1. to 9. [These paras are not reproduced here as they involve minor issues.] 10. The next four grounds are in relation to the addition of Rs. 35.11 lakhs to the value of the closing stock. The assessee as already stated, is a manufacturer of paints. Its closing stock consists of raw materials, work in process and finished goods. In the accounts for the year ended 30-6-1987 relevant for the assessment year under appeal, the closing stock was valued at Rs. 13,88,99.690. The ITO was, however, of the view that the value of the closing stock has to be increased by the MODVAT portion of the excise duty paid by the assessee in respect of the raw materials that are used in the manufacture of the final product, viz., paints and in that view of the matter increased the value of the closing stock by Rs. 35.11 lakhs.
11. The assessee appealed to the CIT(A) who merely endorsed the ITO's conclusion and upheld the addition.
12. Now the events leading up to the addition may have to be stated a little elaborately since the issue was debated at length before us. The assessee, in the course of manufacture of paints is liable to pay excise duty on the final product manufactured, viz., paint. In order to manufacture the paint, it purchases raw material, which are also subject to excise duty which is paid by the assessee. Now in the long term fiscal policy introduced by the Govt. of India, in December, 1985, ways and means of reducing the escalating effect of paying excise duty on both paints, viz., at the point of purchase of inputs and at the point of manufacture of the final product, were explored. The Finance Minister had introduced a system called MODVAT system whose basic object was the shifting of the effective burden of excise taxation away from the inputs and on the final products. In other words the object and effect of MODVAT system was to reduce the spiralling effect which the payment of excise duty on both points had on the price of the final product. In short, the system worked like this. Since the manufacturer pays the excise duty on the raw materials which are called inputs, he is entitled to take credit for the same against the excise duty liability on the final product. This credit can be utilised for paying the excise duty on the final product. For instance, if Rs. 2 is paid on one unit of input as excise duty and if the excise duty payable on the final product is Rs. 6 per unit, the manufacturer can set off Rs. 2 against Rs. 6. Now, naturally, when this system was introduced, questions arose with regard to the treatment to be given to the MODVAT system in the books of account maintained by the manufacturer. The matter engaged the attention of the Institute of Chartered Accountants of India (for brevity 'ICAI') who suggested two methods, one known as "exclusive" method and the other known as the "inclusive" method. Under the exclusive method the excise duty paid on the inputs is not debited in the manufacturing or profit and loss account, but is debited to a separate account styled as MODVAT Credit Receivable Account. In this method, therefore, the purchase account debited in the P & L A/c and the raw materials account debited therein would be net of MODVAT duty.
The inventory of the input would also be valued on the basis of purchase cost not of input duty. The following journal entries would be passed:--Purchases A/c Dr. (with cost price of input)MODVAT Credit Receivable A/c Dr. (with excise duty on input)To Sundry Creditors A/c (total) The purchases account would be debited only with the cost price of the raw materials or in other words inputs and the MODVAT Credit Receivable A/c would be debited with the excise duty on inputs as per the MODVAT system. When excise duty is paid or is payable when the final product is manufactured, the amount is debited to excise duty paid A/c and credited to MODVAT credit receivable A/c, showing utilisation of the MODVAT credit taken at the time of purchase of inputs. The followingjournal entry is passed:--Excise duty paid A/c ..
Dr. (Gross excise duty on the final product) The MODVAT Credit Receivable A/c will now show the balance credit which the assessee is eligible to avail of in future. The balance, according to the ICAI, should be shown on the assets side of the balance sheet under the head 'Advances'.
13. A simple illustration will suffice to explain the working of the exclusive method. The following are the assumptions:-- (c) 60 units of inputs are consumed to manufacture 50 units of final product.
Now, the journal entries to be based under the exclusive method of accounting would be as under:--(1) Purchases (100 x 10) Dr. Rs. 1000 Rs MCRA/c (100 x 2) Dr. 200 To Sundry Creditors or Bank A/c or cash A/c 1200(2) Excise Duty paid (50 x 3) Dr. Rs. 150 To MCRA/c 150 (being final excise duty on 50 Units Rate Rs. Units Rate Rs.To purchases 100 10 1000 By Sales 50 20 1000To Excise Duty 50 3 150 By Raw Materials 40 10 400To Gross profit 250 in stock 1400 1400To Sundry 200 By Excise duty 150creditors (Inputs) (utilisation) By Balance c/d 50 14. The above "exclusive" method was adopted by the assessee in the present appeal. As the illustration itself would show, the excise duty on inputs has not been debited in the P & L A/c at all. The contention of the assessee on the above facts before us, presented by Dr. D. Pal, is that when the P & L A/c is not 'loaded' with the MODVAT element of excise duty there is no Justification for the departmental authorities to add the same to the value of the closing stock. After all, says Dr.
Pal, the purpose of valuing the closing stock is to quote the words of his Lordships the learned CJ Patanjali Shastri in the well-known decision of the Supreme Court in Chainrup Sampatram v. CIT [1953] 24 ITR 481 at page 485, "...to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would have only the transactions on which there have been actual sales in the course of the year showing the profit or loss actually realised on the year's trading". The point sought to be made, in short, was that the "balance" is upset if something that is not charged to the debit side of the P & L A/c is added on to the credit side thereof as part of the value of the closing stock.
Alternatively, it was submitted, the ITO having added the MODVAT element to the value of the stock occurring in the credit side of the P & L A/c, it should be "balanced" by debiting a like amount to the P & L A/c, which will have the effect of wiping out the addition. A few incidental points were also made by Dr. Pal. He pointed out that the addition was contrary to the avowed object of the MODVAT system as formulated in the long-term fiscal policy which was, to recapitulate, to arrest the cascading effect of payment of excise duty on both inputs and final products. He further submitted that the assessee was only following an accounting practice recognised and approved by the ICAI and that it was not open to the taxing authorities to reject the same as unsound as was done in the present case. In this regard he referred to the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 at page 175 and the decision in CIT v.Nagarjuna Steels Ltd. [1988] 171 ITR 663 (AP) and Sivakami Mills Ltd. v. CIT [1979] 120 ITR 211 (Mad.).
15. Sri S.C. Sen, the learned departmental representative supported the order of the departmental authorities and also reinforced the same with a short note submitted at our instance. His point was that the MODVAT element of excise duty has got to be taken Into account while valuing the closing stock of raw materials and work in process even if the methodology of valuation adopted by the assessee is accepted. He drew our attention to this aspect of the matter which was highlighted by the ITO at page 7 of the assessment order. He also invited our attention to the decision of the Supreme Court in the assessee's own case as CIT v.British Paints India Ltd. [1991 ] 188 ITR 44 especially to the observation at page 45 (head-note) wherein the Supreme Court discouraged the practice of shifting the profit of one year to another year on the ground that it would be an incorrect method of computing profits. He further pointed out that the ITO had already made the adjustments to the value of the opening stock and only after making such adjustments has arrived at the addition of Rs. 35.11 lakhs and, therefore, no further adjustment as suggested by Dr. Pal was required or justified. He also made a point that the assessee must be taken to have accepted the addition since it was the assessee who furnished the figure of Rs. 35.11 lakhs in the proforma filed by it at the instance of the ITO who required the assessee to do the exercise by letter dated 19-3-1991.
16. We have carefully considered the rival submissions. We have gone through the paper book filed by the assessee (paper book No. 1) and the note submitted by Sri Sen, at our instance which is only a summary of the points made by him at the time of hearing. We have also studied the authorities cited by both sides. In our opinion, on the facts of the case, the assessee is entitled to succeed. The undisputed facts are that the assessee had paid excise duty on the raw materials that is inputs, which as per the MODVAT scheme, it is entitled to take credit against the excise duty payable on the final product. The scheme (mala fide system of value added tax) provides for instant credit of the excise duty paid on inputs when used in or in relation to the manufacture of the final products. The system enables a manufacturer to obtain instant and complete reimbursement of excise duty paid on inputs. The scheme would avoid payment of duties on earlier duties paid. The entire MODVAT system is regulated in accordance with Rules 57(A) or 57(B) of the Central Excise Rules, 1944. In the instant case, the excise duty paid on the inputs has not been debited to the P & L A/c, a fact which is not disputed by the departmental authorities. In the accounts, or rather the P & L A/c, only the excise duty paid on the final product is debited. As recognised by the ICAI the assessee follows the "exclusive" method of accounting for MODVAT excise duty under which the MODVAT excise duty, i.e., the excise duty paid on raw materials is taken directly to the MODVAT Credit Receivable A/c. In the background of these facts the ITO has made the addition. His reasons are two-fold: firstly, that irrespective of the method followed by the assessee the closing stock must be valued by including therein the excise duty element paid on inputs; secondly that the accounts would otherwise depict a distorted picture of the profits. Now, a close reading of the assessment order and the reasons given therein shows that the departmental authorities have found that the assessee has followed the exclusive method recognised by the ICAI. It is not, therefore open to them to say that the method followed by the assessee in respect of accounting for MODVAT excise duty is wrong or unsound. As was held by the Supreme Court in Challapalli Sugar Ltd.'s case (supra), the view of the ICAI on a particular method of accounting treatment to be given in the accounts represents the accepted commercial view. This decision has been cited and followed by the Madras High Court in Sivakami Mills Ltd. 's case (supra) and by the Andhra Pradesh High Court in Nagarjuna Steels Ltd. We have, therefore, to proceed on the footing that the method of accounting followed by the assessee in respect of MODVAT excise duty is one which is accepted in the commercial world. The next step would, therefore, be to examine the validity of the conclusion of the departmental authorities that if MODVAT excise duty is not debited to the P & L A/c the accounts would show a distorted picture calling for an addition to the value of the closing stock. Now, it is no more a subject of controversy that whatever be the method of accounting employed by the assessee, the closing stock must be valued and brought to account in order to arrive at the true profit of the business. This position has for long been settled now. What is the object of valuing the closing stock? To quote the words, as stated earlier, of His Lordship the learned CJ Patanjali Shastri, the object is "to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions on which there have been actual sales in the course of the year showing the profit or loss actually realised on the year's trading". The crucial word in this sentence is "balance". It implies that something that has gone into the left hand side of the P & L A/c or the trading account has to go into the right hand side also as part of the value of the closing stock.
Only by maintaining the "balance" one can arrive at the profit that has arisen in respect of the actual sales that have taken place during the year of account. Per contra, what has not gone into the left hand side of the P & L A/c cannot be included in the right hand side as part of the value of the closing stock; otherwise there will be no "balance", but the closing stock value will show an inflated figure. If this fundamental proposition is kept in view, the conclusion in the present case would be obvious. Excise duty paid on inputs not having been debited in the P & L A/c of the assessee cannot be added in the credit side of the P & LA/c to increase the value of the closing stock. If a balance is to be maintained, then, as pointed out by Dr. Pal, the ITO should have, while adding the excise duty on inputs to the value of the closing stock, recast the P & L A/c by "loading" the debit side of the P & LA/c with the excise duty paid under the MODVAT system. Of course the amount to be so added will be the same. An addition to the value of the closing stock will have to be offset by an addition of an identical amount to the cost of goods sold which will mean, as stated elsewhere in this order, that there will be no real addition.
17. Faced with this situation, Sri Sen sought to wriggle out of the same by pointing out that the assessee has debited the gross excise duty payable on the final product which means that it is getting a double advantage in the sense that the closing stock is also valued by it sans excise duty under MODVAT scheme and the gross excise duty (without setting off the MODVAT credit) is also being debited to the P & L A/c. This approach immediately puts one on guard, but a closer look at the argument, in the backdrop of all the facts of the case reveals, if we may say so, a fallacy. A manufacturer of excisable goods becomes liable to pay excise duty the moment the goods are manufactured. The excise duty on the goods manufactured constitutes a proper deduction against the receipts, as part of the cost of goods sold. Under the MODVAT scheme, the credit a manufacturer receives on payment of excise duty on the raw materials or inputs goes towards reducing the cost of the goods. In fact, this is the object of introducing the scheme as we have seen earlier. Now, under the alternative method suggested by the ICAI the excise duty paid on raw materials is debited as part of the cost of goods in the P & L A/c. Under this method, known as the "inclusive" method, the closing stock has, therefore, got to be loaded with the excise duty element, falling in line with the principle of "balancing". The illustration given earlier can now be worked out under the "inclusive" method as under:--or Bank 1200(cost of raw material at Rs. 10 Units Rate Rs. Units Rate Rs.To purchases 100 12 1200 By Sales 50 20 1000To Excise duty 50 3 150 By Stock ofpaid (gross) raw material 40 12 480To Gross Profit 250 By MODVAT It will be seen from the above that in the inclusive method of accounting for MODVAT excise duty since the purchases are valued at cost plus MODVAT excise duty the inventory of inputs (raw materials) also has to be valued on the basis of gross value, the gross value being Rs. lOperunit as cost plus Rs. 2 per unit as MODVAT excise duty.
Contrasting this method with the exclusive method of accounting it will be readily seen that the value of the closing stock of raw materials under the exclusive method does not include the excise duty paid on inputs. Under the inclusive method it is so included. Even so it will be seen that under both the methods, the gross profit remains the same, viz., Rs. 250. Therefore, the point sought to be made by Sri Sen for the department that the assessee gets a double advantage by debiting the gross excise duty paid on the final product has in our view no merit. The gross excise duty on goods manufactured by the assessee is in any case to be deducted against the receipts. But the point to be noted is that whereas in the exclusive method followed by the assessee the purchases are debited not of MODVAT excise duty paid on inputs, under the inclusive method it is included in both sides - in the debit side as part of purchases or cost of raw materials and in the credit side as part of the value of closing stock, as presented in the illustration above. In the present case, the objection of the taxing authorities is that MODVAT excise duty is not being included by the assessee as part of the value of the closing stock. It is not their objection that even the excise duty paid on finished goods has not been so included, or has not gone in as an element of costs that have gone to make up the value of the closing stock of finished goods. Had that been found as a matter of fact by the departmental authorities, then the grievance that the assessee would be getting away with a double advantage would have merited attention. But in the absence of any such case of the ITO we are not able to accept the plea of Sri Sen about the assessee getting a double benefit.
18. The other objection sought to be raised by Sri Sen that the ITO has already made adjustments to the value of the opening stock and, therefore, there was no question of balancing the addition made to the value of the closing stock by corresponding increase of the value of the purchases as suggested by Dr. Pal cannot also be upheld. The objection of Dr. Pal was not that the value of the opening stock has to be correspondingly increased. In fact, the objection was that if the MODVAT excise duty element paid by the assessee during the relevant accounting year is to be included as part of the closing stock of the year of account then the balance has to be maintained by correspondingly increasing the total of the debit side by the MODVAT excise duty paid on inputs during the year of account. Dr. Pal's contention was raised only as an alternative contention that in case the addition is sustained, the Income-tax authorities should be directed to enhance the debit side of P & L A/c by a like amount representing the MODVAT excise duty paid on inputs during the year of account. However, this discussion becomes academic in view of the decision we have taken in the present case, viz., the addition itself is not justified.
19. That leaves us with Sri Sen's submission based on the decision of the Supreme Court in the assessee's own case in British Paints India Ltd. 's case (supra). In that case the assessee contended that the closing stock had to be valued on direct cost method ignoring the overhead expenditure debited in the accounts. The stand of the revenue was that the stock had to be valued on the on-cost method including the overheads. The Supreme Court, reversing the judgment of the Calcutta High Court, upheld the on cost method followed by the Revenue. As the facts themselves would show, that decision had nothing to do with the present controversy. One noticeable distinction on facts is that in that case the assessee had debited the overhead expenses in the accounts but still wanted exclusion of the same when it came to a question of valuation of closing stock. The Supreme Court did not accept this contention. If anything, that decision, by a process of reasoning, may be taken to be in support of the assessee's case before us, if it is understood as also laying down, per contra, the proposition that if certain expenses are not debited in the P & L A/c they cannot be taken into account for the purpose of valuing the closing stock.
20. A minor point made by Sri Sen, incidentally, has also to be dealt with. He submitted that the assessee has accepted the addition proposed on account of valuation of closing stock before the ITO and, therefore.'he should not be allowed to agitate the matter. This is far from correct. In the course of assessment proceedings when the issue had cropped up the ITO had, while making it known that he proposed to make the addition on the footing that the MODVAT component of the excise duty should be included in the value of the stock called upon the assessee to furnish a working of the addition on that basis. By letler dated 22-3-1991 the assessee furnished the working of the same, but it made it clear that the working is given merely because it was called for and only by way of compliance to the ITO's requisition and that the addition, if made in the assessment would be unjustified. The assessee, as it is often said, reserved its rights to agitate the matter. Towards the end of the said letter the assessee had requested the ITO not to enhance the value of the stocks as per the predetermined formulae given in the proforma supplied by the ITO merely in order to arrive at a higher amount of taxable profit. The fact that the assessee had furnished the figures which, incidentally, have been accepted in toto by the ITO, does not mean that he has accepted or agreed to the addition. If it were to be so, it would have been quite unnecessary for the ITO to discuss the issue at length and be at pains to justify the addition on various grounds.
21. For these reasons we delete the addition of Rs. 35.11 lakhs made to the value of the closing stock.
22. Ground No. 16 is against the disallowance of Rs. 30,000 out of the total law charges of Rs. 2,64,204. The disallowance is seen to have been made on a routine manner without any specific reason. The assessee has furnished the details of the law charges at pages 22 to 25 of the paper book No. 3 filed before us. We have scrutinised the same and we do not see any basis or ground made out for the disallowance. It is, therefore, deleted. This ground is allowed.
The ground on which the above claims were disallowed by the ITO is that as required by the relevant statutory provisions the assessee had not furnished the audit report along with the return of income. The audit report under Section 32AB is dated 8-8-1988 but it was filed on 30-9-1988. The audit report under Section 80HHC is dated 26-12-1989 but it was filed on 9-4-1990. The return of income was filed on 24-6-1988.
The assessment was completed under Section 143(3) of the Act on 25-3-1991. It will be seen from the above that the audit reports both under Section 32AB and Section 80HHC were furnished before the assessment was completed. The departmental authorities have raised a technical objection. The learned counsel for the assessee invited our attention to the decision of the Kerala High Court in the case of CIT v. Malayalam Plantations Ltd. [1976] 103 ITR 835 where the requirement under Section 33A that the audit report should be furnished along with the return of income was held to be merely directory and not mandatory.
As pointed out by the Kerala High Court the production of the certificate along with the return of income is not a matter entirely within the volition of the assessee. In the present case the return of income could not be delayed beyond 30-6-1988 and therefore the assessee had filed it on 24-6-1988. The audit reports, however, were dated 8-8-1988 and 26-12-1989. It is, therefore, clear that the assessee had no control over the delay that took place in obtaining the audit certificates. When the audit certificates, though filed after the date of filing the return, are available to the ITO for the purpose of examining the assessee's claim under Sections 32AB and 80HHC, the object of both the Sections would be, as held by the Kerala High Court, defeated by the consideration that the requirement that the audit certificate should be filed along with the return of income is a mandatory provision, non-compliance of which will disentitle the assessee to the benefits of both the sections. We also find that the ITAT has held in the following decisions that such a requirement is merely directory and not mandatory: We are, therefore, of the opinion that the departmental authorities were not justified in not granting the benefits of the allowance under Sections 32AB and 80HHC to the assessee. This issue is decided in favour of the assessee. In the view we have taken that the requirement that the audit certificate should be filed along with the return of Income is not mandatory but merely directory, we are not deciding the alternative argument put forth by Dr. Pal based on the proviso to Section 32AB(4) that the assessee being a company subject to audit under the Companies Act is not bound by the requirement under the main provision that the audit certificate should be filed along with the return-of income.
24. In ground No. 25 the assessee questions the disallowance of Rs. 84,594 under Rule 6B on account of expenses incurred on gifts and presentation articles. We, however, find that the CIT (Appeals) has held that even in the audit report filed along with the return of income the amount to be disallowed has been stated as Rs. 82,687 and that the CIT (Appeals) has confirmed this amount and deleted the balance of Rs. 1907. Since the tax audit report itself shows that the amount to be disallowed under Rule 6B is Rs. 82,687, we see no reason to interfere. The disallowance of Rs. 82,687 is confirmed.
25. Ground No. 26 is a general ground and does not call for any decision.