Whether warranty expenses are allowable expenses under the Income Tax Act?

 

Query:

1.A manufacturing company is engaged in manufacturing, execution and commissioning of machine equipments. Defects existed in     some of the sophisticated goods manufactured in the past and sold and the Company was making provisions in respect thereof.

2.Based on past experience and technical estimates for warranty, expenses are provided in accounts on an accrual basis. The  Company provides for 0.5% on sale for liabilities under the contract towards obligations/warranties.

3.The question is whether such warranty expenses are allowable U/S 37(1) of the Income Tax Act?

Reply:

1.This case is very similar to a recent Jharkhand HC judgement in the case of PCIT Vs Heavy Engineering Corporation Limited (T.A.      No. 25 of 2019), wherein it was held that:

Where defects existed in some of the sophisticated goods manufactured in the past and sold and the assessee was making provisions in respect thereof, deduction under section 37(1) could not be disallowed in respect of such provision made for warranty.

2.In fact the proposition that warranty expenses are allowable expenses has already been accepted by the Hon Supreme Court in         the case of Rotork Controls vs. CIT ( 3506-3510 OF 2009), wherein it was held that a liability is a present obligation arising from         past events, the settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate is             possible of the amount of obligation. If the facts established show that defects exist in some of the items manufactured and sold             then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deductions