Sushma Chowla, JM:
1. The appeal filed by the assessee is against the order of CIT(A)-I, Nashik, dated 10.12.2014 relating to assessment year 2006-07 against order passed under section 143(3) r.w.s. 254 of the Income-tax Act, 1961 (in short 'the Act').
2. The assessee has raised the following ground of appeal:-
1. On the facts and in the circumstances of the case and in law the lower authorities have erred in making the disallowance of warranty claim amounting to Rs.2,76,87,623/- by rejecting appellants contention and all the documentary evidences produced before them. Your appellant prays for total relief.
3. The assessee is in appeal against the order of CIT(A) in making disallowance of warranty claim of Rs. 2,76,87,623/-.
4. Briefly, in the facts of the case, the assessee was engaged in the business of trading in Aircraft parts and engines. For the year under consideration, the assessee had furnished return of income declaring total income at Rs. 4.97 crores. The assessment under section 143(3) of the Act was completed after making various disallowances at Rs. 8.41 crores. The CIT(A) partly allowed appeal of assessee, against which both the assessee and Revenue went in appeal before the Tribunal. The Tribunal in ITA Nos.121/PN/2010 and 112/PN/2010 vide orders dated 15.06.2011 and 21.06.2011 had set aside the issue of Provision for Gratuity, Vacation leave and Warranty expenses with direction to the file of Assessing Officer. The case of assessee was taken up for re-scrutiny. The Assessing Officer noted that the assessee had claimed that provision for warranty expenses at Rs. 3.25 crores in the return of income, which was disallowed in earlier order passed under section 143(3) of the Act on the ground that warranty expenses were contingent in nature and were not incurred and hence, the claim of provision for warranty expenses was not allowable deduction. During the course of assessment proceedings for assessment year 2004-05, the assessee had made submission on 20.11.2010 in support of its claim relating to provision for warranty expenses. The Assessing Officer on observation of information furnished i.e. from 'Sampal contract' dated 03.04.2002 between Indo Russian Aviation Ltd. i.e. the assessee company and Ministry of Defence (Indian Air Force), the assessee company was supplying various material to the vendor and offered warranty to replace damaged material free of cost. Further, the Assessing Officer noted the contents of letter dated 29.05.2001 addressed by the assessee to its vendor, wherein the vendor had claimed for replacement of material supplied under warranty. Another letter dated 24.03.2001 was addressed to M/s. Russian Aviation Ltd., Moscow, Russia by the assessee company. The Assessing Officer noted that the assessee had asked for replacement of material supplied which was found defective by the customer of assessee company. The Assessing Officer also noted that the assessee was not manufacturing any material supplied to its vendor. The conclusion of Assessing Officer was that the assessee was working as dealer of supplier company; hence warranty expenses were not attributable to the assessee. The assessee was thus, show caused as to why the said expenditure be allowed in its hands. The assessee explained that provision for warranty was recognized on the basis of claim of engine R-29-300 at Rs. 2.76 crores and other claims of Rs. 48,12,377/-, totaling Rs. 3.25 crores. The claims worth Rs. 48,12,377/- were the warranty claims by the customers against supplies made by assessee during the financial year 2005-06. The assessee gave details in this regard. It also gave the details in respect of claims raised by Indian Air Force (IAF) on assessee towards the overhauling of engine No.R-29B-300. The assessee explained that the sale of engine to IAF was under Tripartite Agreement among IAF, assessee and M/s. UMPO UFA through M/s. Rosoboronexport was channel partner/Indian representative for Russian counterpart. The sale/overhaulding of specific engine was effected by assessee vide Invoice dated 27.09.2001. The said engine was fitted in a MIG aircraft No.SM-257 which suffered an accident on 21.02.2002. The assessee also pointed out that the primary responsibility of the warranty claim fulfillment was of M/s. UMPO UFA through M/s. Rosoboronexport and assessee was supposed to act as intermediary. The assessee then pointed out the sequence of events and refusal of the said concern to accept warranty claim. The assessee thus,
recognized warranty provision in its Balance Sheet as on 31.03.2006 to the extent of Rs. 2.76 crores based on the actual overhauling charges billed to IAF of Rs. 2,27,29,604/- (basic price) + Rs. 49,58,019/- (interest). The assessee pointed out that though IAF pursued the matter but M/s. UMPO UFA was not ready to perform part of their contract and further vide letter dated 11.06.2009 IAF had asked for payment of claims from assessee and no payment was made and it was indicated that as per contract, the same would be recovered from outstanding invoice payments of assessee company, the assessee admits that though no such deduction was done till date. The Assessing Officer held that the said submissions do not elucidate regarding actual expenditure made towards warranty expenses. The Assessing Officer allowed the claim of warranty expenses to the extent of Rs. 48,12,377/- and balance claim of Rs. 2.76 crores was not allowed as deduction. The Assessing Officer relied on various judicial decisions in this regard and provision of warranty expenses was disallowed.
5. The CIT(A) upheld the order of Assessing Officer since the assessee had not owned the warranty claim which as per the assessee was required to be settled by M/s. UMPO UFA. The assessee before the CIT(A) also furnished all the copies of letters addressed to IAF where outstanding payments worth USD 190780 against various supplies made by assessee to Air Headquarters, were held-up. The CIT(A) dismissed the claim of assessee and upheld the addition of Rs. 2.76 crores.
6. The assessee is in appeal against the order of CIT(A).
7. The learned Authorized Representative for the assessee pointed out that MIG aircraft was supplied to IAF and in that agreement, assessee had to take care of supply and maintenance of engines which were refurbished. On 21.02.2002 because of engine failure, there was accident of MIG and the said failure of engine was within warranty period of overhauling of engines and hence covered by warranty provisions. The assessee intimated the accident to Russian counterpart on 25.02.2002. However, the Russian company refused to accept the claim as not within time. The assessee was concerned with the engine loss. Enquiry about the air accident was finalized in 2006 and IAF lodged the claim with assessee in 2006, so the assessee in the year 2006 had made the provision for warranty expenses of Rs. 2.76 crores. Our attention was drawn to the order of Tribunal, wherein the Assessing Officer was directed to look into thebasis of provision for warranty. However, both the Assessing Officer and CIT(A) denied the claim of assessee. The learned Authorized Representative for the assessee pointed out that it was the responsibility of assessee which is further strengthened by the fact that amount due to the assessee against supplies to IAF have not been released to the assessee by Air Headquarters. He further pointed out that total cost of engine as per the claim was Rs. 4.61 crores and the overhaul part of engine was Rs. 2.27 crores. The documents in this regard are placed at pages 98 to 100 of Paper Book. Further documents were separately filed showing methodology of calculation of warranty claim. He placed reliance on the order of Hon'ble Supreme Court in Bharat Earth Movers Vs. CIT (2000) 245 ITR 428 (SC).
8. The learned Departmental Representative for the Revenue on the other hand, referred to the agreement between the parties and questioned whether it was the liability of assessee especially where the assessee while writing letters to the Counterpart claimed it was not its liability. The learned Departmental Representative for the Revenue placed reliance on the order of CIT(A) in para 3 at page 8.
9. We have heard the rival contentions and perused the record. The issue arising in the present appeal is the provision made by the assessee on account of its liability of providing warranty of MIG engines supplied. The assessee had entered into Tripartite agreement with Russian company M/s. UMPO UFA, IAF and assessee; copy of said agreement is placed at page 1 onwards of Paper Book. As per understanding between the parties, M/s. UMPO UFA was to carry out overhaul of 30 pcs of R29B-300 engines and the price of engines was also fixed between the parties. The price of overhaul engines was fixed at USD 432,800 and the total amount of contract was USD 129,84,000. The said engines were to be delivered after overhaul. The overhauling had to be carried out by UFA. As per understanding, life of engines, quality and warranty services were also discussed. As per clause 5.3, UFA was to ensure the warranty period for the engines after overhaul for 180 hours of operation or 12 months of operation or 18 months from the date of dispatch, whichever was earlier. It was also agreed that warranty does not spread for consumable materials and small parts which could be replaced during services. It was further agreed that whenever defect was discovered within warranty period, then claims could be presented by the customer to the assessee in respect of followings:-
a. Quantity of the overhauled engine in case it is not in conformity with the quantity stipulated in the Packing List if the engines have arrived at the place of destination in undamaged packages within 60 days after the date of delivery after overhaul and if there is no carrier responsibility and if it does not correspond to the quantity in the invoice and the quantity actually received within 120 days.
b. Quality of the overhauled engines if it does not correspond to the quality stipulated in article 5 of this contract within the warranty period and not later than 30 days of the expiration of warranty period.
10. The said claim was to be made by customer to the assessee within 30 days from the date of revalling of defect. The assessee in turn, was entitled to check ground of the claim on spot through his representatives or engines being returned to M/s. UFA premises for investigation. It is further understood as under:-
"6.4 The customer will provide immediately full details of defects discovered within the warranty period to M/s IRAL to enable them to inform M/s. UFA for elimination of defects within 90 days from the date of communication of the defect.
6.5 Whenever the defect is discovered within warranty period the defect may be localized by the customer's personnel at the level of an aggregate, equipment or system, the same will be dispatched to UFA plant for repairs by agreement with UFA.
6.6 In case M/s. UFA does not examine the claim in terms indicated in the present Contract or does not respond within 120 days of the date of the claim, the CUSTOMER can unilaterally eliminate defects by himself or recover the cost of the item from any outstanding invoice. In case the customer repairs the item unilaterally, he shall submit to M/s. IRAL and account of expenses borne for the defect elimination with calculation of expenses and act - report of the work done. M/s. IRAL is to refund the expenses borne without demur within 60 days of the receipt of the act report. Alternatively the CUSTOMER has a right to deduct the amount from any outstanding invoice. M/s. UFA warranty obligations in this case are to be valid.
6.7 In case it is established that the claim is due to the Customer's fault all costs shall be borne by the customer for the rectification of the defect."
11. In other words, as per understanding between the parties, the claim during warranty period had to be made to the assessee and where the customer repairs the items during warranty period, then the assessee had to refund expenses borne. Alternatively, it was also provided that customer had the right to deduct amount from any outstanding dues to the assessee. In other words, though the assessee was not manufacturing or refurbishing the engines but it had to bear the cost of warranty expenses, wherein if within stipulated period any defect was found in the engines, then the same would be reimbursed by third party to the Contract i.e. M/s. UFA. Other terms and conditions were agreed upon between the parties, which we are not referring as they do not relate to the issue before us.
12. The question which arises in the present appeal before us is the allowability of provision made by assessee for warranty expenses within warranty period. Coming to the facts of the case, the assessee during the year under consideration had booked an expenditure of Rs. 3.25 crores under the head 'Provision for Warranty Expenses'. The Assessing Officer has allowed the claim to the extent of Rs. 48,12,377/- and balance claim of Rs. 2.76 crores is in dispute. The said claim was on account of actual overhauling charges billed to IAF of Rs. 2.27 crores (basic price) + Rs. 49,58,019/- (interest). The reason for said provision was against an accident of MIG Aircraft which was supplied by assessee to IAF. The expenditure of MIG Aircraft was because of engine failure, which in turn, was within warranty period of overhauling of engine. Hence, the claim was covered by warranty provisions arising out of Tripartite Agreement between the person overhauling engine, the assessee and IAF. The said accident was intimated to the Russian Counterpart on 25.02.2002 by the assessee. The Russian company has refused to accept the claim being not made in timeframe. The assessee has booked the expenditure in 2006 i.e. the year in which enquiry about the accident was finalized and IAF lodged the claim of recovery of Rs. 2.76 crores with the assessee. The question which arises in the present appeal is against allowability of said provision in the hands of assessee.
13. The Hon'ble Supreme Court in Bharat Earth Movers Vs. CIT (supra) have laid down the law in respect of provision to be made i.e. recognition of liability which may be quantified and discharged at a future date. The Apex Court held as under:-
"4. The law is settled; if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If
these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain."
14. The Hon'ble Supreme Court relied on the ratio laid down in Metal Box Co. of India Ltd. Vs. Their Workmen (1969) 73 ITR 53 (SC), wherein few principles were laid down which were referred to and were extracted and reproduced as under:-
"(i) For an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is paid; permissible only in case of amounts actually expended or paid
(ii) Just as receipts, though not actual receipts but accrued due are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business;
(iii) A condition subsequent, the fulfillment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability;
(iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to be made in a subsequent year if it can be satisfactorily estimated.
15. Applying the said principle, the provision made by the assessee therein for meeting the liability incurred under the Leave Encashment Scheme proportionate with the entitlement earned by the employees of the company, were held to be deductible out of gross receipts for the year during which such provision was made.
16. Taking the shelter from the principles laid down by the Hon'ble Supreme Court (supra), we find that the orders of authorities below suffer from infirmity to the extent that it cannot be held that merely because liability had not been discharged by assessee and was being pursued for reimbursement from the Russian authority would make the claim of assessee as not allowable. As understood from the terms of agreement after the engines were supplied, then warranty for the specified period was the responsibility of assessee though to be discharged jointly by M/s. UFA i.e. for taking care of any defects in refurbishment of engines which have been supplied to IAF. However, in the present case, there was complete failure of engine which resulted in MIG accident in 2002 and after enquiry was co
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mpleted in 2006, it was established that accident was due to the engine failure and hence, the claim was raised by IAF upon the assessee to reimburse cost of engines. The assessee forwarded the said claim to the Russian company, which refused to acknowledge it on the ground that it was not made within timeframe stipulated in the agreement. The assessee was no doubt raising the issue with the Russian company till date and there are series of correspondence but in none of the said correspondence, the Russian company had acknowledged its liability of paying damages on account of failure of engine. The assessee on the other hand, was also corresponding with IAF to which it was making regular supplies and IAF had not released the payments due to the assessee because the issue of warranty claim had not been settled by the assessee. In other words, the payments which were due to assessee, were being withheld by IAF against warranty claims. Undoubtedly, it is the liability of assessee as per contract to provide warranty within stipulated period to the customer i.e. IAF. In this case under the circumstances, where there was engine failure within warranty period, then as per terms of agreement and since the enquiry had been completed in 2006, the assessee which was following mercantile system of accounting, had accounted for the said claim of warranty under the head 'Provision for Warranty'. Such claim made by the assessee under the provisions of the Act was duly allowable as deduction in the hands of assessee, applying the ratio laid down by the Apex Court in Bharat Earth Movers Vs. CIT (supra). It may also be reiterated that other claim of warranty provision of about Rs. 48 lakhs had been allowed by Assessing Officer. Accordingly, we hold so. Thus, we find no merit in the orders of authorities below and the same are reversed. The ground of appeal raised by assessee is thus, allowed. 17. In the result, appeal of assessee is allowed.