TMI Blog2005 (11) TMI 522X X X X Extracts X X X X X X X X Extracts X X X X ..... . 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 were 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 80 HHC of the Income-tax Act 1961 (hereinafter to be referred to as an 'Act'). It is the case of the assessee that during the Financial year 1991-92, the Rupee had undergone de-valuation against U.S. $. The price of the U.S. $ as on 1.4.1991 was ₹ 18/- per Dollar and at the time of the closing as on 31.3.1992, it was ₹ 31/- per U.S. Dollar. As per the evidence, the assessee's case is that at the relevant time the market price of the blanket in the international market was U.S.$ 4.59 per kg. and the rate of U.S. Dollar in ₹ 18.20 per Dollar. As such, the market price was ₹ 90/- per kg. as on 31.3.1991/1.4.1991 (closing stock of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... First Year and also for the Second Year before the C.I.T. (Appeals). Both the appeals were dismissed by C.I.T. (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 British Paints vs. C.I.T. [1991]188 I.T.R. 44. It was held that the Assessing Officer had rightly interfered, as duty bound under provisions of Section 145 of the Act to conclude the correct taxable income of each year and for that purpose, there was need to change the system of accounting regularly followed by the assessee, that must be done. As per the appellate authority, no person could earn profit from his own pocket. The valuation of the closing stock required valuing of closing stock either at cost or at market price, whichever was lower. The assessee, aggrieved by the orders passed by C.I.T. (Appeals), further filed appeals before the I.T.A.T. The Income-tax Appellate Tribunal allowed the appeals of the assessee taking the view that the application on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee 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 80 HHC, 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 are not attracted as the assessee had adopted the valuation of the finished goods on market price and consistently followed the same. The contention of the counsel proceeded on the exercise of jurisdiction and he urged that the power under Section 145 of the Act could only be exercised if there is material to prove that the method in question is such that in the opinion of the Assessing Officer, the income cannot be properly deducted. The sine qua non for enforcing the provisions of Section 145 of the Act is that the Assessing Officer should be of the opinion that from the method of accounting the income cannot be properly deducted and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s not satisfied about the correctness or the completeness of the accounts of the assessee, the Assessing Officer may make an assessment in the manner provided in Section 144. Section 145 provides that in case assessing officer is of the view that the assessee's accounts are incomplete or incorrect or method of accounting has not been regularly followed by the assessee, the Assessing Officer may resort to make best judgment assessment in the manner provided under Section 144 of the Act instead of making assessment under Section 145 of the Act. To attract Section 145 of the Act, it is necessary that: a) the assessee has computed the income in accordance with the method of accounting regularly employed by the assessee ; and b) provided where the accounts are correct and complete to the satisfaction of the assessing officer; but c) the method employed is such that in the opinion of the assessing officer, the income cannot be deduced therefrom then the assessing officer may adopt a different method of computation of the income as he may determine. The assessee may employ whichever basis of valuation of stock in hand, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 the gross profit ratio was ₹ 2054.60% for the first year which stood in stark contrast to 119.18% for the accounting year 1991-92 and 64.85% for accounting year 1991 and, therefore, the method adopted shows artificially inflated profit in order to get the deduction benefit under Section 80HH (C) 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 ITAT was justified in holding that the higher market rate of valuation of closing stock adopted by the assessee was correct, without appreciating that acceptance of said method had resulted in doctored abnormal gross profit ratio of 2054.60%, which by no yardstick of basic principle of accountancy could be held as proper reflection of income. The High Court has arrived at the conclusion that this gross inflation in the profit was made merely to get the benefit of Section 80HH(C) for the first year and suppress the profit in the second year. Thus it is apparent that the assessing officer as well as the High Court were impressed by the factor that the method adopted by the assessee in computing the income results in showi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 case 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 of the stock-in-trade at the beginning and at the end of the year. From the above it is clear that it is settled law that true profit of business for an accounting period cannot be ascertained without taking into account the value of the stock in trade remaining at the end of the period and that such valuation is a necessary element in the process of determining the trade result of the period. The principles on which the method of valuation of closing stock is done is also well settled. They have been set out in Whimster and Co. vs. C.I.R. [1925] 12 Tax Cases 813 in the following words :- In computing the balance of profits and gains for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the canceling 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 the trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure From this rigid doctrine one exception is very generally recognized on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less, than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The aforesaid catena of decision recognized in 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 value of the stock at a market value would be only if the valuation of the market value of the stock is lower than the cost of the stock. In C.I.T. vs. A.Krishnaswami Mudaliar [1964] 53 I.T.R. 122, at page 128:- Again as observed by this Court in C.I.T. vs. McMillan and Co. [1958] 33 I.T.R. 182, the expression 'in the opinion of the Income- tax Officer' in the proviso to Section 13 of the Indian Income-tax Act, 1922 does not confer a mere discretionary power ; in the context it imposes a statutory duty on the Income-tax Officer to examine in every case the method of accounting employed by the assessee and to see whether or not it has been regularly employed and to determine whether the income, profits and gains of the assessee could properly be deduced therefrom. It is said in S.N. Namasivayam Chettiar vs. C.I.T. [1960] 38 I.T.R. 579 (S.C.), it is for the officer to consider the material placed before him and, if, upon such co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 vs. C.I.T. [1953] 24 I.T.R. 481 (S.C.) and CIT vs. Hind Construction Ltd.. (1972) 83 ITR 211. Thirdly, it is settled principle of Income-tax Law that it is the real income, which is taxable under the Act. This proposition was enunciated in C.I.T. vs. Birla Gwalior (P.) Ltd., [1973] 89 I.T.R.266 (S.C.), which was pronounced in C.I.T., Bombay City I vs. Messrs. Shoorji Vallabhdas and Co. [1962] 46 I.T.R. 144 (S.C.). Under Section 145 of the Act chargeable income has to be deduced from the accounts regularly employed by the assessee, if in the opinion of the assessing officer the accounts are correct and complete. The assessing officer can apply a different method of accounts to deduce the income chargeable if in his opinion the method employed by the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X
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