2014 (10) TMI 1026 - HC - Income Tax

Valuation of closing stock - Method of valuation of inventory - change in method of valuation - Tribunal reversing the finding of AO that the assessee had valued the work in progress at material cost (closing stock) contrary to Accounting Standard-2 as opined by the assessee s statutory Auditor that profit before tax and profit after tax are understated by the assessee - HELD THAT - If the change is bonafide and is accepted by the revenue then the question of changing the opening stock would not arise. If such a change is not bonafide it will be open to the Revenue not to accept such a change in valuation and assess without such valuation. Once the said change in the valuation is accepted by the Revenue the consequence is the value of the closing stock in the previous year would become value of the opening stock in the succeeding year. But if the assessing authority rejects the assessee s valuation of the closing stock then to arrive at the correct figure of profit the assessing authority should value the opening stock in a similar fashion. If the assessee s method of valuation of the opening stock is accepted and at the same time his valuation of the closing stock is rejected then a highly distorted figure of profit will be arrived at. This will be the scope of charging section. When the assessee changes the valuation of the closing stock there is no necessity to change the opening stock. But when the assessing authority changes the closing stock it becomes obligatory that the opening stock valuation has to be correspondingly changed on the basis of which the valuation of the closing stock is changed in order to arrive at correct figure of tax which is chargeable as tax under Section 4 - order passed by the Tribunal holding that the opening stock should also be revalued cannot be found fault with. Accordingly the substantial questions of law 1 and 2 framed are answered in favour of the assessee. Nature of expenditure - expenditure towards professional charges press announcements and statutory fees - revenue or capital expenditure - assessee formulated the proposal to buy back equity shares from existing share holders on aproportionate basis and through a tender - HELD THAT - The increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making. The expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company. Issue of bonus shares does not result in the expansion of capital base of the company. It does not lead to any inflow of fresh funds into the company. The capital structure is not expanded. On the contrary the consequence of such buy-back of shares is the capital base of the company gets reduced and the capital structure will go down. It is not of an enduring effect so as to bring the expenditure incurred in this regard as capital expenditure. Where there is no flow of funds or increase in the capital employed the expenditure incurred would be revenue expenditure. Therefore rightly the Tribunal held that it is in the nature of revenue expenditure and allowed the same. - Decided against revenue.

Issues Involved:

1. Valuation of work-in-progress and finished goods.
2. Change in valuation of closing stock and corresponding opening stock.
3. Deductibility of expenses incurred for buying back shares.
4. Inclusion of proceeds from the sale of raw material and stores in total turnover for Section 80HHC deduction.
5. Computation of interest component for Section 80HHC deduction.

Detailed Analysis:

1. Valuation of Work-in-Progress and Finished Goods:

The primary issue revolves around whether the assessee's method of valuing work-in-progress at material cost and finished goods at prime cost aligns with Accounting Standard-2 (AS-2). The statutory auditor pointed out that this practice understates inventories, current liabilities, and provisions while overstating loans and advances, leading to understated profits. The assessing authority determined that this method did not reflect true profits and adjusted the valuation to conform to AS-2, resulting in additional taxable profit.

2. Change in Valuation of Closing Stock and Corresponding Opening Stock:

The Tribunal held that if the closing stock's valuation is changed by the assessing authority, the opening stock must also be revalued to avoid distorted profit figures. This was supported by various judgments, including those from the Bombay High Court and the Privy Council, which emphasized that undervaluation at one end should not occur without corresponding adjustments at the other end. The High Court upheld this view, stating that to arrive at the correct taxable income, both opening and closing stock valuations should be consistent.

3. Deductibility of Expenses Incurred for Buying Back Shares:

The assessee incurred expenses for professional charges, press announcements, and statutory fees related to a share buy-back scheme. The assessing authority treated these expenses as capital expenditure, arguing they provided an enduring benefit. However, the Tribunal, following the Supreme Court's judgment in Commissioner of Income-Tax vs. General Insurance Corporation, held that such expenses are revenue in nature since the buy-back results in a reduction, not an expansion, of the capital base. The High Court agreed, noting that the expenditure did not result in any enduring asset or benefit and thus should be treated as revenue expenditure.

4. Inclusion of Proceeds from Sale of Raw Material and Stores in Total Turnover for Section 80HHC Deduction:

The assessing authority included the proceeds from the sale of raw materials and stores in the total turnover for computing the deduction under Section 80HHC. The Tribunal set aside this inclusion, following its earlier orders in the assessee's case. The High Court affirmed this decision, referencing its previous judgment in ITA No. 734/07, which ruled in favor of the assessee.

5. Computation of Interest Component for Section 80HHC Deduction:

The Tribunal also addressed the computation of the interest component for the Section 80HHC deduction, which the assessing authority had included in the total turnover. The Tribunal followed its earlier orders, excluding the interest component from the total turnover calculation. The High Court upheld this decision, consistent with its previous rulings in the assessee's favor.

Conclusion:

The High Court dismissed the revenue's appeal, affirming the Tribunal's decisions on all substantial questions of law. The valuation of both opening and closing stocks must be consistent to reflect true profits. Expenses related to share buy-backs are revenue in nature, and proceeds from the sale of raw materials and interest components should be excluded from the total turnover for Section 80HHC deductions.

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