Claim for sales return provision was in accordance with AS notified u/s 145 being best estimate of information available

In a recent judgment, ITAT Delhi has allowed claim for provision made for sales return holding that as per Accounting Standard notified u/s 145 of Income Tax Act, 1961, provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.

Case Law Details:
ITA No. 2685/M/2009 Asstt. Year : 2004-05
Bayer Bioscience P. Ltd. vs. DCIT 
Date of Order/Judgment: 21/04/2016

Brief Facts of the Case:
During the relevant year, the assessee claimed a provision for sales return. The assessee explained that the provision for discount and sales return was accounted for as a provision for expenses. These expenses were actually incurred during the previous year and accounted for on the basis of actual bills/details received after the balance sheet date and before closing and finalization of accounts. The Assessing Officer did not accept the contention of the assessee and made disallowance stating that the provision for sales return could not be treated as expense in the first place and even if it is so considered, the same could not be pertaining to the year in question as the sales return in the relevant year’s sale were totally uncertain. According to AO, the provision for such uncertain obligation towards sales return was contingent in nature and also was against the accrual system of accounting wherein an expenditure is allowable only when it is incurred for it has been crystallized. On appeal by the assessee, CIT(A) also upheld the order of the AO.

Contentions of the Assessee:
1.  The provision for sale return was accounted for as a provision for expenses and these expenses were actually incurred during the year.
2. The provision for sales return was not merely an adhoc provision but was determined/accounted for on the basis of actual bills/details received after the balance sheet date, but before closing/finalization of accounts.
3. The provision was created on the basis of information received in subsequent year with respect to sales made during the subject year. However, the actual quantification was done after the balance sheet date.
4. This is an accepted practice in the seed industry whereby anticipating the crop season, seed companies sell seeds to the distributors for onward sale to the farmers. In case of any contingency, the unsold stock is returned back to the company.
5. As per Accounting Standard 9, Revenue Recognition of ICAI recognition of revenue in such circumstances depends on the substance of the agreement.
6. In the case of retail sales offering a guarantee of “money back if not completely satisfied” it might be appropriate to recognize the sale as well as to make a suitable provision for sales return, based on previous experience.
7. The appellant made the provision as a certain percentage of the sales, based on the past year sales return of various crops, strength of its product portfolio and market dynamics and not merely on adhoc basis.
8. The provision is reviewed during the season and updated as and when required. At the end of the season, when the accounting for actual sales return is made, the surplus sales return, if any, is reversed.
9.  In the assessee’s own case this issue has been settled in favour of the assessee.

Excerpt from ITAT Judgment:

“16. Section 145 of the Income Tax Act, as it stands now, inter alia lays down that business income has to be computed “in accordance with the cash or mercantile system of accounting as regularly employed by the assessee”. The only rider to this statutory requirement regarding method of accounting is that “the Central Government may notify, in the official gazette from time to time, accounting standards” and the applicable accounting standards will have to be followed by the assessee in the method of accounting followed. One of these mandatory accounting standard, notified vide notification no. 9949 dated 25th January 1996, inter alia provides that “provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information”. This approach requires all anticipated losses to be taken into account in computation of income taxable under the head ‘profits and gains from business and profession’. Unlike in the pre amended section, as it stood before 1.4.1997, which provided that “in any case where the accounts are correct and complete to the satisfaction of the Assessing Officer but the method employed is such that, in the opinion of the Assessing Officer, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Assessing Officer may determine”, there is no enabling provision now which permits the Assessing Officer to tinker with the profits computed in accordance with the method of accounting so employed under section 145 and as long as the mandatory accounting standards are duly followed. It is not even Assessing Officer’s case that the mandatory accounting standards have not been followed. This analysis of Section 145, read with applicable accounting standards, apart, even on first principles, deduction in respect of anticipated losses, as a measure of prudent accounting principles, cannot be declined. It is only elementary that the accountancy principle of conservatism, which has been duly recognized by the Courts, mandates that anticipated losses are to be provided for in the computation of income but it does not permit anticipated profits to be taken into account till the profits actually arise. Even an anticipated loss, even if it may not have crystallized in the relevant previous year, is to be allowed as a deduction in the computation of business profits. There is no dispute that sales have been returned in the subsequent year and this fact is known before the date of finalization of accounts. Therefore, there is no point in first taking into account income on sales, which never reached finality, and then accounting for loss on sales return in the subsequent year i.e. in which sales return did take place. In our considered view, the approach of the assessee is in consonance with the well settled accountancy principles and the Assessing Officer was not justified in rejecting the same. The disallowance for provision for sales return is, accordingly, deleted.”

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