1990 (12) TMI 2 - SC - Income Tax

Method of valuation of Stock - ITO held that there was no justification for the assessee to vary from the regular accounting principle of valuing stock - Whether the ITO could reject the consistent practice of the assessee in valuing stock in exercise of his powers under s. 145 - ITO is justified under s. 145 to reject the books of accounts and determine the correct profits and gains.

Summary

Issues Involved:
1. Justification for the method of valuation of goods-in-process and finished products.
2. Inclusion of overhead expenditure in the valuation of stock.
3. Applicability of Section 145 of the Income-tax Act, 1961.
4. Consistency and correctness of the assessee's method of accounting.
5. The duty of the Assessing Officer in determining true income.

Issue-wise Detailed Analysis:

1. Justification for the Method of Valuation of Goods-in-Process and Finished Products:
The assessee, a limited liability company engaged in the manufacture and sale of paints, consistently valued its goods-in-process and finished products exclusively at the cost of raw materials, excluding overhead expenditure. The justification was that paints have a limited storage life, risking a loss in market value if not quickly disposed of. However, the Income-tax Officer rejected this practice, noting that the assessee had never claimed deductions for deterioration or damage to its goods. The Tribunal upheld this view, stating there was no evidence of deterioration and no justification for excluding overhead expenditure.

2. Inclusion of Overhead Expenditure in the Valuation of Stock:
The Income-tax Officer recalculated the value of the opening and closing stocks by adding overhead expenditure, leading to an addition of Rs. 1,04,417 for the assessment year 1963-64 and a deduction of Rs. 3,338 for the assessment year 1964-65. This recalculation was confirmed by the Appellate Assistant Commissioner and the Tribunal. The Tribunal emphasized that the valuation of stock solely with reference to the cost of raw materials was inappropriate for computing income chargeable under the Income-tax Act.

3. Applicability of Section 145 of the Income-tax Act, 1961:
Section 145(1) mandates that income chargeable under the head "Profits and gains of business or profession" shall be computed in accordance with the method of accounting regularly employed by the assessee. However, if the method employed does not allow proper deduction of income, the Assessing Officer must compute the income upon such basis as he determines. The question of whether income can be properly deduced from the accounts is a factual determination that the officer must make based on relevant material and correct principles.

4. Consistency and Correctness of the Assessee's Method of Accounting:
The assessee argued that its method of accounting had been accepted by the Revenue for several years without objection. However, the Revenue raised an objection during the assessment years in question, arguing that overhead expenditure was not included in the stock value. The Tribunal found that the method adopted by the assessee, which excluded all costs other than raw materials, was likely to result in a distorted picture of the business's true state for computing chargeable income. The Tribunal's findings were based on cogent evidence and correct principles.

5. The Duty of the Assessing Officer in Determining True Income:
The Assessing Officer is obligated to ensure that the accounts disclose the true state of affairs for determining tax. If the method of accounting does not disclose the true income, the officer must adopt a computation method that accurately reflects the taxable income. This duty is imposed by Section 145 of the Income-tax Act, 1961. The officer is not bound by the method followed in earlier years and must consider whether the accounts provide a true picture of profits and gains.

Conclusion:
The Supreme Court set aside the judgment of the Calcutta High Court, which had ruled in favor of the assessee. The Tribunal's order, affirming the Assessing Officer's inclusion of overhead expenditure in the stock valuation, was based on findings of fact made on cogent evidence and in accordance with correct principles. The High Court was wrong in interfering with those findings. The appeals of the Revenue were allowed with costs throughout.