Warranty provision allowable deduction if based on past events and reliable scientific estimate – ITAT

Provision for warranty allowable deduction if based on past events and reliable scientific estimate is made of future liability likely to be incurred

ABCAUS Case Law Citation:
ABCAUS 2471 (2018) 08 ITAT

Important Case Laws Cited/relied upon by the parties:
Rotork Controls India Pvt.Ltd

In this appeal, the Revenue had challenged the order of CIT(A) allowing the deduction on account of provision for warranty while computing income from business.

The Assessee had claimed deduction as provision for warranty liability on the electronic items sold by it.

When asked to clarify, the assessee stated that warranty made every year was computed at 1% of the sale value. It was further stated that electrical appliances range of products had been launched in the recent years. It was further stated that when new product range in the electrical appliances being launched every year, the warranty claims are expected to balloon in the ensuing years.

The AO held that the assessee company had not been able to establish that the warranty provision had been estimated on the basis of some scientific method and it had followed consistency in creating the provision. Therefore he found that the deduction in respect of provision for warranty not allowable and the same was disallowed and added to the returned income of the assessee company.

On appeal by the assessee, the CIT(A) deleted the addition made by the AO by accepting the submission of the Assessee that the basis given by the assessee for making provision on account of warranty liability was scientific. Aggrieved by the order of the CIT(A), the revenue has preferred the present appeal before the Tribunal.

The Tribunal observed that the Hon’ble Supreme Court had laid down three conditions for provision to be regarded as liability. The Hon’ble Supreme Court while answering the question as to what is a provision opined that a provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when:

(a) an enterprise has a present obligation as a result of a past event;

(b) it is probable that an outflow of resources will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.

The Hon’ble Supreme Court held that if the above three conditions are not met, no provision can be recognized.

The Tribunal observed that the CIT(A) had considered warranty expenses in two preceding years which should be the basis of making provision. The conditions laid down by the Hon’ble Supreme Court is that because of a past event the future liability is likely to be incurred and the basis of such expenditure to be incurred is a reliable scientific estimate.

It was noted that the assessee was in this line of business for a very long time and he should be in a position to demonstrate that making provision of 1% of the sale as provision for anticipated liability on account of warranty claims was based on its own past experience.

The Tribunal set aside the order of the CIT(A) and remanded it to the AO for fresh consideration of the question of proper estimate of liability on account of provision for warranty based on past events in the light of the principles laid down by the Hon’ble Supreme Court.

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