TMI Blog1993 (1) TMI 126X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee ended on 31-3-1989. It would appear that the year of account was changed to comply with the provisions of the Income-tax Act. Issue No. 1--- Valuation of Closing Stock : 3. In the course of the examination of accounts, the assessing officer found, as was made clear in the Note No. 9 of Notes on Accounts contained in Schedule 15 to Accounts as on 31-3-1989, that during the relevant year of account, the assessee had switched over to " Factory Direct Cost Method " from " Full Factory Cost Method " which the assessee was hitherto following. The Note also made it clear that as a result of the said change in the method of valuation of closing stock and work-in-progress, the profits for the year of account ending on 31-3-1989 stood reduced by Rs. 340.98 lakhs. 4. The Assessing Officer refused to recognise the aforesaid change in the method of valuation. In this regard, she was impelled by fhe following considerations : (i) No explanation was forthcoming as to the reasons for the change in the method of valuation. (iii) As respects the Fertilisers Division, it was only in the immediately preceding year of account that the assessee changed the method of valuation of closing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uling of the Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 188 FM 44. He also took the line that the Madras case of Carborandum Universal Ltd.'s case was not applicable to the facts of the case. 7. Shri Ramamani, the learned, counsel for the assessee took us through the facts and circumstances of the case and contended that ' direct cost ' method of valuation of closing stock is one of the recognised methods. For a fact, the jurisdictional High Court has also approved that method in the case of Carborandurn Universal Ltd, What is more, the Department's S. L.P. against the said judgment was dismissed by the Supreme Court. 8. Secondly, the Supreme Court case of British Paints India Ltd's case cannot avail the Department because there, even while adopting ' direct cost ' method, the assessee had left out of reckoning certain costs, such as direct labour, fuel, etc. It was in that context that the Supreme Court ruled that any system of accounting which excludes, for the valuation of stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products, it likely to result in a distorted picture of the true state of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for switchingover to ' direct cost ' method. (ii) The assessee has not taken the previous approval of the Assessing Officer for the switchover. (iii) The rejection by the Supreme Court of the Department's S. L. P. in the case of Carborandum Universal Ltd. is neither here nor there. For a fact, the Supreme Court ruling in the case of British Paints Indi Ltd. fully supports the Department's case. (iv) The assessee had in the previous year ending on 30-6-1987 switched over to ' standard cost ' method of valuing the closing stock in respect of the Fertiliser Unit. It is well-settled that after effecting a change in the method of valuation of closing stock, the assessee is obligated to regularly follow that method. The assessee cannot, therefore, be permitted to change the method of accounting once again. (v) The orders of the Tribunal referred to an relied upon by Shri Ramamani cannot avail the assessee, because there the decisions turned on the peculiar facts of those cases. Thus, in the case of Modi Rubber Ltd. the method of valuation of closing stock came up for consideration in the very first year of assessment of the assessee. Properly viewed, that was really not a case of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... During the previous year relevant to the assessment year 1989-90 which is now before us, the assessee switched over to ' direct cost ' method. In the context of the switchover, the assessee had explained its stand to the Assessing Officer through its letters dated March, 18, 1992 and March 30, 1992. In support of the switchover, it had made two basic points before the Assessing Officer, namely, (i) ' direct cost ' method is based on sound Accounting Principles and is one of the methods recognised by the Institute of Chartered Accountants of India as also International Accounting Standards ; and (i) in the Madras case of Carborandum Universal Ltd. that method was also approved by the High Court. But the said explanations did not interest the Assessing Officer who decided the issue against the assessee. 17. Before the C.I.T. (A) also the assessee explained its stand through its letter dated July 30, 1992. In that letter, it was shown that ' direct cost ' method was applied only to the products manufactured by it, and not to ' purchased items '. The letter also gave the break-up of the aggregate figure of Rs. 340.98 lakhs referred to above. The items of costs which had been take ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee gets recognition from the practising accountants and the commercial world for valuation of stock-in-trade, the adoption of that method cannot be questioned by the Revenue unless the adoption of that method is found to be not bonafide or restricted for a particular year." 20. The position that emerges is that when ' direct cost ' method has been recognised as being more accurate as a method of computation and when the said method had been approved by the jurisdictional High Court, a switch over to that method cannot be regarded as being bereft of reasons. 21. The second consideration which weighed with the lower authorities in rejecting the assessee's claim was that the assessee had changed the method of accounting in the immediately preceding previous year. As we see it, the lower authorities have misdirected themselves as to facts. What had happened in the previous year relevant to the assessment year 1988-89 was that, owing to labour trouble, the assessee was unable to ascertain the total cost of certain fertiliser products and plant protection chemicals. Anxious as it was to beat the statutory deadline in matters relating to finalisation of accounts, the assessee had pe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ver to " direct cost " method, resulting as it did in the current year's profit being understated by Rs. 340.98 lakhs, cannot be accepted, because it goes counter to the well-known principle that for purposes of assessment, the true profits of each year must be ascertained. There is no gainsaying the facts that the endeavour and duty of the Assessing Officer is to deduce the true profits of each year of account on the basis of well-recognised method of accounting including the method of valuation of work-in-progress and closing stock. True, again, the switchover from one method of accounting to another method of accounting, or from one method of valuing closing stock to another, might entail the reduction of one year's income and increase in the immediately succeeding year of account, and the consequential deferring of liability to that extent. If one were to go only on the basis of such deferment of tax liability, one would never permit a change in the method of accounting or the method of valuing closing stock. The position in law, however, is that deferment of tax liability comes into focus only in the cases where the switch over is to a unrecognised method or is mala fide. Wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exemplified by the House of Lords case of B.S. C. Footwear Ltd. v. Ridgway (Inspector of Taxes) [1972] 83 ITR 269and the Supreme Court case of British Paints India Ltd. In the case of B.S.C. Footwear Ltd. the House of Lords found that the stock valuation made by the assessees were incorrect and as a sequel produced some distortion of the assessment of taxable profits for a given year of account. In the case of British Paints India Ltd. also, the incorrect method followed by the assessee produced a distorted picture of the true state of the business for the purpose of computing the chargeable income. It was, therefore, that the Supreme Court held that the method adopted by the assessee was such that its income could not be properly deduced therefrom, and that, consequently, the Assessing Officer was justified in determining what, in his opinion, was the correct taxable income of the assessee. 25. The position may be sunmmarised as follows : If in the facts and circumstances of a given case, the change in the method of accounting or in the method of valuing closing stock is bonafide, then the fact that such a change entails the reduction in or a postponment of the assessee's tax li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f money borrowed by it from banks at much a higher rate of interest (17.5%). The Assessing Officer found that in the process, the assessee-company had paid the banks an aggregate sum of Rs. 65,65,645 as and by way of interest over and above the aggregate sum of Rs. 38,08,940 being the interest which the assessee had collected from the subsidiary. According to the Assessing Officer, the said differential amount was not laid out wholly and exclusively for the purposes of the business of the assessee. The C.I.T. (A) declined to interfere in the matter. 29. In support of the contention that the lower authorities were not justified in making the impugned addition, Shri Ramamani, the learned counsel for the assessee, made two points. The first point was that the sum in question was expended wholly and exclusively for the purposes of the assessee's business. The assessee is a selling agent for the products of Coromandel Fertilisers Ltd. - a company promoted by the assessee, that apart from the equity shares of Coromandel Fertilisers which the assessee had initially acquired qua promoter, the assessee considered it desirable to acquire more shares of the said company and this was done th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e looked into the facts of the case ; we have heard the rival submissions. As we see it, the decision in the Mysore case turned on the facts of that case. No doubt, in that case also, the question that arose for consideration was whether the interest paid by United Breweries on money borrowed by United Breweries at interest and advanced to its subsidiaries free of interest would be revenue deductible. The Tribunal held that the assessee was entitled to succeed on the ground that the holding company was an agent of its subsidiaries. It was in that context that the Mysore High Court observed : " In deciding whether a subsidiary company is an agent of the parent company the true test is whether there is in addition to capitalist control, functional control by the parent over its subsidiary. If the parent company did exercise functional control over its subsidiary, the exisstence of such subsidiary company as a separate legal entity would not prevent the business of the subsidiary being treated as that of the parent company." Apart from the obvious fact that the assessee's claim was allowed by the Tribunal invoking the principle of agency, there is the further significant point tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... however, there was no evidence to show that the diversion by United Breweries's case of the money borrowed by it to its subsidiaries directly benefited it in any fashion. Issue No. 3 -- Claim under section 43B of the Act 35. During the relevant previous year, the assessee had naturally paid excise duty on the products manufactured by it in the Ceramics division. For purposes of valuing the closing stock of ceramic products, the assessee had naturally taken into account. inter alia, the excise duty attributable to such stock. Relying on the provisions of section 43B of the Act, the assessee set up a claim that it was entitled to a deduction in a sum of Rs. 6,67,708, being the excise duty component of the value of the closing stock, subject of course to suitable adjustment being made in a sum of Rs. 80,007 being the excise duty component of the opening stock. The assessee was unsuccessful both before the Assessing Officer and the first appellate authority. 36. We find the said issue stands covered, against the assessee, by the decision of the I.T.A.T. Madras Bench ' B ' in the case of Southern Asbestos Cement Ltd. v.Dy. CIT [1991] 38 ITD 449. We, therefore, decline to interfere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is halfyearly every year, the assessee opted to receive the present value of halfyearly interest for 3 years in the first year itself. In view of the option exercised by the assessee the interest does not accrue half yearly every year but receivable in the first year itself at a discounted value. Instead of receiving the interest on yearly basis the assessee exercised the option of receiving the interest in lumpsum in the first year itself at a reduced value. Hence either on accrual basis or on due basis or on receipt basis the present value of interest received is chargeable to tax in this year." The C.I.T. (A) declined to interfere in the matter. In this regard, he was impelled by two considerations basically namely, first that the option exercised by the assessee under rule 11(b) of the 3 Year IDBI Capital Bonds Scheme, was irrevocable, and secondly, that by virtue of the option exercised by it, the assessee became entitled to the discounted interest immediately. To quote the C. I.T. (A) : " This is a case where the reduced amount of interest had accrued as soon as the option under Rule 11(b) was exercised by the appellant. Even if the appellant had not received the interest a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ulated half-yearly intervals. In the case before us, the assessee exercised the discounted value option and received interest on that basis. 42. The question that arises for consideration is whether the aggregate sum of Rs. 92,40,329 is chargeable to tax in the assessment for the assessment year 1989-90, as it was received during the relevant previous year or whether the amount will have to be spread over the ensuing three assessment years as claimed by the assessee. The assessee's case is that it is following mercantile system of accounting and that consequently it is entitled to the spread over. It must at once be pointed out that mercantile system of accounting can be relevant only to determine the point of time at which tax liability is attracted and it cannot be relied upon to determine the range of taxable income or the ambit of taxation. In this regard, the following observations of the jurisdictional High Court in the case of CIT v. Motor Credit Co. (P.) Ltd. [1981] 127 ITR 572 (Mad.) are apposite : " In the mercantile system of accounting credit entries are made in respect of amounts as soon as they became legally due and even before they are actually received and si ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at which tax liability is attracted and it is here that the system of accounting followed by the assessee is relevant. If the assessee of following mercantile system of accounting, then the point of time of accrual of income will be taken into account for purpose of computing his taxable income. If, on the contrary, cash system of accounting is followed, then the time of receipt of income would be the deciding factor. 44. In the case before us, the assessee had invested Rs. 416 lakhs in 3-Year IDBI Capital Bonds carrying interest at 9% per annum. The scheme gives the investors two options. They may either opt for receiving interest at half-yearly intervals and on the stipulated dates ; or again, they may opt for receiving the present discounted value of the future payments. The scheme itself has quantified the discounted interest payable on Bond of face value of Rs. 1,000 at Rs. 235. As we see it, by exercising the option to receive the present discounted value of the interest payable in future, the assessee has secured for itself the right to receive the discounted value here and now. This right accrued or arose during the relevant year of account. The discounted interest was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount, particularly in view of the fact that it arose out of a termination agreement contaning restrictive covenant. To a query in this regard from the Bench. Shri Ramamani fairly conceded that the compensation occasioned by the cancellation of a selling agreement would go to fill the hole in the profits of the assessee-company. Even so relying on the Supreme Court case of CIT v. Best Co. (P.) Ltd. [1966] 60 ITR 11, Shri Ramamani contended that since the termination agreement contained a restrictive clause, the compensation received would have to be apportioned between capital and revenue on a reasonable basis. 49. On his part, Shri Bose, the learned Departmental Representative, relying on the Supreme Court case of CIT v. Bombay Burmah Trading Corpn. [1986] 161 ITR 386 contended that this was not a case of sterilisation of rights and that consequently, the impugned orders of the lower authorities did not invite any interference on this issue. 50. We have looked into the facts of the case. We have considered the rival submissions. On 18-4-1986, an agreement was entered into between the assessee and one Amphetronix Ltd. The said agreement was be in force for a period of five y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d a minor part of the entire business of the assessee. Therefore, when the Selling Agreement was terminated, it was not as though the trading structure of the assessee's business was affected thus paralysing the very source of its income. After the termination of the selling agency, the assessee was free to carry on, and did in fact carry on, its other manufacturing and business activities. Since the trading structure of the assessee-company was not in any way inpaired, it should be held that the compensation received by the assessee-company from Amphetronix Ltd. just went to fill the hole in the profits of the assessee. Thus viewed, the receipt was very much on revenue account. 52. But it is contended by Shri Ramamani that the termination agreement contained a restrictive covenant and that consequently, the compensation received or receivable by the assessee must be apportioned between capital and revenue. In this regard, reliance is placed on the Supreme Court case of Best Co. (P.) Ltd. 53. As we see it, the Supreme Court case of Best Co. (P.) Ltd. cannot avail the assessee. The distinguishing feature of the case before the Supreme Court was that the transaction between t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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