DCIT, GURGAON vs. M/S. CARRIER AIR CONDITIONING & REFRIGERATION LTD., GURGAON

This appeal is preferred by the revenue against the order of the ld CIT(A)-I, Gurgaon dated 20.04.2015 for Assessment Year 2004-05. The revenue has challenged the order of the ld CIT(A) only on the issue that disallowance of Rs. 21406000/- made by the ld AO on account of warranty expenses, is deleted by the ld CIT(A).

The brief facts of the case is that the assessee is a company who filed its return of income on 31.10.2004, showing business loss of Rs. 24050560/- which was revised on 21.03.2006. Subsequently, the assessment was completed u/s 143(3) of the Income Tax Act, 1961 on 29.12.2006. Subsequently, notice u/s 148 of the Act was issued and the case of the case was reopened by the ld AO stating that on perusal of the assessment records it was found that the assessee has debited Rs. 62561000/- to the profit and loss account on account of warranty expenses. Further, on scrutiny of the balancesheet it revealed that the assessee has increased the provision of amount of Rs. 21406000/- for the warranty expenses. The assessee was asked about the allowability of the claim of warranty Page | 1 DCIT Vs. Carrier Air Conditioning & Refrigeration Ltd (Assessment Year: 2004-05) expenses. The assessee submitted that warranty expenses are incurred by the assessee as assessee is a manufacturer and in the sale price itself the warranty expenses is realized. It was further stated that it is in accordance with the accounting standard 29 which is mandatory in case of the company. It was stated that it is a liability in present and is not a contingent liability. Further, the assessee contended that the allowability of this deduction is covered by the decision of the Hon'ble Supreme Court in case of Rotork Controls India Pvt. Ltd Vs. CIT 314 ITR 62. The ld AO rejected the explanation and held that provision of warranty is not allowable deduction as it is a contingent liability. He therefore, disallowed Rs. 21406000/-. The order u/s 143(3) read with section 148 of the Act was passed on 30.12.2011 making the above disallowances.

The assessee contested the above disallowance before the ld CIT(A) who allowed the claim of the assessee. Therefore, the revenue is in appeal before us.

The ld Sr. DR vehemently contested that the liability of warranty is allowed only if same is determined in scientific method. He argued that the assessee has increased in the warranty provision in the profit and loss account, however, unutilized liability created in the earlier years not used, is not credited to the profit and loss account. She further stated that though the claim of the assessee is not based on past claims received by the assessee during the year. She vehemently relied on para No. 4.2 of the order of the ld CIT(A).

The ld AR relied upon the order of the ld CIT(A) and submitted that in para 4.4 the ld CIT(A) has allowed the claim of the assessee based on the order of the coordinate bench for earlier years.

We have carefully considered the rival contentions and perused the orders of the lower authorities. During the year the assessee has debited Rs. 21406000/- as warranty expenses. The warranty provision has been created by the assessee following the accounting standard 29 of “provision, contingent liability and contingent assets” which is mandatory DCIT Vs. Carrier Air Conditioning & Refrigeration Ltd (Assessment Year: 2004-05) for the companies. The Hon'ble Supreme Court in Rotork Controls India Pvt. Ltd Vs. CIT (supra) has held that provision of warranty expense is allowable as deduction u/s 37 of the Act. It was further held that warranty is an integral part of the sale price which is attached to the sale price of the product. It was further held that warranty provision had to be recognized because the assessee had a present obligation as a result of the past events resulting in an outflow of resources and reliable estimate can be made of the amount of the obligation. The Hon’ble Court has stated that present value of the contingent liability if properly ascertained and discounted on accrual basis can be an item of deduction u/s 37. In the present case there is no allegation on the assessee that the warranty provision made by the assessee is not a reliable estimate. The ld CIT(A) has decided the issue vide para 4.2 to 4.5 as under:- “4.2 I have considered the facts of the case and gone through the submissions of the appellant. The appellant is engaged in the business of manufacturing and sale of Air-conditioners and compressors etc. and gives a free of cost repair and replacement warranty as per agreed Terms & Conditions with the costumers for a minimum period of one year at the time of sale. The 'Provision for Warranty' has been recognized on the basis of a number of acts which include past claims received during the year and unspent provisions for warranty for previous years therefore, the issue of separately crediting the unspent provisions of warranty for prior years to P&L Account does not arise since the is factored into while recognizing provisions for warranty for subsequent years. This treatment of „Provision for Warranty‟ is in accordance with the accepted principle of accounting which the appellant has been following consistently. The A.O., after examining the legal position regarding deduction on account of 'Provision for Warranty' in the light of this practice being followed by the appellant for so many years allowed provision for warranty while passing the assessment order u/s 143(3) of the Income Tax Act for A.Y- 2005-06, 06-07, 07-08, 08-09 and 10-11. 4.3 The creation of provision for warranty is in consonance with provisions of Section 145 of the Income Tax Act and mandatory accounting standards notified by the CBDT through Notification No. S069E dated 25-01-1996. As per clause 6(b) of the said notification, accrual refers to "the assumption that revenue and cost are accrued, i.e. recognized as they are earned or incurred and Page | 3 DCIT Vs. Carrier Air Conditioning & Refrigeration Ltd (Assessment Year: 2004-05) recorded in the financial statement of the period to which they relate". Thus, the method of accounting for provisions in the year of sale based on historical trend is in consonance with the accrual system of accounting. The issue of allowability of provision for warranty made on scientific basis and past experience has been clinched by the Hon'ble Supreme Court in the case of Rotork Controls India Pvt. Ltd. vs. CIT (314 ITR 62) and the Hon'ble P&H High Court in the case of CIT vs. Majestic Auto Ltd. (156 taxman 460). The relevant extracts of these orders have already been reproduced in the submissions of the appellant. Thus, based on the aforesaid judgments and in light of the facts of the case, it is amply clear that the warranty clause which is a part of a sale document imposes a liability on the appellant to discharge its obligation under that clause for the period of warranty. It is a liability capable of being construed in definite terms and has arisen in the course of the year. The thing left to a future date is its exact quantification and discharge. Thus the appellant is maintaining its accounts on mercantile basis and a liability has accrued during the year. Consequently, the appellant is entitled to a deduction on this account, considering the accepted principle of commercial practice and accountancy. Such a provision which is neither unascertained, nor of a contingent nature should be allowed as a deduction. 4.4 The Hon'ble Delhi ITAT vide order dated 12-04-13 (ITA No. 2961 and 2962/DEL/2012) has upheld the deletion of the addition on account of 'Provision for Warranty' by the Ld. CIT(A) in the appellant's case for AYs 1998-99 and 2001-02. The judgement assumes a lot of importance in view of facts in those cases being identical to the facts in the present case. The relevant extracts of the order of Hon'ble ITAT are reproduced here under:- 'We have carefully considered the submissions and perused the records. We find that in this case the assessee is engaged in the business of manufacturing and sale of air conditioners, compressors etc. and gives a free of cost repair and replacement warranty as per the agreed terms and conditions with the customers for a minimum period of one year at the time of sale. The provision for warranty has been recognized based on past warranty trends, warranty claims received during the year and the unspent provision for warranty for prior years. Thus, we agree with the Ld. Commissioner of Income Tax (A) that the treatment of warranty provision is in consonance with accepted principles of commercial practice and accountancy followed year after year consistently. It is undisputed that the warranty clause is a part of the sales document and imposes a liability upon the assessee to discharge its obligations under that clause for the period of Page | 4 DCIT Vs. Carrier Air Conditioning & Refrigeration Ltd (Assessment Year: 2004-05) warranty. In this regard, we find that Hon'ble Apex Court in the case of Rotark Controls India P Ltd. vs. C.I.T. [2009] 314 ITR 62 (SC) (supra) has held as under:- "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) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. The principle is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and the facts show that defects existed in some of the items manufactured and sold, then provision made for warranty in respect of such sophisticated goods would be entitled to deduction from the gross receipts under section 37." We further find that the Hon'ble Jurisdictional High Court in the case of C.I.T. vs. Majestic Auto Ltd. (Supra) has affirmed the Tribunal's order and held that the provision for warranty claims and free services charges were allowable as deduction on the facts that quantification of warranty claim and liability of free services has been made on scientific basis. In the background of the aforesaid discussions and precedents, we hold that the provision for warranty made in this cases has been arrived at on a scientific basis, as per the past trend and there is no infirmity in the order of the Ld. Commissioner of Income Tax (A). Accordingly, we uphold the same." Thus, it is submitted that the liability for provision for warranty is not to be treated as contingent liability and therefore, should be allowed as deduction in the accounting year itself." 4.5 Hence after a careful consideration of the facts of the case, particularly the judgment of Hon'ble Supreme Court in the case of Rotork Controls India Pvt. Ltd. vs. CIT (Supra),the judgment of Hon'ble Jurisdictional High Court in the case of CIT vs. Majestic Auto Ltd. (Supra) and the decision of Hon'ble ITAT in the appellant's case for A.Ys 1998-99 and 2001- 02, I hold that the A.O erred in making the addition of Rs. 2,14,06,000/- on account of Provision for Warranty'. Accordingly, Grounds No. 3 of the appeal is allowed.”