2018 (4) TMI 447 - AT - Income Tax

Addition on account of prior period expenses in respect of closing stock of raw materials and work in progress - Held that - The undisputed facts are that the over valuation of stock and WIP was revealed on the basis of physical verification carried out by the firm of chartered accountants. The amount of over valuation of stock & WIP was duly debited in the profit and loss account of the assessee. As per the AO the over valuation of stocks & WIP represents the prior period items, therefore the same have been debited in the profit and loss account of the respective years to which it pertains. The fact of over valuation of closing stock was crystallized in the year under consideration therefore the same has to be written off in the current year only. In holding so, we find support and guidance from the order of ITAT Cuttack Bench in the case of National Aluminium Co Ltd (2005 (11) TMI 483 - ITAT CUTTACK). We are of the view that the loss on account of over valuation of closing stock/WIP is liable for deduction under section 37(1) of the Act. There is neutral effect of writing off the closing stock & WIP on the profitability of the assessee as it has consequential effect. Indeed the profit of the current year shall come down by the amount written off during the year on account of over valuation of closing stock - Decided against revenue

Summary

Issues Involved:
1. Deletion of addition of ?15,74,43,000/- on account of prior period expenses related to closing stock of raw materials and work-in-progress.

Issue-wise Detailed Analysis:

1. Deletion of Addition of ?15,74,43,000/- on Account of Prior Period Expenses Related to Closing Stock of Raw Materials and Work-in-Progress:

The Revenue's sole issue in this appeal is the deletion of the addition of ?15,74,43,000/- by the Commissioner of Income Tax (Appeals) [CIT(A)] on account of prior period expenses related to the closing stock of raw materials and work-in-progress.

The assessee, a public sector undertaking engaged in the business of Erection/Fabrication of railway bridges, had adjusted its profit & loss account by ?345.77 lakhs and ?1228.66 lakhs for closing stock and work-in-progress, respectively. The Assessing Officer (AO) found these adjustments to pertain to earlier years and thus disallowed them as prior period items. The AO's objections included the non-relation of expenses to the current year, the need for revised returns for the years in question, and the lack of proper identification and estimation of overvalued stock and work-in-progress.

Upon appeal, the CIT(A) was presented with the Chartered Accountant's report and other audited financial statements, which supported the adjustments. The CIT(A) noted that the overvaluation was identified in the current year and that the adjustments were necessary to present a true and fair view of the financial statements. The CIT(A) emphasized that the exact quantum of overvaluation was determined only in the current year, making it impractical to revise returns for previous years. The CIT(A) concluded that the adjustments were not prior period items but changes in accounting estimates, which are permissible under the relevant accounting standards.

The CIT(A) further referenced the Supreme Court's decision in Kedarnath Jute Mfg. Co. Ltd. v. Commissioner of Income-tax, which held that entitlement to a deduction depends on the law, not the assessee's view or book entries. The CIT(A) also cited an ITAT Cuttack Bench decision supporting the rectification of errors in subsequent years when identified.

The Tribunal upheld the CIT(A)'s decision, agreeing that the overvaluation was crystallized in the current year and thus should be written off in the current year's profit & loss account. The Tribunal found support in the ITAT Cuttack Bench's principles, which allowed such adjustments to reflect true business profits. The Tribunal also noted the neutral effect on profitability, as the current year's reduced profit would be offset by increased profit in the subsequent year due to the adjusted opening stock.

Conclusion:

The Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s deletion of the ?15,74,43,000/- addition. The Tribunal concluded that the adjustments were correctly made in the current year and were allowable under section 37(1) of the Income Tax Act, 1961. The decision was pronounced in open court on 04/04/2018.