Karnataka H.C : A provision made for warranty liability in respect of products sold is not a contingent liability but should be allowed as a revenue expense ?

High Court Of Karnataka

CIT-Tax Vs. IBM India Ltd.

Assessment Year : 1998-99

Section : 37(1)

N.Kumar And B. Manohar, JJ.

IT Appeal No. 130 Of 2007

April  10, 2013

JUDGMENT

N. Kumar, J. – The Revenue has preferred this appeal against the order passed by the Tribunal which has granted the relief to the assessee on four grounds.

2. The assessee is a limited company engaged in the business of sale of computer hardware and software. The products sold by them carry warranty for a specified period. The assessee, on the basis of the past experience and certain fair and best estimated basis, has provided for such warranty liability in respect of sales made during the year. The assessee claimed amounts spent towards amount as revenue expenditure. It also sought relief in respect of provision made for doubtful debts under section 115JA(ii) of the Income-tax Act, 1961 (for short, “the Act”). Further, the assessee contended, in the absence of any liability under section 115JA, there is no liability to pay advance tax and, consequently, no interest is payable under section 234B of the Act. The assessing authority overruling all those contentions framed an assessment order. Aggrieved by the same, the assessee preferred an appeal. The appellate authority/Commissioner of Income-tax (Appeals), dismissed the appeal. Aggrieved by the same, the assessee preferred an appeal before the Tribunal which granted relief on all those grounds. Aggrieved by the same, the Revenue has preferred this appeal.

3. This appeal is admitted to consider the following substantial questions of law :

“(i) Whether the Tribunal was correct in holding that a sum of Rs.4,92,69,808 being a provision made for warranty liability in respect of products sold is not a contingent liability but should be allowed as a revenue expense ?

(ii) Whether the Tribunal was correct in holding that the purchase of software amounting to Rs. 33,14,298 should be allowed as a revenue expenditure without recording a finding as to the nature of the purchase, its durability and its application before deciding the issue ?

(iii) Whether the Tribunal was correct in holding that the provision for the doubtful debts as unascertained liability and, therefore, cannot be reduced while computing the book profit under section 115JA of the Act ?

(iv) Whether the Tribunal was correct in holding that no interest under section 234B of the Act is liable when income is computed under section 115JA of the Act while omitting to taking into consideration the saving clause sub-section (4) to section 115JA of the Act ?”

4. The assessee claimed a sum of Rs. 4,92,69,808 being a provision made for warranty liability in respect of products sold and contended that it is not a contingent liability but should be allowed as revenue expenditure. The Tribunal held the liability to pay for warranty claims arises no sooner the sale are effected. The assessee has provided for liability on the basis of sales made during the year. Though the exact amount cannot be quantified, however, the sum is based on the scientific approach and based on the past experience and, therefore, reliance is placed on the judgment of various High Courts, which directed of the deletion of Rs. 4,92,69,808.

5. Learned counsel for the Revenue contends though now the said issue is covered by the judgment of the hon’ble Supreme Court in Rotork Controls India P. Ltd. v. CIT reported in [2009] 314 ITR 62 (SC). Such a relief is permissible only if the condition set out in the said judgment is fulfilled. In the instant case, the same is not fulfilled and, therefore, the finding of the Tribunal is to be set aside and the matter is to be remanded back to the assessing authority for fresh consideration in the light of the law declared by the apex court in the said judgment.

6. On the contrary, learned senior counsel appearing for the assessee submitted the warranty liability which is provided for is based on the scientific calculation. In fact, 3 per cent. to 4 per cent. of the sale price has been consistently provided as the warranty liability and, therefore, he submits the conditions stipulated in the apex court judgment is fulfilled and no case for interference is made out and, accordingly, the judgment of the Tribunal is to be affirmed.

7. From the assessment order, it is clear in the returns filed, they have shown warranty liability as on March 31, 1998, as Rs. 21,87,75,410. The actual liability incurred as on April 1, 1997, is Rs. 16,95,05,602. Therefore, a sum of Rs. 4,92,69,808 was not spent towards warranty liability. Therefore, the said amount is added to the total income of the assessee to the subsequent year. Relying on the said figures, the first appellate authority has recorded a finding that the assessee has consistently provided a sum equivalent to 3 per cent. to 4 per cent. of the sale price of the products sold towards the liability that it has incurred to carry out repairs and replacement during the warranty period. The liability to carry out such repairs and replacement arises as a result of the contracts of sale that it enters into as this event takes place during the year of the liability is an accrued liability and, hence, has to be allowed as a deduction. Relying on the said finding, the Tribunal also held though the exact amount cannot be quantified, the same is based on scientific approach and the past experience. Once the warranty liability is based on a scientific calculation, the assessee is entitled to deduction under section 37 of the Income-tax Act.

8. In the light of the aforesaid facts, we are of the view that the finding recorded by the Tribunal as well as the first appellate court is based on evidence on records and once the condition stipulated in the apex court judgment is fulfilled, no case for interference with the said finding or for remanding the matter to the assessing authority is made out. In that view of the matter, the first substantial question of law is answered in favour of the assessee and against the Revenue.

9. The second substantial question of law relates to application of the amount utilized for projects of software in a sum of Rs. 33,14,298.

10. The Tribunal, on consideration of the material on record and the rival contentions held, when the expenditure is made not only once and for all but also with a view to bringing into existence an asset or an advantage for the enduring benefit, the same can be properly classified as capital expenditure. At the same time, even though the expenses are once and for all and may give an advantage for enduring benefit but is not with a view to bringing into existence any asset, the same cannot be always classified as capital expenditure. The test to be applied is, is it a part of the company’s working expenses or is it expenditure laid out as a part of the process of profit earning. Is it on the capital layout or is it an expenditure necessary for acquisition of property or of rights of a permanent character, possession of which is condition on carrying on trade at all. The assessee in the course of its business acquired certain application software. The amount is paid for application of software and not system software. The application software enables the assessee to carry out his business operation efficiently and smoothly. However, such software itself does not work on stand alone basis. The same has to be fitted to a computer system to work. Such software enhances the efficiency of the operation. It is an aid in manufacturing process rather than the tool itself. Thus, for payment of such application software, though there is an enduring benefit, it does not result into acquisition of any capital asset. The same merely enhances the productivity or efficiency and, hence, to be treated as revenue expenditure. In fact, this court had an occasion to consider whether the software expenses is allowable as revenue expenses or not and held, when the life of a computer or software is less than two years and as such, the right to use it for a limited period, the fee paid for acquisition of the said right is allowable as revenue expenditure and these softwares if they are licensed for a particular period, for utilizing the same for the subsequent years fresh licence fee is to be paid. Therefore, when the software is fitted to a computer system to work, it enhances the efficiency of the operation. It is an aid in manufacturing process rather than the tool itself. Though certain application is an enduring benefit, it does not result into acquisition of any capital asset. It merely enhances the productivity or efficiency and, therefore, it has to be treated as revenue expenditure. In that view of the matter, the finding recorded by the Tribunal is in accordance with law and does not call for any interference. Accordingly, the second substantial question of law is answered in favour of the assessee and against the Revenue.

11. The third substantial question of law relates to the computation of the income under the provisions of section 115JA of the Act.

12. The case of the assessee is that, while computing, within the meaning of section 115JA, the provision made for doubtful debts should not be added as it does not amount to provision made for meeting liabilities other than ascertained liabilities within the meaning of section 115JA(ii). The assessee in its profit and loss account depicted a sum of Rs. 30,45,96,133 as provision for bad and doubtful debts. The Assessing Officer held that the provision is for unascertained liabilities. Since it was merely a provision for unascertained liabilities and as per clause (c) of section 115JA(ii), the same cannot be reduced while computing the “book profit” under section 115JA of the Act. The said view was accepted by the first appellate authority. However, the Tribunal held that the amount being provision made for bad and doubtful debts cannot be considered as provision for meeting any liability, which is not ascertained liabilities and, hence, “book profit” is not to be increased for such amount provided for. This court had an occasion to consider this question in the case of CIT v. Weizmann Homes Ltd. in I. T. A. No. 918/2006 and connected matters decided on March 4, 2013-since reported in [2013] 357 ITR 74 (Karn.) where it was held, if the total income of the company as computed under the provisions of this Act is less than 30 per cent. of book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to 30 per cent. of such book profit. The Explanation to the section states for the purposes of this section, “book profit” means the net profit as shown in the profit and loss account for the relevant previous year prepared under subsection (2) as increased by the amount mentioned in the Explanation. One such amount which we are concerned is in sub-clause (c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities. By the Finance (No. 2) Act of 2009, with effect from April 1, 1998, the present clause (g) has been substituted by including the amount or amounts set aside as provision for diminution in the value of any asset. Therefore, in the light of the aforesaid judgment, the finding recorded by the Tribunal cannot be sustained. The said amount is to be added to the book profit and in that view of the matter, the third substantial question of law is answered in favour of the Revenue and against the assessee.

13. The fourth substantial question of law is regarding the payment of interest under section 234B. The Supreme Court in the case of Joint CIT v. Rolta India Ltd. in [2011] 330 ITR 470 (SC) dealing with an identical issue held the pre-requisite condition for the applicability of section 234B is that the assessee is liable to pay tax under section 208 and the expression “assessed tax” is defined to mean the tax on the total income determined under section 143(1) or under section 143(3) as reduced by the amount of tax deducted or collected at source. Thus, there is no exclusion of section 115J/115JA in the levy of interest under section 234B. The expression “assessed tax” is defined to mean the tax assessed on regular assessment which means the tax determined on the application of section 115J/115JA in the regular assessment. Thus, it can be concluded that interest under sections 234B and 234C shall be payable on failure to pay advance tax in respect of tax payable under section 115JA/115JB. In Circular No. 13 of 2001 (see [2001] 252 ITR (St.) 50), it has been clarified that section 115JB is a self-contained code and thus, all companies were liable for payment of advance tax under section 115JB and, consequently, the provisions of sections 234B and 234C imposing interest on default in payment of advance tax were also applicable. In view of the authoritative pronouncements of the apex court on the point, the order passed by the Tribunal which is contrary to the same requires to be set aside. Accordingly, the findings are set aside and the fourth substantial question of law is answered in favour of the Revenue and against the assessee.

The appeal is partly allowed.

[Citation : 357 ITR 88]