Whether provision for warranty can be allowed as an expense under Income Tax Act?
A warranty is written guarantee, issued to the purchaser of an article by its manufacturer, promising to repair or replace it if necessary within a specified period of time. It is thus a future expense of a manufacturer which he may or may not incur.
Hon. Supreme court in the case of M/S. Rotork Controla India (P) Ltd vs Commnr. Of Income Tax, Chennai (CA No. 3506-10 of 2009) on 12 May, 2009 made the following observations on this issue:
1. There are 3 options in the case of accounting for warranty:
a) account for warranty expense in the year in which it is incurred ; (b) it makes a provision for warranty only when the customer makes a claim ; and (c) it provides for warranty at certain percentage of turnover of the company based on past experience (historical trend).
2. Among these three options, the first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis. The second option is also inappropriate since it does not reflect the expected warranty costs in respect of revenue already recognized. The third option is the most appropriate because it fulfils accrual concept as well as the matching concept.
Conclusion: The provision of warranty should be decided using a scientifically devised method based on past experience depending on factors like turnover of the company of previous years and provision for expenses on repairs during the warranty period.