Income Tax Appellate Tribunal - Madras
Durametaliic (India) Ltd. vs Inspecting Assistant Commissioner on 22 March, 1991
Equivalent citations: [1991]38ITD211(MAD)
ORDER
G.E. Veerabhadrappa, Accountant Member
1. [This para is not reproduced here as it involves minor issues.]
2. The assessee is a company engaged in the production of mechanical seals. The previous year relevant to the assessment year under consideration is the year ending 30-6-1983.
3. The first ground in the assessee's appeal relates to the valuation of closing stock of imported raw material. The assessee disputes the inclusion of the customs duty of Rs. 24,72,651. The assessee uses a number of imported materials in the manufacture of final products. The customs duty paid on imported raw material is charged to the profit and loss account only to the extent attributable to the materials consumed. During the previous year relevant to the assessment year 1984-85, the assessee paid a sum of Rs. 53,12,994 towards customs duty in respect of imported raw material and components. The whole of such imported raw material was not consumed during the previous year. A part of the imports remained unutilised as at the end of the accounting year. The customs duty paid in respect of such imported raw materials which were remaining in stock as at the close of the accounting year was Rs. 24,72,651. The assessee for the purpose of audited accounts took the cost of such closing stock at Rs. 92,61,206 which included the customs duty component of Rs. 24,72,651. The assessec's contention before the IAC (Asst.) was that this customs duty component represents the customs duty paid and in view of the special provisions of Section 43B, the amount of Rs. 24,72,651 should be allowed as a deduction in computing the total income for the year. The Inspecting Asstt. Commissioner (Asst.) did not accept this contention and did not allow the assessee's claim for amending the method of valuing the closing stock of imported raw materials. The Commissioner (Appeals) confrmed the said action of the IAC (Asst.)
4. In the further appeal before us, the learned counsel for the assessee heavily relied on the decision of the Gujarat High Court in the case of Lakhanpal National Ltd. v. ITO [1986] 162 ITR 240. He submitted that the introdution of Section 43B into the Act disregards the established accounting principle for claiming deduction of taxes. The said section indirectly affects the valuation of the closing stock of raw materials where there is involvement of pre-paid taxes such as customs duty. The expenditure which was paid goes as a debit to the raw materials account and does not itself result in the deduction under Section 43B. The effect of valuing the closing stock by including the component of customs duty so paid, ultimately results in a disallowance of such customs duty though paid which is not in accordance with the provisions of Section 43B. Therefore, it was vehemently argued that the customs duty paid by the assessee should be allowed as a deduction by means of an adjustment in the valuation of the closing stock of raw materials. He has tried to demonstrate the effect of Section 43B on the method of valuation of the closing stock in the computation of the assessce's total income and pleaded that taxes paid in respect of the raw material in stock should be allowed as a deduction under Section 43B on payment basis.
5. The Departmental Representative, on the other hand, relied on the decision of the Tribunal in Raymond Woollen Mills Ltd. v. ITO [1986] 18 ITD 64 (Bom.) (TM). He also further relied on the latest decision of the Supreme Court in CIT v. British Paints India Ltd. [1991] 188 ITR 44 in support of his contention. He vehemently argued that the provisions of Section 43B are not the provisions made by the Income-tax Act to alter the established principle of valuation of the closing stock. They are only intended to disallow the claim for deduction of taxes which remained unpaid. The provisions of Section 43B, according to the contentions of the Revenue, are not relevant for the purpose of valuing the closing slock. In the operation of the accounting system, the customs duty paid gets a deduction. The method of accounting alone cannot change the results disclosed. In the Supreme Court decision cited above, it has been held that the method of accounting should be consistently followed and should be capable of disclosing true profits and gains. If the system adopted by the assessee docs not disclose true and proper income, the assessing officer is entitled to and has the duty to adopt appropriate computation to determine the true income. It has been made abundantly clear by the authoritative pronouncement of the Supreme Court that Section 145 confers not only a power on the assessing officer, but imposes a duty upon him, to make such computation for the purpose of deducing the correct profits and gains. This means that where accounts are prepared without properly valuing the stock-in-trade, it becomes the duty of the assessing officer to determine the income after making adjustments for the deficiency in the method of valuing the closing stock. The learned Departmental Representative further heavily relied on the order of the CIT(Appeals) in support of his contentions. He submitted that the decision of the Gujarat High Court in the case of Lakhanpal National Ltd. (supra) is not applicable to the facts of the case.
6. We have carefully considered the rival contentions and perused the records. Section 43B does not govern the valuation of closing stock and deals only with the disallowance of claim for deduction under Section 43B where taxes remained unpaid. The established method of claiming deduction in the mercantile system of accounting based on the provision made in the accounts has all been disturbed by the provisions of Section 43B and the case of Lakhanpal National Ltd. cited above was more concerned with the provisions of Section 43B. The assessee has been consistently valuing the closing stock by including the customs duty for the purpose of valuing the same. The opening stock for the year in fact contains the element of customs duty so paid and any other method which excludes the component of customs duty in the valuation of the closing stock of raw material will only result in an arbitrary and distorted valuation of the closing stock. This is against the established principles of accounting of closing stock. It is pertinent to note the following observations of the Supreme Court in relation to the valuation of the closing stock, at pages 51 to 53 of the British Paints India Ltd.'s case (supra):
In the present case, what the assessee contends for is neither the 'direct cost' method nor any other method which takes into account the actual or even part of the cost involved in the manufacture of the goods-in-process and finished products. What it contends for is valuation of the raw material without taking into account any portion of the cost of manufacture. No decision has been brought to our notice in support of such a contention. The question of fact which the Assessing Officer must necessarily decide is whether or not the method of accounting followed by the assessee discloses the true income.
It is 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. As stated by the Lord President in Whimster and Co. v. CIR [1925] 12 TC 813, 823 (C. Sess.):
... In computing the balance of profits and gains for the purposes of income-tax ... two general and fundamental common places have always to be kept in mind. In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as possible and in conformity with the rules of the Income-tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profits and loss account of a merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower, although there is nothing about this in the taxing statutes....
Where the market value has fallen before the date of valuation and, on 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 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 such computation as he deems appropriate for the proper determination of the true income of the assessee. 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 the true and proper income.
The correct principle of accounting is to enter the stock in the books of account at cost unless the value is required to be reduced by reason of the fall in the market value of those goods below their original cost. Ordinarily, therefore, the goods should not be written down below the cost price except where there is an actual or anticipated loss. On the other hand, if the fall in the price is only such as it would reduce merely the prospective profit, there would be no justification to discard the initial valuation at cost. ln B.S.C. Footwear Ltd. v. Ridgway (Inspector of Taxes) [1972] 83 ITR 269, 294; [1971] 2 WLR 1313, 1332 (HL), Lord Pearson, criticising the system adopted in the valuation of a retailer's stock observed:
Then is the incorrectness of the stock valuation such as to be likely to distort the assessment of the profits and gains for the year? The system produces a comparatively low valuation of the opening stock at the beginning of the year and a comparatively low valuation of the closing stock at the end of the year and therefore a comparatively low difference between them... Then in a period of rising turnover and rising prices the difference is an element of profit and by keeping down that difference the system diminishes the assessment of taxable profit for the year.
Over a series of years there is a continuing deferment of tax liability. In my opinion, therefore, the system does produce some distortion of the assessment of taxable profits for any particular year.
In that case, the House of Lords accepted the contention of the Inland Revenue that, although the assessee's system of stock valuation has been accepted for tax purposes for many years up to 1959, it was liable to be rejected for the relevant and subsequent years as the system adopted by the assessee was likely to produce stock valuations which were seriously and substantially incorrect, thereby causing distortion of the assessment of the profits and gains for the year.
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 deduced therefrom. It is incorrect to say, as contended 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.
and again the following observations at page 56 are relevant:-
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 advice 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.
Any system of accounting which excludes, for the valuation of the stock-in-trade, all costs other than the cost of raw materials 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 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. 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 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, as he has done in the instant case, for determining what, in his opinion, is the correct taxable income.
In view of the above position of law as enunciated by the Supreme Court, which we respectfully follow, we are only to hold that the assessee having valued the opening stock by including the customs duty, cannot value the closing stock by excluding the same. We cannot accept the arbitrary method of valuation of the closing stock which is very much relevant in the determination of the profits and gains of the business or profession. In the result, we uphold the order of the CIT(A) in relation to this issue.
7 to 18. [These paras are not reproduced here as they involve minor issues.]
19. The next ground in the Revenue's appeal relates to the disallowance of Rs. 2,77,740 being interest paid on monies borrowed. The assessee had claimed deduction of a sum of Rs. 6,21,228 as interest. The IAC (Asst.) noticed that the assessee had advanced Rs. 25 lakhs to its subsidiary company, Corporate Investments Ltd. The amounts were paid on two dates - Rs. 15 lakhs on 10-10-1982 and Rs. 10 lakhs on 30-11-1982 through cheques on Hongkong Bank where the assessee had overdraft facilities. The IAC (Asst.) held that to this extent of borrowing the funds are diverted for advancing to the subsidiary company. On a proportionate basis, interest of Rs. 2,77,740 on a sum equal to the sum advanced to the subsidiary company was disallowed. The contention of the assessee that such transfer of funds was made for business purposes for purchase of shares was not accepted by the IAC(Asst.). The Commissioner (Appeals) found that the subsidiary company is wholly owned by the assessee and the Commissioner (A) found that the assessee could have paid the entire sum of Rs. 25 lakhs to its subsidiary with the accumulated profits of Rs. 114.53 lakhs and depreciation of Rs. 8.74 lakhs, even after meeting other outgoings and capital expenditure. Following the decision of the Calcutta High Court in Woolcombers of India Ltd. v. CIT [1982] 134 ITR219, the CIT(A)allowed the assessee's claim. It was noticed by the CIT (A) that the assessee was operating a combined account with the Hongkong Bank and all business transactions are carried through that account. All the credits by way of receipts in the business were also credited in that account. Profits of the business are embedded in the said account. Even when advances are considered as payments made on 10-10-1982 and 30-11-1982, the profits embedded in the transactions up to that date would be sufficient to make the payment of Rs. 25 lakhs to the subsidiary company. In coming to this conclusion, the CIT(A) also considered a fund-flow statement produced by the assessee and went on the presumption that where the overdraft account comprised of the revenue receipt and also advances, the sum of Rs. 25 lakhs will be deemed to have been advanced from the profits credited into the overdraft account. The CIT(A) deleted the entire addition of Rs. 2,77,740 holding that the advance of Rs. 25 lakhs came to be financed by the accumulated profits which were more than 25 lakhs and which were embedded in the current assets including the overdraft account of the assessee.
20. The Departmental Representative vehemently argued that the disallowance has been wrongly deleted by the CIT(A) for a reason not considered by the IAC (Asst.). The disallowance is very much justified in view of the nexus between the overdraft account and the drawings made by the assessee for the purpose of diverting the funds to the subsidiary company. For such proposition, he relied on the decision of the Karnataka High Court in the case of CIT v. United Breweries [1973] 89 ITR 17 (Mys.)
21. The assessee's representative, on the other hand, submitted that the words "for the purpose of the business" used in Section 36(1)(iii) should receive a wider consideration and includes the business activities of the 100% subsidiary also. According to the Memorandum of Association of the assessee-company, it has one of its objects the following :-
To promote any company or companies for the purpose of acquiring all or any of the property, rights and liabilities of this Company and also to take or otherwise acquire or hold shares in any other company.
Viewed from the Articles of Memorandum of Association, the assessee's business extends to the activities of promoting and maintaining the activities of the subsidiary company. So, the entire amount of Rs. 25 lakhs represents the use of borrowed funds for the purpose of the assessee's business, which inter alia includes the maintenance and sustenance of its 100% subsidiary. The business purpose has, therefore, prompted the assessee-company to divert its own funds in favour of its 100% subsidiary. In fact, the profits and gains of the subsidiary are ultimately the profits and gains of the assessee-company. The assessee's representative, therefore, submitted that factually and functionally the control of the subsidiary having vested with the assessee-company, the disallowance under Section 36(1)(iii) is not justified and the CIT(A) has rightly deleted the same. Alternatively, he submitted, relying on the fund-flow statement, that the assessee-company had profits of Rs. 114.53 lakhs which is sufficient to finance the diversion of funds to the extent of Rs. 25 lakhs. The overdraft account is embedded with all the revenue receipts of the assessee. So, the earlier revenue receipts should be taken to have sufficed to finance the diversion of funds in favour of 100% subsidiary. The assessee's representative further vehemently argued that the Department has not proved any non-business purpose in which the diverted funds have come to be used. The disallowance under Section 36(1)(iii), according to him, is therefore, not justified in the facts and circumstances of the case. He relied on the decisions in CIT v. Bombay Samachar Ltd. [1969] 74 ITR 723, Madhav Prasad Jatia v. CIT [1979] 118 ITR 200 (SC), Woolcombers of India Ltd. v. CIT [1982] 134 ITR 219 in support of his contentions.
22. We have carefully perused the records and considered the rival submissions. The Department in this case had established the nexus between the borrowing of funds and the diversion of funds. Admittedly, the assessee had given a sum of Rs. 25 lakhs to its 100% subsidiary for the purpose of the assessee's own business which includes the business of sustaining and maintaining the subsidiary company's activities. After all, the activities of the assessee should comprehend within itself the activities of managing its branches and subsidiaries. Formation of subsidiary companies is a commercial concept and does not in any way affect the reality of the situation that the profits and losses of the subsidiary ultimately is the profits and losses of the holding company. Even taken from this view, to call there is a diversion of funds for non-business purpose by the assessee itself is misapplication of law to the facts especially when the parent company has capital and functional control over its 100% subsidiary. The words "for the purpose of the business" in Section 36(1)(iii), in pur view, should be widely construed. The alternative submission of the assessee is that it had Rs. 114.53 lakhs as profits embedded in the current accounts including the overdraft account. The assessee has been crediting all the sale proceeds in its overdraft account and the assessee was having overdraft limits. These are the facts and in view of the mixture of funds in the overdraft account, the assessee's contention that to the extent of Rs. 25 lakhs the assessee should be deemed to have drawn from the sale proceeds credited into the overdraft account seems to be reasonable and the fund-flow statement relied upon by the assessee and thoroughly discussed in the order of the CIT (A) clearly demonstrates how in this situation an amount of Rs. 25 lakhs though apparently drawn from the overdraft account is financed through the revenue receipts embedded in the overdraft account. In these circumstances, we hold that the CIT(A) has rightly approached the matter from the businessman's point of view. The disallowance, therefore, in our view, is rightly deleted in the facts and circumstances of the case. In the result, we do not find any reason to interfere with the finding of the CIT(A). We uphold his order on this point.
23. [This para is not reproduced here as it involves minor issues.]