1996 (1) TMI 142 - AT - Income Tax

Summary

Issues Involved:
1. Valuation of closing stock of cut and polished diamonds.
2. Addition on account of interest on interest-free loans.

Issue-Wise Detailed Analysis:

1. Valuation of Closing Stock of Cut and Polished Diamonds:

The common controversy in both the appeals relates to the valuation of closing stock of cut and polished diamonds at the end of the accounting year. The assessee declared closing stock of cut and polished diamonds at 1635.08 cts, valued at different rates. The AO believed the diamonds weighing 1,431.51 cts were undervalued and issued a show cause notice to the assessee. The assessee argued that the diamonds were of inferior quality and presented sale bills from the succeeding year to support the valuation. However, the AO was not satisfied, citing several reasons including high rejection rates, lack of proof of market price, and discrepancies in sales bills. The AO concluded that the assessee undervalued the stock to manipulate profits, especially in light of the changes in the deduction under s. 80HHC in the succeeding year. The AO valued the closing stock at Rs. 24,38,018, making an addition of Rs. 20,50,348 to the income of the assessee.

The CIT(A), upon reviewing the submissions and evidence, directed the AO to value the closing stock at Rs. 1000 per carat, considering the arguments of the assessee about the change in the pattern of purchases and sales and the inferior quality of the closing stock. The CIT(A) noted the significant differences in the purchase prices and the quality of diamonds compared to the previous year.

The Revenue appealed against this decision, arguing that the CIT(A) was not justified in directing the AO to adopt the valuation at Rs. 1000 per carat, while the assessee was aggrieved by the partial relief given. The Tribunal considered the rival submissions and noted that the assessee did not provide detailed size-wise, shape-wise, and color-wise details of the closing stock. The Tribunal agreed with the AO that the average cost price was a fair and reasonable method for valuation and reversed the CIT(A)'s finding, restoring the AO's valuation.

The Tribunal also acknowledged the motive for undervaluation due to the changes in the deduction under s. 80HHC, concluding that the assessee had enough time to manipulate the closing stock valuation.

2. Addition on Account of Interest on Interest-Free Loans:

The AO added Rs. 16,200 to the income of the assessee for interest-free loans advanced to M/s Vandit Steel and Vanitaben, wife of one of the partners, arguing that the assessee paid heavy interest on bank loans. The CIT(A) deleted this addition, stating that the AO made the addition purely on an estimate basis.

The Revenue contended that there was no commercial urgency in advancing the loan to Vanitaben. The assessee argued that no loans were raised by the firm for advancing the interest-free loans, and the total capital of the partners was sufficient to cover these advances.

The Tribunal found that the AO did not establish any nexus between the interest-free loans and the advances raised by the firm. It was noted that the loan to M/s Vandit Steel was for purchasing a plot for business purposes, and the loan to Vanitaben could be from the partners' capital account. Therefore, the Tribunal upheld the CIT(A)'s finding and declined to interfere.

Conclusion:

The appeal filed by the Revenue was allowed in part, restoring the AO's valuation of closing stock, while the appeal filed by the assessee was dismissed. The Tribunal upheld the CIT(A)'s decision to delete the addition on account of interest on interest-free loans.