TMI Blog1982 (10) TMI 220X X X X Extracts X X X X X X X X Extracts X X X X ..... 4. The facts briefly stated are that the assessee-firm derives income from dealing in precious and semi-precious stones. It sells such ready goods after purchase from the market as well as out of its own manufacture. Goods are also sold through the agency of others mostly the sister concerns. It also undertakes to sell goods of others, again mostly of its sister concerns, as commission agents. The sister concerns mainly are K.D. Jhaveri, Jaipur and Mahendra Jewellers, Jaipur. The assessee is mainly an exporter of precious stones. In the jewellery account, on total sales of ₹ 10,18,213 gross profit shown is at ₹ 4,05,603 which reflects a rate of about 40 per cent. The value of the closing stock shown in this account is ₹ 25,58,907. The ITO has observed that proviso to section 145(1) of the Income-tax Act, 1961 ( the Act ) is applicable in the case of the assessee as held by the Tribunal in the assessee's appeal [IT Appeal No. 946 (JP.) of 1979] for the assessment year 1975-76. The ITO has further observed that admittedly, the assessee has been valuing its closing stock at cost. He also observed that this method has been followed by the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs . Value of the closing stock as on 21-10-1976 on the basis that the rate of dollar on the said date was ₹ 8.95 54,61,251 Less: Disparity at the rate of 40 per cent 21,84,500 32,76,751 Less: Value of the closing stock as declared by the assessee 25,58,907 Amount by which the closing stock has been undervalued 7,17,844 5. The assessee challenged the above addition before the Commissioner (Appeals) who has upheld the applicability of proviso to section 145(1) but deleted the entire addition, observing as follows: In my appellate order for 1975-76, I have carefully perused the orders of the Tribunal in appellant's own case and in the case of Mahendra Jewellers as also the order of the Settlement Commission in the case of K.D. Jhaveri Bros. The arguments of the appellant and the department in all th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear. In fact the discussion in the assessment order as well as in the preceding paragraphs has been focussed on only the manner of arriving at the correct cost price. As the learned representative has expressed, the proforma invoice price or the asking price is mentioned by them in terms of the dollar as well as the corresponding exchange value in rupees as on the date of signing of the proforma invoice. In other words, the exchange rate adopted at the time of making the proforma invoice is nearer the date of production than the exchange rate prevalent as on the closing day of the accounting year. Therefore, in the fitness of things the exchange rate as adopted in the proforma invoice is simultaneously giving the price both in terms of the dollar and the rupee would be the most proper. Hence, there is no justification for substituting the rate of ₹ 8.95 per dollar as on the valuation date to convert the closing stock value of the goods lying unsold abroad in terms of dollar into rupee. Hence the addition made in this regard is to be deleted. 6. The revenue is aggrieved against the deletion made by the Commissioner (Appeals). Shri P.C. Hadia, on behalf of the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,61,535 on account of exchange difference and by taking into account these profits, the gross profit rate by the assessee works out to 48 per cent. (Kindly see page 12 of the supplementary paper book filed by the assessee). Shri N.M. Ranka further pointed out that on similar basis profits for the assessment year 1975-76 worked out to 39 per cent and that for 1976-77 at 43.2 per cent while the disparity rates adopted by the assessee were 40 per cent and 45 per cent respectively. He then stated that disparity rate has been accepted by the Tribunal for the assessment year 1975-76 while it has been restored to the Commissioner (Appeals) for the assessment year 1976-77. Based on above facts he urged that since the disparity rate adopted by the assessee at 48 per cent is the same as gross profit rate, the closing stock was properly valued by the assessee and as such there was no under valuation thereof so as to warrant any additions. Shri N.M. Ranka also pointed out that since the export invoice value is the one which is offered by the assessee, it is likely to be below that price on actual sale depending upon the negotiations and at any rate it would not go beyond the export invoice val ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1975-76 39 40 1 1976-77 43.2 45 1.8 1977-78 48 48 Nil He, therefore, submitted that the disparity rate of 48 per tent adopted by the assessee was quite reasonable. He also supported the order of the Commissioner (Appeals) that the reasonable gross profit rate will take care of the valuation of closing stock and no separate valuation thereof was called for According to him, the gross profit rate of the assessee was most reasonable looking to the assessee s own past history and that of its sister concerns as extracted above as well as other comparable cases. A list of other cases relied upon is at page 185 of the paper book, according to which the following gross profit rates disclosed by those assessee's have been accepted by the ITOs concerned as reasonable for the assessment year 1977-78: Name and address Total sales Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rupee. He submitted that at the time of export of the goods abroad export invoice is prepared which indicates the asking price in dollars. At the bottom of this document, the conversion rate in Indian rupee is also given. In this connection he referred to paper book pages 63, 64 and 65. He submitted that the same conversion rates as are indicated in the export invoices from time to time are adopted for the goods not actually sold and lying in closing stock at the end of the year and this method was regularly followed by the assessee year after year and accepted by the department. The ITO had also not recorded any finding that true profits cannot be deduced by following such method consistently. The ITO had also not given any basis for adopting disparity rate of 40 per cent. He was, therefore, not justified in charging the disparity rate adopted by the assessee or the method regularly employed by it. He also submitted that the method employed by the assessee was not unreasonable and it could not be substituted unless a better one was adopted by the ITO. In support of these contentions Shri N.M. Ranka relied upon a number of judicial pronouncements by the various High Courts. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tock, Shri H.R. Lodha, supported the order of the ITO. 10 . From the above submissions made by the rival parties, the following points emerge for our consideration: A When the gross profit shown is reasonable, whether it would still be necessary to value the closing stock to arrive at the gross profit? B Whether the closing stock is to be valued first to arrive at the gross profit rate and disparity rate is then to be adopted. C Principles to be followed for adopting the gross profit and disparity rates for arriving at the cost price with reference to export invoice value (EIV) (asking price)? D Whether the assessee has adopted the correct diparity rate in valuing the closing stock ? 11 . Before answering the above points, we would like to state in brief the method followed by the assessee in arriving at the cost price of the closing stock. As stated earlier, the assessee is a trader in precious and semiprecious stones. It purchases ready goods from the market and sells the same without any processing. It also manufactures its own goods from the raw material purchased from the mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the date of remittances as compared to the exchange rate on the date of actual sale. This will be clear from the following illustrations. The exchange rates adopted in EIV are ₹ 7.50 and ₹ 8.50 per dollar. Let us take exchange rate in the EIV of ₹ 7.50 per dollar. Suppose on the date of actual sale the exchange rate is ₹ 8.50 per dollar and on the date of remittance to India at ₹ 9.75. The gain of ₹ 1 per dollar (₹ 8.50 minus ₹ 7.50) will fall under the first category and that of ₹ 1.25 (₹ 9.75 minus ₹ 8.50) under the second category. Remittances during the accounting period may be for sales during the same year or even of the earlier year. 12 . With this background we shall consider the above questions. Our answers to the above questions are that the value of the closing stock on the principles of accountancy has to be made to arrive at the correct gross profits. Simply because the assessee is showing reasonable profits with reference to the past history of the case or other comparable cases in the same line of trade would not lead to the conclusion that the profits shown are correct. The cor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at closing stock is to be valued first to arrive at the correct gross profit rate and the correct valuation of the closing stock would reflect the correct gross profit (of course subject to other considerations) and that the disparity rate and the gross profit rates have to be the same, we shall give the following illustrations of three different assumed trading accounts. Trading Account ( 1 ) Rs. Rs. Purchases including open- ing stock (20 items at the rate of ₹ 1,000 each) Sales (15 items) 20,000 Closing stock (5 items at cost, i.e ., at the rate of ₹ 1,000 each) 20,000 Gross profit 5,000 5,000 25,000 25,000 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the value of which has been placed at ₹ 5,000 at cost (purchase price). If we follow the method adopted by the assessee, the asking price of 5 items left in the closing stock would be at ₹ 6,666 taking the basis of the sale price of 15 items sold. The gross profit rate is at 25 per cent. If 25 per cent from the asking price of ₹ 6,666 is deducted, the balance cost will be at ₹ 5,000 which is otherwise adopted on the basis of the purchase price reflected in the vouchers. This shows that there is no difference between the gross profit rate and the disparity rate. Coming to the second trading account, it may be pointed out that the gross profit rate in this account is at 37.5 per cent. The asking price of 5 items left in the closing stock at the sale rate adopted in the second trading account would work out to ₹ 8,000. After adopting 37.5 per cent thereof being the gross profit or disparity rate, the cost price would work out to ₹ 5,000. This illustration also shows that the gross profit rate and the disparity rate have to be the same. In the third trading account, the value of the 5 items in the closing stock has been adopted at ₹ 2,000 whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... creased further by the same percentage by which actual sale price has decreased compared to EIV to arrive at the disparity rate. On the other hand, if the actual sales have been made at prices more than those shown in the EIV, the gross profit percentage is to be reduced by the same percentage by which the actual sale price has increased as compared to EIV. This again has to be worked out with reference to actual sales transactions at random spread over all the months, as pointed out earlier for the purpose of finding out the gross profit embedded in the sales. 14 . The other point for consideration is as to whether the EIV of goods in the closing stock should be valued at the exchange rate prevailing on the last date of the accounting period or the value as shown in EIV should be adopted out of which deductions are to be made for disparity. This issue does not require much discussion. The answer is that if the gross profit and disparity rates are to be worked out with reference to the exchange rates on the dates of actual sales, ignoring the EIV, then the conversion of EIV has to be made with reference to the exchange rate prevailing on the last day of the acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e-gross profit will be based on the actual sale rates in the market and not on the assumed rates mentioned in EIV the necessary corollary would be to take the value of the goods in the closing stock at the exchange rate prevailing on the date on which it is to be valued, i.e., Diwali 1976 (20-10-1976) and not the value shown in the EIV. 15. We are in agreement with the learned departmental representative that other comparable cases on gross profit rates or disparity rates will be of no help when the details and basis thereof are not available. In the cases of sister concerns of the assessee, we are not aware as to how the disparity rate was arrived at and how the assumed gross profit was adopted. It is for these reasons that it is not considered necessary to rely upon these comparable cases. 16 . Applying the above test we have now to consider whether the closing stock in the case of the assessee has correctly been valued. Shri N.M. Ranka, the counsel of the assessee pointed out before us that raw material of the value of ₹ 1,34,267 is included in the jewellery purchases account. This material was transferred from precious and semi-preciou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of 45.3 per cent. Total EIV sales as per this statement are at ₹ 20,247 which are negligible against total sales of over ₹ 10 lakhs and, therefore, not representative. Assuming, while not conceding, that 45.3 per cent is a representative and correct rate of profit earned throughout the year, then it contradicts the assessee's own stand. The claim is that exchange profits of ₹ 1,61,535 are also part of gross profit. Total sales are shown at ₹ 10,18,213. Added to this, exchange profits of ₹ 1,61,535, total sales, will be at ₹ 11,79,748. These account for about 14 per cent of sales, of ₹ 11,79,748. 45.3 per cent profit stated on behalf of the assessee is without taking into consideration these profits. In other words, the rate of gross profit including exchange rate gains should be at 59 per cent whereas such profits are said to be at 48 per cent. We have also pointed out earlier that exchange rate profits will consist of two components. The second component on account of remittance being the difference from the date of sale to the date of remittance will not be the part of trading receipt. On the other hand, it will be a gain on account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 18 . The second ground of appeal reads as under : The learned Commissioner (Appeals) has erred in holding that since the export sales constitute 75 per cent of the total sales, it would be reasonable to treat 75 per cent of the expenses as relating to export instead of 50 per cent thereby directing the ITO to modify the computation accordingly. The assessee claimed weighted deduction under section 35B of the Act on expenditure aggregating to ₹ 69,770 under various heads as detailed below: Head of account Amount of expenses debited under the head Amount in respect of which weighted deduction has been claimed under section 35B Shop expenses 20,401 7,000 Postage 19,344 15,000 Salaries 17,825 12,000 Travelling expenses 26,237 22,897 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e export activities of the assessee appeared to be half of the total business. In view of this position, he was of the opinion that expenses on postage, salary, rent and stationery to the extent of half of the claim could only qualify for deduction under section 35B. This is how the ITO worked out the qualifying amount for deduction under section 35B at ₹ 42,425. The assessee aggrieved against the above working of the ITO went up in appeal before the Commissioner (Appeals). One of the claims was that the export sales were more than 75 per cent of the total sales and, therefore, the ITO was wrong in observing that only 50 per cent of the expenditure was admissible for weighted deduction under section 35B. The Commissioner (Appeals) accepted this contention and held that since the export sales constituted 75 per cent of the total sales, it would be more reasonable to treat 75 per cent of the expenses as relating to export instead of 50 per cent as adopted by the ITO. He, therefore, directed the ITO to modify the computation for deduction under section 35B accordingly. 20. The revenue is aggrieved against the above direction given by the Commissioner (Appeals). Shri H ..... X X X X Extracts X X X X X X X X Extracts X X X X
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