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 despite the same having not incurred during the assessment year

High Court Of Karnataka

CIT vs. Hewlett Packard India Sales (P.) Ltd.

Section : 37(1)

Dilip B. Bhosale And B. Manohar, JJ.

IT Appeal No. 585 Of 2008

March 3, 2014

JUDGMENT

Dilip B. Bhosale, J. – This income-tax appeal is directed against the order dated January 11, 2008, passed by the Income-tax Appellate Tribunal, Bangalore Bench “B” (for short “the Tribunal”) in I. T. A. No. 639(Bang)/ 2007, for the assessment year 2003-04, by which the Tribunal has dismissed the appeal filed by the Revenue.

2. The Revenue has raised the following substantial questions of law in the instant appeal :

“Whether the Tribunal was correct in holding that a sum of Rs. 4,96,60,442 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 despite the same having not incurred during the assessment year ?”

3. At the outset, Mr. K.P. Kumar, learned senior counsel for the assessee, invited our attention to the judgment of the Supreme Court in Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62/180 Taxman 422 and so also the judgment of this court in CIT v. IBM India Ltd. [2013] 357 ITR 88 (Kar.) to contend that the substantial question of law formulated by the Revenue in the present appeal is squarely covered by these two judgments. In IBM India Ltd. (supra), the substantial question of law that fell for consideration of the Division Bench of this court read thus (page 91 of 357 ITR):

“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 ?”

This question was ultimately answered by the Division Bench, based on the judgment of the hon’ble Supreme Court in Rotork Controls India (P.) Ltd. (supra), in favour of the assessee and against the Revenue.

4. In Rotork Controls India (P.) Ltd. (supra), the Supreme Court was considering the question what is provision ? (for warranty). The Supreme Court while dealing with this question observed that (page 71) : “a provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when : (a) an enterprise has a present obligation as a result of a past event ; (b) it is probable that an outflow of resources will be required to settle the obligation ; and (c) reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized”. On the basis of these observations and following the observations made by the Supreme Court in paragraph 13, Mr. Aravind, learned counsel appearing for the Revenue submitted that to find out whether all the tests laid down by the Supreme Court stand satisfied in the present case, it deserves to be remanded to the Tribunal. Relevant observations in paragraph 13 read thus (page 73) :

“A detailed assessment of the warranty provisioning policy is required particularly if the experience suggests that warranty provisions are generally reversed if they remained unutulized at the end of the period prescribed in the warranty. Therefore, the company should scrutinize the historical trend of warranty provisions made and the actual expenses incurred against it. On this basis a sensible estimate should be made. The warranty provision for the products should be based on the estimate at year end of future warranty expenses. Such estimates need reassessment every year. As one reaches close to the end of the warranty period, the probability that the warranty expenses will be incurred is considerably reduced and that should be reflected in the estimation amount. Whether this should be done through a pro rata reversal or otherwise would require assessment of historical trend. If warranty provisions are based on experience and historical trend(s) and if the working is robust then the question of reversal in the subsequent two years, in the above example, may not arise in a significant way. In our view, on the facts and circumstances of this case, provision for warranty is rightly made by the appellant-enterprise because it has incurred a present obligation as a result of past events. There is also an outflow of resources. A reliable estimate of the obligation was also possible. Therefore, the appellant has incurred a liability, on the facts and circumstances of this case, during the relevant assessment year which was entitled to deduction under section 37 of the 1961 Act. Therefore, all the three conditions for recognizing a liability for the purposes of provisioning stand satisfied in this case. It is important to note that there are four important aspects of provisioning. They are-provisioning which relates to present obligation, it arises out of obligating events, it involves out-flow of resources and lastly it involves reliable estimation of obligation. Keeping in mind all the four aspects, we are of the view that the High Court should not to have interfered with the decision of the Tribunal in this case.”

5. In support of this contention, he invited our attention to the following facts of the present case : In Schedule XIV to the profit and loss account, the assessee had debited an amount of Rs. 45,64,21,746 as “provision for warranty”. The assessee, in fact, had spent an amount of Rs. 40,56,50,088 towards warranty. In addition, the year end expenses which had accrued on this count amounts to Rs. 11,11,216, hence, from out of the total provision of Rs. 45,64,21,746, the amount actually spent/accrued, amounting to Rs. 40,67,61,304, was allowed and the balance of Rs. 4,96,60,442 was added back to the assessee’s income. Mr. Aravind, learned counsel appearing for the Revenue, submitted that this amount which was added back to the assessee’s income was ultimately wrongly allowed by the Tribunal. There does not appear to be any dispute that the amount of Rs. 4,96,60,442, which was added back to the income by the Assessing Officer was allowed by the Tribunal. According to the learned senior counsel for the respondent-assessee, the said amount was either added back to the income or adjusted while making the claim provision in the subsequent assessment year, i.e., 2004-05 so much so there was no double deduction. This submission of the learned senior counsel for the assessee has not been disputed by the learned counsel appearing for the Revenue.

6. It is pertinent to note that in so far as the present assessee is concerned, years prior to the relevant assessment year, i.e., 2003-04 and the subsequent assessment years, namely, 2004-05, 2005-06 and 2006-07, the concerned authorities allowed the deduction. We may also notice that the Supreme Court in Rotork Controls India (P.) Ltd. (supra) considered the case of the very same respondent-assessee for the assessment year 1999-2000 (bearing Civil Appeal No. 3524 of 2009 by special leave from the judgment and order dated July 29, 2008, of this court in I. T. A. No. 2642 of 2005). Even for the assessment year 2000-01 this court in I. T. A. No. 2640 of 2005, vide order dated July 29, 2008, allowed the deduction and the Revenue’s appeal to the Supreme Court also came to be dismissed, vide order dated March 12, 2010.

7. Keeping that in view and considering the judgment of the hon’ble Supreme Court in Rotork Controls India (P.) Ltd. (supra) and this court in IBM India Ltd. (supra), in our opinion, the question raised for our consideration is squarely covered by the said judgments. No substantial question of law is involved in this appeal and the appeal is accordingly dismissed.

[Citation : 364 ITR 499]