2017 (3) TMI 1184 - HC - Income Tax

Revaluation of closing stock routed through profit and loss account - Held that - Process of revaluation of stock by itself can not bring in any real profit as held in C.I.T. versus K.A.R.K. Firm (1933 (7) TMI 11 - RANGOON HIGH COURT) C.I.T. and Tribunal have examined the matter and accepted explanation of Assessee that it wanted to construct an office building on the said plot, hence transferred it from Current Assets Account to Fixed Assets Account by passing general entries. Further, as market value of plot is not much more in books while transferring plot to Fixed Assets, it was enhanced to ₹ 1,00,00,000/- and a cross entry was passed in the consequence. This contrary entry has been passed by debiting Quinton Road plot account and crediting Revaluation Reserve Account. There was some error which was rectified and it was shown to be part of Fixed Schedule and not part of entries. The view taken by C.I.T.(A) that revaluation of Fixed Assets does not lead to any taxable income of an Assessee could not be shown incorrect. The said value has also been accepted by Tribunal. This is findings of facts. - Decided in favour of Assessee.

Issues Involved:

1. Revaluation of closing stock and its routing through the profit and loss account.
2. Disturbance of closing stock and its impact on profit and loss account.
3. Conversion of current assets to fixed assets and its tax implications.
4. Legitimacy of tax planning versus tax evasion.

Issue-wise Detailed Analysis:

1. Revaluation of Closing Stock and its Routing through Profit and Loss Account:

The primary issue was whether the revaluation of closing stock must be routed through the profit and loss account. The Assessing Authority (A.A.) added ?1 crore to the income of the assessee, claiming that the revaluation was not routed through the profit and loss account, which disturbed the balance sheet. However, the Commissioner of Income Tax (Appeals) [C.I.T.(A)] and the Tribunal found that the revaluation of a fixed asset does not lead to taxable income. The Tribunal upheld that since the plot was not sold to an outsider, the adjustment was correctly made through a journal entry. The court concluded that the A.A.'s assumption was incorrect as there is no legal or accounting principle mandating that every reserve must route through the profit and loss account.

2. Disturbance of Closing Stock and its Impact on Profit and Loss Account:

The A.A. argued that any disturbance in closing stock must be carried out through the profit and loss account. The C.I.T.(A) partially upheld this by considering the book value of the plot as part of the sales, but deleted the addition of ?94,00,250/-. The Tribunal agreed with this partial addition but rejected the rest, stating that the revaluation and transfer to fixed assets did not generate real income. The court supported this view, emphasizing that revaluation alone does not constitute real profit or taxable income.

3. Conversion of Current Assets to Fixed Assets and its Tax Implications:

The Revenue contended that the conversion of stock in trade to a capital asset should be routed through the profit and loss account to avoid tax evasion. However, the court found no income was received or accrued from the conversion. The Tribunal noted that the market value was correctly reflected in the fixed assets, and the corresponding revaluation reserve was justified. The court highlighted that tax is only applicable on real income, which was not the case here as no actual income accrued from the conversion.

4. Legitimacy of Tax Planning versus Tax Evasion:

The court acknowledged that while tax planning within legal frameworks is permissible, any attempt to avoid tax through sham transactions is not. However, in this case, the court found no evidence of fraudulent conversion or tax evasion. The revaluation and transfer entries were legitimate and aimed at reflecting the correct market value of the plot. The court cited precedents affirming that revaluation of stock does not bring real profit and thus is not taxable.

Conclusion:

The court dismissed the appeal, answering both substantial questions of law against the Revenue and in favor of the Assessee. It concluded that the revaluation and transfer entries were correctly handled and did not result in any taxable income. The approach taken by the C.I.T.(A) and the Tribunal was neither illegal nor contrary to law. The appeal was dismissed with no order as to costs.

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