Auto, pharma firms set to get major tax liability relief

Written by Gireesh Chandra Prasad | Gireesh Chandra Prasad | Roudra Bhattacharya | New Delhi | Updated: Aug 22 2013, 22:12pm hrs
Automobile and pharmaceutical companies are set to get a major relief in their tax liability as the revenue department has decided to make it binding on tax officials to honour the potential costs of warranty and litigation as a deductible expenses while calculating their total income.

The move is seen as an attempt to reduce litigation and provide certainty to taxpayers.

The Tax Accounting Standards (TAS) finalised by the revenue department would prevent officers from disallowing the provision made for potential cost of warranty or litigation as a deduction, holding them as notional items.

There have been many instances in the automobile and consumer durables sectors, where companies such as Hyundai Motor India, Maruti Suzuki India and Carrier Airconditioning & Refrigeration were disallowed the provisions made for meeting the potential cost of warranty, saying such expenses cannot be allowed until these have actually been incurred.

The disputes on provisioning of cost of warranty between the tax department and manufacturers in a given year run into several crores of rupees and the row recurs year after year. Hyundai Motors India was disallowed a provision of Rs 8.26 crore in assessment year 2002-03, while Whirlpool India was denied a deduction of Rs 3 crore in assessment year 1996-97. Career Airconditioning & Refrigeration was denied deduction of Rs 60 lakh for assessment years 1998-99 to 2001-02.

The revenue authorities till three or four years ago were not allowing the provision made for warranty cost and admitted only cash-basis expenses and this has led to a high level of litigation, said Sethuraman R, director, finance, Hyundai Motor India.

TAS, which is expected to be notified under the Income Tax Act soon, will bring a great relief for automobile and consumer durable goods makers by upholding the spirit of Accounting Standard (AS) 29 on provisions and contingent liabilities notified under the Companies Act even for tax purposes, sources said.

"The move to uphold the spirit of AS29 in the proposed Tax Accounting Standards will be beneficial for this industry at a time when margins are under pressure and volumes sluggish," said Maruti SuzukiCFO Ajay Seth.

AS 29 allows a provision for cost of servicing a warranty, which may include cost of labour, spare parts or other expenses calculated in a scientific manner based on past experience. But assessing officers used to disallow the provision of such warranty costs, saying these are actually in the nature of contingent liabilities and, therefore, not allowable deductions in determining business profits for the purpose of income-tax. Unlike a liability for which a provision is made, contingent liabilities are only disclosed and not accrued as these represent possible obligations, the settlement of which may not result in outflow of resources, or present obligations that cannot be measured. In the case of extended warranty for, say, three more years, automobile companies and consumer durable makers in India have been following the same approach of making provisions for those years too, leading to larger sums in dispute.

Sources privy to the revenue departments move said TAS seeks to remove the differences in the treatment of warranty cost for book purposes and for tax purposes by clarifying that as long as the cost of warranty is determined on a scientific basis, it should be allowed as a provision for something that is likely to happen. Because TAS will now be notified as part of the Income Tax Act itself, it will become more binding on the assessment officers and therefore, wherever AS 29 is correctly followed, it shall hold good for tax purposes as well.

There are many accounting areas where uncertainties have led to disputes and litigation in the past. Because the TAS provisions are worded very close to the AS 29 on Provisions ,Contingent` Liabilities and Contingent Assets, if these are correctly applied and the auditor has certified it, assessees will have a lot more certainty as far as the tax treatment and deductions are concerned, said Jamil Khatri, KPMG's global head of Accounting Advisory Services.

Recently, judicial pronouncements have led to the acceptance of provision on warranty, provided reliable estimates are made and supported with documentary evidence and technical data which can convince the authorities. As the proposed TAS supports this view, it will help in mitigating litigation, said Sethuraman.

The other area where TAS is about to bring certainty to businesses is on the treatment of provisions made for issues under litigation, say, on a patent infringement suit. Historically, tax authorities have been disallowing such provisions considering them as contingent liabilities. However, TAS will make it clear that as long as the provisions made are based on reasonable principles laid down in AS 29, there is no reason why they should not be allowed as a deduction for tax purposes too.