Raymond Woollen Mills Ltd. Vs. Income-tax Officer - Court Judgment

SooperKanoon Citationsooperkanoon.com/61971
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided OnMar-31-1986
JudgeT Sugla, V Balasubramanian, Vice, Y Meena
Reported in(1986)18ITD64(Mum.)
AppellantRaymond Woollen Mills Ltd.
Respondentincome-tax Officer
Excerpt:
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Notice (8): Undefined variable: query [APP/View/Case/amp.ctp, line 123]
1. the assessee is a manufacturer of woollen material from mostly imported wool and exports them. different grounds of appeal have been raised. these are considered seriatim.2. disallowance under section 40(c)/40a(5) of the income-tax act, 1961: the point relating to the treatment of contribution of a sum of rs. 1,80,750 to the directors/employees retirement benefit fund trust as a perquisite is covered by the decision of the tribunal for the assessment year 1973-74 in the assessee's own case in it appeal nos.1270 and 1271 (bom.) of 1980 and 576 and 3303 (bom.) of 1981 against the assessee. the other grounds of appeal relating to reimbursement of medical expenses, disallowance of foreign travel expenses and disallowance of depreciation claimed on assets used for scientific purposes are.....
Judgment:
1. The assessee is a manufacturer of woollen material from mostly imported wool and exports them. Different grounds of appeal have been raised. These are considered seriatim.

2. Disallowance under Section 40(c)/40A(5) of the Income-tax Act, 1961: The point relating to the treatment of contribution of a sum of Rs. 1,80,750 to the directors/employees Retirement Benefit Fund Trust as a perquisite is covered by the decision of the Tribunal for the assessment year 1973-74 in the assessee's own case in IT Appeal Nos.

1270 and 1271 (Bom.) of 1980 and 576 and 3303 (Bom.) of 1981 against the assessee. The other grounds of appeal relating to reimbursement of medical expenses, disallowance of foreign travel expenses and disallowance of depreciation claimed on assets used for scientific purposes are not pressed.

3. Closing stock valuation : The ITO found that the assessee was valuing the closing stock exclusive of customs and other fiscal levies.

According to the ITO the customs duty on raw materials could not be excluded from the valuation of the goods in stock since it formed an important element in the total cost of the goods. The value of the stock could be made at cost or market price whichever is lower but could not be less than the cost if the cost price was less than the market price. The ITO, therefore, held that the method of valuing the closing stock adopted by the assessee had no scientific basis and the accounts did not indicate the correct profits the assessee earned during the year. Apart from customs duties there were also other fiscal levies, like excise, octroi duty, etc.

4. The ITO, therefore, estimated the value of the closing stock on a proportionate basis of the total duty paid on the goods of both imported and indigenous varieties consumed by the assessee. The total consumption of imported and indigenous goods came to about Rs.13.52 crores on which the customs duty worked out to Rs. 3.93 crores which worked to an average of 29 per cent. The assessee disclosed closing stock of raw material, components, finished goods, semi-finished goods and goods-in-process at Rs. 4.32 crores on which, on a proportionate basis, he worked out the customs duty at Rs. 1.25 crores. In his proposal to the IAC under Section 144B of the Income-tax Act, 1961 ('the Act') the ITO suggested addition of the above amount of Rs. 1.25 crores. The IAC went in detail, into the matter, heard the assessee's representative and came to the conclusion that the closing stock valuation was not properly done and on the basis of the system of valuation followed by the assessee proper income of the year could not be ascertained. He, however, restricted the addition to Rs. 25.96 lakhs in place of the sum of Rs. 1.25 crores added by the ITO. He also gave certain directions for adjustments to be made to this valuation after getting certain factual details from the assessee. According to the IAC, since the opening stock and the closing stock for the year had been revalued on the same basis, some adjustment to the total income assessed in the past was called for. He directed the ITO to make the necessary rectification as a result of these adjustments. The assessee has challenged this addition.

5. Supporting the method of valuation adopted by the assessee for this and all the years, the learned counsel for the assessee has pointed out that the assessee has been following a free and consistent method of valuing the stock for several years. This has been accepted by the department and assessments have been made on the above basis.

Ordinarily, closing stock can be valued under one of three methods : (i) on cost, i.e., direct cost plus a portion of the overhead expenses, if necessary, including an estimate of the head office expenses, etc., (ii) direct cost, only the direct cost involved in the manufactured portion being considered and (iii) certain selected item's of direct cost and not all items being considered. The assessee has followed the last method every year from 1961 onwards. In fact, the auditors' reports for some of these years have clearly clarified the manner in which the closing stock is valued by the assessee. The assessee's stock consisted of two parts, work-in-progress and the finished goods, as regards the first, the assessee has taken into account the cost of materials involved but not all the fiscal levies or labour. In respect of the finished goods, the valuation had been made on the principle of direct cost plus labour and fuel but not fiscal levies. Thus, for both finished goods as well as work-in-progress, the fiscal levies have been omitted. But, this, according to the learned counsel, has been done not only in a systematic manner but regarding it as a thoroughly ascertainable and scientific method.

6. Objecting to the method/procedure followed by the department, the learned counsel has pointed out that on this basis the stock as on 1-1-1976 would have to be revalued. The opening stock of 1976 will not tally with the closing stock of 1975. The department gave notice for revaluing the closing stock of 1975 and the assessee had to approach the High Court on a writ and the High Court had granted stay. Whatever be the earliest year in which the revaluation of stock is attempted, the opening stock cannot tally with the closing stock of the earlier year and the accounts have to be disturbed continuously and from year to year. Since the assessee has been following the same method without any change from year to year, the disturbance of the valuation of the closing stock would not affect, over the period of years, the income of the assessee. The same quantum of income would be disclosed and taxed according to the learned counsel. Unsettling the closing stock, thus, is a case of much ado about nothing.

7. Reference is made in this connection to Section 43B of the Act newly introduced, which supports the assessee's case. Under this section all fiscal levies and duties should be allowed as deductions when they are paid. Following the method suggested by the department of including the fiscal levies in the cost would virtually nullify this requirement of law. The fiscal levies being included in the closing stock, what is allowed under Section 43B would get cancelled by valuation of the closing stock. Even though Section 43B as such, was introduced later, the principle involved in this treatment of the accounts of the assessee cannot be ignored.

8. The method of valuing the closing stock followed by the assessee is adopted by many other companies as well. Apart from other things, the assessee, being a substantial exporter, it is pointed out that if the assessee was to follow the inflation of closing stock, as suggested by the revenue, in the export market, it would be confronted with the charge of dumping the goods. By following this conservative method, the assessee is able to hold its own both in the local as well as foreign markets. Dilating on the importance of the customs duty, in this connection, it is pointed out that the imports are of three types : import duty-free, import after paying the customs duty with a benefit of drawback on export and customs duty fully paid for goods not exported. Of the stock on hand, the assessee cannot identify the particular category to which it would fall. It is also pointed out that in view of the above uncertainty, it is not proper to relate the proper duty to any particular item of stock. The department has interfered with the valuation and tinkered with it even though it has not itself found any way of relating the fiscal levies correctly with the stock on hand but has followed only a dubious method stated to be the average basis. The same difficulty of apportioning the labour amongst the items has to be faced. An accurate estimate, especially when a large number of items are there, is not possible. Against this background, it is pointed out that the inclusion of duty would give a very distorted picture of the profitability and even the annual profit of the assessee's business. It cannot also be stated, according to the learned counsel, that the profit of the business cannot be ascertained. The department's right of interference under Section 145 of the Act comes in only when the accounts do not give a correct picture and the profit cannot be properly ascertained. In other circumstances, the department cannot interfere with the method of accounting regularly followed by the assessee.

9. The learned counsel has relied on British Paints India Ltd. v. CIT [1978] 111 ITR 53 (Cal.), as directly supporting his case. Qualified chartered accountants have given unqualified reports of valuation for all years. It was, therefore, difficult and even erroneous, to hold that the method is incorrect. Apart from fixing the amount of duty to any particular stock on hand, the vast divergence in the rates of duties also affect such valuation. British Paints India Ltd.'s case (supra) has clearly laid down the relevance of method regularly followed by the assessee. In that case, the Tribunal's decision was against the assessee but the High Court laid down that there was no rule of law about the valuation at cost or market value. The assessee is, moreover in kits business, confronted by continuous change in fashion involved in clothing and garments with the result that inclusion of direct expenses, like fiscal levies, would completely distort the accounts as well as the profit structure.

10. Taking us through the detailed order of the Commissioner (Appeals), it is pointed out that it bristles with several inconsistencies, approximations, etc. It is incorrect to say that the department knew about the principle of valuation of closing stock for the first time in 1977-78. The chartered accountants' notes gave this information all through. Referring to the additions suggested by the ITO in the various years in respect of customs duty, excise duty, octroi, sales tax, etc., it is pointed out that in respect of each of these items, while for some years an increase can be made, for others there would be clear decrease. The duties have also to be apportioned between the various stages of production, such as, raw wool, wool tops, work-in-progress, etc. Referring to the elaborate discussion about the guidelines issued by the Institute of Chartered Accountants, it is pointed out that this is the position in a normal case. The assessee has maintained books and prepared accounts on the basis of the circumstances special to it.

Rough and ready methods, applicable to all assessees have not been given even by the guidelines of the Institute of Chartered Accountants.

It is also pointed out that the guidelines dealt, namely, with the duties which fell on the assessees and not with all duties. In view of the erratic incidence of duties over the years, the learned counsel also questions as to how the department can reopen the assessments for all the twenty years the assessee has been in existence so as to do justice. In fact, following the department's method would result in refund being given to the assessee for some years.

11. The assessee's business involved polyester fibre to a good part.

Cost Accounting Rules framed in respect of the polyester fibre industries would be very relevant in this connection. The proforma prescribed by the authorities in respect of this industry also does not point out to any defects in the assessee's method of stock valuation.

Support is also derived from the Tribunal's decision in the case of Goodlass Nerolac Paints Ltd. v. IAC [1985] 13 ITD 270 (Bom.) as also the House of Lords' decision in the case of Duple Motor Bodies Ltd. The assessee cannot have any particular motive in following this system of stock valuation especially over a period of nearly two decades. That this is the position would be clear also from certain observations of the Tribunal in Goodlass Nerolac Paints Ltd.'s case (supra). Since over the years there cannot be any loss to the revenue or gain to the assessee on account of the stock valuation according to the learned counsel disturbance of the stock valuation was a mere futile exercise.

12. Further, dealing with the points made out on behalf of the revenne, it is pointed out that the rule of cost or market followed by the accountants for valuing the closing stock cannot be elevated to the position of a rule of law. The only rule that both accountancy and income-tax recommends is that the method of valuation should be one from which profit can be reasonably well ascertained. Apart from the fact that these are not hard and fast rules, stock valuation has no bearing on the components of the cost; the valuation must also not take into account unearned profit. Stress is laid on the positive and negative data under which the fiscal levy was worked out, even by the departmental authorities for different years. There cannot be a case for any addition in all the years. In fact, the order giving effect to the Commissioner (Appeals)'s order has not been worked out for all the years either.

13. The method suggested by the department, as an alternative, according to the learned counsel, is not only arbitrary but unrelated to the realities. Reference is made in this connection to the valuation reports given by two chartered accountants, both following the department's method of valuation of closing stock resulting in vast divergence. The assessee's method is neither unscientific nor inconsistent. It is pointed out that the distribution of labour cost over the finished goods and work-in-progress cannot give a figure in excess of the total cost incurred. In the case of sales tax paid by a dealer to hand over to the State, the question is whether the stock valuation should take into account this fiscal levy. There is no hard and fast rule that it should be added one way or the other. The burden is on the revenue to show that the profits cannot reasonably be ascertained by following the method adopted by the assessee. There is nothing to show, on the contrary, that the method adopted by the assessee is wrong. On the contrary in the treatment given to the drawback of the customs duty by the department, there is clear error in the application of the department's method. It is incorrect to say that drawback is unrelated to the customs duty as would be clear from Rule 3 of the Customs and Central Excise Duties Drawback Rules, 1971.

14. The learned counsel has referred to the decision in the case of CST v. Berar Oil Industries [1975] 36 STC 473 (Bom.) and in the case of CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC). The decision in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 (SC) relied on by the revenue, it is pointed out, involved the artificial definition of 'turn over'. What the assessee has done is totally consistent with the statute as would be clear from the provisions of Section 43B. Even the condition that each year is a self-contained period cannot be used against the assessee in the present case since the question of valuation involves consideration of different years telescoping into one another. Reliance is placed on the decision in the case of Mahendra Mills Ltd. v. P.B. Desai, AAC 15. The ITO and the IAC visited the factory of the assessee and examined the records. It is pointed out that even after this, they could not properly identify the items of the raw materials or the duty paid. It is against these defects that the principle of averaging has been evolved. The company law authorities had investigated the assessee's affairs both from the point of view of dumping and also stock valuation as directed by the Income-tax Department. Being satisfied about the correctness of the method they have dropped the proceedings. Stress is also laid, in this connection on certain proceedings before the Delhi High Court in connection with the stock valuation of the subsequent years. Those proceedings pointed out also how the valuation made by different experts, two chartered accountants, Shri P.N. Shah and Thakur, Vaidyanath Aiyar & Co., even in respect of computation made by adopting the same broad principles differed.

15.1 The learned counsel for the department has pointed out that over the year it is well settled that closing stock is to be valued at cost or market price. Even though this is only a practice, this practice has been exalted to the level of a rule of law. The books relating to income-tax, wealth-tax, etc., have given no proper or infallible guidance as to the valuation of stock, opening or closing. The question is whether the assessee has valued the stock on the basis of universal practice almost resolved into a legal proposition. If the assessee was to follow the cost method, it must take into account all the expenditure involved. In the present case, the assessee has followed neither the direct cost method nor on cost method. Fiscal duties not taken into account would partake the character of the positive expenditure in two different circumstances: (i) import of certain goods on which duties are paid ; and (ii) purchase from another trader who has imported the goods. Here also, the customs duty, etc., form part of the purchase price. It is necessary, according to the learned counsel, to keep these concepts clear and separately. Under different circumstances, sometimes, some levies are effective. But, some of the levies are subject to and under an obligation of the statute whereas others are not collected but paid to the vendors, with the sale price.

In respect of the latter levies, certainly, there can be no dispute as to their inclusion in the stock valuation. The assessee's is an expanding business. There can, therefore, be no question of any refund or a reduction if the fiscal levies are to be considered as suggested by the department. Reference is made in this connection to the factual details regarding the fact of taking into account the customs duties, excise duties, sales tax and other levies. The learned counsel for the assessee has considered only one or other of the duties levied for the different years. In this context, he has referred to the reduction in the customs duty for the year 1980-81 as against additions on account of the same duty in the earlier three years. According to the learned counsel for the department if the overall position of the duties is considered and the total effect on the profit for each year reckoned, there could be no question of a negative overall figure or a loss.

16. Regarding the question of accepting the results in the earlier years, the learned counsel has pointed out that the averment as to the stock valuation was obtained in the audit report for the first time for the assessment year 1977-78. The fact that the assessee was not valuing the closing stock on a particular basis in consonance with the normal, proper and legal method, was known to the department only from the auditors' report on the accounts for the year ended 31-3-1977 where they stated : In the case of raw materials and the finished goods (other than the merchanting goods) such cost or market value has been determined exclusive of customs and excise duties.

Such a statement occurs at note No. 12 in the auditors' report of the year ended 31-3-1978 also. At any rate, according to the learned counsel, an erroneous assessment for one year does not justify repetition of the mistake for any subsequent year or years. The deficiency, if not manipulation, was known to the department for the first time and the ITO sought to rectify it immediately thereafter. One cannot get away from the fact that the closing stock was not valued by the assessee according to law and the normal practice in the trade. It is also pointed out that even the statement of the auditors is not supported by any reference to history or practice. In view of the above defect, especially referred to by the auditors, the ITO made inquiries regarding the stock valuation and revalued the stock as on 31-12-1975, 31-3-1977, 31-3-1978, 31-3-1979 and 31-3-1980. It is incumbent on the assessee to follow a proper and legal method for stock valuation. Since there was no evidence to show that this was not done or at any rate this was not known to the department, the accounts of the assessee excluding the stock valuation were accepted by the department.

17. The learned counsel has detailed the facts of the assessee's case in relation to payments of taxes and duties at the three stages of import of wool, polyester fibre, etc., production at the intermediate stage and the duty on the manufactured fabric. The assessee also paid sales tax. In valuing the work-in-progress the assessee has not taken into account the duties and also the direct expenses like, labour, even though in respect of the manufactured goods all these have been included. The assessee also has not taken into account the fiscal duties paid by the seller. As correctly pointed out in the detailed order of the Commissioner (Appeals), the assessee has only debited in the books the excise duty actually paid on the manufactured fabric which has been sold and which is lying in stock with the retail shops.

The other impositions which are normal have been ignored. The assessee's contention in respect of the method followed could not be justified on any ground, theoretical or practical. In fact, the assessee has not been even able to show other cases where such methods of closing stock valuation has been followed and accepted as correct, scientific and legal. According to the learned counsel, the extent of error involved in the computation would be clear from the fact that the assessee has not taken into account even the sales tax, etc., paid by his vendor. These levies of sales tax are not paid by the assessee to the State but to its vendor-which would certainly constitute only the cost of purchase or purchase price to the assessee. Sales tax is certainly a part of the purchase price. Labour cost which is inevitably incurred in manufacture whether half way or full, certainly has to be considered as a part of the price. There is no justification, therefore, for excluding this item even in the valuation of the work-in-progress. That the assessee knew the importance of inclusion of some of these items in the valuation is clear from the fact that the assessee itself has followed this principle in respect of some of the items. The assessee has also adopted the averaging method of inclusion of levies in the closing stock valuation. The learned counsel referred to the example elaborately set out in the order of the Commissoner (Appeals) which unambiguously showed how the non-inclusion of fiscal levies in the stock valuation distorted the entire profit computation picture. The assessee itself while valuing the closing stock of finished goods has taken into account some of the direct expenses which conforms to the legal and accountancy requirement of the department's case. In the fact of such an inaccurate and incomplete method of stock valuation which, not merely indirectly but even directly, distorted the computation of profit, it was clear that the correct income of the assessee for any of the years cannot be properly worked out.

18. The assessee has made huge profits from year to year and the adjustment of the same by following a correct and scientific method of stock valuation urged by the department, showed that huge additions have to be made to the assessee's income not only for one year but for all the years. There is, in fact, no set off from one year to another over a period as vociferously contended/or by the assessee. The learned counsel has also relied on the elaborate report of the research committee of the Institute of Chartered Accountants which unambiguously laid down the principle to be followed for stock valuation. A large number of organisations, as noted in the guidance note prepared by the research committee, follow a method of valuation of closing stock taking into consideration the excise duty paid in respect of the closing stock remaining on hand at the end of the year. If excise duty is includible in the cost, there is no question of not including the other fiscal levies also which are direct imposts on the cost of the commodity manufactured for sale by the assessee. There is also no merit in the assessee's contention that merely because it has followed the same method of valuation over a period, the mistake clearly pointed out by the department should be allowed to continue. It is well settled in law that each year is a self-contained period. There cannot be any adjustment of what happens in one year for working out the income of any other year except where the law itself provides for some such adjustment as carry forward, etc. No such adjustment is possible or permissible under the law in the present case.

19. There is inconsistency in the very method followed by the assessee if its overall accounting system is gauged. The assessee itself follows two different items of inclusion or exclusion of duties. In respect of machinery, plant, etc., customs duty is included at cost for the purpose of claiming depreciation. The assessee had also been following the method of averaging in working out the cost in several cases. That the system of averaging cannot, naturally, be called unscientific but is, in fact, the method to be followed, according to the learned counsel, has judicial support. Reference, in this connection, is made to the decision of the Privy Council in the case of British South Africa Co. v. CIT [1946] 14 ITR Suppl. 17, Berar Oil Industries" case (supra) and Concordia Corp. Ltd. v. CIT [1952] 22 ITR 344 (Trav.-Coch.) and certain passages in Kanga and Palkhivala's Law and Practice of Income-tax, Seventh edn., pp. 875 to 879 regarding the valuation of work-in-progress as adverted to in this case. Reliance is also placed on the decisions in the cases of British Paints India Ltd. (supra) and A. Krishnaswamy Mudaliar (supra). According to the learned counsel, the last case cited furnishes a clear answer to many of the doubts expressed. Ultimately, one has to find out what is the cost price in the hands of the assessee. All includible items should be included in working out this figure unless permitted to be excluded either by law or by practice or accountancy principles. Any other arrangement or method of valuation including that of stock would suggest attempts to avoid proper tax payments. Reference is made in this connection, to the dictum of the Supreme Court in the case of McDowell & Co. Ltd. (supra).

20. The assessee's claim that the goods are perishable and a particular method of valuation has, therefore, to be adopted, has also no merit.

The assessee is a manufacturer of textile fabrics, wool, etc. Polyester fabrics are not like vegetable and other perishable commodities. Even the reference to the change of fashion as a factor in this regard cannot be seriously taken note of. In fact, according to the learned counsel, the assessee pampers to the high elites of the society and non-perishability is not a criterion in purchase of goods in such circumstances/ circles. Reference to Section 43B has also no significance. In the first place, it comes into operation from the assessment year 1985-86. It is not also declaratory of the existing law. On the contrary, it is urged that if the actual operation of Section 43B leads to such results as are found in the assessee's case, the very question of the validity of Section 43B has to be considered.

It is also pointed out that while all other assessees follow an acceptable principle of valuation of closing stock as suggested by the department, if the assessee's method is recognised as proper, the question would be whether it would not lead, in fact, to a case of discrimination against the businessman following a scientific and traditional system.

21. The assessee manufactures woollen materials. The raw wool is mostly imported and a good part of the finished products is exported. The issue involved in this appeal relating to the closing stock valuation is simple by itself but has got wide ramifications for this assessee as well as other cases where such valuation has to be made. The assessee has been carrying on the business for several years and during none of these years the system of closing stock valuation has been disturbed by the ITO. Both the opening and closing stock have been valued on the same method. The assessee's income returned on the basis of accounts following this has been accepted for all these years. Only for the year under appeal the ITO for the first time disturbed the closing stock.

22. The closing stock of the assessee includes finished goods and work-in-progress. The process of manufacturing woollen garments broadly consists of three stages, the first involving preliminary processes on raw wool, second, the manufacture of woollen tops and lastly the manufacture of the finished products. In valuing the closing stock of the last item, the assessee took into account all items of expenditure other than fiscal levies such as customs duty, sales tax, octroi duty, etc. In valuing the closing stock of work-in-progress the assessee did not include the labour charges or even the fuel cost. The auditors in their report had made reference to this method of valuation for some of the years though for the years no specific mention has been made. Since the ITO thought that the closing stock valuation of work-in-progress as well as finished goods should include the fiscal levies, expenditure relating to power, labour, etc., he held that the assessee was not following a scientific method of closing stock valuation. Its correct annual income, therefore, could not be worked out properly in view of the method of valuing closing stock followed. He got the closing stock revalued by taking into account the fiscal levies, etc. and made additions to the total income. Both the opening and the closing stocks were valued. The ITO adopted in the absence of accurate figures for these levies and expenditure estimates on a proportionate or averaging method. This is the subject-matter of the dispute.

23. The Act lays down specific methods of arriving at the income of the assessee for the purpose of its assessments. The items of income are worked out under different heads like salary, income from property, business, etc. Separate computation is made of each item of income under the appropriate head and the total income is computed by adding the figures and making any adjustments thereto as laid down by the Act.

The expression 'income', which is the subject-matter of assessment, is not defined in the Act. Both from the generality, therefore, of this definition usually derived from judicial decisions and also the division of the total income for computation purposes under different heads, it is clear that the method of working out of income under each head is not the same. Where a person derives a net income from some source, it is included in the total income. In the case of property, a notional income is worked out. In the case of dividends, interest, etc., methods such as receipts, accrual, etc., are followed. In the case of business or professional income, the Act envisages computation of the income on the basis of the method ot accounting followed by the assessee. When the method of accounting followed by the assessee does not give his true income from that source, the ITO is empowered to work out the income by estimate or other means.

24. Inherently, therefore, in the computation of income from business is a uniqueness which does not attach itself to the computation of income from other heads of income. Since the assessees can maintain books of account on one or other well recognised or scientific methods, the computation of business income also would depend on this. Well recognised methods of accounting are not exhaustive. If, therefore, an assessee even as a solitary individual follows a system of accounting which is capable of giving his business income figure, that cannot be tampered with by the income-tax authorities. We are stressing this just to show that the mere fact that no other assessee follows a similar method of accounting or all others follow a different method of accounting would not be a reason to reject the books of account or the income returned of any particular assessee. Vital to the system of accounting is another peculiarity of the computation of business income. A business continues from year to year. It is impossible, therefore, whatever be the method of accounting followed for any year to compute the business income for that year without taking into account what happened earlier or what would happen in the subsequent year. Business income computation, thus, differs vitally from the computation of income from other sources where definite receipts of income during the year can be fixed without any ambiguity. The natural corollary of this is as what has been correctly stated in the decision of the Supreme Court in the case of Mahendra Mills Ltd. (supra) the results of each year telescoping into that of the others in business income computations. The income of the business is computed as the excess earned during the year over the assets it had at the, beginning of the year. The definition of 'income' as given in the classic definition in Spanish Prospecting Co. Ltd. In re. [1911] 1 Ch. 92, 98 per Lord Justice Moulton : 'Profits' implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates.

25. In finding out, therefore, the income of a business, the value of the net assets at the beginning of the year and their value at the end has to be computed. In a running business at the end of each year there would be stock accumulated and not sold. The stock would consist of the finished products, work-in-progress at various stages of manufacture or production, raw materials, stores and other accessories, tools and a variety of other items. The net income earned during the year can be evaluated only by taking into account the relative value of the above-mentioned items between the beginning and the end of the year in addition to the sale proceeds, receipts in cash and kind, etc., from the business. It is in this context that different businesses and even different assessees adopt methods of finding out the relative values of the above items. Stock valuation, therefore, relevant to the product the business brings out is very important. The other items like stores spent, tools, etc., exhausted also are important. Sometimes these are valued both at the beginning and at the end of the year and the value of the exhausted goods debited to the profit and loss account.

Sometimes, the value of the stores, etc., purchased is straightaway debited to the profit and loss account, no account, being taken of what remains in the beginning of the year and what remains at the end of the year. When the business is continuous and, since, the only way the profit of the year in a business can be ascertained is by taking the relative values only, a method systematically followed from year to year is regarded as giving the correct profit for computation purposes.

26. The position with regard to the stock is also the same as above.

The difference between closing stock and opening stock would require to be adjusted for arriving at the annual profit. Whatever, therefore, be the nature of any absolute method of valuation conceived of in this respect, provided the method of valuation is the same for the opening and the closing stock that would give the most approximate figure of profit going into the computation. In short, what we want to stress is thus : Even theoretically there is no absolute method of determining the annual business income of an assessee as that of determining his annual salary. The only basis is the excess earned over the year.

This involves finding out of the relative values of all items which go into the revenue account and not capital account. The same method of valuation, therefore, is more important; in fact, the only important thing for such computation of business income. In our view even from a purely theoretical point of view to say that a particular method of valuing the items including stock which go into the trading account is the only correct method would be clearly erroneous from any point of view. If an assessee who has been following one method of valuation of stock or stores, etc., suddenly switches over to another method, thus, gaining a temporary advantage for a year, that would be wrong. But so long as he follows the same method of valuation for every year of continuance of the business any method of valuation consistently followed with regard to the stock, stores, etc., should be regarded as the-correct one. This is primarily because there is no cut and dried absolute method of working out business income ignoring its continuity over the years or assuming its winding up at the end of every year.

27. The department has set much store both from the theoretical as well as practical point of view on methods of valuation of closing stock. It has also been urged that the system of valuing closing stock at market or cost value, whichever is lower, is almost a rule of law. There is a fallacy in these contentions which would be clear from the nature of business income explained at length in the above paragraphs. Even accountancy experts advocate the cost or market value whichever is less principle only as one of the best methods. It would be correct for an assessee to value the closing stock at cost for all years, or at market value for all years. If there are different components in the cost he could also without any damage to the theoretical or practical working of profit, value the stocktaking into account or omitting any of the components, provided that is done both for opening stock valuation as well as the closing stock valuation. Where the assessee values the closing stock at cost if the market price has fallen, he has not taken into account the loss he has already suffered. Where he values the closing stock only at market value, he ignores the loss but he might have taken credit for profit not realised. In these and other situations neither the cost nor the market value will have any significance if the demand for the goods on stock is low or non-existent. If a commodity manufactured is not saleable in the market, valuing that commodity in stock at cost or maket, whichever is lower, would definitely not give the correct profit of the businessman.

It also deserves to be noted that in this arbitrary but consistent adoption of method of stock valuation there is an inherent assumption that all the goods on hand could be sold. As a matter of fact, even though stock is valued at market value, if all the stock of all the businessmen were put on the market either the goods cannot be sold or would fetch much lower a value than the market value adopted for stock valuation even if that be less than the cost. What we want to emphasise is that even the principles laid down for cost valuation are at best approximate, arbitrary and more a means of working out the profit than representing an absolute value or truth. Again, it is only the consistent following of the method which gives even these methods of valuation any scientific support or realistic worth. Even the authorities cited including the guidelines issued by the Institute of Chartered Accountants do not deny the above concepts. The guidelines and other authorities have only considered what would be the better method to adopt in certain circumstances. At any rate, while giving their opinion as an expert on stock valuation, the guidelines do not show that any other method than the ones recommended by them is wrong or incapable of indicating the correct profit. The guidelines also have not directed their attention to the importance of following a consistent system of valuation from year to year. Granting that there is a business only for one year what should be the profit And how could that be found out This seems to be the issue which the guidelines have considered. In none of the authorities quoted before us any serious discussion as to how in a continuous business following a consistent system of stock valuation, how any method other than that recommended by the guidelines would be defective is not indicated. It would be, therefore, incorrect to say that either what the guidelines have laid down is the best or only method of stock valuation or that all other methods of valuation would be erroneous and will not indicate the correct annual profit of the business.

28. The departmental authorities, while drawing support from expert opinion like the guidelines, have urged that to arrive at the stock valuation the raw materials cost, the manufacturing cost and all other imposts levied and expenditure incurred thereon should be taken into account. As an abstract concept, certainly no objection can be taken to this contention. It is where one comes to apply this principle to practical realities that difficulties emerge. If a simple proposition of an asset on which some definite expenditure is incurred alone is to be considered for the closing stock, the abstract principle can be even made a reality, but when the variables involved in the computation are numerous, uncertain and unascertainable, the abstract principle clearly breaks down. Taking for instance, the case of the present assessee, stock on hand consists of finished material and work-in-progress to consider two items at least. Both these have been worked out starting with some raw material, incurring expenditure by way of fiscal levies, freight, manufacturing operations, supervising operations, management operations and any number of other items of expenditure. In an extreme case we can even think of unrelated expenditure like those on advertisements or examination by experts being involved, not only the expenditure on raw materials and the other several items of expenditure are incurred at different times, in fact for different years, for different purposes and at different rates. For instance, units of raw materials may be purchased at Rs. 100, Rs. 120, Rs. 150 per month, etc.

and different quantities of this may be mixed in the manufacturing process. Likewise stores and other accessories purchased at different times with different rates may be utilised. Some of the production might go under a normal labour charge; it is possible that idle labour costing practically nothing to the factory has enabled some manufacture to be made. Fiscal levies also may vary. Some items might have suffered import duties and that too at different rates; some items might have been subject to sales tax ; some to octroi and so on. The same uncertainty may apply to the expenditure of power, in allocable expenditure on account of management, examination, supervision, etc.

When, thus, different quantities of raw material subjects to variable and different levies and expenditure on account of the above items are mixed together for obtaining the final product to say that any near-accurate tally of these items of expenditure can be made is an extraordinary proposition. Even from a purely theoretical point of view an accurate allocation of such expenditure is impossible. The difficulty is more when we consider the fact that both the finished product as well as work-in-progress have reached that stage of production starting with different raw materials purchased at different times at different rates, different levies-fiscal and otherwise-and also different items of expenditure on different lots at different times. In addition to the above, work-in-progress itself is a fluid commodity, starting with wool as raw material there is a continuous process of manufacture at various stages going to make the finished product. Even if the several stages can be regarded as quantised like the movement of the needle of a watch, the stages of movement are so numerous that it would be impossible to allocate even to an extent of good approximation these levies and expenditure. The work-in-progress may consist of wool in some form, woollen tops at various stages, cloth at various stages, etc. We have, therefore, no doubt, in holding that even from a purely theoretically point of view an accurate method of allocation of expenditure for closing stock valuation is an impossibility.

29. It is against the above background that the assessee has claimed instead of making a futile attempt at accurate allocation of expenditure including fiscal levies for the purposes of stock valuation, it has followed a systematic method of assigning certain items by way of on cost in arriving at the closing stock. The claim made is that insofar as no manipulation is intended or is done so as to reduce the profit or avoid the tax, a bona fide method followed from year to year should be accepted. The department has suggested that where the actually allocable expenditure or levy cannot be determined, the system of averaging can be followed. In fact, in making such an average, the procedure advocated is to take the expenditure over a period of years and divide it by a suitable denominator. The argument is also advanced that in respect of some items even the assessee has adopted such an averaging method. Certain judicial decisions are also put in to support this claim. We do not see how the system of averaging especially taking into account several years for the purpose would in any case give an accurate or even near accurate allocation of expenditure or levies. If actual computation and allocation are impossibilities, the averaging especially over several years would not only be the limit of confusion but clearly erroneous. It would be even better to speculate and make an estimate in the dark. This point, therefore, has neither the merit of scientific support nor an approach to reality. The argument simply is that where a task cannot be done properly we should go about it in some roundabout form. We are not convinced that this is correct. The assessee's following the averaging method for some limited purpose also cannot exalt that method to any high level. What the assessee has done is to completely ignore the niceties and difficulties involved in an attempt at accurate allocation, but rest correctly and solely on adopting the same method of valuation for the opening and the closing stock. For the reasons we have set out earlier, this cannot be said to' be wrong at all for the purpose of arriving at the annual profit. As a matter of fact the assessee has included on a proportionate basis the labour and fuel cost for the purposes of valuing the finished goods. It has not included this for valuing work-in-progress. Fiscal levies have not been considered for the valuation of either of the items. In an extreme case if the assessee wants to completely ignore even the work-in-progress at the beginning of the year and at the end of the year and, consistently, value only the other items, we do not see how even this can be regarded as incorrect.

30. In our view the revenue's reliance on a general principle of taxation law that each year is a self-contained period and so the continuity of business or what happens in the earlier or later year should be ignored, cannot be supported. The department has completely ignored the particular manner in which the business income is computed and how it is different from the computation of income from other heads. In the case of a continuous business each year telescopes into the subsequent year. Annual income can be worked out only on this understanding. In this context it has been urged that factually there has been a reduction of income for every year in the method of valuation followed by the assessee. The department has relied to support this argument on the computation of the excess to be added while giving effect to the direction of the Commissioner (Appeals). It would appear that the Commissioner (Appeals) has directed the ITO to refer the matter of stock valuation to a chartered accountant. The valuation for two years only have been completed and this gives an increased income for both the years. Evidence in support of the department's case is, thus, limited to two years. The assessee had been following the present method of accounting for about two decades. The valuer chartered accountant has also adopted some methods of averaging, approximation, etc. In the first place what would happen if several more years are considered, is not clear. Secondly and more important, the value assigned to the closing stock has necessarily to be adjusted in the opening stock valuation of the next year. If by increasing the closing stock of the first year, there is an excess of profit say 'X', necessarily the otherwise computable profit for the subsequent year will definitely go down by the same figure of 'X'. This cannot be otherwise whether one looks at it from the theoretical or practical view point. It may be in a situation where for a period the quantity in stock at the end of the year is more than the quantity in stock at the beginning, there may be an increase, but if the quantity of stock at the end is less than that at the beginning, the department's method of valuation would certainly result in a reduction. This argument of the department, therefore, cannot be accepted.

31. It was also brought out before us that two valuers (Shri P.N. Shah and Thakur Vaidyanathan Aiyar & Co.) made the stock valuation. The values were different. According to the learned counsel for the assessee, this itself indicated the arbitrariness and extreme approximation relevant in the system. The learned counsel for the department has on the contrary pointed out that certain aspects of the problem noted in Shri P.N. Shah's valuation have not been considered by Thakur Vaidyanathan Aiyar & Co. These two valuations, according to the learned counsel, were also made under different circumstances, one in pursuance of the Commissioner (Appeals) direction and the other in connection with the writ petition filed before the Delhi High Court be that as it may, in our view, the values do indicate that unless there are only few variables in a computation two experts cannot agree.

Basically, therefore, where variables involved are too many, it would be incorrect to treat any valuation as absolutely correct and not an approximation to some extent.

32. Reference was made for the department to certain computations given by way of illustrations in the order of the Commissioner (Appeals) (paragraphs 82 to 84). The purpose was to show that the method of valuation adopted by the assessee distorts the profit computation. The assessee's counsel likewise has referred to certain other illustrations going to show that the method followed by the department would certainly give a wrong picture of profit.

33. The Commissioner (Appeals)'s computation deals with a simple theoretical problem such as one that can be given for the high school students to solve. It ignores the simple fact that the number of variables involved in the computation of closing stock are so numerous that such an easy computation cannot be made. The point made out by the assessee's counsel on the contrary relates to two problems : one the taking into account of labour, etc., charges in valuing the work-in-progress ; and the other the relevance of the newly introduced Section 43B. As regards the first, the point made out is that in valuing the closing stock of work-in-progress as well as the finished goods, the entire labour charges incurred is taken into account and whatever labour charges are not referable to the items of goods sold would be treated as relevant to stock on hand-finished goods as well as work-in-progress. This entire amount the assessee has added to the stock of finished goods. The department's case is that part of the labour expenses should be added to the work-in-progress. Closing stock includes both work-in-progress and finished goods. If the entire labour charge incurred for the goods on stock at whatever stage they be is included in valuing the finished products, we do not see what difference from the point of view of stock valuation or profit computation it can make by bifurcating this expenditure on some rational or irrational basis between the finished goods and the work-in-progress. It is certainly not the case of the department that any part of the labour expenditure is omitted in its relation to the goods sold and the goods in stock.

34. The other question is about the applicability of Section 43B. For the department it was pointed out that since this section came into the statute subsequent to this year, it has no relevance. The question before us is not whether Section 43B applies or not. The point made out is that Section 43B gives a right to the assessee to claim the expenditure incurred in a year during that year. This may come up perhaps only in the year when the section was introduced. If, however, the method of computation now urged by the department is adopted even for the earlier years, certainly it cannot be changed for any subsequent year. When one comes, thus, to future year where even according to the department Section 43B is applicable since the department cannot alter the method of accouting already adopted the resultant effect would be that Section 43B would be a nullity.

Certainly the Parliament would not have gone through all these processes to put on statute a provision of no consequence. In other words, if the department's method is accepted for this year, in order to give effect to Section 43B in the future when it applies, necessarily that method has to be given up and the assessee's method adopted. On both these points the assessee's claim seems to be sound.

35. Other objections raised against the assessee's method are that the department came to know about this defective method of stock valuation only in the year under appeal and from the auditors' report. The learned counsel for the department in fact has p ointed out that the auditors' report is so unqualified as to point out to a real defect in maintenance of accounts in this regard. This view cannot be accepted.

In the first place the auditors had made these remarks even in the earlier years. Remarks of the auditors were unqualified not in the sense of pointing out a defect but in the sense of pointing out a particular method being followed. Even so neither the large body of shareholders nor the company law authorities have regarded this as a defect. In fact there seems to have been some proceedings before the company law authorities in this regard and after full verification of the facts they dropped the proceedings. The department has also been accepting the method from year to year for a very long time. It is idle to say that because the assessee followed this method, the department accepted the figures ignorant of the method followed. The assessee's is one of the biggest cases for assessment. The ITO for every year has satisfied himself about the books of account and computed the profit.

We find that he has issued the usual questionnaires to the assessee, called for all specific and several details regarding the balance sheet, profit and loss account, etc., analysed them and then only completed the assessment. In the case of an assessee with big income, certainly the trading account is an important part of the accounts. The -ITO has certainly analysed the trading account for every one of these years. This in conjunction with the auditor's report leads to the conclusion that the department knowingly accepted the stock valuation every year. It did not regard it in any way as defective or not giving out the correct profit computation.

36. The disturbance of the figures of the closing stock for any reason whatsoever but for the purpose of computation of annual profit necessarily involves interference with the opening stock. If this is done for one year necessarily the same has to be done for all the years past. Otherwise it may lead to a situation where the assessee would lose for a particular year in the past. It is open to the department to take action for reassessing of an income which has escaped on account of revaluation. But if the revaluation leads to a loss for the assessee in the sense of a larger profit having been assessed for that eariler year, there appears to be apparently no remedy for the assessee. It may be noted that even for revaluing the stock for the year under appeal the department has not referred to any revaluation of the stock for the several years for which it has accepted the assessee's books. Apart, therefore, from any relevance to the years assessment allowing the department to disturb the stock valuation for this year would certainly prejudice the assessee substantially. The fact that the department has accepted the method of accounting for several years past would operate as highly unjust if the department were now to change the method of accounting. When the accounts are maintained on the same basis from year to year, a mere change of closing stock valuation would over the years not affect the overall profit taxable and give any particular advantage to the assessee by way of reduction of tax. From these points also we have no hesitation in holding that the present attempt made by the department to disturb the closing stock valuation is a futile exercise and should not be permitted.

37. The Commissioner (Appeals) has while confirming the ITO's recomputation of closing stock valuation referred to the customs duty drawback and on that account interfered with the assessment. It is pointed out that the drawback is unrelated to the custom duty. This is clearly incorrect as would be clear from Rule 3 of the Customs and Central Excise Drawback Rules. The drawback is specifically related to the customs and excise duty paid. The scheme appears to be that the manufacturer pays duty on the imports, but to the extent of goods exported gets a drawback on the duty paid. Apparently there is a limit on the drawback to the extent of duty paid. The duty is paid on items like raw wool which forms the raw material for the finished products which alone is finally exported. The drawback is not an incentive for the export but is only a retund of the duty paid insofar as the imported material has been exported either in the same form or in a different form. It would not, therefore, be incorrect to say that on the exported material no net duty has been paid at all. If the imported material is utilised for sale within the country, the duty would necessarily fall on the finished goods sold in the country. If part of the goods are so sold part of the duty only would be covered. To the extent the goods are exported the entire duty would be refunded. It would not, therefore, be correct to say that the goods on stock on which import duty has been paid should be valued including the import duties, but while the drawback is received it should not go to reduce the overall duty paid. That the computation made by the Commissioner (Appeals) thus is neither correct on a clear appreciation of the nature of the drawback nor takes into account the distortion in the profit computation cannot be denied. The enhancement made by the Commissioner (Appeals) by taking into account the duty drawback, therefore, cannot be supported on any ground.

(1) In computing the profit from a business continuous over the years the method of accounting followed by the assessee would only be the basis unlike in the case of income from other heads.

(2) Though for income-tax purposes each year is a self-contained period, computation of income from a business cannot ignore the results of the earlier and subsequent years.

(3) Stock valuation even as similar dealings with stores, tools, etc., is an important aspect in the method of accounting adopted by a businessman.

(4) There is nothing absolute by way of method in stock valuation.

Stock valuation is only an aid to arrive at a profit from the trading account. This being so, so long as the same method of stock valuation is adopted from year to year by a continuous business, it cannot be said that the correct profit cannot be computed from that method.

(5) Where closing stock valuation is disturbed and to the same extent opening stock valuation for the next year has to be adjusted, there can be no escapement of profit over the years whether seen from the theoretical or the practical point of view.

(6) The assessee's accounts have been in our view, consciously accepted by the department from year to year. The assessee has not changed the method of accounting. The method of stock valuation followed by the assessee cannot be said to be to the extent we are concerned not with the method itself but only with the determination of the annual profit, erroneous or unscientific.

39. We, therefore, hold that tampering with the method of stock valuation followed by the assessee is neither necessary nor justified for the purpose of arriving at the correct profit from the business.

The additions made by such revaluation are deleted and the ITO is directed to accept the profit on the basis of the method of stock valuation followed by the assessee.

1. I have gone through the order of my learned brother. After careful consideration of the order of my learned brother, I am unable to persuade myself to be agreed with the view taken by him so far as the valuation of the closing stock is concerned. For other issues, I agree with the view taken by my learned brother.

2. The main dispute between the assessee and the revenue is that while valuing the closing stock, the fiscal duties, such as excise, customs, sales-tax, octroi, etc., should be included in the purchase price for raw materials, for valuing the closing stock. The assessee has not included these fiscal duties, etc., for valuing the closing stock while claiming the same as deduction in the profit and loss account; and the same system is followed by the assessee in the past and accepted by the department. Now, the only issue is whether the ITO can invoke the provisions of Section 145(1) and thereby disturb the valuation of the closing stock as disclosed by the assessee. The Commissioner (Appeals) has taken the view that (1) the method of accounting (valuation of closing stock employed by the assessee) is such that its income from business of an accounting period cannot properly be deducted therefrom; (2) that for determining the income or loss actually for the accounting period, the closing stock of the raw materials, work-in-progress and the finished products (other than the finished product lying in stock with the retail shops of the assessee) will have to be valued by taking into consideration the custom duties, countervailing excise duties, intermediate excise duties, sales-tax, octroi duty paid as also the direct expenses incurred by the assessee; (3) for the valuation of the closing stock of the finished products lying in the retail shops of the assessee all the duties/taxes/direct expenses mentioned at (2) above also will have to be taken into consideration; and (4) that the value of the closing stock as mentioned above cannot be found out by correlating the stock with purchase price and duty/taxes paid in respect thereof, the same may be found out by resorting to the well recognised method of averaging.

3. In view of the above, the Commissioner (Appeals) has upheld the action of the ITO in valuing the stock for the assessment year 1980-81.

In the appeal before us, the learned counsel for the assessee Shri N.A.Palkhivala has submitted that similar system was followed for the last so many years and accepted by the department. When that has been accepted by the department in the past and there is no change in the facts, similar method should be accepted this year also. Shri Palkhivala's next submission was that the method of valuing the closing stock is not exactly as laid down in the guidelines circulated by the Institute of Chartered Accountants, but it is a little bit conservative ; but that does not mean that it should be rejected. He also submitted that similar method was followed by some other companies. Shri Palkhivala further contended that when there is no statutory provision to adopt the particular system in valuing the closing stock, the ITO was not justified in disturbing the value taken on the basis of a particular system followed by the assessee in the past. He also submitted that in any system, "if the ITO has added some amount in the income of the assessee in other years, that will result in reduction from the income of the assessee in future. Therefore, the ultimate result will be the same. He relied on British Paints India Ltd.'s case (supra). He also argued that the amendment in the Act by insertion of Section 43B that confers the method followed by the assessee.

4. On the other hand, the learned counsel for the revenue Shri Jetly, submitted that it is not correct that the inclusion or exclusion of fiscal duties while valuing the closing stock does not make any difference. In fact, if these fiscal duties including the expenses of manufacturing at various stages makes a substantial difference, if these are included in valuing the closing stock, then that will result in addition of crores every year in the income of the assessee. He further clarified that the system followed by the assessee has not been followed by any other company. Therefore, if the system has been wrongly followed, that does not give any right to the assessee to put into loss the department for ever in future also.

5. I have heard the rival submissions. The basic issue for consideration is to find out the fact whether the system for valuing the closing stock followed by the assessee is such whereby the proper income cannot be deducted. First of all, I do not agree with the learned counsel Shri Palkhivala next any system which is followed in the past should be accepted in the future also when throughout that system is wrong. The basic thing to be seen is whether the system followed by the assessee was proper or not. Once, the authority comes to the conclusion that the system as followed by the assessee in the past was wrong, that can be rejected at any time, at any stage. It does not give any right to the assessee to follow the wrong system for ever.

So far the guidelines issued by the Institute of Chartered Accountants are concerned, I agree with Shri Palkhivala that the guidelines are only asset for guidance. If the assessee chose some modifications in his system to adjust it with the normal practice as prescribed in the guidelines issued by the Institute of Chartered Accountants in considering the nature of the business of the assessee. There is nothing wrong in it, especially when there is no statutory provision as provided in the Act, regarding the method of valuation of the closing stock. But at the same time the assessee is not free to the extent to follow the method he likes. He should follow such a method whereby the profits are properly deducted. Therefore, basically before, as there is a question of fact rather than law, whether by the method applied by the assessee for valuation of the closing stock is such, whereby proper income or profit can be deducted. For this purpose, some relevant facts are necessary to refer. They are produced below. Shri P.N. Shah, chartered accountant clarified the points to the ITO vide his letter dated 23-8-1985 wherein he has clarified the reason for the different results by applying the method of inclusion of fiscal duties, etc., between his report and the report given by TVA & Co. Further, if the fiscal duties are included in valuing the closing stock, results will be in addition in the income of the assessee in every year. Shri P.N.Shah has given the items and the relevant amounts which were not included in valuing the closing stock by the assessee as on 31-3-1983.

Shri P.N. Shah's comparative chart is as under :--------------------------------------------------------------------Items not included by the company Figures in Figures in TVAin valuation of stock as at my report & Co. statement31-3-1983 (Rs. in lakhs) (Rs. in lakhs)--------------------------------------------------------------------(i) Custom duty/excise duty, 516.36 444.29sales tax and other charges(ii) Intermediary duty (wool 79.18 24.25tops/yarn)(iii) Excise duty on finished goods.

18.48 -(iv) Sales tax/octroi on stocks/stores 16.35 -and spare parts Similarly. Shri Palkhivala has given a comparative chart of the valuation of the closing stock by inclusion of these duties on the basis of the reports given by Shri P.N. Shah and TVA & Co. regarding valuation of closing stock as on 31-3-1981, 31-3-1982 and 31-3-1983 :------------------------------------------------------------------------ 31-3-1981 31-3-1982 31-3-1983--------------------------------------------------------------------------(A) Duties/taxes 358.63 244.84 438.44 307.66 532.71 444.29Increase/(decrease) - - 79.81 62.82 95.37 136.63(B) Intermediary duties 108.87 83.62 131.48 59.99 97.66 24.25-Increase/(decrease) - - - (23.63) (33.82) (35.74)(C) Total duties/taxes 467.50 328.46 569.92 367.65 630.37 468.54-Total increase/ - - 102.42 39.19 60.45 100.89(decrease) The above figures are based on the materials supplied by the assessee.

From the perusal of these figures, it is apparent that if we add these fiscal duties in valuing the closing stock, the result is addition in the income of the assessee. Shri Palkhivala pointed out that if we look into these comparative figures given by P.N. Shah and TVA & Co., following the same method, even then, the result is not the same.

Therefore, the system is also not 100 per cent correct. The assessee has followed some conservative system, that should not be rejected. To clarify this position regarding the difference among the figures given in the comparative chart as produced by Shri Palkhivala, Shri P.N. Shah has clarified this in his letter dated 23-8-1985. He has pointed out the reasons for difference in the addition of income by inclusion of these fiscal duties, etc. The first reason is that in the Valuation given by TVA & Co., TVA & Co. has included customs duties on imports, but the other related direct expenses have not been considered. The second reason given by Shri P.N. Shah is that TVA & Co. have made the entire calculation on an average basis that gives a distorted picture.

On. the other hand, Shri P.N. Shah has worked out the duty on the real figures and on the actual basis. Similarly, TVA & Co. has not considered wages, power and fuel which were used for processing and manufacture of goods which formed part of the closing stock. Similarly, he has given other two or three reasons in his report regarding some of the relevant expenses which were not considered by TVA & Co. In valuing of the closing stock of stores and spare parts, TVA & Co. has excluded sales tax and octroi.

Considering the clarifications given by Shri P.N. Shah indicating the difference in the result, in his report from the report given by TVA & Co., in my view, it cannot strictly be said that by following the same method, the results are different. Therefore, that system is not correct. As had been clarified above, when TVA & Co. has not included some of the items which were included by P.N. Shah, the result naturally will be different. Therefore, it cannot be said that following the same system, the results are different.

6. Shri Palkhivala also argued that in the business of the assessee in case of imports, there is a duty drawback system. If the assessee paid some customs duty on the imports and part of it is finally exported after manufacture, the assessee gets some refund. Therefore, the inclusion of such customs duty is not justified in valuing closing stock and not practical also. In reply to this argument, Shri Jetty submitted that it is not correct that due to drawback system in customs duty, the assessee cannot follow the system on the basis of the guidelines given by the Institute of Chartered Accountants. He also gave some names of those companies who have similar business as that of the assessee. The drawback system is available in those companies, but they are following the system for valuation of the closing stock on the guidelines issued by the Institute of Chartered Accountants. It is specifically inquired from Shri Palkhivala to give the name of any company having similar business and has followed the system as followed by the assessee exactly. Not even a single name was given by the learned counsel Shri Palkhivala. Therefore, considering these facts, the submission of Shri Jetly has to be accepted when other companies have followed the system, for valuing the closing stock on the guidelines given by the Institute of Chartered Accountants, the assessee has no specific reasons to depart from those lines especially when proper income is not deducted. Further, when the assessee gets the refund of customs duty, it will not affect the profit as deduction of that was already allowed. If that will be reduced from closing balance, similarly that part has to be reduced from deductions already allowed in the profit and loss account. So far, the provision of Section 43B is concerned, I have gone through it carefully. In my view, it cannot be said that it is in conformity with the system followed by the assessee.

Section 43B provides that deductions cannot be allowed unless they are paid. Therefore, it is just an additional requirement for claiming the deduction. Secondly, this provision came into force with effect from 1-4-1984 and that has no relevance for the year under consideration ; after 1-4-1984 taxes can be taken into account on the basis of payment.

7. Now reverting back to the case law cited by Shri Palkhivala, British Paints India Ltd.'s case (supra), the issue before their Lordships of the Calcutta High Court was whether long standing commercial and accountancy practices followed by the assessee should be rejected.

Their Lordships has taken the view that in valuing the stock, it should be valued at cost or the market price whichever is less as a rule of law, but that can be modified having regard to the particular business carried on by the assessee.

8. It is true that there is nothing wrong in it if the assessee followed any method for valuing the closing stock which may not be on the normal lines but the basic requirement still remained; whether the assessee can follow such a method under which the proper income or profits cannot be deducted, the answer will be in the negative. In the case before us, the reason given by Shri Palkhivala for not following the general practice of accountancy was because there was a drawback system in the nature of business. It could be accepted but from the facts it is apparent that when other assessees having similar business of drawback system have followed the general system on the basis of the guidelines given by the Institute of Chartered Accountants, it cannot be said that the assessee could not follow the general system because of the nature of the business. The learned counsel Shri Jetly has brought to our notice the names of some companies which are having similar business. They are placed at page 8 of the revenue's paper book and reproduced for ready reference : Though Shri Jetly has given the names of the above companies having similar business and drawback system, Shri Palkhivala has not brought to my notice even a single case, where because of the similar difficulty, the system followed by the assessee was followed by similar other assessees. Shri Palkhivala also relied on the order of the Tribunal in the case of Goodlass Nerolac Paints Ltd. (supra), which is placed at pages 97 to 122 of the assessee's paper book. I have gone through the order cited by Shri Palkhivala. The Tribunal has mainly taken into consideration the bona fides of the assessee and also came to the conclusion that there is no escapement of tax. Further, the basic issue before the Tribunal is that is the changed method of valuing the closing stock is proper Here we are not concerned with the bona fides, etc. We are basically concerned with the result of system followed by the assessee; whether that results in reduction of the proper or fair income by valuing the closing stock. Therefore, on the facts, the order of the Tribunal in Goodlass Nerolac Paints Ltd.'s case (supra) is of no help to the assessee.

9. From the figures regarding the valuation of the stock by inclusion of these fiscal duties, etc., given by Shri P.N. Shah in his report on the basis of materials supplied by the assessee and the comparative chart by Shri Palkhivaia, one thing is certain. That, if we include these fiscal duties, in valuing the closing stock, the ultimate result is an addition of the income of the assessee. Not only that, excise duties, sales tax, octroi, labour and customs duty always form part of the cost. When, on the one hand, the assessee is claiming these items as deduction in the profit and loss account for computing the income and reducing the profit, the assessee is not fair in excluding these items from the valuation of the closing stock which results in reduction of the profit. Further, it is also not clear, when the assessee is claiming as deduction for the fiscal duties, etc., in the profit and loss account and have not been shown in valuing the closing stock, at what stage, the assessee has taken these into account; whether in subsequent years also they were taken into consideration. If so, how that will affect the valuation of the closing stock when the assessee has not taken into account these fiscal duties. That should also be examined by the ITO. In other words, whether these fiscal duties are totally escaped of the income or only a postponement of income but one thing is certain that fiscal duties and other expenses which are claimed as deduction that should be taken into account for valuing the closing stock for computing the proper income. Excise duty forms part of price in McDowell & Co. Ltd.'s case (supra).

To sum up the case, in my view, non-inclusion of the fiscal duties, etc., in valuing the closing stock is wrong; these duties should be taken into account which are claimed as deduction in computing the income in the profit and loss account as expenses. The drawback system in customs duties does not affect the profits even in a case if the assessee values its closing stock by including the fiscal duties, etc.

Section 43B is not in conformity with the system followed by the assessee for valuing the closing stock. Though the ITO has added Rs. 1.25 lakhs in his draft assessment order, the same was reduced. In my view, this matter should be re-examined on the basis of guidelines issued by the Institute of Chartered Accountants and any expenses such as fiscal duties, etc., which are claimed as deduction in computing income in the profit and loss account should be included while valuing the closing stock and on that basis, the addition should be made accordingly.

10. In the result, the matter is restored to the ITO, to examine the matter in the light of the observations made above and decide this issue afresh, full opportunity of being heard should be given to the assessee. The order of the Commissioner of Sales Tax (Appeals), the reports of P.N. Shah and TVA & Co. should be considered while deciding this issue. In case, the assessee does not co-operate with the ITO, the ITO is free to estimate the addition on the basis of facts available on the record. In the result, the appeal is partly allowed.

The above appeal was heard by Dr. V. Balasubramanian, Senior Vice President and myself (Y.R. Meena). Since there is a difference of opinion between the Members on the conclusion in the appeal under consideration the following questions are referred to the Hon'ble President for appointing a Third Member to hear the above appeal so that the same may be decided in accordance with the majority view : 1. Whether the income can be properly deduced if the assessee does not include the fiscal duties and other expenses in valuing the closing stock, while the assessee claimed the same as deduction while computing the income in the profit and loss account 2. Whether, setting aside the order of the Commissioner is justified to decide the valuation of the closing stock in the light of the discussions in the order of the Judicial Member.

1. There has been a difference of opinion on one issue between the learned Members who heard the appeal originally. The points of difference have been stated by them as under : 1. Whether the income can be properly deduced if the assessee does not include the fiscal duties and other expenses in valuing the closing stock, while the assessee claimed the same as deduction while computing the income in the profit and loss account 2. Whether, setting aside the order of the Commissioner is justified to decide the valuation of the closing stock in the light of the discussions in the order of the Judicial Member 2. The facts have been stated, in detail, by the learned Accountant Member, the Vice President in this case (to be referred hareinafter as the Accountant Member only). However, during the course of the hearing before me as a Third Member, a few facts have been straightened. It is, therefore, considered desirable to state the facts relevant to the points of difference, in brief, in my own way. I am happy to say that there is no dispute between the parties about the facts which are stated herein.

3. The assessee is a manufacturer of woollen fabrics from mostly imported wool. It has also units for making readymade garments out of the above fabrics and for engineers' files. Its export of woollen fabrics, readymade garments and engineers' files are considerable and are stated to be more than 70 per cent of its total sales. The assessee, inter alia, pays the following duties : (a) customs duty on raw materials, e.g., wool and synthetic fibres improted by it; (b) countervailing duty on synthetic fibres imported and excise duty on locally purchased synthetic fibres ; (c) excise duty on production and manufacture of intermediate products, viz., wool tops and yarn and excise duty on its end products, viz., finished fabrics and engineers' files. The duty on wool tops and yarn is payable when the intermediate product is removed for further manufacture of the end product. The duty on the end product is payable when the end products are removed from the specified premises, i.e., the bonded warehouse of the appellant for sale to customers or on transfer to a separate factory for manufacture of readymade garments or on transfer to retail shops of the company ; and (d) sales tax/purchase tax, octroi duty, etc., on materials purchased as well as on goods sold.As a matter of necessity, the assessee has also to incur other expenses, such as, direct labour, direct expenses, production overheads, other overheads, to bring the raw material into, what is known in the accounting circles, their 'present location and condition'. However, while valuing its closing stock of- the assessee, though has apparently followed a well recognised method of valuing the inventory, namely, cost price or market price whichever is lower, has not taken into account the abovestated fiscal duties paid on or in respect of the closing stock nor included the expenses like direct labour, direct expenses, production overheads and other overheads, incurred for bringing the raw materials into their present location and condition.

4. The proceedings relate to the assessee's assessment for the assessment year 1977-78 for which the previous year is the financial year 1976-77. The auditors of the assessee-company for the first time in the history of the assessee-company gave a note, being note No. (3), in the annexure to the auditors' report reading as under : (3) The stocks of finished goods, stores, spare parts and raw materials have been physically verified during the period by the management. In our opinion, the frequency of verification is reasonable. The discrepancies noted on verification between the physical stock and the book records were not significant. The stocks of finished goods, stores (apart from spare parts which are written off in the year of purchase) and raw materials have been valued at the lower of cost or market value, due allowance being made for defective, obsolete or slow moving items, but in the case of raw materials and finished goods (other than merchanting goods) such cost or market value has been determined exclusive of customs and excise duties (amount not ascertainable). Apart from this, in our opinion, the valuation of the stocks is fair and proper in accordance with the normally accepted accounting principles. The valuation is on the same basis as in the earlier years.

The department has accepted whatever method the assessee has followed in the matter of valuing its closing stock in the past without discussion. It is the department's case that it never suspected the assessee of following an irregular or an incorrect method and that this could come to its notice during the year under appeal only because of the auditors' note referred to above. This seems to be correct. All the same, I propose to assume for the purpose of this appeal that so far as the assessee is concerned, it is following this very method of valuing its closing stock since inception even though there was no indication given of it in the past by the assessee and of verification of it by the department. I say this as I find that the auditors have clearly stated in their above note that the valuation is on the same basis as in the earlier years and the lower authorities have not doubted it at any stage of the proceedings earlier. It is, therefore, assumed that the assessee is following the particular method of valuing its closing stock regularly since inception though in the circumstances mentioned above it is not possible to accept that the department has accepted it consciously.

5. The ITO as well as the IAC (who had to consider the issue in view of the applicability of the proviso to Section 144B) took the view that the method of valuing the closing stock adopted by the assessee was such that the assessee's income for the year could not properly be deduced. The ITO proposed an addition of Rs. 1.25 lakhs on the ground of under-valuation of the closing stock in his draft assessment order.

However, eventually, he made an addition of Rs. 25,96,000 to the closing stock in view of the directions of the IAC issued under Section 144B. On appeal, the Commissioner (Appeals) vide paragraph* 129 of his order, held that for the purpose of valuation of the closing stock the customs duty paid without reducing the amount of customs duty by the amount of (duty drawback received), excise duty paid, sales tax paid, octroi duty paid and direct expenses including labour, etc., incurred in respect of the stocks remaining on hand have to be taken into consideration. Vide paragraph 130 of his order, he has directed the ITO to make addition to the returned income by revaluing the stocks for the years under appeal in the light of his directions.

6. As stated earlier, the learned Members hearing the appeal, originally, differed. The learned Accountant Member has summarised his conclusions vide paragraphs 39 and 40 of his order as under : (1) In computing the profit from a business continuous over the years the method of accounting followed by the assessee would only be the basis unlike in the case of income from other heads.

(2) Though for income-tax purposes each year is self-contained period, computation of income from a business cannot ignore the rasults of the earlier and subsequent years.

(3) Stock valuation even as similar dealings with stores, tools, etc., is an important aspect in the method of accounting adopted by a businessman.

(4) There is nothing absolute by way of method in stock valuation.

Stock valuation is only an aid to arrive at a profit from the trading account. This being so, so long as the same method of stock valuation is adopted from year to year by a continuous business, it cannot be said that the correct profit cannot be computed from that method.

(5) Where closing stock valuation is disturbed and to the same extent opening stock valuation for the next year has to be adjusted, there can be no escapement of profit over the years-whether seen from the theoretical or the practical point of view.

(6) The assessee's accounts have been, in our view, consciously accepted by the department from year to year. The assessee has not changed the method of accounting. The method of stock valuation followed by the assessee cannot be said to be to the extent we are concerned not with the method itself but only with the determination of the annual profit, erroneous or unscientific.

40. We, therefore, hold that tampering with the method of stock valuation followed by the assessee is neither necessary nor justified for the purpose of arriving at the correct profit from the business. The additions made by such revaluation are deleted and the Income-tax Officer is directed to accept the profit on the basis of the method of stock valuation followed by the assessee.

The learned Judicial Member has summed up his conclusions in the penultimate paragraph of his order as follows : To sum up the case, in my view-non-inclusion of the fiscal duties, etc., in valuing the closing stock is wrong ; these duties should be taken into account which are claimed as deduction in computing the income in the profit and loss account as expenses. The drawback system in customs duties does not affect the profits even in a case if the assessee values its closing stock by including the fiscal duties, etc. Section 43B is not in conformity with the system followed by the assessee for valuing the closing stock. Though, the ITO has added Rs. 1.25 lakhs in his draft assessment order, the same was reduced. In my view, this matter should be re-examined on the basis of guidelines issued by the Institute of Chartered Accountants and any expenses such as fiscal duties, etc., which are claimed as deduction in computing income in the profit and loss account should be included while valuing the closing stock and on that basis, the addition should be made accordingly.

The learned Judicial Member has restored the matter to the ITO for making an addition to the closing stock after allowing the assessee an opportunity of being heard in the light of the observations made by him.

7. Shri N.A. Palkhivala, the learned counsel for the assessee, ably assisted by Shri Haresh Salvi has appeared for the assessee. Shri G.S.Jetly, senior standing counsel for the department, ably assisted by senior authorised representative, Shri K.K. Tuli, has appeared for the department. The counsels for both the sides were heard at length.

Having regard to the complexity of the issue, the quantum of the additions involved and the general public importance of the issue, the counsels were requested to give their submissions, briefly, in writing so that no contention is left out of consideration. These have been respectively received on 12-1-1986 and 20-1-1986.

8. On behalf of the assessee, strong reliance has been placed on the order of the learned Accountant Member in support of the claim that the valuation of the closing stock by the assessee is proper and need not be disturbed. It is pointed out that the assessee is entitled to drawback of customs and excise duties paid by it in respect of the goods to be exported. Besides, it is also entitled to import raw material, like, wool and synthetic fabrics duty free for fulfilment of the export orders. It is difficult, if not impossible, to envisage at the time of valuing the closing stock, the amount of customs and excise duty that the closing stock will ultimately bear. This is the method of valuation under which all duties and taxes paid are treated as revenue expenditure and when receive-backs are treated as income is quite convenient. The method is stated to have been followed by the assessee regularly from the inception of its business in the year 1961 and accepted by the department as such. That apart, if the assessee was to value its closing stock in the manner suggested by the department, the value so determined would be greater than the export sale price. The assessee, in such a situation, will expose itself to a charge of dumping its goods in the export market which is a positive handicap in the export trade. Our attention in this regard is invited to the stringent anti-dumping laws obtaining in many countries to which the assessee's exports are made. To substantiate this, part of the statement, reference is made to the inquiries started by the Company Law Board about the valuation of closing stock by the assessees in this manner. The inquiries were not only dropped the assessee was also exempted from furnishing particulars with regard to omission of sales in respect of each class of goods dealt with by the assessee and indicating quantities of sales of each goods separately, raw materials consumed giving itemwise break-up and indicating quantities thereof and the opening and closing stocks of goods purchased giving break-up of each class of goods and indicating quantities thereof. However, in response to a query from the Bench, it was admitted that if an inquiry is instituted under the anti-dumping laws of a country or countries, the assessee can be asked to give all these details.

9. According to the learned counsel, the impugned note of the auditors has been given because of the Manufacturing and Other Companies' (Auditor's Report) Order, 1975. It does not mean by any stretch of imagination, that the report of the auditors on the affairs of the assessee for the year is a qualified one. Reference in this regard is made to 'Statement on qualifications in auditor's report' published by the Research Committee of the Institute of Chartered Accountants.

Inviting then our attention to the provisions of Section 145, it is submitted that the choice of the method of accounting is that of the assessee as long as the method results in ascertainment of true and fair profit. Referring to the text book on Accounting Theory and Practice by M.W.E. Glautier and B. Underdown, it is submitted that there are a large number of methods of accounting prevalent regarding valuation of closing stock all of which are accepted by the accountancy profession and all of which result in ascertainment of true and correct profit. The short question, according to the assessee, therefore, is whether the method of valuation of closing stock adopted by the assessee is consistently followed and results in ascertainment of true and correct profit.

10. Inviting our attention to the fact that the departmental authorities have rejected the assessee's method of valuation, mainly, on the following two grounds : (i) the method of valuation is not in accordance with the suggestion made in the guidance note of the Institute of Chartered Accountants ; and (ii) the method suggested by the department would result in higher profit.

It is submitted that both these conditions are fallacious and untenable. For this purpose, I am taken through the guidance note of the Institute of Chartered Accountants to show that the note does not lay down an inviolable rule. It only suggests the method of accounting which should normally be followed. This, according to the counsel, means that the departure from the suggestions made in the guidance note is conceivable. It is stated that the guidance note itself recalls that a number of companies are following the method under which fiscal levies are excluded while valuing the closing stock. In support, it was stated that Sandvik Asia Ltd., Glaxo Laboratories Ltd. and Goodlass Nerolac Paints Ltd., are the companies where the method of valuing the closing stock is the same as followed by the assessee. Apart from contending that the mere fact that the method suggested by the department would result in higher profit is no ground for rejecting the assessee's method of valuation, it is urged that there is no indefinite postponement of income as a result of the method of valuation followed by the assessee. At best, it could be said that the profits of this year are shifted to the next year. In other words, the method suggested by the department would result in profits of the following year being shifted back to the earlier year. In support of the first proposition, reliance is placed on the Madras High Court's decision in the case of CIT v. Carborundum Universal Ltd. [1984] 149 ITR 759.

11. It is stated that Section 43B has since been inserted by the Finance Act, 1983, with effect from 1-4-1984. The section provides that sums payable by an assessee by way of tax or duty under any law will be allowed in the year in which the amount is actually paid irrespective of the method of accounting. The implication of this section is stated to be that for the assessment year 1984-85 and onwards fiscal levies will not automatically be treated as part of the cost of goods unless paid during the year. This means that the method of valuing the closing stock followed by the assessee up to and including the assessment year 1976-77 and for the assessment year 1984-85 onwards will be treated as proper whereas for the intervening years the method suggested by the department will be applied. This is, according to the counsel for the assessee, clearly contrary to the provisions of Section 145. Reference, in this context, is made to the determination of the value of the closing stock by Shri P.N. Shah, a senior chartered accountant, at the instance of the ITO and Thakur, Vaidhyanatha Aiyar & Co., at the instance of the assessee. The difference between the two sets of figures, clearly shows that the method of valuing the closing stock suggested in the guidelines is very complicated and even experts like Shri P.N. Shah and Thakur, Vaidhyanatha Aiyar & Co., have different ideas about the same. To say that the method regularly adopted by the assessee in this regard is not correct is, according to the counsel, too much in the circumstances.

12. The last submission made is that being in the fancy trade, the products marketed by the assessee both for domestic and export markets, are subject to frequent changes in fashion and the shade changes from season to season. Hence, timely delivery of goods in complete shade and design is crucial since even a fortnight's delay can result in cancellation of the order which may mean carry forward of stocks to the next corresponding season and, thus, the products will become obsolete.

It is for this reason that stocks in particular cases are valued at raw material cost without adding any amount of labour charge, etc. In support, reliance is placed on the Calcutta High Court's decision in the case of British Paints India Ltd. (supra).

13. Strong reliance is placed on the order of the learned Judicial Member on behalf of the department. It is emphasised that fiscal levies, like customs, excise duty, sales tax, octroi, etc., are parts of the cost of the goods. It is beyond anybody's comprehension that while valuing the closing stock, such levies are excluded from consideration. It is stated that the assessee is a manufacturer of woollen textiles and the excise duty, etc., are passed on to the buyers and form part of the sales price. Similarly, it will represent cost of the goods in the hands of the assessee. When an article is subjected to purchase tax, the customs duty or excise duty, the tax becomes a part of the price which, ordinarily, a buyer will have to pay. No doubt, the term 'cost price' is not defined in the Act. This only means the meaning will be given to this term as is understood by businessmen and by those in the profession of accountancy. Applying this test it would be abundantly clear that the fiscal levies on the purchase of goods are the parts of the purchase price. My attention is invited to the fact that it is not as if the assessee has never included the fiscal duties as parts of the cost of the goods. When it suits the assessee's convenience, it has included the fiscal duties for the purpose of computing the cost. This is stated to be so with regard to the capital assets on which the assessee has claimed depreciation on the cost.

14. The contention of the assessees that they had ever since followed this system of valuation of stock which has been accepted by the department, is stated to be factually incorrect. The department never knew about the exclusion of fiscal duties by the assessee while valuing its closing stock. It was only in the annual report and accounts for the accounting year 1976-77 that the department came to know about the exclusion while valuing the closing stock. This was possible to detect from note No. 3 at page 13 being an annexure to the auditors' report.

At no point of time earlier than the said report the assessee had ever indicated or disclosed to the department that while valuing the closing stock the assessee was excluding the fiscal duties. The allegation that the department knew about this method of valuation and accepted it is far from truth. In fact, the department was not even aware of the fact that the assessee was following a peculiar method of valuing its closing stock. The question of the department applying its mind and consciously accepting the method as correct, therefore, has never arisen.

15. The moot point, according to the standing counsel, is whether true and correct profits could be deduced from the method of valuing the closing stock adopted by the assessee. It is stated that for this purpose it is necessary to keep in mind that under the Act each year is a separate unit of assessment. What one has to see is whether the true profits of a particular year can be deduced from the method followed.

It is of no consequence what happened in the following year or in the earlier year. The assessee has also omitted to take into account the expenses incurred with regard to some processed goods, i.e., work-in-progress. The omission to include the expenses does not certainly reveal the true picture of the accounts. Assuming it is correct that two or three companies, whose instances are cited by the assessee's counsel, are following a method some-what similar to the assessee valuing the closing stock but 99 per cent companies follow the method of valuing the closing stock suggested by the Institute of Chartered Accountants. Therefore, inasmuch as the method of valuing the closing stock adopted by the assessee is incapable of resulting in correct and true profits of the assessee for the year, the method adopted by the assessee has got to be rejected.

16. According to the learned standing counsel the provisions of Section 43B introduced in the Income-tax Act with effect from 1-4-1984 have no bearing whatsoever on the issue. It is not understood how these provisions stand in the way of adopting the method of valuing the closing stock suggested by the Research Committee of the Institute of Chartered Accountants. After all, the Institute is a professional body and it must have taken into account all relevant aspects while suggesting the method for valuing the closing stock. Lastly, it is emphasised that it is not a question of a part of the profits of this year being taxed in the following year. The method adopted by the assessee results in perpetual postponement of income from being taxed.

After all, the assessee is a prosperous company. As the records suggest its closing stock of the current year is less than the closing stock of the following year and so on and so forth. The result is that if by adopting this method the assessee has been able to postpone taxation of the profits to the extent of Rs. 1 crore this year, in the next year the postponement will be of Rs. 1.25 lakhs. In the next following year, it may be Rs. 1.50 lakhs and so on and so forth. Such a method cannot certainly be said a proper method of valuing the closing stock.

17. I have heard the parties and have carefully gone through the orders of the learned Members, the orders of the Commissioner (Appeals) and the ITO as also the other material on record. I find that the learned Accountant Member has accepted the submissions made on behalf of the assessee to the effect that the assessee was following a particular method of valuing its closing stock since inception of the business, i.e., the year 1961 and that in their reports in some of the years in the past, the auditors had indicated the assessee's method of valuing its closing stock which the department had accepted with open eyes rather without verification. The conclusion of the learned Accountant Member is not correct inasmuch as in the course of the hearing before me the facts have been thrashed out and about which there is no dispute that the method of valuing the closing stock has not been indicated in the printed accounts of the assessee in any of the earlier years. Nor had the auditors referred to this aspect in their reports and the department had also no occasion to know about it. In the circumstances, it is not correct to say that the department has accepted the assessee's particular method of valuing the closing stock consciously.

On the facts, as found, one could even justifiably say that the method of valuing the closing stock followed by the assessee in the past is yet to be ascertained. However, in the absence of a specific dispute raised by the department and the fact that the auditors in their note have stated that the particular method was followed by the assessee regularly in the past, I proceed on the assumption that the assessee has been following this method regularly from inception though the same was accepted by the department taking it as a proper method in good faith.

18. It may now be desirable to exemine the provisions of Section 145(1) which, inter alia, deal with computation of income from business. The Sub- section provides that income chargeable under the head 'Profits and gains of business or profession' shall be computed in accordance with the method of accounting regularly followed by the assessee.

Though, ordinarily, the expression 'method of accounting' refers to the accounting methods, such as, mercantile, cash and hybrid, it is, more or less, a settled law that a method an assessee adopts for valuing its closing stock is an integral part of the method of accounting. The omission to include the value of the closing stock altogether or inclusion of it at improper and incorrect value will give a false or absurd picture of the profit. This is what has been held by the Madras High Court in the cases of CIT v. Chari and Ram [1949] 17 ITR 1 and Indo-Commercial Bank Ltd. v. CIT [1962] 44 ITR 22. That the value of the unsold stock-in-trade is an essential item in the computation of profits and gains for a period has been affirmed by the Supreme Court in the case of Chainrup Sampatram v. CIT [1953] 24 ITR 481 in which case the purpose and importance of correct value of the unsold stock has been stated by the Hon'ble Supreme Court in the following words : .... The true purpose of crediting the value of unsold stock 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 aptually realised on the year's trading. As pointed out in paragraph 8 of the Report of the Committee on Financial Risks attaching to the holding of Trading Stocks, 1919 : 'As the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure.... From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less than cost. It is of course an anticipation of the loss that may be made on those goods in the following year and may even have the effect, if prices rise again, of attributing to the following year's results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question' (extracted in paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to British Parliament in April 1951). While anticipated loss is, thus, taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation.... (p. 485) 19. To emphasise the need to value the closing stock for ascertaining the profits of a given year, I do not think I can do better than to refer to the observations of the Supreme Court in the cases of- .... Under the Income-tax Act for the purpose of assessment each year is a self-contained unit and in the case of a trading adventure the profits have to be computed in the manner provided by the statute. It is true that the Income-tax Act makes no express provision with regard to the value of stock. It charges for payment of tax the income, profits and gains which have to be computed in the manner provided by the Income-tax Act. In the case of a trading adventure the profits have to be calculated and adjusted in the light of the provisions of the Income-tax Act permitting allowances prescribed thereby. For that purpose it was the duty of the Income-tax Officer to find out what profit the business has made according to the true accountancy practice. As a normal rule, the profit should be ascertained by valuing the stock-in-trade at the beginning and at the end of the accounting year.... (p. 743) .... whichever method of book-keeping is adopted in the case of a trading venture, for computing the true profits of the year the stock-in-trade must be taken into account. If the value of stock-in-trade is not taken into account, in the ultimate result the profit or loss resulting from trading is bound to get absorbed or reflected in the stock-in-trade unless the value of the stock-in-trade remains unchanged at the commencement of the year and the end of the year.... (p. 130) From the discussion above, it can be reasonably taken that the purpose of valuing the opening stock and the closing stock is to see that the profits of the year are computed as far as possible on the goods already sold. While the appreciation in the value of the closing stock may be ignored the depreciation in the value of the closing stock for any reason whatsoever may have to be taken care of provided the assessee is valuing its closing stock at cost or market price whichever is lower. It is also evident that under the Act, for the purpose of assessment, each year is a self-contained unit.

20. It may, however, be mentioned that though the method of valuing the closing stock adverted to in the above cases, is cost or market price whichever is lower, the Supreme Court has, in the case of Investment Ltd. v. CIT [1970] 77 ITR 533 held that the assessee is free to adopt a method of accounting only at cost instead of evaluing the closing stock at cost or market price whichever is lower.

21. No doubt, Section 145(1) provides for computation of income from business in accordance with the method of accounting regularly followed by the assessee which will of course include, as stated above, the method of valuing the closing stock. This, however, does not mean that the assessee has a licence to adopt any method of valuing its closing stock. The Sub- section has a proviso which authorises the income-tax authorities to discard even the regularly employed methods including the method of valuing the closing stock if in their opinion, true profits of the business for the year cannot be properly arrived at. In other words, even the regularly followed methods of accounting including the method of valuing the closing stock are required to satisfy the test, namely, the true and correct profits of the business are reflected thereby.

22. The pertinent question that arises for consideration is as to the concept of proper income envisaged in the proviso. The word 'income' has been inclusively defined in Section 2(24) of the Act to include profits and gains. The expression 'profits and gains' is not defined in the Act as such but as held by the Supreme Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 that expression has to be understood in its commercial sense. It is here that the observations of the Supreme Court in the case of Chainrup Sampatram (supra) assume importance, namely, the profits as far as possible, subject to the exception referred to therein, should be the profits earned on the sales already made. It is for this reason that, ordinarily, the closing stock is required to be valued at cost price or market price whichever is lower. However, it is not a rule of law. A number of systems of valuation based upon commonsense keeping in view the ultimate object that the true and correct profits of the year are reflected, have been recognised as proper methods for the valuation of the closing stock in the commercial world and by the accountancy profession, such as : The assessee having, admittedly, followed the cost method what is required to be considered is the meaning and purport or concept of 'cost' and whether the cost method would or could include within it the method adopted by the assessee and whether such a method of valuation would fulfil the object of reflecting the true and correct profits of the year.

23. That cost comprises the purchase price including import duties, transport and handling charges and any other directly attributable costs less trade discount and rebate plus such other expenses which have been incurred in the normal course of the business in bringing the products, finished or in progress, to its present location and condition, is a well known concept. Reference in this context can usefully be made to Advanced Accounting by J.R. Batliboi, Eighth edn., pp. 46 and 47 and to Research Publication Series as 12 by G P. Kapadia, pages 19-20, paragraphs 17 to 20 made Annexures to this order as Annexures 'A' and 'B', respectively.

24. No doubt, the cost method, particularly in the case of an assessee manufacturing goods out of various raw materials and in different stages is difficult of uniform application. For instance, the cost has to take care of direct labour and direct expenses, production overheads and other overheads besides fiscal levies, if any, suffered at different stages. To this extent the learned counsel for the assessee is right and I am in agreement with the view expressed in this regard by M.W.E. Glautier and B. Underdown in their treatise Accounting Theory and Practice at pp. 622-627.

On carefully going through these pages, I find that the complication referred to by the learned authors pertains to production overheads and other overheads and not to fiscal levies and direct labour and expenses in bringing the raw material, finished goods or semi-finished goods to their present location and condition.

25. In this context, it is considered desirable to refer to the five principles of valuation of closing stock indicated by the Calcutta High Court in its decision in the case of British Paints India Ltd. (supra).

The principle Nos. (3) to (5) appear to be of particular significance in this case : (3) For the purpose of the aforesaid valuation, it is necessary to determine what in all circumstances represent the costs of stock-in-trade and work-in-progress. What is and what is not profit or gain in those circumstances must necessarily be one of fact and fact to be ascertained by the tests of ordinary business.

(4) There are no statutory rules for making this valuation and the ordinary method of commercial accounting must be followed except insofar as there is any specific statutory provision requiring otherwise. The method must be fair to the taxpayer and fair to the revenue. Traders are allowed to value their unsold stock and work-in-progress either 'at cost or market price, whichever is lower'. This is, however, a short hand way of expression; it is not a rule of law. It must be adopted in commercial sense in consonance with accounting practice. Anticipated losses and profits for the aforesaid purpose are permissible, provided, however, there is a market in the ordinary sense and the anticipation is backed by consistency of the method followed and the method followed is supported by recognised accounting principles.

(5) Whatever is the method, it must be one recognised by accounting practice and sanctioned by commercial practice. The method adopted and regularly followed over the periods and accepted by the revenue should not be departed from unless there is good reason for the same. If, however, the method adopted and regularly followed by the assessee does not result in the determination of the true profits for tax purposes, even for one particular year, or there is some other good reason, the revenue is entitled to reject the method followed and value the stock upon such basis as will result in the determination of true profits. (p. 54) It is evident from the above that the method of determination of the cost of stock-in-trade must be fair both to the taxpayer and the revenue. The method must be one recognised by the accountancy practice and sanctioned by commercial practice. If, however, the method adopted does not result in the determination of the true and correct profits for tax purposes even of one year the department is entitled to reject such a method. In the case before me, the assessee is, admittedly, valuing its stock-in-trade at cost, which is one of the recognised methods of valuing the closing stock. However, while taking the cost of the closing stock what the assessee has done is, it has taken some of the components of the cost leaving quite a few important components, such as, fiscal levies and direct labour and expenses for bringing the closing stocks to their present location and condition. This is, certainly, not a proper method and, in any event, it is not a method which is recognised by the principles of accountancy and sanctioned by commercial practice. It is like the assessee saying that it values its closing stock at cost but it will take the cost at 75 per cent of the actual cost. I do not think such a method can be accepted as a proper method fair both to the assessee and the Income-tax Department. If the opening stock and the closing stock were revalued at cost in its proper concept, the profits of the year will, admittedly, go up by several lakhs of rupees, if not crores. Having regard to the above discussion, I am inclined to agree with the learned Judicial Member that the manner in which the assessee has taken the cost of the closing stock does not result in the determination of the true and correct profits of the year and the department is, therefore, justified in rejecting the assessee's method of valuation and in revaluing the closing stock on proper basis.

26. In view of my above conclusion, strictly speaking, it is not necessary to deal with the other submissions made on behalf of the assessee. However, since these were vehemently urged, I propose to deal with them, in brief as under : 26.1 Firstly, the difficulty and variation envisaged in valuing the closing stock at cost by the learned authors M.W.E. Glautier and B. Underdown in their treatise Accounting Theory and Practice is regarding the production overheads and other overheads. In any event, the mere fact that there is difficulty in valuing the closing stock at cost (in its proper concept) would not justify the valuation of the closing stock without taking into account the material components of the cost. There is an indirect authority in the decision of the Supreme Court in the case of Calcutta Co. Ltd. (supra) in the context of liability to be allowed as expenditure that the difficulty in the estimation thereof does not mean that an accrued liability need not be taken into account. It was held that it was always open to the income-tax authorities to arrive at a proper estimate of the liability having regard to the facts and circumstances of the case. Moreover, the Institute of Chartered Accountants has itself prescribed certain methods for valuing the raw material, work-in-progress, finished goods, etc., in terms of the guidelines issued. In the circumstances, it is difficult, if not impossible, to accept that the method indicated by the Institute of Chartered Accountants is incapable of implementation.

26.2 It was pointed out on behalf of the assessee that the method followed by the assessee has been followed by at least three other companies, namely, Glaxo Laboratories (India) Ltd., Sandvik Asia Ltd. and Goodlass Nerolac Paints Ltd. While the printed accounts of the first two companies for the years ended 30-6-1983 and 31-12-1979, were filed, reference was made to the Tribunal's order in the case of Goodlass Nerolac Paints Ltd. (supra) (at pages 97 to 122 of the assessee's paper book, Vol. II). I, however, find that the case of Glaxo Laboratories (India) Ltd., does not support the assessee's case at all. Note 6 of the 'Notes to the Accounts', at page 18 of the printed accounts reads as under : (6) In past years it has been the practice to charge the total expenses on excise duty to the profit and loss account and include the amount relating to the unsold stocks in the closing stock valuation. For the current year excise duty has been so charged as an expense only in respect of goods cleared and sold and the balance amount of Rs. 242.46 lakhs relating to goods manufactured and remaining unsold has been included under loans and advances in Schedule 15. Had the previous year's practice been followed, the charge to excise duty and the value of closing stock would have been higher by Rs. 242.46 lakhs. However, this charge has no effect upon the profits for the year.

It is evident the excise duty paid in respect of unsold goods was not debited to the purchase account or profit and loss account in this case. It was shown on the assets' side" and, therefore, its non-inclusion as a part of the cost of the closing stock had no effect whatsoever upon the profits of the year.

Note 3 in the 'Annexure to the auditors' report' in the case of Sandvik Asia Ltd., reads as under : 3. The stocks of finished goods, stores and spare parts and raw materials have been physically verified during the year by the management except for such stocks held by third parties in respect of which confirmations have been received for most of the stocks. In our opinion, the frequency of verification is reasonable. The discrepancies noticed on verification between the physical stocks and book records were not significant and these have been properly dealt with in the books of account. In our opinion, the valuation of the abovementioned stocks is fair and proper in accordance with normally accepted accounting principles, except that the company has not included excise duty in respect of excisable goods manufactured and subsequently used in the manufacture of other products, in the valuation thereof. The basis of valuation, however, is the same as that of the previous year.

It is not clear from the note or the accounts whether any excise duty was paid by the assessee in respect of the goods manufactured at the intermediary stage which were subsequently used in the manufacture of finished products. It is also not clear whether the amounts paid as excise duty, if any, were debited to the purchase account or profit and loss account or debited to the excise duty account itself standing as an asset in the accounts of the assessee. In the circumstances, it cannot be assumed that Sandvik Asia Ltd., are following the method of valuation of closing stock adopted by the assessee. In any event, no material has been placed before me to show that assuming the assessee's method of valuation is the same as that adopted by Sandvik Asia Ltd., it has been accepted by the department.

The case of Goodlass Nerolac Paints Ltd. (supra) supports the assessee's claim on the face of it. The closing stock in that case was valued at cost without including the excise duty paid up to and including the assessment year 1976-77 and this method was accepted by the department, though it is not clear whether it was accepted consciously or without noticing it. In fact, the auditors' note for the year ended 31-12-1973 as reproduced in paragraph 20 of the Tribunal's order is in the following words : 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. (p. 274) Indicates that the method may have been accepted by the departmental authorities in good faith. For the intervening two years, i.e., assessment years 1977-78 and 1978-79, the assessee changed the method of valuation of closing stock and included the excise duty as a part of the cost and this is reflected in the auditors' note in the accounts for the year ended 31-12-1976. The accounts for these two years have to be taken as accepted by the department with full knowledge. For the assessment years 1979-80 and onwards, the company reverted to the old method which was rejected by the ITO as well as the Commissioner (Appeals). The Tribunal has, it is true, by its order dated 29-11-1984, accepted the change. It is also true that the Tribunal has observed in that case that the method resulted in the determination of true and correct profits of the year. However, it appears to me that to a great extent, the Tribunal was influenced by factors, such as, (iii) the amounts requiring addition on account of revaluation of closing stock vis-a-vis the yearly profits of the assessee, were not significant.

In the circumstances I do not think that it will be proper to take that order to be an authority for the proposition that the valuation of the closing stock at cost and taking the cost by ignoring its material components, such as, fiscal duties, direct expenses and a portion of the overhead expenses, is proper.

26.3 Next, I deal with the difficulty aspect in ascertaining the cost of the closing stock in the manner suggested in the guidelines issued by the Institute of Chartered Accountants. No doubt, there is considerable difference between the value of the closing stock estimated by the firm of chartered accountants, Shah & Co., who valued the stock at the instance of the ITO and by the firm of chartered accountants, Thakur, Vaidhyanatha Aiyar & Co., who did it at the instance of the assessee. Firstly, the fact that two experts have interpreted the guidelines differently does not entitle the assessee to ignore the complicated part of it altogether. I, then, find from the letter issued by the ITO to Shah & Co. and the letter issued by the assessee to Thakur, Vaidhyanatha Aiyar & Co., that the mandate given to them were different and, therefore, the results were bound to be different. Nothing much, thus, turns, on this part of the assessee's submissions.

27. I now deal with the question of anti-dumping laws. The argument has been that if the fiscal levies and other direct and overhead expenses are included as parts of the cost, the cost was likely to be more than the export sale price. In that case, the foreign buyers may not be interested in importing the assessee's goods on account of the strict anti-dumping laws obtaining in those countries. This argument assumes that the foreign buyers are not aware of the policies of the Government of India in the matter of promotion of exports. To my mind, it is a well known fact known to all the foreign buyers. Almost all companies engaged in the export business, value their closing stock in the manner suggested by the Institute of Chartered Accountants in the guidelines.

Nobody has suggested that their exports are adversely affected on account thereof. In any event, if that is the reason, the assessee could have followed the method adopted by Glaxo Laboratories (India) Ltd. After all, as observed by the Supreme Court in the case of Chainrup Sampatram (supra), the purpose of valuing the closing stock is to find out the amounts that have gone into the profit and loss account in respect of the stock remaining unsold. This would have served the assessee's purpose as well as resulted in true and correct profits of the year.

The fact that the Company Law Board dropped the proceedings started against the assessee as a result of the auditors' note with regard to the method of valuation of the closing stock adopted by the assessee and/or exonerated the assessee from the obligation of giving various details in its printed accounts, at best, shows the assessee's bona fides. However, there is no reason to accept that any method of determining the cost followed by the assessee, if bona fide, must be correct irrespective of its impact on the determination of the true and correct profits of the year. I, however, accept Shri Salve's submission that the auditors' note cannot be treated as a qualification and that they have only highlighted the method followed by the assessee. That is why I have independently tried to appreciate the impact of the method of valuation of the closing stock adopted by the assessee.

28. The last argument advanced is that the valuation of the closing stock of this year does not really affect the determination of the true and correct profits, that in the case of computation of income from business the year's accounts are telescoped in that of the following year and so on and so forth and that it is for this reason that Courts have held almost uniformly that the opening and the closing stock of a year must be valued on the same basis and that the value given to the closing stock in the current year must be the value of the opening stock of the following year. By giving an illustration, it was pointed out that an addition of income as a result of revaluation of the closing stock this year, ordinarily, means shifting of the following year's profit to the immediately preceding year and it was vehemently contended that the method adopted by the assessee does not result in postponing a part of the profits as suggested by the department.

In order to appreciate this part of the submission on behalf of the assessee, it is desirable to refer to the assessee's sales and the closing stock in terms of value. The assessee's sales have progressively gone up from Rs. 323.22 lakhs to Rs 14,079.31 lakhs during the course of the past 24 years. The value of the closing stock has also gone up from Rs. 94.77 lakhs to Rs. 1,528.88 lakhs in the corresponding period. It is only in five years that the closing stock in terms of value has been a little less than the closing stock of the preceding year and that too marginally. Otherwise, the closing stock has increased both in quantity and value considerably year to year. The figures of these five years are :Year Closing stock Closing stock of the of the year earlier year1965 78.18 91.441968 114.49 137.811970 125.30 128.811974 235.12 263.001980-81 545.04 567.60 Assuming the cost of the closing stock is taken as x instead of x+y, the result will be the profit, by revaluing the closing stock at the rate of x+y, will go higher and higher year after year. In other words, if an assessee has, by undervaluing its closing stock, disclosed its income less by Rs. 1 lakh in the current year, it is not to pay tax on this amount perpetually because in the next year the revaluation of the closing stock is going to result in an addition of Rs. 1,25,000, if not more and so on and so forth. After all, the fact cannot be ignored that the assessee is a prosperous company. Therefore, I am not inclined to accept that it is only postponement of profits of one year to next year simpliciter.

29. During the course of the hearing, it was argued that debiting fiscal levies straight to the profit and loss account is convenient as it is not possible to envisage which goods will be exported and in respect of which goods the assessee will receive the drawback, etc.

Firstly, this was not one of the difficulties envisaged by the Institute of Chartered Accountants otherwise, they would not have suggested the method of valuation. In any event, when almost all other companies are valuing their closing stock in the other manner, it is beyond at least my comprehension that the assessee would not have been able to find a way out for properly arriving at the cost of the closing stock.

30. As regards Section 43B which has been introduced in the Income-tax Act with effect from 1-4-1984, according to me, it only means that the assessee cannot claim deduction without at least acknowledging the liability, if not actually making the payment. It is assumed that even now quite a few assessees pay tax as and when the liability arises. The effect of Section 43B is going to be in the manner of computing the income for tax purposes. I have my doubts whether it will have any bearing in the manner of maintaining accounts. For instance, the Act even now contemplates, a number of disallowances out of actual expenses incurred by the assessee. Similarly, the Act has been contemplating allowances which, quite often, are not debited by the assessees in their profit and loss account. These have never presented any difficulty in the maintaining of accounts. To my mind, undue emphasis is laid on the provision. I am sure that the Institute of Chartered Accountants will definitely come out with some suggestion in this regard. Just as Sections 37(3A), 37(3B), 40, 40A, etc., of the Act have no effect so far as the book-keeping is concerned, Section 43B is not likely to have any effect on the maintenance of accounts. At best, a trader might be asked to indicate in the account whether a liability has or has not already been discharged. The facts in the Madras High Court's decision in the case of Carborandum Universal Ltd. (supra) were that the assessee was formerly valuing its closing stock in respect of work-in-progress and finished goods at cost which meant not only the cost of the goods and direct expenses but also overhead expenses. In the previous year relevant for the assessment year 1971-72, the assessee changed the method of valuing its closing stock from total cost to direct cost, the difference being that in direct cost the overheads, such as, administrative department expenses were excluded while in the total cost such overheads were included. The change was accepted by the Tribunal and the view of the Tribunal was confirmed by the Hon'ble High Court. On my part, I would have accepted the assessee's method of valuation as proper if it had been only on the question of total cost or direct cost both being recognised method.

Unfortunately, however, the method here adopted is not at all showing the correct cost of the stock-in-hand. The Madras High Court case is, therefore, distinguishable.

The assessee had also contended at one stage that its products were out of fashion very soon and that if the material remained unsold for some time, it was of no value. Firstly, no material has been placed before me in this regard. Moreover, if a portion of the closing stock is damaged or is out of fashion, etc., the assessee can always value such stock at market rate depending upon the extent of loss expected on sale.

31. Having regard to the above discussion, I am inclined to agree with the learned Judicial Member that the true and correct profits cannot be deduced by allowing the assessee to follow the method of valuing the closing stock it has adopted. I also agree with him that in this view of the matter, the order of the Commissioner (Appeals) requires to be set aside for the purpose of revaluing the closing stock and making a proper computation of the assessee's income for the year.

My order will now go to the Division Bench for deciding the appeal according to the majority view.

Extract from ADVANCED ACCOUNTING, Eighth edn. by Shri J.R. Batliboi (page Nos. 46 and 47) Raw Materials and Stores.-In a manufacturing concern, this item would denote purchases of raw materials and stores and will appear on the debit of the manufacturing account. Freight, carriage or cartage and dock charges, if any, on the purchase of raw materials must also be shown in the manufacturing account.

As raw materials and stores are held by a manufacturing concern not for the purpose of resale in their original condition, but to be utilised in the process of manufacture, the basis of valuation usually adopted is the cost price. The cost price for this purpose would be the net invoice price plus freight, duty, carriage inwards, etc. Under ordinary circumstances, even if the market price has fallen below cost, the value of raw materials and stores in stock need not be brought down to that level. When, however, the fall in market price is appreciably heavy so as to affect the selling price of the manufactured products, it would be desirable to value these at market price.

Work-in-progress.-In a manufacturing concern, the item 'work-in-progress' would mean goods in process of manufacture, whereas in case of a contractor the same expression would mean work partly executed but not completed. Where a separate manufacturing account is prepared work-in-progress at commencement will appear on the debit and that at the end of the financial period will appear on the credit side of the manufacturing account. Great care should be taken in valuing work-in-progress. The basis of valuation considered as sound and correct and the one that is generally followed in practice is the cost of raw materials and direct wages plus a reasonable proportion of works on-cost, i.e., manufacturing expenses.

Finished products.-The basis for the valuation of finished products should be the actual factory cost as in case of partly finished goods.

It is always sound and prudent not to add any percentage in respect of office on-cost. An important point to be borne in mind while valuing finished and partly finished products is that if the actual cost of these exceeds their market price, the market price should be the basis of valuation and not the cost price.

Where a manufacturing account is prepared quite distinct from the trading account, the opening and closing stocks of finished products will appear on the debit and credit sides of the trading account and not in the manufacturing account, as the latter account is supposed to deal with raw materials and work in process of manufacture and the trading account with finished products.

Extracts from Research Publication Series-12 by G.P. Kapadia, pages 19-20, pnragraphs 17 to 20 17. Cost is defined in relation to the different categories of stocks and work-in-progress as being that expenditure which has been incurred in the normal course of business in bringing the product or service to its present location and condition. This expenditure should include, in addition to cost of purchase (as defined in paragraph 18) such costs of conversion (as defined in paragraph 19) as are appropriate to that location and condition.

18. Cost of purchase comprises purchase price including import duties, transport and handling costs and any other direct attributable costs, less trade discounts, rebates and subsidies.

(a) costs which are specially attributable to units of production, i.e., direct labour, direct expenses and sub-contracted work ; (c) other overheads, if any, attributable in the particular circumstances of the business to bring the product or service to its present location and condition.

20. Production overheads : Overheads incurred in respect of materials, labour or services for production, based on the normal level of activity, taking one year with another. For the purpose each overhead should be classified according to function (e.g., production, selling or administration) so as to ensure the inclusion in cost of conversion of those overheads (including depreciation) which relate to production, notwithstanding that these may accrue wholly or partly on a time basis.