2005 (9) TMI 506 - AT - Income Tax

Depreciation in respect of plant and machinery, generator, dies and moulds - Method of accounting - Manufacturing activities discontinued - scaling down the value of obsolete items of raw material as on the year-end - HELD THAT - It is also not in dispute that the value of the obsolete stock in question as on 31-3-1998 was lower than its actual cost. This is supported by the price at which such stock has been subsequently sold by the assessee by way of re-export. The object of valuing closing stock in terms of the method followed by the assessee is to bring into the charge of income the true profits for the year. In a hypothetical situation, it could be understood that the object of crediting the value of unsold stock to the Profit Loss account is to balance the cost of those goods entered on the debit side of the Profit Loss account at the time of their purchase, so that the cancelling out of the entries relating to the same stock would leave only the transactions on which there have been actual sales in the course of year thereby showing the actual profit or loss pertaining to the particular year s trading. If the value of the stocks, which is lying unutilized at the end of the year, is equivalent to or more than the cost, then, to cull out the true profits on the goods actually sold during the year, one will have to state the value of such unsold stocks only at the cost. This is a well understood and accepted principle of commercial accounting. However, an exception is in a situation where the value of such unsold stock is less than its actual cost. In such a situation, adoption of market value, to value it at the end of the year would imply accounting for an anticipated loss that may result on sale of such goods, may be in the following year. The said treatment of recognizing the loss in the year itself is based on prudence as no trader would show increased profits before its actual realization. Moreover, this principle is established in the commercial world. In fact, the Hon ble Supreme Court in the case of Chainrup Sampat Ram v. CIT 1953 (10) TMI 2 - SUPREME COURT referred with approval the following observation of the learned Judges in Whimster Co. v. Commissioners of Inland Revenue. We may also mention here that it is not the case of the revenue that the accounting policy with regard to valuation of inventories followed by the assessee is not consistent or was lacking in bona fides. Therefore, once the accounting policy of the assessee, which is generally accepted in the commercial world, is not doubted by the revenue, the loss resulting on account of its application cannot be disallowed merely on the ipse dixit of the Assessing Officer. In view of the aforesaid discussion, in our view, the stand of the assessee is liable to be upheld. Accordingly, we set aside the order of the CIT(A) and direct the Assessing Officer to allow the claim of the assessee with regard to the provision of loss with regard to the obsolete items of stock. In the result, the appeal of the assessee is partly allowed.

Issues Involved:
1. Denial of reasonable opportunity of being heard by the Assessing Officer.
2. Disallowance of depreciation on plant and machinery, generator, dies, and moulds.
3. Disallowance of deduction on account of the purchase of obsolete items representing a fall in the value of the closing stock of raw materials.

Issue-wise Detailed Analysis:

1. Denial of Reasonable Opportunity of Being Heard by the Assessing Officer:
The first ground preferred by the assessee dealing with the denial of reasonable opportunity of being heard by the Assessing Officer has not been pressed before us and is accordingly dismissed.

2. Disallowance of Depreciation on Plant and Machinery, Generator, Dies, and Moulds:
The assessee, engaged in the business of assembly (manufacturing) and trading of electronic items, claimed depreciation on plant and machinery, generator, dies, and moulds amounting to Rs. 1,73,732. The Assessing Officer denied the claim on the ground that the manufacturing activities had been discontinued from 1-12-1996, and thus, the assets were not put to use during the assessment year 1998-99. The assessee contended that the machinery was used for trading activities and job work related to warranties on previously sold items, and the assets were kept in ready condition for manufacturing.

In appeal, the CIT(A) upheld the disallowance, agreeing with the Assessing Officer's reasoning. The assessee argued before the Tribunal that the assets were kept in running condition and ready for use, and manufacturing activities resumed in the subsequent assessment year 1999-2000, where depreciation was allowed. The assessee cited judicial precedents to support the claim that assets kept ready for use qualify for depreciation.

The Tribunal noted that the assessee had temporarily discontinued manufacturing but used the assets for trading and job work. It emphasized that section 32 of the Income-tax Act requires the assets to be used for business purposes, which includes passive use (assets kept ready for use). The Tribunal referred to the Delhi High Court's decision in Capital Bus Service Ltd. and the Supreme Court's decision in State of Haryana v. Dalmia Dadri Cement Ltd., which support the interpretation that assets kept ready for use are considered used for business. Consequently, the Tribunal allowed the assessee's claim for depreciation, setting aside the CIT(A)'s order and directing the Assessing Officer to allow the depreciation claim.

3. Disallowance of Deduction on Account of Purchase of Obsolete Items Representing Fall in the Value of the Closing Stock of Raw Materials:
The assessee made a provision of Rs. 9,80,177 for obsolete items of stock by adjusting the closing stock value. The Assessing Officer disallowed the provision due to lack of evidence. The assessee explained that continuous research and development in the electronic items business led to certain raw materials becoming obsolete and losing value. The assessee valued the stock at the lower of cost or realizable value, resulting in a loss of Rs. 9,80,177, and demonstrated that the obsolete stock was re-exported at the said value in the subsequent year.

The CIT(A) upheld the disallowance, stating that no loss was incurred as the goods were exported in the subsequent year. The assessee argued before the Tribunal that its accounting policy of valuing inventories at the lower of cost or net realizable value was consistent and supported by evidence of re-export.

The Tribunal referred to the Supreme Court's decision in CIT v. British Paints India Ltd., which supports the principle of valuing closing stock at cost or market value, whichever is lower, to reflect true profits. The Tribunal emphasized that the assessee's method of valuation is consistent with commercial accounting principles and recognized the loss due to obsolescence. It noted that the revenue did not dispute the accounting policy's consistency or bona fides. The Tribunal concluded that the provision for loss on obsolete stock was allowable, setting aside the CIT(A)'s order and directing the Assessing Officer to allow the claim.

Conclusion:
The appeal of the assessee is partly allowed, with the Tribunal allowing the claims for depreciation on plant and machinery, generator, dies, and moulds, and the provision for loss on obsolete stock, while dismissing the ground related to the denial of reasonable opportunity of being heard.

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