DCIT, CIRCLE - 7, KOLKATA, KOLKATA vs. M/S. BCH ELECTRIC LTD., KOLKATA

The only issue in these two appeals of revenue is against the order of CIT(A) in allowing the entire provision of warranty expenses of Rs.1,50,43,597/- in AY 2006-07 and Rs.1,60,88,554/- in AY 2007-08. For this, revenue has raised identically worded grounds. Since facts and circumstances are exactly identical and grounds are also common we will take the issue from AY 2006-07 in and decide the appeal. The relevant ground no. 1 raised by revenue reads as under: “1. That under the facts and circumstances of the case the Ld. CIT(A) has erred in law as well as in facts in holding that the entire provision of warranty expenses amounting to Rs.1,50,43,597/- as an allowable expenses and deleting the entire addition. Whereas, only the part of such provision which got crystallized during the relevant previous year i.e. the amount of actual payment made during the year under the said head only should be allowed and the closing provision as on 31.03.2005 should be added back to the total income for the FY 2005-06 (AY 2006-07), as any sort of provision is not allowable as expenses, if it is not crystallized.”

Briefly stated facts are that the assessee company is engaged in the business of manufacturing and marketing of control gears, motor control censors, control panels and enclosures etc. The AO while framing assessment required the assessee to explain the warranty expenses claimed by the assessee at Rs.1,56,85,757/-. The assessee explained before the AO that these expenses consist of two portions, firstly, the expenses actually incurred for meeting the warranty liability known as warranty replacement expenses and the second portion being in the nature of provision. The assessee contended that these expenses are in the normal course of business and likely to be incurred over a period of warranty. The assessee filed the working of three years of expenses, which reads as under:

The AO noted that there is no actual expenses incurred for replacement of goods under warranty and even for FY 2004-05 relevant to AY 2005-06 the actual expenses incurred are hardly 5% of what has been debited in the books of account. Accordingly, he disallowed the warranty replacement expenses at Rs.1,50,43,597/- out of total expenses debited by the assessee at Rs.1,56,85,757/-. Aggrieved, assessee preferred appeal before CIT(A). The CIT(A) allowed the claim of assessee by observing as under: “5.2 Ground No.2 - This ground of appeal is directed against the disallowance of Rs.15043597/- claimed towards the warranty expenditure. It is seen that the A. O. has disallowed such expenses on the ground that the actual expenses incurred are hardly 5% of what has been debited in the Books of Accounts. It was submitted by the appellant before the assessing officer that it had actually debited Rs.15685757/- as warranty expenses in its accounts and the said expenses consisted of two portions, firstly the expenses actually incurred for meeting warranty liability i.e. warranty replacement expenses and the second portion being in the nature of provisions. The A/R of the appellant contended that even though the expenses had not crystallized they were in the normal course of business and likely to be incurred over the period of warranty. In support of its contention the appellant produced the quantum of expenses actually incurred in last three years with detailed working of warranty, replacement expenditure then warranty expenses and total pertaining to F.Y. 2002-03, 2003-04 & 2004-05. At the appellate stage the appellant submitted that it is true that in F.Y.2002-03 & 2003-04 there was no warranty replacement expenses but the same was incurred only when the customers insist on the same otherwise payout is being made by the appellant which is the warranty expenses incurred during the year. It is submitted that the contention of the A.O. that only 5% of the amount has been paid which is grossly incorrect and indeed the method is being followed since earlier years and on the basis of the past experiences such provisions is being made in the Books of Accounts which is evident from the details of working furnished by the appellant. For the current year i.e. the relevant year 2006-2007, provisions of such warranty expenses is being made on the basis of past experience and had been computed in a systematic and scientific manner and hence the same is 3 & 1538/K/2011 BCH Electric Ltd. AY 2006-07 & 2007-08 allowable expenses. In support of its contention that such expenses are clearly allowable expenditure; the appellant relied upon a numbers of decisions of the various High Courts and Supreme Court. My attention was drawn to the decision of the Hon'ble Supreme Court in the case of Rotork Control India Pvt. Ltd Vs. CIT 314 ITR 62 (SC) where in it has been held that such estimated provisions for warranty as an allowable expenses. In this case the Hon'ble Supreme Court held that in a case where there was warranty obligation such obligation was part of the sale price and should attach to the sale price of the product. Warranty obligation is a present obligation as a result past events resulting in an outflow of resources and a reliable estimate could be made of the amount of obligation. If it is so made it is a liability allowable as deduction U/s.37 of the IT Act. It is seen that the Hon'ble Apex Court has also laid down that the estimate of liability has to be on the basis of statistical data available in the past. In the present case the appellant had filed the necessary data on the basis of which the provision of warranty expenses had been made but the same was not considered by the A.O. Since the appellant has made the provisions on the basis of a principle laid down by the Apex Court, I am of the view that the claim of the appellant in the present case has to be allowed. Recently the Hon'ble ITAT Mumbai Bench 'B' in the case of M/s. Bharat Bigly Ltd Vs. Addl. CIT, Range-61, Mumbai in ITA No.64l0/Mum/2008 had also held the similar view as held by the Hon'ble Supreme Court. Thus, this ground of appeal is allowed and addition made by the A.O. is deleted.”

At the time of hearing, Ld. Counsel for the assessee drew our attention to assessee’s paper book consists of pages 1 to 198 wherein complete details of working of warranty provision is given at pages 196 and 197 for the relevant AY 2006-07 and 2007-08 respectively. The relevant details from page 196 for AY 2006-07 reads as under: “Warranty expenses: Warranty Expenses Booked as per warranty claimed processed during the year 10,956,851 Provision made for the year ended 31.03.2006 4,086,746 Add: Warranty Replacement Exp. 642,160 Total Expenses debited in the P/L A/c 15,685,757 Calculation of warranty provision: Year Sales Actual payout % Year Amount 2004-05 1,013,342,025 2005-06 12,824,037 1.27 2003-04 818,478,271 2004-05 8,028,072 0.98 Total 1,831,820,296 20,852,109 2.25 Average 610,606,765 6,950,703 0.75 Ld. Counsel for the assessee stated that such warranty expenses are being made on the basis of past experience and has been computed in a systematic and scientific manner year on year basis. Ld. Counsel for the assessee drew our attention to the chart reproduced by AO and even by us in para 3 above. He narrated that by applying the percentage on the sale for AY 2005-06 relevant to FY 2004-05 the warranty expenses works out and he filed the details as under: Year Sales Actual year of pay out Amount of pay out 2003-04 Rs.81,84,78,271/- 2004-05 Rs. 80,28,072/- 2002-03 Rs.68,87,60,046/- 2003-04 Rs.66,90,068/- Aggregate Rs.150,72,38,317/- Rs.1,47,18,140/- Average – 1,47,18,140/150,72,38,317 = 0.9765% By applying the above percentage on the sale of AY 2005-06 relevant to FY 2004-05 the warranty expenses is worked out which is as follows: Sale Rs.101,33,42,025/- Warranty pay out Rs. 98,95,257/- Actual pay out Rs. 80,28,072/- Provision made Rs. 18,67,185/- In view of the above, Ld. Counsel for the assessee stated that the warranty pay out works out at Rs.98,35,257/- out of which Rs.80,28,072/- has already been paid during the year and provision for warranty expenses is only for Rs.18,67,185/-. Ld. Counsel for the assessee stated that the contention of the AO that only 5% of the amount has been paid is totally incorrect. According to him, indeed this method is being following since earlier years and on the basis of past experience such provision is being made in the books of account and similar provision is made in the current assessment year i.e. 2006-07 as well as the provision has been made as under: Year Sales Actual payout (Year) Amount 2004-05 Rs.1,013,342,025.00 2005-06 Rs.12,824,037.31 2003-04 Rs. 818,478,271.00 2004-05 Rs. 8,028,072.00 Aggregate Rs. 915,910,148.00 Rs.10,426,054.66 Ld. Counsel for the assessee stated that applying the percentage to current sales the warranty replacement provision is as under: “By applying above % to current year sale. Sale 2005-06 A 1,485,581,912.17 Warranty pay out B 16,910,783.49 B x Average Actual pay out C 12,824,037.31 Provision made D 4,086,746.12 B – C Existing provision E 1,867,185.00 Provision required F 2,219,561.18 D-E Detail of Warranty Expenses Current year expenses 10,956,851 Provision made 4,086,746 Total 15,043,597 Add: Warranty Replacement Exp. 642,160 15,685,757”

In view of the facts and circumstances of the case, now we will go through the case of Hon’ble Supreme Court, as referred by Ld. Senior Advocate Sh. Bajoria, in the case of Retork Controls India P. Ltd. Vs. CIT (2009) 314 ITR 62 (SC) wherein Hon’ble Supreme court held that such estimated provision for warranty as an allowable expenses. Hon’ble Supreme court finally held as under:-

For the above reasons, we set aside the impugned judgment of the Madras High Court dated February 5, 2007, and accordingly the civil appeals stand allowed in favour of the assessee with no order as to costs.” In view of the above facts and circumstances and the precedent of Hon’ble Supreme Court, since in the present case before us the provision for such warranty is being made on the basis of past experience and has been computed in a systematic and scientific manner, as in the present case, surely we have to appreciate that these warranty expenses are towards expenses which have been incurred or are likely to be incurred within the period for which warranty has been assured to the customers against the sale of products and as such, such expenses are deductible as business expenditure. Such expenditure having been incurred wholly for the purpose of business is fully allowable as business expenditure. Accordingly, we uphold the order of CIT(A). Hence, we dismiss both the appeals of revenue.

In the result, both appeals of revenue are dismissed.

Order is pronounced in the open court on 18.12.2015 Sd/- Sd/- (M. Balaganesh) (Mahavir Singh) Accountant Member Judicial Member