Thermax Babcock & Wilcox Ltd. vs Dy. Cit on 11 May, 2001

Income Tax Appellate Tribunal – Pune

ORDER

B.L. Chhibber, A.M.

The assessee is a public limited company and is engaged in the business of designing, engineering, fabrication, procurement and assembly, erection, installation and commissioning on ground boilers with the help of sophisticated technology for petrochemical, fertilisers, sugar and other process industries. The first grievance of the assessee relates to addition of Rs. 60,30,000 on account of provisioning made on account of revenue recognition on percentage of completion method. The year under consideration is the first year of assessees business and for arriving at the portion of the profit of the long-term contracts, whose execution is spread over more than one accounting period, the company maintained accounts on the percentage of completion method, now formally recognised as Accounting Standard 7 (AS-7) of the Institute of Chartered Accountants of India. In other words, in respect of long-term contracts the profit was shown by adopting the following method :

Value of invoices raised

x Estimated profit from the contract as a whole

Contractor value

Following break-up of the provisions of cost of jobs were furnished before the assessing officer :

Rs.

Provision for job cost on estimated material cost and percentage completion basis

55,36,000

Provisions for rectification to be carried out on Deepak Fertilizers FM Boiler Unit assembled in shop

5,00,000

60,36,000

The assessee contended before the assessing officer that the provision of Rs. 60.36,000 was liable to be allowed as the company regularly followed percentage of completion method and amount of revenue recognized is determined by reference to stage of completion at the end of the accounting period. It was further stated that for convenience of execution of job and supplies of various components required for assembly of boiler at site, a price break-up is preferred and approved by the client before commencement of the supply. Material costs were booked against the job and same were also recognized at job level. It was also stated that provisions were made for all the job in progress where the consumption was short of the expected cost of the job as well as booked. The assessing officer noted that the assessee was accounting for its sales on the basis of sales bills prepared upto completion of work. As far as expenses were concerned, they were accounted for as and when incurred though sometimes the assessee had incurred less expenses in comparison with the estimated cost. In such cases, the provision was made for expenses which was claimed as deduction. The assessing officer disallowed the claim of the assessee holding that the provisioning is not an expenditure. He further states that sale bill amounts are credited to the profit & loss account and expenses incurred on each product is also accounted for. Accordingly, he held that “This provision appears to imaginary and made in order to increase the cost without incurring it actually. This has also resulted in reduction of profit”.

2. The assessee appealed to the Commissioner (Appeals) and made detailed submissions which have been reproduced by the Commissioner (Appeals) in para 12.3 (pp 8 to 10) of his order. He concurred with the findings of the assessing officer holding that provisioning in the accounting was made for an unknown liability and such a provision cannot be considered as a charge on profit. According to the learned Commissioner (Appeals), the assessee-company has created the provision of Rs. 60,36 lakhs for job cost on estimated material cost and percentage of completion basis and thus, provision was made basically in respect of the likely material cost and not for the actual material cost. In the view of the learned Commissioner (Appeals), provisioning the amount per se cannot be allowed unless it was created for an ascertained and accrued liability and that assessee cannot create a notional liability by way of equalization charge and claim deduction for the same.

3. Aggrieved by the orders of authority below, the assessee is in appeal before us.

4. Shri B.K. Khare, the learned counsel, submitted that the learned Commissioner (Appeals) erred in disallowing without ascertaining the raison detre of provisioning, a sum of Rs. 60,36,000 in the companys accounts maintained regularly on the percentage of completion method now formally recognized as Accounting Standard 7(AS-7) of the Institute of Chartered Accountants of India for arriving at the portion of the profit of the long-term contract for the assessment year 1990-91, whose execution spread over more than one accounting period based upon the extent of work performed during the year as measured in the assessee companys case with reference to the value of the invoices raised during the previous year against despatches of the site of the components, equipment and material in terms of the billing schedule agreed to between the assessee company and the client. According to the learned counsel for the assessee, the Commissioner (Appeals) has further erred in mistaking the simple surplus per se (invoice-cost price of the despatches) such profit for the year, without understanding the central fact that there is only one profit of an indivisible long-term contract, a portion of which is to be disclosed for the year as envisaged by the percentage of completion method and as such annual profit is a representative of the estimated profit of a long-term contract as a whole, necessitating provision in the accounts to ensure that the surplus disclosed during the year referred to above is brought in line with the estimated profit expected of the contract. He drew our attention to yearwise provisioning made for equalisation contribution :

Rs. in lakhs

Assessment year

Provision at the end of each previous year

Reversal in the subsequent year

Charge/Credit after reversal

1990-91(The first year)

60.36

1991-92

156.75

60.36

96.39

1992-93

99.95

156.75

56.80

1993-94

56.47

99.95

43.48

5. Relying upon the above chart, the learned counsel for the assessee submitted that the books of account, especially trading account have been accepted, save and except the addition of provisioning. For lack of understanding on the part of tax department that such provisioning is not for the actual expenditure or any liability incurred but it is made for the purpose of finding out the profit on the basis of percentage of completion method as the provisioning is by way of distribution of profit for contract to various previous years for which the contract was in progress. In other words, according to the learned counsel, it is in the nature of profit rationaliser, divider, allocater, etc., in order to determine profit of each year during which contract was in progress. In the year of completion of contract, ultimately true profits emerged and such profits are not interfered with. In other words, ultimate profit in the year of completion of the contract also includes stage by stage profit as worked out by the assessee-company and in that sense profit from the contract as per the books of account is fully accepted. The learned counsel submitted that the assessee has worked out the profits on the long-term contract as per well accepted norms of accountancy. In this connection, he drew our attention to the extracts from standard books of accountancy placed at pp 134 to 171 of the paper-book. In the Book Keeping and Accounts-16th Edn. p 301 by Spicer & Pegler under the head long-term credits, it has been stated

“Provisions should be made for foreseeable losses and allowances should be made as far as practicable for penalties, guarantees and other contingencies.”

Similar are the observations in the book of Advanced Accounting.6th Edn. by Yorsten, Smyth & Brown, pp 475 and 476 (p 135 of the paper-book). He specially drew our attention to the extract from the Advance Accountancy by Shukla/Grewal, p 606 which reads as under :

“In case the contract is at least 1/4 complete, a certain proportion of realised profit, that is profit revealed by the contract less the percentage of retention money, should be transferred to the profit & loss account and the balance left as reserve. The proportion is, usually :

(i) 1/3rd in case the completed (certified) work is less than half the total contract, and

(ii) 2/3rd in case the certified work is completed upto 50 per cent or more.

Or, the profit may be transferred to the profit & loss account by using the formula :

Realised profit

Work certified

Total value of contract

This practice is becoming popular.

If the contract account reveals loss, the whole of it should be transferred to the profit & loss account.”

6. On the legal side, the learned counsel submitted that the method of accounting regularly followed by the assessee for the year under appeal and for subsequent years is as per the provisions of law. In support of this contention, he relied upon the following authorities :

1. Aruna Mills Ltd. v. CIT (1957) 31 ITR 153 (Bom);

2. CIT v. Guttoffnungashutto Sterkrado (1992) 197 ITR 66 (Ori);

3. M.N. Dastur & Co. v. Deputy CIT (1997) 61 ITD 167 (Cal);

4. Metal Box (India) Co. Ltd. v. Their Workmen (1969) 73 ITR 53 (SC);

5. Tata Iron & Steel Co. Ltd. v. D.V. Bapat, ITO (1975) 101 ITR 292 (Bom);

6. Calcutta Company Ltd. v. CIT (1959) 37 ITR 1 (SC);

7. CIT v. U.P. State Industrial Dev. Corpn. (1997) 225 ITR 703 (SC).

8. Madras Industrial Investment Corpn. Ltd. (1997) 225 ITR 802 (SC);

9. P.M. Mohammed Meerkhan v. CIT (1969) 73 ITR 735 (SC).

10. Chainrup Sampatram v. CIT (1953) 24 ITR 481 (SC); and

11. Badridas Daga v. CIT (1958) 34 ITR 10 (SC).

7. Shri Naresh Kumar, the learned Departmental Representative strongly supported the orders of authorities below. He submitted that for computing the profit for any assessment year, the following points have to be considered

(i) Whether the income has accrued to the assessee?

(ii) How the assessee treats the profits?

(iii) Whether profits have accrued?

(iv) Whether the accountancy principle would overrule the provisions of income-tax and whether shifting of the profit as has been done by the assessee is permitted?

Coming to the first point, the learned Departmental Representative submitted that it is clear that the receipts which have been received by the assessee have accrued to it. All the payments have been received in pursuance of the contract. Therefore, it cannot be said that the income had not accrued to the assessee. In this connection, he relied upon the decision of Supreme Court in the case of E.D. Sassoon & Co. Ltd. & Ors. v. CIT (1954) 26 ITR 27 (SC).

8. Coming to the second point, the learned Departmental Representative argued that it is immaterial how the assessee treats the receipts in its books of account. The same principle was canvassed by Karnataka High Court in the case of CIT v. Syndicate Bank in (1986) 159 ITR 464 (Karn).

9. Coming to the third point that is whether the profit have accrued to the assessee, the learned Departmental Representative submitted that as per elementary principles of accounting, the receipts minus expenses will give the profits of assessee. Therefore, in the present case, profits have accrued to the assessee. In this connection, in support of this contention he placed reliance on the decision of Honble Madras High Court in the case of CIT v. Indian Overseas Bank (1985) 151 ITR 446 (Mad) (in particular on page No. 451). He pointed out that according to the learned Judges in that case, the principle of commercial accounting is that a notional profit or a notional loss cannot enter into the computation of profits in a year. That principle is subject to exception in regards to stock-in-trade and this aspect of the case has been dealt with in the said decision (B.S.C. Footwear Ltd. v. Ridgway (Inspector of Taxes), (1972) 83 ITR 269 (HL)). He also placed reliance on the decision in the case of Badridas Daga v. CIT (1958) 34 ITR 10 (SC) and the decision of Gujarat High Court reported as CIT v. Gujarat State Warehousing Corpn. (1976) 104 ITR 1 (Guj).

10. Coming to the last question, whether accountancy principle would overrule the provisions of income-tax and whether shifting of the profit as has been done by the assessee is permitted, the learned Departmental Representative again referred to the decision of Madras High Court in the case of CIT v. Indian Overseas Bank (supra). He also relied upon the decision of Orissa High Court in the case of Tripty Drinks (P) Ltd. v. CIT (1978) 112 ITR 721 (Ori). The learned Departmental Representative also again placed reliance on the judgment of Honble Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT (1997) 227 ITR 172 (SC).

11. The learned Departmental Representative further submitted that assessee has claimed to create the provision for apportioned profits in line with the estimated percentage of profit. In fact, the profits cannot be shifted from one unit to other unit. In support of this contention, he placed reliance in the case of CIT v. Kalyan Mal Phool Chand (1987) 166 ITR 180 (SC). The learned Departmental Representative, however, stated that the only decision which can help the assessee is the case of Calcutta Co. Ltd. v. CIT (supra). But, in the said case, assessee had offered for taxation the total receipt and claimed deductions on account of liability, which that assessee had incurred in subsequent years not in order to fulfil the contractual agreement. According to the learned Departmental Representative under the peculiar circumstances, the Supreme Court allowed that deduction on account of liability to be incurred in subsequent year. However, in the instant case, the receipts had been received by the assessee during the assessment year and that these receipts have been earned by the assessee by performing the job as envisaged in the contract. For earning the receipts, whatever expenses have to be incurred as per the contract, have already been incurred as per the terms of payment; payments are to be made only after production of the certificate that the relevant work has been done. In other words, raising of bills tantamounts to the completion of relevant portion of work. Therefore, the learned Departmental Representative submitted that, so far as these receipts are concerned, the assessee has not incurred any further expenses. Therefore, he submitted that ratio of decision of Supreme Court in Calcutta Co. Ltd. v. CIT (supra) is not applicable to the facts of the present case. On the other hand, the judgment of the Honble Supreme Court in the case of CIT v. British Paints Ltd. (1991) 188 ITR 44 (SC) was applicable because the method adopted by the assessee is one which does not give correct position on accounts and the correct profits cannot be deduced therefrom. The learned Departmental Representative further submitted that Accounting Standard AS-7 of ICAI was not issued in the relevant assessment year and accordingly, even if the assessee has followed Accounting Standard AS-7, it had no relevance for the year under operation.

12. We have considered the rival submissions and perused the facts on record. It is well accepted that it is open to an assessee to decide/adopt a regular method of accounting. If such a method is an acceptable method of accounting, it will follow that the profits can be properly ascertained therefrom. In the case before us, the assessee has followed constantly for this year (which is first year of operation) and for the subsequent years a method which is one of the accepted accounting principles and practices sanctified by usage and in line with Institutes recommended standard which is known AS 7. No doubt, AS 7 was issued in the year 1983, but AS 7 is merely a codification of existing accounting practices for which evidence of commentries of various authors have already been referred to (supra) in para. 5. Further, AS 7 has been made mandatory from 1-4-1991. From the chart reproduced on p 4 (supra), it is noted that the books of account, especially trading account has been accepted, save and except the addition of provisioning. As pointed above, the assessee is engaged in long-term contracts and the provisioning was made for the purposes of finding the profits on the basis of percentage of completion method as the provisioning is by way of distribution of profit for the contract in various previous years for which the contract was in progress. Thus, provisioning is in the nature of profit rationalizer, divider and allocator in order to determine profit each year during which contract was in progress. In the year of completion of contract, ultimately true profit emerged and such profit was not interfered with. In other words, ultimate profit in the year of completion of project also includes stage by stage as worked out by the assessee-company and in that sense, profit from the contract as per the books of account is fully acceptable.

13. In the case of CIT v. Guttoffnungashutto Sterkrado (supra), the Honble Orissa High Court, in effect held that income determined in respect of long-term contract as per its books of account covering the entire period of contract and the net income so ascertained was apportionable over the four years in question on the basis of yearly turnover-again highlighting the principles of measurement of yearly profit in the case of percentage of completion method used in the case of long-term contracts. In the case of M.N. Dastur & Co. v. Deputy CIT (supra), the Calcutta Bench of Tribunal, following the judgment of the Honble Orissa High Court in the case reported in (1992) 197 ITR 66 (Ori) (supra) held that the basis of Accounting Standard issued by the Institute of Chartered Accountants of India i.e., AS-7 is a well-recognised method and the assessee was right in following the same.

14. In the case of CIT v. U.P. State Industrial Development Corporation (supra), the Honble Supreme Court held as under :

“In order to determine the question of taxability, well settled legal principles as well as principles of accountancy have to be taken into account. It is a well accepted proposition that for the purpose of ascertaining profits and gains, the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes.”

In the case of Madras Industrial Investment Corporation Ltd. (supra), the Honble Supreme Court reiterated the same principle as enunciated in the case of U.P. State Industrial Development Corporation (supra).

15. In Calcutta Company Ltd. v. CIT (supra), the Honble Supreme Court has held that a long-term indivisible contract spread over more than one accounting period, the profit from the contract as a whole is determined with reference to the entire value of the contract against the cost already incurred and the estimated cost yet to be incurred for its completion. This decision of the Honble Supreme Court is of direct help to the assessee and this was also accepted by the Departmental Representative but he tried to distinguish it. According to the Departmental Representative in the said case, the assessee had offered for taxation of total receipts and claimed for reduction on account of liability, which the assessee had to incur in subsequent years in order to fulfil the contractual agreement. According to the learned Departmental Representative under these particular circumstances, the Supreme Court allowed the deduction on account of liabilities to be incurred in subsequent year. However, according to the learned Departmental Representative, in the instant case the receipts have been received by the assessee during the assessment year and that these receipts have been earned by assessee by performing the object as envisaged in the contract. This distinction given by the learned Departmental Representative has no relevance because the assessees reliance is for limited purpose that a deduction is allowable not only on the basis of incurrence of a liability under section 37 and that section 28 is the real repository of all the deductions unless negated by the legislature. Further, while estimating the profit from the contract as a whole, and that contract value was juxtaposed against the estimated cost for execution of the whole contract with a view to finding out gross profit from the contract as a whole which was uniformally applied based upon the work done as measured by invoicing made as per billing schedule. Thus, the ratio laid down by the Supreme Court in the aforesaid case squarely applies to the facts and circumstances of the case of the assessee.

16. One of the star arguments of the learned Departmental Representative was that method of accounting should not violate provisions of charging section and for this he relied upon the decision of the Madras High Court in the case of CIT v. Standard Triumph Motor Co. Ltd. (1979) 119 ITR 573 (Mad). After going through the details of the method of accounting adopted by the assessee, we do not find any violation of the provisions of the charging section. As regards the reliance placed by the learned Departmental Representative on the judgment of the Honble Madras High Court referred to supra, the Honble Madras High Court was considering the case of a non-resident assessee. The method of accounting applied was such that in the opinion of the High Court, the income earned in India could not be brought to be charged at all under section 5(2). In the case of the assessee, the position is different; the charge is not at all defeated; it is only rationalised.

17. Coming to the judgment of the Honble Supreme Court in the case of British Paints Ltd. (supra) relied upon by the learned Departmental Representative we hold that the ratio does not apply to the facts of the present case because in that case, the system of accounting adopted was such which excluded, for valuation of stocks-in-trade, all costs other than cost of raw-material, for the goods in process, finished products and same was likely to result in a distorted picture of the true state of business for the purpose of computing the chargeable income. In the present case, the assessee as pointed above, has adopted one of the acceptable accounting principles and practices sanctified by usage and in line with Institutes recommended standard AS-7 and such method does not result in a distorted picture of the true state of business for the purpose of computing the chargeable income.

18. Reliance placed by the learned Departmental Representative on the judgment of the Honble Supreme Court in the case of Tuticorin Alkalies Chemicals & Fertilizers Ltd, (supra) is also of no assistance to the revenue. This decision of the Honble Apex Court in nowhere falls foul of the accounting principles which have found acceptance in several cases. Here, in this case, the business was not started yet the company earned income by way of interest from the available surplus fund. Accounting practice is such that when the project is in construction stage, interest should be set off against the capital cost of the project, However, the Institutes guidelines of pre-construction accounting clearly states that even that income earned during the construction period is to be set off against the project cost yet in the profit & loss account tax provision is required to be made. Further, there is a specific provision which charges such income under section 56. Obviously, therefore, here accounting principles fractures specific provision of section 56 and, therefore, the court ruled that such interest income is liable to be taxed in this context. Here, it is noteworthy that the Honble Supreme Court refers to the observations of Their Lordships in B.S.C. Footwear Ltd. v. Ridgway (Inspector of Taxes) (1970) 77 ITR 857 (CA) as follows :

“In the case of B.S.C. Footwear Ltd. v. Ridway (Inspector of Taxes) (1970) 77 ITR 857, 860 (CA), Russell, L.J while rejecting an argument based on well-settled accountancy practice, pointed out that the income-tax law does not march step by step in the divergent footprints of the accountancy profession.”

Further, contrasting this decision is the one of the Supreme Court in the case of CIT v. Bokaro Steels Ltd. (1999) 7 DTC 221 (SC) : (1999) 236 ITR 315 (SC). Here the income like scrap, etc. directly linked with the construction on the project, was allowed to be set off against the project cost. It was not allowed to suffer any tax thereto by considering such income as a separate entity particularly when there is no legislative mandate or negation to the contrary.

19. In the light of the above discussion, we hold that there is no justification for the impugned addition of Rs. 60,30,000 on account of provisioning made on account of revenue recognition of percentage of completion method. The same is accordingly deleted. This ground accordingly succeeds.

20. The next grievance of the assessee is that the learned Commissioner (Appeals) is not justified in confirming an addition of Rs. 11,64,000 on account of warranty provision made in the accounts. During the course of assessment proceedings, the assessing officer noted that the assessee-company had debited a sum of Rs. 11,64,000 as provision for warranty. This amount had remained unpaid/unadjusted and, therefore, has been shown as liability as on 31-3-1990. The assessing officer called upon the assessee to explain the nature of this provision, The assessee submitted that contracts with customers imposed warranty obligation. The company had to replace defective components during the warranty period. The assessee had made provision on account of services/replacements required to be made in terms of the warranty obligation. The assessing officer holding that the amount claimed was in the nature of the provision and the provisioning had been made on estimated basis, disallowed the claim of the assessee.

21. The assessee appealed to the Commissioner (Appeals). Detailed submissions were made before Commissioner (Appeals) and he has reproduced the same verbatim in para 10 of his order. Not convinced by the arguments put forth by the representative of the assessee, the Commissioner (Appeals) confirmed the addition. According to the Commissioner (Appeals) “a mere provision in the accounts for a liability which is not ascertained, cannot be considered for a deduction. The provision is generally made in respect of a known liability for which the quantification cannot be made in the accounting year. In the instant case, warranty liability has been provided on estimate basis at 2 per cent of the billing amount, considering it as charge on the profit and as a known liability. To my mind such unascertained liabilities cannot be allowed on estimate basis.”

22. Shri B.K. Khare, the learned counsel for the assessee, submitted that in the case of the assessee-company, the guarantee is given in respect of supply of every project boiler, which enjoins the company to make the boiler operational as per the specifications, after removing the deficiency found during the warranty period. This warranty period lasts from 12 to 18 months from handing over the project boiler or from the date of project has become operational, generally, whichever is earlier. The contract value will necessarily include the cost required to be incurred in the warranty period. This cost is estimated based upon the experience in the industry, experience of companys collaborators/promoters, namely, Thermax Ltd., etc. The learned counsel submitted that it will be appreciated that the company was the first time using new technology provided by companys collaborators Babcock, Wilcox for evaluation of project boiler which Indian customers were not familiar with. The boiler was multi-fuelled. Feedstock could be bagasse, agricultural waste, gas, oil, etc., besides incorporating many modern features, enhancing the power and efficiency of the boiler. Based upon the experience of the companys collaborators, it was though in the initial year when this product was introduced for the first time 2 per cent of the invoices raised as per the billing schedule will be necessary for foreseeable warranty cost (p 131 of the paper book). For the accounting year 1989-90, i.e., assessment year 1990-91 against the warranty provision of Rs. 11.64 lakhs, total cost incurred amounted to Rs. 10.78 lakhs. For accounting year 1990-91, i.e., for assessment year 1991-92, against the warranty provision of Rs. 31.51 lakhs (43.15 lakhs minus reversal of last years provision of Rs. 11.64 lakhs) the actual cost incurred for the said provision amounted to Rs. 32.31 lakhs (p 132 of the paper book). Currently, the measure of estimating the warranty cost is materially changed, where it is made on the basis of job classified as hereunder :

(a) High pressure of FOAX or new technology jobs

2% (approx)

(b) No FOAK :

0.5% (approx)

0.25% (approx)

Even though the warranty period starts after handing over the boiler, the provision for liability on account of warranty is to be made in respective years of the progressive execution of the contract as per the Accounting Standard 7 where it is stated that the costs attributable to the contract include expected warranty costs. Warranty costs are provided for when such costs can be reasonably estimated (p 147 of AS-7). The learned counsel concluded that such provision is allowable deduction in view of the following authorities

(1) LRC v. Mitsuibi Motors (1996) 222 ITR 697 (PC);

(2) ITO v. Wanson India Ltd. (1983) 5 ITD 102 (Pune-Trib); and

(3) Voltas Ltd. v. Deputy CIT (1998) 64 ITD 232 (Mum-Trib).

23. Shri Naresh Kumar, the learned senior Departmental Representative strongly supported the orders of the authorities below. He strongly articulated on para 11 of the order of Commissioner (Appeals), where the latter held that a mere provision in the accounts for the liability which is not ascertained, cannot be considered for deduction. He pointed out that the Commissioner (Appeals) denied the claim of the assessee on the ground that the said liability is not an ascertainable liability. As per the contract, the warranty liability would start from the date of delivery of project boiler and thereafter for a period between 18 to 24 months. However, provision for warranty liability has been created on estimated basis at the rate of 2 per cent of the billing itself. Thus, provision of warranty has been created even before the product has come into existence, The creation of warranty or provision made, therefore, is premature since the provision in respect of which the warranty provision is created has not yet come into existence. According to the learned Departmental Representative, no contingent liability is allowable as deduction as has been held by the Bombay High Court in the case of CIT v. Rajkumar Mills Ltd. (1971) 80 ITR 244 (Bom). The learned Departmental Representative submitted that the decision of the Tribunal, Pune Bench, in the case of ITO v. Wanson (India) Ltd. (supra) relied upon by the assessee is not applicable to the facts of the present case. According to the learned Departmental Representative the most important distinguishing feature in the present case is that the provision for warranty has been created even before the produce has come into existence. In the Wanson case the products were in existence. Similarly, according to the learned Departmental Representative, the decision of Voltas Ltd. (supra) is also not applicable because in that case the decision of Pune Tribunal in the case of Wanson (India) Ltd. (supra) has been followed. Further, in Voltas case, the Tribunal has not considered Rajkumar Mills case even though the same was cited before the Bench by the department. As regards the reliance placed by the learned counsel of the assessee in the case of Commissioner of Inland Revenue v. Mitsuibi Motors (supra), the Departmental Representative submitted that the decision was delivered under the Income Tax Act of New Zealand and there being material difference between the provisions of income-tax in New Zealand and income-tax in India. The said decision has no relevance. The learned Departmental Representative accordingly, concluded that the action of the authorities below deserves to be upheld.

24. We have considered the rival submissions and perused the facts on record. In the case of manufactured capital goods, invariably, a provision is made in the contract that should any deficiencies and infirmities be found in its working, then, for certain period, the suppliers will undertake, free of cost, to remove such deficiencies or infirmities which prevent the promised working by the capital asset. This is very important as offending unit could put into disarray the whole working of the enterprise. In the case of the assessee-company, as explained above, the guarantee is given in respect of supply of every project boiler which enjoins the company to make the boiler operational as per the specification, after removing the deficiencies found during the warranty period. This warranty period lasts from 12 to 18 months from handing over the project boiler or from the date the project has become operational. The contract value will necessarily include the cost required to be incurred in the warranty period. Such cost is estimated based upon the experience in the industry, and on the experience of the companys collaborators, and accordingly provided for. Thus, therefore, in our considered opinion, warranty provision is not a stray provision. It has been provided after scientific analysis based on the assessees experience and experience of collaborators and the assessee assessed on total liability upto 2 per cent of turnover and provisioning made accordingly. The same practice has been consistently followed in the subsequent years whereas excess provision has been done was adjusted in the succeeding year. Dealing with ground No. 1 (supra) i.e., with regard to the provisioning made on account of revenue recognition of percentage of completion method, we have held that the assessee has rightly been following accounting standard 7(AS-7) and such standard does allow provisioning for warranties. In para 5 (supra), we have referred to the accounting principles extracted from the standard books of accountancy and have quoted an extract from the book of Spicer & Pegler and this extract clearly states that “allowances should be as far practicable for penalties, guarantees and other contingencies.”

24.1. In the case of Commissioner of Inland Revenue v. Mitsuibi Motors (supra), it has been held that the warranty provision was a deductible expenditure. This case though decided under the New Zealand Income Tax Act, supports the principle of measurement of profit on accepted trading principles and generally accepted accounting principles, thus unless the statute expressly or impliedly provided to the contrary. We do not find any force in the contention of the learned Departmental Representative that as this case was decided under the New Zealand Income Tax Act does not apply to cases in India because as pointed out above, it supports a universal principle of measurement of profit.

25. In the case of ITO v. Wanson (I) Ltd. (supra) decided by this Bench, the assessee was supplying industrial machines along with certain guarantees by way of warranties for their performance. The experience of the company showed that it, invariably, had to incur some expenditure on replacement of parts. Therefore, it attracted a practice of creating a provision for such expenditure and excess provision so used is to be written back in the accounts for the next year. The assessing officer did not allow such excess provision on the ground that it was only an estimate amounting to contingent liability and the same basis given by the assessing officer in the case of present assessee before us. On appeal, the Tribunal held that no doubt, the provision made was contingent at the time when it was made, but such estimate was based on the assessees experience in the earlier years. The assessee knew for certain that some expenditure had to be incurred and as a prudent businessman, had to make a provision which approximated to the amount of expenditure. The method followed was consistent and, therefore, there was justification for allowing the assessees claim. The case of the assessee is on all fours and accordingly, we hold that above case clearly comes to the assistance of the assessee. The distinguishing factor pointed out by the learned Departmental Representative that the provision for warranty has been created by the assessee even before the produce has come into existence is of no relevance because it is the principle of accounting which is of vital importance. We further find that the case of the assessee stands supported by the decision of the Tribunal in the case of Voltas Ltd. (supra).

25.1. Coming to the decision of the Bombay High Court in the case of Rajkumar Mills (supra) relied upon by the learned Departmental Representative we find that the same is not applicable for the following reasons :

(a) No evidence in respect of any standard accounting practice brought on record.

(b) The Bombay High Court in the case of CIT v. United Motors (1990) 181 ITR 347 (Bom) has taken a different view.

(c) The High Court dealt with incurrence of expenditure in terms of section 37 whereas our claim is on the basis of section 28 itself.

26. From the above discussion, it is clear that law now stands well settled that warranty provision, as long as it is made on rational and bona fide basis where the accounts are maintained on mercantile method, is tax deductible. We have minutely gone through the provisions made by the assessee on account of warranty and find that the same have been made on rational and bona fide basis. Accordingly, we hold that there is no justification for the impugned addition of Rs. 11,64,000. The same is accordingly deleted. This ground accordingly succeeds.

27. Ground No. 3 raised by the assessee reads as under :

“The learned Commissioner (Appeals) erred, while working out the disallowance under section 37(2A), in restricting the companys claim for deduction on account of participation of the companys officials in the business lunches extended to the customers in the normal course of the companys business to 20 per cent of such expenditure of Rs. 1,47,523 against the claim of the appellant at 50 per cent based upon the fact that in the companys business of selling sophisticated capital goods evolved with the state of the art technology newly introduced in this country, where usually the number of such employee-participants in the business lunch discussion outstrip the clients and their teams, which contention of the appellant is not refuted by the authorities.”

The assessee-company quantified the entertainment expenditure as under :

Rs.

(1)

Business lunch

1,47,523

(2)

Out of travelling

33,170

(3)

Club

1,009

(4)

Out of canteen expenses

5,000

1,86,702

In the computation of total income, it had claimed 50 per cent business lunch expenses incurred by employees accompanying the guests and had shown Rs. 1,12,941 as disallowed. The assessing officer held that the entire expenses of Rs. 1,47,523 incurred on business lunches were in the nature of entertainment and accordingly, he applied the provisions of section 37(2A).

28. On appeal, the Commissioner (Appeals) gave partial relief inasmuch as he directed the assessing officer to treat 20 per cent of the expenditure to be attributable to employees out of the total lunch expenses of Rs. 1,47,523.

29. Shri B.K. Khare, learned counsel for the assessee stated that the claim of the assessee at 50 per cent was in accordance with the judgment of Karnataka High Court in the case of CIT v. Mysore Minerals Ltd. (1986) 162 ITR 562 (Karn). The learned Departmental Representative Shri Naresh Kumar relied upon the orders of the authorities below.

30. We have considered the rival submissions and perused the facts on record.

It is noted that out of the total entertainment expenses of Rs. 1,86,702, the assessee had incurred a sum of Rs. 1,47,523 on business lunches. The business lunches were also attended by the employees of the company who accompanied the guests for such lunches. In accordance with the ratio of the Karnataka High Court in the case of Mysore Minerals Ltd. (supra), we direct the assessing officer to allow 50 per cent of the total expenditure on business lunches as attributable to employees. This ground accordingly succeeds.

31. Ground No. 4 reads as under :

“The learned Commissioner (Appeals) failed to appreciate that interest income in the sum of Rs. 11,07,085 was earned by deploying the business funds which, being intermittently available as temporary surplus, assumed the colour of business income and in the alternative, at any rate, such interest goes to reduce the total cost of interest payable which constitutes an obvious deductible expenditure under section 36(1)(iii).”

At the time of hearing, this ground was not pressed and the same is accordingly dismissed.

32. Ground No. 5 reads as under :

“The learned Commissioner (Appeals) erred in not accepting the appellants ground for deduction of pro rata lease premium in the amount of Rs. 46,163 by amortization of such lease premium paid to M.I.D.C. in respect of land taken on lease.”

It is the common contention of both the sides that the issue stands covered against the assessee and in favour of the revenue by the decision of this Bench in the case of Maharashtra Scooters Ltd. in ITA No. 870/Pn/1988. We accordingly dismiss this ground.

33. Ground No. 6 reads as under :

“The learned Commissioner (Appeals) erred in not accepting the appellants contention that the provision in the amount of Rs. 24,41,000 towards royalty and technical know-how fees payable to foreign collaborators ought not to have been disallowed by the assessing officer since on the facts and in the circumstances of the case, requirements of section 40A(7) were satisfied.”

At the time of hearing, this ground was not pressed. The same is accordingly dismissed.

34. Ground No. 7 (last ground) reads as under :

“The learned Commissioner (Appeals) erred in confirming the addition of Rs. 4,70,000 made by the assessing officer in respect of the provision made in the accounts for foreign travel expenses.”

At the time of hearing, this ground was not pressed. The same is accordingly dismissed.

35. In the result, the appeal is allowed in part.

B.L. Chhibber, A.M.

2nd Feb., 2000

36. The above draft order was placed before the J.M. who, after perusing the same, vide his note dated 11-1-2000, requested me to reconsider the issue of guarantee, in view of the ratio laid down by the Honble Supreme Court in the case of Shri Sajjan Mills Ltd. v. CIT (1985) 156 ITR 585 (SC) at 598-99. After going through the judgment of the Honble Supreme Court in the case of Shree Sajjan Mills Ltd. I find that the ratio laid down by the Honble Supreme Court in the said case is not applicable to the facts of the case of the assessee.

37. In the matter of claim made by an assessee for deduction of provision made towards warranty obligations, a question often arises as to whether admission of such a claim will run counter to the fundamental postulate that an expenditure which is not actually incurred by the assessee and which is only of a contingent nature cannot be allowed under section 37(1) of the Income Tax Act. Among others, the Supreme Court in the case of Shree Sajjan Mills Ltd. (supra) and in the case of Madras Industrial Investment Corporation Ltd. (supra) has observed that an expenditure which is of a contingent nature cannot be admitted into the limited confines of section 37(1) which allows deduction for an expenditure which is incurred by an assessee.

38. In fact, this proposition is self-evident and way back in the year 1959, the Supreme Court in the case of Indian Molasses Co. (P) Ltd. v. CIT (1959) 37 ITR 66 (SC) held that the term “expenditure” is equal to “expense”, i.e., actual laying out of money. Looked at differently, expenditure means “spending” in the sense of “paying out or away” in an irretrievable manner. Thus, there cannot be any quarrel with this basic test which is required to be fulfilled if an assessee makes a claim for deduction under section 37(1).

38.1. However, the matter assumes an altogether different complexion when the assessees claim is sought to be advanced through the basic governing provision of section 28 itself. Time and again, it has been reiterated in the course of the evolution of judgemade law that the starting point of computing of taxable income is the commercial profit derived on the basis of applicable principles of accounting and such profits can be disturbed only if the legislature provides to the contrary.

39. On this footing, the Supreme Court in the case of Metal Box (supra) upheld the contention that an estimated liability under a gratuity scheme, even if it amounted to contingent liability, was deductible while preparing the profit & loss account if the quantum thereof is properly ascertained by applying scientific process of evaluation. The Supreme Court held so notwithstanding that under section 36(1)(v), actual contributions made to an approved gratuity fund were admissible, as deductions.

40. Now, coming to the decision of Shree Sajjan Mills (supra), it may be taken note of that the court was dealing with the situation of the amended law which witnessed insertion of section 40A(7) which specifically provides that no provision for gratuity will be allowed as a deduction unless the provision is under the auspices of an approved gratuity fund. This was a clear case where the legislature stepped in an unequivocal manner and specifically provided that notwithstanding the principles of accounting, the provision for gratuity simpliciter without the obligation (sic) gratuity scheme will not be allowed to be deducted in computing taxable business income. Notwithstanding this non obstante provision of law, the assessee in the case of Shree Sajjan Mills (supra) sought to reduce the taxable income by contending that it had in fact not made any provision for gratuity in the books of account and, therefore, provisions of section 40A(7) which frown upon only provisions made in the accounts, should not come in the way of the assessees claim. The apex court declined to bless this contention which, though was the result of the working of a clever mind but could be said to be guilty of making mockery of the clearly intended provision of a statute. In the course of the judgment, the Apex Court dealt with the provisions of section 37 and reiterated the principles laid down in the case of Indian Molasses (supra) to the effect that the expenditure deductible for income-tax purpose is towards the liability which actually exists. However, setting apart money which might become an expenditure on the happening of an event is not expenditure. To repeat, these observations were made in the context of section 37 at p 598 of the judgment.

41. The court also noticed the decision of Metal Box (supra) and reaffirmed its validity at p 599 of the judgment. Some very pertinent observations came to be made by the court on p 600 of the reported judgment in the following words :

“As there were several methods which the assessee might choose to adopt in meeting his liability to pay gratuity, the treatment which he would receive under the Income Tax Act would depend upon the method adopted by him. The assessee is only under an obligation to pay gratuity when it becomes due and payable. The other methods adopted by the assessee for meeting the liability for gratuity as and when it arose are provisions or arrangements made by him at his option. It is not obligatory on him to make any such provision and if not such arrangement or provision was made, no question arose to consider its deductibility or allowance under the Act.”

42. In other words, what has been emphatically held is that if an assessee seeks to claim a deduction on the touchstone of section 28, then, he has not only to establish that such deduction is in accordance with correct principles of accounting, but further that such principles have been translated by employing a regular method of accounting in the process of drawing up the accounts. A deduction could be allowed by the assessee by invoking the fundamental provisions of section 28 can only be with regard to the method of accounting regularly employed. From the above, following two points emerge :

(a) an expenditure which is of contingent nature cannot be and must not be allowed to be deducted under section 37(1);

(b) a deduction which is claimed on the touchstone of section 28, on the basis of accounting principles must be so claimed by employing a regular method of accounting in drawing up the accounts.

That is to say, an assessee cannot be heard to say that an estimated liability for warranty obligation should be allowed under section 28 without following the proper grammar of accounting principles and employment of regular method of accounting in drawing up the accounts which take into reckoning such provision. The other choice with the assessee is to claim the deduction on the basis of actual incurrence by report to the second option of section 37(1).

43. The second case of the Supreme Court in the case of Madras Industrial Investment Corporation Ltd. (supra) need not be considered in more detail since the attention in that case again was focussed to the provisions of section 37.

44. In other words, if the assessee can satisfy the authorities that :

(a) a provision for warranty has been fairly estimated,

(b) such provision finds acceptance from the accounting standpoint or rather making of such a provision is considered mandatory in arriving at nature of true commercial profits,

(c) the provision so made is as per the regular method of accounting, then there cannot be any objection for the admissibility of such a claim as discussed by me in para 24 (supra). In my view, the assessees case satisfies an the three tests enumerated supra and, accordingly, in my view, the claim of warranty is allowable deduction.

K.C. Singhal, J.M.

9-2-2000

45. After going through the order proposed by my learned Brother and having discussion at length with him, I have not been able to persuade myself to agree with the conclusion arrived at by him in para No. 26 of his order regarding deduction on account of provisions made for warranty liability. Therefore, I proceed to express my dissenting view.

46. The issue for our consideration is whether the assessee is entitled to deduction in respect of the provisions made for warranty liability in respect of goods being manufactured/constructed by the assessee. The facts regarding this issue are in short compass and have been set out in the proposed order in para 20. However, it would be useful to refer to few more facts, which in my opinion, are relevant for disposal of this issue. Though the production commenced in the assessment year 1989-90, but the actual and effective business was started in this year. So, for all practical purposes, the year under consideration is the first year of the business. The assessee had obtained six contracts for construction of boilers from various parties namely, 1. L. H. Sugar, 2. M. R. F. Ltd., 3. Deepak Fertilizers Ltd., 4. Colgate, 5. Sesa Goa and 6. N.H.E.C. The contracts were on turnkey basis i.e., for construction, supply, erection and commissioning at the site for the customer. The assessee used to raise sale bills at various stages of construction though in none of the case, the contract was fully executed. The details furnished in the chart (in addition to paper book) filed before us shows that completion of work was in the range of 60 per cent to 82 per cent. That means, in none of the case, sale was complete and the boilers were still in the construction stage though the amounts received from the customers have been shown as sales consideration. It is on the basis of such sale proceeds that provisions for warranty have been made by the assessee at the rate of 2 per cent of the billing price. A copy of the contract with M/s Deepak Fertilizers has been placed in the paper book appearing at p 1 to 15. The relevant term in the contract at page 9 of the paper book reads as under :

Clause 1.11 Guarantee

“You shall guarantee the equipment for design, workmanship and material for construction for a period of 12 months from the date of commission or 24 months from the date of despatch whichever is earlier.”

The claim made by the assessee on the basis of above clause has been rejected by the assessing officer as well as Commissioner (Appeals) on the ground that liability is contingent one.

47. The contention on behalf of the assessee is that its business profits and gains which are chargeable to tax under section 28 and, therefore, the same are to be determined/understood in the commercial sense. According to Mr. Khare, the learned counsel for the assessee, the profits and gains of the business must be determined first in accordance with commercial practice and then, such profits should be further computed in accordance with the provisions of sections 30 to 43C. Therefore, it was argued by him that warranty liability, even though not deductible under section 37 being contingent liability, is deductible under section 28 itself in accordance with the accounting principles. Reference was made to Accounting Standard 7 issued by the Institute of Chartered Accountants of India as well as International Standard of Accounting.

48. On the other hand, the contention on behalf of revenue is that warranty liability is contingent in nature and, therefore, not allowable at all in view of the Supreme Court decision in the case of Shri Sajjan Mills Ltd. v. CIT (1985) 156 ITA 585 (SC). According to the learned senior Departmental Representative, it makes no difference whether such claim of assessee is tested under sections 28 or 37. It is also the contention of the senior Departmental Representative that claim of the assessee is premature since the occasion for such liability has not arisen. According to him, the boilers were in the stage of construction as only a part of construction was completed in the year under consideration while according to the terms of warranty, the assessee is liable only from the date of delivery or from the date of commission, as the case may be. Since the boilers were in the construction stage itself, the claim of the assessee was thus prematured and, therefore, not allowable.

49. According to the proposed order, the claim of the assessee regarding warranty liability is allowable for the following reasons :

(a) That starting point of computation of taxable income is the commercial profits derived on the basis of commercial accounting principles. If a particular claim is allowable according to the commercial accounting principles, then, it should be allowed under section 28 itself despite the fact that it may not be allowable under section 37. Heavy reliance is placed on the Supreme Court judgment in the case of Metal Box (I) Co. Ltd. v. Their Workmen (1969) 73 ITR 53 (SC), (supra).

(b) The claim of the assessee is based upon experience in the industry and the experience of companys collaborators. Thus, the provisions for warranty liability is provided on scientific analysis and such practice has been followed in the subsequent years. Further, such practice is recognised by Accounting Standard 7 issued by Institute of Chartered Accountants.

(c) The decision of Supreme Court in the case of Shri Sajjan Mills (supra) is distinguishable in the sense that in that case, the court was concerned with deduction of gratuity liability under section 37 read with section 40A(7) and not under section 28. Since there was specific provision in respect of gratuity, the said decision cannot be applied to the facts of the present case.

(d) As per para 42 of the order, it has been finally concluded that liability of contingent nature cannot and must not be allowed under section 37, but it can be allowed if it is claimed on the touchstone of section 28 itself.

50. After giving my deep thoughts to the aforesaid propositions, it is my view that claim of the assessee is not allowable for the reasons mentioned hereafter. There is no difference on the opinion that liability on account of warranty is contingent in nature inasmuch as it accrues only when the defect in the item manufactured by the assessee is notified by the customer. If no defect is notified, no liability would accrue. This proposition has not even been disputed by the learned counsel for the assessee. Further, there is no dispute between us on the point that such claim of the assessee cannot be allowed under section 37 (see para 42 of the proposed order).

51. So, the only short question for consideration remains is whether such claim can be allowed under section 28 itself despite the fact that it is not allowable under section 37. In my considered view, the legal position is the other way around. Section 28 provides that the profits and gains of the business are chargeable to tax. Section 29 provides that income referred to in section 28 shall be computed in accordance with the provisions of sections 30 to 43C. Similar provisions were on the statute in the form of section 10(1) and 10(2) of 1922 Act. These old provisions were subject matter of the consideration before the Honble Supreme Court in the case of Badridas Daga v. CIT (1958) 34 ITR 10 (SC). In that case the question arose whether the loss on account of embezzlement by an employee could be allowed as deduction. The Supreme Court held that such deduction could not be allowed either under section 100(xi) or under section 10(2)(xv). It then proceeded to observe that deductions and allowances enumerated in section 10(2) are not exhaustive of all the allowances which could be made in ascertaining the profits of the business taxable under section 10(1) which are to be understood according to the ordinary commercial principles. It is in this context, it was observed that if any deduction cannot be allowed under section 10(2), then it can be allowed under section 10(1) since tax is to be levied on true profits provided such deduction springs directly from the carrying on of the business and is incidental to it. The relevant portion which is quite often referred to in various cases by the court is extracted below :

“The result is that when a claim is made for a deduction for which there is no specified provisions in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act.”

52. The aforesaid view has again been affirmed by a larger Bench of four Judges of the Supreme Court in the case of CIT v. Mysore Sugar Co. Ltd., (1962) 46 ITR 649 (SC). In that case, the assessee carrying on the business of manufacture of sugar used to advance seedlings, fertilizers and money to sugarcane growers under an agreement by which the growers agreed to sell the next crop of sugarcane grown by them exclusively to the assessee at the current market price and to have the advances adjusted towards the prices of sugarcane to be delivered to the assessee-company. In certain cases, the growers could not grow sugarcane due to drought and the advances remained not recovered. Accordingly, the loss arisen out of such transactions was claimed as deduction either under section 10(1) or 10(2)(xi) and 10(2)(d)(sic) of 1922 Act. Their Lordships of the Supreme Court, after considering the earlier judgment in the case of Badridas Daga (supra) held at p 652 as under :

“If an expenditure comes within any of the enumerated clauses of allowances, the case can be considered under the appropriate clause; but there may be an expenditure which, do not exactly covered by any of the enumerated clauses, may have to be considered in finding out the true assessable profits or gains. This was laid down by the Privy Council in CIT v. Chitnavis and has been accepted by this court. In other words, section 10(2) does not deal exhaustively with the deduction, which must be made to arrive at the true profits and gains.”

53. The perusal of the relevant observations in the aforesaid two Supreme Court decisions clearly shows that claim of the assessee could not be considered under section 10(1) if the claim could be considered under specific provisions of section 10(2)(i) to 10(2)(xv). The court had held that claim of the assessee in those two cases did not fall under the specific provisions of section 10(2) and, therefore, the same could be considered under section 10(1) itself because ultimately it is the true profits of the business which are not taxed. Therefore, it is very much clear that starting point of computation is not under section 10(1) (corresponding to section 28 of 1961 Act) as has been held by my learned Brother. Therefore, the profits are first to be computed in accordance with the provisions of sections 30 to 43C and if any claim of the assessee cannot be considered under these sections, then it can be considered under section 28 and for that purpose, the aspect of commercial profits would arise.

54. If the contention of the assessee is accepted, then scheme of the Act would become redundant. The reason is that all the expenditures referred to in sections 30 to 43C are generally deductible in accordance with the principle of commercial accountancy. For example, general expenses of business i.e., the salary and wages, bonus, interest on borrowings, telephone, electricity, repairs, rent, rates and taxes, etc., are allowable according to commercial accounting and would be allowable under section 28 also. In such cases, there would be no scope of sections 30, 31, 36 and 37. Such construction which would render such provisions redundant cannot be accepted. Accordingly, it is to be held that expenditure which is specifically disallowable under section 37 cannot be allowed under section 28. It has been accepted by my learned brother that warranty liability being contingent cannot be allowed under section 37. Therefore, in the present case, the provisions made for the warranty liability cannot be allowed.

55. The decision of the Supreme Court in the case of Metal Box Co. v. Their Workmen (1969) 73 ITR 53 (SC) has been relied upon by my learned brother for the proposition that claim, even if not allowable under section 36(1)(v) of 1961 Act, could be allowed under section 28(1) of that Act. On the same analogy, the claim of the assessee should be allowed under section 28(1) even though it is disallowable under section 37. No doubt, such observations in the aforesaid Supreme Court judgment do support the case of the assessee, but, with all due respect it is stated that such observations are contrary to observations of the Honble Supreme Court in the case of Badridas Daga (supra) and in the case of Mysore Sugar Co. Ltd. (supra). These decisions were delivered by larger Bench of three Judges and four Judges respectively while the decision in the case of Metal Box was delivered by Bench of two Judges. Therefore, to that extent, the ratio on the judgment in the case of Metal Box does not hold good. It is to be noted that the aforesaid judgments of the Honble Supreme Court delivered by larger Benches were not referred to before the Supreme Court in the case of Metal Box Co (supra). Had these judgments been referred to, such observations might not have been made by that Bench. In view of the above discussion the ratio of the Supreme Court decision in the case of Metal Box Co. that a claim though not allowable under section 36(1)(v) could be allowed under section 28 is not binding and, therefore, to be ignored in view of the decisions of the larger Benches in the case of Badridas Daga and Mysore Sugar Co. Ltd. (supra) and consequently cannot be applied in the present case.

56. Even assuming for the sake of argument, the claim of the assessee can be considered under section 28. Still, such claim in my opinion, cannot be allowed. The contingent liabilities are not allowable either under section 28 and section 37 unless it falls within the exception laid down by the Honble Supreme Court in the case of Metal Box Co. (supra). In order to appreciate this contention, it would be useful to refer the decision of the court of appeal in the case of Peter Merchant Ltd. v. Stedeford 30 Tax Cases 496, facts of which are similar to the present case. That case was relied on by the revenue before the Honble Supreme Court in the case of Calcutta Co. Ltd. v. CIT (1959) 37 ITR 1 (SC) in support of the contention that future liability cannot be allowed as deduction. The Honble Supreme Court has discussed in facts of that case and the ratio laid down by the court of appeal at p 5 of the report as under :

“Reliance was placed on behalf of the revenue on the case of Peter Merchant Ltd. v. Stedefor (Inspector of Taxes) 30 Tax Cases 496, in which a distinction was drawn between an actual, i.e., legal, liability, which is deductible, and a liability which is future or contingent and for which no deduction can be made. The facts of that case were that the company, which carried on the business of managing factory canteens, had contracted with a factory owner to maintain the crockery, cutlery and utensils used in the canteen otherwise known as the light equipment in its original quantity and quality. The cost of replacements was admittedly a proper deduction in computing profits, as was also any sum paid to a factory owner in settlement of the value of shortages on termination of the contract. Owing to war and other circumstances it was impossible or impracticable for the company to obtain replacement in some cases, and the obligations under the contracts with the factory owners in those cases still remained to the performed. In the accounts for the year deductions had been made both of the amounts actually expended on replacements and the amounts which the company was liable to expend when the equipment became available. The company claimed to be entitled to deduct in computing its profits amounts representing at current prices, the liability to effect replacements as soon as the required equipment became obtainable. The former amounts were allowed as deductions, and the latter the court of appeal (reversing the decision of the court below) held not to be deductible. The basis of the decision was that the real liability under the contract was contingent, not actual, since the obligations of the company were not such that it might be sued for the cost of replacements at current prices, but only for possible damages for breach of contract in the event of the factory owner preferring a claim under the contract, and since no legal liability could arise until such a claim was made, the liability had to be regarded as contingent and not deductible.”

The aforesaid decision of the court of appeal was distinguished by the Supreme Court in-the following words :

“It is clear from the above that on the facts and circumstances of that case the court held that it was not an accrued liability but was merely a contingent one and if that was the case only the sums actually expended could be deducted and not those which the company was liable to expend in the future.”

57. By distinguishing the decision of court of appeal, the Honble Supreme Court has made a distinction between a liability which has accrued during the year though to be discharged at a future date and a liability which is contingent in the year, but may become an accrued liability in future upon the happening of an event. In the former case, deduction was held to be allowable while in the latter case held to be not allowable. It is to be noted that Supreme Court in the case of Calcutta Co. Ltd. (supra) was considering the claim of the assessee under section 10(1) of 1922 Act corresponding to section 28 of 1961 Act. Therefore, it follows that even under section 28, contingent liability cannot be allowed while computing the profits in the commercial manner.

58. Having held that contingent liability cannot be allowed under section 28, there is no scope of argument that such liability can be allowed on estimate basis if it is based on past experience of the assessee or the industry. Even otherwise, the decision of the Supreme Court in the case of Metal Box Co. (supra) does not help the assessee. What has been held in that case is that the contingent liability, if it is a properly ascertainable and it is possible to arrive at a proper discounted value, it can be taken into account for determining the commercial profits. It is to be noted that the court was considering the deduction on account of statutory liability of gratuity which was properly ascertainable in accordance with the provisions of relevant Act on the basis of year of service and the proper amount could be known in respect of the year concerned. But in the present case, warranty liability cannot be properly ascertained. There is no and cannot be any actuarial valuation in this regard. No basis has been established on the basis of any material on the record to show that 2 per cent of billing price is the ascertainable liability of the assessee. Mere statement of the assessee that it is based on the experience of the industry or of the collaborators cannot establish the claim of the assessee. The possibility that there may not be any defect in the boilers constructed by the assessee itself indicates that such liability is not ascertainable properly. Therefore, the case of the assessee cannot be brought within the four corners of the decision of the Supreme Court in the case of Metal Box Co.

59. The Honble Supreme Court in the case of Shri Sajjan Mills Ltd. v. CIT (supra) has laid down the legal position at pp 598 and 599. The legal position so laid down was with reference to the law prevailing prior to insertion of section 40A(7) in the year 1973. Therefore, it is incorrect to say that this decision is distinguishable on the ground that their Lordships were deciding the issue with reference to section 40A(7).

60. As far as Accounting Standards are concerned, they are made by the Institute of Chartered Accountants keeping in view the provisions of Companies Act, so that the surplus may be determined for the purpose of distribution of dividends. If there is any possibility of certain liability being accrued in future in respect of the business carried on by the assessee, then it would be prudent for a trader to make provisions for such liability in the accounts, but on that account, it cannot be allowed as deduction if it is not allowable under the provisions of income-tax. In this connection, reference may be made to Supreme Court decision in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd., v. CIT (1997) 227 ITR 172 (SC) wherein it has been held that income-tax provisions would prevail over the accounting principles. Reference may also be made to recent decision of the Tribunal Bombay Bench in the case of Deputy CIT v. Associated Capsules (P) Ltd. (1999) 65 TTJ (Mum-Trib) 774, wherein it has been held vide para 17 at p 779 :

“The ICAI has recommended the provision of such a liability on grounds of prudence. Now prudent accounting is, one thing and determination of income for tax purposes is another. One may be almost sure that a certain liability win arise on the happening or non-happening of an event, and from the viewpoint of the management, it may be prudent to set apart a specified amount, but undoubtedly, the liability has not arisen till the happening or non-happening of the event.”

In view of the above, the claim of the assessee cannot be allowed on the principle of accounting.

61. Lastly, even on facts, in my opinion, the claim of the assessee is premature. According to the guarantee clause, the assessee is liable to remove defects notified by the customer within a period of 12 months from the date of commissioning or 24 months from the date of despatch whichever is earlier. The perusal of the facts narrated by me shows that boilers were still under construction and, therefore, neither delivered nor commissioned. Therefore, in my view, the claim of the assessee appears to be premature.

62. The decisions of the Tribunal in the case of Voltas Ltd. v. Deputy CIT (1998) 64 ITD 232 (Mum-Trib) and in the case of ITO v. Wanson India Ltd. (1983) 5 ITD 102 (Pune-Trib) relied upon by the learned counsel for the assessee are contrary to the ratio laid down by the Apex Court in various cases cited by me in the order. Therefore, the same cannot be applied to the present case. For the similar reasons, the decision of Privy Council in the case of IRC v. Mitsuibi Motors (1996) 222 ITR 697 (PC) arising from Newzealand, cannot be applied.

63. In view of the above discussion, it is my considered view that liability of warranty, being contingent one, cannot be allowed either under section 28 or section 37. Accordingly, it is held so. The order of Commissioner (Appeals) is, therefore, upheld on this issue.

64. Except as stated above, I agree with the rest of the proposed order.

ITA No. 158/Pn/1995; Assessment year 1991-92

B.L. Chhibber, A.M.

December, 1999

2. The first grievance of the assessee relates to the addition of Rs. 96,37,000 on account of provisioning made on account of revenue recognition of percentage of completion method. The facts and arguments of both sides are identical to those discussed by us in ITA No. 157/Pn/1995 for the earlier assessment year i.e., 1990-91. As such the decision given by us in the aforesaid order will apply mutatis mutandis to the facts of the present case. For the reasons discussed therein, we hold that there is no justification for the impugned addition of Rs. 96,37,000 on account of provision made on account of revenue recognition on percentage of completion method. The same is accordingly deleted. This ground accordingly succeeds.

3. The next grievance of the assessee is that the learned Commissioner (Appeals) is not justified in confirming the addition of Rs. 31,51,000 on account of warranty provision made in the accounts. The facts and arguments of both sides are identical to those discussed by us in ITA No. 157/Pn/1995 for the earlier assessment year i.e., 1990-91. As such the decision given by us in the aforesaid order will apply mutatis mutandis to the facts of the present case. For the reasons discussed therein we hold that there is no justification for the impugned addition of Rs. 31,51,000 on account of provision made in respect of warranty in the accounts. The same is accordingly deleted. This ground accordingly succeeds.

4. Ground No. 3 raised by the assessee reads as under :

“The learned Commissioner (Appeals) erred, while working out the disallowance under section 37(2A), in restricting the companys claim for deduction on account of participation of the companys officials in the business-lunches extended to the customers in the normal course of the companys business to 20 per cent of such expenditure of Rs. 1,41,138 against the claim of the appellant at 50 per cent based upon the fact that in the companys business of selling sophisticated capital goods evolved with the state of the art technology newly introduced in this country, where usually the number of such employee-participants in the business lunch discussion outstrip the clients and their teams, which contention of the appellant is not refuted by the authorities.”

5. The assessee-company quantified the entertainment expenditure as under :

Rs.

Business lunch

1,41,138

Out of travelling

1,08,858

Out of canteen expenses

7,500

Out of foreign expenses

39,446

2,96,962

In the computation of total income, it had claimed 50 per cent of business lunch expenses incurred on employees accompanying guests and shown Rs. 2,26,393 as disallowable. The assessing officer for the reasons discussed in the assessment order denied the claim. On appeal, the Commissioner (Appeals) gave partial relief, inasmuch as he directed the assessing officer to treat 20 per cent of the expenditure to be attributable to employees out of total lunch expenses of Rs. 1,41,138.

6. The facts and arguments of both the sides are identical to those discussed by us in ITA No. 157/Pn/1995 for the assessment year 1990-91. For the reasons discussed therein we direct the assessing officer to allow 50 per cent of the total expenditure on business lunches as attributable to employees. This ground accordingly succeeds.

7. Ground No. 4 relates to the disallowance of investment allowance of Rs. 3,60,096. During the course of assessment proceedings, the assessing officer noted that in the computation of income, a sum of Rs. 3,60,096 was claimed in respect of investment allowance on plant and machinery (including computers) purchased in the accounting period ending 31-3-1989, and 31-3-1990. It was submitted before the assessing officer that in the earlier year the claim could not be claimed in view of the losses. The assessing officer disallowed the claim on the ground that in the returns for the earlier years i.e., 1989-90 and 1990-91 neither investment allowance had been claimed nor allowed. The assessing officer further held that incurring of losses is no criteria for not claiming investment allowance. He further held that the investment allowance on computer is not allowable. He accordingly disallowed the claim of the assessee in toto.

8. On appeal, the Commissioner (Appeals) confirmed the addition observing as under

“I have considered the submission of the appellant, and facts in issue. The deduction under section 32A is admissible in respect of machinery or plant acquired or installed or put to use in the previous year. In the instant case, the plant and machinery including computers had been put to use in the assessment year 1989-90 and 1990-91 and as such cannot be considered for deduction in assessment year 1991-92. The mere fact that the assessee could not claim deduction due to losses in the earlier years does not mean that it is eligible for such claim in later years. There is no material to show that computers or other plant and machinery for which disallowance is made had been installed or put to use in the previous year relevant to assessment year 1991-92 or in immediately succeeding year. Considering these facts, the disallowance of Rs. 3,60,096 is confirmed.”

9. Shri B.K. Khare, the learned counsel submitted that in the return of income, the assessee had sought deduction of investment allowance of Rs. 3,60,096 under section 32A of the Act as per the details given on para 9 of the paper book. The investment allowance reserve of Rs. 2,71,000 was created in the accounts of the previous year relevant to assessment year 1991-92. He submitted that the lower authorities have not resisted the claim of the assessee on the ground that the plant and machinery in question is not eligible to be conferred the benefit of investment allowance in the assessees favour by the decision of the Bombay High Court in the case of CIT v. IBM World Trade Corporation (1981) 130 ITR 739 (Bom), not to speak of location of the computer which was in the precincts of the plant itself which helped efficient plant operations by performing important functions such as production planning, procurement of material, inventory control and for generating critical information for effective plant management. The learned counsel, drawing our attention to sub-section (1) of section 32A, submitted that the section allows deduction of investment allowance not in the year in which the machinery is installed or in the immediately succeeding year in which the machinery in put to use but rather, the deduction is allowed in respect of the previous year in which the machinery is installed or, as the case may be, is put to use. Sub-section (1) of section 32A therefore, has only a limited though vital role of crystallising the eligibility of investment allowance with respect to the year of installation or use and such year is to be reckoned with for the purpose of computing the period during which the assessee is not entitled to sell or otherwise transfer the asset, etc. on which investment allowance is claimed (section 32A(5)(a)). The learned counsel further submitted that the investment allowance in respect of which the eligibility is crystallised in terms of sub-section (1) of section 32A is not allowed to enter the stream of computation of total income unless there is sufficient total income to contain such allowance, such total income being computed after making all the deductions other than the deduction under section 32A itself and the deductions available under Chapter VI-A, In other words, the amount of investment allowance is not allowed to convert income into a negative total income. At best it is allowed to enter into the computing mechanism so as to reduce the total income to Nil and no further. In this respect, he drew our attention to sub-section (3) of section 32A. The learned counsel further submitted that the deduction for investment allowance is further constrained by the conditions of creation of appropriate reserve with an option to create such reserve in the in year the deduction is to be allowed under sub-section (3) of section 32A or in any earlier year not being earlier to the year in which the machinery is installed or put to use (section 32A(4)(ii)). The learned counsel further submitted that the assessee has no right of first appeal under section 246 if the claim for investment allowance is rejected where such claim is outside the scope of total income assessed. There is no specific clause under section 246 conferring right of appeal in such a case unless the allowance affects the amount of income assessable (section 246(1)(a)). Unlike section 157 providing for intimation of loss there is no procedure for intimating to the assessee the investment allowance to the carried forward for set off. It is therefore, in effect submitted that the assessee is compulsively called upon in asserting his right to deduction under section 32A only in the year in which the total income is sufficient to contain and absorb the allowance. In support of his contention, the learned counsel relied upon the following decisions :

(1) CIT v. Dalmia Cement Ltd. (1995) 216 ITR 79 (SC);

(2) CIT v. Arun Prasad (1991) 190 ITR 179 (Pat); and

(3) CIT v. Valiappa Textiles Ltd. (1988) 172 ITR 168 (Karn).

10. Last but not the least, the learned counsel drew our attention to the cardinal rule of construction that incentive provision should be so interpreted which will advance the cause behind providing the fiscal incentive in bringing about the economic and industrial growth an not in too much a technical and restrictive manner as would retard the objective behind the incentive provided by the statute. In support of this contention, he relied upon the judgment of the, Supreme Court in the case of Bajaj Tempo Ltd. v. (1992) 196 ITR 188 (SC).

11. Shri Naresh Kumar, the learned Senior Departmental Representative strongly supported the order of the authorities below. He submitted that the claim of the assessee has been rejected by the assessing officer as well as the Commissioner (Appeals) primarily on the ground that the machinery on which investment allowance was claimed was not installed during the previous year. Therefore, neither the assessing officer nor the Commissioner (Appeals) has gone into the question whether the assessee fulfils other conditions i.e., whether machinery was used for the business or machinery was such as to be eligible for investment allowance. The learned Departmental Representative further submitted that part of the machinery installed has been descried as computer. The Honble Pune Bench of the Tribunal in the case of Deputy CIT v. Kirloskar Cummins Ltd. ITA No. 1287/Pn/1990 for assessment year 1985-86), M/s Sunnygold Wineries (P) Ltd. v. Deputy CIT (ITA No. 1288/Pn/1993 for assessment year 1990-91) and (Tribunal Delhi A Bench) in the case of UBS Publishers Distributors Ltd. v. IAC (1991) 41 TTJ (Del-Trib) 449, held that no investment allowance is allowable on computers. Therefore, if the present issues is to be decided in favour of the assessee, the matter may be restored to the file of the assessing officer for finding out whether or not the assessee fulfils the other conditions.

12. The learned Departmental Representative further submitted that as per section 32A the assessee can claim investment allowance only in the assessment year relevant to the previous year in which the machinery was acquired or was installed or was first put to use immediately succeeding the assessment year. In the instant case, the machineries have been installed in earlier years as can be seen from the annexure. Therefore, the primary condition for the claim of the investment allowance has not been fulfilled by the assessee. The learned Departmental Representative relied upon the judgment of the Calcutta High Court in the case of CIT v. J. Thomas & Co. (P) Ltd. (1977) 110 ITR 566 (Cal) wherein it has been held that for claiming any concession the assessee must strictly comply with the requirements of the section. According to the learned Departmental Representative the decision of the Patna High Court in the case of Arjun Prasad (supra) relied upon by the learned counsel for the assessee is distinguishable from the facts of the case. He submitted that in Arjun Prasads case, the assessee had made the claim in the relevant assessment year. The assessee fulfilled all the conditions including creation of statutory reserve. However, no valid assessment was completed since the return was filed beyond statutory limit. Hence, it was held by the Honble Patna High Court that the assessee was entitled to deduction under section 33(2) since the assessee fulfilled all the conditions for becoming entitled to deduction on account of development rebate and the carry forward does not depend upon quantification by the assessing officer. In the instant case, no claim was made even though valid return was filed for the relevant assessment year. Hence, having missed the bus it is not open to the assessee now to wake up and claim investment allowance. Finally, the learned Departmental Representative relied upon the judgment of the Supreme Court in the case of Shri Shubhalaxmi Mills Ltd. v. Addl. CIT (1989) 177 ITR 193 (SC).

13. We have considered the rival submissions and perused the facts on record. So far as the contention of the learned Departmental Representative that the plant and machinery in question is not eligible to be conferred the benefit of investment allowance in respect of computers is concerned, the issue now stands covered in assessees favour by the decision of the Bombay High Court in the case of IBM World Trade Corporation (supra) not to speak of location of the computer which was in the precincts of the plant itself which helped efficient plant operations by perfuming important functions such as production, planning, procurement of material, inventory control and for generating critical information for effective plant management.

14. So far as the allowance of investment allowance on merits is concerned, the same is not allowable in view of the judgment of Supreme Court in the case of Shri Shubhalaxmi Mills Ltd. (supra). In this case, the Honble Supreme Court has clearly held that in order to claim the deduction on account of development rebate under section 33(1) of the Income Tax Act 1961, it is obligatory that the debit entries on the profit & loss account and the credit entry in a reserve account should be made in the relevant previous year in which the machinery or plant is installed or first put to use. It has further been held that in view of Explanation added with retrospective effect from the commencement of the Act, to clause (a) of section 34(3) it is clear that what is contemplated is the creation of a reserve fund in the relevant previous year irrespective of the result of the profit & loss account disclosed by the books of the assessee. Mere book entries will suffice for creating such a reserve fund. The debit entries and the entries relating to the reserve fund have to be made before the profit & loss account is finally drawn up. The Supreme Court has clearly held that this is a condition for securing the benefit of development rebate and if the condition is not satisfied, the deduction on account of development rebate cannot be claimed at all. (emphasis here italicised in print, supplied). In the case of the assessee, it is an admitted fact that in the earlier two assessment years 1988-89 and 1989-90 when the machinery was first installed and put to use, neither any reserve was created nor claim for deduction of development rebate (sic) was made before the assessing officer on the ground that in those years, the assessee-company had suffered losses. The assessee did not make any book entries for creating a reserve fund. The finding of the Honble Supreme Court on the issue is very clear and is reproduced as follows :

“That (creation of reserve) is a condition for securing the benefit of development rebate and if that condition is not satisfied, we fail to see how the deduction on account of development rebate can be claimed at all.”,

The reliance placed by the learned counsel on the judgment of the Honble Supreme Court in the case of Dalmia Cement Ltd. (supra) is of no assistance because in that case, the Honble Supreme Court was dealing with the carry forward and set off of loss and the issue of allowance of development rebate was not before the Honble Supreme Court and accordingly the earlier judgment of the Supreme Court in the case of Shri Shubhalaxmi Mills Ltd. (supra) was not cited before the Supreme Court and that judgment stands in tact even today. As regards the reliance placed by the learned counsel for the assessee on the decision of the Patna High Court in the case of Arjun Prasad (supra) it is noted that the attention of the Patna High Court was not drawn to the judgment of the Supreme Court in the case of Shri Shubhalaxmi Mills Ltd. (supra). Therefore, besides that the facts are distinguishable, this judgment of the High Court can be of no assistance to the assessee. Similarly, reliance placed by the learned counsel on the judgment of Karnataka High Court in the case of Valiappa Textiles Ltd. (supra) pales into insignificance before the judgment of the Apex Court in the case of Shri Shubhalaxmi Mills Ltd. (supra).

15. In the light of the above discussion, we uphold the finding of the authorities below. This ground accordingly stands dismissed.

16. In the result, the appeal is allowed in part.

K.C. Singhal, J.M.

9 February 2000

17. After going through the order proposed by my learned brother and having discussion at length with him, I have not been able to persuade myself to agree with the conclusion arrived at by him in para No. 3 of his order regarding deduction on account of provisions made for warranty liability. Therefore, I proceed to express my dissenting view.

18. The claim of the assessee has been allowed by my learned brother following his order in assessees own case in ITA No. 157/Pn/1995 for assessment year 1990-91. For the reasons given by me in the dissenting order in paras 45 to 62 in that case it is held that Commissioner (Appeals) was justified in confirming the disallowance of Rs. 31,51,000 on account of warranty provisions made in the accounts. Accordingly, the order of Commissioner (Appeals) is upheld on this issue. However, the A would be entitled to deduction in respect of actual expenditure.

19. Except as stated above, I agree with the rest of the proposed order.

R.V. Easwar, J.M. (As Third Member)

10th April, 2001

The following question has been referred to me under section 255(4) for decision :

“Whether, on the facts and in circumstances of the case as well as in law, the assessee is entitled to deduction in respect of the provisions made for warranty liability?”

2. The assessee is a public limited company and is engaged in the business of designing, engineering, fabrication, procurement and assembly, erection, installation and commissioning of ground boilers with the help of sophisticated technology for petrochemical, fertiliser, sugar and other industries. During the relevant years (assessment years 1990-91 & 1991-92), it made provisions for warranty in its accounts in the amounts of Rs. 11,64,000 and Rs. 31,51,000 respectively and claimed deduction in the assessments in respect of them. It was explained before the assessing officer that the assessee was under an obligation to replace defective components of the boilers during the warranty period and that the amounts provided represented the estimated liabilities in respect of the obligation. As per clause 1.11 of the guarantee, the assessee “shall guarantee the equipment for design, workmanship and material for construction for a period of 12 months from the date of commission or 24 months from the date of despatch whichever is earlier”.

3. The assessing officer was of the view that the amounts claimed were mere provisions made on estimated basis without there being any accrued liability and were therefore not allowable as deductions in computing the income.

4. The Commissioner (Appeals), on appeal, was of the view that the amounts claimed were mere provisions in the accounts for a liability which was not ascertained and, therefore, cannot be considered as proper deductions. He noticed that the provision has been made on estimate at 2 per cent of the billing amount considering the same as a charge on the assessees profits, which to his mind could not be allowed since the liabilities were unascertained.

5. The assessee appealed to the Tribunal and took up several contentions. According to it, the contract value necessarily included the cost required to be incurred by the assessee on warranties, that the cost was estimated on the basis of past experience of the companys collaborators or promoters, that since the boilers were being erected/installed in India for the first time it was thought that some provision should be made for foreseeable warranty cost, that even though the warranty period commenced only after the delivery of the boiler, the provisions had to be made in the accounts on progressive execution of the projects as per the Accounting Standard 7 (AS-7) wherein it is stipulated that the costs attributable to the contract include expected warranty costs which can be reasonably estimated. Several authorities were cited in support of the contentions.

6. On behalf of the department, it was contended that the liability in respect of the warranty was not an ascertained liability in the relevant years, that it was merely contingent, that the liability was to commence only after the boilers were delivered. that even before the delivery the assessee had created a provision in anticipation which is not permissible, that till the delivery of the boilers the liability in respect of warranty was a contingent liability which was not allowable as a deduction while computing the assessees income. Strong reliance was placed on the orders of the Departmental authorities and several decided cases.

7. The learned Accountant Member (hereinafter referred to as the A. M) accepted the contentions of the assessee. He held that the contract value would necessarily include the warranty costs, that such costs were properly estimated on the basis of the past experience, that the provisions made in the accounts were approved by AS-7 and standard textbooks on accountancy and that such practice was being followed by the assessee consistently in the following years. He further held that it is the principle of accountancy which is of vital importance and the fact that the assessee made a provision even before the delivery of the boiler was of no relevance. He therefore allowed the assessees claim for both the years.

8. The learned Judicial Member (hereinafter referred to as the J.M.) could not agree with the view proposed by the learned A.M. and would appear to have requested the latter to reconsider his proposed order in the light of the judgment of the Supreme Court in Sajjan Mills v. CIT (1985) 156 ITR 585 (SC). The learned A.M. thereafter passed a sort of an appendix to his proposed order, wherein he gave reasons as to why he was unable to accede to the request of the learned J.M. These are contained in paras 36 to 44. In short, he reasoned that the claim was allowable not under section 37(1) but under section 28 itself, that Sajjan Mills (supra) was not concerned with section 28 but was concerned with section 37(1) and was therefore not applicable to the present case. He further held that in Metal Box Co. v. Their Workmen (1969) 73 ITR 53 (SC), the Supreme Court itself has held that even a contingent liability is allowable as deduction in preparing the profit & loss account if the quantum thereof is scientifically ascertained. He ultimately held that (1) the provision for warranty has been fairly estimated, (2) that making of the provision is mandatory under the accounting principles in arriving at true commercial profits, and (3) that the provision so made is as per regular method of accounting. In this view of the matter, he did not consider any change in his proposed other necessary.

9. The learned J.M. could not agree with the views of the learned A.M. He referred to the argument advanced on behalf of the assessee to the effect that the profits of the business have first to be ascertained on commercial principles and thereafter the deductions provided for in sections 30 to 43C should be allowed and, therefore, the warranty liability, even though not deductible under section 37(1) being a contingent liability, is deductible under section 28 itself in accordance with accounting principles, and held that this argument was not tenable. He took the view that the legal position was the other way round, and the profits had first to be computed as per sections 30 to 43C and it was only thereafter that the provisions of section 28 come into play and if a claim for deduction was not allowable under those provisions there was no question of allowing the same under section 28. He noted that there was no dispute that the liability was contingent and that even the learned A.M. had accepted this to be the position and had also held in para 42 that such a contingent liability cannot be allowed as deduction under 37(1). If that is so, it cannot be allowed as deduction under section 28, because of the prohibition under section 37(1). In support of this view, the learned J.M. cited the judgments of the Supreme Court in Badridas Daga v. CIT (1958) 34 ITR 10 (SC) and in CIT v. Mysore Sugar Co. (1962) 46 ITR 649 (SC). He held that the later judgment of the Supreme Court in Metal Box (supra), on which reliance was placed by the learned A.M., was contrary to the above two earlier judgments rendered by larger Benches and, therefore, cannot be applied to the present case. He further held that even assuming that the claim must be considered under section 28, still it was not allowable because according to him even under this section the liability must be an ascertained liability and not a contingent liability. According to him, in the present case, the warranty liability had not become an ascertained liability during the relevant years, that it was merely estimated at 2 per cent of the billing amount, that even this estimate had no basis, that the claim that it was based on past experience was not established and, therefore, it was not an ascertained or properly evaluated liability. He further observed that the “very possibility that there may not be any defect in the boilers constructed by the assessee itself indicates that such liability is not ascertainable property” and, therefore, the case of the assessee cannot be brought under the principle laid down in Metal Box (supra). He also held that the claim was premature, in the sense that the boilers were not delivered, and the warranty liability starts only after they were delivered. In this view of the matter, the learned J.M. disagreed with the view taken by the learned A.M. and rejected the assessees claim.

10. That is how the matter is now before me. I have heard the rival contentions. While the assessee placed reliance on the order of the learned A.M. and the reiterated the contentions that appealed to him, the department placed reliance on the order of the learned JM. and reiterated the contentions that appealed to him.

11. In my view, the assessee is not entitled to succeed. Since the facts have been elaborately brought out in the orders of the learned A. M. and the learned J.M., I have only adverted to them briefly. Both the learned Members are in agreement on two aspects : (1) that the liability is contingent, and (2) that it is not allowable under section 37(1). The only difference between them is whether the provision is allowable under section 28 itself on commercial or accounting principles. It is not necessary for me to consider whether the learned J.M.s. view, viz., that it is only after computing the profits as per sections 30 to 43C that the provisions of section 28 can be considered and that if a claim is prohibited by section 30 to 43C the same cannot be considered under section 28 on commercial or accounting principles, is correct or not because I am in agreement with the opinion expressed by him that even if the claim is examined under section 28, despite the fact that being a contingent liability the same is not allowable under section 37(1), still it is not allowable as deduction thereunder, for, in my view, a contingent liability does not merit deduction, under the very scheme of the Income Tax Act, while computing the profits of the business. It is no doubt true that the profits have to be ascertained on commercial principles and further that accounting principles and standards have to be given due respect or weight in computing the profits, but to hold that a claim which is sound or prudent on commercial or accounting principles must be, ipso facto, allowed as a deduction also under the income-tax law and must be so allowed irrespective of other relevant principles or considerations under the income-tax law, is unacceptable. That would open the floodgates and even claims that are made on the basis of conservative accounting or commercial practices/policies or on grounds of accounting or commercial prudence, which have no grounding under the established principles of income-tax law, would become allowable, a consequence that can hardly be countenanced.

12. In the present case, it is not disputed that the warranty period starts only when the boilers are delivered. The relevant clause in the contract has been quoted by the learned J.M. It is only when the warranty period starts that the assessee becomes liable to replace or remove the defects and is under the obligation to do whatever has been agreed under clause 1.11 of the contract. There is also no dispute that during the relevant accounting years no boilers were delivered or commissioned by the assessee. This is supported by Note 6 to the printed accounts, to which my attention was drawn on behalf of the Department. Thus, during the relevant accounting years, the liability under the warranty clause did not accrue at all. There was just a possibility that after the boilers are delivered, some defects may be noticed and the warranty clause may come into play. That is a future uncertain event. The provision, admittedly, had been made on the basis of accounting standards (AS-7). The object, in my view, of making such a provision is not far to seek. It has obviously been made on grounds of prudence or as a measure of conservatism in the matter of accounting. That is certainly justifiable so far as the accounting aspect is concerned. But the claim for deduction of the provision has also to satisfy the principles of income-tax law. Under the income-tax law a contingent liabilityone which is dependent on the happening or not happening of a future uncertain event-is not considered deductible until such event has happened or until it has become impossible of happening. There is no finding in the order of the learned AM. that the provision does not represent a contingent liability but it represents a present liability, a liability which has become ascertained, and only the amount or quantum thereof remains to be ascertained. The bedrock of his decision is that the claim is based on commercial or accounting principles regularly followed by the assessee. He has also observed that the fact that the assessee made the provisions even before the boilers were delivered was not of relevance and that it is only the principle of accountancy that was really important. With respect, the real question to be examined is whether the claim represents a real or present liability which has accrued in the relevant accounting years. This question does not appears to have been examined. On the other hand, the learned J.M. with respect, has examined this aspect in para. 58 of his order. In this paragraph, he has also attempted to distinguish the decision of the Supreme Court in Metal Box (supra). He has contrasted the present case with the facts in Metal Box (supra)by observing that in the present case the warranty liability cannot be properly ascertained and even the estimate of 2 per cent of the billing amount arrived at by the assessee had no basis. I am in agreement with the view expressed by the learned J.M. that Metal Box (supra) is distinguishable. I would however add that in my view Metal Box is distinguishable not only because the quantum of the provision made has no established basis but because-and mainly because-the provision made by the assessee in the present case is not on the basis of any statute, as in the case of Metal Box (supra), wherein the liability has already been fastened on the assessee and only the quantification thereof remained to be done, but in the present case, the provision is based on a clause in the contract but the clause is yet to come into operation. Whereas in Metal Box (supra) it was a case of a statutory liability arising under the Payment of Gratuity Act, 1972, in the present case it is a case of a contractual “liability”, where the liability has not accrued to the assessee. It would be commonsense to expect that the assessee would resist, with all the resources it could muster, if any claim is made by its customers under the warranty clause during the years under appeal. The argument of the assessee, if confronted with such a claim, would certainly be that no boilers have been supplied and, therefore, the warranty clause has not come into force and hence there is no question of enforcing the same. In other words, the assessees defence would be that it is not under any liability to honour the warranty clause! An assessee following the mercantile system of accounting, as is the case with the present assessee cannot seek to deduct a liability which has not accrued under the terms of the contract. It may be prudent accounting, but not sufficient to support the claim under the income-tax law. I would prefer to distinguish Metal Box (supra) on this ground also.

13. To my mind, it appears that it is necessary for the assessee to satisfy the conditions imposed by the income-tax law for successfully claiming a deduction in the assessment and if a deduction is claimed solely on the basis of commercial or accounting principles, it is further necessary to show that the claim is not inconsistent with or opposed to the principles of income-tax. law. Under the mercantile system of accounting, which the assessee follows, a deduction in respect of a contractual liability for warranty can be allowed only if the liability has accrued in the relevant accounting period. I am of the view that the liability under the warranty clause in the contract did not accrue during the accounting years relevant to the assessment years under appeal. To repeal, the argument that the provision has been made as per accounting standards or that it has been consistently followed subsequently or that it is in consonance with established commercial principles, ipso facto, is not enough to get it allowed under the income-tax law, if the liability, which the provision seeks to represent, has not accrued. The fact that the claim is entered in the accounts is not conclusive of its allowability. The accounting standards or accounting or commercial principles cannot control the legal position. The correct position, in my humble view, would be that if the claim is in accordance with the legal position under the income-tax law, the fact that there are no entries made in the accounts would not be fatal to its allowability and the fact that entries have also been made in the accounts would undoubtedly support the claim but under no circumstances can a deduction be allowed solely on the ground that it is in accordance with the accounting or commercial principles, if the claim does not satisfy the conditions imposed by the income-tax law.

14. The rule in Badridas Daga (supra), cited by the learned J.M. in a slightly different context, is applicable to the present claim. According to the rule, it is necessary for the assessee to show that the claim arises out of the carrying on of the business and is incidental thereto and if that is established, the claim must be allowed “provided of course there is no prohibition against it, express or implied, in the Act”. The first part of the rule is satisfied in the sense that the warranty liability is incidental to the carrying on of the business and arises out of the same. But the second part of the rule, viz., that there should be no prohibition against the claim, express or implied, under the Income Tax Act, is not satisfied since in my view, the very scheme of the Act prohibits the allowance of a contingent liability as a deduction in computing the profits of the business. I also accept the contention of the department that even the decision of the Honble Bombay High Court in the case of Tata Iron & Steel Co. Ltd. v. D.V. Bapat, ITO (1975) 101 ITR 292 (Bom) does not lay down the proposition that a contingent liability is deductible under section 28 of the Income Tax Act on commercial or accounting principles. This decision was heavily relied upon on behalf of the assessee before me, especially the observations at pp. 307 and 328-329, but I am unable to find anything in the said judgment which would support the assessees claim for deduction of the contingent liability under the warranty clause, represented by the provision made in the accounts on the basis of AS-7, while computing its profits, under section 28 of the Act.

15. Several authorities were cited by both the sides in support of their respective contentions but I do not consider it necessary to deal with each one of them in view of the foregoing discussion. However, I consider it necessary to refer to some of the judgments cited on behalf of the assessee before me. One of them is the judgment of the Supreme Court in the case of Metal Box (supra), which has already been considered by both the learned A.M. as well as the learned J.M. The learned A.M. in para 39 has referred to this judgment and has understood the same as allowing deduction in respect of an estimated liability under a gratuity scheme, even if it amounted to a contingent liability. The learned J.M., however, has expressed the opinion that in the light of the earlier judgments of the Supreme Court in the case of Badridas Daga (supra) and Mysore Sugar Co. Ltd. (supra), which were judgments rendered by a larger Bench, the later judgment in Metal Box (supra), which is a judgment rendered by a smaller Bench, cannot be applied to the present case. In Metal Box (supra), it was held by the Supreme Court (pp. 64-65 of the Report) that a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which the receives from his employees and this he can do, if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. It was further held that “even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account …………………….” These observations were heavily relied upon by the assessee before me. But, in my view these observations have to be understood in the context in which they were made. The assessee in that case had claimed to deduct its liability under two gratuity schemes while arriving at the profits for the purpose of the Payment of Bonus Act. There was an actuarial valuation. It was in this context that the observations relied on by the assessee were made by the Supreme Court. Even from these observations, it would be clear that the liability should be “properly ascertainable” and that the contingent liabilities should be “sufficiently certain” so as to be capable of valuation. In the present case, the liability is neither properly ascertainable nor is it sufficiently certain. It is entirely in the realm of contingency. As the learned Members have found and as is not also disputed by the assessee, no boilers have been delivered or commissioned during the relevant accounting years and, therefore, there is no material with reference to which the “liability” under the warranty clause could be ascertained. Thus, there is not even a semblance of liability during the relevant period, let alone an accrued liability. I find that the learned J.M. has distinguished the judgment of the Supreme Court in Metal Box (supra) in para. 58. I agree with the grounds on which he has distinguished the said judgment. As regards the judgment of the Bombay High Court in the case of Tata Iron & Steel Co. Ltd. (supra),as I have already noted, there is no ruling in the said judgment that a contingent liability can be allowed as a deduction under section 28 of the Income Tax Act. In that case, the assessee kept its accounts on the mercantile system of accounting and claimed deduction in respect of a provision made for gratuity liability, under the Payment of Gratuity Act, 1972, on the basis of actuarial valuation. The High Court accepted the assessees claim for deduction and held as incorrect a circular of the Central Board of Direct Taxes which directed the assessing officers not to allow any liability towards an unapproved gratuity fund under section 37(1) of the Act. The case before the Bombay High Court was not one where the assessee sought deduction in respect of any contingent liability. Therefore, the question whether a contingent liability can be allowed as a deduction under section 28 of the Act, cannot be said to have been decided.

16. I, therefore, agree with the conclusion of the learned J.M. that the provision made in the accounts for the assessment years under appeal in respect of warranty liability is not allowable as deduction in computing the profits of the assessee. The question referred to me is therefore, answered in the negative.

17. The appeals will now be placed before the Bench for consequential orders.

B.L. Chhibber, A.M.

11th May, 2001

As there was a difference of opinion between the A.M. and the JM_ following question was referred to a Third Member :

“Whether, on the facts and in the circumstances of the case as well as in law, the assessee is entitled to deduction in respect of the provisions made for warranty liability ?”

2. The learned J.M., Shri R.V. Easwar, sitting as Third Member by his opinion, dated 10-4-2001 has concurred with the views of the J.M. that the provisions made in the accounts for the assessment years under appeal in respect of warranty liability is not allowable as deduction in computing the profits of the assessee and answered the issue in the negative. In accordance with the majority view, the issue stands decided against the assessee and in favour of the revenue.

3. In the result, appeal is allowed in part.

Like this:

Related

Leave a Comment Cancel

Thermax Babcock & Wilcox Ltd. vs Dy. Cit on 11 May, 2001

Share this:

Like this:

Related

Leave a Comment Cancel