TMI Blog1986 (10) TMI 32X X X X Extracts X X X X X X X X Extracts X X X X ..... rks Ltd. At the instance of the Department, the following two questions have been referred to this court for its opinion : " 1. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in relying on their order dated May 21, 1975, in ITA Nos. 3975/1972-73 and 3058/1973-74 for the assessment years 1969-70 and 1970-71 (order not served on the CIT) and in deleting the addition of Rs. 16,30,110 made by the Income-tax Officer in the closing stock of sugar ? 2. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that interest paid on the cane purchase tax arrears under the provisions of the U. P. Sugarcane (Purchase Tax) Act, 1961, was an allowable deduction under the Income-tax Act, 1961, and in deleting thereby the disallowance of interest of Rs. 3,08,800 ? " At the instance of the assessee, the following questions have been referred to this court for its opinion: " 1. Whether, on the facts and in the circumstances of the case, and on a correct interpretation of law, the hon'ble Tribunal was justified in disallowing a sum of Rs. 4,34,827 representing the amount of interest recoverable b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of valuation adopted by the assessee. The Tribunal observed as under: " The change in the method of valuation has wrongly been taken by the authorities below to be mala fide. The conclusion, in our opinion, is based on mere surmises and conjectures. There is no denying the fact that the new sugar policy was announced by the Government, according to which 60% of the sugar produced by a sugar factory was to be sold at controlled rates. This was known as levy sugar. The percentage of levy sugar also fluctuated as in the assessment year 1969-70 it was 60% while in the assessment year 1970-71 it was 70%. The balance 40% or 30% sugar was to be sold in the open market. The rates of sugar were virtually fluctuating. If, therefore, in these circumstances, the assessee changed the method of its valuation from market price to market price or cost, whichever is lower, there is nothing mala fide in it especially when the changed method has consistently been followed in all the subsequent assessment years. On a consideration of the facts and circumstances of the case, we are of opinion that the change in the mode of valuation was bona fide. " The aforesaid order of the Tribunal has become ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Where in the opinion of the Income-tax Officer the income, profits and gains cannot properly be deduced from the method of accounting, it is open to the Income-tax Officer to compute the income upon such basis and in such manner as he may determine ...... under the Indian Income-tax Act, prima facie, the Income-tax Officer has for the purpose of sections 10 and 12 to compute the income, profits and gains in accordance with the method of accounting regularly employed by the assessee. If, therefore, there is a system of accounting regularly employed and by appropriate adjustments from the accounts maintained, taxable profit may properly be deduced, the Income-tax Officer is bound to compute the profits in accordance with the method of accounting." In Investment Ltd. v. CIT [1970] 77 ITR 533, the Supreme Court observed at pages 537-38 as under "A taxpayer is free to employ, for the purpose of his trade, his own method of keeping accounts, and for that purpose to value his stock-in-trade either at cost or market price. A method of accounting adopted by the trader consistently and regularly cannot be discarded by the departmental authorities on the view that be should have adopted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 have the effect, if prices rise again, of attributing to the following year's results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price, whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy." Now, under the Income-tax Act, there is no provision providing for a method for valuing the closing stock. However, the ordinary principles of commercial accounting require that while drawing the profit and loss account, a trader or manufacturer may take the value of the stock-in-trade at the beginning and at the end ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... equent years. In other words, the change should not be casual for temporary gain or for temporary purpose. It must be a bona fide change motivated by business considerations. In the instant case, there is no allegation of lack of bona fides or a statement to the effect that the changed method was not followed in the subsequent years. We have extracted in extenso the findings of the Income-tax Appellate Tribunal in this regard. The assessee had changed its method of valuing its closing stock from market price to cost price or market value, whichever is lower, on bona fide business considerations and to ward-off notional hike in the profit and loss on account of fluctuation in decontrolled sugar which was the subject-matter of valuation at the end of each year. There is a further finding that this change over adopted by the assessee has been regularly followed. The learned standing counsel has not disputed these findings. Another submission made before us by the standing counsel is that the assessee cannot unilaterally change the method of valuation. In support of this proposition, he relied upon a decision of this court in Shiv Prasad Ram Sahai v. CIT [1966] 61 ITR 124. In our opini ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s recorded therein so long as it is not disputed that the said order has been accepted by the Department although it was served later. Having regard to the aforesaid discussion and in the circumstances of the case, we are of the opinion that the Tribunal did not commit any error of law in following its order for the earlier years and in deleting the addition of Rs. 16,30,110 made by the Income-tax Officer on account of undervaluation of closing stock of sugar. In doing so, the Tribunal only permitted the assessee to follow a method of accounting for valuation of its stock which the assessee was allowed to change in the assessment year 1969-70. The assessee was obliged to follow it. The view taken by the Tribunal on the deletion of Rs. 16,30,110 in the circumstances of the case cannot be assailed with any justification whatsoever. We now take up question No. 2. A sum of Rs. 3,08,800 was disallowed out of revenue expenses claimed by the assessee. This represented interest paid by the assessee on cane purchase tax arrears. According to the provisions of the U.P. Sugarcane (Purchase Tax) Act, 1961, if the purchase tax is not paid by the prescribed date, the defaulter is liable to pay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 18.34 lakhs were due as principal amount which the assessee had advanced as interest-bearing loan to M/s. Triveni Engineering Works Ltd. The assessee had been charging interest on the aforesaid amount by debiting the amount of the debtor. The assessee was also being assessed every year on such interest on accrual basis. In the accounts relating to the year in dispute, the assessee had debited the account of the debtor company as in the past but subsequently this entry, which amounted to Rs. 4,34,827 was reversed with a narration " irrecoverable ". The assessee also did not return Rs. 4,34,827 as part of its income on accrual basis as it had done in the past. When called upon by the Income-tax Officer to show cause why the accrued amount of interest be not brought to tax, the assessee gave the following explanation : "In short, we again repeat that advance of money made by the company were business transactions and seeing that the Triveni Engineering Works Ltd. would not be able to pay back the original loans, there was no point to continue charging them interest. In fact, not charging interest from them was in the longer run in the interest of the company and it enabled the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed itself in maintaining the addition on grounds, inter alia, that it did not advert itself to the question raised on behalf of the, assessee, namely, that the amount is not liable to be included in the assessee's assessment on the principle that the amount of interest was forgone on grounds of commercial expediency. Whether the assessee could be exonerated from the taxability of Rs. 4,34,827 on the grounds, inter alia, (a) no income accrued to the assessee, (b) the amount in question constituted a loss incidental to the carrying on of the business, and (c) even otherwise the remission was justified and could be claimed as business expense.. Learned counsel for the assessee further submitted that it was not the case of the assessee that the amount in question was a bad debt and thus irrecoverable. In fact, no argument was addressed to us on behalf of the assessee to the effect that the disputed amount could be claimed as a bad debt in terms of the provisions contained in section 36(1)(vii) read with sub-section (2) thereof. In view of the assessee having abandoned its claim of interest being allowed as bad debt, it is not necessary for us to express any opinion on this point and ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny. On the loans given to the near relations of the directors, the assessee charged interest though at a rate lower than what the assessee was paying to the bank on such borrowings. No interest was charged on the loans advanced to M/s. Triveni Engineering Works Ltd. The disallowance was worked out at Rs. 1,41,861 by the Income-tax Officer which was proportionate to the interest which could have been charged by the assessee on the money due to it from the aforesaid debtors. The assessee appealed to the Appellate Assistant Commissioner. One of the contentions raised was that the assessee had taken no loan for the purpose of advancing money to the persons in respect of which the disallowance has been made by the Income-tax Officer. This part of the case was not accepted by the Appellate Assistant Commissioner and was eventually given up before the Tribunal inasmuch as the claim for reduction of interest was pressed on altogether different grounds. The action of the Income-tax Officer was sustained in the first appeal; but some relief was allowed in the quantum of disallowance made by the Income-tax Officer. The Income-tax Appellate Tribunal, on second appeal, deleted the disallowance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uting the income referred to in section 28 . ...... (iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession." From a bare reading of the aforesaid provisions, it is evident that before a deduction of a claim under the aforesaid section could be allowed, the following conditions must be satisfied: 1. That money must have been borrowed by the assessee. 2. It must have been borrowed for the purposes of the assessee's own business. 3. The assessee must have paid interest on the said amount and claimed it as deduction. In other words, borrowing of capital should be genuine and not colourful or illusory transaction. Interest on such loans can be allowed under the aforesaid provision only if it is proved that the loans were utilised in the accounting year for the assessee's own business. If the loan was incurred not for the purpose of the assessee's business but for the benefit of someone else, the interest on such loans cannot legitimately be claimed under section 36(1)(iii) of the Act. Such a claim would only be device adopted to reduce the tax liability of the assessee.. As noticed earlier, the findings of th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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