2005 (11) TMI 26 - SC - Income Tax

Accounting method rejected under s.145 for valuing closing stock at market price when market exceeded cost

Sanjeev Woollen Mills Versus Commissioner of Income-Tax

SC upheld the Assessing Officer and HC: the AO validly rejected the assessee's method under s.145 because the closing stock was valued at market when ... Valuation method of closing stock - Export - firm engaged in the imports of synthetic waste and manufacture and export of woolen blankets - power exercised by the Assessing Officer under section 145 - method on the mercantile basis right from the inception of its business - HELD THAT:- It is apparent that the Assessing Officer as well as the High Court were impressed by the factor that the method adopted by the assessee in computing the income results in showing of abnormally gross profit ratio and that was done for the purposes of taking benefit under section 80HHC for the first year and for reducing the profit in the second year by showing the value of the finished products at the market rate at the end of the first year and in the beginning of the second year. Although it is correct to say that the regular method of accounting adopted cannot be rejected by the Assessing Officer merely on the basis of profit earned or loss suffered by the assessee in a particular year but that can be certainly a reason for an Assessing Officer to make deeper probe of the accounts to find out whether the accounts reflect the real income, profits and gains of the assessee. Under section 145 of the Act chargeable income has to be deduced from the accounts regularly employed by the assessee, if in the opinion of the Assessing Officer the accounts are correct and complete. The Assessing Officer can apply a different method of accounts to deduce the income chargeable if in his opinion from the method employed by the assessee the chargeable income cannot properly be deduced. The recognized and settled accounting practice of accounting with the closing stock in the accounts has to be valued on cost basis or at market value basis if the market value of the stock is less than the cost value. In the present case the assessee has not adopted the established and settled practice. The market value of the stock has been taken into consideration while arriving at chargeable income although the market value of the stock is more than the cost value of the stock. The profit earned is only notional. There is no transfer of the goods and the closing stock remains the opening stock of the next accounting year. The income which has not been derived by the assessee cannot be said to be the income chargeable for income-tax and, therefore, the rejection of the accounts maintained by the assessee for the valuation of the closing stock by the Assessing Officer and confirmed by the High Court is in accordance with law. The power exercised by the Assessing Officer under section 145 is as per the principles enunciated by various authorities and the courts. We do not find any good or sufficient reason to interfere with the order passed by the High Court. The appeals are dismissed with no order as to costs. Issues Involved:1. Valuation method of closing stock.2. Application of Section 80HHC of the Income-tax Act, 1961.3. Application of Section 145 of the Income-tax Act, 1961.4. Consistency in the method of accounting.5. Determination of true profit and income.Issue-wise Detailed Analysis:1. Valuation Method of Closing Stock:The core issue revolves around the method adopted by the assessee for valuing the closing stock. The assessee valued the closing stock at market price, which resulted in a stark contrast in the gross profit ratio for the accounting years 1990-91, 1991-92, and 1992-93. The Assessing Officer (AO) concluded that this method led to an inflated profit picture, artificially increasing profits to claim benefits under Section 80HHC of the Income-tax Act, 1961. The AO found that the correct principle for valuing inventory should be at cost or market price, whichever is lower, and added an amount of Rs. 2,67,38,280 to the total income of the assessee for the second year.2. Application of Section 80HHC of the Income-tax Act, 1961:The assessee claimed benefits under Section 80HHC for the first year. The AO and the High Court observed that the valuation method adopted by the assessee was a device to inflate deductions under Section 80HHC and suppress profits in the second year. The High Court held that the method adopted by the assessee was incorrect and aimed at tax avoidance.3. Application of Section 145 of the Income-tax Act, 1961:Section 145(1) stipulates that income chargeable under the head 'Profits and gains of business or profession' must be computed in accordance with the method of accounting regularly employed by the assessee. However, if the AO is of the opinion that the method employed does not allow for proper deduction of income, he may adopt a different method. The Supreme Court noted that the AO and the High Court were justified in invoking Section 145 as the method employed by the assessee did not reflect the true income, profits, and gains.4. Consistency in the Method of Accounting:The assessee argued that it had consistently followed the method of valuing closing stock at market price since 1985-86. However, the court emphasized that the method of accounting should consistently reflect true income and should not be adopted merely for tax benefits. The Supreme Court upheld the view that the AO could reject the method if it did not provide a true picture of the income.5. Determination of True Profit and Income:The court reiterated that the true trading result of a business for an accounting period cannot be ascertained without taking into account the stock-in-trade at the end of the period. The valuation of closing stock should be at cost or market price, whichever is lower, to reflect true profits. The court cited precedents, including CIT v. British Paints India Ltd., to support this principle. It was held that the method adopted by the assessee, which resulted in notional profits, could not be accepted as it did not reflect the real income.Conclusion:The Supreme Court dismissed the appeals, affirming the High Court's decision that the method of valuing closing stock at market price adopted by the assessee was incorrect and aimed at tax avoidance. The court upheld the AO's application of Section 145, emphasizing that the method of accounting should consistently reflect true income and not be used for tax planning. The valuation of closing stock should be at cost or market price, whichever is lower, to provide a true picture of the profits and income.