1. These are four appeals by a limited company in the Income-tax assessment for the assessment years 1979-80 to 1982-83. As certain common contentions are raised, these four appeals are disposed of by this common order.
2. As its name suggests the assessee-company is carrying on business of manufacture of paints. For each of the four assessment years under consideration, the assessee has returned the income exceeding Rs. 1,50,00,000.
3 to 18. [These paras are not reproduced here as they involve minor issues.] 19. Valuation of closing stock, effect of excise duty: Shri Mehta submitted that in his order for the assessment year 1981-82 for the first time, the IAC examined the issue of valuation of closing stock.
For the reasons given in paras 4 and 5 of his order for that year and for similar reasons given in para 6 of his order for the subsequent year, the IAC, respectively, added to the returned income for the two years the amount of Rs. 34,64,179 and Rs. 34,02,272. Dealing with this issue in his consolidated order for two years, the Commissioner (Appeals) considered the assessee's method of valuation of closing stock. It was brought to the notice of the Commissioner (Appeals) that the Research Committee of Chartered Accountants of India prepared the guidelines published in October 1979, for valuation of closing stock wherein it was observed, noted the Commissioner (Appeals): In their recommendation, it is submitted, the committee has expressed its preference for treating excise duty as part of the manufacturing cost to be included in valuing inventories; but they have also opined that system of valuation of inventory on direct cost not including excise duty as permissible one.
The Commissioner (Appeals) considered the assessee's method of valuation of stock for and from the previous year relevant for the assessment year 1976-77 and he concluded by observing that: Even if the method followed by the assessee in the two years under appeal is an accepted method of valuation, the IAC having regard to the past practice of the assessee in the sense that the method of accounting has been altered more than once is within his rights to determine the value of the closing stock inventory in a realistic manner.
The Commissioner (Appeals) then considered the guidelines issued by the Institute of Chartered Accountants and then concluded by observing in para 15.4 as under: The amendment is not based on any accepted or approved principles of commercial accounting and this would be evident from the speech of the Finance Minister explaining the rationale behind the introduction of the new provisions of Section 43B. Such remarks are as under: Several cases have come to notice where taxpayers do not discharge their statutory liability such as in respect of excise duty, employer's contribution to provident fund, employees State Insurance Scheme, for long period of time. For the purpose of their Income-tax assessments, they nonetheless claim the liability as deduction even as they take resort to legal action, thus, depriving the Government of its dues while enjoying the benefit of non-payment. To curb such practices, I propose to provide that irrespective of the method of accounting followed by the taxpayer, a statutory liability will be allowed as a deduction in computing the taxable profits only in the year and to the extent it is actually paid.
It may not be out of place to mention in this connection that excise duty is payable by an industrial enterprise in respect of goods lodged in a warehouse even if such goods are lost or destroyed by unavoidable accident. No doubt, under Rule 147, the Collector has discretion to remit the duty payable thereon. The liability to pay duty even in respect of lost or destroyed goods is clearly a demonstrative proof of the proposition that excise is an element of cost.
The law as it stands today, before the introduction of Section 43B, requires the IAC/ITO to allow the excise duty payable by an assessee on its manufactured goods as a deduction in computing the profits or losses of that year. The provisions of Section 43B do not lay down any principles of accounting but are intended to compel the assessees to pay their statutory duties before a deduction in respect of the same could be claimed. The direct cost method can be considered as an accepted method of stock inventory valuation but the same would not be complete without inclusion of the excise duty which for all purposes has to be considered as an element of cost.
As such, the Commissioner (Appeals) upheld the IAC's action for both the years.
20. Shri Mehta for the assessee pointed out that up to the assessment year 1980-81, the IAC had accepted the valuation of stock as made by the assessee. In this regard, Shri Mehta brought to our notice the assessee's balance sheet for the accounting year ended on 31-12-1973.
This balance sheet discloses that stocks are valued in the following manner: At cost (in the case of stock in process and manufactured goods at raw material cost) or market whichever is lower, as certified by a director.
Shri Mehta pointed out that for the first time in the accounts for the year ended 31-12-1976, there was a slight change in the method of ascertaining the cost for the purposes of the valuation of the closing stock. In the accounts for the year ended 31-12-1976 on this issue in their report, the auditors have commented as under: The company has changed the basis of valuing its stock in process and manufactured goods. As a result, the value of these stocks has increased by Rs. 11,49,296 and the profit for the year by a like amount before tax and Rs. 3,86,394 after tax. The other stocks have been valued on the same basis as in the earlier years. In our opinion, the valuation of stocks is fair and proper in accordance with normally accepted accounting principles.
21. Shri Mehta added that, thus, for the assessable income for the year 1977-78, the value of the closing stock was enhanced by a sum of Rs. 11,49,296 from the figure which otherwise would have been on the basis of the principles of ascertainment of cost followed up to the accounting year 31-12-1975. Shri Mehta then added that in the accounts for the year ended 31-12-1977, the company introduced yet another refinement for the ascertainment of the cost element. In the accounts for this year, on this issue, the auditors' comment was: The company has changed the basis of valuing its manufactured goods by the inclusion of certain additional element of cost. As a result, the value of these stocks has increased by Rs. 7,26,524 and the profit for the year by a like amount before tax and Rs. 1,81,174 after tax. The other stocks have been valued on the same basis as in the earlier years. In our opinion, the valuation of stocks, subject to the exclusion of excise duty (Rs. 12,25,536) from the valuation of finished goods and the work-in-progress having been valued at direct cost, is fair and proper and in accordance with normally accepted principles.
Shri Mehta then added that as regards its accounts for the year ended 31-12-1978, the assessee valued its closing stock in the manner it had valued its closing stock for the immediately preceding the assessment year and that as a result, the assessable income for that year was enhanced similarly by a sum of Rs. 32,19,575. Shri Mehta brought to our notice the auditors' comments on this to which we are not making a reference as primarily they are of the same type as those for the year ended 31-12-1977. In its accounts for the year ended 31-12-1979 on a reconsideration of the issue of the ascertainment of cost, the company considered it advisable for the purpose of ascertainment of cost 'to exclude excise duty and certain additional element' which were considered for the purposes of ascertainment of the cost in the accounts for the years ended 31-12-1977 and 31-12-1978. Shri Mehta pointed out that on this issue in their report for the year ended 31-12-1979, the auditors commented as under: The company has changed the basis of valuing its stocks of manufactured goods by exclusion of excise duty and certain additional elements of cost. As a result of the exclusion of excise duty from cost, the value of finished goods stock has decreased by Rs. 43,10,907 and profit for the year by a like amount before tax and Rs. 10,56,721 after tax. The other stocks have been valued on the same basis as in the previous year. In our opinion, the valuation of stocks is fair and proper and in accordance with normally accepted accounting principles.
22. For the two years ended under consideration, viz., 31-12-1980 and 31-12-1981, the assessee proceeded to ascertain the. cost in the same manner as it had done for the accounting year ended 31-12-1979. The auditors, comments for these two years were as under: The company has changed the basis of valuing its stocks of manufactured goods and stock in process by exclusion of certain elements of costs and inclusion of certain other elements of cost.
As a result of this change, the value of the stocks has increased by Rs. 6.83 lakhs and profit for the year by a like amount before tax and Rs. 2.45 lakhs after tax. The other stocks have been valued on the same basis as in the previous year. In our opinion, the valuation of stocks is fair and proper and in accordance with normally accepted accounting principles.
In our opinion, the valuation of stocks is fair and proper and in accordance with normally accepted accounting principles and is on the same basis as in the previous year.
Shri Mehta pointed out that when for the two years under consideration, the assessee followed the same method of ascertainment of cost as for the year ended 31-12-1979 and was followed uniformly up to the accounting year ended on 31-12-1976, there was no justification for the IAC to make the disputed addition for the reason that for the two intermediate accounting years ending 31-12-1977 and 31-12-1978, the assessee had followed a different method of ascertainment of cost. Shri Mehta submitted that not only up to the assessment year 1977-78, at a point of time when there was no change, the assessee's method of ascertainment of cost the method adopted was accepted by the department but that the assessee's method of ascertainment of cost was accepted for the two intermediate years, when there was an enhancement and equally for the year 31-12-1979, when the assessee had reverted to its original method of ascertainment of cost.
23. On the above basic and primary facts, Shri Tuli for the revenue has no quarrel. However, he added that the acceptance by the department of the assessee's original method of ascertainment of cost or the changed method of ascertainment of cost was an acceptance without any discussion and, therefore, an acceptance without any application of mind by the assessing officer. According to Shri Tuli, therefore, one ought not to attach undue importance to the fact that the department had accepted the assessee's method of ascertainment of cost for some years for the years up to 31-12-1976, the change in that method for the two years 31-12-1977 and 31-12-1978 and the acceptance of the reversion of that method for the year 31-12-1979. According to Shri Tuli, it was for the first time for the assessment year 1981-82 that the assessing officer considered this issue in its proper perspective and that there was full justification for the additions as made by the IAC and sustained by the Commissioner (Appeals).
24. Shri Mehta for the assessee pointed out that as observed by the Commissioner (Appeals). Section 43B of the Income-tax Act, 1961 ('the Act') was inserted by the Finance Act, 1983, with effect from 1-4-1984.
According to Shri Mehta, the issue of the principles of ascertainment of cost had been receiving attention at different levels and that when the department had reopened certain assessments and one such concerned assessee filed writ proceedings before the Bombay High Court wherein reliance was placed on behalf of the department on certain circulars issued by the CBDT and the Commissioner. According to Shri Mehta, the genesis of the action of the IAC in adding for the two years under consideration the amount exceeding Rs. 34 lakhs each has to be seen in the circular of the Commissioner, dated 9-4-1981. Shri Mehta submitted that he is in a position to file the copies of these papers as these papers were relied upon by the department in the writ proceedings to which a reference has been made.
25. Now, Shri Mehta points out that by his letter, dated 9-4-1981, the Commissioner, brought to the notice of the officers working under his charge, the CBDT circular dated 24-3-1981, wherein the Commissioner observed that: The Board is of the opinion on the basis of expert opinion from the Institute of Chartered Accountants of India that normally customs duty and excise duty will enter into the manufacturing expenses and will, therefore, form an element of cost for inventory valuation.
All the ITOs are requested to study the above Instruction No. 1389 along with the guidance notes and take suitable action under Section 145(1) proviso as recommended by the Director of Inspection (Special Cell) wherever under valuation of closing stock has been resorted to by the assessee by the above method.
Vide their Instruction No. 1389, the CBDT has stated that on a reference made to the Institute of Chartered Accountants of India, the CBDT has been informed that the question of appropriate accounting treatment of excise duty as a part of cost price has already been examined by the Research Committee of the Institute and the opinion of the Research Committee was that normally an excise duty should be considered as a manufacturing expense and as an element of cost for inventory valuation. The position will be same in respect of customs duty also. A copy of the conclusion arrived at by the Research Committee of the Institute in this matter is enclosed.
Shri Mehta then brought to our notice, the extract from the Chartered Accountants' Journal, October 1979, pages 387-391 giving guidelines on accounting treatment for the excise duties. He then brought to our notice the conclusion as drawn which are to be seen in para 37 as under: 37.(a) The excise duty should normally be considered as a manufacturing expense and like other manufacturing expenses be considered as an element of cost for inventory valuation.
(b) Where the excise duty contributes directly to bringing inventory to its present location and condition and is a direct cost, it must be included as an element of cost in the valuation of inventories, irrespective of whether the direct costing or the absorption method of costing is used. Excise duty would normally be so considered when it is a specific or ad valorem duty.
(c) Where the excise duty contributes directly to bringing inventory to its present location and condition but is in the nature of a manufacturing overhead, it need not be included as an element of cost when the 'direct costing' system is used but must be included when the absorption costing system in used. Such a situation will normally arise when excise duty is levied on a compounded basis.
26. Shri Mehta then brings to our notice, the publication by the Institute of Cost and Works Accountants of India, published in October 1979. Shri Mehta specifically brings to our notice that the said publication refers to a notification of Ministry of Law, Justice and Company Affairs, Shri Mehta pointed out that the assessee manufactures the dyes according to the proforma prescribed. In this regard, Shri Mehta brings to our notice the proforma 'C' printed at pages 19 and 20 of the publication, according to which the manufacturer has to give information to the concerned authority regarding the different elements of cost, selling and distribution expenses, etc. Shri Mehta then adds that in respect of the quantity sold within the country, one is required to give total expenses excluding excise duty for quantity sold and similarly total sales realisation excluding excise duty for quantity sold, the difference being the margin. Shri Mehta added that it would thus be manifest that with regard to the statement to be filed by a paint and dyes manufacturer with the concerned authority, the excise duty has to be separately indicated. According to Shri Mehta, primarily, the assessee's method of valuation of the stock was as seen from the accounts for the year ended 31-12-1973 'at cost or market value whichever is lower'. According to Shri Mehta, the concept of cost ordinarily should not create any difficulties. However, Shri Mehta added that at times the basic concepts are not free from doubt and it would be manifest that the concept of cost is one such basic concept which is not free from doubt. Shri Mehta added that whereas at one stage, the Institute of Chartered Accountants gave an opinion that the excise duty be considered as an element of cost for determining the valuation. Later, the institute has observed that: Where the excise duty contributes directly to bring inventory to its present location and condition and is a direct cost it must be included as an element of cost in the valuation of inventories, irrespective of whether the direct costing or the absorption method of costing is used. Excise duty would normally be so considered when it is a specific or ad valorem duty.
Shri Mehta further adds that the conclusion drawn by the Institute of Chartered Accountants is: Where excise duty is not considered as a manufacturing expense on the basis that the liability arises only after manufacture is completed and the inventory is valued at direct manufacturing cost it may be charged out as an expense of the period in which the expenditure is incurred.
According to Shri Mehta, merely by valuation of the closing stock, one does not either make a profit or incur a loss but that stocks had to be valued so as to ascertain properly the result of the transaction of the year, the profit being the difference between the sale realisation and the cost of the goods sold as held by the Supreme Court in Chainrup Sampatram v. CIT [1953] 24 ITR 481. According to Shri Mehta, any adjustment made on account of valuation of stock is primarily made to give the true trading results of the year and that merely because on proper advice the assessee changes method of ascertainment of cost, it cannot be said that there is an under valuation of stock much less with an intention to reduce the taxable income. In this regard, Shri Mehta brought to our notice a copy of the letter dated 5-10-1980 from the Director of Inspection (Investigation) (Special Cell), New Delhi, being one of the papers relied upon by the department in the writ proceedings, which states as under: On my recent tour to Bombay, I found that certain other big companies have also started resorting to the same method of undervaluation of stocks as described above. In the case of Goodlass Nerolac Paints (P. A. No. 34-009-CM-5335)/BMY-COM-IV-3 the undervaluation of closing stock in this manner was Rs. 43,10,907 in 1979. The relevant extract from the annual report of the company for the year 1979 reads as under: The company has changed the basis of valuing its stocks of manufactured goods by exclusion of excise duty and certain additional elements of cost. As a result of the exclusion of excise duty from cost, the value of finished goods stock has decreased by Rs. 43,10,907 and profit for the year by a like amount before tax and Rs. 10,56,721 after tax. The other stocks have been valued on the same basis as in the previous year. In our opinion, the valuation of stocks is fair and proper and in accordance with normally accepted accounting principles.
Shri Mehta submitted that in the manner in which both the authorities below have proceeded to examine the issue, it appears to me that the dispute is blown out of proportion. According to Shri Mehta, the reliance by the Commissioner (Appeals) on the speech of the Hon'ble Minister while introducing a new provision, was dealing with an entirely different issue, viz., the claim of a manufacturer as a permissible deduction in the computation of income that amount of excise duty which is being challenged in the writ proceedings in respect of which a stay was obtained from the Courts. According to Shri Mehta in the present case, there was no dispute regarding the assessee's liability towards the excise duty and that neither of the authorities below has even remotely suggested that the present assessee is one, who has obtained deduction for excise duty liability in respect of which it has obtained stay of recovery of excise duties from the Courts. According to Shri Mehta, this dispute should be considered without clouding the thinking on account of insertion of Section 43B, which comes into force from 1-4-1984 only. Shri Mehta brought to our notice the decision of the Madras High Court in CIT v. Carborandum Universal Ltd. [1984] 149 ITR 759.
27. Shri Tuli for the revenue referred to pages 77 and 78 of the assessee's compilation being the extracts from the auditors' note on the accounts for the years 31-12-1976 to 31-12-1981. We have made a reference to those earlier in paras 20 to 22. According to Shri Tuli, when in the first or second year of change, the ITO accepted the refinement in the assessee's method of ascertainment of cost, there is no discussion on the issue by the ITO. Shri Tuli emphasised the fact that for the first time for the year 31-12-1978, the assessee considered for the purposes of ascertainment of cost certain additional element of cost and the additional element of cost considered for the first time in the accounts for the year ended 31-12-1978, was the excise duty element of cost of goods in stock but which were cleared from the bonded warehouse on payment of excise duty. According to Shri Tuli, the ITO accepted this change equally without any discussion. Shri Tuli further submitted that when in the accounts for the year ended 31-12-1979, i.e., accounts for the first year after the guidance note was published in October 1979 issue of the Chartered Accountants' Journal, the assessee had reverted to its original method of ascertainment of cost ignoring the element of excise duty and that on the basis followed by the assessee for the year ended 31-12-1979, there was an under statement of Rs. 43,10,907. Shri Tuli submitted that in accepting the assessee's method, the ITO did not discuss the issue in the assessment order and in the assessment order there was no whisper about the change in the method of ascertainment of cost effected by the assessee in the accounts for the year under consideration by reverting to the original method. Shri Tuli submitted that it was this aspect of the assessment, which was commented by the Director of Inspection (Investigation) (Special Cell), New Delhi, to which a reference has been made in the letter filed by the department in certain writ proceedings to our attention was drawn by Shri Mehta and to which we have made a reference earlier in paras 24 to 26. According to Shri Tuli, since the assessee had made certain changes in the method of valuation of cost unilaterally, the ITO was justified in ignoring the change which the assessee made. Shri Tuli stressed the fact that the method of ascertainment of cost is to be consistent and for a long period. According to Shri Tuli, the manner in which the assessee changed the method of ascertainment of cost over the period 31-12-1976 to 31-12-1979, showed that the assessee was not following consistently a particular method and that the assessee was not entitled to revert in the accounts for the year ended 31-12-1979 to the method of ascertainment of cost which it had followed up to the year ended 31-12-1975. Shri Tuli's attention was drawn to the Madras High Court's decision in CIT v. Chari and Ram [1949] 17 ITR 1, more particularly, the observations of the Court at p. 8. Shri Tuli's attention was further drawn to the decision of the Supreme Court in Chainrup Sampatram's case (supra). Shri Tuli had nothing of special importance to urge on what was brought to his attention.
28. Having heard the parties and examined the record on this last issue, we find that there is no dispute on facts which have been indicated in some details in earlier paragraphs while recording the submissions of Shri Mehta. We have further recorded Shri Tuli's submission that we need not attach undue importance to the fact that the department had accepted the assessee's method of ascertainment of cost for the years up to 31-12-1976, a change in the method for the two years 31-12-1977 and 31-12-1978 and the acceptance of the reversion of that method to the old method for the year ended 31-12-1979. Apart from the noting of the Director of Inspection (Investigation) (Special Cell), New Delhi, brought to our notice by Shri Mehta, we do not find any materials on record which would justify one in coming to the conclusion that the change of method of ascertainment of the cost by the assessee over the years was a motivated one. As we have noted, initially for every one of the years under consideration, the assessee had returned the income of more than a crore and a half rupees. We have further noted the fact that for the first time in the accounts for the year ended 31-12-1976 owing to the change in the method of ascertainment of cost, the value of the closing stock was increased by an amount of Rs. 11,49,296 and for the year ended 31-12-1977, the increase was by an amount of Rs. 7,26,524. Similar increase in the accounting year ended 31-12-1978 was Rs. 32,19,575. In so increasing the valuation, we are unable to find any ulterior motive of the assessee. This is because if for one year there is an enhancement in the value of the closing stock, automatically that figure has to be taken as an opening stock so that there is merely a shifting of profits from one year to another year. Inasmuch as for every one of the years now under consideration, the assessee has returned income of well over crores of rupees, the increase in the value of the closing stock owing to the change in the method of ascertainment of that value cannot be considered as a motivated one. In the accounts for the year 31-12-1979 on the assessee's reverting to its original principle of ascertainment of cost from the method that is adopted in the accounting year 31-12-1978, there was an understatement of an amount of Rs. 43,10,907.
On the same basis for the two years under consideration, the assessing officer has worked out that had the assessee followed the method of valuation that it had followed in the accounting year ending 31-12-1976, the profits would have been, respectively, larger by an amount of Rs. 34,64,179 and Rs. 34,02,272. Inasmuch as without considering this adjustment, the assessee's returned profits were over Rs. 1,50,00,000, we are unable to attribute any motive to the assessee when the assessee reverted to its original method of ascertainment of cost.
29. Once the assessee's bona fides are accepted, one can consider in proper perspective the issue now under consideration. It is unnecessary to add that the concept of cost is not the simple concept to appreciate. In this connection, one finds the decision of the Madras High Court in the case of Chart and Ram (supra). In that case, the dispute was whether while valuing the stock at cost or market whichever is lower what exactly was the concept of the cost. The assessee while ascertaining the opening stock had considered the average cost.
However, for ascertaining the valuation of closing stock the assessee adopted a slightly different method as seen from the headnote: ...At the time of valuing the closing stock, with regard to some of the articles the market rate was lower; whereas with regard to the other articles the market rate was higher than the average cost. The assessees took the average cost as the value of the closing stock for those articles of which the cost was lower than the market rate and adopted the market rate for other articles of which the market rate was lower than the average cost. The Commissioner contended that this method was wrong and that the correct method would be to arrive at two separate valuations of the closing stock, one the aggregate of the actual average cost for each of the articles and the other the aggregate of the market value of the same articles and to adopt the lower of the two aggregates: (p. 1) This was the dispute referred for the Court's opinion. In this connection, one has to consider the observations of the Court as under: ...But if it is found as in this case that the method adopted by the assessee in the period of assessment is in accordance with the method of accounting regularly followed by the assessee in the past then that method must be accepted in the absence of anything to suggest that it is improper or patently false....
Unlike the issue before us, which relates to the Income-tax assessment before the High Court, the dispute related to both the Income-tax and excess profit tax and as such that principle applies in the present case with greater force.
30. We do not find anything on record even to remotely suggest that one could justifiably say that the reversion to the original method of ascertainment of cost by the assessee was improper or patently false.
This conclusion has to be followed as in the very first year when the assessee effected the change, it so effected on the basis of the guidance note prepared by the Institute of Chartered Accountants to which our attention was drawn by Shri Mehta. As brought to our notice earlier and found to be correct, in the account for the year ending 31-12-1976, on the basis of the advice, which the assessee was able to obtain, the assessee made refinement for the purposes of ascertainment of cost and that on that basis, it ascertained the cost for the years ended 31-12-1976, 31-12-1977 and 31-12-1978. We find nothing on record to suggest that when the assessee valued its stock for the year ended 31-12-1979 on the same principles as it had followed up to the year 31-12-1975, there was any mala fide intention. We equally do not find anything on record which would suggest that when for the two years under consideration, the assessee followed the same method for ascertainment of cost as it followed up to 31-12-1975, there was any mala fide intention on the part of the assessee. Shri Mehta pointed out that in reverting to the original method, the assessee strictly followed the guidance notes where it is observed 'it is also advisable in such circumstances to disclose the accounting treatment followed'.
On the basis of facts brought to our notice by Shri Mehta, we find that it would be illogical, unjust, unfair and unreasonable, to challenge with a view to ascertain whether the adjustment or the purposes of ascertainment of cost of the closing stock as made by the assessee, has any ulterior motive or purpose, we have directed the assessee to file for the accounting years 1978 and 1979, the position as it has emerged as recorded in the accounts and as it would emerge if the excise duty incidence is not given effect to in the audited account. For the accounting years ended 31-12-1978 and 31-12-1979, the position is as under:Profit before tax 155 123 219 262Tax 98 78 149 182Profit after tax 57 45 70 80Dividend 32 32 35 35General reserve 25 13 35 45 II--If change in excise duty incidence is not given effect to in audited accounts.
31. With a view to highlight the understanding of the controversy of this issue, we would like to give an illustration. Let us assume that the assessee manufactures only three articles, which will No. 'A', 'B' and 'C' and the basic cost of each is Rs. 100 and on which the excise duty of Rs. 20 is payable. Let us further assume that the assessee has removed from the bonded warehouse items 'A' and 'B' on payment of excise duty of Rs. 40. Thus, to the debit of the manufacturing and trading account, would appear a total debit for basic cost of Rs. 300 and payment of the excise duty of Rs. 340. Let us further assume that the assessee has sold item 'A' for a sum of Rs. 150. The issue now is what exactly the profit is which the assessee has made during the year of account. According to the assessee's original method of ascertainment of cost for the purposes of valuation of closing stock, the assessee was disregarding the excise duty payment of Rs. 20 in respect of item 'B', which has been cleared from the bonded warehouse but has not been sold. Thus, the assessee has valued in its accounts for the years under consideration, viz., 31-12-1980, items 'B' and 'C at Rs. 100 each. There is no dispute that item 'C is properly valued.
The dispute is only about the ascertainment of cost of item 'B'.
According to the department, the assessee ought to have valued at Rs. 120 for item 'B', so that in respect of sale of item 'A' during the year of account the assessee's profit is shown correctly at Rs. 30 and not at Rs. 10. This amount of Rs. 20 is the addition as made by the ITO for the two years under consideration, viz., Rs. 34,64,179 for the first year and Rs. 34,02,272 for the second year.
32. We are satisfied that at no stage, when the assessee changed the method of ascertainment of cost, the assessee's bona fide can justifiably be doubted or challenged. We further have to take a note of the fact that the income returned for each of the years is of the same order and that no one could justifiably say that the assessee was contemplating adjustment of profits from year to year so as to reduce the tax liability.
33. We would now consider Shri Tuli's objection that the assessee had changed its method of accounting. As we have made it clear earlier, the assessee did not make any change in its method of accounting but had made certain changes in the principles followed for ascertainment of value of stock. Even if one were to assume that the change in the method of ascertainment of the value of the closing stock was a change in the method of accounting, unless such a change was mala fide, the change has to be accepted. This follows from the decision of the Calcutta High Court in CIT v. Eastern Bengal Jute Trading Co. Ltd. [1978] 122 ITR 575. In that case, there was a specific change in the method of accounting from mercantile to cash, which method was regularly followed from the accounting year relevant for the assessment year 1966-67. As seen from the head-note "As a result of the change the result was a loss whereas under the previous method it would have been a profit." The Court observed that: . . .that Appellate Tribunal had found that there was no mala fide motive in changing the method of accounting and that the new method had been regularly followed and accepted by the department in the subsequent years. Therefore, the assessee could elect to be assessed on the basis of the cash system of accounting. (p. 575) 34. During the course of hearing, we had asked Shri Tuli whether the assessing officer had made an adjustment so that for every year both the opening and closing stock have been valued on the basis of identical principles of ascertainment of cost. Shri Tuli replied that the ITO need to make adjustment only in respect of valuation of the closing stock and need not revalue the opening stock. For this purpose, Shri Tuli relied on the Allahabad High Court in the case of Ram Luxman Sugar Mills v. CIT [1967] 63 ITR 51. When one turns to that decision, it is seen that the question referred was answered in favour of the department. One also finds that the Court's attention was not drawn to the decision of the Privy Council in CIT v. Ahmedabad New Cotton Mills Co. Ltd. 4 ITC 245. The comments on that case of the learned authors Kanga and Palkhivala's The Law and Practice of Income-tax, Seventh edn., Vol. 1, are to be seen as follows: Where the opening as well as the closing stock for the year is undervalued, the ITO should not revalue the closing stock only at its true value, while declining to revalue the opening stock also on the same basis, for, obviously, proper valuation at one end and an undervaluation at the other would not disclose the true profits of the year. (p. 880) Were one to assume that the assessing officer was justified in making the additions he did, following the Privy Council's decision in Ahmedabad New Cotton Mills Co. Ltd.'s case (supra), it was incumbent on the assessing officer to evaluate both the opening and closing stock on the same principles. Apparently, this has not been done. Based on the Privy Council's decision in the case of Ahmedabad New Cotton Mills Co.
Ltd. (supra), it is manifest that in the assessment for the year 1982-83, the ITO necessarily had to make an adjustment by reducing the opening stock value by an amount of Rs. 36,64,179. To revert to the illustration which we had given earlier, if on valuing item 'B' at Rs. 100 in the subsequent year, the assessee sells the item at Rs. 155, the profit would be Rs. 35. The assessee has accounted for this profit at Rs. 35 in the second year's account. However, in the manner in which the ITO has made the assessment, when he has enhanced the profit of the first year by Rs. 20, he has not reduced the profit of Rs. 35 for the purposes of second year's assessment. Assuming, we are wrong in our decision that the ITO was not justified in making the adjustment of the type which he did for any of the two years in the second year, it has to follow that the ITO must reduce the assessee's assessable income by Rs. 34,64,179 and also revalue the opening stock for the first year.
Once we find that the assessee's bona fides are not suspect but, the dispute is merely in which year particular income is to be taxed and more particularly in the case of a limited company, we recollect the observations of the Bombay High Court in CIT v. Nagri Mills Co. Ltd. [1958] 33 ITR 681 at p. 684. We are aware that the Supreme Court in the case of CIT v. Swadeshi Cotton & Flour Mills (P.) Ltd. [1964] 53 ITR 134 has stated that deduction for profit bonus is admissible in the year in which the dispute was settled by an award of the Industrial Tribunal. However, the enunciation of that principle by the Supreme Court does not detract the merits of the observation of Mr. Justice Tendolkar in Nagri Mills Co. Ltd.'s case (supra) that: ... Judging from the references that come up to us every now and then, the department appears to delight in raising points of the character which do not affect the taxability of the assessee or the tax that the department is likely to collect from him whether in one year or the other. (p. 684) To the best of our knowledge, this observation of Mr. Justice Tendolkar has not been overruled by the Supreme Court.
35. We would now refer to the decision brought to our notice by Shri Mehta, viz., Carborandum Universal Ltd.'s case (supra). It will be seen from that decision that the Madras High Court was examining, among others, the total cost and the direct cost method for the purposes of ascertainment of cost. After considering the difference between the two methods and referring to the decision of the Allahabad High Court in Ram Luxman Sugar Mills' case (supra) relied upon by Shri Tuli and Kantilal Chandulal Dharia v. CIT [1976] 104 ITR 487 (Bom.) a classic decision of the Supreme Court in Chainrup Sampatram's case (supra) the Madras High Court in Carborandum Universal Ltd.'s case (supra) observed as under: . . .The Court found that different accountants were applying either one or the other of the two methods producing a true figure of profit. On the question as to which of the method of valuation should be applied for valuing the work-in-progress in the case, the Court held that in determining what, in the circumstances of a particular business, was the figure which fairly represented the cost of the work-in-progress as per the method employed consistently since 1924, the inland revenue has not discharged the burden of showing good reason that the method should be changed to the 'on cost' method and, therefore, the assessee is entitled to continue to adopt the 'direct cost' method as before.
Thus, the adoption of 'direct cost' method by the assessee cannot be questioned by the revenue as it has been found by the Tribunal that the adoption of this method is bona fide and is a permanent arrangement. The revenue's only contention is that it has shown to be prejudicial to the revenue. As pointed out in Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC) and Indo-Commercial Bank Ltd. v. CIT [1962] 44 ITR 22 (Mad.), merely because the new method adopted by the assessee was detrimental to the revenue, that alone can never be the basis for denying the right to change the method. Further, even though the change of the method has resulted in a detriment to the revenue in the year in question, since the method is to be followed consistently year after year in future, this apparent detriment to the revenue will get adjusted and disappear. Therefore, in view of the findings of the Tribunal that the change of the method is bona fide and is intended to be followed in future, year after year, the change has to be accepted by the revenue, notwithstanding the fact that during the assessment year which is the first year when the change of method is brought about it has resulted in a prejudice or detriment to the revenue. So long as the method of valuation adopted by assessee gets recognition from the practising accountants and the commercial world for evaluation of stock-in-trade, the adoption of that method cannot be questioned by the revenue unless the adoption of that method is found to be not bona fide or restricted for a particular year. (p. 770) 36. We need not refer that in the present case, when the assessee reverted to its original method of ascertainment of cost, the assessee's bona fides can never be justifiably doubted or challenged or it can be said that even an attempt has been made by the revenue to doubt the assessee's bona fide. In our opinion, this is the most important fact and the further fact that as we had explained above, over a period of time there is no difference between the income offered for assessment and the income brought to charge, we do not find any justification to sustain the disputed addition made for any of the two years. It will be seen that in reverting to its original method of ascertainment of cost, the assessee has followed the guidance notes on accounting treatment for the excise duty published in the Chartered Accountants' Journal, October 1979, pages 387-391. In this regard, one recollects the observation of the Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 thus: It would appear from the above that the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets which have been created as a result of such expenditure. The above rule of accountancy should, in our view, be adopted for determining the actual cost of the assets in the absence of any statutory definition or other indication to the contrary. (p. 175) It is for this reason, we considered it proper to accept the assessee's action in reverting to its original method of ascertainment of cost and on that basis, we delete the addition made for each of the two years, respectively, at Rs. 34,64,179 and Rs. 34,02,272.
37. Assuming that our decision be not correct and there is any justification to make an addition for the assessment year 1981-82 of Rs. 34,64,179, on the basis of Privy Council's decision in Ahmedabad New Cotton Mills Co. Ltd.'s case (supra) the opening stock for the assessment year 1981-82 must be valued on the same principles even though the closing stock for the year 1980-81 may not be or cannot be valued on that basis. Therefore, if there be any justification in adding to the closing stock, the value for the assessment year 1981-82, the amount of Rs. 34,64,179, the assessee must be allowed the deduction of Rs. 43,10,907, the undervaluation of closing stock in 1979 as observed by the Director of Inspection (Investigation) (Special Cell), and referred to by us at page 19 of our order and the Auditor's note as referred to by us in para 14 of this order. For the assessment year 1982-83, if on that basis, the addition of Rs. 34,02,272 is to be confirmed, the ITO is bound to reduce the value of the opening stock by an amount of Rs. 34,64,179 added to the value of the closing stock for the year 1981-82. It would thus be seen that if we be wrong in our decision in accepting the assessee's appeal on this ground for these two years, the net result would be that for the assessment year 1981-82 the assessee's income would be reduced by Rs. 8,46,728 (reduction of the opening stock by Rs. 43,10,907 less the addition to the value of closing stock by Rs. 34,64,179). For the assessment year 1982-83, the opening stock will have to be reduced by Rs. 34,64,179 and the closing stock will have to be enhanced by Rs. 34,02,272, so that on this account, the assessee's income for the year 1982-83 will have to be reduced by Rs. 61,907. We have taken note of the fact that a statement was made at the bar, which was not controverted that in its subsequent accounting years the assessee has regularly followed the same system that it had followed originally up to the year ended 31-12-1975 and to which it had reverted in its account for the year ended 31-12-1979. To put it specifically, if our decision for deletion of the two additions now under consideration be held incorrect on this issue alone the assessee's income for the year 1981-82 will have to be reduced by Rs. 8,46,728 and for the year 1982-83 by an amount of Rs. 61,907.
38. In the circumstances, considering the facts and the law, we do not find any justification to sustain the disputed addition for any of the two years.