fixing a percentage on the turnover. In theabsence of any details, accepting the claim of percentage on theturnover could not be sustained. 17. As to the reliance placed on the decision in [1996]222 ITR 697, as rightly submitted by the learned Standing Counselfor the Revenue, the said decision was prompted by the statisticaldata available that in respect of 63% of the vehicles sold by thetax payer, they were returned to the dealers for some kind of workto be done under the warranty clause. The Privy Council held thatthe tax payer could reasonably make an accurate forecast, based onthe previous experience, as to what would be the total cost ofremedial work for all the vehicles sold in a given year. Takingnote of the commercial practice, the Privy Council granted therelief in the assessee's appeal. 18. With no such details in the appeals at any stage ofthe proceedings, we do not find any justification to grant 1.5 percent on the total turnover, as provision for the warranty clauses. 19. Learned counsel for the assessee placed reliance on[2005] 278 ITR 337 (Delhi), a decision of the Delhi High Court, and[2004] 270 ITR 259, a decision of the Kerala High Court. 18. With no such details in the appeals at any stage ofthe proceedings, we do not find any justification to grant 1.5 percent on the total turnover, as provision for the warranty clauses. 19. Learned counsel for the assessee placed reliance on[2005] 278 ITR 337 (Delhi), a decision of the Delhi High Court, and[2004] 270 ITR 259, a decision of the Kerala High Court. 20. A perusal of the above two decisions shows that theclaims in those cases were based on the data of the previous years,which enabled the assessee to estimate its liability under thewarranty clause. 21. In the decision reported in [2005] 278 ITR 337(Delhi), the Delhi High Court noted that the assessee had givenfigures for five years of warranty liability provided vis-a-vis theexpenditure incurred, so also, in the decision reported in [2004]270 ITR 259. https://hcservices.ecourts.gov.in/hcservices/ 22. We do not think that the decisions of the Delhi HighCourt and the Kerala High Court lend support to the cause of action.In the absence of any such details, an adhoc provision on apercentage of the turnover disentitles the assessee to the relief. 23. Learned counsel for the assessees reiterated the factthat under the terms of sale, warranty clause is a committedliability and, as such, the claim is not reasonable as to theparticular percentage in the total turnover. 24. We do not agree with the above said submission of thelearned counsel that they could be granted some ad hoc percentage.Considering the fact that the liability, as such, being a contingentone and not a certainty, we fail to understand the reasoning of theTribunal in accepting the case of the assessee on the strength ofdecisions, which certainly are based on definite data. Under thecircumstances, the decision of the Tribunal deserves to be reversed. 25. As regards the question relating to the charges paidunder additional service charges arising in the case of T.C.Nos.94and 95 of 2004, we find that the Tribunal granted the relief ,without adverting to the facts which required the additionalexpenditure. It is stated that under the terms of the agreement,with increased sales, amount was paid as a corporate service chargeto the holding company. The assessing authority allowed the claim inearlier years based on this. However, in respect of the assessmentyear 1991-92, the assessee claimed that payment at 2% required arevision commensurate with the increase in turnover. The AssessingOfficer, however, rejected the claim, as excessive and unreasonable,having regard to the nature of services rendered by the holdingcompany. The assessee explained the increase in the payment ofcommission, on account of the increase in the turnover. Hence, asum of Rs.25.00 lakhs extra was paid to the holding company. Thefirst appellate authority, confirming the order of the assessingauthority, held that the disallowance of Rs.15.00 lakhs wasreasonable and hence allowance of Rs.10.00 lakhs was upheld. TheCommissioner also held that the assessee had not produced any dataregarding the services rendered extra, justifying the huge payment. 26. On appeal, the Tribunal held that the assessee hadproduced the necessary calculation sheet; that the assessee hadspent less amount towards the charges, consequent to the fact thatwhere it had no branches, it took the services of the holdingcompany to get its business. The Tribunal held that there wasnothing to show that the calculation given by the assessee was foundto be false. Consequently, it was not open to the revenue to rejectthe contention in an ad hoc manner. 26. On appeal, the Tribunal held that the assessee hadproduced the necessary calculation sheet; that the assessee hadspent less amount towards the charges, consequent to the fact thatwhere it had no branches, it took the services of the holdingcompany to get its business. The Tribunal held that there wasnothing to show that the calculation given by the assessee was foundto be false. Consequently, it was not open to the revenue to rejectthe contention in an ad hoc manner. 27. The learned Standing Counsel referred to the decisionsin Commissioner of Income-Tax v. Shatrunjay Diamonds, [2003] 261 ITR258 and V.S.T.Motors Ltd. v. Commissioner of Income-Tax, [2003] 260ITR 440, wherein it was held that in the absence of necessarydetails to support the claim, disallowance was justified and, hence,prayed for restoring the order of the Assessing Officer. 28. Per contra, learned counsel for the assessees,however, submitted that there is no denial of the fact that theholding company had rendered additional services. He submitted thatthe authorities must look at the commercial exigencies, whichrequire the payment to the fixed extent. Learned counsel alsosubmitted that considering the various aspects of the claim, theTribunal had rightly concluded the issue in favour of the assessee. 29. A perusal of the order of the Tribunal shows that theTribunal has mainly accepted the plea of the assessee that theexpenditure was warranted by commercial exigencies and the assesseewould have spent more if it were to maintain branches, instead oftaking services of a holding company. 30. We feel, in the absence of any details in the order asto the services rendered, in order to result in a better business,the matter be remitted to the assessing authority for freshconsideration on issue of granting relief to enable the assessee tofurnish the details as to the additional services rendered, tojustify the payment over and above 2% services charges on the saleseffected. Consequently, the first question in T.C.Nos.94 and 95 of2004, namely, whether the Income Tax Appellate Tribunal was right inholding that the disallowances made under Section 40 A (2) (b) (iv)of the Income Tax Act in respect of corporate service charges paidto a closely connected company were not justified, stands remandedto the assessing authority to re-do the assessment in this regard. 31. As regards T.C.No.2203 of 2006, learned counselappearing for the assessee submitted that the calculation of theliability was made on scientific basis with reference to the pastexperience. Consequently, the decision of the Privy Council as wellas the decision of the Apex Court will have a bearing on the issue. 32. A perusal of the assessment order shows that theassessee company paid on an average Rs.150/- per set toT.D.Electronics. The liability to pay arose as and when sales wereeffected. The assessing authority noted that in the case of fiveyear warranty, the entire expenditure spent was dependent on theliability occurring. Since the obligation was purely contingent andnot actual, their claim was not sustainable. The Tribunal followedthe earlier year's order in the assessee's case as well as that ofthe Privy Council in [1996] 222 ITR 697. https://hcservices.ecourts.gov.in/hcservices/ 33. It may be noted that the assessee was providingwarrantee for the repair for a period of one year, when they werepaying Rs.150/- per set to another company, by name, T.D.ElectronicsService Company. That apart, there was another five year warrantyand the expenditure on this account was estimated at Rs.68.00 lakhsand this expenditure was to be incurred only when there arose aliability, to be borne. The facts herein are no different from thatof the earlier cases. https://hcservices.ecourts.gov.in/hcservices/ 33. It may be noted that the assessee was providingwarrantee for the repair for a period of one year, when they werepaying Rs.150/- per set to another company, by name, T.D.ElectronicsService Company. That apart, there was another five year warrantyand the expenditure on this account was estimated at Rs.68.00 lakhsand this expenditure was to be incurred only when there arose aliability, to be borne. The facts herein are no different from thatof the earlier cases. 34. Under the circumstances, we do not find anyjustification to accept the plea of the assessee that the provisomerited a deduction. In the light of the view that we have taken,which is supported by the decision of the Supreme Court, the appealspreferred by the Revenue, on the question of warranty charges as acontingent liability, are allowed, holding that the same as notdeductible. No costs. dixitSd/Asst.Registrar/true copy/Sub Asst.RegistrarTo1. The Assistant Registrar,Income Tax Appellate TribunalIII Floor, Rajaji Bhavan,Besant Nagar, Chennai-90 2a. The Commissioner of Income tax(Appeals) I, Chennai. 2b. The Commissioner of Income tax(Appeals) IV, Chennai.2c. The Commissioner of Income tax(Appeals) V, Chennai.3a. The Income Tax Appellate TribunalA, Bench, Chennai.3b. The Income Tax Appellate TribunalB, Bench, Chennai. 3c. The Income Tax Appellate Tribunal C, Bench, Chennai. 3d. The Income Tax Appellate TribunalD Bench, Chennai.D Bench, Chennai. 4. The Commissioner of Income Tax, Chennai 5. The Deputy Commissioner of Income tax, Special Range I, Chennai 6. The Asst Commissioner of Income Tax, Company Circle III (2) Chennai. + 6 ccs to the M/s. Pushya Sitaraman, SR SC (Income Tax) SR Nos.6954, 6957, 6958, 6959, 6956, 6955. + 5 ccs to Mr. R. Vijaya Raghavan, Advocate SR No. 7068, 7078 to 7081 + 1 cc to Mr. K. J. Chandran Advocate SR No. 6743 T.C.(A) No.163 OF 2003 BATCH MS(CO)SR/1.3.2007