Stock valuation: The amount pertaining to element of capital incentive or amount which stand diverted at source need to be excluded for valuation purposes- a discussion in view of recent Supreme Court judgment.

[C.A. DEV KUMAR KOTHARI]

Commissioner of Income-tax, Coimbator Versus Bannari Amman Sugars Ltd. 2012 (9) TMI 848 - SUPREME COURT

Ponni Sugars & Chemicals Ltd.(2008 (9) TMI 14 - SUPREME COURT )

CIT v. New Horizon Sugar Mills P. Ltd. 2002 (2) TMI 103 - SUPREME COURT

CIT v. Ambur Co-op. Sugar Mills Ltd. 2001 (8) TMI 1329 - SUPREME COURT

 

Types of stock held when incentive scheme was in force:

When an incentive by way of additional free quota of sugar is in force a sugar mill can have stock of sugar in the following categories:

a. Levy sugar say at levy price of sugar @ 2500/-  per quintal

b.  Free sugar (normal) which can be sold in open market and entire price is revenue receipt.

c.  Free ( additional quota) sugar which can be sold in open market. The price up to levy price say @ Rs.2500/- per quintal is revenue receipt and excess above that amount is capital  incentive element  which is capital receipt as per ruling of the Supreme Court in case of Ponnie Sugar.

Valuation of stock:

The generally accepted method of stock valuation is ‘cost or market price whichever is lower. There cannot be dispute that in case of levy sugar the levy price fixed by the government is market price. In case of free sugar the market price is the price prevailing on the last working day of the previous year. Therefore, one has to consider such market value and cost, and in case market value is lower than cost, then stock has to be valued at market value as it is lower.

In case of levy sugar (purchased by government at prefixed price) for distribution through public distribution system, ground reality was that levy price was usually lower than the cost. Therefore, the stock earmarked was to be valued at levy price.

In case of normal free stock the stock was valued at cost if it was lower than the market price.

In case of  additional free stock, the issue was that price realized over and above levy price was capital receipt,(granted by government by way of sacrificing its levy quota of sugar to mitigate hardship due to high capital cost of new or expanded sugar mills). Therefore, for computation of income stock under additional free quota be valued at levy price because any amount realised  above levy price is not income but capital receipt.

The revenue disputed this and valued additional free quota of sugar also in similar manner as normal free quota, that is at cost price.

Capital receipt:

The issue about capital receipt was  also disputed by revenue contending that extra amount realized was revenue receipt, however this was ultimately settled by the Supreme Court in the case of Ponni Sugar after considering purposes of incentive scheme.

Dispute as to valuation settled by the Supreme Court:

Inspite of accepting that extra price realized was capital receipt, the revenue still contended that in case of sugar stock under additional free sugar quota under incentive scheme should be valued at cost instead of at levy price, which was lower. The dispute went up to the Supreme Court and the Supreme Court decided the issue in favour of   the assessee, taking view that the price realized over and above levy price is capital incentive and not revenue receipt. Therefore, the element of capital receipt should not be considered as income by way of valuation of additional free sugar under incentive scheme.

Conclusion:

The purpose of stock valuation of the stock lying unsold on the last day of previous year is to ascertain taxable income by taking credit in form of valuation of stock to balance the costs debited in the account. The normal valuation rule is at cost or market price whichever is lower. The market price is to be determined in the sense of price which can be realized if the stock is sold in open market. However, when a part of stock is subject to prior obligations like sale to government under levy scheme, the price receivable will be levy price. Similarly some stock which is kept for sale against deals already executed at fixed price, the market value will be price fixed under contracts.

When under any scheme, a portion of price of product is considered as ‘capital receipt’ or is otherwise diverted at source for some other purposes, then such portion, not being income, cannot be considered as part of market value, because that element will not be revenue of assessee. In such cases, the portion of price which is revenue receipt of assessee shall only be considered as market value for the purpose of stock valuation.  In case capital element or element which represents receipt which is diverted at source before accrual is included in income by way of increased value of stock, the result would be that an amount which is not chargeable to tax as income being a capital receipt or an amount diverted at source would be considered as income merely because the stock remained unsold. In that case stock will be valued at amount which will include non taxable receipt. Stock valuation in a manner  which leads to treating capital receipt or receipt which is not income at all, as revenue will not be proper.    taxmanagementindia.com

Other situation in case of Sugar Mills:

In case of sugar mills in some states a certain portion of sale value of molasses is to be statutorily contributed to Molasses Reserve. Such contribution is diverted at source and is not income. Contribution to molasses Reserve is a statutory requirement and the amount stands diverted at source, before accrual as income. In the following cases the Supreme Court has affirmed case of diversion:

CIT v. New Horizon Sugar Mills P. Ltd. 2002 (2) TMI 103 - SUPREME COURT

CIT v. Ambur Co-op. Sugar Mills Ltd. 2001 (8) TMI 1329 - SUPREME COURT

Therefore, following the decision in case of Bannari Aman Sugar, molasses can also be valued at the portion of market value or stock price which is taxable as income and the amount that would have to be contributed to molasses reserve can be excluded from valuation of molasses stock to determine taxable income vis a vis closing stock also.

Recent  judgment of the Supreme Court in case of Bannari Amman Sugar:

Commissioner of Income-tax, Coimbator Versus Bannari Amman Sugars Ltd. 2012 (9) TMI 848 - SUPREME COURT