M/s. Palm Logistic & Automation (P) Ltd, New Delhi v. ITO, New Delhi

ITA 4340/DEL/2009 | 2006-2007
Pronouncement Date: 05-02-2010 | Result: Allowed

Appeal Details

RSA Number 434020114 RSA 2009
Assessee PAN AADCP5553B
Bench Delhi
Appeal Number ITA 4340/DEL/2009
Duration Of Justice 2 month(s) 22 day(s)
Appellant M/s. Palm Logistic & Automation (P) Ltd, New Delhi
Respondent ITO, New Delhi
Appeal Type Income Tax Appeal
Pronouncement Date 05-02-2010
Appeal Filed By Assessee
Order Result Allowed
Bench Allotted F
Tribunal Order Date 05-02-2010
Date Of Final Hearing 14-01-2010
Next Hearing Date 14-01-2010
Assessment Year 2006-2007
Appeal Filed On 13-11-2009
Judgment Text
IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH F: NEW DELHI BEFORE SHRI C.L. SETHI JUDICIAL MEMBER & SHRI SHAMIM YAHYA ACCOUNTANT MEMBER ITA NO. 4340/DEL/2009 ASSESSMENT YEAR: 2006-07 PALM LOGISTIC & AUTOMATION (P) LTD. 9/27 KALKAJI EXTN. NEW DELHI VS. INCOME TAX OFFICER WARD 14(1) NEW DELHI (APPELLANT) (RESPONDENT) PAN : AADCP 5553 B APPELLANT BY : SHRI K. SAMPATH ADVOCATE SHRI S. KRISHNAN ADVOCATE RESPONDENT BY : SHRI ISTIYAQUE AHMAD SR. DR O R D E R PER: C.L. SETHI J.M. THE ASSESSEE HAS FILED THIS APPEAL AGAINST THE ORD ER DATED 29.09.2009 PASSED BY THE LD. CIT(A) IN THE MATTER O F AN ASSESSMENT MADE BY THE AO U/S. 143(3) OF THE INCOME TAX ACT 1961 ( THE ACT) FOR THE A.Y. 2006-07. 2. THE ONLY GROUND RAISED BY THE ASSESSEE IS AS UND ER:- THAT ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE AND IN LAW THE LEARNED CIT(A) ERRED IN CONFIRMING THE ACTION OF THE AO IN ESTIMATING TURNO VER IN A SUM OF RS.25 22 466/- AS UNDISCLOSED SALES AND THEREBY MAKING AN ADDITION OF THE AMOUNT TO THE RETURNED INCOME. THE ACTION IS WHOLLY ARBITRARY ITA NO. 4340/DEL/2009 PAGE 2 OF 49 PALPABLY ERRONEOUS AND GROSSLY UNLAWFUL AND THEREFORE MUST BE QUASHED. 3. THE ASSESSEE FILED ITS E-RETURN DECLARING TOTAL INCOME AT RS. 2 71 979/- ON 29.11.2006. THE CASE WAS SELECTED FO R SCRUTINY AND THE FIRST NOTICE U/S. 143(2) WAS ISSUED BY THE AO ON 05.10.20 07 WHICH HAS BEEN DULY SERVED UPON THE ASSESSEE. THE ASSESSEE IS ENG AGED IN THE BUSINESS OF SELLING MODEMS AND THEIR INSTALLATION. DURING THE YEAR THE ASSESSEES CLIENTS WERE M/S. BSES RAJDHANI POWER LTD. AND M/S. BSES YAMUNA POWER LTD. IN THE PROFIT AND LOSS ACCOUNT FOR THE RELEVANT YEAR THE ASSESSEE HAD SHOWN FOLLOWING ITEMS OF INCOME:- SALES RS.2 20 27 534/- INCOME FROM INSTALLATION RS.2 30 525/- SHORT & EXCESS RECOVERY RS.10/- INTEREST RECEIVED RS.9 649/- TOTAL RS.2 26 67 718/- AGAINST THE AFORESAID TOTAL RECEIPT OF RS. 2 26 67 718/- THE ASSESSEE HAD DEBITED VARIOUS EXPENSES TO THE EXTENT OF RS. 2 19 75 576/- IN THE PROFIT & LOSS ACCOUNT AND HAD SHOWN THE NET PROFIT AT RS.2 92 142/-. IN THE COURSE OF ASSESSMENT PROCEEDINGS THE ASSESSEE WAS ASKED TO FURNISH A COPY OF VAT RETURN OF THE RELEVANT YEAR IN RESPONS E TO WHICH THE ASSESSEE FILED THE COPIES OF VAT RETURN FOR THE FOU R QUARTERS IN WHICH THE ASSESSEE HAD DISCLOSED THE SALES AND PAID TAXES THE RE UPON AS UNDER:- ITA NO. 4340/DEL/2009 PAGE 3 OF 49 QUARTER GROSS TURNOVER OF SALES 01-04-2005 TO 30-06-2005 0 01-07-2005 TO 30-09-2005 49 90 000 01-10-2005 TO 31-12-2005 0 01-01-2006 TO 31-03-2006 1 95 60 000 TOTAL TURNOVER OF SALES 2 45 50 000 4. ON COMPARISON OF TOTAL TURNOVER OF SALES DISCLOS ED IN THE VAT RETURN WITH THE SALES DISCLOSED IN THE PROFIT & LOS S ACCOUNT FILED ALONGWITH THE RETURN OF INCOME IT WAS NOTICED BY T HE AO THAT THERE WAS A DIFFERENCE OF RS. 25 22 466/- (RS.2 45 50 000/- (-) RS.2 26 67 718/-) IN THE AMOUNT OF SALES DISCLOSED IN THE I.T. RETURN VI Z-A`-VIZ VAT RETURN. THE ASSESSEE WAS THUS ASKED BY THE AO TO EXPLAIN AS TO WHY THE DIFFERENCE OF RS.25 22 466/- AS POINTED OUT ABOVE SHOULD NOT BE TREATED AS SUPPRESSION OF SALES AND THE WHY IT SHOULD NOT BE ADDED TO THE ASSESSEES TOTAL INCOME. 5. IN REPLY TO THE AOS QUERY TO EXPLAIN THE DIFFER ENCE OF RS. 25 22 466/- IN THE SALES SHOWN IN THE VAT RETURN A S COMPARED TO THE SALES SHOWN IN THE INCOME TAX RETURN THE ASSESSEE FILED ITS REPLY WHICH HAS BEEN REPRODUCED BY THE AO IN HIS ASSESSMENT ORD ER AS UNDER:- OUR SALE IS PERFORMANCE BASED SALE AS WE RECEIVED ORDERS FROM BSES RAJDHANI POWER LTD. AND BSES YAMUN A POWER LTD. FOR SUPPLY OF AMR (AUTOMATIC METER READE RS) WITH THE PERFORMANCE AND COMMISSIONING GUARANTEE FO R THE ITA NO. 4340/DEL/2009 PAGE 4 OF 49 NEXT 18 MONTHS. WITH ONE MORE CONDITIONS OF OPEN B ANK GUARANTEE OF 10% OF THE VALUE OF THE ORDER. AS WE HAVE THE PERFORMANCE GUARANTEE OF 18 MONTHS OUT OF WHICH 10% AMOUNT RETAIN AS OPEN BANK GUARANT EE I.E. BSES RAJDHANI POWER LTD. AND BSES YAMUNA POWER LTD. CAN INVOKE ANYTIME DURING THE PERIOD OF 18 MONTHS WITHO UT CITING ANY REASON FOR THE SAME THIS GIVES THE BUYER UNLIM ITED RIGHT TO RETURN UP TO 10% OF THE TOTAL SALE. ACCORDINGLY WE RECOGNIZED REVENUE OF 10% WHEN THE TIME PERIOD OF BANK GUARANTEE OVER TO COMPLY THE CO NDITION OF THE ACCOUNTING STANDARD OF REVENUE RECOGNITION. 6. IT WAS FURTHER SUBMITTED BY THE ASSESSEE BEFORE THE AO THAT THE ASSESSEE HAS BEEN FOLLOWING ACCOUNTING STANDARD 9 FOR RECOGNITION OF REVENUE. 7. AFTER CONSIDERING THE ASSESSEES REPLY THE AO H AS TAKEN A VIEW THAT ADOPTING THE ACCOUNTING STANDARD 9 BY THE AS SESSEE FOR RECOGNITION OF THE REVENUE/SALE ARISING OUT IN THE COURSE OF OR DINARY ACTIVITIES OF THE ENTERPRISE I.E. THE SALE OF GOODS IS NOT CORRECT AND NOT AS PER THE PROVISIONS OF LAW. THE AO HAS MADE A REFERENCE TO THE PROVISIONS CONTAINED IN SECTION 145(1) AND THEN HELD THAT AN Y METHOD OF ACCOUNTING ADOPTED BY THE ASSESSEE MUST SATISFY THE FOLLOWING CONDITIONS:- A. IT MUST BE A METHOD RECOGNIZED BY THE ACCOUNTING PRACTICE AND SANCTIONED BY THE COMMERCIAL PRACTICE. B. THE SYSTEM OF ACCOUNTING MUST BE REGULARLY FOLLO WED BY THE ASSESSEE. ITA NO. 4340/DEL/2009 PAGE 5 OF 49 C. ACCOUNTS MAINTAINED UNDER THE SAID SYSTEM MUST B E COMPLETE AND CORRECT. D. IT MUST BE POSSIBLE TO DEDUCE PROFITS FROM IT. 8. THE AO FURTHER OBSERVED THAT FINANCE BILL 1995 H AS BROUGHT ABOUT TWO MAJOR CHANGES IN SECTION 145 OF THE ACT. FIRST LY THAT THE INCOME FROM BUSINESS OR PROFESSION AND INCOME FOR OTHER SO URCES ARE TO BE COMPUTED W.E.F. A.Y. 1997-98 IN ACCORDANCE WITH EI THER CASH SYSTEM OR MERCANTILE SYSTEM OF ACCOUNTING. THE AO FURTHER OB SERVED THAT THIS WOULD MEAN THAT HYBRID SYSTEM WHICH HAS ELEMENTS O F BOTH THE ABOVE STATED TWO METHODS IS NO LONGER RECOGNIZED METHOD OF ACCOUNTING FOR THE PURPOSE OF SECTION 145 OF THE ACT. IT WAS THEN OBS ERVED BY THE AO THAT AS PER THE TAX AUDIT REPORT IT WAS EVIDENT THAT THE A SSESSEE WAS FOLLOWED MERCANTILE SYSTEM OR ACCRUAL SYSTEM OF ACCOUNTING WHERE THE ACCOUNTS ARE KEPT ON MERCANTILE BASIS AND THE PROFIT OR GAIN ARE CREDITED ON DUE BASIS THOUGH THEY ARE NOT ACTUALLY RECEIVED OR REAL IZED. THE AO THEREFORE STATED THAT OUT OF THIS TOTAL SALE OF RS . 2 45 50 000/- THE ASSESSEE HAD SHOWN ONLY SALES OF RS.2 20 27 534/- A ND THE REMAINING AMOUNT OF RS. 25 22 466/- EQUIVALENT TO THE MARGIN INCOME OF BANK GUARANTEE WAS NOT SHOWN ON THE GROUND THAT THE SAME WOULD BE RECOGNIZED ONLY AT THE TIME OF ACTUAL RECEIPT AFTER PERFORMANCE GUARANTEE OF 18 MONTHS IS OVER. THE AO THUS TAKEN A VIEW THOUGH THE ASSESSEE ITA NO. 4340/DEL/2009 PAGE 6 OF 49 HAS FOLLOWED MERCANTILE SYSTEM OF ACCOUNTING FOR RE COGNITION OF PURCHASES AND OTHER EXPENSES BUT HAS FOLLOWED HYB RID SYSTEM OF ACCOUNTING IN RESPECT OF SALES MADE BY THE ASSESSEE WHICH IN THE OPINION OF THE AO WAS NOT RECOGNIZED METHOD U/S. 145(1) OF THE ACT. THE AO WAS ALSO OF THE VIEW THAT THE ASSESSEES RELIANCE O N ACCOUNTING STANDARD 9 IN SUPPORT OF HIS SYSTEM IS MISPLACED IN SO FAR AS RECOGNITION OF SALES BY THE ASSESS IS CONCERNED. IN THIS RESPECT THE A O MADE REFERENCE TO PARA 10 & 11 OF ACCOUNTING STANDARD 9 AND THEN HELD T HAT THE REVENUE IN CASE OF SALES SHOULD BE RECOGNIZED WHEN ALL THE FOL LOWING CONDITIONS ARE SATISFIED:- (I) THE SELLER HAS TRANSFERRED TO THE BUYER ALL SIG NIFICANT RISKS AND REWARDS OF OWNERSHIP AND THE SELLER RETAI NS NO EFFECTIVE CONTROL ON THE GOODS SOLD.; (II) NO SIGNIFICANT UNCERTAINTY EXISTS REGARDING TH E AMOUNT OF THE CONSIDERATION THAT WILL BE DERIVED FROM THE SALES; AND (III) IT IS NOT UNREASONABLE TO EXPECT ULTIMATE COL LECTION. 9. HAVING SAID SO THE AO HAD TAKEN A VIEW THAT ONC E THE ASSESSEE RAISED THE BILLS AND ITS CUSTOMERS ACCEPTED THE PH YSICAL DELIVERY OF THE GOODS SOLD BY THE ASSESSEE THE ASSESSEE SHOULD HAV E RECOGNIZED THE TOTAL SALES FOR THE PURPOSE OF DETERMINING ITS INCOME. I N THIS RESPECT THE FOLLOWING OBSERVATIONS AND DISCUSSIONS MADE BY THE AO IS MATERIAL: ITA NO. 4340/DEL/2009 PAGE 7 OF 49 ONCE THE ASSESSEE SENDS THE BILLS AND THE BSES RAJDHANI POWER PVT. LTD. AND BSES YAMUNA POWER LTD ACCEPT THE PHYSICAL DELIVERY OF THE GOODS SOLD THE ASSESSEE CEASED TO HAVE ANY EFFECTIVE CONTROL ON THE GOODS S OLD. AS FAR AS RISK AND REWARDS ARE CONCERNED THE PRICE RISK I S CONSIDERED AS ONE OF THE MOST SIGNIFICANT RISK WHIC H IS ALSO TRANSFERRED AT THE TIME PHYSICAL DELIVERY OF GOODS ARE MADE AND BILLS RAISED. SINCE BSES RAJDHANI POWER LTD. AND BSES YAMUNA POWER LTD. WHICH ARE JOINT VENTURE OF THE D ELHI GOVERNMENT AND RELIANCE GROUP ARE RESPONSIBLE FOR DISTRIBUTION OF POWER IN NATIONAL CAPITAL TERRITORY OF DELHI THESE COMPANIES ENTERED INTO A TRANSACTION WITH TH E ASSESSEE COMPANY AFTER CONSIDERING THE RISK AND REWARDS ASPE CTS IN RESPECT OF TRANSACTION. THIS IS ONLY AFTER ALL THE SIGNIFICANT RISKS AND REWARDS HAVE BEEN TRANSFERRED TO THE BUYE RS THAT THE ASSESSEE HAS OBLIGED TO PERFORM ANY SUBSTANTIAL AC TS LIE COMMISSIONING AND INSTALLATION OF GOODS ETC. WHEN THE AMR (AUTOMATIC READER MACHINE) IS INSTALLED AT THE SITE OF THE ASSESSEE LOSSES EFFECTIVE CONTROL WHICH ALSO SUBSEQ UENTLY TRANSFERS TO THE BSES RAJDHANI POWER LTD. AND BSES YAMUNA POWER LTD. AS REGARDS EXISTENCE OF UNCERTAINTY REG ARDING THE AMOUNT OF THE CONSIDERATION IS CONSIDERED THE AMOU NT OF CONSIDERATION IS CLEARLY SPECIFIED IN THE AGREEMENT PURCHASE ORDER/LETTER OF AWARD. THEREFORE NO SIGNIFICANT U NCERTAINTY EXISTS REGARDING THE AMOUNT OF CONSIDERATION THAT W ILL BE DERIVED FROM THE SALES. IT ALSO SHOWS THE EVIDENC E OF BUYERS COMMITMENT FOR THIS TRANSACTION WITH THE ASSESSEE COMPANY AND THEIR COMMITMENT TO MAKE COMPLETE PAYMENT. FRO M THE DETAILS SUBMITTED IT IS SEEN THAT THERE WAS NO OCCA SION TO SEE THAT THE PURCHASER WOULD NOT BE WILLING TO FULFILL ITS PART OF THE CONTRACT. AS STATED ABOVE THE BUYERS HAVE ALREADY PAID SUBSTANTIAL CONSIDERATION AS PER THE SCHEDULE OF PA YMENT DURING THE YEAR ITSELF. PART PERFORMANCE OF THE CO NTRACT IS THEREFORE SUFFICIENT. SINCE BSES RAJDHANI POWER LT D. AND BSES YAMUNA POWER LTD. ARE REPUTED CONCERNS AND THE Y HAD THE RESPONSIBILITY OF GENERATION AND DISTRIBUTION O F ELECTRICITY IN DELHI THEY HAVE INVESTED A LOT IN OBTAINING AND GETTING THE MATERIAL COMMISSIONED. HENCE IT IS NOT POSSIBLE T HAT THESE PARTIES AFTER HAVING INVESTED SO MUCH WOULD NOT BE WILLING TO FULFILL THE REMAINING PART CONTRACT. THUS REASONA BLENESS TO EXPECT ULTIMATE COLLECTION CANNOT BE ALSO QUESTIONE D. ITA NO. 4340/DEL/2009 PAGE 8 OF 49 10. EVEN OTHERWISE THE AO HAS TAKEN A VIEW THAT AC COUNTING PRACTICE CANNOT OVERRIDE THE PROVISIONS OF THE INCOME TAX AC T WHERE THE ASSESSEE IS REQUIRED TO RECOGNIZED ITS REVENUE AS PER PROVIS IONS OF SECTION 145(1) OF THE ACT. THE AO THEN DECIDED THE ISSUE AGAINST THE ASSESSEE BY CONCLUDING AS UNDER:- IT IS ALSO PERTINENT TO MENTION HERE THAT FOR THE PURPOSE OF VAT RETURN THE ASSESSEE HAS DISCLOSED T HE ENTIRE AMOUNT RS.2 45 50 000/- AS SALES TURNOVER AND HAS A LSO PAID THE VAT ON THE ENTIRE AMOUNT OF SALES WITHOUT DEDUC TING THE MARGIN MONEY. HOWEVER FOR THE PURPOSE OF INCOME TA X THE ASSESSEE IN ITS PROFIT AND LOSS ACCOUNT HAS DEDUCT ED THE AMOUNT OF RS.25 22 466/- FROM THE TOTAL TURNOVER ST ATING THAT THE SAME AMOUNT HAS NOT BEEN RECOGNIZABLE DURING TH E YEAR AS SALES. THUS THE ASSESSEE HAS ADOPTED TWO DIFFERE NT YARDSTICKS FOR REFLECTING SAME ITEM OF INCOME-ONCE FOR THE PU RPOSE OF SALES TAX ACT AND OTHER FOR THE INCOME TAX WHICH IS NOT ALLOWABLE. THE MARGIN MONEY OF 10% WHICH THE ASSES SEE IS REQUIRED TO OPEN AS PERFORMANCE BANK GUARANTEE IS N OTHING BUT A DEPOSIT AND THE SAME CANNOT BE DEDUCTED WHILE ARRIVING AT THE VALUE OF SALES ONCE THE SALES IS COMPLETE WI TH BILLS AND PHYSICAL DELIVERY OF GOODS HAS BEEN DULY ACKNOWLEDG ED BY THE BUYERS. IN VIEW OF ABOVE IT IS HELD THAT THE ASSESSEE H AS NOT DISCLOSED THE FULL AND TRUE VALUE OF SALES IN THE PROFIT & LOSS ACCOUNT ONLY WITH A VIEW TO AVOID PAYMENT OF TAX. THEREFORE THE AMOUNT OF RS.25 22 466/- WHICH IS INCLUDED IN T HE SALES TURNOVER AS PER THE VAT RETURN AND NOT INCLUDED IN THE SALES TURNOVER AS PER THE INCOME TAX RETURN IS ADDED IN T HE INCOME OF THE ASSESSEE AS UNDISCLOSED SALES. UNDERSIGNED IS SATISFIED THAT TO THE EXTENT OF RS. 25 22 466/- THE ASSESSEE HAS CONCEALED ITS INCOME OR/AND FURNISHED INACCURATE PA RTICULAR OF ITS INCOME AND THEREFORE PENALTY PROCEEDINGS U/ S. 271(1)(C) IS ALSO INITIATED AGAINST THE ASSESSEE. ITA NO. 4340/DEL/2009 PAGE 9 OF 49 11. BEING AGGRIEVED THE ASSESSEE PREFERRED AN APPE AL BEFORE THE CIT(A). 12. BEFORE THE CIT(A) THE ASSESSEE CONTENDED AS UN DER:- 1. THE COMPANY WAS INCORPORATED ON 21.04.2005 AND YEAR UNDER APPEAL IS THE FIRST YEAR OF OPERATION. IT GOT LICENSE FROM MINISTRY OF COMMUNICATION FOR IMPORT OF MODEMS. ACCORDINGLY IT IMPORTED MODEM AND SOFTWARE TO RUN THE MODEM. THE MODEM WAS IMPORTED FROM M/S. HORTEIC TECHNOLOGY LYD. HONG KONG. THE AVERAGE COST OF THE MODEM WAS RS.1200/-. THUS TOTAL COST OF THE MODEM WAS RS. 3700/-. 2. THE RELIANCE GROUP COMPANY BSES YAMUNA POWER LTD. & BSES RAJDHANI POWER LTD. AWARDED TWO CONTRACTS TO THE COMPANY. 1 ST FOR SUPPLY OF MODEM @ RS. 5000/- PER MODEM AND SECOND FOR INSTALLATION OF MODEM @ RS. 450/- PER MODEM. THE PURCHASE ORDERS STATED VARIOUS TERMS AND CONDITIONS WHICH WE HAVE ALREADY BEEN FILED VIDE OUR LETTER DATED 19.06.2009. THE SUPPLIER OF MODEM HAD NOT GRANTED ANY WARRANTY TO THE PRODUCTS AS THE FOREIGN SUPPLIER WAS ALSO DEALER OF THE MODEM AND THE RATE WERE NEGOTIATED ACCORDINGLY. THEREFORE THE COMPANY GOT AVERAGE MARGIN OF RS. 1300/- PER MODEM BESIDE INSTALLATION CHARGES OF RS. 450.00 PER MODEM. THE APPELLANT COMPANY GRANTED 18 MONTHS WARRANTY TO BSES SINCE TERMS OF OFFER OF BSES WAS SUCH THAT ORDERS SHALL BE GIVEN TO THOSE PARTIES WHO GIVE WARRANTY/GUARANTEE FOR 18 MONTHS. THE AVERAGE MARGIN OF RS. 1300/- PER MODEM THUS COVERED WARRANTY PERIOD EXPENDITURE. THE BSES COULD ITSELF IMPORT THE MATERIAL BUT IT WANTED A FIRM WHO COULD OFFER ONSITE WARRANTY OF THE MODEM AS IT WAS A HIGHLY PROFESSIONAL WORK AND REQUIRE GOOD TEAM OF PROFESSIONALS. ITA NO. 4340/DEL/2009 PAGE 10 OF 49 THE MODEM SO IMPORTED REQUIRE INSTALLATION AT SITE AND FREQUENT ADJUSTMENTS IN THE FORM OF: DECLINING TONES ANTENNA NOT WORKING ADOPTER WIRE LOOSE ETC. ADOPT FAILURE ETC. RELOADING OF SOFTWARE 3. IT IS SUBMITTED BEFORE YOUR HONOUR THAT IT IS NOT NECESSARY THAT THE WARRANTY CAN BE UNDERTAKEN BY THE MANUFACTURES ONLY. WARRANTY CAN BE UNDERTAKEN BY THE TRADERS ALSO IF THE CONTRACT BETWEEN THE PARTIES ARE SO. 4. WE HAVE ALREADY QUOTED VARIOUS JUDGMENTS WHEREBY IT IS HELD THAT PROVISIONS FOR WARRANTY IS ELIGIBLE BUSINESS EXPENSES VIDE OUR LETTER DATED 19-06-2009. YOUR KIND ATTENTION IS INVITED TO JUDGMENT OF CIT (2000) 245 ITR 428 WHEREIN IT WAS HELD THAT IF A BUSINESS LIABILITY HA S DEFINITELY ARISEN IN ACCOUNTING YEAR DEDUCTION SHOULD BE ALLOWED ALTHOUGH LIABILITY MAY HAVE TO BE QUANTIFIED AND DISCHARGED AT FUTURE DATE BUT WHAT SHOULD BE DEFINITE IS INCURRING LIABILITY. IN THE CASE OF THE APPELLANT COMPANY THE COMPANY HAD WRITTEN AGREEMENT (PURCHASE ORDERS) WHEREBY THE COMPANY HAD UNDERTAKEN TO SERVICE THE PRODUCTS. AT THE END OF FINANCIAL YEAR 31-3- 2006 COMPANY HAD TO INCURRED EXPENDITURE FOR THE REMAINING PERIOD OF WARRANTY HENCE THERE WAS A CLEAR CRYSTAL LIABILITY AS ON 31-3-2006. THE COMPANY HAD BOOKED THE ENTIRE AMOUNT OF SALES AS ITS REVENUE AT RS. 2 45 50 000.00 THEREFORE THE COMPANY HAD TO MAKE ADEQUATE PROVISION FOR THE REMAINING PERIOD OF WARRANTY. 5. WE HAVE ALREADY FILED AND PLACED ON RECORD A STATEMENT SHOWING THE TOTAL ESTIMATED LIABILITY FOR THE REMAINING PERIOD OF WARRANTY WAS ABOUT RS. 24 70 000.00 BUT THE APPELLANT COMPANY ITA NO. 4340/DEL/2009 PAGE 11 OF 49 HAD GIVEN BANK GUARANTEE FOR RS. 24 55 000.00 ONLY HENCE THE LOWER OF THE TWO AMOUNT WAS PROVIDED IN THE BOOKS BY DEBITED THE SALES ACCOUNT. THE SECOND REASON FOR DEBITING THE SALES A/C. BY RS. 24 55 000/- WAS THE COMPANY HAD GIVEN BANK GUARANTEE OF RS.10% OF THE SALE VALUE TO BSES WHICH THEY CAN REVOKE ANY TIME DURING WARRANTY PERIOD. THEREFORE THERE WAS CONSIDERABLE RISK AND UNCERTAINTY TO THE TUNE OF RS . 24 55 000.00 AS ON 31-3-2006. 6. IT IS ALSO SUBMITTED BEFORE YOUR HONOR THAT BASIC REQUIREMENT IMPLICIT IN THE PROVISION OF SECTION 145 AS WELL AS THE GENERAL COMMERCIAL WORLD IS THAT THE FINANCIAL STATEMENTS OF AN ENTERPRISE SHOULD IN RESPECT OF THE SAME SOURCE THE ASSESSEE FOLLOWED MERCANTILE SYSTEM FOR PURCHASE AND OTHER EXPENSES AND HYBRID SYSTEM FOR SALES WHICH IS NO LONGER A RECOGNIZED METHOD U/S. 145(1). THE LEARNED ASSESSING OFFICER DID NOT CONSIDER THAT PERFORMANCE WARRANTY OF 18 MONTHS REQUIRE EXPENDITURE DURING WARRANTY PERIOD AND ADEQUATE PROVISION MUST BE MADE BY THE APPELLANT COMPANY FOR THE REMAINING PERIOD OF WARRANTY SO AS TO GIVE TRUE AND FAIR VIEW OF THE PROFIT OF THE COMPANY. THE REASON FOR DEBITING THE SALE A/C TO THE EXTENT OF BANK GUARANTEE HAS ALREADY BEEN EXPLAINED HEREIN ABOVE. THE COMPANY VIDE ITS LETTER (COPY ALREADY FILED) HAD STATED THE FOLLOWING REASONS OF DEBITING THE RS. 24 55 000.00 TO THE SALES A/C. OUR SALE IS PERFORMANCE BASED SALE AS WE RECEIVED ORDERS FROM BSES RAJDHANI POWER LTD. AND BSES YAMUNA POWER LTD. FOR SUPPLY OF AMR (AUTOMATIC METER READER) WITH THE PERFORMANCE AND COMMISSIONING GUARANTEE FOR THE NEXT 18 MONTHS. ITA NO. 4340/DEL/2009 PAGE 12 OF 49 ONE MORE CONDITION OF OPEN BANK GUARANTEE OF 10% OF THE VALUE OF ORDER. ACCORDINGLY WE RECOGNIZE REVENUE OF 10% WHEN THE TIME PERIOD OF BANK GUARANTEE IS OVER TO COMPLY THE CONDITION OF THE ACCOUNTING STANDARD OF REVENUE RECOGNITION. 9. IT IS SUBMITTED BEFORE YOUR HONOUR THAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDI A HAS PRESCRIBED VARIOUS ACCOUNTING STANDARD AND THE BASIC REASON FOR DOING SO IS TO GIVE TRUE AND FAIR VIEW OF THE FINANCIAL ACCOUNTS OF A CONCERN. THE BASIC REQUIREMENT IMPLICIT IN THE PROVISIONS OF SECTION 145 AS WELL AS THE GENERAL COMMERCIAL WORLD IS THAT THE FINANCIAL STATEMENTS OF AN ENTERPRISE SHOULD GIVE A TRUE & FAIR VIEW OF ITS POSITION & WORKING RESULTS (2201) 79 ITD 196 (AHD). 13. IN SUPPORT OF THE ASSESSEES CONTENTION BEFORE THE LD. CIT(A) THE ASSESSEE HAD RELIED UPON VARIOUS DECISIONS INCLUDIN G THE FOLLOWING:- (I) BHARAT EARTH MOVERS LTD. VS. CIT 245 ITR 428 (II) M/S. VINITEC CORP. PVT. LTD. (2005) 278 ITR 33 7 (DELHI). 14. AFTER CAREFULLY CONSIDERING THE SUBMISSION OF T HE ASSESSEE AND THE ASSESSMENT ORDER OF THE AO THE CIT(A) DECIDED THE ISSUE AGAINST THE ASSESSEE BY HOLDING THAT THE ASSESSEE HAS NOT BEE N ABLE TO PROVE THE ACTUAL INCURRING OF LIABILITY UNDER THE WARRANTY CL AUSE WHICH WAS MADE MERELY ON THE BASIS OF CERTAIN PERCENTAGE OF THE TU RNOVER. THE CIT(A) ITA NO. 4340/DEL/2009 PAGE 13 OF 49 FURTHER OBSERVED THAT THE DECISION OF HONBLE DELHI HIGH COURT IN THE CASE OF CIT VS. M/S. VINITEC CORP. PVT. LTD. (2005) 278 ITR 337 (DELHI) THE DECISION OF KERALA HIGH COURT IN THE CASE OF CI T VS. INDIAN TRANSFORMERS LTD. (2004) 270 ITR 259 (KER.) AND DEC ISION OF PRIVY COUNCIL IN THE CASE OF COMMISSIONER OF INLAND REVEN UE VS. MITSUBISHI MOTORS NEW ZEALAND LTD. (1996) 222 ITR 697 (PC) W OULD BE OF NO HELD TO THE ASSESSEE IN AS MUCH AS THOSE CASES CLAIM OF WARRANTY WAS ALLOWED ON THE BASIS OF DATA OF THE PREVIOUS YEAR OF INCURR ING ACTUAL WARRANTY EXPENSES IN RESPECT OF THE WARRANTY PROVIDED BY THE ASSESSEE IN RESPECT OF THE GOODS SOLD BY THE ASSESSEE. THE CIT(A) FURT HER OBSERVED THAT IN THE ABSENCE OF SUCH DETAILS IN THE PRESENT CASE AN AD-HOC PERCENTAGE ON THE BASIS OF THE TOTAL TURNOVER IS NOT ALLOWABLE. THE CIT(A) FURTHER OBSERVED THAT THE IN RELEVANT YEAR BEING THE FIRST YEAR OF THE BUSINESS THERE COULD NOT BE ANY DATA OF THE PREVIOUS YEAR ON THE BASIS OF WHICH EXACT WARRANTY EXPENSES COULD BE ASCERTAINED. THE CIT(A) FURTHER OBSERVED THAT THE ASSESSEE HAS REVERSED THE ENTRY O F PROVISIONS OF WARRANTY OF THIS YEAR IN THE NEXT YEAR BY CREDITIN G ENTIRE PROVISIONS TO THE PROFIT & LOSS ACCOUNT WHICH WOULD GO TO ESTABLISH THAT THERE WAS NO ACTUAL LIKELIHOOD OF ANY DEFECT ARISEN TO THE GOODS SUPPLIED BY THE ASSESSEE. ITA NO. 4340/DEL/2009 PAGE 14 OF 49 15. THE LD. CIT(A) HAS PLACED RELIANCE UPON THE DEC ISION OF HONBLE MADRAS HIGH COURT IN THE CASE OF CIT VS. ROTORK CON TROLS INDIA LTD. (2007) 293 ITR 311 (MAD.) THE CIT(A) WAS THEREFOR E OF THE OPINION THAT ENTIRE SALE PROCE XEDS WAS TO BE INCLUDED IN T HE TURNOVER FOR THE PURPOSE OF DETERMINING THE ASSESSEES PROFIT AND I N THAT VIEW OF THE MATTER THE AO WAS JUSTIFIED IN MAKING THE ADDITION OF RS. 25 22 466/- ON ACCOUNT SUPPRESSION OF SALES. 16. STILL AGGRIEVED THE ASSESSEE IS IN APPEAL BEFO RE US. 17. THE LD. COUNSEL FOR THE ASSESSEE HAS REITERATED THE CONTENTIONS AND SUBMISSIONS THAT WERE MADE BEFORE THE AUTHORITIES B ELOW AND RELIED UPON THE DECISION OF HONBLE DELHI HIGH COURT IN THE CAS E OF VINITEC CORPORATION PVT. LTD. (SUPRA) IN SUPPORT OF THE CON TENTION THAT WARRANTY PROVISIONS ARE IN THE NATURE OF ASCERTAINED LIABILI TY AND NOT CONTINGENT ONE. HE FURTHER SUBMITTED THAT OUT OF THE PROVISIO NS MADE DURING THIS YEAR THE AMOUNT FOUND TO BE EXCESSIVE AFTER THE EX PIRY OF WARRANTY PERIOD HAS BEEN DULY CREDITED TO THE PROFIT AND LOS S ACCOUNT IN SUBSEQUENT YEAR AND HAS BEEN OFFERED TO TAX AND THEREFORE N O TAX LIABILITY OF THE ASSESSEE HAS BEEN OTHERWISE BEEN REDUCED. IN THIS CONNECTION A RELIANCE HAS BEEN PLACED UPON THE DECISION OF THE HONBLE D ELHI HIGH COURT IN THE CASE OF CIT VS. VISHNU INDUSTRIES GASES PVT. LT D. DECIDED ON ITA NO. 4340/DEL/2009 PAGE 15 OF 49 06.05.2008 IN ITR NO. 229 OF 1988 WHERE THE HONBLE HIGH COURT HAS HELD THAT THE QUESTION AS TO THE YEAR IN WHICH THE DEDUCTION IS ALLOWABLE MAY BE MATERIAL WHEN RATE OF TAX CHARGEABLE ON THE ASSESSEE IN TWO DIFFERENT TWO YEARS IS DIFFERENT; IN THE CASE OF IN COME OF A COMPANY THE TAX IS ATTRACTED AT A UNIFORM RATE AND WHETHER DED UCTION IN RESPECT OF BONUS WAS GRANTED IN THE A.Y. 1952-53 OR IN THE A.Y . 1953-54 IT SHOULD BE A MATTER OF NO CONSEQUENCES TO THE DEPARTMENT AN D THUS THERE IS HARDLY A QUESTION THAT SHOULD REQUIRED THE COURT TO EXERCISE THEIR MIND PARTICULARLY SINCE THERE WAS NO DOUBT THAT THE TAX HAS BEEN PAID AND THE RATE OF TAX REMAIN THE SAME FOR BOTH THE ASSESSMENT YEARS. 18. THE LD. DR ON THE OTHER HAND SUPPORTED THE OR DERS OF THE AUTHORITIES BELOW AND CONTENDED THAT THE ASSESSEES CLAIM OF PROVISIONS TOWARDS WARRANTY MADE MERELY ON THE BASIS OF CERTAI N PERCENTAGE OF THE TURNOVER CANNOT BE CONSIDERED TO BE ASCERTAINED LIA BILITY INCURRED BY THE ASSESSEE DURING THE YEAR SO AS TO ENTITLED THE ASS ESSEE TO CLAIM THE DEDUCTION. THE VARIOUS OBSERVATIONS AND THE DISCUS SIONS MADE BY THE AO AS WELL AS BY THE CIT(A) IN THEIR RESPECTIVE ORDERS HAS BEEN REITERATED BY THE LD. DR. 19. RIVAL CONTENTIONS OF BOTH THE PARTIES HAVE BEEN CONSIDERED AND ORDERS OF THE AUTHORITIES BELOW HAVE BEEN PERUSED. WE HAVE DELIBERATED ITA NO. 4340/DEL/2009 PAGE 16 OF 49 UPON THE VARIOUS DECISIONS CITED AT THE BAR AS WELL AS DECISIONS RELIED UPON BY THE AUTHORITIES BELOW. 20. THE ASSESSEE COMPANY IS ENGAGED IN THE BUSINESS OF SELLING MODEMS AND THEIR INSTALLATION. DURING THE YEAR UND ER CONSIDERATION THE ASSESSEE WAS AWARDED TWO CONTRACTS BY BSES YAMUNA P VT. LTD. AND BSES RAJDHANI PVT. LTD. TO SUPPLY MODEM @ RS. 5 000 /- PER MODEM AND FOR INSTALLATION OF MODEM @ RS. 450/-PER MODEM. TH E PURCHASE ORDERS PLACED BY THE AFORESAID TWO PARTIES CONTAINED VARIO US TERMS AND CONDITIONS. AS PER TERMS AND CONDITIONS OF THE PUR CHASE ORDERS THE ASSESSEE COMPANY GRANTED 18 MONTHS PERFORMANCE AND COMMISSIONING WARRANTY TO THE PURCHASER IN RESPECT OF THE GOODS S UPPLIED BY THE ASSESSEE COMPANY. AS PER THE WARRANTY THE ASSESSEE HAD TO UNDERTAKE CERTAIN SERVICES TO THE PRODUCTS SUPPLIED BY IT FOR A PERIO D OF 18 MONTHS FROM THE DATE OF SUPPLY. DURING THE CURRENT YEAR ENDED ON 3 1.03.2006 THE ASSESSEE HAD INCURRED CERTAIN EXPENSES AMOUNTING TO RS. 4 76 000/- TOWARDS WARRANTY AND FOR THE REMAINING PERIOD OF W ARRANTY THE ASSESSEE MADE A PROVISIONS OF RS. 24 55 000/-. WITH A VIEW TO ENSURE THAT THE ASSESSEE WOULD UNDERTAKE SERVICES TO THE PRODUCTS S UPPLIED BY THE ASSESSEE TO THESE TWO COMPANIES THE ASSESSEE HAD T O GIVE A BANK GUARANTEE TO THE EXTENT OF RS. 24 55 000/- TO THE P URCHASER WHICH IS ITA NO. 4340/DEL/2009 PAGE 17 OF 49 EQUIVALENT TO 10% OF THE SALE VALUE OF THE ITEMS. THE BANK GUARANTEE GIVEN BY THE ASSESSEE WAS REVOCABLE AT ANY TIME DUR ING THE WARRANTY PERIOD AND THE RESPECTIVE PARTY COULD ENCASH THE GU ARANTEE AMOUNT IN CASE THE ASSESSEE FAILED TO DISCHARGE ITS OBLIGATIO N ARISING FROM THE WARRANTY CLAUSE. IN THE LIGHT OF THESE FACTS IT I S THEREFORE TO BE SEEN AS TO WHETHER THE ASSESSEE HAS INCURRED ANY ASCERTAINE D LIABILITY TOWARDS WARRANTY DURING THE YEAR UNDER CONSIDERATION SO AS TO ALLOW IT AS DEDUCTION WHILE COMPUTING THE ASSESSEES PROFIT FRO M BUSINESS OF SUPPLY OF GOODS SOLD WITH WARRANTY CLAUSE. IT IS NOT IN D ISPUTE THAT THE ASSESSEE HAS BEEN MAINTAINING ITS BOOKS OF ACCOUNTS ON MERCA NTILE BASIS. THE LAW IS WELL SETTLED THAT UNDER THE MERCANTILE SYSTEM OF ACCOUNTING IF A BUSINESS LIABILITY IS DEFINITELY ARISEN IN THE ACCO UNTING YEAR THE DEDUCTION SHOULD BE ALLOWED ALTHOUGH THE LIABILITY MAY HAVE TO BE QUANTIFIED AND DISCHARGE AT A FUTURE DATE. WHAT SHOULD BE ASCERTA INED IS THE INCURRING OF THE LIABILITY. IT SHOULD ALSO BE CAPABLE OF BEING ESTIMATED WITH A REASONABLE CERTAINTY THOUGH THE ACTUAL QUANTIFICATI ON MAY NOT BE POSSIBLE. IF THESE REQUIREMENTS ARE SATISFIED THE LIABILITY IS NOT A CONTINGENT ONE. THE LIABILITY IS IN PRESENTI THOUGH IT WILL BE DISC HARGED AT A FUTURE DATE. IT DOES NOT MAKE ANY DIFFERENCE IF THE FUTURE DATE ON WHICH THE LIABILITY SHALL HAVE TO BE DISCHARGE IS NOT CERTAIN. THIS IS SO OBSERVED AND HELD BY ITA NO. 4340/DEL/2009 PAGE 18 OF 49 THE HONBLE SUPREME COURT IN THE CASE OF BHARAT EAR TH MOVERS VS. CIT (2000) 245 ITR 428 (SC). 21. AT THE SAME TIME IT IS WELL SETTLED THAT CONTI NGENT LIABILITY DID NOT CONSTITUTE EXPENDITURE AND CANNOT BE THE SUBJECT MA TTER OF DEDUCTION EVEN UNDER THE MERCANTILE SYSTEM OF ACCOUNTING. 22. THEREFORE FOR DETERMINING WHETHER THERE IS A E XPENDITURE TO BE ALLOWED AS DEDUCTION IT IS NECESSARY TO SEE WHETHE R THERE IS A EXISTING LIABILITY TO PAY OUT MONEY IRRETRIEVABLY. THE HON BLE SUPREME COURT IN THE CASE OF CALCUTTA CO. LTD. V. COMMISSIONER OF IN COME-TAX [1959] 37 ITR 1 (SC) HAS POINTED OUT THAT DISTINCTION SHOULD BE MADE BETWEEN CONTINGENT LIABILITY WHICH MAY OR MAY NOT ARISEN IN THE FUTURE AND PRESENT LIABILITY WHICH HAS TO BE PERFORMED IN FUTURE. IN THE LATTER CASE THE LIABILITY HAVING ACCRUED IN THE YEAR OF ACCOUNT TH E AMOUNT TO BE EXPENDED IN DISCHARGE OF THAT LIABILITY WOULD HAVE TO BE EST IMATED IN ORDER THAT UNDER THE MERCANTILE SYSTEM OF ACCOUNTING THE AMOU NT SO ESTIMATED COULD BE DEBITED BEFORE ITS ACTUAL DISBURSED. IN THE CAS E OF CIT VS. GEMINI CASHEW SALES CORPORATION (1967) 65 ITR 643 (SC) TH E HONBLE SUPREME COURT REITERATED THE ABOVE LEGAL POSITION AND OBSER VED AS UNDER:- BROADLY STATED THE PRESENT VALUE ON COMMERCIAL VALUATION OF MONEY TO BECOME DUE IN FUTURE UNDER A DEFINITE OBLIGATION WILL BE A PERMISSIBLE OUTGOING OR DEDUC TION IN ITA NO. 4340/DEL/2009 PAGE 19 OF 49 COMPUTING THE TAXABLE PROFITS OF A TRADER EVEN IF IN CERTAIN CONDITIONS THE OBLIGATION MAY CEASE TO EXIST BECAUS E OF THE FORFEITURE OF THE RIGHT. WHERE HOWEVER THE OBLIG ATION OF THE TRADER IS PURELY CONTINGENT NO QUESTION OF ESTIMAT ING ITS PRESENT VALUE MAY RISE FOR TO BE A PERMISSIBLE OUT GOING OR ALLOWANCE THERE MUST IN THE YEAR OF ACCOUNT BE A P RESENT OBLIGATION CAPABLE OF COMMERCIAL VALUATION. 23. IT IS ALSO WELL SETTLED THAT IN DECIDING THE QU ESTION WHETHER PRESENT LIABILITY IS ACCRUED AGAINST THE ASSESSEE ALL THE CIRCUMSTANCES OF THE CASE HAVE TO BE TAKEN INTO ACCOUNT. THEREFORE WE NOW P ROCEED TO SEE WHETHER ANY BUSINESS LIABILITY HAS DEFINITELY ARISEN ON ACC OUNT OF WARRANTY PROVISION IN THE CURRENT YEAR UNDER CONSIDERATION AND FOR THAT PURPOSE WE HAVE TO TAKE INTO ACCOUNT ALL THE FACTS AND CIRCUMS TANCES OF THE PRESENT CASE. 24. AT THIS STAGE WE FIND IT FIT NECESSARY TO REFE R THE PROVISIONS CONTAINED IN SECTION 145 OF THE ACT. SUB SECTION ( 1) OF SECTION 145 PROVIDES THAT INCOME CHARGEABLE UNDER THE HEAD PRO FIT AND GAINS OF BUSINESS OR PROFESSION OR INCOME FROM OTHER SOURC ES SHALL SUBJECT TO THE PROVISIONS OF SUB-SECTION (2) OF SECTION 145 B E COMPUTED IN ACCORDANCE WITH EITHER CASH OR MERCANTILE BASIS OF ACCOUNTING REGULARLY EMPLOYED BY THE ASSESSEE. IN THE PRESENT CASE IT IS NOT IN DOUBT THAT THE ASSESSEE HAS BEEN MAINTAINING REGULARLY MERCANTILE SYSTEM OF ACCOUNTING AND ITS INCOME CHARGEABLE UNDER THE HEAD PROFIT AN D GAIN OF BUSINESS OR ITA NO. 4340/DEL/2009 PAGE 20 OF 49 PROFESSION OR INCOME FROM OTHER SOURCES IS TO BE COMPUTED IN ACCORDANCE WITH THIS MERCANTILE SYSTEM OF ACCOUNTIN G REGULARLY EMPLOYED BY THE ASSESSEE. SUB-SECTION (2) OF SECTION 145 PR OVIDES THAT THE CENTRAL GOVERNMENT MAY NOTIFY IN THE OFFICIAL GAZETTE FROM TIME TO TIME ACCOUNTING STANDARDS TO BE FOLLOWED BY ANY CLASS OF ASSESSEE OR IN RESPECT OF ANY CLASS OF INCOME. IN THE LIGHT OF SUB-SECTION (2) OF SECTION 145 THE CENTRAL GOVERNMENT HAS ISSUED ACCOUNTING STANDARD I U/S. 145 OF THE ACT VIDE NOTIFICATION NO. SO.69(E) DATED 25.01.199 6 WHERE IT HAS BEEN PROVIDED UNDER PARAGRAPH 4(I) OF THE SAID STANDARD IN THE FOLLOWING WORDS:- (I) PRUDENCE: PROVISIONS SHOULD BE MADE FOR ALL KN OWN LIABILITIES AND LOSSES EVEN THOUGH THE AMOUNT CANNO T BE DETERMINED WITH CERTAINTY AND REPRESENTS ONLY A BEST ESTIMATE IN THE LIGHT OF AVAILABLE INFORMATION ; THEREFORE IN THE LIGHT OF THE SAID NOTIFICATION I T IS CLEAR THAT THE ASSESSEE CAN MAKE PRUDENT PROVISIONS FOR ALL KNOWN LIABILITIES AND LOSSES EVEN THOUGHT THE AMOUNT CANNOT BE DETERMINED WITH C ERTAINTY AND REPRESENTS ONLY A BEST ESTIMATE IN THE LIGHT OF AVA ILABLE INFORMATION. THEREFORE PROVISION FOR KNOWN LIABILITY OF WARRANT Y CAN BE MADE BY THE ASSESSEE EVEN THOUGH THE AMOUNT CANNOT BE DETERMINE D WITH CERTAINTY AND IT IS BASED ON BEST ESTIMATE IN THE LIGHT OF THE FA CTS OF THE PRESENT CASE. ITA NO. 4340/DEL/2009 PAGE 21 OF 49 25. IN THE LIGHT OF THE FACTS OF THE PRESENT CASE A S COULD BE GATHERED FROM THE ORDERS OF THE AUTHORITIES BELOW AND THE SU BMISSIONS OF THE ASSESSEE IT IS CLEAR THAT THE ASSESSEE HAD SUPPLIE D MODEMS TO TWO PARTIES VIZ. BSES RAJDHANI POWER LTD. AND BSES YAMUNA POWE R PVT. LTD. WITH THE PERFORMANCE AND COMMISSIONING GUARANTEE FOR A P ERIOD OF NEXT 18 MONTHS FROM THE DATE OF SUPPLY. FOR DUE COMPLIANCE AND DISCHARGE OF THE PERFORMANCE AND COMMISSIONING WARRANTY PROVIDED TO THE CUSTOMERS THE ASSESSEE HAD GIVEN A BANK GUARANTEE TO THE EXTENT O F 10% OF THE VALUE OF THE PURCHASE ORDERS. FROM THE DETAILS SUBMITTED BY US THE SUM OF RS. 4 76 000/- HAS BEEN INCURRED BY THE ASSESSEE IN THE WARRANTY YEAR BEING EXPENSES INCURRED TOWARDS PERFORMANCE AND COMMISSIO NING GUARANTEE. THE ASSESSEE SUPPLIED GOODS FROM THE MONTH OF AUGUS T 2005 DURING THIS FIRST OF ITS OPERATION. THE GUARANTEE PERIOD OF 18 MONTHS IN RESPECT OF EACH SUPPLY FROM THEIR RESPECTIVE DATES HAS NOT BEE N EXPIRED DURING THE YEAR ITSELF. THE POSITION ABOUT THE DATE ON WHICH GUARANTEE PERIOD WOULD EXPIRE AND THE NUMBER OF MONTHS REMAINING LEFT OVER AT THE END OF THE PRESENT YEAR UNDER CONSIDERATION WITH REFERENCE TO THE EACH SALE ARE TABULATED AS UNDER:- ITA NO. 4340/DEL/2009 PAGE 22 OF 49 SALES DATE OF SALE DATE ON WHICH GUARANTEE PERIOD EXPIRED REMAINING MONTHS OF WARRANTY PERIOD AMOUNT OF PROVISIONS 499000 01.08.2005 31.01.2007 10.00 33000 499000 18.08.2005 18.02.2007 10.00 33000 998000 31.08.2005 28.02.2007 10.00 66000 2994000 06.09.2005 06.03.2007 11.00 220000 9780000 31.01.2006 31.07.2007 15.50 1010000 7335000 18.03.2006 30.09.2007 17.0 830000 2445000 24.03.2006 30.09.2007 17.00 278000 24550000 2470000 26. FROM THE AFORESAID DETAILS IT IS CLEAR THAT AS SESSEE HAD A LIABILITY TOWARDS COMMISSIONING AND PERFORMANCE GUARANTEE TO BE DISCHARGED IN FUTURE IN RESPECT OF THE SALES EFFECTED BY THE ASSE SSEE DURING THE YEAR UNDER CONSIDERATION AND IN RESPECT OF WHICH PROVIS IONS TO THE EXTENT OF RS. 24 70 000/- WAS MADE RESTRICTING IT TO THE AMO UNT OF BANK GUARANTEE GIVEN FOR RS. 24 55 000/-. THE TOTAL AFTER-SALES E XPENDITURE TOWARDS WARRANTY OBLIGATION INCURRED BY THE ASSESSEE DURING THE FIRST YEAR OF OPERATION ENDING ON 31.03.2006 AND IN SUBSEQUENT P ERIODS ENDING ON 31.03.2007 AND 31.03.2008 ARE TO THE EXTENT OF RS. 4 76 000/- RS. 25 79 797/- AND RS.10 75 546/- RESPECTIVELY. THE TOTAL SALES MADE BY THE ASSESSEE IN THE YEAR ENDED ON 31.03.2006 TO 31.03.2 008 ARE TO THE EXTENT ITA NO. 4340/DEL/2009 PAGE 23 OF 49 OF RS. 2 45 50 000/- 99 80 000/- AND RS NIL RESPE CTIVELY. FROM THE ABOVE IT IS CLEAR THAT THE ASSESSEE HAS BEEN INCURR ING AFTER SALES SERVICE EXPENSES EVEN IN THE YEAR IN WHICH NO SALES HAS TAK EN PLACE BECAUSE OF THE REASONS THAT THE WARRANTY GIVEN BY THE ASSESSEE IN THE YEAR OF SALE WAS IN FORCE DURING THE PERIOD FALLING WITHIN THE SUBSE QUENT YEARS. IT IS THUS CLEAR THAT THE WARRANTY CLAUSE IS EMBEDDED IN THE S ALES OF THE GOODS ITSELF. IN OTHER WORDS THE WARRANTY IS INTEGRAL PART OF TH E SALE PRICE OF THE MODEMS SUPPLIED BY THE ASSESSEE OR THE WARRANTY STO OD ATTACHED TO THE SALE PRICE OF THE PRODUCT. THEREFORE WHEN WHOLE O F THE SALE IS RECOGNIZED AS THE REVENUE A REASONABLE ESTIMATE OF WARRANTY PROVISION IS TO BE PROVIDED IN THE ACCOUNTS SO AS TO DETERMINE T HE TRUE AND REAL INCOME OF THE ASSESSEE IN THE RELEVANT YEAR. THIS WOULD A LSO SATISFY THE CRITERIA OF MATCHING CONCEPT. UNDER THE MATCHING CONCEPT IF T HE REVENUE IS RECOGNIZED THE COST INCURRED TO EARN THAT REVENUE I NCLUDING WARRANTY COST HAS TO BE FULLY PROVIDED FOR. WHEN MODEMS ARE SOLD AND THE WARRANTY CLAUSE IS AN INTEGRAL PART OF THE SALE PRICE OF THE MODEM THEN THE ASSESSEE HAS TO PROVIDE FOR SUCH WARRANTY COST IN ITS ACCOUN TS FOR RELEVANT YEAR OTHERWISE THE MATCHING CONCEPT FAILS. THE PAST EVE NT OF PROVIDING WARRANTY AS AN INTEGRAL PART OF SALE HAS CREATED A DEFINITE LIABILITY UPON THE ASSESSEE TO BE DISCHARGED WITHIN WARRANTY PERIO D. THEREFORE PROVIDING PROVISION FOR WARRANTY AT CERTAIN PERCENT AGE OF THE TURNOVER ITA NO. 4340/DEL/2009 PAGE 24 OF 49 FULFILLS THE ACCRUAL CONCEPT AS WELL AS MATCHING CO NCEPT. IN THE PRESENT CASE THERE COULD NOT BE POSSIBILITY OF ANY DATA OF ACTUAL DEFECTS OCCURRING TO THE GOODS BEING AVAILABLE OF PAST YEARS BUT THE WARRANTY EXPENSES ACTUAL INCURRED BY THE ASSESSEE IN THE YEAR UNDER C ONSIDERATION AS WELL AS IN THE FUTURE YEARS AND THE TERMS AND CONDITIONS OF SUPPLY ORDER WHEREIN WARRANTY WAS PROVIDED TO THE CUSTOMERS WITH A BANK GUARANTEE TO THE EXTENT OF 10% OF VALUE OF GOODS SOLD CAN BE A BEST GUIDING FACTORS TO MAKE A REASONABLE PROVISIONS FOR WARRANTY EXPENSES. IN THE PRESENT CASE AFTER MAKING SENSIBLE ESTIMATE IN ONE YEAR ON THE B ASIS OF TERMS OF SALE THE SURPLUS OF PROVISIONS REMAINING AFTER ACTUAL EX PENDITURE WERE INCURRED HAS BEEN REVERSED AND CREDITED IN THE PROF IT AND LOSS ACCOUNT IN THE YEAR IN WHICH THE WARRANTY PERIOD EXPIRES AND T HE SAME HAS BEEN OFFERED TO TAX. 27. IN THIS CONNECTION A RELIANCE MAY BE PLACED UP ON THE DECISION OF JURISDICTIONAL DELHI HIGH COURT IN THE CASE OF VINI TEC CORPORATION PVT. LTD. (SUPRA) WHERE IT HAS BEEN OBSERVED AND HELD A S UNDER:- IN OUR OPINION THE JUDGMENT OF THE SUPREME COURT IN BHARAT EARTH MOVERS [2000] 245 ITR 428 HAS A DIRECT BEARING ON THE ISSUE IN CONTROVERSY BEFORE US. DEAL ING WITH THE PROPOSITION WHETHER THE ASSESSEE WOULD BE ALLOW ED DEDUCTION IN THE ACCOUNTING YEAR ALTHOUGH THE LIAB ILITY MAY HAVE TO BE QUANTIFIED AND DISCHARGED AT A FUTURE DA TE THE LIABILITY IS TO BE TREATED IN THE PRESENT TIME AND WOULD OR WOULD NOT BE A CONTINGENT LIABILITY THE COURT HELD AS UNDER : ITA NO. 4340/DEL/2009 PAGE 25 OF 49 SO IS THE VIEW TAKEN IN CALCUTTA CO. LTD. V. CIT [ 1959] 37 ITR 1 (SC) WHEREIN THIS COURT HAS HELD THAT THE LIA BILITY ON THE ASSESSEE HAVING BEEN IMPORTED THE LIABILITY WOULD BE AN ACCRUED LIABILITY AND WOULD NOT CONVERT INTO A COND ITIONAL ONE MERELY BECAUSE THE LIABILITY WAS TO BE DISCHARGED A T A FUTURE DATE. THERE MAY BE SOME DIFFICULTY IN THE ESTIMATIO N THEREOF BUT THAT WOULD NOT CONVERT THE ACCRUED LIABILITY INTO A CONDITIONAL ONE ; IT WAS ALWAYS OPEN TO THE TAX AUTHORITIES CON CERNED TO ARRIVE AT A PROPER ESTIMATE OF THE LIABILITY HAVING REGARD TO ALL THE CIRCUMSTANCES OF THE CASE. APPLYING THE ABOVE SAID SETTLED PRINCIPLES TO THE F ACTS OF THE CASE AT HAND WE ARE SATISFIED THAT THE PROVISION MA DE BY THE APPELLANT-COMPANY FOR MEETING THE LIABILITY INCURRE D BY IT UNDER THE LEAVE ENCASHMENT SCHEME PROPORTIONATE WIT H THE ENTITLEMENT EARNED BY EMPLOYEES OF THE COMPANY INC LUSIVE OF THE OFFICERS AND THE STAFF SUBJECT TO THE CEILING ON ACCUMULATION AS APPLICABLE ON THE RELEVANT DATE IS ENTITLED TO DEDUCTION OUT OF THE GROSS RECEIPTS FOR THE ACCOUNTING YEAR DURIN G WHICH THE PROVISION IS MADE FOR THE LIABILITY. THE LIABILITY IS NOT A CONTINGENT LIABILITY. THE HIGH COURT WAS NOT RIGHT IN TAKING THE VIEW TO THE CONTRARY. THE APPEAL IS ALLOWED. THE JUDGMENT UNDER APPEAL IS SET ASIDE. THE QUESTION REFERRED BY THE TRIBUNAL TO THE HIGH COURT IS ANSWERED IN THE AFFIRMATIVE I.E. IN FAVOUR OF T HE ASSESSEE AND AGAINST THE REVENUE. IT WILL BE USEFUL FOR US TO MAKE A REFERENCE TO THE JUDGMENT OF THE PRIVY COUNCIL IN THE CASE OF COMMIS SIONER OF INLAND REVENUE V. MITSUBISHI MOTORS NEW ZEALAND LTD. [1996] 222 ITR 697 WHERE THE PRIVY COUNCIL DEALING WITH A TAXPAYER WHO WAS SELLING NEW MOTOR VEHICLES TO THE DEALERS TO INDEMNIFY THEM AGAINST WARRANTY CLAIMS WHICH IN TURN RESULTED IN PROVIDING OF WARRANTY CLAUSE FOR 12 MON THS FROM THE DATE OF DELIVERY TO THE PUR-CHASER BY THE DEALE R HELD AS UNDER (HEADNOTE): HELD DISMISSING THE APPEAL THAT ALTHOUGH THE TAXPAYER'S LIABILITY UNDER THE WARRANTY FOR EACH VE HICLE SOLD WAS CONTINGENT ON A DEFECT APPEARING AND BEING NOTI FIED TO THE DEALER WITHIN THE WARRANTY PERIOD SO THAT NO LI ABILITY WAS INCURRED BY THE TAXPAYER UNTIL THOSE CONDITIONS WERE SATISFIED REGARD COULD BE HAD TO ITS ESTIMATION OF WARRANTY CLAIMS BASED ON STATISTICAL INFORMATION WHICH SHOW ED THAT ITA NO. 4340/DEL/2009 PAGE 26 OF 49 AS A MATTER OF EXISTING FACT NOT FUTURE CONTINGENCY 63 PER CENT. OF ALL VEHICLES SOLD BY THE TAXPAYER CONTAINE D DEFECTS LIKELY TO BE MANIFESTED WITHIN THE WARRANTY PERIOD AND REQUIRE WORK UNDER WARRANTY ; THAT SINCE THEORETICA L CONTINGENCIES COULD BE DISREGARDED THE TAXPAYER WA S IN THE YEAR OF SALE UNDER AN ACCRUED LEGAL OBLIGATION TO MAKE PAYMENTS UNDER THOSE WARRANTIES AND EVEN THOUGH IT MIGHT NOT BE REQUIRED TO DO SO UNTIL THE FOLLOWING YEAR IT WAS DEFINITIVELY COMMITTED IN THE YEAR OF SALE TO THAT EXPENDITURE ; AND THAT ACCORDINGLY IN COMPUTING T HE PROFITS OR GAINS DERIVED BY THE TAXPAYER FROM ITS B USINESS IN THE YEAR IN WHICH THE VEHICLES WERE SOLD THE TAXPA YER WAS ENTITLED UNDER SECTION 104 TO DEDUCT FROM ITS TOTAL INCOME THE PROVISION WHICH IT HAD MADE FOR THE COSTS OF IT S ANTICIPATED LIABILITIES UNDER OUTSTANDING WARRANTIE S IN RESPECT OF VEHICLES SOLD IN THAT YEAR. THE RATIO DECIDENDI OF THE ABOVE CASES IS SQUARELY APPLICABLE TO THE FACTS OF THE PRESENT CASE. IT IS NOT DISPUTED THAT THE WARRANTY CLAUSE IS PART OF THE SALE DOCUME NT AND IMPOSES A LIABILITY UPON THE ASSESSEE TO DISCHARGE ITS OBLIGATIONS UNDER THAT CLAUSE FOR THE PERIOD OF WAR RANTY. IT IS A LIABILITY WHICH IS CAPABLE OF BEING CONSTRUED IN DEFINITE TERMS WHICH HAS ARISEN IN THE ACCOUNTING YEAR. MAY BE ITS ACTUAL QUANTIFICATION AND DISCHARGE IS DEFERRED TO A FUTURE DATE. ONCE AN ASSESSEE IS MAINTAINING HIS ACCOUNTS ON THE MERCANTILE SYSTEM A LIABILITY ACCRUED THOUGH TO B E DISCHARGED AT A FUTURE DATE WOULD BE A PROPER DEDU CTION WHILE WORKING OUT THE PROFITS AND GAINS OF HIS BUSI NESS REGARD BEING HAD TO THE ACCEPTED PRINCIPLES OF COMM ERCIAL PRACTICE AND ACCOUNTANCY. THERE IS NOTHING ON RECO RD BEFORE US WHICH EVEN CAN REMOTELY SUGGEST THAT THE CHANGE IN ACCOUNTANCY SYSTEM WAS MOTIVATED OR WAS IMPROPER . THERE IS ALSO NOTHING ON RECORD TO SUGGEST THAT THE PROVISIONS MADE IN THE ACCOUNTING YEAR AND DEDUCTIO N CLAIMED AS BUSINESS EXPENDITURE ARE UNDULY EXHAUSTI VE AND ARE INTENDED TO EVADE TAXATION. FOR THE REASONS AF ORESTATED AND IN VIEW OF THE ABOVE REFERRED JUDGMENTS OF THE SUPREME COURT AND OTHER COURTS WE ARE OF THE CONSIDERED VI EW THAT NO QUESTION OF LAW MUCH LESS A SUBSTANTIAL QUESTION OF LAW ARISES FOR DETERMINATION IN THE PRESENT APPEAL. THE APPEAL OF THE REVENUE THUS IS DISMISSED WHILE LEAVING THE P ARTIES TO BEAR THEIR OWN COSTS. ITA NO. 4340/DEL/2009 PAGE 27 OF 49 28. IN THE CASE VINITEC CORP. PVT. LTD. THE HONBL E DELHI HIGH COURT HAS RELIED UPON THE RATIO OF DECISION OF PRIVY COUN CIL IN THE CASE OF COMMISSIONER OF INLAND REVENUES VS. MITSUBISHI MOTO RS NEW ZEALAND (SUPRA) THE DECISION OF HONBLE SUPREME COURT IN T HE CASE OF BHARAT EARTH MOVERS (SUPRA) AND IN THE CASE OF CALCUTTA CO . LTD. VS. CIT (SUPRA). IN THE CASE OF COMMISSIONER OF INLAND REVENUE VS. M ITSUBISHI MOTORS NEW ZEALAND IT HAS BEEN OBSERVED THAT THE TAX PAYE R WAS IN THE YEAR OF SALE UNDER AN ACCRUED LEGAL OBLIGATION TO MAKE PAYM ENTS UNDER THE WARRANTY CLAUSE AND EVEN THOUGH IT MIGHT NOT BE RE QUIRED TO DO SO UNTIL THE FOLLOWING YEAR IT WAS DEFINITELY COMMITTED IN THE YEAR OF SALE TO THAT EXPENDITURE AND THEREFORE THE TAX PAYER WAS ENTIT LED TO DEDUCT FROM ITS TOTAL INCOME THE PROVISION WHICH IT HAD MADE FOR TH E COST FOR ITS ANTICIPATED LIABILITIES UNDER OUTSTANDING WARRANTY IN RESPECT OF VEHICLE SOLD IN THAT YEAR. SIMILARLY THE HONBLE SUPREME COURT IN THE CASE OF CALCUTTA CO. LTD. VS. CIT HAS HELD THAT LIABILITY T O INCUR CERTAIN EXPENSES IN RESPECT OF THE PROPERTY SOLD DURING THE YEAR AND IN RESPECT OF WHICH THE REVENUE HAS BEEN RECOGNIZED IN THE ACCOUNTS THE AS SESSEE WAS ENTITLED TO MAKE A PROVISION FOR THE EXPENDITURE TO BE INCURRED IN THE FOLLOWING YEARS AS BECAUSE THE LIABILITY TO INCURRED EXPENDI TURE HAVING BEEN IMPORTED UPON THE ASSESSEE AT THE TIME OF SALE OF T HE PROPERTY ALTHOUGH THE LIABILITY MAY HAVE TO BE QUANTIFIED AND DISCHAR GED AT A FUTURE DATE. ITA NO. 4340/DEL/2009 PAGE 28 OF 49 29. HONBLE KERALA HIGH COURT IN THE CASE OF CIT VS . INDIAN TRANSFORMERS (SUPRA) ALSO HAS OBSERVED AND HELD AS UNDER:- IT IS EVIDENT FROM THE FINDINGS OF THE TWO APPELL ATE AUTHORITIES WHICH WE HAVE EXTRACTED ABOVE THAT THEY CAME TO THE CONCLUSION THAT THE PROVISION CREATED WAS TOWAR DS A DEFINITE LIABILITY ACCRUED AT THE TIME OF SUPPLY OF THE MACHINERY AND SO THE ASSESSEE IS ENTITLED TO THE CL AIM FOR DEDUCTION. AS ALREADY NOTED THE FIRST APPELLATE AU THORITY HAS CLEARLY NOTED THAT DURING THE ACCOUNTING PERIOD REL EVANT TO THE ASSESSMENT YEAR 1991-92 ITSELF DEFECTS IN THE TRANSFORMERS SUPPLIED WERE BROUGHT TO THE NOTICE OF THE ASSESSEE AND THAT THE SECOND TRANSACTION REFERRED T O IN THE APPELLATE ORDER IS IN RESPECT OF TEN TRANSFORMERS S UPPLIED TO BHEL AND THAT ALL THE TEN TRANSFORMERS FAILED WITHI N A YEAR OF OPERATION WHICH RESULTED IN SERIOUS ISLOCATION O F PRODUCTION AT ROURKELA. IT IS ALSO RELEVANT TO NOTE THAT THE BHEL ITSELF HAD BROUGHT THIS FACT TO THE NOTICE OF THE CHAIRMAN OF THE GEC AND REQUESTED HIM TO GIVE SERIO US ATTENTION TO THE QUALITY. THE TRIBUNAL CONSIDERED T HE FURTHER FACT THAT THE ACTUAL EXPENSES INCURRED FOR THE ASSE SSMENT YEAR 1991-92 WAS RS. 7 98 958 AS AGAINST THE PROVIS ION MADE FOR RS. 3 50 000. THE TRIBUNAL HAD ALSO NOTED THAT THE AMOUNT OF RS. 12 23 381 WRITTEN BACK AS THE PROVISI ON DID NOT RELATE TO THE WARRANTY CLAIM. THUS IT IS CLEAR THAT THE TRIBUNAL HAS FOUND AS A FACT THAT THE CLAIM OF DEDU CTION FOR THE AMOUNT OF RS. 3 50 000 MADE TOWARDS AFTER SALES SERVICES IS AN ASCERTAINED LIABILITY. WE DO NOT FIN D ANY ILLEGALITY IN THE SAID FINDING OF THE TRIBUNAL. AS ALREADY NOTED IF THE FINDING OF THE TWO APPELLATE AUTHORITI ES THAT THE PROVISION MADE IS FOR AN ASCERTAINED LIABILITY IS U PHELD QUESTIONS NOS. 1 AND 2 STAND ANSWERED TO THE EFFECT THAT THE ASSESSEE IS ENTITLED TO THE CLAIM FOR DEDUCTION MAD E BEFORE THE ASSESSING OFFICER ON THIS ACCOUNT. NOW WE WILL DEAL WITH THE DECISIONS RELIED ON BY ST ANDING COUNSEL FOR THE REVENUE. IN INDIAN MOLASSES CO. (P. ) LTD. V. CIT [1959] 37 ITR 66 THE SUPREME COURT CONSIDERED THE QUESTION REGARDING THE PRINCIPLES TO BE APPLIED FOR ALLOWING BUSINESS EXPENDITURE AND OBSERVED THUS (PAGE 75): ITA NO. 4340/DEL/2009 PAGE 29 OF 49 THE INCOME-TAX LAW DOES NOT ALLOW AS EXPENSES ALL THE DEDUCTIONS A PRUDENT TRADER WOULD MAKE IN COMPUTING HIS PROFITS. THE MONEY MAY BE EXPENDED ON GROUNDS OF COMMERCIAL EXPEDIENCY BUT NOT OF NECESSITY. THE TEST OF NECESSITY IS WHETHER THE INTENTION WAS TO EARN TRADING RECEIPTS OR TO AVOID FUTURE RECURRING PAYMENTS OF A REVENUE CHARACTER. EXPENDITURE IN THIS SENSE IS EQUAL TO DISBURSEMENT WHICH TO USE A HOMELY PHRASE MEANS SOMETHING WHICH COMES OUT OF THE TRADERS POCKET. THUS IN FINDING OUT WHAT PROFITS THERE BE THE NORMAL ACCOUNTANCY PRACTICE MAY BE TO ALLOW AS EXPENSE ANY SUM IN RESPECT OF LIABILITIES WHICH HAVE ACCRUED OVER THE ACCOUNTING PERIOD AND TO DEDUCT SUCH SUMS FROM PROFITS. BUT THE INCOME-TAX LAWS DO NOT TAKE EVERY SUCH ALLOWANCE AS LEGITIMATE FOR PURPOSES OF TAX. A DISTINCTION IS MADE BETWEEN AN ACTUAL LIABILITY IN PRAESENTI AND A LIABILITY DE FUTURO WHICH FOR THE TIME BEING IS O NLY CONTINGENT. THE FORMER IS DEDUCTIBLE BUT NOT THE LATTER . . . AGAIN THE SUPREME COURT IN SHREE SAJJAN MILLS LTD. S CASE [1985] 156 ITR 585 IN THE CONTEXT OF ALLOWANCE OF PROVISION FOR GRATUITY REITERATED THE ABOVE PRINCI PLES AND OBSERVED THUS (HEADNOTE): CONTINGENT LIABILITIES DO NOT CONSTITUTE EXPENDITURE AND CANNOT BE THE SUBJECT MATTER OF DEDUCTION EVEN UNDER THE MERCANTILE SYSTEM OF ACCOUNTING. EXPENDITURE WHICH IS DEDUCTIBLE FOR INCOME-TAX PURPOSES IS TOWARDS A LIABILITY ACTUALLY EXISTING AT THE TIME BUT SETTING APART MONEY WHICH MIGHT BECOME EXPENDITURE ON THE HAPPENING OF AN EVENT IS NOT EXPENDITURE. IT IS ALSO OBSERVED THAT THE POSITION TILL THE PROV ISIONS OF SECTION 40A(7) WERE INSERTED IN THE ACT IN 1973 WAS THAT THE PROVISION MADE IN THE PROFIT AND LOSS ACCOUNT FOR T HE ITA NO. 4340/DEL/2009 PAGE 30 OF 49 ESTIMATED PRESENT VALUE OF THE CONTINGENT LIABILITY PROPERLY ASCERTAINED AND DISCOUNTED ON AN ACCRUED BASIS AS F ALLING ON THE ASSESSEE IN THE YEAR OF ACCOUNT COULD BE DED UCTIBLE EITHER UNDER SECTION 28 OR SECTION 37 OF THE ACT. THESE DECISIONS WOULD SHOW THAT IF THE PROVISION MA DE IS TOWARDS A CONTINGENT LIABILITY AND NOT FOR A LIABIL ITY IN PRAESENTI SUCH PROVISION IS NOT DEDUCTIBLE UNDER S ECTION 37. IN OTHER WORDS IF THE PROVISION MADE IS TOWARDS AN ACTUAL LIABILITY IN PRAESENTI IT IS DEDUCTIBLE. THE DECISI ON OF THE PRIVY COUNCIL IN MITSUBISHI MOTORS NEW ZEALAND LTD. S CASE [1996] 222 ITR 697 RELIED ON BY SENIOR COUNSEL FOR THE ASSESSEE IS RELEVANT. IN THAT CASE THE TAXPAYER SOL D NEW MOTOR VEHICLES TO DEALERS UNDERTAKING TO INDEMNIFY THEM AGAINST WARRANTY CLAIMS. ON SELLING A VEHICLE TO A PURCHASER THE DEALER GAVE THE PURCHASER A WARRANTY IN RESPECT OF DEFECTS IN MATERIALS OR WORKMANSHIP APPEARING WITHI N 12 MONTHS AFTER DELIVERY SUBJECT TO THE PURCHASER RET URNING THE VEHICLE TO THE DEALER WITH NOTIFICATION OF THE DEFE CT. BASED ON STATISTICAL INFORMATION THE TAXPAYER ESTIMATED THAT 63 PER CENT. OF ALL VEHICLES SOLD WOULD CONTAIN DEFECTS RE QUIRING REPAIR UNDER WARRANTY. IN CALCULATING ITS ASSESSABL E INCOME FOR THE YEAR ENDING DECEMBER 31 1988 THE TAXPAYER CLAIMED AS A DEDUCTION THE AMOUNT OF A RESERVE FOR ITS ANTICIPATED LIABILITIES UNDER UNEXPIRED WARRANTIES IN RESPECT OF VEHICLES SOLD IN THAT YEAR. IN ASSESSING THE TAX PAYER TO INCOME-TAX FOR THE YEAR ENDING MARCH 31 1989 BASE D ON THE TAXPAYERS RETURN OF INCOME FURNISHED ON DECEMB ER 31 1988 THE COMMISSIONER DISALLOWED THAT DEDUCTION. O N A CASE BEING STATED IN THE HIGH COURT OF NEW ZEALAND THE JUDGE HELD THAT THE WARRANTY PROVISION WAS DEDUCTIB LE EXPENDITURE WITHIN SECTION 104. HOWEVER THE COURT OF APPEAL OF NEW ZEALAND HELD THAT IT WAS NOT DEDUCTIB LE UNDER SECTION 104. ON THE COMMISSIONERS APPEAL TO THE JU DICIAL COMMITTEE OF THE PRIVY COUNCIL IT WAS OBSERVED THUS (HEADNOTE) : THE TAXPAYERS LIABILITY UNDER THE WARRANTY FOR EACH VEHICLE SOLD WAS CONTINGENT ON A DEFECT APPEARING AND BEING NOTIFIED TO THE DEALER WITHIN THE WARRANTY PERIOD SO THAT NO LIABILITY WAS ITA NO. 4340/DEL/2009 PAGE 31 OF 49 INCURRED BY THE TAXPAYER UNTIL THOSE CONDITIONS WERE SATISFIED REGARD COULD BE HAD TO ITS ESTIMATION OF WARRANTY CLAIMS BASED ON STATISTICAL INFORMATION WHICH SHOWED THAT AS A MATTER OF EXISTING FACT NOT FUTURE CONTINGENCY 63 PERCENT OF ALL VEHICLES SOLD BY THE TAXPAYER CONTAINED DEFECTS LIKELY TO BE MANIFESTED WITHIN THE WARRANTY PERIOD AND REQUIRE WORK UNDER WARRANTY ; THAT SINCE THEORETICAL CONTINGENCIES COULD BE DISREGARDED THE TAX-PAYER WAS IN THE YEAR OF SALE UNDER AN ACCRUED LEGAL OBLIGATION TO MAKE PAYMENTS UNDER THOSE WARRANTIES AND EVEN THOUGH IT MIGHT NOT BE REQUIRED TO DO SO UNTIL THE FOLLOWING YEAR IT WAS DEFINITELY COMMITTED IN THE YEAR OF SALE TO THAT EXPENDITURE ; AND THAT ACCORDINGLY IN COMPUTING THE PROFITS OR GAINS DERIVED BY THE TAXPAYER FROM ITS BUSINESS IN THE YEAR IN WHICH THE VEHICLES WERE SOLD THE TAXPAYER WAS ENTITLED UNDER SECTION 104 TO DEDUCT FROM ITS TOTAL INCOME THE PROVISION WHICH IT HAD MADE FOR THE COSTS OF ITS ANTICIPATED LIABILITIES UNDER OUTSTANDING WARRANTIES IN RESPECT OF VEHICLES SOLD IN THAT YEAR. SECTION 104 OF THE NEW ZEALAND INCOME TAX ACT 1976 USES THE EXPRESSION ALL LOSSES AND OUTGOINGS TO THE EXTENT TO WHICH TH EY ARE INCURRED IN GAINING OR PRODUCING THE ASSESSABLE INC OME OR ARE NECESSARILY INCURRED IN CARRYING ON A BUSINESS FOR THE PURPOSE OF GAINING OR PRODUCING SUCH INCOME SHALL BE ALLOWABLE DEDUCTIONS EXCEPT TO THE EXTENT TO WHICH THEY ARE LOSSES OR OUTGOINGS OF CAPITAL OR OF A CAPITAL PR IVATE OR DOMESTIC NATURE OR ARE INCURRED IN RELATION TO THE GAINING OR PRODUCTION OF EXEMPT INCOME. THE SAID EXPRESSIO N WAS INTERPRETED TO MEAN THAT THE TAXPAYER MUST HAVE EIT HER PAID OR BECOME DEFINITIVELY COMMITTED TO THE EXPENDITU RE. REGARDING THE WARRANTY LIABILITIES THE PRIVY COUNCI L OBSERVED AS FOLLOWS (PAGE 701): ITA NO. 4340/DEL/2009 PAGE 32 OF 49 THE EVIDENCE OF ACCOUNTING PRACTICE ADDUCED BEFORE DOOGUE J. LEFT NO DOUBT ABOUT THE PROPER TREATMENT OF THE OUTSTANDING WARRANTY LIABILITIES. THEY WERE PART OF THE COST OF THE VEHICLE SALES AND THEREFORE SO FAR AS CAPAB LE OF REASONABLE ESTIMATION SHOULD BE MATCHED AGAINST TH E CORRESPONDING REVENUE. THE EVIDENCE SATISFIED THE J UDGE THAT A REASONABLE ESTIMATE COULD BE PLACED UPON THE ANTI CIPATED LIABILITIES. ALL VEHICLES WHICH LEAVE THE TAXPAYER S ASSEMBLY PLANT AT PORIRUA HAVE BEEN TESTED AND EXAMINED FOR DEFECTS. SO FAR AS THE TAXPAYER IS AWARE THERE IS NOTHING W RONG WITH THEM. NEVERTHELESS EXPERIENCE SHOWS THAT IN MANY C ASES A DEFECT WILL BE DISCOVERED DURING THE WARRANTY PERIO D. OFTEN IT IS NO MORE THAN A BLEMISH IN THE PAINTWORK. SOME TIMES IT IS MORE SERIOUS. SIXTY THREE PER CENT. OF THE VEHIC LES SOLD BY THE TAXPAYER IN THE YEAR 1988 WERE RETURNED TO THE DEALERS FOR SOME KIND OF WORK TO BE DONE UNDER THE WARRANTY . ALTHOUGH IT CANNOT OF COURSE BE PREDICTED WHETHER A NY PARTICULAR VEHICLE WILL TURN OUT TO BE DEFECTIVE OR HOW SERIOUS THE DEFECT WILL BE THE TAXPAYER CAN MAKE A REASONABLY ACCURATE FORECAST BASED ON PREVIOUS EXP ERIENCE OF WHAT WILL BE THE TOTAL COST OF REMEDIAL WORK FOR ALL THE VEHICLES SOLD IN A GIVEN YEAR. NORMAL COMMERCIAL PR ACTICE THEREFORE REQUIRES THAT THIS AMOUNT SHOULD BE BROU GHT INTO ACCOUNT AS A DEDUCTION FROM INCOME IN ESTIMATING TH E PROFITS OR GAINS OF THE BUSINESS IN THE YEAR IN WHICH THE V EHICLES WERE SOLD. IT WAS OBSERVED THAT THE QUESTION WHETHER THE EXPEN DITURE HAS BEEN INCURRED INVOLVES CHARACTERISING THE NAT URE OF THE LEGAL RELATIONSHIP BETWEEN THE TAXPAYER AND THE PERSON TO WHOM THE OBLIGATION IS OWED THAT ONE VIEW IS TH AT IT REQUIRES ONE TO DECIDE AS A MATTER OF CONSTRUCTION WHETHER THE OBLIGATION IS CONTINGENT OR VESTED BUT DEFEASIB LE AND THAT THIS IS A NICE DISTINCTION WHICH CAN EASILY BECOME A MATTER OF LANGUAGE RATHER THAN SUBSTANCE AND ON WHICH JUDICIA L VIEWS MAY DIFFER. AFTER REFERRING TO THE WARRANTY THE PR IVY COUNCIL FURTHER CONSIDERED THE MATTER AND OBSERVED THUS (PA GE 707): THE RELEVANCE OF THIS PRINCIPLE IS THAT ESTIMATION ON THE BASIS OF STATISTICAL EXPERIENCE CAN BE USED TO CONCLUDE THAT 63 PER CENT. OR THEREABOUTS OF THE ITA NO. 4340/DEL/2009 PAGE 33 OF 49 VEHICLES SOLD BY THE TAXPAYER IN FACT HAD DEFECTS W HICH WOULD MANIFEST THEMSELVES WITHIN THE WARRANTY PERIO D OF 12 MONTHS OR 20 000 KM. THE FINDING OF DOOGUE J. ON THE EVIDENCE WAS THAT 63 PER CENT. OR THEREABOU TS OF ALL VEHICLES SOLD BY (THE TAXPAYER) CONTAIN DEFE CTS. SINCE THIS INFORMATION COULD ONLY BE DERIVED FROM T HE TAX-PAYERS EXPERIENCE OF WARRANTY CLAIMS THEIR LORDSHIPS UNDERSTAND THE FINDING TO MEAN THAT THIS WAS THE LEVEL OF DEFECTS NOTIFIED TO DEALERS IN ACCORDANCE WITH THE TERMS OF THE WARRANTY. IT ALSO SEEMS A FAIR INFERENCE THAT THE DEFECTS WERE PRESEN T AT THE TIME OF SALE. MR. ANDREW PARK WHO APPEARED FOR THE COMMISSIONER SAID THAT THE TERMS OF THE WARRAN TY DID NOT REQUIRE THAT THE DEFECT SHOULD HAVE EXISTED AT THE TIME OF SALE. IT COULD HAVE COME INTO EXISTENCE WITHIN THE WARRANTY PERIOD. AS A MATTER OF CONSTRUCTION THIS IS TRUE. IT IS HOWEVER HARD TO IM AGINE THE CIRCUMSTANCES IN WHICH A DEFECT IN THE MATERIA L OR WORKMANSHIP OF THE VEHICLE WOULD APPEAR WITHIN 12 MONTHS OF SALE UNLESS IT WAS PRESENT EVEN IF HIDDE N AT THE TIME THE VEHICLE LEFT THE ASSEMBLY PLANT. AT AN Y RATE MR. PARK COULD NOT THINK OF AN EXAMPLE. IN DECIDING WHETHER THE TAX PAYER HAD INCURRED A LIABILITY AT THE TIME WHEN THE VEHICLE WAS SOLD IT IS THEREFORE LEGITIMATE TO HAVE REGARD TO THE EVIDENCE ESTABLISHING THAT 63 PER CENT. WOULD IN FACT HAVE HAD DEFECTS. THIS HOWEVER IS NOT IN ITSELF ENOUGH TO SHOW THAT A LIABILITY WAS INCURRED. AS HAS BEEN SAID THEIR LOR DSHIPS AGREE WITH THE COURT OF APPEAL THAT THE LANGUAGE IN WHICH THE WARRANTY WAS EXPRESSED MADE LIABILITY DEPENDENT UPON THE MANIFESTATION AND NOTIFICATION OF THE DEFECT WI THIN THE 12 MONTHS PERIOD. BUT THE AUSTRALIAN AUTHORITIES SHOW THAT THE QUESTION OF WHETHER THE TAXPAYER IS DEFINITIVELY C OMMITTED TO AN EXPENDITURE OR WHETHER IT IS MERELY IMPENDIN G THREATENED OR EXPECTED (TO ADOPT THE LANGUAGE USED IN THE LEADING CASE OF FEDERAL COMMISSIONER OF TAXATION V. JAMES FLOOD PTY. LTD. [1953] 88 CLR 492 506-507) DOES NO T DEPEND SIMPLY UPON WHETHER FUTURE EVENTS WHICH MAY DETERMINE LIABILITY ARE EXPRESSED IN THE LANGUAGE O F ITA NO. 4340/DEL/2009 PAGE 34 OF 49 CONTINGENCY OR DEFEASANCE. THEIR LORDSHIPS THINK IT WOULD BE STRANGE IF A CONCEPT SO EMINENTLY PRACTICAL AS T HE COMPUTATION OF PROFITS FOR INCOME-TAX DEPENDED UPON THEORETICAL DISTINCTIONS MORE APPROPRIATE TO THE RU LE AGAINST PERPETUITIES. THE QUESTION IS RATHER WHETHER IN TH E LIGHT OF ALL THE SURROUNDING CIRCUMSTANCES A LEGAL OBLIGATI ON TO MAKE A PAYMENT IN THE FUTURE CAN BE SAID TO HAVE AC CRUED. FOR THIS PURPOSE MERELY THEORETICAL CONTINGENCIES CAN BE DISREGARDED. IN COLES MYER FINANCE LTD. V. FEDERAL COMMISSIONER OF TAXATION 176 CLR 640 671-672 DEAN E J. GAVE SOME EXAMPLES OF LINGUISTIC CONTINGENCIES WHIC H WERE SOON UNLIKELY AS NOT TO AFFECT THE CERTAINTY OF THE OBLIGATION. AND IN COMMERCIAL UNION ASSURANCE CO. OF AUSTRALIA LTD. V. FEDERAL COMMISSIONER OF TAXATION 14 ALR 651 659 -660 NEWTON J. FELT ABLE TO DISREGARD A CONDITION IN AN INSURANCE POLICY REQUIRING NOTICE OF THE OCCURRENCE OF AN INS URED EVENT TO BE GIVEN WITHIN A STIPULATED TIME ON THE GROUND THAT ACCORDING TO THE EVIDENCE THE CONDITION WAS HARDLY EVER INSISTED UPON. IF ONE ASKS WHETHER IN RESPECT OF EACH OF THE VEHIC LES SOLD BY THE TAX-PAYER THE WARRANTY CONDITIONS MAKE ITS LIABILITY CONTINGENT IN SUBSTANCE AS WELL AS IN FORM THE ANS WER MUST BE YES. A SUBSTANTIAL NUMBER37 PER CENT. WILL HAV E NO DEFECTS AT ALL. BUT FOR THE REASONS GIVEN ABOVE TH EIR LORDSHIPS THINK IT LEGITIMATE TO NARROW THE FOCUS T O THOSE VEHICLES WHICH LEFT THE ASSEMBLY PLANT WITH DEFECTS OF A KIND LIKELY TO MANIFEST THEMSELVES WITHIN THE WARRANTY P ERIOD OF 12 MONTHS OR 20 000 KM. THAT 63 PER CENT. OF VEHICL ES HAD SUCH DEFECTS WAS A MATTER OF EXISTING FACT NOT FUTU RE CONTINGENCY. SINCE THESE DEFECTS WERE BY DEFINITION LIKELY TO SHOW THEMSELVES WITHIN THE WARRANTY PERIOD THEIR L ORDSHIPS CONSIDER THAT THE CONTINGENCY THAT THE OWNERS MIGHT BE CONTENT NOT TO REQUIRE REMEDIAL WORK WOULD BE REAL ONLY IN THE CASE OF THE MOST TRIVIAL DEFECTS. IT WOULD NOT MAKE ANY MATERIAL DIFFERENCE TO THE ACCURACY OF THE ESTIMATE D AMOUNT OF EXPENDITURE TO WHICH THE TAXPAYER COULD BE SAID AS A MATTER OF LAW TO BE DEFINITIVELY COMMITTED. THE SUPREME COURT IN BHARAT EARTH MOVERS CASE [200 0] 245 ITR 428 CONSIDERED THE GENERAL PRINCIPLES REGAR DING ITA NO. 4340/DEL/2009 PAGE 35 OF 49 ALLOWANCE OF BUSINESS EXPENDITURE AND THE DIFFERENC E BETWEEN ACCRUED AND CONTINGENT LIABILITIES. IT WAS HELD THAT (PAGE 431) IF A BUSINESS LIABILITY HAS DEFINITELY ARISEN IN THE ACCOUNTING YEAR THE DEDUCTION SHOULD BE ALLOWED AL THOUGH THE LIABILITY MAY HAVE TO BE QUANTIFIED AND DISCHAR GED AT A FUTURE DATE. WHAT SHOULD BE CERTAIN IS THE INCURRIN G OF THE LIABILITY. IT SHOULD ALSO BE CAPABLE OF BEING ESTIM ATED WITH REASONABLE CERTAINTY THOUGH THE ACTUAL QUANTIFICATI ON MAY NOT BE POSSIBLE. IF THESE REQUIREMENTS ARE SATISFIE D THE LIABILITY IS NOT A CONTINGENT ONE. THE LIABILITY IS IN PRAESENTI THOUGH IT WILL BE DISCHARGED AT A FUTURE DATE. IT D OES NOT MAKE ANY DIFFERENCE IF THE FUTURE DATE ON WHICH THE LIABILITY SHALL HAVE TO BE DISCHARGED IS NOT CERTAIN. THE DECISION OF THE PRIVY COUNCIL IS ALMOST ON THE POINT. EVEN THOUGH THE WARRANTY PROVIDES FOR THAT THE PURC HASER RETURNING THE VEHICLE TO THE DEALER WITH NOTIFICATI ON OF THE DEFECT WITHIN 12 MONTHS AFTER DELIVERY THE TAXPAYE R HAD MADE PROVISION ON AN ESTIMATED BASIS EVEN BEFORE AN Y SUCH EVENT ON THE BASIS OF THE STATISTICAL INFORMATION T HAT 63 PER CENT. OF ALL VEHICLES SOLD WOULD CONTAIN DEFECTS RE QUIRING REPAIR UNDER WARRANTY. THE PROVISION MADE BASED ON THIS EXPERIENCE WAS HELD TO BE DEDUCTIBLE. IN THE PRESEN T CASE ALSO AS WE HAVE ALREADY NOTED THE TWO INSTANCES O F DEFECTS CAME TO THE NOTICE OF THE ASSESSEE OF WHICH ONE WAS WITH RESPECT TO TEN NUMBERS OF TRANSFORMERS SOLD TO BHEL AND AS PER THE COMPLAINT ALL THE TRANSFORMERS FAILED WITHI N ONE YEAR OF SUCH PURCHASE. THIS GAVE A CLEAR PICTURE THAT A MAJOR PORTION OF THE TRANS-FORMERS SOLD WERE DEFECTIVE AN D THEREFORE A REASONABLE PROVISION HAS TO BE MADE. WE HAVE NOTED THAT FOR THE ASSESSMENT YEAR THE ASSESSEE HA D MADE A PROVISION OF RS. 3 50 000 BUT THE ACTUAL EXPENSES I NCURRED FOR THAT YEAR WAS RS. 7 98 958. THESE CIRCUMSTANCES CLEARLY SHOW THAT THE PROVISION IS MADE ON A REASONABLE BAS IS. BY APPLYING THE PRINCIPLES LAID DOWN BY THE SUPREME CO URT IN BHARAT EARTH MOVERS CASE [2000] 245 ITR 428 IT HA S TO BE HELD THAT THE TRIBUNAL HAS RIGHTLY HELD THAT THE PR OVISION MADE FOR THE THREE YEARS IS BASED ON AN ASCERTAINED LIABILITY AND THAT IT CANNOT BE TREATED AS A CONTINGENT LIABI LITY. THUS OUR ANSWER TO THE QUESTION REFERRED IS IN THE AFFIR MATIVE THAT IS IN FAVOUR OF THE ASSESSEE AND AGAINST THE REVEN UE. ITA NO. 4340/DEL/2009 PAGE 36 OF 49 IN THE ABOVE CIRCUMSTANCES WE DO NOT FIND ANY MERIT IN THESE APPEALS FILED BY THE DEPARTMENT. THEY ARE ACC ORDINGLY DISMISSED. 30. AT THIS STAGE IT IS PERTINENT TO NOTE THAT THE CIT(A) HAS DECIDED THE ISSUE AGAINST THE ASSESSEE BY OBSERVING THAT MAKIN G PROVISIONS OF WARRANTY ON CERTAIN PERCENTAGE OF TURNOVER IS NOT I N ACCORDANCE WITH THE PREPOSITION LAID DOWN BY THE HONBLE DELHI HIGH COU RT IN THE CASE OF VINITEC CORPORATION PVT. LTD. OR BY THE PRIVY COUNC IL IN THE CASE OF CIT VS. MITSUBISHI MOTORS NEW ZEALAND AND HAS RELIED U PON THE DECISION OF HONBLE MADRAS HIGH COURT IN THE CASE OF CIT VS. RO TORK CONTROLS INDIA LTD. (2007) 293 ITR 311 (MAD.). BUT THE AFORESAID DECISION OF HONBLE MADRAS HIGH COURT IN THE CASE OF CIT VS. ROTORK CON TROLS INDIA LTD. HAS BEEN REVERSED BY THE HONBLE SUPREME COURT IN THE C ASE OF ROTORK CONTROLS INDIA LTD. VS. CIT ALONGWITH OTHER CASES V IZ. CIT VS. WIPRO GE MEDICAL SYSTEMS LTD. HEWLETT PACKARD INDIA (P.) LT D. AND COMPAQ COMPUTER (I) PVT. LTD. REPORTED IN (2009) 314 ITR 6 2 (SC) WHERE REVERSING THE DECISION OF HONBLE MADRAS HIGH COURT THE HONBLE SUPREME COURT HAS HELD THAT WHEN THE WARRANTY BECAM E AN INTEGRAL PART OF SALE THE AMOUNT TOWARDS THE WARRANTY PROVISIONS HAD TO BE RECOGNIZED BECAUSE THE ASSESSEE HAD PRESENT OBLIGATION AS A R ESULT OF PAST EVENT ITA NO. 4340/DEL/2009 PAGE 37 OF 49 RESULTING IN OUTFLOW AND RELIABLE ESTIMATE COULD BE MADE OF THE AMOUNT OF THE OBLIGATION. THE HONBLE SUPREME COURT HAS OBSE RVED AND HELD AS UNDER:- WHAT IS A PROVISION ? THIS IS THE QUESTION WHICH NEEDS TO BE ANSWERED. A PROVISION IS A LIABILITY WH ICH CAN BE MEASURED ONLY BY USING A SUBSTANTIAL DEGREE OF ESTI MATION. A PROVISION IS RECOGNIZED WHEN : (A) AN ENTERPRISE HA S A PRESENT OBLIGATION AS A RESULT OF A PAST EVENT ; (B ) IT IS PROBABLE THAT AN OUTFLOW OF RESOURCES WILL BE REQUI RED TO SETTLE THE OBLIGATION ; AND (C) A RELIABLE ESTIMATE CAN BE MADE OF THE AMOUNT OF THE OBLIGATION. IF THESE COND ITIONS ARE NOT MET NO PROVISION CAN BE RECOGNIZED. LIABILITY IS DEFINED AS A PRESENT OBLIGATION ARISIN G FROM PAST EVENTS THE SETTLEMENT OF WHICH IS EXPECTED TO RESULT IN AN OUTFLOW FROM THE ENTERPRISE OF RESOURCES EMBODYI NG ECONOMIC BENEFITS. A PAST EVENT THAT LEADS TO A PRESENT OBLIGATION IS CALLED AS AN OBLIGATING EVENT. THE OBLIGATING EVENT IS AN EVENT THAT CREATES AN OBLIGATION WHICH RESULTS IN AN OUTFLOW O F RESOURCES. IT IS ONLY THOSE OBLIGATIONS ARISING FRO M PAST EVENTS EXISTING INDEPENDENTLY OF THE FUTURE CONDUCT OF THE BUSINESS OF THE ENTERPRISE THAT ARE RECOGNIZED AS P ROVISION. FOR A LIABILITY TO QUALIFY FOR RECOGNITION THERE MU ST BE NOT ONLY PRESENT OBLIGATION BUT ALSO THE PROBABILITY OF AN OUTFLOW OF RESOURCES TO SETTLE THAT OBLIGATION. WHERE THERE ARE A NUMBER OF OBLIGATIONS (E.G. PRODUCT WARRANTIES OR SIMILAR CONTRACTS) THE PROBABILITY THAT AN OUTFLOW WILL BE REQUIRED IN SETTLEMENT IS DETERMINED BY CONSIDERING THE SAID O BLIGATIONS AS A WHOLE. IN THIS CONNECTION IT MAY BE NOTED THA T IN THE CASE OF A MANUFACTURE AND SALE OF ONE SINGLE ITEM THE PROVISION FOR WARRANTY COULD CONSTITUTE A CONTINGEN T LIABILITY NOT ENTITLED TO DEDUCTION UNDER SECTION 37 OF THE S AID ACT. HOWEVER WHEN THERE IS MANUFACTURE AND SALE OF AN A RMY OF ITEMS RUNNING INTO THOUSANDS OF UNITS OF SOPHISTICATED GOODS THE PAST EVENT OF DEFECTS B EING ITA NO. 4340/DEL/2009 PAGE 38 OF 49 DETECTED IN SOME OF SUCH ITEMS LEADS TO A PRESENT O BLIGATION WHICH RESULTS IN AN ENTERPRISE HAVING NO ALTERNATIV E TO SETTLING THAT OBLIGATION. IN THE PRESENT CASE THE APPELLANT HAS BEEN MANUFACTURING AND SELLING VALVE ACTUATORS. THEY ARE IN THE BUSINESS FROM THE ASSESSMENT YEARS 1983- 84 ONWARDS. VALVE ACTUATORS ARE SOPHISTICATED GOODS. O VER THE YEARS THE APPELLANT HAS BEEN MANUFACTURING VALVE AC TUATORS IN A LARGE NUMBERS. THE STATISTICAL DATA INDICATES THAT EVERY YEAR SOME OF THESE MANUFACTURED ACTUATORS ARE FOUND TO BE DEFECTIVE. THE STATISTICAL DATA OVER THE YEARS ALSO INDICATES THAT BEING SOPHISTICATED ITEM NO CUSTOMER IS PREPAR ED TO BUY VALVE ACTUATOR WITHOUT A WARRANTY. THEREFORE THE W ARRANTY BECAME INTEGRAL PART OF THE SALE PRICE OF THE VALVE ACTUATOR(S). IN OTHER WORDS THE WARRANTY STOOD ATT ACHED TO THE SALE PRICE OF THE PRODUCT. THESE ASPECTS ARE IM PORTANT. AS STATED ABOVE OBLIGATIONS ARISING FROM PAST EVEN TS HAVE TO BE RECOGNIZED AS PROVISIONS. THESE PAST EVENTS ARE KNOWN AS OBLIGATING EVENTS. IN THE PRESENT CASE THEREFORE THE WARRANTY PROVISION NEEDS TO BE RECOGNIZED BECAUSE T HE APPELLANT IS AN ENTERPRISE HAVING A PRESENT OBLIGAT ION AS A RESULT OF PAST EVENTS RESULTING IN AN OUTFLOW OF RE SOURCES. LASTLY A RELIABLE ESTIMATE CAN BE MADE OF THE AMOU NT OF THE OBLIGATION. IN SHORT ALL THE THREE CONDITIONS FOR RECOGNITION OF A PROVISION ARE SATISFIED IN THIS CASE. IN THIS CASE WE ARE CONCERNED WITH PRODUCT WARRA NTIES. TO GIVE AN EXAMPLE OF PRODUCT WARRANTIES A COMPANY DEALING IN COMPUTERS GIVES A WARRANTY FOR A PERIOD OF 36 MONTHS FROM THE DATE OF SUPPLY. THE SAID COMPANY CO NSIDERS FOLLOWING OPTIONS : (A) ACCOUNT FOR WARRANTY EXPENS E IN THE YEAR IN WHICH IT IS INCURRED ; (B) IT MAKES A PROVI SION FOR WARRANTY ONLY WHEN THE CUSTOMER MAKES A CLAIM ; AND (C) IT PROVIDES FOR WARRANTY AT 2 PER CENT. OF TURNOVER OF THE COMPANY BASED ON PAST EXPERIENCE (HISTORICAL TREND). THE FIRST OPTION IS UNSUSTAINABLE SINCE IT WOULD TANTAMOUNT TO ACCOUNTING FOR WARRANTY EXPENSES ON C ASH BASIS WHICH IS PROHIBITED BOTH UNDER THE COMPANIES ACT AS WELL AS BY THE ACCOUNTING STANDARDS WHICH REQUIRE A CCRUAL CONCEPT TO BE FOLLOWED. IN THE PRESENT CASE THE DE PARTMENT IS INSISTING ON THE FIRST OPTION WHICH AS STATED A BOVE IS ERRONEOUS AS IT RULES OUT THE ACCRUAL CONCEPT. THE SECOND ITA NO. 4340/DEL/2009 PAGE 39 OF 49 OPTION IS ALSO INAPPROPRIATE SINCE IT DOES NOT REFL ECT THE EXPECTED WARRANTY COSTS IN RESPECT OF REVENUE ALREA DY RECOGNIZED (ACCRUED). IN OTHER WORDS IT IS NOT BAS ED ON THE MATCHING CONCEPT. UNDER THE MATCHING CONCEPT IF RE VENUE IS RECOGNIZED THE COST INCURRED TO EARN THAT REVENUE I NCLUDING WARRANTY COSTS HAS TO BE FULLY PROVIDED FOR. WHEN V ALVE ACTUATORS ARE SOLD AND THE WARRANTY COSTS ARE AN IN TEGRAL PART OF THAT SALE PRICE THEN THE APPELLANT HAS TO P ROVIDE FOR SUCH WARRANTY COSTS IN ITS ACCOUNT FOR THE RELEVANT YEAR OTHERWISE THE MATCHING CONCEPT FAILS. IN SUCH A CAS E THE SECOND OPTION IS ALSO INAPPROPRIATE. UNDER THE CIRCUMSTANCES THE THIRD OPTION IS THE MOST APP ROPRIATE BECAUSE IT FULFILS ACCRUAL CONCEPT AS WELL AS THE M ATCHING CONCEPT. FOR DETERMINING AN APPROPRIATE HISTORICAL TREND IT IS IMPORTANT THAT THE COMPANY HAS A PROPER ACCOUNTI NG SYSTEM FOR CAPTURING THE RELATIONSHIP BETWEEN THE N ATURE OF THE SALES THE WARRANTY PROVISIONS MADE AND THE ACT UAL EXPENSES INCURRED AGAINST IT SUBSEQUENTLY. THUS TH E DECISION ON THE WARRANTY PROVISION SHOULD BE BASED ON PAST EXPERIENCE OF THE COMPANY. A DETAILED ASSESSMENT OF THE WARRANTY PROVISIONING POLICY IS REQUIRED PAR TICULARLY IF THE EXPERIENCE SUGGESTS THAT WARRANTY PROVISIONS ARE GENERALLY REVERSED IF THEY REMAINED UNUTILISED AT T HE END OF THE PERIOD PRESCRIBED IN THE WARRANTY. THEREFORE T HE COMPANY SHOULD SCRUTINISE THE HISTORICAL TREND OF W ARRANTY PROVISIONS MADE AND THE ACTUAL EXPENSES INCURRED AG AINST IT. ON THIS BASIS A SENSIBLE ESTIMATE SHOULD BE MADE. T HE WARRANTY PROVISION FOR THE PRODUCTS SHOULD BE BASED ON THE ESTIMATE AT THE YEAR END OF FUTURE WARRANTY EXPENSE S. SUCH ESTIMATES NEED REASSESSMENT EVERY YEAR. AS ONE REAC HES CLOSE TO THE END OF THE WARRANTY PERIOD THE PROBAB ILITY THAT THE WARRANTY EXPENSES WILL BE INCURRED IS CONSIDERA BLY REDUCED AND THAT SHOULD BE REFLECTED IN THE ESTIMAT ION AMOUNT. WHETHER THIS SHOULD BE DONE THROUGH A PRO R ATA REVERSAL OR OTHERWISE WOULD REQUIRE ASSESSMENT OF H ISTORICAL TREND. IF WARRANTY PROVISIONS ARE BASED ON EXPERIEN CE AND HISTORICAL TREND(S) AND IF THE WORKING IS ROBUST TH EN THE QUESTION OF REVERSAL IN THE SUBSEQUENT TWO YEARS I N 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-ENTER PRISE ITA NO. 4340/DEL/2009 PAGE 40 OF 49 BECAUSE IT HAS INCURRED A PRESENT OBLIGATION AS A R ESULT OF PAST EVENTS. THERE IS ALSO AN OUTFLOW OF RESOURCES. A RELIABLE ESTIMATE OF THE OBLIGATION WAS ALSO POSSIBLE. THERE FORE THE APPELLANT HAS INCURRED A LIABILITY ON THE FACTS AN D CIRCUMSTANCES OF THIS CASE DURING THE RELEVANT ASS ESSMENT YEAR WHICH WAS ENTITLED TO DEDUCTION UNDER SECTION 37 OF THE 1961 ACT. THEREFORE ALL THE THREE CONDITIONS FOR R ECOGNISING A LIABILITY FOR THE PURPOSES OF PROVISIONING STANDS SATISFIED IN THIS CASE. IT IS IMPORTANT TO NOTE THAT THERE ARE FOUR IMPORTANT ASPECTS OF PROVISIONING. THEY ARE PROVIS IONING WHICH RELATES TO THE PRESENT OBLIGATION IT ARISES OUT OF OBLIGATING EVENTS IT INVOLVES OUTFLOW OF RESOURCES AND LASTLY IT INVOLVES RELIABLE ESTIMATION OF OBLIGATI ON. KEEPING IN MIND ALL THE FOUR ASPECTS WE ARE OF THE VIEW TH AT THE HIGH COURT SHOULD NOT TO HAVE INTERFERED WITH THE DECISI ON OF THE TRIBUNAL IN THIS CASE. IN THIS CASE THE HIGH COURT HAS PRINCIPALLY GON E BY THE JUDGMENT OF THE SUPREME COURT IN THE CASE OF SHREE SAJJAN MILLS [1985] 156 ITR 585. THAT WAS A CASE OF GRATUITY. FOR THE ASSESSMENT YEAR 1974-75 THE ASSE SSEE- COMPANY SOUGHT TO DEDUCT A SUM OF RS. 18 37 727 TOW ARDS THE AMOUNT OF GRATUITY PAYABLE TO ITS EMPLOYEES AND WORKED OUT ACTUARIALLY. NO PROVISION WAS MADE FOR RS. 18 3 7 727. THE CLAIM FOR DEDUCTION WAS MADE ON THE GROUND THAT THE LIABILITY STOOD ASCERTAINED BY ACTUARIAL VALUATION AND THERE- FORE WAS DEDUCTIBLE UNDER SECTION 37 OF THE 1961 A CT. THE INCOME-TAX OFFICER ALLOWED THE DEDUCTION ONLY IN RE SPECT OF THE AMOUNTS ACTUALLY PAID BY THE ASSESSEE AND THE R EST WAS DISALLOWED ON THE GROUND OF NON-COMPLIANCE WITH THE PROVISIONS OF SECTION 40A(7) OF THE 1961 ACT. THIS VIEW OF THE INCOME-TAX OFFICER WAS AFFIRMED BY THE COMMISSI ONER OF INCOME-TAX (APPEALS). THE TRIBUNAL HELD THAT FOR TH E EARLIER ASSESSMENT YEAR RELATING TO 1973-74 ACTUARIALLY AS CERTAINED LIABILITY FOR GRATUITY ARISING UNDER THE PAY- MENT OF GRATUITY ACT 1972 WAS AN ALLOWABLE DEDUCT ION. HOWEVER FOR THE ASSESSMENT YEAR IN QUESTION THE T RIBUNAL HELD THAT THE INCREASED LIABILITY CLAIMED BY THE AS SESSEE FOR DEDUCTION WAS ALLOWABLE ON GENERAL PRINCIPLES OF ACCOUNTING. THIS VIEW WAS TAKEN BY THE TRIBUNAL ON THE BASIS THAT THE ACTUARIALLY DETERMINED LIABILITY WAS NOT P ROVIDED FOR ITA NO. 4340/DEL/2009 PAGE 41 OF 49 IN THE ASSESSEES BOOKS OF ACCOUNT. IN APPEAL BY TH E DEPARTMENT THE HIGH COURT HELD THAT THE ASSESSEE W AS NOT ENTITLED TO DEDUCTION WITHOUT COMPLYING WITH THE PR OVISIONS OF SECTION 40A(7) OF THE 1961 ACT. THIS VIEW OF THE HIGH COURT WAS AFFIRMED BY THIS COURT. IT WAS HELD THAT SECTION 40A(7) WHICH STOOD INSERTED BY THE FINANCE ACT 19 75 WITH EFFECT FROM APRIL 1 1973 HAS BEEN GIVEN AN OVERRI DING EFFECT OVER SECTION 28 AS WELL AS SECTION 37 OF THE 1961 ACT. CONSEQUENTLY THE DEDUCTION ALLOWABLE ON GENERAL PR INCIPLES WAS RULED OUT AS SECTION 40A(1) MADE IT CLEAR THAT SECTION 40A HAD EFFECT NOTWITHSTANDING ANYTHING CONTAINED I N SECTIONS 30 TO 39 OF THE 1961 ACT. IN OTHER WORDS AS REGARDS DEDUCTION IN RESPECT OF GRATUITY THE ASSESSEE WAS REQUIRED TO COMPLY WITH THE PROVISIONS OF SECTION 40A(7) AFT ER THE FINANCE ACT 1975. IT IS INTERESTING TO NOTE THAT P RIOR TO APRIL 1 1973 ACTUAL PAYMENT OR PROVISION FOR PAYMENT WA S ELIGIBLE FOR DEDUCTION EITHER UNDER SECTION 28 OR U NDER SECTION 37 OF THE 1961 ACT. THIS HAS BEEN REITERATE D IN SHREE SAJJAN MILLS [1985] 156 ITR 585. THE POSITION GOT A LTERED ONLY AFTER APRIL 1 1973. BEFORE THAT DATE PROVISI ON MADE IN THE PROFIT AND LOSS ACCOUNT FOR THE ESTI-MATED PRES ENT VALUE OF THE CONTINGENT LIABILITY PROPERLY ASCERTAINED AN D DISCOUNTED ON AN ACCRUED BASIS COULD BE DEDUCTED EI THER UNDER SECTION 28 OR SECTION 37 OF THE 1961 ACT. THI S HAS BEEN EXPLAINED IN SHREE SAJJAN MILLS [1985] 156 ITR 585 (SC) AT PAGE 599. SECTION 40A(7) DEALS ONLY WITH TH E CASE OF GRATUITY. EVEN IN THE CASE OF GRATUITY BUT FOR INSE RTION OF SECTION 40A(7) PROVISION MADE IN THE PROFIT AND LO SS ACCOUNT ON THE BASIS OF THE PRESENT VALUE OF THE CO NTINGENT LIABILITY PROPERLY ASCERTAINED AND DISCOUNTED ON AN ACCRUED BASIS WAS ENTITLED TO DEDUCTION EITHER UNDER SECTIO N 28 OR UNDER SECTION 37 OF THE SAID ACT. THIS ASPECT THER EFORE INDICATES THAT THE PRESENT VALUE OF THE CONTINGENT LIABILITY LIKE THE WARRANTY EXPENSE IF PROPERLY ASCERTAINED AND DISCOUNTED ON ACCRUED BASIS COULD BE AN ITEM OF DE DUCTION UNDER SECTION 37 OF THE SAID ACT. THIS ASPECT IS NO T NOTICED IN THE IMPUGNED JUDGMENT. WE MAY ADD A CAVEAT. AS STAT ED ABOVE THE PRINCIPLE OF ESTIMATION OF THE CONTINGEN T LIABILITY IS NOT THE NORMAL RULE. AS STATED ABOVE IT WOULD D EPEND ON THE NATURE OF BUSINESS THE NATURE OF SALES THE NA TURE OF THE PRODUCT MANUFACTURED AND SOLD AND THE SCIENTIFIC ME THOD OF ITA NO. 4340/DEL/2009 PAGE 42 OF 49 ACCOUNTING BEING ADOPTED BY THE ASSESSEE. IT WILL A LSO DEPEND UPON THE HISTORICAL TREND. IT WOULD ALSO DEP END UPON THE NUMBER OF ARTICLES PRODUCED. AS STATED ABOVE I F IT IS A CASE OF SINGLE ITEM BEING PRODUCED THEN THE PRINCIP LE OF ESTIMATION OF CONTINGENT LIABILITY ON PRO RATA BASI S MAY NOT APPLY. HOWEVER IN THE PRESENT CASE IT IS NOT SO. IN THE PRESENT CASE WE HAVE THE SITUATION OF A LARGE NUMB ER OF ITEMS BEING PRODUCED. THEY ARE SOPHISTICATED GOODS. THEY ARE SUPPORTED BY THE HISTORICAL TREND NAMELY DEFE CTS BEING DETECTED IN SOME OF THE ITEMS. THE DATA ALSO INDICA TES THAT THE WARRANTY COST(S) IS EMBEDDED IN THE SALE PRICE. THE DATA ALSO INDICATES THAT THE WARRANTY IS ATTACHED TO THE SALE PRICE. IN THE CIRCUMSTANCES WE HOLD THAT THE PRINCIPLE LA ID DOWN BY THIS COURT IN THE CASE OF METAL BOX COMPANY OF INDIA [1969] 73 ITR 53 WILL APPLY. IN TH AT CASE THIS COURT HELD THAT CONTINGENT LIABILITIES DISCOUN TED AND VALUED AS OUT OF NECESSITY COULD BE TAKEN INTO ACCO UNT AS TRADING EXPENSES IF THESE WERE CAPABLE OF BEING VAL UED. IT WAS FURTHER HELD THAT AN ESTIMATED LIABILITY EVEN U NDER A GRATUITY SCHEME EVEN IF IT WAS A CONTINGENT LIABILI TY IF PROPERLY ASCERTAINABLE AND IF ITS PRESENT VALUE STO OD FAIRLY DISCOUNTED WAS DEDUCTIBLE FROM THE GROSS PROFITS W HILE PREPARING THE PROFIT AND LOSS ACCOUNT. IN VIEW OF T HIS DECISION IT BECAME PERMISSIBLE FOR AN ASSESSEE TO P ROVIDE IN HIS PROFIT AND LOSS ACCOUNT FOR THE ESTIMATED LIAB ILITY UNDER A GRATUITY SCHEME BY ASCERTAINING ITS PRESENT VALUE ON ACCRUED BASIS AND CLAIMING IT AS AN ASCERTAINED LIA BILITY TO BE DEDUCTED IN THE COMPUTATION OF PROFIT AND GAINS OF THE PREVIOUS YEAR EITHER UNDER SECTION 28 OR UNDER SECT ION 37 OF THE 1961 ACT. HOWEVER THE ABOVE PRINCIPLE WOULD NO T APPLY AFTER INSERTION OF SECTION 40A(7) WITH EFFECT FROM APRIL 1 1973. IT MAY BE STATED THAT THE PRINCIPLES OF COMME RCIAL ACCOUNTING MENTIONED ABOVE FORMED THE BASIS OF TH E JUDGMENT OF THIS COURT IN THE CASE OF METAL BOX COM PANY OF INDIA [1969] 73 ITR 53 AND THOSE PRINCIPLES ARE AFF IRMED BY THE JUDGMENT OF THE SUPREME COURT IN SHREE SAJJAN M ILLS [1985] 156 ITR 585 UP TO APRIL 1 1973. IN THIS CAS E WE ARE CONCERNED WITH WARRANTY CLAIMS. IN RESPECT OF WARRA NTY CLAIMS DURING THE RELEVANT ASSESSMENT YEARS IN QUES TION THERE IS NO PROVISION SIMILAR TO SECTION 40A(7) OF THE 1961 ACT. WE MAY ADD THAT THE ABOVE PRINCIPLE OF COMMERC IAL ITA NO. 4340/DEL/2009 PAGE 43 OF 49 ACCOUNTING IN METAL BOX COMPANY OF INDIA [1969] 73 ITR 53 (SC) ALSO FIND PLACE IN THE JUDGMENT OF THIS COU RT IN THE CASE OF MADRAS INDUSTRIAL INVESTMENT CORPORATION LT D. V. CIT [1997] 225 ITR 802 IN WHICH THE COURT HAS EXPL AINED THE MEANING OF THE WORD EXPENDITURE IN SECTION 37 OF THE 1961 ACT. IN OTHER WORDS THE PRINCIPLE E NUNCIATED IN METAL BOX COMPANY OF INDIA [1969] 73 ITR 53 (SC) WHICH HAS BEEN REITERATED IN SHREE SAJJAN MILLS [19 85] 156 ITR 585 (SC) (UP TO APRIL 1 1973) WHICH DEALS WITH MAKING OF THE PROVISION ON THE BASIS OF ESTIMATED PRESENT VALUE OF CONTINGENT LIABILITY HOLDS GOOD DURING THE ASSESSME NT YEARS IN QUESTION QUA WARRANTY CLAIMS. BEFORE CONCLUDING WE MAY REFER TO THE JUDGMENT O F THIS COURT IN THE CASE OF INDIAN MOLASSES CO. [1959] 37 ITR 66. IN THAT CASE THE FACTS WERE AS FOLLOWS (PAGE 68) : ONE JOHN BRUCE RICHARD HARVEY WAS THE MANAGING DIRECTOR OF THE ASSESSEE-COMPANY IN 1948. HE HAD BY THEN SERVED THE COMPANY FOR 13 YEARS AND WAS DUE TO RET IRE AT THE AGE OF 55 YEARS ON SEPTEMBER 20 1955. THERE WA S IT APPEARS AN AGREEMENT BY WHICH THE COMPANY WAS UNDE R AN OBLIGATION TO PROVIDE A PENSION TO HARVEY AFTER HIS RETIREMENT. ON SEPTEMBER 16 1948 THE COMPANY EXEC UTED A TRUST DEED IN FAVOUR OF THREE TRUSTEES TO WHOM THE COMPANY PAID A SUM OF 8 208- 19-0 (RS. 1 09 643) AND FURT HER UNDERTOOK TO PAY ANNUALLY RS. 4 364 ( 326.14 SH.) FOR SIX CONSECUTIVE YEARS AND THE TRUSTEES AGREED TO EXECU TE A DECLARATION OF TRUST. THE TRUSTEES UNDERTOOK TO HOL D THE SAID SUMS UPON TRUST TO SPEND THE SAME IN TAKING OUT A D EFERRED ANNUITY POLICY WITH THE NORWICH UNION LIFE INSURANC E SOCIETY IN THE NAME OF THE TRUSTEES BUT ON THE LIFE OF HARVEY UNDER WHICH 720 PER ANNUM WERE PAYABLE TO HARVEY FOR LIFE FROM THE DATE OF HIS SUPERANNUATION. IT WAS AL SO PROVIDED IN THE DEED THAT NOTWITHSTANDING THE MAIN CLAUSE THE TRUSTEES WOULD IF SO DESIRED BY THE ASSESSEE-C OMPANY TAKE OUT INSTEAD A DEFERRED LONGEST LIFE POLICY WI TH THE SAID INSURANCE COMPANY IN THEIR NAMES BUT IN FAVOUR OF HARVEY AND MRS. HARVEY FOR AN ANNUITY OF 558-1-0 PER ANN UM PAYABLE DURING THEIR JOINT LIVES FROM THE DATE OF H ARVEYS SUPERANNUATION AND DURING THE LIFETIME OF THE SURVI VOR ITA NO. 4340/DEL/2009 PAGE 44 OF 49 PROVIDED FURTHER THAT IF HARVEY DIED BEFORE HE ATTA INED THE AGE OF 55 YEARS THE ANNUITY PAYABLE TO MRS. HARVEY WOULD BE 611-12-0 DURING HER LIFE. IT WAS FURTHER PROVI DED THAT SHOULD HARVEY DIE BEFORE ATTAINING THE AGE OF 55 YE ARS THE TRUSTEES WOULD STAND POSSESSED OF THE CAPITAL VALUE OF THE DEFERRED ANNUITY POLICY UPON TRUST TO PURCHASE THE REWITH AN ANNUITY FOR MRS. HARVEY WITH THE ABOVE INSURANCE CO MPANY OR OTHER INSURANCE COMPANY OF REPUTE. THE OTHER CON DITIONS OF THE DEED OF TRUST NEED NOT BE CONSIDERED BECAUS E THEY DO NOT BEAR UPON THE CONTROVERSY. IN FURTHERANCE OF THESE PRESENTS THE TRUSTEES TO OK OUT A POLICY ON JANUARY 12 1949. IN ADDITION TO CONDITIO NS USUAL IN SUCH POLICIES IT PROVIDED FOR THE FOLLOWING BEN EFITS : AMOUNT PER ANNUM OF DEFERRED ANNUITY. 563-5-8 P.A . IF BOTH MR. AND MRS. HARVEY BE LIVING ON SEPTEMBER 20 1955. 720-0-0 P.A. IF MRS. HARVEY SHOULD DIE BEFORE SEPTEMBER 20 1955 LEAVING HARVEY SURVIVING HER. 645-0- 0 P.A. IF HARVEY SHOULD DIE BEFORE SEPTEMBER 20 19 55 LEAVING MRS. HARVEY SURVIVING HIM. THERE WAS A SPECIAL PROVISION WHICH MUST BE REPRODUCED: PROVIDED THE CONTRACT IS IN FORCE AND UNREDUCED THE GRANTEES (I.E. THE TRUSTEES) SHALL BE ENTITLED TO SURRENDER THE ANNUITY ON THE OPTION ANNIVERSARY (I.E. SEPTEMBER 20 1955) FOR THE CAPITAL SUM OF 10 169 SUBJECT TO WRITTEN NOTICE OF THE INTENTION TO SURRENDER BEING RECEIVED BY THE DI RECTORS OF THE SOCIETY WITHIN THE THIRTY DAY PRECEDING THE OPT ION ANNIVERSARY. TWO OTHER CLAUSES OF THE SECOND SCHEDULE OF THE P OLICY MAY ALSO BE QUOTED : (III) IF BOTH THE NOMINEES SHALL DIE WHILST THE CO NTRACT REMAINS IN FORCE AND UNREDUCED AND BEFORE THE OPTIO N ANNIVERSARY THE SAID FUNDS AND PROPERTY OF THE SOCI ETY SHALL BE LIABLE TO MAKE REPAYMENT TO THE ITA NO. 4340/DEL/2009 PAGE 45 OF 49 GRANTEES OF A SUM EQUAL TO A RETURN TO ALL THE PREM IUMS WHICH SHALL HAVE BEEN PAID UNDER THIS CONTRACT WITH OUT INTEREST AFTER PROOF THEREOF AND SUBJECT AS HEREINB EFORE PROVIDED. (IV) THE GRANTEES SHALL BEFORE THE OPTION ANNIVERSA RY AND AFTER IT HAS ACQUIRED A SURRENDER VALUE BE ENTITLED TO SURRENDER THE CONTRACT FOR A CASH PAYMENT EQUAL TO RETURN OF ALL THE PREMIUMS (AT THE YEARLY RATE) WHICH HAVE BEEN PAID LESS THE FIRST YEARS PR EMIUM OR FIVE PER CENT. OF THE CAPITAL SUM SPECIFIED IN THE SPECIAL PROVISION OF THE FIRST SCHEDULE WHICHEVER SHALL BE THE LESSER SUM PROVIDED THAT IF THE DEFERRED ANNUITY HAS BEEN REDUCED AN EQUIVALENT RED UCTION IN THE GUARANTEED SURRENDER VALUE AS CALCULATED ABO VE WILL BE MADE. THE ASSESSEE-COMPANY PAID THE INITIAL SUM AND THE YEARLY PREMIA FOR SOME YEARS BEFORE HARVEY DIED. IN THE ASSESSMENT YEARS 1949-50 1950-51 1951-52 AND 1952 -53 IT CLAIMED A DEDUCTION OF THESE SUMS FROM ITS PROFITS OR GAINS UNDER SECTION 10(2)(XV) O F THE INDIAN INCOME-TAX ACT (HEREINAFTER CALLED THE ACT) WHICH PROVIDES : SUCH PROFITS OR GAINS SHALL BE COMPUTED AFTER MAKI NG THE FOLLOWING ALLOWANCES NAMELY : ANY EXPENDITURE (NOT BEING IN THE NATURE OF CAPITAL EXPENDITURE OR PERSONAL EXPENSES OF THE ASSESSEE) L AID OUT OR EXPENDED WHOLLY AND EXCLUSIVELY FOR THE PURPOSES OF SUCH BUSINESS PROFESSION OR VOCATION. THIS CLAIM WAS DISALLOWED BY THE DEPARTMENT AND THE APPELLATE TRIBUNAL. THE TRIBUNAL HELD THAT IT WAS N OT NECESSARY TO DECIDE IF THE EXPENDITURE WAS WHOLLY O R EXCLUSIVELY FOR THE PURPOSES OF THE COMPANYS BUSIN ESS AND IF SO WHETHER IT WAS OF A CAPITAL NATURE BECAUSE IN THE TRIBUNAL'S OPINION THERE WAS NO EXPENDITURE AT ALL. THE REASON WHY THE TRIBUNAL HELD THIS WAY MAY BE STATED IN ITS OWN WORDS : ITA NO. 4340/DEL/2009 PAGE 46 OF 49 CLAUSES (I) AND (II) DO NOT CONTAIN ANY PROVISION HAVING A MATERIAL BEARING UPON CLAUSE (III). THEREFORE IF I T HAPPENS THAT BOTH MR. AND MRS. HARVEY DIE BEFORE SEPTEMBER 20 1955 ALL THE PAYMENTS TILL THEN MADE THROUGH THE T RUSTEES TO THE INSURANCE SOCIETY WILL COME BACK TO THE TRUSTEE S AND AS THERE IS NOT THE SLIGHTEST TRACE OF ANY INDICATION ANYWHERE THAT THE TRUSTEES SHOULD HAVE ANY BENEFICIAL INTERE ST IN THESE MONEYS THERE WOULD BE A RESULTANT TRUST IN FA VOUR OF THE COMPANY IN RESPECT OF THE MONEYS THUS FAR PAID OUT. IN OTHER WORDS WHAT HAS BEEN DONE AMOUNTS TO A PROVIS ION FOR A CONTINGENCY WHICH MAY NEVER ARISE. SUCH A PROVISION CAN HARDLY BE TREATED AS PAYMENT TO AN EMPLOYEE WHETHER OF REMUNERATION OR P ENSION OR GRATUITY AND CANNOT BE A PROPER DEDUCTION AGAIN ST THE INCOMINGS OF THE BUSINESS OF THE COMPANY FOR THE PU RPOSE OF COMPUTING ITS TAXABLE PROFITS. IN SHORT THERE HAS BEEN NO EXPENDITURE BY THE COMPANY YET ; THERE HAS BEEN ONL Y AN ALLOCATION OF A PART OF ITS FUNDS FOR AN EXPENDITUR E WHICH MAY (OR MAY NOT) HAVE TO BE INCURRED IN FUTURE. THE QUESTION WHICH AROSE FOR DETERMINATION WAS : WHETHER DURING THE ASSESSMENT YEARS 1949-50 1950-5 1 1951-52 AND 1952-53 THE ASSESSEE-COMPANY WAS ENTITL ED TO CLAIM DEDUCTION OF THE YEARLY PREMIUM FROM ITS PROF ITS UNDER SECTION 10(2)(XV) OF THE INCOME-TAX ACT 1922. IT W AS HELD THAT THE PROVISION IN THE POLICY FOR SURRENDERING A NNUITY AND THE PROVISION IN POLICY FOR RETURN OF PREMIUM WAS N OT ENTITLED TO DEDUCTION AS THE PAYMENT MADE TO THE TR USTEES BY THE ASSESSEE-COMPANY WAS TOWARDS A CONTINGENT LIABILITY OR TOWARDS A LIABILITY DEPENDING ON A CON TINGENCY NAMELY THE LIFE OF A HUMAN-BEING. IT WAS HELD THAT PUTTING ASIDE OF MONEY WHICH MAY BECOME EXPENDITURE ON THE HAPPENING OF AN EVENT IS NOT AN EXPENDITURE UNDER S ECTION 10(2)(XV) OF THE 1922 ACT. IT WAS HELD ON FACTS THA T THE MONEY WAS PLACED IN THE HANDS OF THE TRUSTEES AND/O R THE INSURANCE COMPANY TO PURCHASE ANNUITIES IF REQUIRE D BUT TO BE RETURNED IF THE ANNUITIES WERE NOT PURCHASED. TH EREFORE IT WAS A CASE OF SETTING APART OF THE MONEY AND CON SEQUENTLY THE ASSESSEE WAS NOT ENTITLED TO DEDUCTION UNDER TH E SAID SECTION. ITA NO. 4340/DEL/2009 PAGE 47 OF 49 AT THIS STAGE WE ONCE AGAIN REITERATE THAT A LIABILITY IS A PRESENT OBLIGATION ARISING FROM PAST EVENTS THE SETTLEMENT OF WHICH IS EXPECTED TO RESULT IN AN OUT FLOW OF RESOURCES AND IN RESPECT OF WHICH A RELIABLE ESTIMA TE IS POSSIBLE OF THE AMOUNT OF OBLIGATION. AS STATED ABO VE THE CASE OF INDIAN MOLASSES CO. [1959] 37 ITR 66 (SC) I S DIFFERENT FROM THE PRESENT CASE. AS STATED ABOVE I N THE PRESENT CASE WE ARE CONCERNED WITH AN ARMY OF ITEMS OF SOPHISTICATED (SPECIALISED) GOODS MANUFACTURED AND SOLD BY THE ASSESSEE WHEREAS THE CASE OF INDIAN MOLASSES CO . [1959] 37 ITR 66 (SC) WAS RESTRICTED TO AN INDIVIDU AL RETIREE. ON THE OTHER HAND THE CASE OF METAL BOX C OMPANY OF INDIA [1969] 73 ITR 53 (SC) PERTAINED TO AN ARMY OF EMPLOYEES WHO WERE DUE TO RETIRE IN FUTURE. IN THAT CASE THE COMPANY HAD ESTIMATED ITS LIABILITY UNDER TWO GRATU ITY SCHEMES AND THE AMOUNT OF LIABILITY WAS DEDUCTED FR OM THE GROSS RECEIPTS IN THE PROFIT AND LOSS ACCOUNT. THE COMPANY HAD WORKED OUT ITS ESTIMATED LIABILITY ON ACTUARIAL VALUATION. IT HAD MADE PROVISION FOR SUCH LIABILITY SPREAD OVE R TO A NUMBER OF YEARS. IN SUCH A CASE IT WAS HELD BY THIS COURT THAT THE PROVISION MADE BY THE ASSESSEE-COMPANY FOR MEET ING THE LIABILITY INCURRED BY IT UNDER THE GRATUITY SCHEME WOULD BE ENTITLED TO DEDUCTION OUT OF THE GR OSS RECEIPTS FOR THE ACCOUNTING YEAR DURING WHICH THE P ROVISION IS MADE FOR THE LIABILITY. THE SAME PRINCIPLE IS LA ID DOWN IN THE JUDGMENT OF THIS COURT IN THE CASE OF BHARAT EA RTH MOVERS [2000] 245 ITR 428. IN THAT CASE THE ASSESS EE- COMPANY HAD FORMULATED LEAVE ENCASHMENT SCHEME. IT WAS HELD FOLLOWING THE JUDGMENT IN METAL BOX COMPANY O F INDIA [1969] 73 ITR 53 (SC) THAT THE PROVISION MADE BY T HE ASSESSEE FOR MEETING THE LIABILITY INCURRED UNDER T HE LEAVE ENCASHMENT SCHEME PROPORTIONATE WITH THE ENTITLEMEN T EARNED BY THE EMPLOYEES WAS ENTITLED TO DEDUCTION OUT OF GROSS RECEIPTS FOR THE ACCOUNTING YEAR DURING WHICH THE PROVISION IS MADE FOR THAT LIABILITY. THE PRINCIPLE WHICH EMERGES FROM THESE DECISIONS IS THAT IF THE HISTORI CAL TREND INDICATES THAT A LARGE NUMBER OF SOPHISTICATED GOOD S WERE BEING MANUFACTURED IN THE PAST AND IN THE PAST IF T HE FACTS ESTABLISHED SHOW THAT DEFECTS EXISTED IN SOME OF TH E ITEMS MANUFACTURED AND SOLD THEN THE PROVISION MADE FOR ITA NO. 4340/DEL/2009 PAGE 48 OF 49 WARRANTY IN RESPECT OF THE ARMY OF SUCH SOPHISTICAT ED GOODS WOULD BE ENTITLED TO DEDUCTION FROM THE GROSS RECEI PTS UNDER SECTION 37 OF THE 1961 ACT. IT WOULD ALL DEPEND ON THE DATA SYSTEMATICALLY MAINTAINED BY THE ASSESSEE. IT MAY B E NOTED THAT IN ALL THE IMPUGNED JUDGMENTS BEFORE US THE AS SESSEE(S) HAS SUCCEEDED EXCEPT IN THE CASE OF CIVIL APPEAL NO S. OF 2009ARISING OUT OF S. L. P. (C) NOS. 14178-14182 O F 2007 ROTORK CONTROLS INDIA (P) LTD. V. CIT IN WHI CH THE MADRAS HIGH COURT HAS OVERRULED THE DECISION OF THE TRIBUNAL ALLOWING DEDUCTION UNDER SECTION 37 OF THE 1961 ACT. HOWEVER THE HIGH COURT HAS FAILED TO NOTICE T HE REVERSAL WHICH CONSTITUTED PART OF THE DATA SYSTE MATICALLY MAINTAINED BY THE ASSESSEE OVER LAST DECADE. 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. 31. IN THE LIGHT OF THE DISCUSSIONS MADE ABOVE AND RELYING ABOUT THE AFORESAID DECISION OF HONBLE SUPREME COURT IN THE CASE OF CIT VS. ROTORK CONTROLS INDIA LTD. (SUPRA) CALCUTTA CO. LT D. V. COMMISSIONER OF INCOME-TAX (SUPRA) BHARAT EARTH MOVERS LTD. VS. CI T (SUPRA) AND HONBLE DELHI HIGH COURT IN THE CASE OF CIT VS. M/S . VINITEC CORP. PVT. LTD. (SUPRA) AND HONBLE KERALA HIGH COURT IN THE CASE OF CIT VS. INDIAN TRANSFORMERS LTD. (SUPRA) AND PRIVY COUNCIL IN THE CASE OF COMMISSIONER OF INLAND REVENUE VS. MITSUBISHI MOTOR S NEW ZEALAND LTD. (SUPRA) WE HOLD THAT THE ASSESSEE IS ENTITLED TO CLAIM THE DEDUCTION ON ACCOUNT OF PROVISIONS MADE TOWARDS WARRANTY WHI CH WAS EMBEDDED IN THE SALE DOCUMENT ITSELF AND THE SAME WARRANTY PRO VISION HAS BEEN ITA NO. 4340/DEL/2009 PAGE 49 OF 49 CLAIMED BY THE ASSESSEE BY REDUCING THE AMOUNT OF SALE VALUE BY THE AMOUNT OF PROVISIONS MADE TOWARDS WARRANTY. WE TH EREFORE DECIDE THIS ISSUE IN FAVOUR OF THE ASSESSEE AND DIRECT THE AO T O ALLOW THE ASSESSEES CLAIM. WE ORDER ACCORDINGLY. 32. IN THE RESULT THE APPEAL FILED BY THE ASSESSE E IS ALLOWED. 33. THIS DECISION IS PRONOUNCED IN THE OPEN COURT O N 5 TH FEBRUARY 2010. SD/- (SHAMIM YAHYA) ACCOUNTANT MEMBER SD/- (C.L. SETHI) JUDICIAL MEMBER DATED: 5 TH FEBRUARY 2010 *NITASHA COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A) 5. DR ITAT NEW DELHI. BY ORDER DEPUTY REGISTRAR