TaxTMI 
TaxTMI 
1986 (3) TMI 105
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....tion : The ITO found that the assessee was valuing the closing stock exclusive of customs and other fiscal levies. According to the ITO the customs duty on raw materials could not be excluded from the valuation of the goods in stock since it formed an important element in the total cost of the goods. The value of the stock could be made at cost or market price whichever is lower but could not be less than the cost if the cost price was less than the market price. The ITO, therefore, held that the method of valuing the closing stock adopted by the assessee had no scientific basis and the accounts did not indicate the correct profits the assessee earned during the year. Apart from customs duties there were also other fiscal levies, like excise, octroi duty, etc. 4. The ITO, therefore, estimated the value of the closing stock on a proportionate basis of the total duty paid on the goods of both imported and indigenous varieties consumed by the assessee. The total consumption of imported and indigenous goods came to about Rs. 13.52 crores on which the customs duty worked out to Rs. 3.93 crores which worked to an average of 29 per cent. The assessee disclosed closing stock of raw mate....
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....had been made on the principle of direct cost plus labour and fuel but not fiscal levies. Thus, for both finished goods as well as work-in-progress, the fiscal levies have been omitted. But, this, according to the learned counsel, has been done not only in a systematic manner but regarding it as a thoroughly ascertainable and scientific method. 6. Objecting to the method/procedure followed by the department, the learned counsel has pointed out that on this basis the stock as on 1-1-1976 would have to be revalued. The opening stock of 1976 will not tally with the closing stock of 1975. The department gave notice for revaluing the closing stock of 1975 and the assessee had to approach the High Court on a writ and the High Court had granted stay. Whatever be the earliest year in which the revaluation of stock is attempted, the opening stock cannot tally with the closing stock of the earlier year and the accounts have to be disturbed continuously and from year to year. Since the assessee had been following the same method without any change from year to year, the disturbance of the valuation of the closing stock would not affect, over the period of years, the income of the assessee.....
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....of the assessee's business. It cannot also be stated, according to the learned counsel, that the profit of the business cannot be ascertained. The department's right of interference under section 145 of the Act comes in only when the accounts do not giver a correct picture and the profit cannot be properly ascertained. In other circumstances, the department cannot interfere with the method of accounting regularly followed by the assessee. 9. The learned counsel had relied on British Paints India Ltd. v. CIT [1978] 111 ITR 53 (Cal.), as directly supporting his case. Qualified chartered accountants have given unqualified reports of valuation for all years. It was, therefore, difficult, and even erroneous, to hod that the method is incorrect. Apart from fixing the amount of duty to any particular stock on hand, the vast divergence in the amount of duties also affect such valuation. British Paints India Ltd.'s case has clearly laid down the relevance of method regularly followed by the assessee. In that case, the Tribunal's decision was against the assessee but the High Court laid down that there was no rule of law about the valuation at cost or market value. The assessee is, moreov....
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....n the case of Duple Motor Bodies Ltd..The assessee cannot have any particular motive in following this system of stock valuation especially over a period of nearly two decades. That this is the position would be clear also from certain observations of the Tribunal in Goodlass Nerolac Paints Ltd.'s case. Since over the years there cannot be any loss to the revenue or gain to the assessee on account of the stock valuation according to the learned counsel disturbance of the stock valuation was a mere futile exercise. 12. Further, dealing with the points made out on behalf of the revenue, it is pointed out that the rule of cost or market followed by the accountants for valuing the closing stock cannot be elevated to the position of a rule of law. The only rule that both accountancy and income-tax recommends is that the method of valuation should be one from which profit can be reasonably well ascertained. Apart from the fact that these are not hard and fast rules, stock valuation has no bearing on the components of the cost; the valuation must also not take into account unearned profit. Stress is laid on the positive and negative data under which the fiscal levy was worked out, even....
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....5] 99 ITR 135 (SC). 15. The ITO and the IAC visited the factory of the assessee and examined the records. It is pointed out that even after this, they could not properly identify the items of the raw materials or the duty paid. It is against these defects that the principle of averaging has been evolved. The company law authorities had investigated the assessee's affairs both from the point of view of dumping and also stock valuation as directed by the Income-tax Department. Being satisfied about the correctness of the method they have dropped the proceedings. Stress is also laid, in this connection on certain proceedings before the Delhi High Court in connection with the stock valuation of the subsequent years. Those proceedings pointed out also how the valuation made by different experts. two charted accounts, Shri P. N. Shah and Thakur, Vaidyanath Aiyar & Co., even in respect of computation made by adopting the same broad principles differed. 15.1 The learned counsel for the department has pointed out that over the year it is well settled that closing stock is to be valued at cost or market price. Even though this is only a practice, this practice has been exalted to the l....
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....the closing stock on a particular basis in consonance with the normal, proper and legal method, was known to the department only form the auditors' report on the accounts for the year ended 31-3-1977 where they stated : "In the case of raw materials and the finished goods (other than the merchanting goods) such cost or market value has been determined exclusive of customs and excise duties." Such a statement ccurs at note No. 12 in the auditors' report of the year ended 31-3-1978 also. At any rate, according to the learned counsel, an erroneous assessment for one year does not justify repetition of the mistake for any subsequent year or years. The definciency, if not manipulation, was known to the department for the first time and the ITO sought to rectify it immediately thereafter. One cannot get away from the fact that the closing stock was not valued by the assessee according to law and the normal practice in the trade. It is also pointed out that even the statement of the auditors is not supported by any reference to history or practice. In view of the above defect especially referred to by the auditors, the ITO made inquiries regarding the stock valuation and revalued th....
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....n respect of some of the items. The assessee has also adopted the averaging method of inclusion of levies in the closing stock valuation. The learned counsel referred to the example elaborately set out in the order of the Commissioner (Appeals) which unambiguously showed how the non-inclusion of fiscal levies in the stock valuation distorted the entire profit computation picture. The assessee.itself while valuing the closing stock of finished goods has taken into account some of the direct expenses which conforms to the legal and accountancy requirement of the department's case. In the fact of such an inaccurate and incomplete method of stock valuation which, not merely indirectly bet even directly, distorted the computation of profit, it was clear that the correct income of the assessee for any of the years cannot be properly worked out. 18. The assessee has made huge profits from year to year and the adjustment of the same by following a correct and scientific method of stock valuation urged by the department, showed that huge additions have to be made to the assessee's income not only for one year but for all the years. There is, in fact, no set off from one year to another o....
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....udaliar. According to the learned counsel, the last case cited furnishes as clear answer to many of the doubts expressed. Ultimately, one has to find out what is the cost price in the hands of the assessee. All includible items should be included in working out this figure unless permitted to be excluded either by law or by practice or accountancy principles. Any other arrangement or method of valuation including that of stock would suggest attempts to avoid proper tax payments. Reference is made in this connection, to the dictum of the Supreme Court in the case of McDwell & Co. Ltd. 20. The assessee's claim that the goods are perishable and a particular method of valuation has, therefore, to be adopted, has also no merit. The assessee is a manufacturer of textile fabrics, wool, etc. Polyester fabrics are not like vegetable and other perishable commodities. Even the reference to the change of fashion as a factor in this regard cannot be seriously taken note of. In fact, according to the learned counsel, the assessee pampers to the high elites of the society and non perishability is not a criterion in purchase of goods in such circumstances circles. Reference to section 43B has a....
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....ing to power, labour, etc., he held that the assessee was not following a scientific method of closing stock valuation. It is correct annual income, therefore, could not be worked out properly in view of the method of valuing closing stock followed. He got the closing stock revalued by taking into account the fiscal levies, etc., and made additions to the total income. Both the opening and the closing stocks were valued. the ITO adopted in the absence of accurate figures for these levies and expenditure estimates on a proportionate or averaging method. This is the subject-matter of the dispute. 23. The Act lays down specific methods of arriving at the income of the assessee for the purpose of its assessments. The items of income are worked out under different heads like salary, income from property, business, etc. Separate computation is made of each item of income under the appropriate head and the total income is computed by adding the figures and making any adjustments thereto as laid down by the Act. The expression 'income', which is the subject-matter of assessment, is not defined in the Act. Both from the generality, therefore, of this definition usually derived from judic....
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....iness income computations. The income of the business is computed as the excess earned during the year over the assets it had at the beginning of the year. The definition of 'income' as given in the classic definition in Spanish Prospecting Co. Ltd. In re. [1911] 1 Ch. 92, 98 per Lord Justice Moulton : "'Profits' implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates." is relevant in this connection. 25. In finding out, therefore, the income of a business, the value of the net assets at the beginning of the year and their value at the end has to be computed. In a running business at the end of each year there would be stock accumulated and not sold. The stock would consist of the finished products, work-in-progress at various stages of manufacture or production, raw materials, stores and other accessories, tools and a variety of other items. The net income earned during the year can be evaluated only be taking into account the relativ....
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....es, etc., suddenly switches over to another method, thus, gaining a temporary advantage for a year, that would be wrong. But so long as he follows the same method of valuation for every year of continuance of the business any method of valuation consistently followed with regard to the stock, stores, etc., should be regarded as the correct one. This is primarily because there is no cut and dried absolute method of working out business income ignoring its continuity over the years or assuming its winding up at the end of every year. 27. The department has set much store both from the theoretical as well as practical point of view on methods of valuation of closing stock. It has also been urged that the system of valuing closing stock at market or cost value, whichever is lower, is almost a rule of law. There is a fallacy in these contentions which would be clear from the nature of business income explained at length in the above paragraph. Even accountancy experts advocate the cost or market value whichever is less principle only as one of the best methods. It would be correct for an assessee to value the closing stock at cost for all years, or at market value for all years. If t....
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....e the profit ? And how could that be found out ? This seems to be the issue which the guidelines have considered. In none of the authorities quoted before us any serious discussion as to how in a continuous business following a consistent system of stock valuation, how any method other than that recommended by the guidelines would be defective is not indicated. It would be, therefore, incorrect to say that either what the guidelines have laid down is the best or only method of stock valuation or that all other methods of valuation would be erroneous and will not indicate the correct annual profit of the business. 28. The departmental authorities, while drawing support from expert opinion like the guidelines, have urged that to arrive at the stock valuation other raw materials cost, the manufacturing cost and all other imposts levied and expenditure incurred thereon should be taken into account. As an abstract concept, certainly no objection can be taken to this contention. It is where one comes to apply this principles to practical realities that difficulties emerge. If a simple proposition of an asset on which some definite expenditure is incurred alone is to be considered for ....
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....ems of expenditure on different lots at different times. In addition to the above, work-in-progress itself is a fluid commodity, starting with wool as raw material there is a continuous process of manufacture at various stages going make the finished product. Even if the several stages can be regarded as quantised like the movement of the needle of a watch, the stages of movement are so numerous that it would be impossible to allocate even to an extent of good approximation these levies and expenditure. The work-in-progress may consist of wool in some form, woollen tops at various stages, cloth at various stages, etc. We have, therefore, no doubt, in holding that even form a purely theoretically point of view an accurate method of allocation of expenditure for closing stock valuation is an impossibility. 29. It is against the above background that the assessee has claimed instead of making a futile attempt at accurate allocation of expenditure including fiscal levies for the purposes of stock valuation, it has followed a systematic method of assigning certain items by way of on cost in arriving at the closing stock. The claim made is that insofar as no manipulation is intended o....
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....a self-contained period and so the continuity of business or what happens in the earlier or later year should be ignored, cannot be supported. The department has completely ignored the particular manner in which the business income from other heads. In the case of a continuous business each year telescopes into the subsequent year. Annual income can be worked out only on this understanding. In this context it had been urged that factually there has been as reduction of income for every year in the method of valuation followed by the assessee. The department has relied to support this argument on the computation of the excess to be added while giving effect to the direction of the Commissioner (Appeals). It would appear that the Commissioner (Appeals) has directed the ITO to refer the matter of stock valuation to a chartered accountant. The valuation for two years only have been completed and this gives an increased income for both the years. Evidence in support of the department's case is, thus, limited to two years. The assessee had been following the present method of accounting for about two decades. The valuer chartered accountant has also adopted some methods of averaging, app....
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....would certainly give a wrong picture of profit. 33. The Commissioner (Appeals)'s computation deals with a simple theoretical problem such as one that can be given for the high school students to solve. It ignores the simple fact that the number of variables involved in the computation of closing stock are so numerous that such an easy computation cannot be made. The point made out by the assessee's counsel on the contrary relates to two problems : one the taking into account of labour, etc., charges in valuing the work-in-progress; and the other the relevance of the newly introduced section 43B. As regards the first, the point made out is that in valuing the closing stock of work-in-progress as well as the finished goods, the entire labour charges incurred is taken into account and whatever labour charges are not referable to the items of goods sold would be treated as relevant to stock on hand-finished goods as well as work-in-progress. This entire amount the assessee has added to the stock of finished goods. The department's case is that part of the labour expenses should be added to the work-in-progress. Closing stock includes both work-in-progress and finished goods. If the ....
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....out a particular method being followed. Even so neither the large body of shareholders nor the company law authorities have regarded this as a defect. In fact there seems to have been some proceedings before the company law authorities in this regard and after full verification of the facts they dropped the proceedings. The department has also been accepting the method from year to year for a very long time. It is idle to say that because the assessee followed this method, the department accepted the figures ignorant of the method followed. The assessee's is one of the biggest cases for assessment. The ITO for every year has satisfied himself about the books of account and computed the profit. We find that he has issued the usual questionnaires to the assessee, called for all specific and several details regarding the balance sheet, profit and loss account, etc., analysed them and then only completed the assessment. In the case of an assessee with big income, certainly the trading account is an important part of the accounts. The ITO has certainly analysed the trading account for every one of these years. This in conjunction with the auditor's report leads to the conclusion that th....
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....extent of goods exported gets a drawback on the duty paid. Apparently there is a limit on the drawback to the extent of duty paid. The duty is paid on items like raw wool which forms the raw material for the finished products which alone is finally exported. The drawback is not an incentive for the export but is only a refund of the duty paid insofar as the imported material has been exported either in the same form or in a different form. It would not, therefore, be incorrect to say that on the exported material no net duty has been paid at all. If the imported material is utilised for sale within the country, the duty would necessarily fall on the finished goods sold in the country. If part of the goods are so sold part of the duty only would be covered. To the extent the goods are exported the entire duty would be refunded. It would not, therefore, be correct to say that the goods on stock on which import duty has been paid should be valued including the import duties, but while the drawback is received it should not go to reduce the overall duty paid. That the computation made by the Commissioner (Appeals) thus is neither correct on a clear appreciation of the nature of the dra....
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....view taken by him so far as the valuation of the closing stock is concerned. For other issues, I agree with the view taken by my learned brother. 2. The main dispute between the assessee and the revenue is that while valuing the closing stock, the fiscal duties, such as excise, customs, sales-tax, octroi, etc., should be included in the purchase price for raw materials, for valuing the closing stock. The assessee has not included these fiscal duties, etc., for valuing the closing stock while claiming the same as deduction in the profit and loss account; and the same system is followed by the assessee in the past and accepted by the department. Now, the only issue is whether the ITO can invoke the provisions of section 145(1) and thereby disturb the valuation of the closing stock as disclosed by the assessee. The Commissioner (Appeals) has taken the view that (1) the method of accounting (valuation of closing stock employed by the assessee) is such that its income from business of an accounting period cannot properly be deducted therefrom; (2) that for determining the income or loss actually for the accounting period, the closing stock of the raw materials, work-in-progress and t....
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....e inclusion or exclusion of fiscal duties while valuing the closing stock does not make any difference. In fact, if these fiscal duties including the expenses of manufacturing at various stages makes a substantial difference, if these are included in valuing the closing stock, then that will result in addition of crores every year in the income of the assessee. He further clarified that the system followed by the assessee has not been followed by any other company. Therefore, if the system has been wrongly followed, that does not give any right to the assessee to put into loss the department for ever in future also. 5. I have heard the rival submissions. The basic issue for consideration is to find out the fact whether the system for valuing the closing stock followed by the assessee is such whereby the proper income cannot be deducted. First of all, I do not agree with the learned counsel Shri Palkhivala next any system which is followed in the past should be accepted in the future also when throughout that system is wrong. The basic thing to be seen is whether the system followed by the assessee was proper or not. Once, the authority comes to the conclusion that the system as ....
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....------------------------------------------------------------------ (i) Custom duty/excise duty, sales tax and other charges 516.36 444.29 (ii) Intermediary duty (wool tops/yarn) 79.18 24.25 (iii) Excise duty on finished goods. 18.48 - (iv) Sales tax/octroi on stocks/stores and spare parts 16.35 - --------------------------------------------------------------------------- Similarly, Shri Palkhivala has given a comparative chart of the valuation of the closing ....
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....bsp; 39.19 60.45 100.89 (decrease) --------------------------------------------------------------------------- The above figures are based on the materials supplied by the assessee. From the perusal of these figures, it is apparent that if we add these fiscal duties in valuing the closing stock, the result is addition in the income of the assessee. Shri Palkhivala pointed out that if we look into these comparative figures given by P. N. Shah and TVA & Co., following the same method, even then, the result is not the same. Therefore, the system is also not 100 per cent correct. The assessee has followed some conservative system, that should not be rejected. To.clarify this position regarding the difference among the figures given in the comparative chart as produced by Shri Palkhivala, Shri P. N. Shah has clarified this in his letter dated 23-8-1985. He has pointed out the reasons for difference in the addition of income by inclusion of these fiscal duties, etc. The first reason is that in the valuation given by TVA & Co., TVA & Co. has included customs duties on imports, but the other related direct expenses have not been considered. The seco....
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....en other companies have followed the system for valuing the closing stock on the guidelines given by the Institute of Chartered Accountants, the assessee has no specific reasons to depart from those lines especially when proper income is not deducted. Further, when the assessee gets the refund of customs duty, it will not affect the profit as deduction of that was already allowed. If that will be reduced from closing balance, similarly that part has to be reduced from deductions already allowed in the profit and loss account. So far, the provision of section 43B is concerned, I have gone through it carefully. In my view, it cannot be said that it is in conformity with the system followed by the assessee. Section 43B provides that deductions cannot be allowed unless they are paid. Therefore, it is just an additional requirement for claiming the deduction. Secondly, this provision came into force with effect from 1-4-1984 and that has no relevance for the year under consideration; after 1-4-1984 taxes can be taken into account on the basis of payment. 7. Now reverting back to the case law cited by Shri Palkhivala, British Paints India Ltd.'s case, the issue before their Lordships ....
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....re the Tribunal is that is the changed method of valuing the closing stock is proper ? Here we are not concerned with the bona fides, etc. We are basically concerned with the result of system followed by the assessee; whether that results in reduction of the proper or fair income by valuing the closing stock. Therefore, on the facts, the order of the Tribunal in Goodlass Nerolac Paints Ltd.'s case is of no help to the assessee. 9. From the figures regarding the valuation of the stock by inclusion of those fiscal duties, etc., given by Shri P. N. Shah in his report on the basis of materials supplied by the assessee and the comparative chart by Shri Palkhivala, one thing is certain. That, if we include these fiscal duties, in valuing the closing stock, the ultimate result is an addition of the income of the assessee. Not only that, excise duties, sales tax, octroi, labour and customs duty always form part of the cost. When, on the one hand, the assessee is claiming these items as deduction in the profit and loss account for computing the income and reducing the profit, the assessee is not fair in excluding these items from the valuation of the closing stock which results in reduct....
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....EFERENCE UNDER SECTION 255(4) OF THE INCOME-TAX ACT, 1961 The above appeal was heard by Dr. V. Balasubramanian, Senior Vice President and myself (Y. R. Meena). Since there is a difference of opinion between the Members on the conclusion in the appeal under consideration the following questions are referred to the Hon'ble President for appointing a Third Member to hear the above appeal so that the same may be decided in accordance with the majority view : "1. Whether the income can be properly deduced if the assessee does not include the fiscal duties and other expenses in valuing the closing stock, while the assessee claimed the same as deduction while computing the income in the profit and loss account ? 2. Whether, setting aside the order of the Commissioner is justified to decide the valuation of the closing stock in the light of the discussions in the order of the Judicial Member." THIRD MEMBER ORDER Per Shri T. D. Sugla, President - There has been a difference of opinion on one issue between the learned Members who heard the appeal originally. The points of difference have been stated by them as under : "1. Whether the income can be properly deduced if the as....
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....les, their 'present location and condition'. However, while valuing its closing stock of -. (i) raw materials, (ii) work-in-progress, and (iii) finished goods, the assessee, though has apparently followed a well recognised method of valuing the inventory, namely, cost price or market price whichever is lower, has not taken into account the abovestated fiscal duties paid on or in respect of the closing stock nor included the expenses like direct labour, direct expenses, production overheads and other overheads, incurred for bringing the raw materials into their present location and condition. 4. The proceedings relate to the assessee's assessment for the assessment year 1977-78 for which the previous year is the financial year 1976-77. The auditors of the assessee-company for the first time in the history of the assessee-company gave a note, being note No. (3), in the annexure to the auditors' report reading as under : (3) The stocks of finished goods, stores, spare parts and raw materials have been physically verified during the period by the management. In our opinion, the frequency of verification is reasonable. The discrepancies noted on verification between the p....
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....g stock in view of the directions of the IAC issued under section 144B. On appeal, the Commissioner (Appeals) vide paragraph 129 of his order, held that for the purpose of valuation of the closing stock the customs duty paid without reducing the amount of customs duty by the amount of (duty drawback received), excise duty paid, sales tax paid, octroi duty paid and direct expenses including labour, etc., incurred in respect of the stocks remaining on hand have to be taken into consideration. Vide paragraph 130 of his order, he has directed the ITO to make addition to the returned income by revaluing the stocks for the years under appeal in the light of his directions. 6. As stated earlier, the learned Members hearing the appeal, originally, differed. The learned Accountant Member has summarised his conclusions vide paragraphs 39 and 40 of his order as under : "39. Summarising the position we hold that : (1) In computing the profit from a business continuous over the years the method of accounting followed by the assessee would only be the basis unlike in the case of income from other heads. (2) Though for income-tax purposes each year is self-contained period, computatio....
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....basis of guidelines issued by the Institute of Chartered Accountants and any expenses such as fiscal duties, etc., which are claimed as deduction in computing income in the profit and loss account should be included while valuing the closing stock and on that basis, the addition should be made accordingly." The learned Judicial Member has restored the matter to the ITO for making an addition to the closing stock after allowing the assessee an opportunity of being heard in the light of the observations made by him. 7. Shri N. A. Palkhivala, the learned counsel for the assessee, ably assisted by Shri Haresh Salvi has appeared for the assessee. Shri G. S. Jetly, senior standing counsel for the department, ably assisted by senior authorised representative, Shri K. K. Tuli, has appeared for the department. The counsels for both the sides were heard at length. Having regard to the complexity of the issue, the quantum of the additions involved and the general public importance of the issue, the counsels were requested to give their submissions, briefly, in writing so that no contention is left but of consideration. These have been respectively received on 12-1-1986 and 20-1-1986. ....
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....been given because of the Manufacturing and other Companies' (Auditor's Report) Order, 1975. It does not mean by any stretch of imagination, that the report of the auditors on the affairs of the assessee for the year is a qualified one. Reference in this regard is made to 'Statement on qualifications in auditor's report' published by the Research Committee of the Institute of Chartered Accountants. Inviting then our attention to the provisions of section 145, it is submitted that the choice of the method of accounting is that of the assessee as long as the method results in ascertainment of true and fair profit. Referring to the text book on Accounting Theory and Practice by M. W. E. Glautier and B. Underdown, it is submitted that there are a large number of methods of accounting prevalent regarding valuation of closing stock all of which are accepted by the accountancy profession and all of which result in ascertainment of true and correct profit. The short question, according to the assessee, therefore, is whether the method of valuation of closing stock adopted by the assessee is consistently followed and results in ascertainment of true and correct profit. 10. Inviting our a....
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....means that the method of valuing the.closing stock followed by the assessee up to and including the assessment year 1976-77 and for the assessment year 1984-85 onwards will be treated as proper whereas for the intervening years the method suggested by the department will be applied. This is, according to the counsel for the assessee, clearly contrary to the provisions of section 145. Reference, in this context, is made to the determination of the value of the closing stock by Shri P. N. Shah, a senior chartered accountant, at the instance of the ITO and Thakur, Vaidhyanatha Aiyar & Co., at the instance of the assessee. The difference between the two sets of figures, clearly shows that the method of valuing the closing stock suggested in the guidelines is very complicated and even experts like Shri P. N. Shah and Thakur, Vaidhyanatha Aiyar & Co., have different ideas about the same. To say that the method regularly adopted by the assessee in this regard is not correct is, according to the counsel, too much in the circumstances. 12. The last submission made is that being in the fancy trade, the products marketed by the assessee both for domestic and export markets, are subject to ....
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....e closing stock. This was possible to detect from note No. 3 at page 13 being an annexure to the auditors' report. At no point of time earlier than the said report the assessee had ever indicated or disclosed to the department that while valuing the closing stock the assessee was excluding the fiscal duties. The allegation that the department knew about this method of valuation and accepted it is far from truth. In fact, the department was not even aware of the fact that the assessee was following a peculiar method of valuing its closing stock. The question of the department applying its mind and consciously accepting the method as correct, therefore, has never arisen. 15. The moot point, according to the standing counsel, is whether true and correct profits could be deduced from the method of valuing the closing stock adopted by the assessee. It is stated that for this purpose it is necessary to keep in mind that under the Act each year is a separate unit of assessment. What one has to see is whether the true profits of a particular year can be deduced from the method followed. It is of no consequence what happened in the following year or in the earlier year. The assessee has ....
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....as following as particular method of valuing its closing stock since inception of the business, i.e., the year 1961, and that in their reports in some of the years in the past, the auditors had indicated the assessee's method of valuing its closing stock which the department had accepted with open eyes rather without verification. The conclusion of the learned Accountant Member is not correct inasmuch as in the course of the hearing before me the facts have been thrashed out and about which there is no dispute that the method of valuing the closing stock has not been indicated in the printed accounts of the assessee in any of the earlier years. Nor had the auditors referred to this aspect in their reports and the department had also no occasion to know about it. In the circumstances, it is not correct to say that the department has accepted the assessee's particular method of valuing the closing stock consciously. On the facts, as found, one could even justifiably say that the method of valuing the closing stock followed by the assessee in the past is yet to be ascertained. However, in the absence of a specific dispute raised by the department and the fact that the auditors in thei....
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....ess than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure ... From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following year's results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods.in question' (extracted in paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to British Parliament in April 1951.). While anticipated loss is, thus, taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation'..." 19. To emphasise the need to value the closing stock for ascertaining the profits of a given year, I do not think ....
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....TR 533 held that the assessee is free to adopt a method of accounting only at cost instead of valuing the closing stock at cost or market price whichever is lower. 21. No doubt, section 145(1) provides for computation of income from business in accordance with the method of accounting regularly followed by the assessee which will of course include, as stated above, the method of valuing the closing stock. This, however, does not mean that the assessee has a license to adopt any method of valuing its closing stock. The sub-section has a proviso which authorises the income-tax authorities to discard even the regularly employed methods including the method of valuing the closing stock if in their opinion, true profits of the business for they year cannot be properly arrived at. In other words, even the regularly followed methods of accounting including the method of valuing the closing stock are required to satisfy the test, namely, the true and correct profits of the business are reflected thereby. 22. The pertinent question that arises for consideration is as to the concept of proper income envisaged in the proviso. The word 'income' has been inclusively defined in section 2(2....
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....niform application. For instance, the cost has to take care of direct labour and direct expenses, production overheads and other overheads besides fiscal levies, if any, suffered at different stages. To this extent the learned counsel for the assessee is right and I am in agreement with the view expressed in this regard by M. W. E. Glautier and B. Underdown in their treatise Accounting Theory and Practice at pp. 622-627. On carefully going through these pages, I find that the complication referred to by the learned authors pertains to production overheads and other overheads and not to fiscal levies and direct labour and expenses in bringing the raw material, finished goods or semi-finished goods to their present location and condition. 25. In this context, it is considered desirable to refer to the five principles of valuation of closing stock indicated by the Calcutta High Court in its decision in the case of British Paints India Ltd. The principle Nos. (3) to (5) appear to be of particular significance in this cases : "(3) For the purpose of the aforesaid valuation, it is necessary to determine what in all circumstances represent the costs of stock-in-trade and work-in-pro....
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....evies and direct labour and expenses for bringing the closing stocks to their present location and condition. This is, certainly, not a proper method and, in any event, it is not a method which is recognised by the principled accountancy and sanctioned by commercial practice. It is like the assessee saying that is values its closing stock at cost but it will take the cost at 75 per cent of the actual cost. I do not think such a method can be accepted as a proper method fair both to the assessee and the Income-tax Department. If the opening stock and the closing stock were revalued at cost in its proper concept, the profits of the year will, admittedly, go up by several lakhs of rupees, if not crores. Having regard to the above discussion, I am inclined to agree with the learned Judicial Member that the manner in which the assessee has taken the cost of the closing stock does not result in the determination of the true and correct profits of the year and the department is, therefore, justified in rejecting the assessee's method of valuation and in revaluing the closing stock on proper basis. 26. In view of my above conclusion, strictly speaking, it is not necessary to deal with t....
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....he balance amount of Rs. 242.46 lakhs relating to goods manufactured and remaining unsold has been included under loans and advance is in Schedule 15. Had the previous year's practice been followed, the charge to excise duty and the value of closing stock would have been higher by Rs. 242.46 lakhs. However, this charge has no effect upon the profits for the year". It is evident the excise duty paid in respect of unsold goods was not debited to the purchase account or profit and loss account in this case. It was shown on the assets' side and, therefore, its non-inclusion as a part of the cost of the closing stock had no effect whatsoever upon the profits of the year. Note 3 in the "Annexure to the auditors' report' in the case of Sandvik Asia Ltd., reads as under : "3. The stocks of finished goods, stores and spare parts and raw materials have been physically verified during the year by the management except for such stocks held by third parties in respect of which confirmations have been received for most of the stocks. In our opinion, the frequency of verification is reasonable. The discrepancies noticed on verification between the physical stocks and book records were no....
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....knowledge. For the assessment years 1979-80 and onwards, the company reverted to the old method which was rejected by the ITO as well as the Commissioner (Appeals). The Tribunal has, it is true, by its order dated 29-11-1984, accepted the change. It is also true that the Tribunal has observed in that case that the method resulted in the determination of true and correct profits of the year. However, it appears to me that to great extent, the Tribunal was influenced by factors, such as, (i) this very method was accepted in the past; (ii) the change was bona fide; and (iii) the amounts requiring addition on account of revaluation of closing stock vis-a-vis the yearly profits of the assessee, were not significant. In the circumstances I do not think that it will be proper to take that order to be an authority for the proposition that the valuation of the closing stock at cost and taking the cost by ignoring its material components, such as, fiscal duties, direct expenses and a portion of the overhead expenses, is proper. 26.3 Next, I deal with the difficulty aspect in ascertaining the cost of the closing stock in the manner suggested in the guidelines issued by the Inst....
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.... bona fides. However, there is no reason to accept that any method of determining the cost followed by the assessee, if bona fide, must be correct irrespective of its impact on the determination of the true and correct profits of the year. I, however, accept Shri Salve's submission that the auditors note cannot be treated as a qualification and that they have only highlighted the method followed by the assessee. That is why I have independently tried to appreciate the impact of the method of valuation of the closing stock adopted by the assessee. 28. The last argument advanced is that the valuation of the closing stock of this year does not really affect the determination of the true and correct profits, that in the case of computation of income from business the year's accounts are telescoped in that of the following year and so on and so forth and that it is for this reason that courts have held almost uniformly that the opening and the closing stock of a year must be valued on the same basis and that the value given to the closing stock in the current year must be the value of the opening stock of the following year. By giving an illustration it was pointed out that an additi....
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.... 1974 235.12 263.00 1980-81 545.04 567.60 Assuming the cost of the closing stock is taken as x instead of x + y, the result will be the profit, by raveling the closing stock at the rate of x + y, will go higher and higher year after year. In other words, if an assessee has, by undervaluing its closing stock, disclosed its income less by Rs. 1 Lakh in the current year, it is not to pay tax on this amount perpetually because in the next year the revaluation of the closing stock is going to result in an addition of Rs. 1,25,000 if not more, and so on and so forth. After all, the fact cannot be ignored that the assessee is a prosperous company. Therefore, I am not inclined to accept that the assessee is a only postponement of profits of one year to next year simpliciter. ....
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...., the assessee changed the method of valuing its closing stock from total cost to direct cost, the difference being that in direct cost the overheads, such as administrative department expenses were excluded while in the total cost such overheads were included. The change was accepted by the Tribunal and the view of the Tribunal was confirmed by the Hon'ble court. On may part, I would have accepted the assessee's method of valuation as proper if it had been only on the question of total cost or direct cost both being recognised method. Unfortunately, however, the method here adopted is not at all showing the correct cost of the stock-in-hand. The Madras High court is, therefore, distinguishable. The assessee had also contended at one stage that its products were out of fashion very soon and that if the material remained unsold for some time, it was of no value. Firstly, no material has been placed before me in this regard. Moreover, if a portion of the closing stock is damaged or is out of fashion, etc. the assessee can.always value such stock at market rate depending upon the extent of loss expected on sale. 31. Having regard to the above discussion, I am inclined to agree with....
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.... always sound and prudent not to add any percentage in respect of office on-cost. An important point to be borne in mind while availing finished and partly finished products is that if the actual cost of these exceeds their market price, the market price should be the basis of valuation and not the cost price. Where a manufacturing account is prepared quite distinct from the trading account, the opening and closing stocks of finished products will appear on the debit and credit sides of the trading account and not in the manufacturing account, as the latter account is supposed to deal with raw materials and work in process of manufacture, and the train account with finished products. ANNEXURE 'B' Extract from Research publication Series 12 by G. P. Kapadia, pages 19-20, paragraphs 17 to 20. 17. Cost is defined in relation to the different categories of stock and work in progress as being that expenditure which has been incurred in the normal course of business in bringing the product or service to its present location and condition. This expenditure should include, in additions to cost of purchase [as defined in paragraph 18] such costs of conversion (as defined in paragra....