TMI Blog1999 (2) TMI 90X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany and it filed its return of income for the assessment year 1995-96 on 30-11-1995 declaring an income of Rs. 7,88,39,962. The assessee derives income from manufacture of worsted woollen fabrics, woollen 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 page 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 stage of manufacture. (ii) Finished goods are valued at cost or market value whichever is lower. Cost is arrived at con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ------------------------------------------------------------------------------------------------- Pertaining Total as per to Platewel Profit Loss Division Description Account (Chemicals Dvn.) Balance --------------------------------------------------------------------------------------------------------------------------------------------------- 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 37,80,416 4,60,644 33,19,773 Conveyance 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' 9,25,000 9,25,000 Remuneration Interest- 80,63,899 1,25,442 79,38,457 other --------------------------- Total : 12,85,00,701 --------------------------- ------------------------------------------------------------------------------------------------------ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee is aggrieved and has challenged the action of the CIT(A) by taking a specific ground No. 1. Before us, Shri J.P. Shah, the learned representative of the assessee submitted that the CIT(A) has failed to appreciate that for the last several years not only the assessee had regularly followed "Direct Costing Method" but the same was approved 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(A) 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. on which the Assessing Officer as well as the CIT(A) have relied upon. It was submitted that the "Direct Costing Method" is also approved by the Hon'ble Madras High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Income-tax Act, 1961 does not contain any prescription in the matter of valuation of stock of finished goods by an assessee and 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) (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 emphasised that even the "Absorption Costing Method" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he P L Account on account of employees' emoluments is Rs. 6,95,82,272. Out of this, the company has taken into account Direct Labour Cost of Rs. 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 Rs. 6,95,82,272 Less: Amount pertaining to Platewel Division Rs. 43,13,059 Salaries in General and Wages of Service Deptt. Rs. 4,26,61,361 ------------------------ Rs. 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 can not 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 Carborand ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 89,089 made by the Assessing Officer as sustained by the CIT(A) on account of alleged undervaluation of the closing stock of finished goods deserves to be deleted. 6. The learned Senior DR. strongly relied on the orders of the Assessing Officer as well 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 Arbind Mills Ltd. v. CIT [1978] 112 ITR 64 (Guj.) and CIT v. Nirlon Synthetic Fibres Chemicals Ltd. [1982] 137 ITR 1/8 Taxman 90 (Bom.) and on the decision of the Supreme Court in the case of British Paints India Ltd. The learned Senior D.R. read extensively from pages 10 to 13 of the assessment order and submitted that various items of expenditure considered by the Assessing Officer are relate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. 6.6 Absorption Costing 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 system of accounting, regularly employed by an assessee. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y right arising as a consequence to such payments." 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 with effect from 1-4-1997, 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 alongwith variable production overheads into consideration while valuing the closing stock. For example, out of the total amount of Rs. 2,24,08,230 debited in the P L Account under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 August 31, 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 cost such overheads are included. The ITO sought further elucidation from the assessee as to what is meant by "total cost" and "direct cost" and as to what was the difference between the method of ascertaining the cost. The assessee by its letter dated January 1, 1974, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not 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. because in the abovesaid 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, the method employed is such that income can not properly be deduced therefrom. However, what is significant to note is that the Supreme Court has nowhere said that it would be open to the Assessing Officer to reject even a recognised method of valuation. Indeed, the Supreme Court could not have said so for the simple reason that it can not at all be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the Bombay High Court in the case of Bralco Metal Industries (P.) Ltd. v. CIT [1994] 206 ITR 477/74 Taxman 132 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 DR on the other hand submitted that the issue in dispute is covered by the decision of the Gujarat High Court in the case of McGaw Ravindra Laboratories v. CIT [1994] 207 ITR 239/74 Taxman 312. Reliance was also placed on the decisions in the cases of Ciba of India Ltd. v. CIT [1993] 202 ITR 1/70 Taxman 505 (Bom.) and Shree Digvijay Woollen Mills Ltd. v. CIT [1993] 204 ITR 398 (Guj.). 9. We have considered the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 : Profits of business X 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 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 statutory levies, such as excise duty and sales-tax, in addition to the sale price has to be ignored because these statutory levies collected by the assessee have no element of profit. According to the accounting principles also, it does not form part of the trading and profit and loss account, inasmuch as these levies are charged separately in addition to the price and the same are separately credited to their respective accounts. Such amounts whenever paid to the government are debited to such accounts and the balance amount is shown in the balance sheet as liability. Therefo ..... X X X X Extracts X X X X X X X X Extracts X X X X
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