AI Drafter 
TaxTMI 
TaxTMI 
1982 (10) TMI 220
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....efly stated are that the assessee-firm derives income from dealing in precious and semi-precious stones. It sells such ready goods after purchase from the market as well as out of its own manufacture. Goods are also sold through the agency of others mostly the sister concerns. It also undertakes to sell goods of others, again mostly of its sister concerns, as commission agents. The sister concerns mainly are K.D. Jhaveri, Jaipur and Mahendra Jewellers, Jaipur. The assessee is mainly an exporter of precious stones. In the jewellery account, on total sales of Rs. 10,18,213 gross profit shown is at Rs. 4,05,603 which reflects a rate of about 40 per cent. The value of the closing stock shown in this account is Rs. 25,58,907. The ITO has observed that proviso to section 145(1) of the Income-tax Act, 1961 ('the Act') is applicable in the case of the assessee as held by the Tribunal in the assessee's appeal [IT Appeal No. 946 (JP.) of 1979] for the assessment year 1975-76. The ITO has further observed that 'admittedly, the assessee has been valuing its closing stock at cost.' He also observed that this method has been followed by the assessee year after year. Since the actual cost of ....
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.... was Rs. 8.95 54,61,251 Less: Disparity at the rate of 40 per cent 21,84,500 32,76,751 Less: Value of the closing stock as declared by the assessee 25,58,907 Amount by which the closing stock has been undervalued 7,17,844 5. The assessee challenged the above addition before the Commissioner (Appeals) who has upheld the applicability of proviso to section 145(1) but deleted the entire addition, observing as follows: "In my appellate order for 1975-76, I have carefully perused the orders of the Tribunal in appellant's own case and in the case of Mahendra Jewellers as also the order of the Settlement Commission in the case of K.D. Jhaveri Bros. The arguments of the appellant and the department in all these cases were more or less on the same lines as in the case now before me. The uniform conclusion to which both the Tribunal and the Settlement Commission have come is as follows: (i) When the gross profit rate is held to be reasonable by the department, the closing stock should be treated to have been correctly valued even though there may be no supporting evidence in the form of a verifiable closing stock inventory. ....
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....voice is nearer the date of production than the exchange rate prevalent as on the closing day of the accounting year. Therefore, in the fitness of things the exchange rate as adopted in the proforma invoice is simultaneously giving the price both in terms of the dollar and the rupee would be the most proper. Hence, there is no justification for substituting the rate of Rs. 8.95 per dollar as on the valuation date to convert the closing stock value of the goods lying unsold abroad in terms of dollar into rupee. Hence the addition made in this regard is to be deleted." 6. The revenue is aggrieved against the deletion made by the Commissioner (Appeals). Shri P.C. Hadia, on behalf of the revenue, submitted that the disparity rate adopted by the assessee was imaginary. It had no basis whatsoever and the assessee was changing the same year after year suiting its convenience. He further submitted that the disparity rate of 48 per cent adopted by the assessee had no basis, whereas the disparity rate of 40 per cent adopted by the ITO was held to be reasonable by the Tribunal for the assessment year 1975-76. He further pointed out that the finding by the Commissioner (Appeals) that reason....
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....een accepted by the Tribunal for the assessment year 1975-76 while it has been restored to the Commissioner (Appeals) for the assessment year 1976-77. Based on above facts he urged that since the disparity rate adopted by the assessee at 48 per cent is the same as gross profit rate, the closing stock was properly valued by the assessee and as such there was no under valuation thereof so as to warrant any additions. Shri N.M. Ranka also pointed out that since the export invoice value is the one which is offered by the assessee, it is likely to be below that price on actual sale depending upon the negotiations and at any rate it would not go beyond the export invoice value or the asking price. It is because of this likely fluctuation that cushion of 1 to 2 per cent is kept which is added to the gross profit rate. The disparity rate in such circumstances is a little more than the gross profit rate. Shri N.M. Ranka also referred to the varying disparity and gross profit rates in cases of sister concerns of the assessee as well as in the case of the assessee itself for various assessment years tabulated at page 1 of the compilation, which are as under: COMPARATIVE CHART OF EIV BOOK V....
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....ed for even though proviso to section 145(1) may be applicable, technically. He also pointed out that by taking into consideration the addition of Rs. 7,17,844 made by the ITO on account of alleged under valuation of closing stock, the gross profit rate works out to 125 per cent which is absurd and unsupported by any comparable cases by the revenue. He then referred to the exchange rate for conversion of dollar into Indian rupee. He submitted that at the time of export of the goods abroad export invoice is prepared which indicates the asking price in dollars. At the bottom of this document, the conversion rate in Indian rupee is also given. In this connection he referred to paper book pages 63, 64 and 65. He submitted that the same conversion rates as are indicated in the export invoices from time to time are adopted for the goods not actually sold and lying in closing stock at the end of the year and this method was regularly followed by the assessee year after year and accepted by the department. The ITO had also not recorded any finding that true profits cannot be deduced by following such method consistently. The ITO had also not given any basis for adopting disparity rate of 4....
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....and, therefore, those cases could not be relied upon. Similarly, he pointed out that other comparable cases relied upon by the assessee could not be compared in the absence of complete details and the nature of the business done by the assessee and the mode of valuation of the closing stock in those cases. Regarding the exchange rate for conversion of dollar in respect of goods in the closing stock, Shri H.R. Lodha, supported the order of the ITO. 10. From the above submissions made by the rival parties, the following points emerge for our consideration: A When the gross profit shown is reasonable, whether it would still be necessary to value the closing stock to arrive at the gross profit? B Whether the closing stock is to be valued first to arrive at the gross profit rate and disparity rate is then to be adopted. C Principles to be followed for adopting the gross profit and disparity rates for arriving at the cost price with reference to export invoice value (EIV) (asking price)? D Whether the assessee has adopted the correct diparity rate in valuing the closing stock? 11. Before answering the above points, we would like to state in brief....
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.... with reference to the sale price recorded in the account books. The gain or loss in conversion will cover two situations, viz., ( i) gain or loss of exchange rate on the dates of actual sales with reference to exchange rate mentioned in EIV, and (ii) gain or loss on account of revaluation or devaluation of currencies on the date of remittances as compared to the exchange rate on the date of actual sale. This will be clear from the following illustrations. The exchange rates adopted in EIV are Rs. 7.50 and Rs. 8.50 per dollar. Let us take exchange rate in the EIV of Rs. 7.50 per dollar. Suppose on the date of actual sale the exchange rate is Rs. 8.50 per dollar and on the date of remittance to India at Rs. 9.75. The gain of Rs. 1 per dollar (Rs. 8.50 minus Rs. 7.50) will fall under the first category and that of Rs. 1.25 (Rs. 9.75 minus Rs. 8.50) under the second category. Remittances during the accounting period may be for sales during the same year or even of the earlier year. 12. With this background we shall consider the above questions. Our answers to the above questions are that the value of the closing stock on the principles of accountancy has to be made to arrive at the....
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....m the asking price to arrive at the cost price. Whatever rate of gross profit is arrived at, that rate will also be the disparity rate. There will, therefore, be no difference between the disparity rate and the gross profit rate. To strengthen our view that closing stock is to be valued first to arrive at the correct gross profit rate and the correct valuation of the closing stock would reflect the correct gross profit (of course subject to other considerations) and that the disparity rate and the gross profit rates have to be the same, we shall give the following illustrations of three different assumed trading accounts. Trading Account (1) Rs. Rs. Purchases including open- ing stock (20 items at the rate of Rs. 1,000 each) Sales (15 items) 20,000 Closing stock (5 items at cost, i.e., at the rate of Rs. 1,000 each) 20,000 Gross profit 5,000 5,000 25,000 25,000 Gross profit percentage with respect to sales 25 per cent Gross profit percentage with respect to cost 33.33 per cent Trading Account ( II) Rs. Rs. Purchases including o....
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.... cost. In this account the gross profit rate works out to 25 per cent. If closing stock had been valued correctly at Rs. 5,000 as in the second trading account, the gross profit rate would have been at 37.5 per cent. In this case, the closing stock is undervalued but the reasonable gross profit rate of 25 per cent as in the first trading account is maintained. Even though, there is reasonable gross profit in the third account as compared to the first trading account but the profits are understated by Rs. 3,000. The inferences to be drawn, therefore, are that closing stock has to he valued for arriving at the correct gross profit and the resultant figure will be the correct gross profit. We shall now test the accuracy of the above principles by working out the market price from cost price. The cost price in the first trading account of 5 items left in the closing stock is at Rs. 5,000. From this value, we have to arrive at the market price. The gross profit rate in the first trading account is at 25 per cent with reference to the sale price and 33.33 per cent with reference to the cost price. For arriving at the market price from the cost price, the cost price has to be increased by....
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.... to be adopted with reference to EIV, then the EIV will remain unchanged. The adoption of uniform rates of exchange for converting dollars into rupees at the rate of Rs. 7.50 per dollar up to 30-6-1976 at Rs. 8.50 thereafter, in our opinion is not a correct approach. The correct approach should be to record the sales by converting the price in dollars at the exchange rates prevailing on the actual dates of sales. The argument on behalf of the assessee that the exchange conversion gains of Rs. 1,61,535 will take care of this situation, will only be partly correct. We have pointed out earlier in paragraph No. 11, the two components of such gains or losses. Only the gains or losses falling under the first category and that too on account of part sales made during the accounting period will cover this situation. This will not reflect gain or loss of sales for the entire accounting period. It will partly cover gains of periods prior to the accounting period. Then there is no basis to sort out as to what remittances related to arrears of earlier period and which to sales of current accounting period. The proper course, therefore, would be to work out sales with reference to the exchange ....
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....his account. In other words, the assessee's own manufactured goods of the value of Rs. 1,72,897 (1,34,267 plus 38,630) are also included in the jewellery account. We have pointed out earlier that in own manufactured goods, the profit rate is generally more than the ready goods. The quantity of manufactured goods included in the jewellery trading account is much less as compared to the ready goods. We, therefore, presume that sales of such goods included in the total sales are also of small quantity. Since the quantity of own manufactured goods which may have been included in the total sales is very small, it shall not materially vary the gross profit rate. We have already said earlier that gross profit rate and the disparity rate would be the same. Shri N.M. Ranka from pages 182 to 183 and 184 tried to show that the gross profit or the disparity rate in respect of the assessee's ready goods was 45.3 per cent and in respect of Jakhad goods at 46 per cent. Perusal of statement at pages 182 and 183 would show that total purchases shown therein are Rs. 18,884.15 and EIV at Rs. 34,631.81. The statement further shows that sales shown therein are at exchange rates of Rs. 7.50 or 8.50 per ....
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....oss profit rate on the lower side of 59 per cent. At any rate we do not accept these statements as the correct reflection of the gross profits earned by the assessee. 17. The gross profit in the jewellery account as per the copy of account filed in the paper book of is about 40 per cent. By adding exchange rate gains of Rs. 1,61,535 the gross profit rate works out to 48 per cent, which as pointed out earlier has not been controverted by the departmental representative. We have also held earlier that gross profit rate and the disparity rates have to be the same. Since the gross profit rate and disparity rate in the present case are materially the same, it presents no difficulty. Since the revenue has not brought on record the component of the exchange rate gains representing the appreciation in money value, we take the gross profit rate of 48 per cent as nearly correct. In this view of the matter, we hold that disparity rate of 48 per cent adopted by the assessee calls for no interference. The second point for consideration is the value to be adopted in converting the asking price. We have pointed out earlier that the scientific approach would be to adopt the exchange rate prevai....
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....ent 1,280 (vii)Stationery 1,981 32,653 On behalf of these 16,326 42,326 One-third of Rs. 42,425=Rs. 14,142 The weighted deduction at the rate of one-third of expenses of Rs. 42,425 was allowed by the ITO. The ITO observed that the assessee was mainly engaged in the export of precious stones. During the accounting period relevant to the assessment year under appeal, total sales were at Rs. 15,79,947 out of which export sales were to the extent of Rs. 12,50,280. The ITO, therefore, observed that the export activities of the assessee appeared to be half of the total business. In view of this position, he was of the opinion that expenses on postage, salary, rent and stationery to the extent of half of the claim could only qualify for deduction under section 35B. This is how the ITO worked out the qualifying amount for deduction under section 35B at Rs. 42,425. The assessee aggrieved against the above working of the ITO went up in appeal before the Commissioner (Appeals). One of the claims was that the export sales were more than 75 per cent of the total sales a....