Important Point
The assessee may employ whichever basis of valuation of stock in hand, but it must adhere to that consistently year after year.

Headnote:Income Tax Act, 1961—Sections 80HHC, 144 and 145—Profits and gains of business or profession—Method of accounting—Casual departure of valuation of trading stock in hand at cost or market value—Not permissible—Method adopted of maintaining the accounts should be definite method of valuation which is carried by the assessee from year to year—Appellant assessee was a firm engaged in imports of synthetic waste and manufacture and export of woolen blankets—Assessee was maintaining books of accounts on a consistent method on mercantile basis right from the insertion of its business—Since the Account Year, 1986-87, assessee followed the method of accounting, and for which the stock of raw material/semi finished goods were valued at cost price and finished goods at the market price—For Assessment Year 1992-93, assessee valued the closing stock at the rate of Rs. 130/- per kg. whereas opening stock were shown at Rs. 90/- per kg.—In subsequent year 1993-94, assessee valued the opening stock at Rs. 130/- per kg. for finished goods and there was no closing stock—For the first year, assessee claimed benefit u/s 80HHC—Assessee has taken value of closing stock as on 31st of March as the opening stock on 1st of April to be the same—Assessing Officer ruled that by this method, assessee showed to earn income out of itself—Whether order of the Assessing Officer is justified—(Yes).
       Held : The assessee may employ whichever basis of valuation of stock in hand, but it must adhere to that consistently year after year. Casual departure of valuation of trading stock in hand at cost or market value is not permissible. The method adopted of maintaining the accounts should be definite method of valuation which is carried by the assessee from year to year. To attract the provision of Section 145 of the Act the consistent method of maintaining accounts books is a first condition thereafter the assessing officer should be of the view that the accounts are correct and complete but the method employed is such that in the opinion of the assessing officer the income cannot properly be deduced therefrom. The choice of method of accounting regularly employed by the assessee lies with the assessee but the assessee would be required to show that he has followed the chosen method regularly. The Department is bound by the assessee’s choice of method regularly employed unless by this method the true income, profit of accounts cannot be arrived at. The assessee’s regular method would not be rejected as improper merely because it gives him the benefit in certain years or that as per the assessing officer the other method would have been more preferable. The method of accounting cannot be substituted by the assessing officer merely because it is unsatisfactory. What is material for the purpose of Section 145 is, the method to be such that the real income, profit and gain can be properly deduced therefrom. If the method adopted does not afford true picture of profit, it would be rejected, but then such rejection should be based on cogent evidence and would be done with caution. The power can be exercised by the assessing authority to choose the basis and manner in computation of income but he must exercise his discretion and judgment judicially and reasonably. (Para 10)
       In the present case the assessee through out has computed the income and maintained accounts on the basis of valuation of opening stock of raw material and semi finished goods at stock price and finished goods at the market price. The assessee has adopted method of accounting whereby closing stock of the year is the opening stock of the next year, and the valuation placed by the assessee upon his closing stock of the year as the valuation of the opening stock of the next year. As per the assessing officer by virtue of this method in the assessment year 1992-93 the gross profit ratio was Rs. 2054.60 for the first year which stood in stark contrast to 119.18 for the accounting year 1991-92 and 64.85 for accounting year 1991 and, therefore, the method adopted shows artificially inflated profit in order to get the deduction benefit under Section 80HH (C) of the Income Tax Act. (Para 11)
       It is settled law that true profit of business for an accounting period cannot be ascertained without taking into account the value of the stock in trade remaining at the end of the period and that such valuation is a necessary element in the process of determining the trade result of the period. The principles on which the method of valuation of closing stock is done is also well settled. (Para 12)
       Under Section 145 of the Act chargeable income has to be deduced from the accounts regularly employed by the assessee, if in the opinion of the assessing officer the accounts are correct and complete. The assessing officer can apply a different method of accounts to deduce the income chargeable if in his opinion the method employed by the assessee the chargeable income cannot properly be deduced. The recognized and settled accounting practice of accounting with the closing stock in the accounts has to be valued on the cost basis or at the market value basis if the market value of the stock is less than the cost value. In the present case the assessee 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 notional. There is no transfer of the goods and the closing stock remains the opening stock of the next accounting year. The income which has not been derived at by the assessing cannot be said to be the income chargeable for income and, therefore, the rejection of the accounts maintained by the assessee for the valuation of the closing stock by the assessee officer and confirmed by the High Court is in accordance with law. The power exercised by the assessing officer under Section 145 is as per the principles enunciated by various authorities and the courts. We do not find any good or sufficient reason to interfere with the order passed by the High Court. (Para 19)

JUDGMENT

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. $ 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 Account Year, 1986-87, the assessee followed the method of accounting, and for which the stock of raw-material/semi-finished goods were valued at cost price and finished goods at the market price.

2. 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. 130/- per kg. whereas the opening stock were shown at Rs. 90/- per kg. In the subsequent year 1993-94, the assessee valued the opening stock at Rs. 130 per kg. for the finished goods and there was no closing stock. The assessee returned a loss of Rs. 54,420/- for the second year. For the First year, the assessee claimed benefit under Section 80 HHC of the Income-tax Act 1961 (hereinafter to be referred to as an ‘Act’). It is the case of the assessee that during the Financial year 1991-92, the Rupee had undergone de-valuation against U.S.$. The price of the U.S. $ as on 1.4.1991 was Rs. 18/- 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 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 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 1st of April to be the same in every year for the 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.

3. 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 of the Act, which amounted to tax planning with intent to defraud the Revenue. The Assessing Officer ruled that by following the aforementioned method, 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

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Judicial Analysis

SupremeToday

2005 Supreme(SC) 1530

Important PointThe assessee may employ whichever basis of valuation of stock in hand, but it must adhere to that consistently year after year.

Cases Referred (8)

Judicial Analysis

Important Point
The assessee may employ whichever basis of valuation of stock in hand, but it must adhere to that consistently year after year.