Excise duty to be included in value of closing stock only if related excise duty has been debited in accounts- matching principal to be followed- a discussion in view of recent judgments.

[C.A. DEV KUMAR KOTHARI]

Excise duty:

Excise duty is a tax or duty on manufacture of goods. However Excise Duty is payable on clearance of goods from  factory. Goods manufactured and lying at factory is in the condition and location  even without payment of excise duty. When goods are taken out of factory, generally excise duty become payable. Though excise duty is on manufacture of goods but rate of excise duty payable will be the rates applicable on the day of clearance of goods from factory or excise bonded warehouse. Therefore, excise duty is not payable on goods lying in factory so as to bring the goods in condition and location (factory).

Matching principal:

As per the matching principal of accounting including valuation of stock, general rule is that costs debited in accounts should be considered as cost for the purpose of ascertaining cost of goods sold and cost of goods remaining in stock. This is subject to certain refinement about what should be included in cost and what not. Costs which have no connection with production and are in nature of periodical costs

Therefore, in case excise duty relating to stock on closing day of previous year is not debited in the P & L account, then excise duty cannot be considered as part of valuation of such stock. Only when excise duty relating to closing stocks is debited in P & L account, the question of adding such excise duty in value of stock will arise.

Excise duty and section 43B:

Excise duty  is a tax , duty or fees which is covered by section 43B. Therefore, excise duty  is to be allowed in the year of actual payment or at option of assessee he can claim in the computation of income of previous  year itself if the excise duty is actually paid before due date to file return of income u/s 139(1). 

Involves only deferment of claim and no effect on revenue over a period of time:

We find that addition and / or deduction of excise duty in respect of closing stocks is not having any major impact on revenue over a period of two or more years. Generally items like excise duty or other cost elements affecting valuation can have effect on income of two years. An item of element which is added or disallowed on the basis of stock valuation will have to be allowed in next year. In case of stock –in-trade generally stock of first year is sold in second year and therefore, related duties are also paid in second year. Therefore,  if an addition is made in stock valuation in first year, the same amount become allowable in second year.  Therefore, there is hardly any major impact on revenue if a broader perspective is considered  for tax collection over a period of two – three years.

Litigation about stock valuation is not desirable:

In view of only impact of deferment of claim , it is desirable that revenue should not indulge into un-necessary litigation about additions in stock valuation.  However, unfortunately the revenue is indulging into un-necessary and avoidable litigation about stock valuation and also some more deductions which are allowable either in first or in second year. The attitude is that if an assessee has claimed deduction in first year, the revenue officer will try to  shift deduction in second year. In case assessee has clamied in second year, the AO may try to take view that the amount was allowable in first year and cannot be allowed in second year. This approach is not proper and justified.

Recent judgment of the Supreme Court:

In a recent judgment in case of  Dynavision Limited (SC) the Supreme Court held that AO was not justified  while making addition of  Excise Duty  on stock valuation. The supreme court has upheld the principle of exclusion of excise duty component from valuation of closing stock . Rules  laid down in the case of Chainrup Sampatram1953 (10) TMI 2 - SUPREME COURT &  Hindustan Zinc Ltd 2007 (5) TMI 195 - SUPREME COURThas been reiterated in the latest  decision  by observing inter alia on the following lines: 

1. the purpose of crediting the value of unsold stock is to balance the cost of the goods entered on the other side of the account (that is debit side of P & L account)  so that on cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions in which actual sales in the course of the year has taken place and thereby showing the profit or loss actually realized on the year’s trading.

2. The entry for stock which appears in the trading account is intended to cancel the charge for the goods bought which have remained unsold which should represent the cost of the goods”.

In this regard we  decisions of the Supreme Court in case of  British Paints India Ltd 1990 (12) TMI 2 - SUPREME COURTis also relevant wherein  it was held that all “overheads” had to be included in closing stock. In case of  Berger Paints 2004 (2) TMI 4 - SUPREME COURT it was held that in view of Section 43B, excise duty need not be included in closing stock. taxmanagementindia.com

Following the above rules, it can be said that excise duty will form part of value of stock only if excise duty relatable to stock has been  debited in P & L account.

Position after insertion of section 145A:

As stated earlier, excise duty is not payable  before clearance of excisable goods from factory or excise bonded warehouse. Excise duty is not payable for the bringing or putting of goods in condition and location at factory after goods are manufactured but not cleared. Therefore, addition is not required to be made in respect of goods manufactured and lying un-cleared. A question arose in case of  CIT v Loknete Balasaheb Desai S.S.K. Ltd. 2011 (6) TMI 48 - BOMBAY HIGH COURT This is decision for period after insertion of section 145A. In this case also after consideration of the provisions of section 145A the High Court held that  ITAT was justified in holding that in respect of unsold sugar lying in stock, central excise liability was not incurred and consequently the addition of excise duty made by the assessing officer to the value of the excisable goods was liable to be deleted.

The judgments of the Supreme Court and Bombay High Court are reproduced with highlights marked in red colour for easy analysis:

Commissioner of Income tax, Tamilnadu Versus M/S Dynavision LTD2012 (9) TMI 265 - SUPREME COURT

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO.197 OF 2005

Commissioner of Income ax, Tamil Nadu …Appellant(s) Versus

M/s. Dynavision Limited …Respondent(s)

O R D E R

Assessee is a private limited company. It carries on the businessof manufacture and sale of television sets. For the Assessment Year 1987-88 the AO while computing the assessment under Section 143(3) found that the assessee had not included in the closing stock the element of excise duty. Accordingly, he added a sum of Rs. 16,39,000/- to the income of the assessee on the ground of undervaluation of closing stock.

The question before us is whether the department is right in alleging that the closing stock is undervalued to the extent of Rs. 16,39,000/-?

At the outset, it may be stated, that, it is not in dispute that the assessee has been following consistently the method of valuation of closing stock which is “cost or market price whichever is lower.”

Moreover, the AO conceded before the CIT(A) that he revalued the closing stock without making any adjustment to the opening stock (see: page 50 of the Paper Book). Lastly, though under section 3 of the Central Excise Act, 1944, the levy of excise duty is on the manufacture of the finished product the same is quantified and collected on the value (i.e. selling price). Before concluding, we may rely on judgment of this Court in the case of Chainrup Sampatram vs. CIT, reported in 24 ITR 481 in which it has been held that, “valuation of unsold stock at the close of the accounting period was a necessary part of the process of determining the trading results of that period.

It cannot be regarded as source of profits. That, the true purpose of crediting the value of unsold stock is to balance the cost of the goods entered on the other side of the account at the time of the purchase, so that on cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions in which actual sales in the course of the year has taken place and thereby showing the profit or loss actually realized on the year’s trading. The entry for stock which appears in the trading account is intended to cancel the charge for the goods bought which have remained unsold which should represent the cost of the goods”. (see also : para 8 of the judgment of this Court in the case of CIT vs. Hindustan Zinc Ltd. reported in 291 ITR 391).

For the above reasons, we hold, that, the addition of Rs. 16,39,000/- to the income of the assessee on the ground of undervaluation of the closing stock was wrong and that the order of CIT(A) is accordingly upheld. Consequently, this civil appeal filed by the department is dismissed with no order as to costs.

New Delhi, August 30, 2012.

Authors observations:

Though it is not clear but it is implied that excise duty relating to closing stock  was not debited as an element of cost of goods in the P & L account. If excise duty is already debited in P & L account, then it will form part of cost for valuation of stock also.

 

CIT v Loknete Balasaheb Desai S.S.K. Ltd.

High Court of Bombay

ITA No. 4297 of 2009

Decided on: 22 June 2011 

Judgment

J.P. Devadhar, J

1. Heard. Admit on the following question of law:-

“Whether on the facts and in the circumstances of the case and in law, the ITAT was justified in holding that under section 145A of the Income Tax Act, 1961 the excise duty element cannot be added to the value of unsold sugar lying in stock on the last day of the accounting year?”

 2. By consent, appeal is taken up for final hearing. 

3. The assessment year involved is AY 2001-02. 

4. The assessee is engaged in the business of manufacture and sale of white sugar. In the assessment year in question, the assessing officer held that the excise duty on sugar manufactured but not sold and lying in closing stock was a liability incurred by the assessee under section 145A(b) (sic)1 of the Income Tax Act, 1961 (‘the Act’ for short) and has to be considered for disallowance under section 43B of the Act. 

5. On appeal filed by the assessee, the CIT(A) upheld the order of the assessing officer. According to CIT(A), the liability to pay excise duty is incurred on manufacture and the obligation to pay the excise duty continues when the goods are in stock and does not cease to exist. 

6. On further appeal filed by the assessee, the ITAT following the judgment of the Madhya Pradesh High Court in the case of Assistant Commissioner of Income Tax -1(1), Indore v D and H Secheron Electrodes P. Ltd. reported in (2008) 173 Taxman 188 held that the assessing officer was not justified in adding excise duty to the price of the unsold sugar lying in stock on 31/3/2001. 

7. The argument of the revenue is that the excise duty liability is incurred on manufacture of sugar and since section 145A(a) specifically used the expression ‘incurred’, the Tribunal ought to have held that the excise duty liability has to be taken into consideration in valuing the unsold sugar in stock on the last day of the accounting year. 

8. Section 145A inserted by the Finance (No.2) Act, 1998 w.e.f. 1/4/1999 reads thus:-

“145A. Method of accounting in certain cases- Notwithstanding anything to the contrary contained in Section 145, the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head “Profits and gains of business or profession” shall be:-

(a) in accordance with the method of accounting regularly employed by the assessee, and

(b) further adjusted to include the amount of tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation. Explanation – For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payments notwithstanding any right arising as a consequence to such payment. “ 

9. The expression ‘incurred by the assessee’ in Section 145A(a) is followed by the words ‘to bring the goods to the place of its location and condition as on the date of valuation’. Thus, the expression ‘incurred by the assessee’ relates to the liability determined as tax, duty, cess or fee payable in bringing the goods to the place of its location and condition of the goods. Explanation to section 145A(a) makes it further clear that the income chargeable under the head profits and gains of business shall be adjusted by the amount paid as tax, duty, cess or fee. Therefore, the expression ‘incurred’ in section 145A(a) must be construed to mean the liability actually incurred by the assessee. 

10. Where the excisable goods are manufactured and are lying in stock on the last day of the accounting year, whether the manufacturer has incurred liability to pay excise duty on the manufactured goods is the question. 

11. The Apex Court in the case of Commissioner of Central Excise v Polyset Corporation and Anr. reported in 115 ELT 41 (S.C.) has held that the dutiability of excisable goods is determined with reference to the date of manufacture and the rate of excise duty payable has to be determined with reference to the date of clearance of the goods. Therefore, though the date of manufacture is the relevant date for dutiability, the relevant date for the duty liability is the date on which the goods are cleared. In other words, in respect of excisable goods manufactured and lying in stock, the excise duty liability would get crystallised on the date of clearance of goods and not on the date of manufacture. Therefore, till the date of clearance of the excisable goods the excise duty payable on the said goods does not get crystalised and consequently the assessee cannot be said to have incurred the excise duty liability. In respect of the excisable goods lying in stock, no liability is determined as payable and consequently, there would be no question of incurring excise duty liability.

12. In the present case, it is not in dispute that the manufactured sugar was lying in stock and the same were not cleared from the factory. Therefore, in the facts of the present case, the ITAT was justified in holding that in respect of unsold sugar lying in stock, central excise liability was not incurred and consequently the addition of excise duty made by the assessing officer to the value of the excisable goods was liable to be deleted.

13. In the result, the question raised in this appeal is answered in the affirmative i.e. in favour of  the assessee and against the revenue.

14. The appeal is disposed off accordingly with no order as to costs.

Discussions to this article

[CA GOPALJI AGRAWAL]

With great regard to Kothariji, I am totally disagreement with the view due to following reasons:

1. It is a deviation from the Accounting Standard 2 as notified under Companies Act, read with the guidance note (revised) on Accounting of Excise duty issued by ICAI.

2. It is again a departure from AS-29 since it is a liability for which provision has to be made.

3. The Supreme Court in the case of Wallace Flour Mills Co. Ltd. vs. CCE [1989 (44) ELT 598] summed up the legal position as  under:

    “It is well settled by the scheme of the Act as clarified by several decisions that even though the taxable event is the manufacture or production of an excisable article, the duty can be levied and collected at a later stage for administrative convenience. The Scheme of the said Act read with the relevant rules framed under the Act particularly Rule 9A of the said rules, reveals that the taxable event is the fact of manufacture or production of an excisable article, the payment of duty is related to the date of removal of such article from the factory.”

 

Supreme Court in another case, viz., CCE vs. Vazir Sultan Tobacco Co. [1996 (83) ELT 3] held as under:

“We are of the opinion that Section 3 cannot be read as shifting the levy from the stage of manufacture or production of goods to the stage of removal. The levy is and remains upon the manufacture or production

alone. Only the collection part of it is shifted to the stage of removal.”

4. FRRB of ICAI has also taken quiet negative view on excluding the excise duty from inventory. (Page no 14 of "A study of the compliance of financial reporting requirements" by giving the reference of AS-2 and Guidance Note. 

 

[Niral Shah]

Respected Sir,

 

1) In case of  Excise duty as per S: 3 is LIEVED on manufacture but for convinience  collected on clearance.

Constitutional right of excise duty is based on the fact that there should be MANUFACTURE.(Not clearance nor sale)

So just take a situation where it was lieved as well as collected on manufacture.

In that case closing stock of finished goods being manufactured would have been DUTY CHARGED AND PAID and thus such excise expense would have been included in  " BRINGING GOODS TO SUCH CONDITION AND LOCATION."

But just because excise department is so kind to collect duty on clerance, It shall not be taken other way.

ALSO Excise department would take each penny of excise even when goods are stolen or distributed as commercial samples....Its strange but we need to [pay excise duty in any case whatsoever may happen to goods.

 

Unless goods are pilferaged and damaged in front of Assesing officer. So it is clear that whatever the goods may be done to, it is now inevitable to NOT pay duty on such fnished goods.

It is inevitable cost...or jokingly take it as sunk Cost ( Though not incurred, but excise dept is not going to forgive it).

 

So not supporting view of HONOURABLE SUPREMEN COURT, that it is" not a cost in brining goods top present location......"

2) ALSO as per s: 211 of co. act., we need to give true and fair view.....and make goods on accrual basis.

So this cost is already accrued......So we need to take it inorder to avoid violation of such section.

 

3) Now AS-2 even states as COST OR NRV whichever is less......The purpose behind the same is that the QUALITY of goods, if found improper or market dull then we need to take lower of value.

But definition of NRV is

"Net realisable value is the estimated selling price in the ordinary course of

business less the estimated costs of completion and the estimated costs

necessary to make the sale."

 

MCA Sites AS-2 as recommended by NACAS states"

NRV:

The cost of inventory may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling price have declined. The cost of inventory may also not be recoverable if the estimated costs of completion or estimated costs neccessary to make sale have increased."

Estimated cost to sale which we will deduct from above Selling price includes administration and S&D and other charges which are debited to P&L A/c, but not Excise which is manufacturing expense debited to Trading account.

 

So while calculating NRV we include excise in its calculation, and compare with COST.

So in order to compare 2 Things, they should constitute equall elements.....MEANING thereby, if NRV includes excise, COST shall also include Excise....

 So in this view as extension, Closing stock of finished goods shall contain ECISE element by way of making provision.....

 

I think i was able to convey what i meant. Please forward any arguments or correct me if i am wrong. You can even mail me in case of any point from your side on [email protected].

[DEV KUMAR KOTHARI]

I am glad to read comments of  CA Shri Gopal ji Agarwal and Shri Niral Shah. Both are correct on the point discussed by them.I am sorry for delay in replying.

No doubt on  event of manufacture, liability for excise duty is attracted.  This has also been considered by the Supreme Court.

However, my article and appended and analyzed judgments concern provisions of  Income-tax Act sections 28, 29, 43B, 145 and 145A  in particular. The title of article itself is " Excise duty to be included in value of closing stock only if related excise duty has been debited in accounts- matching principal to be followed- a discussion in view of recent judgments".

As per discussion in article and judgments referred to therein, AO while computing taxable income can disallow excise duty, only if the same in included in the cost of stock computed for the purpsoe fo P & L account and inventory valuation in P & L A/c.

If the duty is not included in cost of stock, then addition cannot be made for duty payable in respect of stock which is cleared after end of previous year.

If duty is included in stock valuation, then unpaid duty will be added back and duty actually paid before due date will be allowed, Rest will be allowed in year of actual payment.

 

If in accounts, excise duty is not debited, (say company make a disclosure about liability by way of notes, or in a case AS is not applicable) then it cannot be disallowed or added in valuation of stock for computing taxable income by applying S. 145A.