TMI Blog2005 (11) TMI 26X X X X Extracts X X X X X X X X Extracts X X X X ..... of stock valuation, the same was recorded in rupees for which the prevailing exchange rate was applied. The assessee was maintaining books of account on a consistent method on the mercantile basis right from the inception of its business and the Department has accepted the same for the purpose of income-tax except in the years in question. Since the account year, 1986-87, the assessee followed the method of accounting, and for which the stock of raw-material/semifinished goods were valued at cost price and finished goods at the market price. For the assessment year 1992-93 (hereinafter to be referred to as the first year ), the assessee valued the closing stock at the rate of ₹ 130 per kg. whereas the opening stock was shown at ₹ 90 per kg. In the subsequent year 1993-94, the assessee valued the opening stock at ₹ 130 per kg. for the finished goods and there was no closing stock. The assessee returned a loss of ₹ 54,420 for the second year. For the first year, the assessee claimed benefit under section 80HHC of the Income-tax Act, 1961 (hereinafter to be referred to as the Act ). It is the case of the assessee that during the financial year 1991-92, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accountancy, the assessee had to value its closing stock at cost or market price whichever was lower but that was not done. He further found that in the second year, the assessee had valued the opening stock at ₹ 130 per kg. in place of ₹ 90 per kg. which had suppressed the factum of profits. He applied the standard prescribed for valuation of inventory at the cost price and added an amount of ₹ 2,67,38,280 to the total income of the assessee for the second year. The assessee preferred an appeal for the first year and also for the second year before the Commissioner of Income-tax (Appeals). Both the appeals were dismissed by the Commissioner of Income-tax (Appeals) by observing that by merely following a particular system of accounting regularly in the past would not entitle the assessee to follow the same system of accounting which was not in accordance with the standard principles of accountancy and placed reliance on the judgment of this court in CIT v. British Paints India Ltd. [1991] 188 ITR 44. It was held that the Assessing Officer had rightly interfered, as duty bound under the provisions of section 145 of the Act to compute the correct taxable incom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the cost or market value had been fully satisfying the mandatory touchstone of no escapement of tax rule. Against this order of the High Court, the assessee has come before this court. Shri B.V. Desai, learned counsel for the appellant, has urged that in the facts and circumstances of the case where in the first year, the valuation of the stock increased pre-dominantly because of the market factor and also the sudden spurt and increase in the exchange rate of U.S. $, it could not have been said that the appellant has adopted a method of accounting to defraud the Revenue particularly so when the accounting method chosen by the assessee is not for a particular year and is being adopted consistently from the year 1985-86. It is further urged that it is a well-settled principle of income-tax law that the assessee is free to adopt any system of accounting and the valuation chosen at the market rate has been a well settled principle of accounting and therefore simply because the assessee has claimed benefit under section 80HHC, in a particular year the method of accounting could not have been found fault with. It was further urged that the provisions of section 145(1) of the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Assessing Officer may determine: Provided further that where no method of accounting is regularly employed by the assessee, any income by way of interest on securities shall be chargeable to tax as the income of the previous year in which such interest is due to the assessee: Provided also that nothing contained in this sub-section shall preclude an assessee from being charged to income-tax in respect of any interest on securities received by him in a previous year if such interest had not been charged to income-tax for any earlier previous year. (2) Where the Assessing Officer is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting has been regularly employed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144. Section 145 provides that in case the Assessing Officer is of the view that the assessee's accounts are incomplete or incorrect or the method of accounting has not been regularly followed by the assessee, the Assessing Officer may resort to make best judgment assessment in the manner pro-vided under section 144 of the Act instead of making a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcise his discretion and judgment judicially and reasonably. In the present case the assessee throughout has computed the income and maintained accounts on the basis of the valuation of opening stock of raw material and semi-finished goods at stock price and finished goods at the market price. The assessee has adopted the method of accounting whereby closing stock of the year is the opening stock of the next year, and the valuation placed by the assessee upon his closing stock of the year as the valuation of the opening stock of the next year. As per the Assessing Officer by virtue of this method in the assessment year 1992-93 the gross profit ratio was 2,054.60 per cent, for the first year which stood in stark contrast to 119.18 per cent, for the accounting year 1991-92 and 64.85 per cent, for accounting year 1991 and, therefore, the method adopted shows artificially inflated profit in order to get the deduction benefit under section 80HHC of the Income-tax Act. While framing the question of law the High Court has also framed a question whether in the facts and circumstances of the case and in law, the Income-tax Appellate Tribunal was justified in holding that the higher marke ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the period should also be taken in. It would be fantastic not to do it : it would be utterly impossible accurately to assess profits and gains merely on a statement of receipts and payments or on the basis of turnover. It has long been recognized that the right method of assessing profits and gains is to take into account the value of the stock-in-trade at the beginning and the value of the stock-in-trade at the end as two of the items in the computation. I need not cite authority for the general proposition, which is admitted at the Bar, that for the purposes of ascertaining profits and gains the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes'. The court further observed: We have already said that in England there is no provision which compels the tax officer to adopt in the computation of income the system of accounting regularly employed by the assessee. But whatever may be the system, whether it is cash or mercantile, as observed by Croom-Johnson J. in a trading venture it would be impossible accurately to assess the true profits without taking into account the value ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... both sides of the accounts leaves only the transactions on which there have been actual sales and gives a true and actual profit or loss on his year's dealings. The rationale behind valuation of the stock at cost or market , whichever is lower is explained by Patanjali Sastri, C.J. in Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC) at page 485: It is wrong to assume that the valuation of the closing stock at market rate has, for its object, the bringing into charge any appreciation in the value of such stock. The true purpose of crediting the value of unsold stock is to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions on which there have been actual sales in the course of the year showing the profit or loss actually realized on the year's trading. As pointed out in paragraph 8 of the Report of the Committee on Financial Risks attaching to the holding of Trading Stocks, 1919, 'As the entry for stock which appears in a trading account is merely intended to cancel the charge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gher than the cost as that will result in the taxation of the notional profits the assessee has not realized. In Sakthi Trading Co. v. CIT [2001] 6 SCC 455; [2001] 250 ITR 871, this court had held that the proper practice is to value the closing stock at cost. To this rule, the custom recognized only one exception and that is to value the stock at market value if it is lower. But on no principle can one justify the valuation of the closing stock at a market value higher than the cost as that will result in the taxation or notional profits which the assessee has not realized. The aforesaid catena of decisions recognized the accounting practice of valuation of closing stock and permissible limit thereof of showing the stock at cost or at market value whichever is lower. Permissibility of valuation of the stock at market value would be only if the value of the market value of the stock is lower than the cost of the stock. In CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), at page 128: Again as observed by this court in CIT v. McMillan and Co. [1958] 33 ITR 182 the expression 'in the opinion of the Income-tax Officer' in the proviso to section 13 of the Indian ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the fact whether the market value of the stock at the relevant time is more than the cost value of the stock, which necessarily results in imaginary or notional profits to the assessee which he has not actually received. In fact such a notional imaginary profit cannot be taxed. It is a well settled principle as held in Sir Kikabhai Premchand v. CIT [1953] 24 ITR 506 (SC) the Constitution Bench judgment that the firm cannot make a profit out of itself. The transaction which is not business transaction and does not derive immediate pecuniary gain is not subjected to tax. In the present case by showing the market value of the closing stock the assessee has earned potential profit out of itself in as much as the stock-in-trade remained with the assessee at the closing of the accounting year. Secondly, putting the stock at the market value does not and cannot bring in any real profit which is necessary for taxing the income under the Act as is held in Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC) and CIT v. Hind Construction Ltd. [1972] 83 ITR 211 (SC). Thirdly, it is a settled principle of income-tax law that it is the real income, which is taxable under the Act. This proposition ..... X X X X Extracts X X X X X X X X Extracts X X X X
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