Provisions For Unsettled Outstanding & IBNR Claims Allowable U/s 37 Being Ascertained Liabilities: Delhi High Court

Section 37 of Income Tax Act states that any business expenditure, excluding capital expenditure and the individual's personal expenses, that is spent or set out solely and entirely for the business's operations shall be applicable for deduction.

The Division Bench comprising Justice Yashwant Varma and Justice Purushaindra Kumar Kaurav observed that “it would be wholly incorrect to understand IBNR provisioning to be a contingent liability. We, in this regard, bear in consideration the precepts of reasonable estimation, the capability of a liability being quantified based upon historical trends and the known actuarial methods for estimation which are liable to be adopted in accordance with the IRDA Regulations”. (Para 19)

Facts of the case:

For the years in question, the AO held that both the provision for unsettled claims as well as IBNR would amount to contingent liabilities and thus could not be validly claimed u/s 37. The assessee however contended that the provision for unsettled claims cannot be viewed as being ad hoc or an estimate since they record all outstanding claims to the extent lodged by policy holders. When the matter reached before the Tribunal, it was held that provision for unsettled claims was not contingent liability, rather ascertained liability and hence, allowable u/s 37 of the Income tax Act.

Observations of High Court:

As regards the unsettled outstanding claims, the Bench accepted the Tribunal's view that these are not ad hoc or estimate since based on claims lodged by policyholders.

Emphasizing that clear distinction is made between incurrence of liability and its ultimate quantification, the Bench observed that merely because these claims came to be adjudicated subsequently have no bearing on a provision being validly made.

Regarding IBNR claims, the Bench elaborated on the necessity of these provisions under Insurance Regulatory Development Authority (IRDA) regulations, and opined that IBNR provision is based on actuarial estimates and empirical data derived from identified predictive methodology.

While expounding upon the concept of a provision being made in the books of account, the Bench highlighted the “substantial degree of estimation” test laid down by the Apex Court in Rotork Controls India Private Limited. vs. Commissioner of Income Tax, Chennai [(2009) 13 SCC 283] for creation of provision for liabilities.

The Bench observed that as long as a liability is properly ascertainable on the basis of empirical data or a known methodology, the same cannot possibly be held to be a contingent liability.

The Bench went on to explain that additional provision for warranty made in the subsequent year was not contingent liability and was allowable as revenue expenditure if such provision was based on “actuarial study”.

The High Court therefore dismissed Revenue's appeal and concluded that provisions for IBNR claims not contingent liabilities since reasonably estimated based on historical trends and known actuarial methods.

Counsel for Assessee: Senior Advocate Ajay Vohra along with Advocates Kishore Kunal, Ankita Prakash, and Anuj Kumar

Counsel for Revenue: Prashant Meharchandani, Akshat Singh, Ritika Vohra, and Utkarsh Kandpal

Case Title: PCIT Vs Care Health Insurance Limited

Citation: 2024 LiveLaw (Del) 723

Case Number: ITA 304/2024

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