M/S. Sanjeev Woolen Mills v. Commissioner Of Income Tax, Mumbai

MIS. SANJEEV WOOLEN MILLS v. COMMISSIONER OF INCOME TAX, MUMBAI NOVEMBER 24, 2005 [DR. AR. LAKSHMANAN AND P.P. NAOLEKAR, JJ.J Income tax Act, 1961-Section 145-Assessee adopted the method of valuation of closing stock of finished goods at market price-Indian Rupee was devalued against U.S. Dollar in a particular assessment year-Assessee C disclosed huge gross profit in that year and claimed a benefit of deduction under the Act-Assessee disclosed loss in subsequent assessment year-Revenue rejected the method of accounting adopted by the assessee on the ground that income could not be properly deduced-Commissioner (Appeals) dismissed the appeal but the order was set aside by Appellate Tribunal-High Court allowed the appeal of the Revenue-Correctness of-Held, D Revenue has power under the Act to adopt a suitable method of accounting if it is of the opinion that income cannot be properly deducted from the method adopted by the assessee-On facts, assessee has not adopted the correct and established method of valuation of closing stock of finished goods at cost or market price, whichever is lower-Hence, the action of the E Revenue is justified. Appellant-assessee is engaged in import of synthetic waste and manufacture and export of woolen blankets. The appellant was maintaining books of account on mercantile basis. The closing stock of raw-materials/ semi-finished goods was being valued at cost price and finished gods at market F price. The market price of the finished goods in U.S. Dollars was being converted to Indian Rupees by applying prevailing exchange rate on the closing accounting date. During assessment year 1992-93, Indian Rupee was devalued against US Dollar. The price of one US Dollar as on 1.4.1991 and 31.3.1992 were Rs. G 18 and Rs. 31 respectively. Accordingly, the opening and closing stock of finished goods were valued at market price at Rs. 90 and Rs. 130 per kg respectively by applying the prevailing exchange rate. The appellant disclosed huge gross profit thereby and claimed benefit of deduction under section 460 SUPREME COURT REPORTS (2005) SUPP. 5 S.C.R. A 80HHC of the Income Tax Act, 1961. For the assessment year 1993-94, the appellant showed a loss by disclosing nil closing stock. The Revenue invoked Section 145 of the Act on the ground that income could not properly be deduced from the method of accounting adopted by the appellant and hence added an amount of Rs. 2,67,38,280 to the total income of the assessee for the assessment year 1993-94. The appeals by the appellant preferred before B Commissioner of Income Tax (Appeals) were dismissed but were allowed by Income tax Appellate Tribunal. The appeals preferred by tlie Revenue before High Court were allowed. In appeals to this court, the appellant contended that the Revenue has C no jurisdiction to invoke section 145 of the Act on the ground that the finished goods were valued at market price consistently from the year 1985-86 and accepted by the Revenue; and that the method of accounting cannot be questioned for the assessment year 1992-93 merely on the ground of claiming benefit under section 80HHC of the Act in that year. Revenue contended that section 145 of the Act has been rightly invoked on the ground that the appellant did not adopt the well established method of accounting in valuing closing stock at cost or market price whichever is lower; that the appellant adopted the method of accounting in valuing closing stock at market price merely to claim maximum benefit under Section 80HHC of the Act in assessment year 1992-93 and for suppression of profit in the next assessment year; and that since each accounting year being a separate unit in itself, the acceptance of the method of accounting by the Revenue in the past would be no ground to prohibit invoking Section 145 of the Act. Dismissing the appeals, the Court F HELD: 1. 1. Under Section 145 of of the Income Tax Act, 1961, the chargeable Section: CONCLUSION Dismissing the appeals, the Court F HELD: 1. 1. Under Section 145 of of the Income Tax Act, 1961, the chargeable HELD: 1. 1. Under Section 145 of of the Income Tax Act, 1961, the chargeable income has to be deduced from the accounts regularly employed by the appellant The assessing officer can apply a different method of accounting to deduce the income chargeable if he is of the opinion that from the method employed by the appellant, the chargeable income cannot properly be deduced. G The recognized and settled accounting practice of accounting with the closing stock in the accounts has to be valued at cost or market price whiChever is lower. In the present case, the appellant has not adopted the established and settled practice. The market value of the stock has been taken into consideration while arriving at chargeable income although the market value of the stock is more than the cost value of the stock. The profit earned is only SANJEEVWOOLEN MILLS v. COMMISSIONER OF INCOME TAX [NAOLEKAR, J.] notional. There is no transfer of the goods and the closing stock remains the A opening stock of the next accounting year. The income which has not been derived at by the appellant cannot be said to be the income chargeable for income and, therefore, the rejection of the accounts maintained by the appellant for the valuation of the closing stock by the assessing officer and confirmed by the High Court is in accordance with law. [473-B-EI · C.I. T. v. A. Krishnaswami Mudaliar, (1964) 53 ITR 122; Kikabhai Premchandv. C.J.T., (1953) 24 ITR 506; Chainrup Sampatram v. C./.T., (1953) 24 ITR 481; A.L.A. Firm v. C./.T., (1991) 189 ITR 285; Shakti Trading Co. v. C.l. T., [2001] 6 SCC 455; S.N. Namasivayqm Chettiar v. C./. T., (1960) 38 ITR 579; C.l.T. v. Sarangpur Cotton Mfg. Ltd., (1938) 6 ITR 36; C.l.T. v. Hind C Construction Ltd, (1972) 83 ITR 211; C./. T. v. Bir/a Gwalior (P) Ltd., (1973) 89 ITR 266 and C./. T., Bombay City Iv. Messrs. Shoorji Val/abhdas & Co., (1962) 46 ITR 144, referred to. Commissioner of the Inland Revenue v. Cock, Russel and Co. Ltd, (1949) 29 Tax Cases 387 = [19491 All E.R. 889 and Whimster and Co. v. C.l.R., (1925) D 12 Tax Cases 813, referred to. CIVIL APPELLATE JURlSDfCTION : Civil Appeal Nos. 6735-6736 of 2003. From the Judgment and Order dated 11.12.2002 of the Bombay High E Court in LT.A. Nos. 9 and 10 of 2001. B.V. Desai and Ms. Sheenam Parwanda for the Appellant. Rajiv Dutta, Arijit Prasad and B.V. Balaram Das for the Respondent. The Judgment of the Court was delivered by P.P. NAOLEKAR, J. The appellant, (hereinafter to be referred to as an 'assessee') is a firm engaged in the imports of synthetic waste and manufacture and export of woolen blankets. Since the assessee had been in export, the economy of the business of the assessee worked out on the basis of U.S. $ G price and for the purpose of stock valuation, the same was recorded in Rupees for which the prevailing exchange rate was applied. The assessee was maintaining books of accounts on a consistent method on mercantile basis right from the insertion of its business and Department has accepted the same for the purpose of income-tax except in the years in question. Since the H SUPREME COURT REPORTS [2005) SUPJt1j°s S.C.R. 462 A Account Year, 1986-87, the assessee followed the method of accouJlng, and for which the stock of raw-material/semi-finished goods were valu~d at cost price and finished goods at the market price. k 462 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 Rs[1]J301- per B kg. whereas the opening stock were shown at Rs.90/- per kg. In the s bsequent year 1993-94, the assessee valued the opening stock at Rs.130 per · · . for the finished goods and there was no closing stock. The assessee retu ed a loss of Rs.54,420/- for the second year. For the First year, the assesse: claimed benefit under Section 80 HHC of the Income-tax Act 1961 (herein fter to be C referred to as an 'Act'). It is the case of the assessee that during th Financial year 199I-92, the Rupee had undergone de-valuation against U.S.$. The price of the U.S. $ as on l.4.l 991 was Rs.l 8/- per Dollar and at the time of the closing as on 31.3.1992, it was Rs.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 D in Rupees 18.20 per Dollar. As such, the market price was Rs.90/- per kg. as on 31.3.1991/1.4.1991 (closing stock of the previous year/opening stock valuation for the year 1992-93 ). At the end of the year 1992-93, on 31.3 .1992, the market price of the blanket in the international market was U.S. $5.35 per kg. and the rate of U.S.$ in Rupee was Rs.31/- per Dollar and the market price E worked out to be Rs.165 .85 per kg. and on 31.3 .1992 after deducting the transport charges, freight, commission and other incidental charges to the tune of Rs.35.85, price of the blanket at market value was fixed at Rs.130 per kg. which was shown as closing stock value of the Assessment Year 1992-93. The assessee has taken the value of the closing stock as on 31st of March as the opening stock on I st of April to be the same in every year for the F finished product at market value and the raw material at cost price. The assessee also valued the market price of the finished product at the rate of Rs.98/- as on 1.4.1991 as the actual market price of Rs.130/-per kg. as on 31.3 .1992 and also on 1.4.1992 the price of the finished product as opening stock value for the Second Year. G The Assessing Officer has found that on adoption of the aforesaid method, there is a stark contrast in the gross profit ratio for the accounting year 1990-91, 1991-92 and 1992-93. He concluded that the method of valuing the closing stock.at market value resulted in a distorted picture and assessee had artificially inflated the profits in order to get benefit under Section 80 HHC H of the Act, which amounted to tax planning with intent to defraud the Revenue. The Assessing Officer ruled that by following the aforementioned method, A the assessee effectively showed to earn income out of itself, which was totally against the basic principles of accountancy and law. He further observed that by proper application of the provisions of the Act and principles of accountancy, the assessee had to value its closing stock at cost or market price whichever was lower but that was not done. He further found that in the Second Year, the assessee had valued opening stock at Rs.130 per kg. in B place of Rs.90 per kg. which had suppressed the factum of profits. He applied the standard prescribed for "Valuation of Inventory" at the cost price and added an amount of Rs.2,67,38.280.00 to the total income of the assessee for the second year. The assessee preferred an appeal for the First Year and also for the Second Year before the C.l.T. (Appeals). Both the appeals were dismissed by C.l.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 D in British Paints v. C./. T. (1991) 188 l.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 E 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 l.T.A.T. The Income-tax Appellate Tribunal F allowed the appeals of the assessee taking the view that the application on the principle of lower cost or market value was pre-dominantly wrong because there had been several accepted method of accounting such as pure cost method, LIFO, FIFO etc. and observation of the Assessing Officer and the first appellate authority regarding a particular method is the only correct method, was held to be totally absurd. It was observed that lower of the cost G or market value method might certainly be considered to be a prudent method of accounting and might be followed by the vast majority of business enterprises but what might not be considered prudent did not necessarily incorrect or against the principles of accounting and hence if any firm has been employing the market value method for a long time consistently, it could H A~ nofhe considered as against the principles of accountancy nor the method · · ". ;;i ~ . ·a<l~pted for defrauding the Revenue. The Tribunal has directed that valuation -<~ of the finished goods as made by the assessee be accepted. Regarding opening stock of the Second Year, the Tribunal has allowed the assessee to value it as the closing stock of the First year. The Revenue challenged this B order of the Tribunal in the High Court of Bombay by filing an Income-tax Appeal. The Division Bench of the Higt: Court by its judgment dated 11.12.2002 allowed both the appeals and held that the method of valuation of closing stock adopted by the assessee was not correct and that the entire device was C to inflate deduction under Section 80 HHC and to suppress the profits in the Second Year because the correct taxable income could never be computed on the basis of the system of relief provided under Section 80 HHC and that under the different assessment year constituting separate unit and the principle of 'lower of the cost or market value' had been fully satisfying the mandatory touchstone of "no escapement of tax" rule. Against this order of the High D Court, the assessee has came before this Court.