2005 (11) TMI 26 - SC - Income Tax

Export - firm engaged in the imports of synthetic waste and manufacture and export of woolen blankets - power exercised by the Assessing Officer under section 145 - income which has not been derived by the assessee cannot be said to be the income chargeable for income-tax and, therefore, the rejection of the accounts maintained by the assessee for the valuation of the closing stock by the Assessing Officer and confirmed by the High Court is in accordance with law.

Issues Involved:
1. Valuation method of closing stock.
2. Application of Section 80HHC of the Income-tax Act, 1961.
3. Application of Section 145 of the Income-tax Act, 1961.
4. Consistency in the method of accounting.
5. Determination of true profit and income.

Issue-wise Detailed Analysis:

1. Valuation Method of Closing Stock:
The core issue revolves around the method adopted by the assessee for valuing the closing stock. The assessee valued the closing stock at market price, which resulted in a stark contrast in the gross profit ratio for the accounting years 1990-91, 1991-92, and 1992-93. The Assessing Officer (AO) concluded that this method led to an inflated profit picture, artificially increasing profits to claim benefits under Section 80HHC of the Income-tax Act, 1961. The AO found that the correct principle for valuing inventory should be at cost or market price, whichever is lower, and added an amount of Rs. 2,67,38,280 to the total income of the assessee for the second year.

2. Application of Section 80HHC of the Income-tax Act, 1961:
The assessee claimed benefits under Section 80HHC for the first year. The AO and the High Court observed that the valuation method adopted by the assessee was a device to inflate deductions under Section 80HHC and suppress profits in the second year. The High Court held that the method adopted by the assessee was incorrect and aimed at tax avoidance.

3. Application of Section 145 of the Income-tax Act, 1961:
Section 145(1) stipulates that income chargeable under the head 'Profits and gains of business or profession' must be computed in accordance with the method of accounting regularly employed by the assessee. However, if the AO is of the opinion that the method employed does not allow for proper deduction of income, he may adopt a different method. The Supreme Court noted that the AO and the High Court were justified in invoking Section 145 as the method employed by the assessee did not reflect the true income, profits, and gains.

4. Consistency in the Method of Accounting:
The assessee argued that it had consistently followed the method of valuing closing stock at market price since 1985-86. However, the court emphasized that the method of accounting should consistently reflect true income and should not be adopted merely for tax benefits. The Supreme Court upheld the view that the AO could reject the method if it did not provide a true picture of the income.

5. Determination of True Profit and Income:
The court reiterated that the true trading result of a business for an accounting period cannot be ascertained without taking into account the stock-in-trade at the end of the period. The valuation of closing stock should be at cost or market price, whichever is lower, to reflect true profits. The court cited precedents, including CIT v. British Paints India Ltd., to support this principle. It was held that the method adopted by the assessee, which resulted in notional profits, could not be accepted as it did not reflect the real income.

Conclusion:
The Supreme Court dismissed the appeals, affirming the High Court's decision that the method of valuing closing stock at market price adopted by the assessee was incorrect and aimed at tax avoidance. The court upheld the AO's application of Section 145, emphasizing that the method of accounting should consistently reflect true income and not be used for tax planning. The valuation of closing stock should be at cost or market price, whichever is lower, to provide a true picture of the profits and income.

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