TaxTMI 
TaxTMI 
TaxTMI 
2001 (5) TMI 945
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....llowable to the assessee under section 80HHC. 2. Briefly the facts are that the assessee is a public limited company and it filed its return of income for the assessment year 1995-96 on 30th Nov. 1995 declaring an income of ₹ 7,88,39,962. The assessee derives income from manufacture of worsted woollen fabrics, woolen felt and it also has a chemical division named as Platewel Processes & Chemicals. 3. During the course of assessment proceedings, the Assessing Officer required the assessee-company to submit complete details in respect of valuation of various types of finished goods and came to the conclusion that the assessee has not properly valued the closing stock. During the course of assessment proceedings, it was explained by the assessee-company that it has been valuing its closing stock by "Direct Costing Method" and the same method was being followed this year. In the notes forming part of the company's published accounts at p 37 while dealing with the question of valuation of inventories it was indicated as under: (i)Materials in process is valued at cost. Cost is arrived at considering direct material, direct labour and direct factory overheads upto the ....
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....h items debited to the P&L a/c are as under: Description Total as per P&L a/c Pertaining to Platewel Division (Chemicals Dvn.) Balance Rs. Rs. Rs. Depreciation 3,67,92,309 2,55,142 3,65,37,167 Machinery 2,24,08,230 2,24,08,230 Repairs Building 44,85,278 1,65,379 43,19,899 Repairs Other repairs 9,49,052 1,20,779 8,28,273 Technical fees 71,01,302 71,01,302 Employees emoluments: Total: 6,95,82,272 Less: Considered by the Co. 2,26,07,852 4,69,74,420 43,13,059 4,26,61,361 Travelling and Conveyance 37,80,416 4,60,644 33,19,773 Rent 4,78,328 24,416 4,53,912 Rates and taxes 4,87,280 62,509 4,24,771 Insurance 17,46,328 1,63,772 15,82,556 Directors' Remuneration 9,25,000 9,25,000 Interest-other 80,63,899 1,25,442 79,38,457 Total 12,85,00,701 On the basis of the aforesaid stand, the Assessing Officer make an addition of ₹ 68,89,089 to the company's returned income on the ground that the company having not considered the above items of cost, for the purpose of valuation, its closing stock of finished goods were undervalued by that amount and as such true profit of the company could not be worked out and technically the proviso ....
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.... by the Department also and as such there is no justification for the Department to suddenly take a U-turn and say that the method adopted by the assessee is defective and therefore a huge addition of Rs.. 68,89,089 is required to be made. It was submitted that the CIT(Appeals) has failed to appreciate that in the cost method of valuation of closing stock there are two options available to the assessee viz., "direct cost method" and "indirect or total or on cost method", or "absorption cost method". It was pleaded that the assessee had been following the "Direct Costing Method", a method which has not been disapproved even by the Supreme Court in the case of British Paints India Ltd. case (supra) on which the Assessing Officer as well as the CIT(Appeals) have relied upon. It was submitted that the "Direct Costing Method" is also approved by the Hon'ble Madras High Court in the case of CIT v. Carborandum Universal Ltd. case (supra) and the Department's SLP against the above decision of the Madras High Court has since been dismissed by the Hon'ble Supreme Court reported in [1991] 187 ITR (St.) 38. It was pleaded that the "Direct ....
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....nd the Assessing Officer has wrongly invoked the proviso to section 145(1) for making this addition, it was submitted that the "Direct Costing Method" adopted by the assessee-company envisaged the valuation of stock after taking into account only the following elements of costs: (a)Cost of materials; (b)Direct labour and direct expenses (if any); and (c)Variable production overheads. Thus the above method of "Direct Costing" envisages total exclusion of fixed costs and it also excludes overheads other than variable production overheads such as: (a)Selling and distribution expenses; (b)General administration overheads; (c)Research and development cost; and (d)Interest. It was submitted that at the cost of repetition it may be emphasized that the "Direct Costing Method" considers only those production overheads which are variable in nature whereas the other recognised method of valuation viz., "Absorption Costing" considers all production overheads, whether fixed or variable. However, it was emphasized that even the "Absorption Costing Method" does not consider overheads other than the production overheads. 5.2 In view of th....
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....as taken into account direct labour cost of ₹ 2,26,07,852 for the purpose of valuation of stock of finished goods and the figure has been arrived at as under : Total employees' emoluments : 6,95,82,272 Less : Amount pertaining to Platewel Division 43,13,059 4,26,61,361 Salaries in general and wages of service deptt. 2,26,07,852 (vii)Travelling and conveyance not being an item of production overheads, there can be no question for considering the same under "Direct Costing". (viii)Similarly, rent, rates and taxes, insurance and directors" remuneration being all items of fixed overheads cannot be considered under "Direct Costing". (ix)Interest being a finance cost, being an item of period cost by definition and in any case not being part of production overheads (much less, of variable provision overheads), cannot be considered for valuation under the "Direct Costing". 5.3 It was submitted that the above submissions are being supported by the decision of the Madras High Court in the case of CIT v. Carborandum Universal Ltd. (supra) which is a direct authority not only showing that "Direct Costing" is a recognised method of ....
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....be deleted. 6. The learned senior Departmental Representative strongly relied on the orders of the Assessing Officer as well as the CIT(A) and further submitted that there is a distinction between the terms "Costs" and "Price". It was submitted that the term "Cost" includes something more than the price and since the items of expenditure taken into consideration by the Assessing Officer in the assessment order are relatable to the production of goods by the assessee-company these ought to have been taken into consideration while determining the cost of finished goods for the purpose of valuation of closing stock. Reliance was placed on the decisions in the cases of Arvind Mills Ltd. v. CIT 1978 CTR (Guj.) 90 : [1978] 112 ITR 64 (Guj.) and CIT v. Nirlon Synthetic Fibres & Chemicals Ltd. [1981] 25 CTR (Bom.) 155 : [1982] 137 ITR 1 (Bom.) and on the decision of the Supreme Court in the case of British Paints Ltd. (supra). The learned senior Departmental Representative read extensively from pp 10 to 13 of the assessment order and submitted that various items of expenditure considered by the Assessing Officer are related to the production and as such were ....
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....osting is the method whereby the cost of inventories is determined so as to include the appropriate share of both variable and fixed costs, the latter being allocated on the basis of normal level of production. 6.7. Variable costs are those costs of production which vary directly, or nearly directly, with the volume of production. 6.8. Fixed Costs are those costs of production which by their very nature remain relatively unaffected in a defined period of time by variations in the volume of production. On the basis of the above guidelines given by the Institute of Chartered Accountants of India, it is clear that the "Direct Costing Method" employed by the assessee-company is one of the recognised methods of valuation which includes- (1) Cost of purchase; (2) Cost of conversion which are specifically attributable to units of production, i.e., direct labour, direct expenses and sub-contracted works and variable production overheads ascertained in accordance with the Direct Costing although all fixed costs which remain unaffected in a defined period of time by variations in the volume of production are excluded as those could be taken into consideration only in the Absor....
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....ied by the Central Government from time to time for various businesses. This provision is being made applicable from accounting year starting from 1st April, 1996." The relevant portion of the Memorandum explaining the provisions of the Finance Bill, 1995 reads as under : "Methods of accounting and accounting standards for computing income-The existing section 145(1) of the Income-tax Act provides for computation of income from business or profession or income from other sources in accordance with the method of accounting regularly employed by the assessee. Income is generally computed by following one of the three methods of accounting, namely, (i) cash or receipts basis, (ii) accrual or mercantile basis, and (iii) mixed or hybrid method which has elements of both the aforesaid methods. It has been noticed that many assessees are following the hybrid method in a manner that does not reflect the correct income. It is proposed to amend section 145 to provide that income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall be computed only in accordance with either the cash or the mercantile syste....
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.... any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment". Thus, it has to be concluded that the assessee who is following the "Direct Costing Method" for the purpose of valuation of closing stock, is not only following the method recognised by the Institute of Chartered Accountants of India statutorily constituted under the Chartered Accountants Act, 1949 and in the absence of any accounting standard in that behalf notified by the Central Government pursuant to the provisions of the newly inserted section 145 w.e.f. 1st April, 1997, it continues to be a recognised method even today and shall continue to be so till such time as the Central Government prescribes an Accounting Standard pursuant to the provisions referred to supra, disapproving the "Direct Costing Method". Thus out of the various items of expenditure listed in the assessment order which have also been reproduced by us in para 3, it is pertinent to note that the assessee itself has taken into consideration direct labour and direct expenses along with variable production overheads into consideration while valuing the....
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....at pp 761 to 763 in the case of Carborandum Universal Ltd. (supra) reads as under : ".........The assessee by its letter dated 22nd Dec. 1973, had stated that the basis of the valuation of the closing stock was as follows : (1) Raw materials at cost (2) Work-in-progress at direct cost (3) Finished goods at direct cost (4) Other goods at cost In that letter the assessee also pointed out that it has been following the mercantile system of accounting, and that there is no change in the said method of accounting followed by it, but that it has changed only the manner of valuation of certain items (of closing stock), that while the valuation of closing stock in respect of all items in the earlier years was being done at cost, which term was understood to be "total cost" the valuation in respect of the accounting year ended 31st August 1970, has been changed in respect of "work-in-progress" and "finished goods" from "total cost" to "direct cost" and that the difference between the total cost and the direct cost is that in the cost, the overheads such as administrative department expenses are excluded, while in the total....
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....s. Income, profit and gains must, however, be computed in the manner provided by the Act. It is the duty of the officer to determine the profits and gains of a commercial adventure according to the correct principles of accounting. Thus any method of accounting which is in conformity with the well recognised principles of accountancy, cannot be regarded as such that income can not be properly deduced therefrom. The Assessing Officer as well as the CIT(A) have not correctly appreciated the true ratio of the Supreme Court decision in the case of British Paints India Ltd. (supra) because in the above said judgment a regular system of accounting has been referred to as a system regularly employed by the assessee from year to year. There is nothing in the decision which says that even a recognised method of valuation of stock can be rejected by the Assessing Officer. The true ratio of the Supreme Court decision is that the Assessing Officer is not prevented from rejecting a particular method of valuation of stock merely because it was accepted by the Department in earlier years. The Assessing Officer is fully entitled to and in fact duty bound to reject the method if, in his opinion, th....
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....nces of the case, we are of the opinion that the addition of ₹ 68,89,089 made by the Assessing Officer as sustained by the CIT(A) for alleged under valuation of closing stock of finished goods, is not justified and is directed to be deleted because the assessee has been regularly following a recognised method of accounting known as "Direct Costing Method" which is approved by the Institute of Chartered Accountants of India and it has not been subsequently disapproved by any notification by the Central Government in the Official Gazette as envisaged in section 145(2). Accordingly ground of appeal No. 1 is allowed. 8. Coming to ground of appeal No. 2, Shri J.P. Shah, the learned representative of the assessee submitted that the issue in dispute is squarely covered in favour of the assessee as per the decision of the Bombay High Court in the case of Bralco Metal Industries (P.) Ltd. v. CIT [1994] 206 ITR 477 (Bom.) as the expenditure was incurred on foreign travel for the purpose of inspection of machinery to ascertain whether second-hand machinery was in order or not and then to decide whether to purchase or not and on what terms and conditions. The learned Departmen....
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....4 CTR (SC) 283 : [1974] 97 ITR 615 (SC) and McDowell & Co. Ltd. v. CTO [1985] 47 CTR (SC) 126 : [1985] 154 ITR 148 (SC) the excise duty should be considered as a part of the turnover and as such the Departmental authorities were justified in including the excise duty in the turnover for working out the deduction admissible under section 80HHC. 11. We have considered the rival submissions. The Tribunal Pune Bench in the case of Sudarshan Chemicals Ltd. (supra) has considered all the three cases relied upon by the learned Departmental Representative while dealing with the computation of deduction under section 80HHC in the context of determining the total turnover and has held as under : "The formula laid down to arrive at the profit derived from the export in section 80HHC is : Profit of business × export turnover\ total turnover The only intention of the legislature in applying the aforesaid formula is to find out the profits derived from the export. Therefore, the turnover should be restricted to such a receipts only which have elements of profit in it. It is the only actual sale price which is relevant and, therefore, anything charged by the assessee by way of stat....