Delhi High Court Allows Provisions For Unsettled Claims And IBNR Under Section 37 Of Income Tax Act

Delhi High Court Allows Provisions For Unsettled Claims And IBNR Under Section 37 Of Income Tax Act

The Delhi High Court, affirming the ITAT's ruling, upheld the decision to allow deductions under Section 37 of the Income Tax Act for provisions related to unsettled outstanding claims and 'Incurred But Not Reported' (IBNR) claims of a health insurance company.

The court clarified that such provisions do not constitute contingent liabilities and are therefore eligible for deduction as business expenditures, excluding capital expenditures and personal expenses of individuals.

The Division Bench, composed of Justices Yashwant Varma and Purushaindra Kumar Kaurav, stated that "it would be entirely incorrect to categorize IBNR provisioning as a contingent liability. In reaching this conclusion, we have taken into account the principles of reasonable estimation, the ability to quantify liabilities based on historical trends, and the recognized actuarial methods for estimation as stipulated by the IRDA Regulations."

The Assessing Officer (AO) for the relevant years deemed both the provision for unsettled claims and IBNR as contingent liabilities, thereby rejecting their validity under Section 37. However, the assessee argued that the provision for unsettled claims should not be considered ad hoc or estimated, as it accurately reflects all outstanding claims lodged by policyholders. Upon reaching the Tribunal, it was determined that the provision for unsettled claims did not constitute a contingent liability but rather an ascertained liability, making it eligible for deduction under Section 37 of the Income Tax Act.

The Bench, regarding unsettled outstanding claims, agreed with the Tribunal's stance that these provisions are not ad hoc but are grounded in claims lodged by policyholders. It emphasized the distinction between incurring liability and quantifying it, asserting that subsequent adjudication of claims does not invalidate the validity of such provisions.

Concerning IBNR claims, the Bench underscored their necessity under Insurance Regulatory Development Authority (IRDA) regulations, noting that these provisions rely on actuarial estimates and empirical data from established predictive methodologies.

In addition to the criteria for creating provisions in financial records, the Bench referenced the "substantial degree of estimation" criterion established by the Supreme Court in Rotork Controls India Private Limited v. Commissioner of Income Tax, Chennai. It emphasized that liabilities based on empirical data or recognized methodologies cannot be classified as contingent liabilities.

Further explaining, the Bench clarified that additional provisions for warranties made in subsequent years, if supported by actuarial studies, do not constitute contingent liabilities and are deductible as revenue expenditure.

Consequently, the High Court upheld the Tribunal's decision, dismissing the Revenue's appeal and affirming that provisions for IBNR claims are not contingent liabilities, being reasonably estimated using historical trends and established actuarial methods.