2013 (4) TMI 1014 - AT - Income Tax

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these appeals are:

• Whether the assessing officer was justified in rejecting the books of account maintained by the assessee under section 145(3) of the Income Tax Act, 1961, on the ground that the valuation of closing stock did not include certain proportionate related expenses.
• Whether the addition of Rs. 4,76,573 (for assessment year 2008-09) and a similar addition for 2009-10, made by the assessing officer by including expenses such as insurance on goods in transit, freight and inward handling, entry-tax on purchase, channel finance bank interest, and insurance on goods in stock, to the valuation of closing stock, was justified.
• Whether the method of stock valuation adopted by the assessee-valuing closing stock at cost or market price, whichever is less, excluding the above expenses from stock valuation but debiting them directly as expenses-was acceptable under the Income Tax Act and accounting principles.
• Whether the precedents cited by the assessing officer, particularly the Supreme Court decision in CIT v. British Paints India Ltd., are applicable to the facts of the case.
• Whether the assessing officer's invocation of section 145(3) of the Act was valid in the absence of any specific defect pointed out in the books of account or method of accounting followed consistently by the assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of rejection of books of account under section 145(3) of the Act

Relevant legal framework and precedents: Section 145(3) empowers the assessing officer to reject the method of accounting employed by the assessee if it does not disclose the true income or is not in accordance with the provisions of the Act. The Supreme Court in CIT v. British Paints India Ltd. (1991) held that the assessing officer has the right and duty to examine whether the books disclose the true state of accounts and correct income can be deduced therefrom; there is no estoppel by acceptance of accounting methods in earlier years.

Court's interpretation and reasoning: The Tribunal noted that the assessing officer invoked section 145(3) but did not point out any specific defect in the books or method of accounting. There was no allegation of inflated purchases, suppressed sales, or deviation from consistent accounting methods. The assessing officer's basis for rejection was the exclusion of certain expenses from closing stock valuation.

Key evidence and findings: The assessee's books were audited, and the tax audit report under section 44AB confirmed that valuation of closing stock was at cost including direct expenses or market value, whichever was less, with no deviation. The VAT authorities had accepted the trading results and stock valuation in their assessments. The assessee had consistently followed the same method since inception and in earlier assessments, including assessment year 2004-05.

Application of law to facts: The Tribunal held that rejection under section 145(3) requires specific defects or that the method employed does not disclose the true income. Since no such defect was pointed out and the method was consistent and accepted in earlier years, rejection was not justified.

Treatment of competing arguments: The Revenue relied heavily on British Paints India Ltd., emphasizing the assessing officer's duty to ensure correct income determination. The assessee countered that British Paints was a manufacturer's case involving processed goods, whereas the assessee was a trading concern, and the facts were distinguishable. The assessee also cited other precedents supporting the acceptability of the accounting method.

Conclusion: The Tribunal concluded that section 145(3) was not applicable in the absence of any pointed defect or irregularity in the books or accounting method, and the rejection was unjustified.

Issue 2: Justification for addition of proportionate expenses to closing stock valuation

Relevant legal framework and precedents: Accounting Standard 2 (AS 2) on valuation of inventories requires inclusion of all costs of purchase and other costs incurred in bringing the inventory to its present location and condition. Section 145A mandates inclusion of taxes, duties, and fees in valuation of closing stock. The Supreme Court in British Paints India Ltd. supported inclusion of proportionate expenses in stock valuation for correct profit determination. Other decisions such as I.G.E. India Ltd. v. Joint CIT emphasized addition of direct costs and overheads to raw material cost.

Court's interpretation and reasoning: The assessing officer found that the assessee had debited expenses such as insurance on goods in transit, freight, entry-tax, and channel finance interest directly to the profit and loss account but had not included them in the valuation of closing stock, thereby understating the stock value and overstating expenses. The Tribunal analyzed the nature of these expenses and the assessee's explanation that these expenses were directly related to purchases and were already included in purchase cost.

Key evidence and findings: The assessee's trading account showed that these expenses were debited under purchases or expenses during the year. The stock statement showed valuation at cost without adding these expenses separately. The tax audit report confirmed the valuation method as cost including direct expenses or market price, whichever is less. The VAT and sales-tax authorities had accepted the trading results and stock valuation. The gross profit ratio was consistent with earlier years despite increased turnover.

Application of law to facts: The Tribunal found the assessee's explanation plausible and consistent with accounting principles, noting that the expenses were part of purchase cost and not to be added again to closing stock. The assessing officer's addition was therefore a double counting of expenses. The Tribunal also noted that the assessing officer did not demonstrate that the method adopted by the assessee led to incorrect determination of income.

Treatment of competing arguments: The Revenue argued that the expenses should be proportionately added to closing stock to reflect correct cost as per AS 2 and section 145A. The assessee argued that the expenses were already accounted for in purchases and that the assessing officer's approach was hypothetical and based on suspicion without pointing to any defect or deviation.

Conclusion: The Tribunal held that the addition was not justified as it resulted in double counting of expenses already included in purchase cost and that the valuation method adopted by the assessee was acceptable.

Issue 3: Applicability of precedents cited by parties

Relevant legal framework and precedents: The assessing officer relied primarily on CIT v. British Paints India Ltd. The assessee relied on CIT v. Anandha Metal Corporation, I.G.E. India Ltd. v. Joint CIT, CIT v. Ema India Ltd., Chainrup Sampatram v. CIT, Voltamp Transformers Ltd. v. CIT, Investment Ltd. v. CIT, United Commercial Bank v. CIT, CIT v. Tata Iron & Steel Co. Ltd., CIT v. Bilahari Investment (P) Ltd., and Malawi Hamjivan Jagannath v. Asstt. CIT.

Court's interpretation and reasoning: The Tribunal distinguished British Paints India Ltd. as a manufacturer's case involving processed and finished goods, whereas the present case involved a trading concern valuing spare parts and accessories. The Tribunal found the assessee's reliance on other precedents, which upheld consistent accounting methods and valuation practices accepted in earlier years, more pertinent.

Key evidence and findings: The consistent acceptance of the assessee's valuation method by the tax audit, VAT authorities, and prior assessments supported the applicability of precedents favoring the assessee.

Application of law to facts: The Tribunal applied the principle that interference with a consistent accounting method is permissible only if the income cannot be properly deduced therefrom or if there is a specific defect. Since no such defect was found, the precedents supporting the assessee's position were held to be applicable.

Treatment of competing arguments: The Revenue's reliance on British Paints was rejected as not analogous. The assessee's broader reliance on multiple Supreme Court and High Court decisions emphasizing consistency and reasonableness in accounting methods was accepted.

Conclusion: The precedents cited by the assessee were held applicable, and the assessing officer's reliance on British Paints was found misplaced.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"The provisions of section 145(3) of the Act were not applicable to the facts of this case and the learned Commissioner (Appeals) was not justified in confirming the impugned addition made by the assessing officer."

"All the expenses which were added by the assessing officer on proportionate basis for the valuation of closing stock were already included in the purchase and the method of valuation of the assessee was cost or market price, whichever was less."

"The assessing officer did not point out any specific defect in the books of account or the method of accounting consistently followed by the assessee. It is also not the case of the assessing officer that there was a deviation in valuing the closing stock in comparison to the earlier year, no inflated purchases or suppressed sales or expenses not incurred for the business purposes were found."

"The addition made by the assessing officer in the valuation of the closing stock was not correct and was deleted."

Core principles established include:

• An assessing officer can reject the books of account under section 145(3) only if there is a specific defect or if the method of accounting does not disclose the true income.
• Consistent accounting methods regularly employed by the assessee cannot be discarded without justifiable reasons.
• Expenses directly related to purchases and included in purchase cost should not be added again to the valuation of closing stock to avoid double counting.
• The precedent of CIT v. British Paints India Ltd. is not universally applicable and must be considered in the context of the nature of business and facts.

Final determinations:

• The addition of Rs. 4,76,573 for assessment year 2008-09 and the corresponding addition for 2009-10 were deleted.
• The rejection of the books of account under section 145(3) was set aside.
• Both appeals of the assessee were allowed.