2025 (7) TMI 1493 - AT - Income Tax

Valuation of Closing Stock - Method of accounting - applicable method for valuation of the inventory as per the ICDS-II - method of valuation followed by the assessee earlier for the valuation of stock was on the basis of Last In First Out (LIFO) which was no longer an approved method on introduction of introduction of ICDS and the amendment in the Act as the inventory is now required to have been valued as per ICDS-II - HELD THAT - In the case of the assessee the provisions of section 145A mandate the valuation of the inventory as per the ICDS-II which is part of the statute. LIFO is no longer an applicable method for valuation of the inventory as per the ICDS-II. There is merit in the contention of the assessee that both the opening as well as the closing stock should be valued on the basis of the same method as has been held in the case of P.A. Jose 2024 (5) TMI 1366 - KERALA HIGH COURT for ascertaining the profits during the year. This would entail a cascading effect on both the opening as well as closing stock up to the year of introduction of ICDS-II and the impact on the income in the earlier years would have to be assessed in the relevant assessment years concerned instead of adding the entire increase in profit in the year under consideration as the income of the concerned A.Y. has to be assessed in that year otherwise the gross profit rate in the current year becomes abnormally high as the entire impact has been considered in this year alone. Therefore both the intimation as well as the order of the Ld. CIT(A) are hereby set aside and the AO is hereby directed to recompute the profit arising on account of ICDS-II by following the method described in the ICDS-II for valuation of inventory and add the corresponding increase in profit pertaining to the impugned year alone and take recourse to the provisions of section 148 as per law in respect of the past years as the surplus arising on account of application of ICDS-II does not pertain to A.Y. 2022-23 alone but is the accumulated profit on accounting of valuation as per the applicable ICDS-II over the years starting from the year in which ICDS-II was made applicable. The assessee may furnish the calculation chart relating to the Assessment Year wise impact on account of adoption of ICDS-II in the past years and the valuation of closing stock in the past years on applying ICDS-II and the AO shall carry out this exercise uniformly for all the assessment years as the same method of valuation of inventory will have to be followed even for the past years when ICDS-II was applicable. With these directions the appeal of the assessee is partly allowed for statistical purposes including the additional grounds of appeal raised.

Summary

ISSUES:

Whether the addition of Rs. 11,467,009 on account of undervaluation of closing stock, made by applying Weighted Average Cost Method (WACM) contrary to the assessee's consistent use of Last In First Out (LIFO) method, is justified.Whether the valuation of opening and closing stock must be on the same method, particularly when ICDS-II mandates valuation by FIFO or Weighted Average Cost Method.Whether separate valuation of different categories of stock (slow-moving old ornaments and fast-moving new ornaments) by distinct weighted average cost is required under ICDS-II.Whether the addition on account of revaluation of stock leads to taxation of fictional or unrealized income, violating the "Real Income Principle."Whether the retrospective application of ICDS-II valuation method affects prior years and how the cascading effect on opening and closing stock valuation should be addressed.

RULINGS / HOLDINGS:

The addition of Rs. 11,467,009 based on applying Weighted Average Cost Method instead of the consistently followed LIFO method is not justified as it leads to "distorted, fictional and unrealized Income" and violates the principle that "no fictional income could be transformed into real income."The valuation of opening and closing stock must be on the "same basis" to avoid anomalous and abnormal results; therefore, if ICDS-II method is applied to closing stock, it must also be applied to opening stock, consistent with the decision in P.A. Jose (supra).The assessee's contention that different categories of stock require separate weighted average cost valuation under ICDS-II is recognized as a valid ground but was not finally adjudicated in this order.The addition relating to undervaluation of stock arising from retrospective application of ICDS-II has a "cascading effect" on opening and closing stock of prior years; hence, the entire addition cannot be taxed in the current assessment year alone but must be apportioned over relevant years through reassessment proceedings under section 148.The intimation order under section 143(1) and the appellate order confirming the addition are set aside, and the Assessing Officer is directed to recompute income applying ICDS-II valuation consistently for opening and closing stock and to assess the impact year-wise.

RATIONALE:

The Court applied the statutory framework under sections 145, 145A, and 250 of the Income Tax Act, 1961, and the mandatory Income Computation and Disclosure Standards (ICDS-II) notified under section 145(2).It relied on precedent, including the Supreme Court decisions in Chainrup Sampatram v. CIT and ALA Firm v. CIT, which establish that revaluation of stock does not generate taxable income unless realized and that only "real income" is taxable, not "fictional or notional profits."The Court emphasized the principle that the valuation method for opening and closing stock must be consistent to avoid artificially inflated profits and anomalous results, as upheld in P.A. Jose (Kerala High Court) regarding retrospective application of ICDS-II.The decision acknowledges that the retrospective application of ICDS-II valuation standards impacts multiple assessment years, necessitating reassessment under section 148 rather than lump sum addition in a single year to maintain fairness and accuracy in income computation.There was no dissent noted; the ruling reflects a doctrinal adherence to the "Real Income Principle" and consistent application of accounting standards mandated by statute.