Commissioner Of Income Taxcoimbatore v. M/S.venkatesa Spinners Pvt. Ltd

IN THE HIGH COURT OF JUDICATURE AT MADRAS Dated : 23.1.2007 Coram The Honourable Mr.Justice P.D.DINAKARAN and The Honourable Mrs.Justice CHITRA VENKATARAMAN T.C.(Appeal)No.125 of 2003 Commissioner of Income TaxCoimbatore ...Appellant -vs- M/s.Venkatesa Spinners Pvt. Ltd Coimbatore ...Respondent Tax Case (Appeal) is against the order of the Income TaxAppellate Tribunal Madras A bench, dated 7.3.2003 in ITA.No.2161/Mds/94 for the Assessment year 1991-92. against the order ofthe Commissioner of Income Tax (Appeals) Coimbatore dated 29.7.1994in ITA.No.298-C/94-95 against the order of the Deputy Commissionerof Income Tax, special Range I, Coimbatore dated 17.3.94 inPAN/GIR.No.CN.1038/SR.I/CBE,for the Assessment year 1991-1992. For Appellant:Mr.Murali Kumaran,SCGSCFor Respondent :Mr.Vijayaraghavan for M/s.Subharaya Aiyar JUDGMENT (The judgment of the Court was delivered by CHITRA VENKATARAMAN,J) This appeal is at the instance of the Commissioner of IncomeTax, Coimbatore. The assessment year under consideration is 1991-92.The question of law raised in the appeal is whether the AssessingOfficer has the power to reject the change in the method ofvaluation of closing stock adopted by the assessee. There is noquarrel about the settled position of law that the AssessingAuthority has the power to reject the change in the method ofvaluation of closing stock when change itself is not genuine and https://hcservices.ecourts.gov.in/hcservices/ bona fide. It is an accepted principle of law that under Section145, first proviso to sub section (1), that even in cases where theaccounts are correct and complete to the satisfaction of theAssessing Officer, in cases where the income could not be properlydeduced therefrom, then it is open to the Assessing Officer tocompute the income in such a manner as he may determine. The crux ofthe provisions under Section 145 is that even if the AssessingOfficer accepts the assessee's method of accounting, he is not boundby the results flowing from the accounts. The Act enjoins a duty onthe Assessing Officer to consider whether the income on profits andgains can be properly deduced there from. The Authority for thisproposition can be seen from the decision of the Supreme Courtreported in 33 ITR 182 (CIT v. MACMILLAN AND CO.,). 2. As regards the valuation of closing, it is a settled lawthat an assessee is entitled to value the closing stock either onstock price or market price which ever is lower. In the decisionreported in 44 ITR 22 (INDO COMMERCIAL BANK v CIT,) this Court tookthe view that the fact that the option exercised by an assessee isdetrimental to revenue could never be the basis for denying him thatoption. Summarising the principle on the question of valuation ofstock, in the decision reported in 188 ITR 44 (CIT v. BRITISH PAINTSINDIA LTD), the Apex Court held that."The correct principle of accounting is toenter the stock in the books of account at costunless the value is required to be reduced byreason of the fall in the market value of thosegoods below their original cost. Ordinarily,therefore, the goods should not be written downbelow the cost price except where there is anactual or anticipated loss. On the other hand,if the fall in the price is only such as itwould reduce merely the prospective profit,there would be no justification to discard theinitial valuation at cost. ...." 2. The Apex Court further held that, "Section 145 of the Income tax Act, 1961, confers sufficient power upon the officer – nayit imposes a duty upon him- to make suchcomputation in such manner as he determines fordeducing the correct profits and gains. Thismeans that where accounts are prepared withoutdisclosing the real cost of the stock-in-trade,albeit on sound expert advice in the interest ofefficient administration of the company, it isthe duty of the Income-tax Officer to determinethe taxable income by making such computation ashe thinks fit. " 2. The Apex Court further held that, "Section 145 of the Income tax Act, 1961, confers sufficient power upon the officer – nayit imposes a duty upon him- to make suchcomputation in such manner as he determines fordeducing the correct profits and gains. Thismeans that where accounts are prepared withoutdisclosing the real cost of the stock-in-trade,albeit on sound expert advice in the interest ofefficient administration of the company, it isthe duty of the Income-tax Officer to determinethe taxable income by making such computation ashe thinks fit. " 3. Placing reliance on this decision, the learned counsel forthe Revenue submits that considering the provisions of Section 145,it is only the Assessing Authority who has the right to change thesystem of valuation and that an Assessing Authority can ignore themethod of valuation adopted by the assessee to arrive at the properincome. The sum and substance of the submission made by the learnedcounsel for the Revenue is that the assessee has absolutely nooption to change his method of accounting. He placed reliance on 188ITR 44 at page 56 and submits that the assessment made by theofficer is correct. He also submitted that the change in the systemof valuation adopted by the assessee lacked bonafides. In thecircumstances, he submits that the order of the Tribunal meritsreversal. 4. We do not agree with the contention of the learned standingcounsel for the Revenue. A perusal of the decision of the SupremeCourt reported in 188 ITR 44, clearly shows that the well recognisedprinciple of commercial accounting as regards the valuation ofclosing stock is cost price or market price, whichever is lower.Section 145 enjoins an assessee to follow a regular method ofaccounting, so that profits and gains of business or profession orincome from other sources could be computed in accordance with theaccounting method regularly employed by the assessee. 5. In a decision reported in 255 ITR 351 (CIT v PUNJAB STATEINDUSTRIAL DEV. CORPN.), the Punjab and Haryana High Courtinterpreting the word 'regular', held that the provisions cannot beinterpreted to mean that once a system of accounting is adopted, itcan never be changed. 'Regular' cannot in the present context meanpermanent. 6. In a decision reported in 279 ITR 434 (SANJEEV WOOLEN MILLSv. CIT), the Apex Court held that the Revenue is bound by theassessee's choice of method regularly employed. The method ofaccounting followed by the assessee cannot be substituted by theAssessing Officer merely because it is unsatisfactory. What ismaterial for the purpose of Section 145 of the Income Tax Act, 1961is that the method should be such as to enable a real income,profits and gains to be properly deduced therefrom. Speaking on themethod of valuation on closing stock, in the decision reported in250 ITR 871 (SAKTHI TRADING CO. v. CIT), the Apex Court held that, '...But on no principle can one justify thevaluation of the closing stock at a market valuehigher than the cost as that will result in thetaxation of notional profits which the assesseehas not realised......." 7. In the reported case, the assessee followed the valuation ofclosing stock at the market value irrespective of the fact whetherthe market value of the stock at the relevant time was more than thecost value of the stock, which necessarily resulted in imaginary ornotional profits to the assessee which he had not actually received.The Apex Court further held that, '...But on no principle can one justify thevaluation of the closing stock at a market valuehigher than the cost as that will result in thetaxation of notional profits which the assesseehas not realised......." 7. In the reported case, the assessee followed the valuation ofclosing stock at the market value irrespective of the fact whetherthe market value of the stock at the relevant time was more than thecost value of the stock, which necessarily resulted in imaginary ornotional profits to the assessee which he had not actually received.The Apex Court further held that, "........It is a well settled principle asheld in SIR KIKABHAI PREMCHAND v. CIT (1953) 24ITR 506 (SC) the Constitution Bench judgmentthat the firm cannot make a profit out ofitself. The transaction which is not businesstransaction and does not derive immediatepecuniary gain is not subjected to tax. In thepresent case showing the market value of theclosing stock the assessee has earned potentialprofit out of itself in as much as the stock-in-trade remained with the assessee at the closingof the accounting year. Secondly, putting thestock at the market value does not and cannotbring in any real profit which is necessary fortaxing the income under the Act as is held inCHAINRUP SAMPATRAM v. CIT (1953) 24 ITR 481 (SC)AND CIT v. HIND CONSTRUCTION LTD (1972) 83 ITR211 (SC). Thirdly, it is a settled principle ofincome-tax law that it is the real income, whichis taxable under the Act. This proposition wasenunciated in CIT v. BIRLA GWALIOR (P) LTD(1973) 89 ITR 266 (SC), which was pronounced inCIT v. SHOORJI VALLABHDAS AND CO. (1962) 46 ITR144 (SC)". 8. In the circumstances, the Apex Court held that if the methodemployed by the assessee did not enable the Assessing Authority todeduce the correct chargeable income, the Assessing Authority couldapply different methods of accounting to deduce the incomechargeable. As far as the valuation of closing stock is concerned,the recognized and settled legal position is that the closing stockhas to be valued r at market value or cost value, whichever is low. 9. In the light of the settled principle of law and havingregard to the fact that the term 'regular' cannot mean a permanentpattern of accounting working, the learned counsel for the assesseesubmits that the method adopted by the assessee reflected the trueincome, and as such, the Revenue is not entitled to reject themethod of accounting alleging that it lacked bona fides. The learnedcounsel referred to a letter submitted before the Officer, which isextracted at page 2 of the paper book containing the assessment https://hcservices.ecourts.gov.in/hcservices/ order. The reply stated that they had switched over the valuationfrom market value to the cost price which had been recommended bythe Institute of Chartered Accountants of India. They also placedreliance on the decision reported in 149 ITR 759 (CIT v. CARBORANDUMUNIVERSAL LTD). A perusal of the decision shows that so long as themethod of valuation adopted by the assessee gets recognition fromthe practising accountants and the commercial world for valuation ofstock-in-trade, the adoption of that method cannot be questioned bythe Revenue unless the change is found to be not bona fide orrestricted for a particular year. https://hcservices.ecourts.gov.in/hcservices/ order. The reply stated that they had switched over the valuationfrom market value to the cost price which had been recommended bythe Institute of Chartered Accountants of India. They also placedreliance on the decision reported in 149 ITR 759 (CIT v. CARBORANDUMUNIVERSAL LTD). A perusal of the decision shows that so long as themethod of valuation adopted by the assessee gets recognition fromthe practising accountants and the commercial world for valuation ofstock-in-trade, the adoption of that method cannot be questioned bythe Revenue unless the change is found to be not bona fide orrestricted for a particular year. 10. The learned counsel for the assessee submits that theAssessing Authority's view that the change over of method ofvaluation did not reflect true affairs of the profits of theassessee is not correct. The method adopted by the assessee is onthe line of the established accounting principles which are approvedby the decisions of the Apex Court. The learned counsel for theRevenue pleaded for a remand to enable the Assessing Authority togive a finding on the question of bona fides. It must be noted thatthe valuation at cost price or market price whichever is lower is anaccepted method of valuation of closing stock. The decisions, whichwere relied on by the assessee as well as by the Revenue, outlinethe principles given by the Apex Court as to the valuation. The onlydifference in the presentation of the argument between the partiesherein is that while the Revenue contends that the system adopted bythe assessee lacked bona fide, the assessee countered it by sayingthat following the well recognised system of accounting could not bestamped as lacking in bona fide. So long as the system followed bythe accounting standards reflect the true profits of the business,the Revenue cannot reject the method as lacking in bona fide. Aperusal of the order of the Assessing Officer indicates that suchline of reasoning does not indicate that the method adopted did notreveal true profits of business. Placing reliance on 188 ITR 44 theAssessing Authority stated that even if the assessee had adopted aregular system of accounting, it was the duty of the AssessingOfficer under Section 145 of the Income Tax Act, 1961 to considerwhether the correct profits and gains could be deduced from theaccounts and if the Officer feels that true profits could not bededuced from the accounts, he had the right to take recourse to theproviso to Section 145 of the Income Tax Act, 1961. Having thuscorrectly understood the decision, the Assessing Officer hadimmediately jumped to the conclusion without any enquiry, that itwas not possible to accept the change over as it had not reflectedthe true state of affairs of the profits of the company. As alreadystated,while the decision of the Apex Court recognised the authorityof the Assessing Authority to reject the accounts under the statedcircumstance, at the same time, the Apex Court held that the methodof valuation of closing stock needs to be based on market value orcost price which ever is lower. In the absence of any such exercise, mere rejection ipso facto does not support the case of the Revenue.In the absence of any such finding, we do not find any justificationto go against or reject the accounts. 11. In the decision reported in 202 ITR 789 (MELMOULDCORPORATION v. CIT), the Bombay High Court at page 792 referred tothe booklet called "Valuation of stock and work-in-progress-normally accepted accounting principles" brought out by IndianMerchants' Chamber Economic Research and Training Foundation, whichmay usefully be extracted here too, mere rejection ipso facto does not support the case of the Revenue.In the absence of any such finding, we do not find any justificationto go against or reject the accounts. 11. In the decision reported in 202 ITR 789 (MELMOULDCORPORATION v. CIT), the Bombay High Court at page 792 referred tothe booklet called "Valuation of stock and work-in-progress-normally accepted accounting principles" brought out by IndianMerchants' Chamber Economic Research and Training Foundation, whichmay usefully be extracted here too, "2. Where a change from one valid basis toanother valid basis is accepted, certainconsequences normally follow. The opening stcokof the base year of change is valued on the samebasis as the closing stock. Whether the changeis to a higher level or to a lower level, theRevenue normally does not seek to revise thevaluation of earlier years. It neither seeks toraise additional assessments, nor does it admitrelief under the 'error or mistake' provisions. 3. It is not possible to define withprecision what amounts to a change of basis. Itis a convenience, both to the tax payer and tothe Revenue, not to regard every change in themethod of valuation as a change of basis. Inparticular, the Revenue encourages the view thatchange which involves no more than a greaterdegree of accuracy, or a refinement, should notbe treated as a change of basis, whether thechange results in a higher or a lower valuation.In such cases the new valuation is applied atthe end of the year without amendment of theopening valuation' (underlining* ours)" 12. Given the recognition as to the accepted accountingprinciples, and which have been followed by the assessee herein onthe same lines, we do not find any justification to accept the pleaof the Revenue. In the circumstances, the appeal has to bedismissed. 13. As already extracted, the question of law herein is whetherthe Officer has right to reject the valuation method of closingstock, if it is not based on genuine reasons. It must be noted thatirrespective of a change in the method of accounting/valuation, theAct enjoins a duty on the Assessing Authority to get into accountsto deduce what would be the correct and true profit and gains fromthe business. Whatever be the method of accounting, it is the dutyof the Assessing Officer to consider whether the income, profits and gains can be properly deduced from the method adopted by theassessee and if not and to compute the same accordingly. 14. Considering the scope of the power available under Section145 of the Income Tax Act, in the absence of any finding that thechange is not for any genuine reason and considering the fact thatvaluation itself is based on accepted principle of accountancy aswell recognised in several decisions of the Apex court and thisCourt, we do not find any reason to disturb the order of theTribunal. 15. The question itself seems to have been framed with anacademic flavour. Consequently, the appeal is rejected. No costs. bgSd/Asst.Registrar/true copy/Sub Asst.RegistrarTo1. The Assistant Registrar,Income Tax Appellate Tribunal, Rajaji Bhavan, III Floor, Besant Nagar, Chennai-90 2.The Commissioner of Income-Tax, Coimbatore. 3.The Commissioner of Income-Tax (Appeals), Coimbatore. 4. The Deputy Commissioner of Income Tax, Special Range I, Coimbatore. + 1 cc to Mr. N. Muralikumaran, Sr Standing Counsel for Income Tax,SR no. 4743 MA(CO)SR/21.3.2007