1964 (4) TMI 7 - SC - Income Tax

Whether in the computation of the income of the firm under the head Profits and gains of business the Income-tax Officer was bound by the method of accounting in which the cost of acquisition of the film of which the exploitation rights were held was debited at the commencement of the year, but the value of the film at the end of the year was ignored? Held that - There is no warrant in this case for assuming that the revenue authorities and the Tribunal had sought to displace the method of accountancy adopted by the assessee. By applying the proviso to section 13, they made the computation upon the basis and in the manner in which in their opinion profits would be properly deduced. That they were entitled to do. We are, therefore, of the view that the High Court was in error in holding that because the assessee had maintained his accounts in the cash system it was not open to the Income-tax Officer to add to the receipts from the business the value of the stock-in-trade at the end of the year for the purpose of properly deducing the profits of the business for the year in question. The appeal, therefore, must be allowed and the answer to the question referred to the High Court will be in the affirmative

Issues Involved:
1. Correctness of the estimated value of the exploitation rights of the film.
2. Application of the proviso to section 13 of the Indian Income-tax Act.
3. Method of accounting employed by the assessee.
4. Computation of profits and gains of business under the Income-tax Act.
5. Role of stock valuation in computing taxable income.

Issue-wise Analysis:

1. Correctness of the Estimated Value of the Exploitation Rights of the Film:

The respondent firm challenged the valuation of the exploitation rights of the film at Rs. 65,000 by the Income-tax Officer, arguing that the true value was Rs. 4,000, as reflected in the dissolution deed where a retiring partner relinquished his half share for Rs. 2,000. The Appellate Assistant Commissioner rejected this contention, holding that the valuation in the dissolution deed was "dictated by extra-commercial considerations" and confirmed the Rs. 65,000 valuation. The Income-tax Appellate Tribunal partially upheld the firm's plea, reducing the valuation to Rs. 40,000.

2. Application of the Proviso to Section 13 of the Indian Income-tax Act:

The High Court held that the assessee could maintain accounts according to a recognized system of accounting and that the Income-tax Officer had no power under the proviso to section 13 to force a different system on the assessee. The High Court observed, "When we reach the position that it was the cash system that the assessee had adopted in this case, and that valuation of the closing stock was not an incident of that system for ascertaining the profits, it should be obvious that the Income-tax Officer had no power under the proviso to section 13 to force a different system on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock."

3. Method of Accounting Employed by the Assessee:

The Income-tax Officer observed that the firm had not made a stock valuation of the film and had merely taken the excess collection over the purchase value. The High Court held that the assessee had adopted the cash system of accounting, and the Tribunal had no reason to discard that system. However, the Supreme Court noted that the Income-tax Officer implicitly indicated that without valuation of the unexpired exploitation rights, the profits of the year could not be computed accurately.

4. Computation of Profits and Gains of Business Under the Income-tax Act:

Section 10 of the Indian Income-tax Act, 1922, provides that tax shall be payable under the head "Profits and gains of business, profession or vocation." Section 13 mandates that income, profits, and gains shall be computed according to the method of accounting regularly employed by the assessee. However, if the method employed is such that the income cannot be properly deduced, the Income-tax Officer may determine the computation basis. The Supreme Court noted that the Income-tax Officer is not compelled to accept a balance-sheet of cash receipts and outgoings prepared from the books of account but must compute the income in accordance with the method of accounting regularly employed by the assessee.

5. Role of Stock Valuation in Computing Taxable Income:

The Supreme Court emphasized that in computing the true profits of a trading venture, the stock-in-trade must be taken into account. Ignoring the value of the stock-in-trade at the end of the year while debiting its value at the commencement would give a false picture of the firm's profits. The Court highlighted that the Income-tax Act charges tax on income, profits, and gains, not on receipts, and taxable profits cannot be deduced from cash receipts alone. The Court referenced English case law, noting that for accurate profit assessment, the value of stock-in-trade at the beginning and end of the year must be considered.

Conclusion:

The Supreme Court concluded that the High Court erred in holding that the Income-tax Officer was bound by the assessee's choice of the cash system of accounting and could not add the value of the stock-in-trade at the end of the year. The appeal was allowed, and the answer to the question referred to the High Court was in the affirmative. The Commissioner was entitled to costs in the Supreme Court as well as in the High Court.

Appeal allowed.

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