JOINT COMMISSIONER OF INCOME TAX v. SONY INDIA (P) LTD
[Citation -2005-LL-0510-3]

Citation 2005-LL-0510-3
Appellant Name JOINT COMMISSIONER OF INCOME TAX
Respondent Name SONY INDIA (P) LTD.
Court ITAT
Relevant Act Income-tax
Date of Order 10/05/2005
Assessment Year 1997-98, 1999-00, 2000-01
Judgment View Judgment
Keyword Tags unascertained liability • contractual obligation • provision for warranty • corporate membership • contingent liability • superannuation fund • revenue expenditure • provision created • sale transaction • leave encashment • legal obligation • historical cost • warranty claim • total turnover • membership fee • accrual basis • gratuity fund • future date • motor car • tv
Bot Summary: The assessee has claimed an amount of Rs. 3,51,69,044 on account of provision of warranty in the PL a/c and has also reversed the provision for warranty for the earlier asst. The decision of the apex Court in the case of Bharat Earth Movers Ltd. vs. CIT 162 CTR 325: 245 ITR 428 relied upon by the assessee was distinguished by the AO on facts stating that this judgment was in respect of the provision for leave encashment wherein the case of the assessee the provision is in respect of warranty claims. The contentions of the assessee were as follows: That the assessee was offering warranty as a matter of industrial practice under the terms of sale; that the assessee was under contractual obligation to provide after sales service and also replace defective parts. Considering the pleas of the assessee, the CIT(A) has since allowed the claim of the assessee and has also upheld the plea of the assessee with regard to the adjustment made by the AO to the book profits under s. 115JA. Before us, learned Departmental Representative has defended the orders of the AO by placing reliance on the same and has also referred to the reasoning adopted by the CIT(A) in asst. First of all, it is to be understood that having regard to the nature of the assessee s business, it cannot be denied that the warranties undertaken by the assessee to its customers for replacing the defective parts within a specific period is the cost which is incurred in its regular course of business. The arising of defects and its notification to the assessee is a continuous process as the assessee is making not a solitary sale but innumerable sales spread over a large geographical area. On the basis of aforesaid, it has been vehemently argued by the counsel for the assessee that the amount claimed is neither excessive nor arbitrary as the same is based on historical experience of the assessee.


These are four appeals, one by assessee and three by Revenue against respective orders of CIT(A) dt. 12th Sept., 2003, 21st Nov., 2002, 22nd Feb., 2002 and 6th June, 2001, respectively for asst. yrs. 2000-01, 1999-2000, 1998-99 and 1997-98. Since all appeals relate to same assessee and issues are common, all of them are clubbed together and are being disposed of by way of consolidated order for sake of convenience and brevity. One common issue in appeals relates to issue of warranty expenses. AO made disallowance on account of provision for warranty expenses in all four years under consideration. CIT(A) in asst. yrs. 2000-01, 1999-2000 and in 1997-98 has allowed plea of assessee whereas for asst. yr. 1998-99, CIT(A) has taken different view and has sustained action of AO. Nevertheless, as facts are common in all grounds, we deem it fit and proper to take up issue together. As facts are common, we take up for consideration facts as they pertain to asst. yr. 2000-01. facts relevant to this dispute are that assessee-company is engaged n manufacturing and sale of TV and audio systems and as matter of policy offers warranty of one year on all its products sold. assessee creates provision for warranty in respect of products sold and on which warranty extends beyond 31st March of financial year, calculated on basis of past experience. assessee has claimed amount of Rs. 3,51,69,044 on account of provision of warranty in P&L a/c and has also reversed provision for warranty for earlier asst. yr. 1999-2000 of Rs. 2,26,97,000 and net provision of Rs. 1,24,72,044 has been charged to P&L a/c. AO disallowed claim of assessee for provision for warranty holding it to be unascertained and contingent liability. According to AO, there is element of uncertainty involved in provision of warranty because number of products and extent of warranty claims that may arise in future is not known. In opinion of AO, nature of provision being uncertain and contingent is reflected from assessee s own calculation whereby it creates certain provision every year and reverses some amount out of this provision of earlier year and finally claims actual amount of warranty expenses along with provision created for warranty. In support of his stand that contingent liabilities cannot be allowed as deduction, AO relied upon various judicial decisions like Standard Tea Exports vs. CIT (1991) 100 CTR (Ker) 165: (1992) 198 ITR 573 (Ker), ITO vs. Allena Auto Industries (P) Ltd. (1991) 39 TTJ (Del) 439, CIT vs. Oriental Motor Car Co. (P) Ltd. (1980) 16 CTR (All) 140: (1980) 124 ITR 74 (All) and Shree Sajjan Mills Ltd. vs. CIT (1985) 49 CTR (SC) 193: (1985) 156 ITR 585 (SC). decision of apex Court in case of Bharat Earth Movers Ltd. vs. CIT (2000) 162 CTR (SC) 325: (2000) 245 ITR 428 (SC) relied upon by assessee was distinguished by AO on facts stating that this judgment was in respect of provision for leave encashment wherein case of assessee provision is in respect of warranty claims. AO accordingly disallowed claim of provision for warranty of Rs. 1,24,72,044 and added same to income of assessee. AO has further held that in view of Expln. (c) to sub-s. (2) of s. 115JA, provision for warranty being unascertained and contingent liability, was also liable to be added to book profit of assessee under s. 115JA of Act. Aggrieved with order of AO, assessee carried matter in appeal before CIT(A). Before CIT(A), contentions of assessee were as follows: That assessee was offering warranty as matter of industrial practice under terms of sale; that assessee was under contractual obligation to provide after sales service and also replace defective parts. That sales are made on day-to-day basis and on large number of products sold during year, warranty period had not expired on close of financial year; therefore, it became necessary to make provision for warranty expenses for unexpired period of warranty contracts executed at time of making sales of company products on scientific basis. provision is made on basis of technical estimates computed scientifically as percentage of total turnover on basis of its past experience. That assessee has been following consistent policy whereby actual expenditures incurred on warranty claims during year were adjusted with provision made on this account in immediately preceding assessment year. That similarly, provision in respect of sales made during previous year under consideration has been charged to P&L a/c and claimed as allowable deduction. assessee also contended before CIT(A) that there was no contingency in impugned expenditure and it was in line with accounting principles and standards issued by ICAI. Reliance was also placed on decision of apex Court in case of Bharat Earth Movers Ltd. (supra), Metal Box Co. of India Ltd. vs. Their Workmen (1969) 73 ITR 53 (SC), Jay Bee Industries vs. Dy. CIT (1998) 61 TTJ (Asr) 403: (1999) 102 TAXMAN 25 (Asr)(Mag), Kevin Enterprises vs. Jt. CIT (2002) 74 TTJ (Ahd) 127: (2001) 79 I T D 196 (Ahd). Similarly, assessee also contended that impugned provision for warranty could not be considered as unascertained liability and on that basis, no book adjustment under s. 115JA could be made with respect to said provision. Considering pleas of assessee, CIT(A) has since allowed claim of assessee and has also upheld plea of assessee with regard to adjustment made by AO to book profits under s. 115JA. Before us, learned Departmental Representative has defended orders of AO by placing reliance on same and has also referred to reasoning adopted by CIT(A) in asst. yr. 1998-99 wherein disallowance made by AO has been sustained. Learned Departmental Representative in nutshell stated that provision for warranty was contingent liability and was not allowable as revenue expenditure and for that learned Departmental Representative relied on decision of Shree Sajjan Mills Ltd. s case (supra). Learned Departmental Representative also argued that decision of apex Court in case of Bharat Earth Movers Ltd. (supra) would apply only to situation where liability was capable of exact quantification and not on basis of mere estimate as in present case. Thus, according to him, ratio of decision of apex Court cannot be applied herein. On other hand, counsel for assessee made detailed submissions in support of stand of CIT(A) in allowing claim of assessee. According to learned counsel, provision for warranty was not contingent liability and was embedded in every sale transaction done by assessee. It is submitted that AO had failed to appreciate that liability which has been arising from year to year and allowed on year to year basis cannot by any standards be termed as contingent liability. counsel has cannot by any standards be termed as contingent liability. counsel has also justified procedure adopted by assessee of making provision for warranty. It is submitted that assessee-company, based on technical evaluation and past experience was scientifically able to estimate warranty claims likely to arise during warranty period and as such, claim of assessee on accrual basis is tenable. It is further submitted that on scientifically designed basis and considering various items depending upon volume, nature and complexity involved in manufacturing process and use of its product, provision for claim of warranty has been made in account and is consistently followed. Reliance was placed on following decisions of Tribunal: (a) Thermax Babcock & Wilcox Ltd. vs. Dy. CIT (2001) 72 TTJ (Pune)(TM) 827: (2001) 79 ITD 63 (Pune)(TM); (b) Singhal & Co. vs. ITO (1982) 1 ITD 476 (Chd); (c) KCP Ltd. vs. Asstt. CIT (1990) 34 ITD 1 (Hyd)(SB); (d) ITO vs. Wanson (India) Ltd. (1983) 5 ITD 102 (Pune); (e) CIT vs. Majestic Auto Ltd. (1994) 48 TTJ (Chd) 566: (1993) 204 ITR 14 (Chd)(AT); (f) CIT vs. Development Trust (P) Ltd. (1991) 99 CTR (All) 247: (1991) 189 ITR 504 (All); (g) Voltas Ltd. vs. Dy. CIT (1998) 64 ITD 232 (Mumbai); (h) IRC vs. Mitsubishi Motors New Zealand Ltd. (1996) 222 ITR 697 (PC); (i) Jay Bee Industries vs. Dy. CIT (supra); (j) Voltas Ltd. s case; (k) Kevin Enterprise vs. Jt. CIT (supra). It was further argued that warranty claims was accrued and ascertained liability and referred to decisions of apex Court in cases of Bharat Earth Movers Ltd. vs. CIT (supra) and Calcutta Supply Co. Ltd. vs. CIT (1959) 37 ITR 1 (SC). We have considered rival submissions. assessee follows mercantile system of accounting. Under such accounting system, liabilities are liable to be allowed (as) deduction in year when they arise or accrue. First of all, it is to be understood that having regard to nature of assessee s business, it cannot be denied that warranties undertaken by assessee to its customers for replacing defective parts within specific period is cost which is incurred in its regular course of business. obligation of assessee to accept warranty claim is in-built in contract of sale with its customers. On this aspect of matter, there is no dispute. According to Revenue, since period of warranty extends over period of 12 months from date of sale, therefore, liability is contingent upon defect appearing and being notified to assessee within such warranty period. Till such time, there is no liability which is to be met by assessee and, thus, impugned claim of deduction is merely estimated liability which may or may not fructify. In our view, once having accepted that liability arising on account of warranty claims is in-built in sale mechanism itself, it cannot be viewed that it is contingent in nature. arising of defects and its notification to assessee is continuous process as assessee is making not solitary sale but innumerable sales spread over large geographical area. Occurrence of warranty claim has to be, thus, viewed from overall perspective so as to match costs vis-a-vis sales revenues of given period. In our view, if issue is considered in above background, such liability cannot be construed as contingent liability. contingent liability is to be understood as one which is not only dependent on happening of future event but is also incapable of ascertainment or even estimation with fair degree of precision. In contrast, liability whose happening and valuation is possible to be made with reasonable certainty and would arise continually so as to be coterminus with carrying on of business of assessee, same cannot be construed as contingent liability. As in instant case, having noted that assessee is making sales of TV and audio systems, etc., in substantial quantities and such sales are spread across geographical areas and each item of sale is, in turn, embedded with several parts, etc. which are under warranty for defects, etc., appearance of warranty claims over continuous period cannot be avoided. incurring of liability in this regard is reasonably certain. Hon ble Supreme Court in case of Bharat Earth Movers (supra) had occasion to consider claim for deduction on account of contingent liability. following principles were laid down by Hon ble Supreme Court: "If business liability has definitely risen in accounting year, deduction should be allowed although liability may have to be quantified and discharged at future date. What should be certain is incurring of liability. It should also be capable of being estimated with reasonable certainty though actual quantification may not be possible if these requirements are satisfied liability is not as contingent one. liability is in present though it will be discharged at future date. It does not make any difference if future date on which liability shall have to be discharged is not certain." Similarly, in case of Mitshubishi Motors New Zealand Ltd. (supra), Privy Council had occasion to deal with claim for deduction on account of anticipated liability under warranty. It was case of car manufacturer who had undertaken to repair defects appearing within one year of delivery or until vehicle has been driven for 22,000 kms., whichever period is shorter. assessee car manufacturer sought deduction of its anticipated liability under warranty remaining unexpired at end of year in which vehicles were sold. Privy Council held as follows: "The taxpayer s liability under warranty for each vehicle sold was contingent on defect appearing and being notified to dealer within warranty period so that no liability was incurred by taxpayer until those conditions were satisfied, regard could be had to its estimation of warranty claims based on statistical information, which shows that as matter of existing fact not future contingency 63 per cent of all vehicles sold by taxpayer contained defects likely to be manifested within warranty, that since theoretical contingencies could be disregarded, taxpayer was in year of sale under accrued legal obligation to make payment under those warranties and, even though it might not be required to do so until following year, it was definitely committed in year of sale to that expenditure; and that, accordingly, in computing profits or gains derived by taxpayer from its business in year in which vehicles were sold, taxpayer was entitled under s. 104 to deduct from its total income and provision which it had made for costs to its anticipated liabilities under outstanding warranties in respect of vehicles sold in that year." Therefore, in our view, stand of Revenue is not justified. Even otherwise, we find that under mercantile system of account, it would be prudent to match revenue and its attendant cost so as to deduce appropriate profits of given previous year. If sales realizations are credited to P&L a/c of particular previous year, it would be appropriate that liabilities which accrue or are attached to such sales and are capable of quantification precisely or with fair degree of reasonableness, are also debited to P&L a/c of same year. This would ensure that P&L a/c of particular year does not give distorted picture of profits. On this count also, we find merit in claim of assessee that provision for warranty claims is to be set off as deduction against sales realization of particular year. Now with regard to basis of estimation, assessee has placed before us in paper book, details and methodology of making impugned provision. It is discernible that assessee takes into consideration past historical cost, failure rate experienced in past, length of warranty with regard to equipments and spares, increase in volumes over last period, etc. It is also clear that actual expenses incurred on warranty are adjusted to provision account and not to P&L a/c, thereby obviating double deduction. On basis of aforesaid, it has been vehemently argued by counsel for assessee that amount claimed is neither excessive nor arbitrary as same is based on historical experience of assessee. In our view, on consideration of entire gamut of facts and circumstances, (a) provision made reflects accrued liability, (b) that impugned provision is computed on scientific and reasonable basis. Hence, we refrain from interfering with conclusions drawn by first appellate authority. Our decision to hold issue against Revenue is also fortified by decision of High Court of Madras in CIT vs. Revenue is also fortified by decision of High Court of Madras in CIT vs. Beema Mfrs. (P) Ltd. (2003) 130 TAXMAN 400 (Mad). Department fails on this ground. Before we conclude impugned issue, counsel for assessee also submitted that asst. yr. 1995-96 was first year of operation of assessee wherein no such claim was made as there was no past experience relating to warranty claims. In subsequent asst. yr. 1996-97, it was first time that assessee made claim of deduction of provision for warranties on lines as discussed in earlier paras. said claim has since been accepted by AO and no addition has been made on this count. It was, therefore, also pleaded that on principles of consistency, no such disallowance could have been made in subsequent years. We have considered aforesaid plea and find that same is borne out from record. As we have already discussed merits of claim and have upheld stand of assessee, we do not discuss this issue in detail. However, there cannot be dispute that Department is expected to be consistent in its stand once certain fundamental issues which permeate through each assessment year is decided one way or other and no departure from same be made unless any change in law or in facts are brought out by Revenue. With regard to decision of CIT(A) on issue of adjustments made by AO to book profit in terms of s. 115JA, we do not find any substance in stand of Revenue. For reasons discussed in aforesaid paras, in our view, impugned provision cannot be construed as contingent liability and, thus, we uphold decision of CIT(A) on this issue also. With aforesaid, appeals of Revenue in ITA No. 5483/Del/2003; asst. yr. 2000-01 and ITA No. 3728/Del/2001; asst. yr. 1997-98 are fully disposed of as only ground taken by Revenue pertained to provision for warranty. Similarly, ground No. 1 in appeal of assessee in ITA No. 1671/Del/2002 for asst. yr. 1998-99 stands allowed. Also, ground No. 1 in appeal of Revenue in ITA No. 966/Del/2003 for asst. yr. 1999-2000 stands dismissed. Now, we take up for consideration remaining grounds in ITA No. 966/Del/2003 and ITA No. 1671/Del/2002. First we take up ITA No. 966/Del/2003 (Appeal of Revenue Asst. yr. 1999-2000). second ground preferred by Revenue reads as under: "On facts and in circumstances of case, learned CIT(A) has erred in deleting disallowance of claim of Rs. 4,50,000 made by AO in respect of fees paid by assessee-company for membership of golf club on ground that it was in nature of capital expenditure." Briefly, facts are that assessee incurred sum of Rs. 4,50,000 on entrance and membership fee for corporate membership fee of golf club. A O disallowed claim of assessee for deduction treating it as capital expenditure. CIT(A) has since allowed claim of assessee by relying on decision of Hon ble Gujarat High Court in Gujarat State Export Corpn. Ltd. vs. CIT (1996) 131 CTR (Guj) 23: (1994) 209 ITR 649 (Guj). Revenue is before us against order of CIT(A). After considering rival pleas, we are inclined to affirm decision of CIT(A) as same is based on decision of Gujarat High Court. Even decision of Bombay High Court in case of OTIS Elevator Co. (India) Ltd. vs. CIT (1991) 96 CTR (Bom) 14: (1992) 195 ITR 682 (Bom) is on similar lines. Accordingly, Department fails on this ground. This appeal of Revenue is accordingly dismissed. Now, we take up ITA No. 1671/Del/2002 (Appeal of assessee Asst. yr. 1998-99). Second ground in ITA No. 1671/Del/2002 is with regard to disallowance made of Rs. 4,31,342 and Rs. 35,31,223 respectively in respect of contribution to gratuity fund and superannuation fund on ground that such funds were not recognized by CIT during relevant period. factum of non-recognition of funds for year under consideration remained undisputed and, therefore, we do not find any reasons to interfere with conclusions of lower authorities that aforesaid sums cannot be allowed as deduction during year under consideration. Another limb of same disallowance is that AO treated aforesaid contribution as "ineligible expenditure" and added same to book profits while computing income under s. 115JA of Act. Similar is grievance of assessee in its ground Nos. 3 and 4 which relate to adjustments made by AO while computing income under s. 115JA with respect to interest on income-tax of Rs. 12,74,354 by treating same to be income-tax and wealth- tax of Rs. 1,01,866, respectively. On all three issues, we are of opinion that AO shall revisit claim of assessee in light of decision of apex Court in case of Apollo Tyres Ltd. vs. CIT (2002) 174 CTR (SC) 521: (2002) 255 ITR 273 (SC) and also take into consideration decision of Bombay High Court in case of CIT vs. Veekaylal Investment Co. (P) Ltd. (2001) 166 CTR (Bom) 96: (2001) 249 ITR 597 (Bom). Accordingly, ground Nos. 2, 3 and 4 of assessee are disposed of. Ground No. 5 taken by assessee is with regard to charging interest under s. 234B of Act which, in our view, is consequential in nature. In result, appeals of Revenue are treated as dismissed and those of assessee are treated as partly allowed as above. *** JOINT COMMISSIONER OF INCOME TAX v. SONY INDIA (P) LTD.
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