Income Tax Appellate Tribunal - Pune
Finolex Pipes Ltd. vs Deputy Commissioner Of Income Tax on 22 September, 1999
ORDER
B.L. Chhibber, A.M.
1. This appeal by the assessee is directed against the order of the CIT(A)-I, Pune. The assessee is a public limited company and derives income mainly from manufacture and sale of rigid P.V.C. pipes.
2. The first grievance of the assessee is that the authorities below are not justified both on facts as well as in law in taxing a sum of Rs. 5,29,700 under the caption 'difference in closing stock due to change in method'. During the year under appeal, the assessee-company changed the method of valuation of closing stock from total cost method to direct cost method. Earlier, the closing stock was being valued by taking into account the entire cost including the selling and administrative cost. For the year ended 31st March, 1989 while valuing the inventory selling and administration costs were excluded. Note No. 12 of Sch. 18 of the audit report reads as follows :
"12. The company has, "during this period, valued the closing stock of finished goods on a more scientific basis by eliminating selling and administration overheads hitherto included. As a result, the value of closing stock and consequently profit is lower by Rs. 8,51,815."
3. The AO rejected the new method and made the impugned addition of Rs. 5,29,700 observing as under :
"Change in accounting method :
The assessee during the previous year has changed its accounting method of valuing closing stock. This has resulted in profits being lower by Rs. 5,29,700. The assessee was therefore, asked why this difference should not be brought to tax. The assessee had initially replied that only Rs. 5,29,700 would be taxed but subsequently withdrew this claim. Following the Supreme Court decision in the case of CIT vs. British Paints Ltd. (1991) 188 ITR 44 (SC) to which the facts of this case squarely apply, I hold that Rs. 5,29,700 which is the reduction in the value of closing stock as a result in the change of accounting method has to be taxed."
4. On appeal, the CIT(A) confirmed the action of the AO again relying on the Supreme Court decision in the case of CIT vs. British Paints Ltd. (1991) 188 ITR 44 (SC).
5. Shri B. K. Khare, the learned counsel for the assessee submitted that direct cost method is one of the accepted accounting principle and practice sanctified by usage that while valuing inventory, especially of finished goods and work in progress, apart from direct expenses like material and labour cost only the overheads other than production overheads should be included as part of the inventory cost only to the extent that they clearly relate to putting the inventory in their present location and condition. Of course, production overheads ex facie are required to be included. In other words, what should be excluded, among other things, will be overheads in the nature of selling and administrative expenses, which has been done while valuing inventory as on 31st March, 1989 instead of valuing inventory by including every kind of over-head expenditure, including selling and administrative expenses as hitherto done before. The learned counsel emphasised that this is inline with the Institute's recommended Standard, which is known as AS-2, which, though, of course, has since been made mandatory. The learned counsel further submitted that the previous year consisted of 22 months and this change is brought about for the company's natural year ended 31st August, 1988. Same rational method was adopted for the valuation of inventory as on 31st March, 1989, and ever since the assessee has been consistently following the changed method of accounting. He further submitted that there is no need to revalue the opening stock on the same basis as closing stock as long as the system adopted as at the end of the year, namely 31st March, 1989 is recognised method and for this proposition he placed reliance on the decision of the Bombay High Court in the case of Melmould Corporation vs. CIT (1998) 202 ITR 789 (Bom). The learned counsel further submitted that the authorities below have not properly appreciated the decision given by the apex Court in the case of British Paints Ltd. (supra) and have wrongly applied the ratio to the case of the assessee. In the said case, the Supreme Court ruled that if the assessee is adopting unscientific and unrecognised system of valuing the opening and closing stock, then, both opening and closing stock should be valued on identical basis. In this case, even the earlier system, namely, valuing inventory on total cost absorption basis is a recognised system of accounting. According to the learned counsel, refining the system resorted to at the end of the year does not compel the assessee to apply refined system for valuing the opening stock. He therefore, submitted that there is no justification for the impugned addition of Rs. 5,29,700.
6. Shri Naresh Kumar, the learned Senior Departmental Representative, strongly supported the orders of the authorities below.
7. We have considered the rival submissions and perused the facts on record. The method of valuation of stock is a part of assessee's method of accounting. Thus, an assessee's method of valuation of stock would be binding on the ITO under s. 145(1) of the Act. It is well accepted that it is open to an assessee to change his method of accounting and to decide what method of accounting he/she will follow. The assessee has to establish that he has, in fact, changed his regular method of accounting and that such change is on regular or permanent basis. If the altered method is an acceptable method of accounting, it would normally follow that the profits can be properly ascertained therefrom. Hitherto, the assessee was valuing the closing stock by taking into account the entire cost including selling and administrative costs. For the year ended 31st March, 1989, while valuing the inventory selling and administration costs were excluded. In other words, the assessee-company has changed the method of valuation of closing stock from total cost to direct cost method. The new method is one of the accepted accounting principles and practices sanctified by usage and in line with Institute's recommended Standard which is known as AS-2 which has since been made mandatory.
8. In CIT vs. Carbonrandum Universal Ltd. (1984) 149 ITR 759 (Mad), the Madras High Court held that the assessee was entitled to alter its method of valuation of closing stock from absorption costing to direct costing and the difference between the valuation according to the old method and according to the new method cannot be included for assessment. Further it was held that the method of valuation adopted by the assessee had obtained recognition from practising accountants and the Commercial world for valuation of closing stock and adoption of that method could not be questioned by the Revenue authorities, unless the adoption of that method was found to be not bona fide or restricted to a particular year. Further, the following observations of the Madras High Court are important :
"Even if the change of the method has resulted in a detriment to the Revenue in the year in question, i.e. the first year of change, since the method is to be followed consistently year after year in future, this apparent detriment to the Revenue will get adjusted and disappear."
9. The same view has been upheld in Triveni Engineering Works Ltd. vs. CIT (1987) 167 ITR 742 (All). The Allahabad High Court found that :
(1) Method of valuation of closing stock has been changed on bona fide business consideration; and (2) the change has been effected before the relevant previous year; and (3) the changed method has been regularly followed on that basis and they held that the assessee was entitled to follow the changed method.
10. A similar view was taken in New Victoria Mills Co. Ltd. vs. CIT (1964) 51 ITR 395 (All) :
"Though it is open to an assessee to change his method of accounting, the change should be bona fide and the new system is continued in subsequent years."
11. In CIT vs. Mopeds India Ltd. (1988) 173 ITR 347 (AP), it has been held that where method of valuing closing stock on total cost is found unscientific and is changed to works cost, and the change is found to be bona fide and not for reducing income for income-tax purposes, the changed method was found reasonable. The Calcutta High Court in Snow White Food Products Co. Ltd. vs. CIT (1983) 141 ITR 861 (Cal), has held that the year where a change in the method of accounting is introduced for the first time it is to be examined by the Revenue authorities whether the change introduced is meant to be regularly followed or not. Where it is found that the assessee has changed his regular method of accounting by another recognised method and has followed the latter method regularly it is not open to the Revenue authorities to go into the question of bona fide of the introduction and continuation of the change.
12. From the above legal discussion, it may be noted that the Courts have gone to the extent of saying that an assessee is free to change its method of accounting provided the change is a bona fide one. It is evident from the facts of the case as discussed supra that the assessee has changed from total cost method to direct cost method (which is a scientific method of accounting and the change is bona fide one. The assessee has been following the changed method consistently till today. Accordingly, we hold that there is no justification on the part of the authorities below to reject the change of method adopted by the assessee.
13. Coming to the judgment of the Hon'ble Supreme Court in the case of British Paints Ltd. (supra) relied upon by the authorities below, we hold that the ratio does not apply to the facts of the present case because in that case, the system of accounting adopted was such which excluded, for the valuation of stock-in-trade, all costs other than the cost of raw-materials, for the goods in process and finished products, was likely to result in a distorted picture of the true state of the business for the purpose of computing the chargeable income. In the present case, the assessee has changed the method to a more scientific method and such method does not result in a distorted picture of the true state of the business for the purpose of computing the chargeable income. Accordingly, we hold that there is no justification for the impugned addition of Rs. 5,29,700. The same is accordingly deleted.
14. The next grievance of the assessee is that the learned CIT(A) is not justified in confirming the disallowance of Rs. 8,753 by applying r. 6B out of the addition of Rs. 18,753 made by the AO. During the year under appeal, the assessee-company gave gifts to various authorities and persons who were otherwise not connected with the assessee's business to maintain cordial relations. The AO applied r. 6B and made a disallowance of Rs. 18,753. Before the CIT(A) it was contended that the gifts did not contain any emblem, etc. and presentation of such articles could not be considered as advertisement. Hence the provisions of r. 6B were not applicable. The CIT(A) gave partial relief i.e. 10,000 and confirmed the addition of Rs. 8,753.
15. Shri B. K. Khare, the learned counsel for the assessee submitted that the presentation articles did not contain any emblem logo of the assessee-company and accordingly no disallowance under r. 6B was called for. The learned Departmental Representative relied upon the orders of the CIT(A).
16. We have considered the rival submissions and perused the facts on record. In our view, no addition is called for in view of the judgment of the Bombay High Court in the case of CIT vs. Allana Sons (P) Ltd. (1995) 216 ITR 690 (Bom). The addition of Rs. 8,753 is accordingly deleted.
17. Ground Nos. 3, 4 and 5 read as under :
"3. In view of the facts and circumstances of the case the lower authorities have erred both on facts as well as in law in treating a sum of Rs. 7,04,849 as assistance as revenue receipt. Company submits that the amendment being retrospective not applicable for the asst. yr. 1989-90.
4. In view of the facts and the circumstances of the case the AO has erred both on facts as well as in law in disallowing assessee company's claim of Rs. 12,69,750 out of the Revenue expenditure in connection with the increase in authorised capital of the company. Company submits that claim is allowable as revenue expenditure. Same may please be allowed. If it is ultimately decided claim is not allowable revenue expenditure, deduction may please be allowed under s. 35D of the IT Act.
5. In view of the facts and the circumstances of the case assessee-company is submits that deduction under s. 80HHC calculated on deemed exports also. Assessee-company's claim may please be allowed."
18. At the time of hearing, these grounds were not pressed.
19. Accordingly, the same are dismissed.
20. Ground No. 6 reads as under :
21. In view of the facts and the circumstances of the case the lower authorities have erred both on facts as well as in law in not allowing under s. 80-I on interest on deposits with banks, investment income that all the income is income of new industrial undertaking as such it is eligible under s. 80-I. Assessee-company prays that 80-I deduction may please be allowed on all the income from industrial undertaking including the above."
22. A claim was made for deduction of certain income, which was sought to have been derived from the industrial undertaking, as per details reproduced below :
(Rs. in lakhs) (1) Interest on deposit with banks 0.52 (2) Interest on intercorporate deposits 39.53 (3) Interest on our bills 0.13 (4) Interest on deposits 1.28 (5) Interest on advance tax 8.20 (6) Interest on investments 37.35
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87.01
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(7) Misc. income
(a) Sales-tax refund 1984-85 9.71
(b) Sales-tax refund 1985-86 1.00
(c) Sales-tax refund 5.79
(d) Lease rent received 3.06
(e) Compensation for services rendered 1.31
20.87
(8) Dividend received 59.86
(9) Profit on sale of asset 38.71
(10) Profit on sale of investments 4.36
(11) Profit on sale of units 12.65
(12) Provisions written back 18.17
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241.40
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23. According to the AO the above noted items of income emanated out of non-manufacturing activities and accordingly not eligible for consideration for deduction under s. 80-I of the Act. On appeal, the CIT(A) concurred with the findings of the AO.
24. Shri B. K. Khare, the learned counsel for the assessee submitted that the above items of income were earned during the course of business/industrial activities of the assessee-company. Without prejudice to this basic contention, in the alternative, he argued that at any rate, though such income may not be regarded as income springing from the industrial undertaking but nevertheless it should be regarded as diminution in expenditure incurred by the said industrial undertaking, especially in the matter of finance charges. The learned Departmental Representative relied upon the orders of the authorities below.
25. We have heard the rival submissions and perused the facts on record. This Bench in the case of Dy. CIT vs. Jagdish Electronics (P) Ltd. (1998) ITD 542 (Pune) has held that incomes by way of accumulation of surplus funds which have direct nexus with the industrial activity of the assessee have to be considered while computing deduction under s. 80-I of the Act. Keeping in view the ratio laid down by this Bench in the aforesaid decision, we direct as follows :
(1) Interest on deposit with banks - Rs. 0.52 lakhs This issue is restored to the file of the AO with a direction that he should verify whether the funds were used for opening letter of credit and for other allied activities pertaining to the industrial undertaking in the light of the above mentioned decision of this Bench in the case of Jagdish Electronics (P) Ltd. (supra).
(2) Interest on intercorporate deposits - Rs. 39,53 lakhs On the face of it, these deposits do not have any nexus with the industrial undertaking of the assessee-company. Accordingly, the assessee is not entitled to any relief under s. 80-I in respect of this item.
(3) Interest on bills : Rs. 0.13 lakhs This income arises out of industrial undertaking of the assessee. The AO is directed to take into consideration the amount of Rs. 0.13 lakhs while computing the relief under s. 80-I. (4) Interest on deposits : Rs. 1.28 lakhs This issue is restored to the file of the AO with a direction that he should verify whether the funds were used for opening letter of credits and for other activities pertaining to the industrial undertaking in the light of the decision of this Bench in the case of Jagdish Electronics (supra).
(5) Interest on advance tax - Rs. 8.20 lakhs This is interest on advance tax paid in excess and due from the IT Department. It has no nexus with the industrial undertaking of the company. Accordingly this amount will not qualify for deduction under s. 80-I. (6) Interest on investments - Rs. 37.35 lakhs The interest on investments is not incidental to the industrial activity of the assessee. Accordingly, the assessee will not qualify for deduction under s. 80-I in respect of this item.
(7) Misc. income Sales-tax refund 1984-85 Rs. 9.71 lakhs Sales-tax refund 1985-86 Rs. 1.00 lakh Sales-tax refund Rs. 5.79 lakhs
All these three items will qualify for deduction as per the provisions of s. 80-I of the Act, because the refunded amounts have eminated out of industrial activity of the assessee.
(8) Lease rent received - Rs. 3.06 lakhs So far as this item is concerned, it has no relation with the earning of the income from the industrial undertaking. Accordingly, it will not qualify for deduction under s. 80-I. (9) Compensation for services rendered : Rs. 1.31 lakhs The learned counsel could not clarify the nature of services rendered. Accordingly, we consider that the services rendered have no nexus with the industrial undertaking. Accordingly, we hold that the amount of Rs. 1.31 lakhs does not qualify for deduction under s. 80-I. (10) Dividend received - Rs. 59.86 lakhs (11) Profit on sale of asset - Rs. 38.71 lakhs (12) Profit on sale of investments - Rs. 4.13 lakhs (13) Profit on sale of units - Rs. 12.65 lakhs All these items do not qualify for deduction under s. 80-I of the Act as these are not related to industrial activity (14) Provisions written back - Rs. 18.17 lakhs This expenditure relates to manufacturing process and is a part of the manufacturing activity. Accordingly, an amount of Rs. 18.17 will qualify for consideration under s. 80-I. This ground accordingly succeeds in part.
Ground Nos. 7 and 8 read as under :
(7) In view of the facts and circumstances of the case the AO has erred both on facts as well as in law in charging interest under s. 234A and interest under s. 234B. The same may please be cancelled."
(8) Assessee denies its liability to interest under s. 234A and 234B and therefore same may please be cancelled.
At the time of hearing, both these grounds have not been pressed. The same are therefore, dismissed.
Ground Nos. 9 and 10 read as under :
(9) Your petitioner prays leave to add, alter, amend withdraw and/or clarify the grounds of appeal as and when the occasion demands.
(10) Your petitioner prays leave to adduce such further evidence to substantiate his case as and when the occasion demands."
26. Obviously both these grounds are general in nature and call for no comments.
27. In the result, the appeal is partly allowed.