2011 (9) TMI 806 - AT - Income Tax

Under valuation of the closing stock - rejection of books of account - alleged valuation of stock at lower rates against higher average market price and price at which assessee himself sold the same stock in succeeding year - assessee applied average price of items of closing stock as the market price and valued the closing stock accordingly - Held that - Arbitrary valuation of closing stock-in-trade disregarding the recognised practice of valuation either at cost or market price whichever is the lower deserves to be rejected even if the same is adopted uniformally year after year. It is the exclusive discretion of the assessee to value stock-in-trade either at cost or market rate whichever is lower but he is not entitled to value it below both. In cases of undervaluation the AO is competent to reject that part of assessee s method and proceed to compute the income on the basis of either at cost or market price whichever is the lower. The object of under valuation of stock-on-trade may be the creation of secret reserve which involves the retention of profits not to be included in the profits intended for shareholders by the profits and loss account and the balance sheet however such profit constitutes part of taxable income - addition made is restored - Decided against the assessee

Summary

Issues Involved:

1. Deletion of addition made by the Assessing Officer (AO) on account of the difference in the valuation of the closing stock.
2. Consistency in the method of accounting for valuation of closing stock.
3. Application of market rates for valuation of closing stock.
4. Legal principles and precedents regarding the valuation of closing stock.

Detailed Analysis:

1. Deletion of Addition by CIT(A):

The Revenue contested the deletion of an addition of Rs. 18,69,105/- made by the AO due to the difference in the valuation of the closing stock. The AO observed that the assessee had undervalued the market rate of the closing stock by adopting an average price instead of the market price. The AO valued the closing stock at Rs. 23,478/- per MT, leading to the addition of Rs. 18,69,105/- to the returned income of the assessee. The CIT(A) deleted this addition, noting that the AO had not rejected the books of account and that the assessee had been following a consistent method of accounting. The CIT(A) emphasized that any adjustment to the closing stock should be based on proper valuation and consistency in the method of valuation.

2. Consistency in the Method of Accounting:

The CIT(A) highlighted that the assessee had consistently followed the method of valuing the stock at an average cost price throughout the year. The CIT(A) found no evidence that this consistency had been disturbed and stressed that the AO could not discard the method of accounting adopted by the assessee consistently and regularly. The CIT(A) concluded that there was no occasion for the AO to value the closing stock at the sale price of Rs. 23,478/- per MT.

3. Application of Market Rates for Valuation of Closing Stock:

The AO observed that the assessee had undervalued the closing stock by showing items purchased long back at lower rates. The AO noted that the market price as per information gathered was Rs. 26,500/- per MT, while the assessee had sold goods during the year at an average market price of Rs. 23,478/-. The AO adopted the rate of Rs. 23,478/- for valuing the closing stock, resulting in the addition of Rs. 18,69,105/-. The AO argued that the assessee's approach of valuing the closing stock at an average price was contrary to the established principle that closing stock should be valued at cost or market price, whichever is lower.

4. Legal Principles and Precedents:

The Tribunal referred to several legal precedents, including the landmark decision of the Hon'ble Supreme Court in the case of Chainrup Sampatram v. CIT, which established that the closing stock should be valued at cost or market price, whichever is lower. The Tribunal emphasized that proper valuation of closing stock is essential for determining the true profits of the assessee. The Tribunal noted that the assessee's approach of valuing the closing stock at an average price was contrary to the ratio laid down by the Hon'ble Supreme Court. The Tribunal also referred to other cases, such as A.L.A. Firm v. CIT, which reiterated the principle of valuing closing stock at cost or market price, whichever is lower.

Conclusion:

The Tribunal concluded that the findings of the CIT(A) were general in nature and contrary to the established legal principles regarding the valuation of closing stock. The Tribunal restored the order of the AO, allowing the grounds of appeal raised by the Department. The appeal filed by the Department was allowed, emphasizing the importance of proper valuation of closing stock in accordance with established commercial and accounting practices.