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The Division Bench of the High Court by its judgment dated 11.12.2002 allowed both the appeals and held that the method of valuation of closing stock adopted by the assessee was not correct and that the entire device was to inflate deduction under Section 80 HHC and to suppress the profits in the Second Year because the correct taxable income could never be computed on the basis of the system of relief provided under Section 80 HHC and that under the different assessment year constituting separate unit and the principle of 'lower of the cost or market value' had been fully satisfying the mandatory touchstone of "no escapement of tax" rule. Against this order of the High Court, the assessee has came before this Court. Shri B.V. Desai, learned counsel for the appellant has urged that in the facts and circumstances of the case where in the First Year, the valuation of the stock increased pre- dominantly because of the market factor and also the sudden spurt and increase in the exchange rate of U.S. $, it could not have been said that the appellant has adopted a method of accounting to defraud the Revenue particularly so when the accounting method chosen by the assessee is not for a particular year and is being adopted consistently from the year 1985-86. It is further urged that it is a well-settled principle of income- tax law that the assessee is free to adopt any system of accounting and the valuation chosen at the market rate has been a well settled principle of accounting and therefore simply because the assessee has claimed benefit under Section 80 HHC, in a particular year the method of accounting could not have been found fault with. It was further urged that the provisions of Section 145 (1) of the Act are not attracted as the assessee had adopted the valuation of the finished goods on market price and consistently followed the same. The contention of the counsel proceeded on the exercise of jurisdiction and he urged that the power under Section 145 of the Act could only be exercised if there is material to prove that the method in question is such that in the opinion of the Assessing Officer, the income cannot be properly deducted. The sine qua non for enforcing the provisions of Section 145 of the Act is that the Assessing Officer should be of the opinion that from the method of accounting the income cannot be properly deducted and this opinion should be based on sound and reasonable footing. On the other hand, Shri Rajiv Dutt, Sr. Advocate for the respondent has urged that the established and consistent practice of accounting which is accepted by Courts is valuation of the closing stock either at the cost or at market price, whichever was lower. If the established practice of accounting is not adopted, the Assessing Officer was justified in invoking Section 145 of the Act. The method of accounting chosen by the assessee was merely to claim maximum deduction under Section 80 HHC in the First Year and suppression of the profit in the Second year. It is further urged that each accounting year being a separate unit in itself, merely because in the past Department accepted a method, would be no ground to prohibit the assessing officer from exercising his discretion and powers under Section 145 of the Act. To appreciate and to deal with the rival contentions put forward by the learned counsel in the facts of the present case, it would be appropriate to re-produce the relevant provisions of Section 145 (1) of the Income-tax Act as was applicable at the relevant time. Section 145 (1) of Income-tax Act reads as under:

a) the assessee has computed the income in accordance with the method of accounting regularly employed by the assessee ; and
b) provided where the accounts are correct and complete to the satisfaction of the assessing officer; but
c) the method employed is such that in the opinion of the assessing officer, the income cannot be deduced therefrom then the assessing officer may adopt a different method of computation of the income as he may determine.

The assessee may employ whichever basis of valuation of stock in hand, but it must adhere to that consistently year after year. Casual departure of valuation of trading stock in hand at cost or market value is not permissible. The method adopted of maintaining the accounts should be definite method of valuation which is carried by the assessee from year to year. To attract the provision of Section 145 of the Act the consistent method of maintaining accounts books is a first condition thereafter the assessing officer should be of the view that the accounts are correct and complete but the method employed is such that in the opinion of the assessing officer the income cannot properly be deduced therefrom. The choice of method of accounting regularly employed by the assessee lies with the assessee but the assessee would be required to show that he has followed the chosen method regularly. The Department is bound by the assessee's choice of method regularly employed unless by this method the true income, profit of accounts cannot be arrived at. The assessee's regular method would not be rejected as improper merely because it gives him the benefit in certain years or that as per the assessing officer the other method would have been more preferable. The method of accounting cannot be substituted by the assessing officer merely because it is unsatisfactory. What is material for the purpose of Section 145 is, the method to be such that the real income, profit and gain can be properly deduced therefrom. If the method adopted does not afford true picture of profit, it would be rejected, but then such rejection should be based on cogent evidence and would be done with caution. The power can be exercised by the assessing authority to choose the basis and manner in computation of income but he must exercise his discretion and judgement judicially and reasonably.

In the present case the assessee through out has computed the income and maintained accounts on the basis of valuation of opening stock of raw material and semi finished goods at stock price and finished goods at the market price. The assessee has adopted method of accounting whereby closing stock of the year is the opening stock of the next year, and the valuation placed by the assessee upon his closing stock of the year as the valuation of the opening stock of the next year. As per the assessing officer by virtue of this method in the assessment year 1992-93 the gross profit ratio was Rs.2054.60% for the first year which stood in stark contrast to 119.18% for the accounting year 1991-92 and 64.85% for accounting year 1991 and, therefore, the method adopted shows artificially inflated profit in order to get the deduction benefit under Section 80HH (C) of the Income Tax Act. While framing the question of law the High Court has also framed a question whether in the facts and circumstances of the case and in law, the ITAT was justified in holding that the higher market rate of valuation of closing stock adopted by the assessee was correct, without appreciating that acceptance of said method had resulted in doctored abnormal gross profit ratio of 2054.60%, which by no yardstick of basic principle of accountancy could be held as proper reflection of income. The High Court has arrived at the conclusion that this gross inflation in the profit was made merely to get the benefit of Section 80HH(C) for the first year and suppress the profit in the second year. Thus it is apparent that the assessing officer as well as the High Court were impressed by the factor that the method adopted by the assessee in computing the income results in showing of abnormally gross profit ratio and that was done for the purposes of taking benefit under Section 80HH(C) for the first year and for reducing the profit in the second year by showing the value of the finished products at the market rate at the end of the first year and in the beginning of the second year. Although it is correct to say that regular method of accounting adopted cannot be rejected by the assessing officer merely on the basis of profit earned or loss suffered by the assessee in particular year but that can be certainly a reason for an assessing officer to make deeper probe of the account to find and whether the accounts reflects real income, profit and gains of the assessee. It is settled law that the true trading result of business for an accounting period cannot be ascertained without taking into account the stock in trade at the end of the accounting period. While considering the method of accounting in C.I.T. vs. A. Krishnaswami Mudaliar [1964] 53 I.T.R. 122, this Court pointed out that in the event where the assessee is following the cash system of accounting, the valuation of the closing stock cannot be dispensed with. The Court quoted with approval the following observations in Commissioner of the Inland Revenue vs. Cock, Russell and Co. Ltd. [1949] 29 Tax Cases 387 = (1949) All E.R. 889:

It is said in S.N. Namasivayam Chettiar vs. C.I.T. [1960] 38 I.T.R. 579 (S.C.), it is for the officer to consider the material placed before him and, if, upon such consideration, he is of the opinion that correct profits and gains could not be deduced from the accounts, he would then be obliged to have recourse to the proviso to section 13 of 1922 Act which corresponds to Section 145 of the Act In C.I.T. vs. Sarangpur Cotton Mfg. Ltd.

,(1938) 6 ITR 36, Lord Thankerton stated that section 13 of the Indian Income-tax Act, 1922, related to a method of accounting regularly employed by the assessee. The section postulated that such a method of accounting was the necessary basis of computation, unless in the opinion of the Income-tax Officer, the income, profits and gains could not properly be deduced from such method. But it could very well be that, "though the profit brought out in the accounts is not the true figure for income-tax purposes the true figure can be accurately deduced therefrom . . ." But it was not a correct view that the Income- tax Officer was "prima facie entitled" to accept the profits mentioned in the accounts where there was a method of accounting regularly employed by the assessee. "It is the duty of the Income-tax Officer, where there is such a method of accounting to consider whether income, profits and gains can properly be deduced therefrom, and the proceed according to his judgment on this question. From the aforesaid decision one can easily deduce the principle that it is the duty of the assessing officer to examine in every case the method of accounting adopted by the assessee and to see whether the income, profit and gains of the assessee could properly be assessed therefrom. If the assessing officer is of the view that the profit could not be properly deduced from the accounts maintained he can apply the provisions of Section 145 of the Act. In the present case, the method adopted by the assessee is to value the closing stock at the market value irrespective of the fact whether the market value of the stock at the relevant time is more than the cost value of the stock, which necessarily results in an imaginary or notional profits to the assessee which he has not actually received. In fact such a notional imaginary profit cannot be taxed. It is well settled principle as held in Kikabhai Premchand vs. C.I.T. [1953] 24 I.T.R. 506 (S.C.) Constitution Bench judgment that the firm cannot make profit out of itself. The transaction which is not business transaction and does not derive immediate pecuniary gain is not subjected to tax In the present case by showing the market value of the closing stock the assessee has earned potential profit out of itself in as much as the stock in trade remained with the assessee at the closing of the accounting year. Secondly, putting the stock at the market value does not and cannot bring in any real profit which is necessary for taxing the income under the Act as is held in Chainrup Sampatram vs. C.I.T. [1953] 24 I.T.R. 481 (S.C.) and CIT vs. Hind Construction Ltd.. (1972) 83 ITR 211. Thirdly, it is settled principle of Income-tax Law that it is the real income, which is taxable under the Act. This proposition was enunciated in C.I.T. vs. Birla Gwalior (P.) Ltd., [1973] 89 I.T.R.266 (S.C.), which was pronounced in C.I.T., Bombay City I vs. Messrs. Shoorji Vallabhdas and Co. [1962] 46 I.T.R. 144 (S.C.). Under Section 145 of the Act chargeable income has to be deduced from the accounts regularly employed by the assessee, if in the opinion of the assessing officer the accounts are correct and complete. The assessing officer can apply a different method of accounts to deduce the income chargeable if in his opinion the method employed by the assessee the chargeable income cannot properly be deduced. The recognized and settled accounting practice of accounting with the closing stock in the accounts has to be valued on the cost basis or at the market value basis if the market value of the stock is less than the cost value. In the present case the assessee has not adopted the established and settled practice. The market value of the stock has been taken into consideration while arriving at chargeable income although the market value of the stock is more than the cost value of the stock. The profit earned is only notional. There is no transfer of the goods and the closing stock remains the opening stock of the next accounting year. The income which has not been derived at by the assessee cannot be said to be the income chargeable for income and, therefore, the rejection of the accounts maintained by the assessee for the valuation of the closing stock by the assessing officer and confirmed by the High Court is in accordance with law. The power exercised by the assessing officer under Section 145 is as per the principles enunciated by various authorities and the courts. We do not find any good or sufficient reason to interfere with the order passed by the High Court. The appeal is dismissed with no order as to costs.