Income Tax Appellate Tribunal - Hyderabad
Kurisetti Satyanarayanamurthy vs Income-Tax Officer on 27 September, 1987
Equivalent citations: [1988]25ITD18(HYD)
ORDER
K.S. Viswanathan, Accountant Member
1. The main issue in this appeal by the assessee is the valuation of closing stock. The assesses, a registered firm, is running a rice mill. The accounts are closed on 31st October, 1983. The stock of paddy was 4,465 quintals and these were valued at Rs. 157.50 per quintal. In other words, the closing stock value of paddy was Rs. 7,03,276. The Income-tax Officer found from the registers of the assessee that for the last month of the accounting year, the assessee had purchased 6,789 quintals of paddy for Rs. 14,76,345. This indicated the ruling price of the paddy in the last month to be Rs. 217.46. Since the closing stock was valued at less than the last purchase, the Income-tax Officer proposed to increase in valuation of closing stock by Rs. 2,67,682.
2. The assessee stated that they were following the average cost method for all these years and therefore no addition need be made. This submission was rejected by the Income-tax Officer. According to him, the closing stock has to be valued at cost or market rate. There was no authority for valuing at average cost price. He, therefore, made an addition of the difference in the valuation.
3. In a similar manner, he revalued the closing stock of broken rice. On the last day of the accounting year, there was 1,770 quintals which was valued at Rs. 3,71,700. The Income-tax Officer found that broken rice had been sold at an average rate of Rs, 256.12 per quintal. As against this price, the assessee had valued at Rs. 210. On this account also, he had suggested an enhancement in the valuation. On further enquiry regarding the rate at which broken rice was sold immediately after the close of the year, he found that the average rate was Rs. 245. He applied this rate and made an addition of Rs. 62,014.
4. Against these two additions, the assessee appealed. The Commissioner (Appeals) also held that the closing stock should be valued either at cost or at market price whichever is lower. The average purchase price which is the average cost price is not according to the Commissioner an approved or recognised method. He, therefore, upheld the addition in regard to the valuation of closing stock. However, with regard to the broken rice, he accepted that the average sale price should have been Us. 243.05 as against Rs. 245.05 fixed by the Income-tax Officer. On that ground he allowed certain reliefs.
5. The assessee is on appeal before us. Shri Ratnakar appearing for the assessee submitted that the Commissioner (Appeals) is in error in holding that cost or market price is the only method of valuation of closing stock. He submitted that accountancy principles recognise other methods also like First-in-First-Out, Last-in-First-Out, weighted average, simple average, standard costing, etc. He submitted that the assessee had been following the same method of valuation for all the earlier years and the subsequent years. What the assessee has done is to take the purchase price of the whole year and divided the same with. the purchases made in that year and arrive at an average rate. Thus, in the asst. year 1981-82, the average price rate was Rs. 115.04, for the year 1982-83, it was Rs. 145.81 for the year 1983-84, it was Rs. 148.67 and for the year under appeal it was Rs. 157.53. It is true he submitted that the average purchase price will be different from the ruling rate in the last month. But, this also is to be taken into account while working out the average rate. Sometimes, the average rate would be more than the last month's purchase rate. This happened he pointed out in the year 1982-83 when the last month's purchase was at Rs. 143.50 per quintal whereas the average purchase price was Rs. 145.81. Nevertheless, he submitted that the assessee was valuing the stock on the average purchase price.
6. In support of his submissions, he relied on the decision of the Bombay High Court in the case of CIT v. Tata Iron & Steel Co. Ltd. [1977] 106 ITR 363 and the decision of the Madras High Court in the case of CIT v. K. Sankarapandia Asari & Sons [1981] 130 ITR 541. With regard to the valuation of broken rice, he submitted that the yearly average selling price has to be taken into account.
7. Shri Kailasnath for the department submitted that the valuation of stock on average purchase price is not scientific when the stock purchased is easily ascertalnable. He pointed out that the closing stock was only 4,465 quintals and the last purchase was 6,789 quintals. Therefore, the closing stock necessarily must be from the last purchase. The purchase price of this stock is easily ascertainable and therefore on these circumstances, the average purchase price is not a scientific method. Average purchase price can be adopted according to him only when several items of purchase and it is difficult to pin-point the stock with reference to any of the purchase price. He then referred to the decision of Andhra Pradesh High Court in the case of CIT v. Margadarsi Chit Funds (P.) Ltd. [1985] 155 ITR 442. Especially the observations at page 446 :
It must be said at the outset that the choice to account for income on an acceptable basis is that of the assessee and not of the department. This is, however, not an unlimited choice, because the Income-tax Officer has always the liberty to examine the system of accounting regularly employed by the assessee, to determine whether the system of accounting is defective and whether by following such system of accounting, correct profits can be deduced from the account books maintained by the assessee.
8. We have.considered the submissions. We agree with Sri Ratna-kar that there are several other methods of valuing closing stock other than the cost or market rate. A number of systems of valuation based upon commonsense keeping in view the ultimate object that the true and correct profit of the year are reflected have been recognised as proper methods for valuation of the closing stock. These are : cost price method, (2) market price method/net selling value method, (3) cost or market price whichever is lower, (4) first in first out method, (5) last in first out method and (6) direct cost and on cost method, These are discussed in the 3rd Member's decision in the case of Raymond Woollen Mills Ltd. v. ITO [1986] 18 ITD 64 (Bom.) at page 104. Among the cost price methods, there are several variations like ordinary cost, average cost and weighted average cost. The assessee is actually following the weighted average cost method insofar as he is taking into account the entire purchases made for that year with the entire purchase price. Such a method is a recognised method in milling and manufacturing accounts and this is supported by the decision of the Trav. - Coch. High Court in the case of Concordia Corporation Ltd. v. CIT [1952] 22 ITR 344. The Head-notes of this case read as follows :
The assessee-company was carrying on the business of purchasing raw cashew nuts and, after subjecting the stuff to certain processes, selling the kernels by export to America. The year of account was the first year of the company's existence. In valuing the closing stock of the raw nuts the company adopted the average cost price per bag calculated on all the purchases made by it throughout the year. The Income-tax authorities however contended that as the actual price of the closing stock was known or could be easily ascertained from the records in the assessee's possession, the stock must be valued at the actual cost price and not at the average price for the year :
Held, that the stock might be valued at the option of the assessee at the average cost price of the entire stock purchased in the course of the year and need not be at the actual cost of the closing stock and that the method Of valuation of the stock adopted by the assessee was correct.
The liberty reserved to the assessee to choose his method of accounting by Section 17 of the Travancore Income-tax Act (corresponding to Section 13 of the Indian Income-tax Act, 1922) is not confined to adopting the mercantile or the cash basis but extends to adopting a method of valuation of the stock according to cost or market price whichever is lower for purposes of ascertaining the profits of the business. The Section only enjoins upon the assessee the obligation of employing the method chosen, regularly after the choice. The right of the department to interfere with the assesee's method of account arises under the proviso only if no method of accounting has been regularly employed or if the method employed is such that in the opinion of the Income-tax Officer, the income, profits and gains cannot be properly deduced therefrom.
Thus, it will be seen that there is a direct authority for the method used by the assesses in valuing the closing stock. The criticism of Shri Kailasnath on this method has also been answered by the Kerala High Court. Shri Kailasnath had submitted that when the closing stock is easily identified with a last purchase, this method is not scientific. In that case, the assessee was manufacturing and selling cashew nuts. Raw cashew is purchased and kernel is extracted from them. Just as in this case paddy is milled into rice. At page 355 it is observed :
Suppose for instance raw cashew nuts are purchased every day and stored in a room of sufficient capacity and such of it as is required for the purpose of processing is taken out on occasions, how can it be ascertained which is the nut that is being taken out ? You cannot distinguish the nuts. Suppose there have been issues out of the stock for processing every day of the year of account, it will be impossible to attribute the issues to this or that purchase. In valuing the closing stock in such a case the only appropriate and available method would be to value it at the average cost taking into account all the - purchases made during the period. The same is the case with reference to a stock, say for instance, of fuel, wood, coal oil all of which would be stored in one lump or lot and issues thereout can be and would be made without regard to the date or the price; of each purchase. It is unnecessary to multiply instances. It is sufficient to say that the point appears to be so obvious that a doubt was first entertained as to whether the point stressed by the department was at all properly understood.
The same would apply here. No doubt, the closing stock is less than the last purchase. But, there is no guarantee that the last purchase is the only quantity in the stock. The purchases of paddy and the issues for milling are simultaneous process arid it will not be correct to assume that the next purchase of paddy will be made only after the earlier stock has been completely exhausted. Under these circumstances, we are of opinion that the method followed by the assessee must be accepted. Shri Ratnakar had pointed out that there are instances where the average purchase price is higher than the last purchase price. Even then the same method has been consistently followed. We, therefore, hold no disturbance in the closing stock of purchase of paddy and the production of broken rice is required. The additions are deleted. Shri Kailasnath had referred to the decision of Andhra Pradesh High Court in the case of Margadarsi Chit Funds (P.) Ltd. (supra). The observations of the High Court are general in nature and it has not been stated anywhere that the average purchase price is not proper method for valuation of closing stock.
9. The next ground is an allowance of Rs. 10,000. One B. Madhu-sudhana Rao was working in this firm for several years. He travels quite a lot in connection with assessee's business. He was paid salary of Rs. 250 a month. Mr. Madhusudhana Rao periodically drawing advances for meeting his travelling expenses and such advances at the beginning of the year was Rs. 10,484. It appears that Mr. Rao was asking for substantial increase in his salary but that was allowed at the end of the year. It was also agreed that the amount overdrawn to the extent of Rs. 10,000 would not be collected from him. It would appear that at the time he wanted to perform his daughter's marriage and had required some advance payments. It is on this account that Rs. 10,000 was written off.
10. The Income-tax Officer was of opinion that the write off was unconnected with business consideration and it was only like a gift. So it was not allowable. The Commissioner agreed with it.
11. In our opinion, on the facts stated the amount should be allowed as a deduction. It is not in dispute that Shri Madhusudhana Rao was a long standing employee and he was being allowed a salary of Rs. 250 only till the prior accounting year. It is certainly inadequate. It was in connection with the assessee's business that he had to travel the advances taken by him were shown as debits against him. On the occasion of the marriage of the daughter of the employee, it is customary to the Indian businessmen to make some presents and these presentations are to keep cordial relationship between the employer and the staff. It was in this connection that the amount was written off. We, therefore, feel that the assessee is entitled to this deduction.
12. The last ground relates to the depreciation on the diesel engine fitted to the motor car. The department had not allowed depreciation because the assessee has not proved the purchase of the diesel engine. No bills were placed before the Income-tax Officer. Thus, the fact of installation of diesel engine itself has not been proved by the assessee. Under these circumstances, we think that the Income-tax Officer and the Commissioner were justified in holding that the assessee is not entitled to the deduction.
13. In the result, the appeal is partly allowed.