2014 (11) TMI 1125 - HC - Income Tax

Creation of provision of obsolescence in inventories - Held that - Accounting Standards notified under Section 145(2) in particular Accounting Standard-I categorically states that the accounting treatment and presentation in financial statements of transactions should be covered by a substance and not merely by legal form. Further Section 145(A) provides notwithstanding anything to the contrary contained in section 145 the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head Profits and gains of business or profession shall be (a) in accordance with the method of accounting regularly employed by the assessee. Therefore what is to be seen is how the assessee is maintaining the accounts regularly in the course of his business and the accounting treatment and presentation of financial statement of transactions should be covered by the substance and not merely by the legal form. It is the principle which is to be kept in mind by both the appellate authorities. The aforesaid material clearly demonstrate instead of showing cost price as nil in the profit and loss account cost price of the items are given in profit and loss account and a provision is made for obsolescence in inventory showing that the market value is nil and that is the mode in which the assessee was also following even for the previous years. - Decided in favour of the assessee

Issues:
1. Allowability of provision for obsolescence in inventories as a deduction.
2. Valuation of inventory based on cost or market value.
3. Compliance with Accounting Standards and regular accounting practices.

Issue 1: Allowability of provision for obsolescence in inventories as a deduction

The case involved the appellant challenging the allowance of a provision for obsolescence in inventories claimed by the assessee for the assessment year 2001-02. The Assessing Officer initially rejected the claim, considering it a contingent claim not allowable as an expenditure. However, the Appellate Commissioner and the Tribunal upheld the claim, stating that the provision for obsolescence in inventory was a deductible expense due to the hardware becoming obsolete from technological advancements. The revenue contended that the obsolete items should have been shown in the inventory at nil market value instead of claiming a benefit through a provision for obsolescence. The court examined the details provided by the assessee, highlighting the items covered by the provision and the method of accounting employed. The court found that the provision was in compliance with Accounting Standard-2 and the method regularly employed by the assessee, justifying the deduction. The court emphasized that the substance of the accounting treatment should prevail over the legal form, ultimately dismissing the appeal in favor of the assessee.

Issue 2: Valuation of inventory based on cost or market value

The substantial questions of law raised in the appeal included whether the provision for obsolescence in inventory should be allowed when the items continued with the assessee and whether the provision was permissible when inventory valuation was based on the principle of cost or market value. The revenue argued that the market value of obsolete items should have been considered in the inventory valuation instead of creating a provision for obsolescence. However, the court found that the assessee's accounting treatment, following the cost price in the profit and loss account and making a provision for obsolescence in inventory, was consistent with the substance of the transactions and the regular accounting practices. The court emphasized that the valuation of inventory should be in accordance with the method regularly employed by the assessee, as per Accounting Standards and the principle of substance over legal form. Consequently, the court ruled in favor of the assessee on these valuation issues as well.

Issue 3: Compliance with Accounting Standards and regular accounting practices

The court analyzed the compliance of the assessee with Accounting Standards and regular accounting practices concerning the provision for obsolescence in inventories. The assessee's creation of the provision was found to be in accordance with Accounting Standard-2 and the method of accounting regularly employed, as evidenced by similar provisions made in previous years. The court emphasized the importance of substance over legal form in accounting treatment, as mandated by Accounting Standards and relevant provisions. It was noted that the provision for obsolescence was created based on the difference between the cost and net realizable value of inventory items, aligning with the accounting principles. Ultimately, the court upheld the assessee's accounting treatment, highlighting the consistency and compliance with established standards and practices.

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