2013 (7) TMI 1252 - AT - Income Tax

Revenue appeal dismissed as AO wrongly rejected assessee's average-cost closing stock valuation; additions disallowed with books properly maintained

ACIT CIR 25 (3) Mumbai Versus Uday M Ghare

ITAT, Mumbai dismissed the revenue's appeal, holding the assessing officer's rejection of the assessee's average-cost method for closing stock valuation ... Addition on account of method of accounting and valutation of closing stock - assessee was in the business of manufacturing and trading of jewellery - HELD THAT:- Approach adopted by the AO is not correct. The assessee has maintained proper books of accounts in which no defects have been pointed out by the AO either in the purchases or in the sales. The accounting results as per the profit/loss and trading account prepared by the assessee could not be rejected unless some defects are pointed out in the books of accounts. AO has not accepted the method of valuation of closing stock, which was the average cost basis. The assessee has explained the difficulty in following the Lifo or Fifo method as in the sale bills only the net rate and value have been given and it was not possible to correlate various items or inputs which have gone into the manufacturing of jewellery. In such a situation the average cost method has been followed. The average cost method is one of the accepted methods of valuation of as held in Jagdish Chand [2003 (6) TMI 441 - ITAT CHANDIGARH] Such method has also been held valid in several other cases. Secondly in this case, the AO himself has accepted the average cost method in the earlier years as well as in the subsequent year as claimed by the assessee which has not been controverted before us. It is a settled legal position that the profit has to be computed as per the method of accounting regularly followed b the assessee. Therefore, once the average method has been accepted in the earlier year as well as in subsequent years, the same cannot be rejected in the intervening period. The AO has also not placed on record any material to show that gross profit rate or net profit rate declared by the assessee was lower compared to in the earlier years or in relation to similar comparable cases. Appeal filed by the revenue is dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer (AO) is justified in changing the method of accounting/valuation adopted by the assessee (average cost over opening stock and purchases) to FIFO/LIFO for computation of gross profit and making consequential additions, where the assessee has regularly followed and maintained books under the average method. 2. Whether the AO can reject the accounting results and determine gross profit by treating entire opening stock as sold and computing profit on opening stock and purchases separately, without pointing out defects in books of account or adducing material to show incorrectness or incompleteness of accounts. 3. Whether valuation of closing stock on average cost is an acceptable and recognized method in the context of jewellery trading/manufacturing, particularly where sale invoices do not identify constituent inputs and point-to-point matching of purchase to sale is not possible. ISSUE-WISE DETAILED ANALYSIS Issue 1: Legitimacy of changing the accounting/valuation method (average cost ? FIFO/LIFO) Legal framework: A taxpayer is ordinarily entitled to follow a method of accounting/stock valuation regularly adopted, subject to compliance with accounting principles and statutory requirements; change is permissible only with sound justification or where accounts are found defective. Precedent treatment: The Tribunal has upheld the principle that once cost is adopted and consistently employed, the assessee should not be compelled to change the basis; prior decisions treat average cost as an accepted method of valuation and disallow arbitrary method changes by revenue. Interpretation and reasoning: The AO substituted the assessee's average-cost method with FIFO/LIFO, treating opening stock as entirely sold and recomputing gross profit on that basis. The Court finds this approach incorrect where: (a) the assessee consistently applied average-cost in prior and subsequent years; (b) no defect in books of account was pointed out by the AO; and (c) the AO did not produce material showing that the regularly adopted method produced incorrect or misleading results. The unique nature of jewellery items (variations in size, purity, colour) and absence of point-to-point linkage between purchase inputs and sale invoices further impede application of FIFO/LIFO. Ratio vs. Obiter: Ratio - An AO cannot arbitrarily change a consistently applied method of accounting to FIFO/LIFO and recompute profits without demonstrating defects in the books or material justifying such change. Obiter - Observations on the peculiar difficulties in applying FIFO/LIFO to jewellery where sale bills show only net rate/value; while persuasive, they support the principal ratio. Conclusion: The AO was not justified in changing the assessee's method of accounting; the change and resulting additions are disallowed. Issue 2: Validity of rejecting accounting results and separate computation of profit on opening stock and purchases absent defects or material Legal framework: Rejection of books or accounting results requires specific and cogent reasons - defects, incompleteness, or material discrepancies - before the AO can substitute his own computation of profits. Precedent treatment: Prior decisions affirm that mere suspicion or speculative adjustments are insufficient; the revenue must point to misstatements or errors in records to justify overriding the assessee's accounts. Interpretation and reasoning: The AO rejected the assessee's profit and trading account and computed gross profit by assuming entire opening stock sold and calculating profit on opening stock and purchases separately, producing substantial additions. The Tribunal notes that no defects in purchases or sales records were pointed out, and quantitative details were maintained. In absence of any material demonstrating incorrectness or incompleteness, rejection of accounting results is impermissible. Ratio vs. Obiter: Ratio - Authorities support that accounting results cannot be rejected without pointing out defects; absent such material, AO's recomputation is unsustainable. Obiter - The consequence that revenue would not gain by method change across years because adjustments would flow into subsequent years; relevant but ancillary. Conclusion: The AO's rejection of accounting results and separate recomputation of profit is unjustified and the additions based thereon must be deleted. Issue 3: Acceptability of average-cost method for valuation of closing stock in jewellery business Legal framework: Accounting standards and recognized valuation methods include average-cost valuation; choice of a reasonable, consistently applied method is respected for tax computation unless challenged with proper justification. Precedent treatment: Tribunal decisions cited have upheld average-cost valuation where it was regularly followed and the books were reliable; instances where FIFO/LIFO were required turned on the availability of point-to-point matching or specific transactional records. Interpretation and reasoning: The assessee consistently used an average of opening stock and purchases to value closing stock, maintained quantitative details, and could not be expected to apply FIFO/LIFO because sale invoices recorded only net rates/values and did not identify constituent inputs used in manufacturing ornaments. The AO himself had accepted average-cost in earlier and subsequent years. There was no evidence that the declared gross/net profit ratios were abnormally low relative to earlier years or comparables. Ratio vs. Obiter: Ratio - Average-cost is an accepted and valid method for valuation of closing stock in the circumstances described; continuity of method and absence of book defects compels acceptance. Obiter - Practical difficulties in applying FIFO/LIFO to jewellery transactions where invoices lack granular input details. Conclusion: Valuation of closing stock on average-cost basis is acceptable; AO's valuation on FIFO basis and addition for suppression of closing stock is unwarranted. Cross-reference and overall conclusion All issues are interrelated: the AO's attempt to change valuation method (Issue 1) and to reject accounting results (Issue 2) impacted closing stock valuation (Issue 3). In absence of pointed defects, material, or comparative anomalies, the Tribunal upholds the assessee's consistently applied average-cost method and sustains the appellate authority's deletion of the additions made by the AO.