(NOW PERNOD RICARD INDIA PVT.LTD.)

The first Assessee, Seagram Distilleries Private Limited was a 100% subsidiary of Seagram India Private Limited engaged in the business of manufacture and sale of Grain Neutral Spirit (GNS) and India Made Foreign Liquor (IMFL) from its Nasik plant. The parent company, originally incorporated under the Companies Act, 1956 on 3rd September, 1993 under 2015:DHC:8374-DB

The Assessing Officer („AO‟), in the case of the first Assessee, by the order dated 26th March 2004 for AY 2001-02, held that in cases of breakage 2015:DHC:8374-DB

The Revenue then appealed to the ITAT by filing ITA No. 2532/Del/2006 for AY 2001-02. By the time the said appeal was taken up for hearing, the appeals for the other AYs i.e. 2002-03, 2003-04 and 2004-05, being ITA Nos. 113, 114 and 3170/Del/2007, were also filed by the Revenue. By the common order dated 16th March 2009, the ITAT allowed the appeals of the Revenue on the above aspect of provision for breakages for AYs 2001-02, 2002-03, 2003-04 and 2004-05. It was held that the provision made was without “any basis much less scientific one”. It was noted that this was evident by the fact that the first Assessee itself had reversed the provision on the first day of the following year. Analysing the chart submitted by the first Assessee on the provision made on the actual breakages for each of the AYs, the ITAT noted that in each year the provision made was excessive. The first Assessee did not have enough experience of its own to enable it to make provision of expenditure on scientific basis. It appeared to have been made on ad hoc basis depending on the places of destination. By a subsequent order dated 28th November 2014, the ITAT followed its earlier 2015:DHC:8374-DB

It must be noticed that the first Assessee‟s appeal, being ITA No. 1369 of 2009, against the order of the ITAT dated 14th September, 2009 in ITA No. 3195 of 2009 for the AY 2005-06 raising the same question of law is pending. 2015:DHC:8374-DB

This Court has heard the submissions of Mr. Deepak Chopra, learned counsel appearing for the Assessees, Mr. N.P. Sahni, Senior Standing counsel and Mr. Raghvendra Singh, Junior Standing counsel for the Revenue.

Mr. Chopra relied on the decisions in Bharat Earth Movers (supra), Commissioner of Income Tax v. Vinitec Corporation P. Ltd. 278 ITR 337 (Del), Commissioner of Income Tax v. Insilco Ltd. 179 Taxman 55 (Del), Commissioner of Income Tax v. Sony India Pvt. Ltd. [2007] 160 Taxman 397 (Del), Commissioner of Income Tax v. Beema Manufactures Pvt. Ltd. [2003] 130 Taxman 162 (Del) and Commissioner of Income Tax v. Hewlett Packard (P) Ltd. [2008] 173 Taxman 162 (Del) to urge that the provision for transit breakages, having been calculated on a scientific basis, was an allowable deduction under Section 37(1) of the Act. Relying on the decision in Commissioner of Income Tax v. Balaji Distilleries Ltd. 126 Taxman 264 (Madras) and Commissioner of Income Tax v. Brindavan Beverages (P) Ltd. 335 ITR 163 (Karn), Mr. Chopra submitted that transit breakages were normal to the bottling business and, therefore, allowable as a revenue expenditure. By the same analogy, the provision for said breakages should also be allowed particularly since the provision was reversed on the opening day of the following year. Thereby, there was no loss to the Revenue. He placed reliance on the decision of the Commissioner of Income Tax v. Excel Industries Ltd. 358 ITR 295 (SC).

Mr. Chopra referred to the ledger accounts of transit breakages and transit stocks pertaining to the AYs in question. He pointed out that it was not as if 2015:DHC:8374-DB

Countering the above submissions, Mr. N.P. Sahni, learned Senior Standing counsel and Mr. Raghvendra Singh, learned Junior Standing counsel appearing for the Revenue pointed out that the very nature of the line of business of the Assessees was such that the breakages would be known within 15 to 30 days of the dispatch or at the latest on the delivery of 2015:DHC:8374-DB

The Court proposes to begin examining the above contentions by first referring to the applicable AS. The cue for this is to be found in the CBDT Notification No. SO 69(E) dated 25th January 1996 issued under Section 145(2) of the Act, which states that provisions should be made for “all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.” AS-29 deals with “Provisions, Contingent Liabilities and Contingent Assets‟. The purpose of the AS is to ensure that the balance sheet and P&L Account of an enterprise should present a true and fair view of its business affairs. Under AS 29 a 'provision' is defined to mean “a liability which could be measured only by using a substantial degree of estimation.” The word 'liability' is defined as “a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.” „Contingent Liability‟ is defined as under: 2015:DHC:8374-DB

AS 29 further states that 'provisions' are distinguishable from other liabilities such as trade payables and accruals “because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement.” However a 'provision' is recognised only where: “(a) an enterprise has a present obligation as a result of a past event:

Appendix A to AS-29 sets out in a tabular the summary of the AS. The provisions which are recognised and those that are not are set out in separate columns. What is not recognised is a provision for a liability which arises from „a possible obligation‟ that may, but probably will not, require an outflow of resources.

It is not in dispute that as and when transit breakages do occur the resultant losses are allowable as revenue expenditure, given the nature of the business of the Assessees. The decision in Commissioner of Income Tax v. Balaji Distilleries Ltd. (supra) and Commissioner of Income Tax v. Brindavan Beverages (P) Ltd. (supra) recognised this. In fact, for AYs 2002-03 to 2004-05 the AO has allowed transit breakages as revenue expenditure in the year in which the breakages occurred.

The issue, however, is the justification for creating a provision for such breakages anticipating them in advance of the occurrence of the actual breakages. If such transit breakages cannot be estimated with a reasonable degree of certainty then the liability on that score would be considered 'contingent' in terms of the definition of that expression in AS 29 i.e. "a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise". AS 29 itself makes it explicit that no provision for a contingent liability would be recognised.

As regards the judicial decisions on the point, the Court proposes to first 2015:DHC:8374-DB

The Court further summarised the decision in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC) as under: “(i) For an assessee maintaining his accounts on mercantile system, a liability already accrued, thought to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid;

On facts, in Bharat Earth Movers (supra), the Supreme Court was satisfied that the provision made by the Assessee for meeting the liability “incurred by it under leave encashment scheme proportionate with the entitlement earned by the employees of the company... is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability” and that “the liability is not a contingent liability.” The decision acknowledged that where a scheme for leave encashment is floated by a company, the number of employees and their entitlements to leave encashment can be estimated with a reasonable degree of certainty. It would be a case of a 'known' liability.

In Commissioner of Income Tax v. Vinitec Corporation P. Ltd. (supra) the question for consideration was whether a provision for future warranty expenditure is a contingent liability. On facts, it was not in dispute that the warranty clause was part of the sale document and imposed a liability on the Assessee to discharge an obligation under the clause for the period of warranty. “It was a liability which was capable of being construed in definite 2015:DHC:8374-DB

In Rotork Controls India P. Ltd. v. Commissioner of Income Tax (supra), the Assessee sold valve actuators and at the time of sale provided a standard warranty whereby in the event of the product or a part thereof becoming defective within the periods specified thereunder, the Assessee had an obligation to rectify or replace the defective part free of charge. It was noticed that although the AYs in question were 1991-92 to 1994-95 the claim of such allowance had been allowed since AY 1983-84 itself. It was held that the warranty became an integral part of sale price and, therefore, warranty provision has to be recognised because “the Assessee had a present obligation as a result of past event resulting in an outflow of resources and a reliable estimate could be made of the amount of obligation." The Assessee was held entitled to a deduction in respect of the warranty provision under Section 37 of the Act.

The Court in Rotork Controls India P. Ltd. (supra) explained:

Having examined the decisions that explain the legal position, the Court proceeds to examine the facts on hand. The chart produced by the first Assessee shows that for AY 2001-02 the total amount debited to the P&L Account by way of provision for transit breakages was Rs.6,40,338 and the actual breakages were Rs.2874. In effect, therefore, the provision was in excess by Rs.6,37,464. However, the AO while disallowing the provision added back the entire amount of Rs.6,40,338.

For the next four years i.e. AYs 2002-03 to 2005-06, the actual breakages were less than the provision created. The AO allowed the expenditure of the actual breakages as revenue expenditure and added back the excess provision made since it was in the nature of a contingent liability. In other words what was disallowed was the difference between the provision created and reversed.

The Court is unable to discern any uniform scientific method followed by the Appellant in making provision for the breakages. As noticed by the ITAT in its order dated 16th March 2009, the explanation offered by the Appellant was that on an ad hoc basis it fixed a rate per case of bottles. In the case of Andhra Pradesh, the rate was Rs.10 per case, for Goa and Karnataka it was Rs.15 per case. Also the breakages are known within a period of 15 to 30 days after despatch of the goods. The Court also concurs with the view of the ITAT that with the first Assessee having entered the line of business only from AY 2001-02, it cannot be said to have gathered sufficient experience to have reasonably estimated such breakages for the AYs in question. In the circumstances, the 'liability' on that score could at 2015:DHC:8374-DB

Extensive reference has been made to AS-29 since one of the submissions of the Assessees is that its failure to make a provision for transit breakages would violate the applicable accounting standards. However, as has been discussed hereinbefore, the AS is clear that “an enterprise should not recognise a contingent liability”. Therefore, a provision made by the Assessees for transit breakages in future which cannot be reasonably estimated would not adhere to the AS and the balance sheet so prepared would not present a true and fair view of the state of its business affairs.

The question is not whether on account of the reversal of the provision made by the Assessees on the first day of the following year, there would be no loss as such to the Revenue. The question is whether making a provision for transit breakages would be allowable as a business expenditure. In light of the law explained in the above decisions, the Court is satisfied that the view taken by the ITAT in the present case is not erroneous in law.

To summarise the legal position as far as the Assessees are concerned:

Consequently, the question framed is answered in favour of the Revenue and against the Assessees.

It is clarified that while giving an appeal effect to this order, the AO shall allow the actual transit breakages for AY 2001-02 as revenue expenditure consistent with the settled legal position. The Assessees would also be permitted to get the benefit of the reversal of the provision for transit breakages made in the AYs in question accordance with law.

The appeals are dismissed but in the circumstances with no order as to costs.