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PETITIONER: COMMISSIONER OF INCOME TAX, CALCUTTA

       Vs.

RESPONDENT: BRITISH PAINTS INDIA LTD.

DATE OF JUDGMENT13/12/1990

BENCH: THOMMEN, T.K. (J) BENCH: THOMMEN, T.K. (J) PUNCHHI, M.M.

CITATION:  1991 AIR 1338            1990 SCR  Supl. (3) 525  1992 SCC  Supl.  (1)  55 JT 1990 (4)   694  1990 SCALE  (2)1261

ACT:     Income   Tax   Act  1961:  Section   145--Valuation   of stock--Principle    to   be   followed--Cost    or    market value--Whichever  is lower-Assessing officer--Whether  enti- tled to add over head charges.     Method  of accounting--Consistent practice--To  disclose true picture of profits and gains--Assessing  Officer--Enti- tled  to  and has duty to adopt appropriate  computation  to determine true income.

HEADNOTE:     The  respondent-assessee  a  limited  liability  company engaged  in the business of manufacture and sale of  paints, had a consistent practice to value its goods in process  and finished  products exclusively at cost of raw materials  and totally  excluding overhead expenditure.  The  justification for this practice, the assessee contended was that the goods being  paints  had limited storage life and if  not  quickly disposed of were liable to lose their market value.     The Income Tax Officer rejected the aforesaid contention of  the assessee observing that at no time had the  assessee claimed any deduction on account of deterioration or  damage to goods and that there was no justification to recognise  a practice  as  claimed by the assessee of valuing  its  stock otherwise that in accordance with the well recognised  prin- ciple of accounting which require the stock to be valued  at either cost (raw material plus expenditure) or market  value whichever was lower. Recalculating the value of the  opening and  closing stocks by adding the overhead expenditure,  the Income-tax  Officer made an addition of Rs.1,04,417 for  the assessment year 1963-64, and allowed a deduction of  Rs.3338 for the assessment year 1964-65. These orders were confirmed by the Appellate Assistant Commissioner.     On  appeal, the Income Tax Appellate Tribunal held  that there was no evidence to show that the goods in stock  dete- riorated  in value and that there was no  justification  for excluding the overhead expenditure in valuing the stock; and if  it  was in the interest of the business to  value  stock solely  with reference to cost of raw materials and  without including  the overhead expenditure, such valuation was  not appro-

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526 priate  to  the computation of income chargeable  under  the Income Tax Act.     The  High Court, in a reference at the instance  of  the Revenue  noticed that though there was no evidence of  dete- rioration of the goods in stock, came to the conclusion that having  regard to the consistent practice of  the  assessee, the  Tribunal was not justified in rejecting the  assessee’s method  of valuation of its stock-in-trade.  It  accordingly reversed the Tribunals decision.     In  the  appeals by the Revenue to this  Court,  it  was contended  on  behalf of the assessee that for a  number  of years the Revenue did not question the method of  accounting regularly  employed by the assessee, that it was during  the assessment  years in question that the objection was  raised for  the first time on the ground that overhead  expenditure was not included in the value of the stock, that the Assess- ing  Officer  had exceeded his jurisdiction  by  adding  the overhead expenditure to the cost of raw material, especially because  of the short durability of paint and that  the  As- sessing Officer has not appreciated that the method  adopted by  the assessee is a well recognised method among  account- ants of repute.     Allowing the appeals and setting aside, the judgment  of the High Court, this Court,     HELD: 1. The Income Tax Act does not contain any specif- ic provision for the valuation of stock, Income, profits and gains  must, however, be computed in the manner provided  by the  Act.  It is the duty of the Officer  to  determine  the profits and gains of a commercial adventure according to the correct  principle  of accounting. In doing  so,  he  might, dependent  on  the nature of the business  and  its  special character,  allow certain adjustments, but his primary  pur- pose  and duty is to deduce the correct income, profits  and gains, and this he cannot do without taking into account the value of the stock-in-trade at the beginning and at the  end of the year and by ascertaining the difference between them. [537G-538B]     P.M. Mohammed Meerakhan  v. Commissioner of  Income-Tax, Kerala, [1969] 73 I.T.R. SC 735, referred to.     2. The object of stock valuation is the correct determi- nation  of  the  profits and loss resulting  from  a  year’s trading. [538B] 527     Whimster  &  Co.  v. Commissioners of  Inland  Revenue,, [1926] 12 Tax Cases 813, 827; Chainrup Sampatram  v. Commis- sioner of IncomeTax, West Bengal, [1953] 24 I.T.R.  481,485- 486; Patrick (Inspector of Taxes)  v. Broadstone Mills Ltd., [1954]  25 I.T.R. 377, 395; Russell  v. Town & County  Bank, [1888]  13  App. Cas. 418, 424; 4 TLR. 500 and  Minister  of National  Revenue  v. Anaconda American Brass  Ltd.,  [1956] A.C. 85; (1956) I.T.R. 84, 99, referred to.     3.  Section  145  of the Income Tax  Act,  1961  confers sufficient power upon the officer-nay it imposes a duty upon him-to make such computation in such manner as he determines for deducing the correct profits and gains. This means  that where accounts are prepared without disclosing the real cost of the stock-in-trade, albeit on sound expert advise in  the interest  of efficient administration of the company, it  is the duty of the Income Tax Officer to determine the  taxable income by making such computation as he thinks fit. [539E]     4. Even if the assessee had adopted a regular system  of accounting,  it was the duty of the Assessing Officer  under section 145 of the Income Tax Act 1861, to consider  whether the  correct  profits and gains could be  deduced  from  the

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accounts  so maintained. If he was of the opinion  that  the correct  profits could not be deduced from the accounts,  he was  obliged to have recourse of the proviso to section  145 of the Income Tax Act 1961. [536C, G]     Commissioner of Income-Tax, Bombay  v. Sarangpur  Cotton Manufacturing  Co.  Ltd., [1938] 6 ITR 36;  Commissioner  of IncomeTax,  Madras   v.  A. Krishnaswami  Mudaliar  &  Ors., [1964]  53 I.T.R. 122, 128 and 132; Commissioner of  Income- Tax v. Mc-Milan & Co., [1958] 33 I.T.R. 182; S.N.  Namasiva- yam  Chettiar v. Commissioner of Income-tax, Madras,  [1960] 38  I.T.R. 579, 588 and Commissioners of Inland  Revenue  v. Cock,  Russell and Co. Ltd., [1949] 29 Tax Cases  387,  392, referred to.     5.  Any  system of accounting which  excludes,  for  the valuation  of the stock-in-trade, all costs other  than  the cost  of raw material for the goods in process and  finished products, is likely to result in a distorted picture of  the true state of the business for the purpose of computing  the chargeable income. Such a system may produce a comparatively lower valuation of the opening stock and the closing  stock, thus showing a comparatively low difference between the two. In a period of rising turnover and rising prices, the system adopted by the assessee, as found by the Tribunal, is apt to diminish the assessment of the taxable profit 528 of  a year. The profit of one year is ’likely to be  shifted to  another year which is an incorrect method  of  computing profits and gains for the purpose of assessment. [539F-G]     6.  Each year being a self-contained unit, and the taxes of  a  particular year being payable with reference  to  the income  of that year, as computed in terms of the  Act,  the method  adopted  by the assessee has been found to  be  such that the income cannot properly be deduced therefrom. It is, therefore, not only the right but the duty of the  Assessing Officer  to  act  in exercise of his  statutory  power,  for determining  what,  in his opinion, is the  correct  taxable income. [539H-540A]     7. The question to be determined by the Assessing  Offi- cer in exercise of his power under section 145 is whether or not  income can properly be deduced from the accounts  main- tained by the assessee, even if the accounts are correct and complete  to the satisfaction of the Officer and the  income has  been computed in accordance with the  method  regularly employed  by the assessee. What is to be determined  by  the Officer  is  a question of fact i.e. whether or  not  income chargeable  under the Act can properly be deduced  from  the books  of  account,  and he must decide  the  question  with reference  to the relevant material and in  accordance  with the correct principles. [531D-F]     8.  It  is  a well recognised  principle  of  commercial accounting to enter in the profit and loss account the value of the stock-in-trade at the beginning and at the end of the accounting  year at cost or market price, whichever  is  the lower. [533G-H]     Whimster  & Co. v. The Commissioners of Inland  Revenue, [191726] 12 Tax Cases, 813,823 referred to.     (9) Where the market value has fallen before the date of valuation  and at that date the market value of the  article is  less than its actual cost, the assessee is  entitled  to value  the articles at market value and thus anticipate  the loss which he will probably incur at the time of the sale of goods.  Valuation  of the stock-in-trade at cost  or  market value,  whichever is the lower, is a matter entirely  within the  discretion  of the assessee, but  whichever  method  he adopts, it should disclose a true picture of his profits and

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gains. If, on the other hand, he adopts a system which  does not disclose the true state of affairs for the determination of  tax, even if it is ideally suited for other purposes  of his business, such as the creation of a reserve, declaration of  dividends, planning and the like, it is the duty of  the Assessing Officer to adopt any 529 such computation as he deems appropriate for proper determi- nation of the true income of the assessee. [534E-F]     This  is not only a right, but a duty that is placed  on the  Officer, in terms of the first proviso to  section  145 which concerns a correct and complete account, but which  in the  opinion  of the Officer does not disclose  a  true  and proper income. [534G]     B.S.C. Footwear v. Ridgway (Inspector of Taxes),  [1971] 2 W .L.R. 1313, referred to.     (10)  It  is  not only the right, but the  duty  of  the Assessing  Officer  to  consider whether or  not  the  books disclose  the true state of accounts and the correct  income can  be deducted therefrom. It is incorrect to say, as  con- tended on behalf of the assessee, that the Officer is  bound to accept the system of accounting regularly employed by the assessee the correctness of which had not been questioned in the  past.  There is no estoppel in these matters,  and  the Officer  is not bound by the method followed in the  earlier years. [535G]     (11)  What  is the profit of a trade or  business  is  a question  of fact and it must be ascertained, as  all  facts must  be  ascertained, with reference to the  relevant  evi- dence, and not on doctrine or theories. [539C]

JUDGMENT: