DCIT, Bangalore v. M/s Aditya Auto Products & Engg.(I) Pvt. Ltd.,, Bangalore

IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE A BENCH BANGALORE BEFORE SHRI K.P.T.THANGAL VICE PRESIDENT AND SHRI N.L.KALRA AM ITA NO.612(BANG.)/2009 (ASSESSMENT YEAR : 2005-06) THE DEPUTY COMMISSIONER OF INCOME-TAX CIRCLE-11(1) BANGALORE APPELLANT VS M/S ADITYA AUTO PRODUCTS & ENGG(I) PVT.LTD. PLOT NO.13E KIADB INDUSTRIAL AREA DODDABALLAPUR BANGALORE-560 203 RES PONDENT C.O.NO.43(B)/2009 (IN ITA NO.612(B)/2009) (ASSESSMENT YEAR : 2005-06) M/S ADITYA AUTO PRODUCTS & ENGG (I) PVT. LTD. PLOT NO.13E KIADB INDUSTRIAL AREA DODDABALLAPUR BANGALORE-560 203 CROSS O BJECTOR VS THE DEPUTY COMMISSIONER OF INCOME-TAX (TDS) CIRCLE-11(1) BANGALORE RESPONDENT REVENUE BY SHRI JASON P BOAZ ASSESSEE BY : SMT. KAVITHA O R D E R PER SHRI N.L.KALRA AM; THE REVENUE HAS FILED AN APPEAL AGAINST THE ORDER OF LEARNED CIT(A)-I BANGALORE DATED 17-03-2009 WHILE THE ASS ESSEE HAS FILED ITA NO.612 & CO NO.43(B)/09 2 CROSS OBJECTION. THE ASSESSEE HAS CLAIMED A SUM OF RS.74 65 692/- TOWARDS WARRANTY AND THE SAME WAS DISALLOWED IN RES PECT OF WARRANTY PROVISION MADE BY THE ASSESSEE. THE LEARNED CIT(A) HELD THAT THE PROVISION FOR WARRANTY IS ALLOWABLE. HOWEVER LEAR NED CIT(A) HELD THAT THE QUANTUM OF WARRANTY PROVISION MADE BY THE ASSES SEE IS EXCESSIVE. THE LEARNED CIT(A) ALLOWED THE WARRANTY PROVISION T O THE EXTENT OF RS.46 66 057/-. THE REVENUE IS AGGRIEVED AGAINST T HE ALLOWABILITY OF WARRANTY PROVISIONS WHILE THE ASSESSEE IN ITS CROSS OBJECTION IS AGGRIEVED IN RESPECT OF THE FINDING OF LEARNED CIT( A) IN RESTRICTING THE WARRANTY PROVISIONS TO THE EXTENT OF RS.46 66 057/- AS COMPARED TO RS.74 65 692/- MADE BY THE ASSESSEE. THE HONBLE APEX COURT IN THE CASE OF ROTORK CONTR OLS INDIA (P) LTD. VS CIT REPORTED IN 223 CTR 425 (2009) HAD AN OCCASION TO CONSIDER AS TO WHETHER THE PROVISION OF WARRANTY IS ALLOWABLE AS DEDUCTION U/S 37 OF THE IT ACT. THE HONBLE APEX C OURT VIDE PARA 13 OF THE ORDER HELD AS UNDER; IN THIS CASE WE ARE CONCERNED WITH PRODUCT WARRANTIES. TO GIVE AN EXAMPLE OF PRODUCT WARRANTIES A COMPANY DEALING IN COMPUTERS GIVES WARRANTY FOR A PERIOD OF 376 MONTHS FROM THE DATE O F SUPPLY. THE SAID COMPANY CONSIDERS FOLLOWING OPTIONS; (A) ACCOUNT FOR WARRANTY EXPENSE IN THE YE AR IN WHICH IT IS INCURRED; (B) IT MAKES A PROVISION F OR ITA NO.612 & CO NO.43(B)/09 3 WARRANTY ONLY WHEN THE CUSTOMER MAKES A CLAIM; AND (C) IT PROVIDES FOR WARRANTY AT 2 PERCENT OF TURN O VER OF THE COMPANY BASED ON PAST EXPERIENCE(HISTORICAL TREND) THE FIST OPTION IS UNSUSTAINABLE SINCE IT WO ULD TANTAMOUNT TO ACCOUNTING FOR WARRANT EXPENSES ON CASH BASIS WHICH IS PROHIBITED BOTH UNDER THE COMPANIES ACT AS WELL AS BY THE ACCOUNTING STANDARDS WHICH REQUIRE ACCRUAL CONCEPT TO BE FOLLOWED. IN THE PRESENT CASE THE DEPARTMENT IS INSISTING ON THE FIRST OPTION WHICH AS STATED AB OVE IS ERRONEOUS AS IT RULES U THE ACCRUAL CONCEPT. THE SECOND OPTION IS ALSO INAPPROPRIATE SINCE IT DOES N OT REFLECT THE EXPECTED WARRANTY COSTS IN RESPECT OF REVENUE ALREADY RECOGNIZED (ACCRUED). IN OTHER WOR DS IT IS NOT BASED ON MATCHING CONCEPT. UNDER THE MATCHING CONCEPT IF REVENUE IS RECOGNIZED THE COST INCURRED TO EARN THAT REVENUE INCLUDING WARRANTY COSTS HAVE TO BE FULLY PROVIDED FOR. WHEN VALVE ACTUATORS ARE SOLD AND THE WARRANTY COSTS ARE AN INTEGRAL PART OF THAT SALE PRICE THEN THE APPELLANT HAS TO PROVIDE FOR SUCH WARRANTY COSTS IN ITS ACCOUNT F OR THE RELEVANT YEAR OTHERWISE THE MATCHING CONCEPT FAILS. IN SUCH A CASE THE SECOND OPTION IS ALSO INAPPROPRIATE BECAUSE IT FULFILLS ACCRUAL CONCEPT A S WELL AS THE MATCHING CONCEPT. FOR DETERMINING AN APPROPRIATE HISTORICAL TREND IT IS IMPORTANT THAT THE COMPANY HAS A PROPER ACCOUNTING SYSTEM FOR CAPTURING RELATIONSHIP BETWEEN THE NATURE OF THE ITA NO.612 & CO NO.43(B)/09 4 SALES THE WARRANT PROVISIONS MADE AND THE ACCRUAL EXPENSES INCURRED AGAINST IT SUBSEQUENTLY. THUS T HE DECISION ON THE WARRANTY PROVISION SHOULD BE BASED ON PAST EXPERIENCE OF THE COMPANY. A DETAILED ASSESSMENT OF THE WARRANTY PROVISIONING POLICY IS REQUIRED PARTICULARLY IF THE EXPERIENCE SUGGESTS TH AT WARRANTY PROVISIONS ARE GENERALLY REVERSED IF THEY REMAINED UNUTILIZED AT THE END OF THE PERIOD PRESCRIBED IN THE WARRANTY. THEREFORE THE COMPANY SHOULD SCRUTINIZE THE HISTORICAL TREND OF WARRANTY PROVISIONS MADE AND THE ACTUAL EXPENSES INCURRED AGAINST IT. ON THIS BASIS A SENSIBLE ESTIMATE SHOU LD BE MADE. THE WARRANTY PROVISION FOR THE PRODUCTS SHOULD BE BASED N THE ESTIMATE AT YEAR END OF FUTUR E WARRANTY EXPENSES. SUCH ESTIMATES NEED REASSESSMENT EVERY YEAR. AS ONE REACHES CLOSE TO T HE END OF THE WARRANTY PERIOD THE PROBABILITY THAT TH E WARRANTY EXPENSES WILL BE INCURRED IS CONSIDERABLY REDUCED AND THAT SHOULD BE REFLECTED IN THE ESTIMATION AMOUNT. WHETHER THIS SHOULD BE DONE THROUGH A PRO RATA REVERSAL OR OTHERWISE WOULD REQUIRE ASSESSMENT OF HISTORICAL TREND. IF WARRAN TY PROVISIONS ARE BASED ON EXPERIENCE AND HISTORICAL TREND(S) AND IF THE WORKING IS ROBUST THEN THE QUESTION OF REVERSAL IN THE SUBSEQUENT TWO YEARS. IN THE ABOVE EXAMPLE MAY NOT ARISE IN A SIGNIFICANT W AY. IN OUR VIEW ON THE FACTS AND CIRCUMSTANCES OF THIS CASE PROVISION FOR WARRANTY IS RIGHTLY MADE BY THE ITA NO.612 & CO NO.43(B)/09 5 APPELLANT-ENTERPRISE BECAUSE IT HAS INCURRED A PRESENT OBLIGATION AS A RESULT OF PAST EVENTS. THE RE IS ALSO AN OUTFLOW OF RESOURCES. A RELIABLE ESTIMATE OF THE OBLIGATION WAS ALSO POSSIBLE. THEREFORE THE APPELLANT HAS INCURRED A LIABILITY ON THE FACTS AND CIRCUMSTANCES OF THIS CASE DURING THE RELEVANT ASSESSMENT YEAR WHICH WAS ENTITLED TO DEDUCTION U/S 37 OF THE ACT. THEREFORE ALL THE THREE CONDITIONS FOR RECOGNIZING A LIABILITY FOR THE PURPOSES OF PROVISI ONING STANDS SATISFIED IN THIS CASE. IT IS IMPORTANT TO NOTE THAT THERE ARE FOUR IMPORTANT ASPECTS OF PROVISIONI NG. THEY ARE PROVISIONING WHICH RELATES TO PRESET OBLIGATION IT ARISES OUT OF OBLIGATING EVENTS IT INVOLVES OUTFLOW OF RESOURCES AND LASTLY IT INVOLVES RELIABL E ESTIMATION OF OBLIGATION. KEEPING IN MIN ALL THE F OUR ASPECTS WE ARE F THE VIEW THAT THE HIGH COURT SHOU LD NOT TO HAVE INTERFERED WITH THE DECISION OF THE TRIBUNAL IN THIS CASE. 3. IN VIEW OF THE DECISION OF THE HONBLE APEX COU RT IT IS HELD THAT THE PROVISION FOR WARRANTY IS ALLOWABLE PROVID ED THE PROVISION IS MADE ON CERTAIN SCIENTIFIC BASIS CONSIDERING THE P AST HISTORY. IN THE INSTANT CASE THE ASSESSEE HAS MADE WARRANTY PROVIS ION FOR THE FIRST TIME. THE PROVISION FOR WARRANTY CREATED IN SUBSEQ UENT YEARS HAS BEEN NOTICED BY THE LEARNED CIT(A) AND THE CHART AS MENTIONED BY THE LEARNED CIT(A IS REPRODUCED AS UNDE R; ITA NO.612 & CO NO.43(B)/09 6 FY OPENING BALNACE ACTUAL WARRANTY CLAIM PROVISION FOR THE YEAR CLOSING BALANCE 2004-05 1 29 63 101 74 65 692 74 65 692 2005-06 74 65 692 54 21 110 27 85 418 48 30 000 2006-07 48 30 000 43 98 957 18 68 957 23 00 000 2007-08 23 00 000 15 24 976 13 00 000 20 75 024 4. DURING THE YEAR UNDER REFERENCE THE ASSESSEE H AS ESTIMATED WEIGHTED AVERAGE @ 8%. THE LEARNED CIT(A) AT PAGE- 8 OF HIS ORDER HAS NOTICED THE WEIGHTED AVERAGE OF TOTAL CLAIMS IN THE SUBSEQUENT YEARS WHICH VARIED FROM 4.44% TO 1.44% FROM THE AY: 2006- 07 TO 2008-09. THE LEARNED CIT(A) FURTHER MENTIONED THAT THE ASSES SEE HAS NOT FILED ANY EVIDENCE TO SUBSTANTIATE ABOUT THE BREAKAGE OF A PLASTIC PART WAS A REASON FOR MAKING WARRANTY OF WEIGHTED AVERAGE IN THE YEAR UNDER REFERENCE AS COMPARED TO 4.44% TO 1.44% IN THE SUCC EEDING YEARS. IT IS TRUE THAT CLAIM ON WARRANTY MAY BE MORE IN THE F IRST YEAR BECAUSE AFTER GETTING THE FEED BACK CERTAIN IMPROVEMENT IN THE QUALITY IS DONE. IN THE INSTANCE CASE THE DIFFERENCE OF WEIGHTED AV ERAGE IN THE YEAR UNDER REFERENCE IS MUCH MORE THAN THE WEIGHTED AVER AGE IN THE SUBSEQUENT YEARS. THE ONUS WAS ON THE ASSESSEE TO HAVE ADDUCED EVIDENCE WITH IN THE FIRST YEAR THE WEIGHTED AVERA GE OF WARRANTY CLAIM WAS TAKEN AT 8% DUE TO SOME SPECIFIC REASONS. HOWE VER SOME REASONS WERE GIVEN IN RESPECT OF SOME PLASTIC PART BUT NO EVIDENCE WAS FILED TO SUPPORT SUCH CLAIM. AN ARGUMENT CANNOT B E A SUBSTITUTE FOR ITA NO.612 & CO NO.43(B)/09 7 AN EVIDENCE. THE LEARNED AR VIDE WRITTEN SUBMISSIO N HAS FURNISHED ACTUAL WARRANTY CLAIM RECEIVED BY THE ASSESSEE AGAI NST THE SALES MADE DURING THE FY: 2004-05. AS PER THE DETAILS THE AS SESSEE RECEIVED ACTUAL WARRANTY CLAIM FOR THE PRODUCT SOLD IN THE F Y: 2004-05 TO THE EXTENT OF RS.54 21 110/- IN THE FY: 2005-06 AND RS .20 44 582/- IN THE FY: 2006-07. THE WARRANTY PROVISION IS ALLOWABL E EVEN IF THE QUANTIFICATION IS MADE IN THE SUBSEQUENT YEARS AND SUCH QUANTIFICATION IS REASONABLE AS PER THE PROVISIONS MADE. ALL THE DETAILS AS PER THE ANNEXURE-II BEFORE US WERE NOT FILED BEF ORE THE LEARNED AO. THE DETAILS GIVEN IN ANNEXURE-II IS REPRODUCED AS U NDER FOR READY REFERENCE; ADITYA AUTO PRODUCTS AND ENGINEERING (I) PRIVATE LT D. MOVEMENT IN PROVISION FOR WARRANTY FINANCIAL YEAR OPENING BALANCE OF PROVISION(RS. ) PROVISION CREATED DURING THE YEAR (RS.) ACTUAL WARRANTY CLAIM RECEIVED AGAINST THE PROVISION TOTAL ACTUAL CLAIMS (RS. CLOSING BALANCE OF PROVISION (RS.) 2004-05 7 465 692 FY : AMOUNT (RS.) 7 465 692 2005-6 7 465 692 2 785 418 2004-05 5 421 110 5 421 110 4 830 000 2006-07 4 830 00 1 868 957 2004-05 2 044 582 2005-06 2 354 375 4 398 957 2 300 00 2007-08 2 300 000 1 300 000 2005- 06 431 043 2006-07 1 093 933 1 524 976 2 075 024 ITA NO.612 & CO NO.43(B)/09 8 THE AO WILL VERIFY THE ACTUAL WARRANTY CLAIMS IN RE SPECT OF PRODUCTS SOLD IN THE FY: 2004-05 AND SATISFIED THAT THE WARRANTY CLAIMS SETTLED IN SUBSEQUENT YEARS TO THE CUSTOMERS IN RESPECT OF SALES OF FY: 2004-05. IN CASE THE VERIFICATION SHOWS THAT THE WARRANTY CLAIMS IN SUBSEQUENT YEAS RELATED TO THE PRODUCT SOLD DURI NG THE FY 2004-05 THEN THE PROVISION TO THAT EXTENT WILL BE ALLOWED. HENCE TO THIS EXTENT THE ISSUE IS RESTORED BACK TO THE FILE OF ASSESSING OFFICER. 5. IN THE RESULT THE APPEALS OF THE REVENUE AS WE LL AS THE CO BY THE ASSESSEE ARE PARTLY ALLOWED. ORDER PRONOUNCED IN THE OPEN COURT ON (K.P.T.THANGAL (N.L.KALRA) VICE PRESIDENT ACCOUNTANT MEMBER PLACE: BANGALORE DATED: AM* COPY TO : 1. THE ASSESSEE 2. THE REVENUE 3. CIT(A) 4. CIT 5. DR 6. GF(BLORE) 7. GF(DELHI) BY ORDER AR ITAT BANGALORE