1. The court observed that the Income-tax Officer failed to exercise judgment under the Section 13 proviso to determine if true income could be properly deduced from accounts. (Para 13 )
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1937 Supreme(SC) 73
Privy Council At Bombay
Sir George Rankin, Lord Wright, Justice Lord Thankerton, JJ.
Commissioner of Income-tax, Bombay -Appellant
Versus
Sarangpur Cotton Manufacturing Co. Ltd., Ahmedabad -Resopndent
Appeal No.77 of 1936
Decided On : 05-11-1937
Advocates Appeared:
Rogers and Nevill, Barrow, India Office, R.P. Hills, Hubert Hull, J. Millard Tucker
Rogers and Nevill, Barrow, India Office, R.P. Hills, Hubert Hull, J. Millard Tucker
Section 13 of the Income-tax Act, 1922, mandates computation based on the assessee's regular business accounting method unless the officer determines true profits cannot be properly deduced therefrom, in which case the officer must determine a proper basis for computation.
Headnote:(A) Indian Income-tax Act, 1922 - Sections 10 and 13 - Computation of profits and gains - Method of accounting regularly employed - Section 13 requires income, profits, and gains to be computed in accordance with the method of accounting regularly employed by the assessee for their own business purposes, and not the method used for making up a statutory return for assessment. This method is a compulsory basis of computation unless, in the opinion of the tax officer, the income, profits, and gains cannot properly be deduced therefrom. (Paras 13-15)
(B) Proviso to Section 13 - Duty of the tax officer - Where a regular method of accounting is employed, it is the duty of the tax officer to consider whether the true income, profits, and gains can be properly deduced from the accounts. This is a matter of judgment rather than a discretionary power. If the accounts involve gross undervaluation of stocks to create secret reserves, the true profit cannot be properly deduced from such accounts, and the officer must determine the computation on a proper basis. (Paras 15-20)
Facts of the case:
A company filed a tax return consisting of an audited balance sheet and profit and loss account, accompanied by a covering letter. The profit and loss account showed a specific profit, but the covering letter adjusted this figure by accounting for the undervaluation of opening and closing stocks. The tax officer ignored the adjustments in the covering letter and accepted the profit figure as shown in the profit and loss account. The company argued that the method of adjusting for undervaluation was regularly employed and should be accepted for the assessment.
Findings of Court:
The court found that the regular method of accounting employed by the company involved gross undervaluation of stocks to create secret reserves, which meant the accounts did not reflect the true income for tax purposes. The tax officer failed to exercise his judgment under the proviso to Section 13 to determine the correct profits and instead erroneously accepted the figures in the profit and loss account.
Issues: Whether the tax officer was right in computing income, profits, and gains in accordance with the method of accounting regularly employed by the assessee when that method in fact does not show the true income, profits, and gains.
Ratio Decidendi: Section 13 refers to the accounting method used for business purposes, not the method of filing a statutory return. While the regular method is the starting point, the tax officer must determine if true profits can be properly deduced from it. If the regular method results in gross undervaluation, the officer cannot simply accept the figures in the accounts and must instead exercise judgment under the proviso to determine the correct basis for computation.
Result: Appeal dismissed.
Legal Category Hierarchy
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taxation
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income tax
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business profits
- computation of income
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accounting methods
- stock valuation
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business profits
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income tax
Table of Contents
2. Is the Income-tax Officer's power to determine a different basis of computation under Section 13 discretionary?
No, it is a duty to exercise judgment under the proviso to determine if true income can be properly deduced; it is not a discretionary power to simply accept or reject accounts. (Para 13 )
Lord Thankerton:-
This is an appeal from a judgment of the High Court of Judicature at Bombay, dated 28th March 1935 upon a question of law referred to the High Court by the present appellant under S.66, Indian Income-tax Act, 1922. The question arises out of the assessment of the respondents to income-tax for the financial year ending 31st March 1932 and concerns the computation of the profits or gains of their business for the year of account ending on 31st December 1980 under S.10 of the Act. The respondents are a limited liability company doing business at Ahmedabad as manufacturers of cloth and yarn. For the purpose of their assessment for the year ending 31st March 1932 they made a return under S. 22 (1) of the Act on 18th July 1931 to the Income-tax Officer, which consisted of (a) a copy of the audited balance sheet and profit and loss account of the Company for the accounting year ending on 31st December 1930 which showed the profit for the year as Rs.2,64,086, (b) a return of the total income of the Company for assessment, which included the income, profits and gains as per profit and loss account for the accounting year as Rupees 1,99,086 and (c) a covering letter which explained the adjustment of the figure in the profit and loss account so as to arrive at the figure of income in the return, and which was in the following terms :
We herewith beg to enclose the Income-tax Form No. 4449 for the year 1931-32 duly filled in showing therein the profits as per statement shown below, which please receive and pass the receipts for the same.
Rs.
2,64,086 Profit-as per Balance Sheet for the year ending 31st December 1930.
3,43,353 Add-Difference for the undervaluation in stock at the end of 1930 (at market rate).
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6,07,439
3,97,634 Less-Difference for the undervaluation in stock at the end of 1929.
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2,09,805
10,719 Less-Premium received by sale of Government Bond of 1932.
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1,99,086
The printed copy of the Balance Sheet for the year 1930 is enclosed herewith which please note.
On receipt of the above return the Income-tax Officer issued a notice under S.23 (2) of the Act on the assesses to produce evidence in support thereof, and, in compliance, the assesses duly produced their closed accounts for the accounting year. The assesses contended, before the Income-tax Officer, (1) that the undervaluation of the closing stock of the assessee Company for the year 1929 disallowed by Rs.3,97,634 in the assessment year 1930-31, should be allowed as an addition in the opening stock of the current 1930, and that the undervaluation of the closing stock of the Company by Rs.3,59,966, should also be added in the closing stock of the Company in the current assessment; (2) that the method of adopting the undervaluations of the opening as well as closing stocks was adopted by this office in previous assessments and that it should not be departed from in the current year's assessment ; (3) that the ruling in Commr. of Income-tax, Bombay v. Ahmedabad New Cotton Mills Co. Ltd. ,(1930) 17 AIR PC 56=121 IC 543=57 IA 21=54 Bom 213 (PC) is also in consonance with the method adopted by this office in considering the undervaluations of both the opening and closing stocks in computing the income of the Company for income-tax purposes. In his assessment order of 26th February 1932 the Income-tax Officer states :
As regards above contentions, according to the Privy Council's decision in Commr. of Income-tax, Bombay v. Ahmedabad New Cotton Mills Co. Ltd. ,(1930) 17 AIR PC 56=121 IC 543=57 IA 21=54 Bom 213 (PC) I understand that, if the undervaluation of the closing stock of any assessee is considered in the assessment in any year, the undervaluation of the opening stock should also be considered in his assessment of that year; but if the undervaluation of the closing stock is not considered in the assessment, the undervaluation of the opening stock should also be left out of the same assessment. I accordingly set aside the question of
