Investment Ltd v. Commissioner Of Income Tax, Calcutta ((1970) 77 Itr 533

IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT : THE HONOURABLE MR. JUSTICE C.N.RAMACHANDRAN NAIR & THE HONOURABLE MR. JUSTICE K.M.JOSEPH FRIDAY, THE 10TH NOVEMBER 2006 / 19TH KARTHIKA 1928 ST.Rev..No. 335 of 2003 ------------------------- AITA.31/1999 of AGRL.I.T.ADDL.BENCH,KOZHIKODE .................... PETITIONER: ---------------------------- BHADRA ESTATES & INDUSTRIES LTD., EMPIRE INFANTRY, 3RD FLOOR, NO.29,INFANTRY ROAD, BANGALORE-560 001, REPRESENTED BY ITS DIRECTOR, MR.ZACHARIAH KURIYAN. BY ADV. SRI.JOSEPH MARKOSE SRI.JOSEPH KODIANTHARA RESPONDENT: -------------------- STATE OF KERALA, REPRESENTED BY THE SECRETARY (TAXES), TRIVANDRUM. BY GOVT. PLEADER (SHRI GEORGEKUTTY MATHEW) THIS SALES TAX REVISION HAVING BEEN FINALLY HEARD ON 18.9.2006, THE COURT ON 10.11.2006 PASSED THE FOLLOWING: C. N. RAMACHANDRAN NAIR & K. M. JOSEPH, JJ. ------------------------------------------- S.T. REV. NO. 335 OF 2003 ------------------------------------------- Dated this the 10th day of November, 2006 JUDGMENT K. M. Joseph, J. Petitioner questions the correctness of the order of theAppellate Tribunal. Petitioner takes exception to the followingfindings: (1) The disallowance of 15 per cent of the wages paidis proper. (2) Retrenchment compensation paid to the tappers isnot an allowable deduction under the AIT Act. (3) Disallowance of 15 per cent of the Head Officeexpenditure apportioned to the Kerala Estate is proper. (4) Valuation of closing stock of pepper at theaverage sale price realised during the year is proper. S.T.REV. 335/03 2. Petitioner Company filed return under the Agricultural Income Tax Act. Annexure A is the order passed by theAssessing Officer. Assessing Officer proceeded to disallowcertain items which are reflected in the findings as mentionedabove. This has been confirmed in first appeal and also by thetribunal in further appeal. 3. We heard learned counsel for petitioner and the learned Special Government Pleader for the Revenue. Counsel forpetitioner relied on the following decisions: 1) Investment Ltd.v. Commissioner of IncomeTax, Calcutta((1970) 77 ITR 533). Calcutta((1970) 77 ITR 533). 2) S.S. Rajalinga Rajav. The State of Madras(AIR 1967 SC 814). SC 814). 3) New Ambadi Estates Pvt. Ltd.v. State of Tamil Nadu ((1993) 200 ITR 64). 4) Cochin Malabar Estates & Industries Ltd.v. - Commissioner of Agricultural Incometax, Kerala ((1982) 135 ITR 536). 5) Chainrup Sampatramv. Commissioner of Income-Tax,West Bengal((1953) 24 ITR 481).West Bengal((1953) 24 ITR 481). S.T.REV. 335/03 v. 6) George OommenCommissioner of Agricultural--IncomeTax, Kerala((1964) 52 ITR 977). v.7) M/s. Pullala & Rosary Estate Commr. Of Agrl. Income Tax(1993 KLJ Tax Cases221). Income Tax(1993 KLJ Tax Cases221). 4. The Apex Court in Investment Ltd.v. Commissioner of -IncomeTax, Calcutta((1970) 77 ITR 533) held as follows: “A taxpayer is free to employ, for the purposeof his trade, his own method of keeping accounts and--for that purpose to value his stockintrade either atcost or at market price. A method of accountingadopted by the trader consistently and regularlycannot be discarded by the departmental authoritieson the view that it should have adopted a differentmethod of keeping account or of valuation. Themethod of accounting regularly employed may bediscarded only if in the opinion of the taxingauthorities income of the trade cannot be properlydeduced therefrom. Valuation of the stock at cost isone of the recognised methods.” In v. -George Oommen Commissioner of Agricultural Income Tax, Kerala((1964) 52 ITR 977), the Court held as follows: “-Incometax proceedings are judicialproceedings and the accounts of an assessee cannot In v. -George Oommen Commissioner of Agricultural Income Tax, Kerala((1964) 52 ITR 977), the Court held as follows: “-Incometax proceedings are judicialproceedings and the accounts of an assessee cannot be rejected on mere suspicion, but only on positiveevidence of their unreliability. The requirement of alarger proportion of expenditure to improve anestate was not abnormal and the Commissioner'sorder did not disclose any material for disbelievingthe assessee's accounts. On the facts theCommissioner had no jurisdiction to interfere withthe order of the Agricultural Income-tax Officer.” In New Ambadi Estates Pvt. Ltd.v. State of Tamil Nadu ((1993)200 ITR 64), the Madras High Court took the view thatdisallowance of part of the expenditure on the ground thatexpenditure was high is unjustified. This is a case where best ofjudgment assessment was effected. 5. Learned counsel for petitioner would contend that aperusal of Annexure A Order would show that the order waspassed under Section 39(3) notwithstanding the fact that in thebody of the order, the Assessing Officer has purported to make abest of judgment assessment under Section 39(4) of the Act andissued pre-assessment notice to which the petitioner had in factfiled objection. We are not much impressed by the contentionthat a best of judgment assessment may not be available in the facts of this case. The argument of the petitioner overlooks theprovisions of Section 40 of the Act which permits the assessingauthority, in case he finds the return to be incorrect, to make abest of judgment assessment under Section 39(4). But then,learned counsel would submit that a best of judgmentassessment cannot be a capricious affair. He would point outthat it is not open to the respondent to disallow expensesincurred by an assessee. He puts in focus as an example of thesame, the disallowance of wages by 15 per cent on the ground ofit being excessive. Learned Special Government Pleader wouldsubmit that Section 6 of the Act should provide an emphaticanswer to the absence of power to reduce the deduction on theground that it is excessive. The contention of counsel forpetitioner would appear to be that the accounts audited as theyare, should have called for greater circumspection from theassessing authority. While it may be open to the Officer todisallow an amount claimed to be paid on the ground that thepayment was, in fact, not made, it is quite another thing and S.T.REV. 335/03 what is more an illegality to disallow an expense merelydubbing it as excessive, it is submitted. He points out that theOfficer has accepted the figures in relation to the income of theCompany. He would urge that there is an increase in theincome, apparently indicating that there was greater involvementof labour and it was the same which was reflected in the higherwages bill for the year in question. Likewise, he would submitthat there is absolutely no warrant in departing from the ordinaryrule of accountancy, namely that closing stock is to be valued atthe value of the cost of the goods or produce or market pricewhichever is lower. He emphasised that when accounts are keptin mercantile system and if the principles are adhered to over aperiod of years, there is no justification on the part of theassessing officer to merely rely on the average value of sale ofthe produce to fix the value of the closing stock. He pointed outthe difficulties which such an exercise would bring in its train inthe subsequent years. Retrenchment compensation paid was notrelatable to the sale of its assets, it is pointed out. It was a case S.T.REV. 335/03 S.T.REV. 335/03 of a routine payment as retrenchment compensation as mandatedby the Act and there was no basis to treat it as a capital outgo. Itis likewise complained that eleven per cent of the total of headoffice expense was correctly accounted to the operations in theState of Kerala. The Company has plantations in the State ofKarnataka as also in the State of Kerala. It is submitted that thisis apparently premised in proportion to the other expenses inrelation to the plantations in both the States, and there was nobasis to take any exception to this reasonable method of arrivingat the head office expense and apportioning the same. 6. As far as the contention of petitioner that the valuationof the closing stock as adopted by petitioner should not havebeen interfered with by relying on the average sale valuerealised during the year, we are of the view that there is merit inthe said contention. It cannot be in the region of doubt that inthe mercantile system of accounting, closing stock is valuedeither at cost value or at the market value whichever is less. Theassessee has acted on the said principle. No doubt, the S.T.REV. 335/03 8 reasoning of the assessing officer would appear to be that theaverage sale value comes to Rs.30.78 in respect of pepperduring the year and therefore it is only reasonable to adopt thesame for estimating income out of closing stock. No doubt,learned counsel for petitioner relied on the decision of the ApexCourt in Chainrup Sampatramv. Commissioner of Income-Tax,West Bengal((1953) 24 ITR 481), wherein the Court held asfollows: “While we agree with the conclusion that nopart of the profits of the firm in the accounting yearcan be said to have accrued or arisen at Bikaner, thereasoning by which the learned Judges arrived atthat conclusion seems to us, with all respect, toproceed on a misconception. It is wrong to assumethat the valuation of the closing stock at market ratehas, for its object, the bringing into charge anyappreciation in the value of such stock. The truepurpose of crediting the value of unsold stock is tobalance the cost of those goods entered on the otherside of the account at the time of their purchase, so S.T.REV. 335/03 that the cancelling out of the entries relating to the same stock from both sides of the account wouldleave only the transactions on which there have beenactual sales in the course of the year showing theprofit or loss actually realised on the year's trading.As pointed out in paragraph 8 of the Report of theCommittee on Financial Risks attaching to theholding of Trading Stocks, 1919. “As the entry forstock which appears in a trading account is merelyintended to cancel the charge for the goodspurchased which have not been sold, it shouldnecessarily represent the cost of the goods. If it ismore or less than the cost, then the effect is to statethe profit on the goods which actually have been soldat the incorrect figure................From this rigiddoctrine one exception is very generally recognisedon prudential grounds and is now fully sanctioned bycustom, viz., the adoption of market value at the dateof making up accounts, if that value is less than cost.It is of course an anticipation of the loss that may bemade on those goods in the following year, and mayeven have the effect, if prices rise again, ofattributing to the following year's results a greateramount of profit than the difference between the actual sale price and the actual cost price of the actual sale price and the actual cost price of the goods in question” (extracted in paragraph 281 ofthe Report of the Committee on the Taxation ofTrading Profits presented to British Parliament inApril, 1951). While anticipated loss is thus takeninto account, anticipated profit in the shape ofappreciated value of the closing stock is not broughtinto the account, as no prudent trader would care toshow increased profit before its actual realisation,.This is the theory underlying the rule that the closingstock is to be valued at cost or market pricewhichever is the lower, and it is now generallyaccepted as an established rule of commercial-practice and accountancy. As profits for incometaxpurposes are to be computed in conformity with theordinary principles of commercial accounting,unless of course, such principles have beensuperseded or modified by legislative enactments,unrealised profits in the shape of appreciated valueof goods remaining unsold at the end of anaccounting year and carried over to the following'years account in a business that is continuing arenot brought into the charge as a matter of practice,though, as already stated, loss due to a fall in price below cost is allowed even if such loss has not been actually realised.As truly observed by one of thelearned Judges in Whimster & C. v. Commissionersof Inland Revenue, “Under this law (Revenue las)the profits are the profits realised in the course of theyear. What seems an exception is recognised wherea trader purchased and still holds goods or stockswhich have fallen in value. No loss has beenrealised. Loss may not occur. Nevertheless, at theclose of the year he is permitted to treat these goodsor stocks as of their market value..............Again, it isa misconception to think that any profit “arises outof the valuation of the closing stock” and the situs ofits arising or accrual is where the valuation is made.As already stated, valuation of unsold stock at theclose of an accounting period is a necessary part ofthe process of determining the trading results of thatperiod, and can in no sense be regarded as the“source” of such profits.” He also relied on the decision inv. M/s. Pullala & Rosary Estate Commr. Of Agrl. Income Tax(1993 KLJ Tax Cases 221)wherein a Division Bench of this Court held as follows: “The stock in trade has been transferred to thefirm with a condition to retransfer the same on thetermination of the lease. It was not sold by thepetitioner. The same was not used or consumed bythe petitioner in any business run by them.Therefore, the value of the stock in trade cannot beassessed as the agricultural income of thepetitioner.” He would contend that closing stock is valued in arriving at thenet profit and it may not be correct to characterise it as anincome. He pointed out the extreme exemple of a person havingan opening stock and he makes purchases during the year, buttransacts no business at all, leaving him with the closing stock,which would be equal to the entire opening stock to which thepurchases are to be added. It is contended that it would lead tothe absurd situation as the closing stock as valued will be treatedas his income and he would have to pay tax thereon, when inpoint of fact, he had not entered into any transaction attracting S.T.REV. 335/03 tax liability. We are of the view that the assessing officer haspalpably erred in departing from the method of accountingemployed in regard to the valuation of the closing stock relyingon the average sale value of pepper during the year. We would,therefore, direct that the assessing authority value the closingstock as was done by the assessee in regard to pepper. S.T.REV. 335/03 tax liability. We are of the view that the assessing officer haspalpably erred in departing from the method of accountingemployed in regard to the valuation of the closing stock relyingon the average sale value of pepper during the year. We would,therefore, direct that the assessing authority value the closingstock as was done by the assessee in regard to pepper. 7. In regard to the question of payment of retrenchmentcompensation, we feel that the assessee is entitled to succeed.This is a case where retrenchment compensation was paid tosome workers, even though the Company continued. Mere factthat compensation was paid to tappers is hardly sufficient todisallow the claim. This is not a case where the Company hadsold any estate leading to payment of retrenchmentcompensation as such. Compensation was not paid owing toclosure of whole or part of the business which was continuing.It is a statutory liability which the Company is liable to pay.The disallowance is found to be not justified. 8. As regards disallowance of 15 per cent of the wages paid is concerned, the contention of learned Government Pleaderthat it is authorised under Section 6(d) of the Act, cannot holdgood. Section 6(d), no doubt, has no application as the paymentinvolved is wages paid to employees. The tribunal has notedthat the petitioner has no case that they had employed morepersons in view of increased production. It is noted that there isreduction in man power by termination of service of certainpersons. The appellate authority found that in fact there was 42per cent increase in wages. It is found that such a steep hikecould not be attributed to normal increase in wage rates. Thetribunal found that in the absence of any evidence to reveal thatthe assessee employed more workmen than the previous year orthat they paid higher rate than the previous year, etc. was notvalid reason to sustain 42 per cent increase and thus confirm thedisallowance. It is thus on record that more workmen were notemployed. In fact, number of workmen was reduced followingtermination of some employees. It should apparently beunderstood as meaning that the alleged payment of wages was S.T.REV. 335/03 not found acceptable as genuine. The rate of increase is foundat 42 per cent to be excessive. If that be so, we feel that thedecision of the tribunal in this regard is beyond reproach and itis hence supported. 9. The last point falling for our decision is the reduction ofthe proportionate head office expenditure from 11 per centclaimed, to 5 per cent. The appellate authority has found thatthe reason given by the assessing authority, namely that theclaim is excessive, cannot constitute a valid reason for rejectinga major portion of the claim and then proceed to allow deductionof 50 per cent of the claim of expenses under the RubberSection, i.e. 50 per cent of Rs.2,65,973/=. The tribunal whiledealing with the matter takes note of the fact that the head officeat Bangalore controls the activities of the plantations inKarnataka and Kerala. The tribunal noted that Rs.2,65,973/= is11 per cent of the total expenditure related to the rubber section.The tribunal then proceeded to note that in respect of the sisterconcern, 4 per cent was charged in regard to the rubber estate in S.T.REV. 335/03 Kerala. Thereafter, the tribunal has noted that several items ofexpenditure under this head were not supported by anyconvincing piece of evidence and the appellate authority hasmodified the finding of the assessing authority that there was noreason for any enhancement. We note the fact that several itemsof expenditure under the head “Head Office Expenditure” werenot found acceptable. The finding cannot, at any rate, becharacterised as perverse. Hence the said finding is confirmed. The S.T. Rev. is partly allowed as above. C. N. RAMACHANDRAN NAIR, JUDGE K. M. JOSEPH, JUDGE kbk.