2013 (2) TMI 403 - HC - Income Tax

Undervaluation of profits by changing method of valuation of work in progress - CIT (A) allowed the appeal of the appellant but was reversed by ITAT - Applicability of AS-7 issued by ICAI - Held that - CIT (A) in his judgment has rightly held that change in the accounting system was bona fide after taking into consideration the facts in the present case. The ITAT however, while giving its reasons has clearly avoided to give any finding on this question of fact and as such, it cannot be said that ITAT had given any finding against the appellant on the question of bona fides of the appellant or had set aside the finding which was recorded by the CIT (Appeals). The submission made by revenue that this finding was confirmed by ITAT cannot be accepted. CIT(A) has rightly observed that since there was no sale of flats in the earlier assessment year, the appellant could have shown the said expenditure which was incurred, as loss and could have carried forward the loss in the next year. Secondly, it is admitted position that in the subsequent years, the appellant has been following AS-7 accounting system and the same was accepted by the AO. In fact thereafter, the Central Government has directed all the developers and builders to follow AS-7 accounting system. Taking into consideration the aforesaid facts, therefore, the ITAT has clearly erred in setting aside the order passed by the CIT(A). Thirdly the ratio of the judgment in the case of British Paints India Ltd (1990 (12) TMI 2 - SUPREME COURT) would strictly not apply to the facts of the present case as in the present case, however, the costs in fact were indirect costs namely financial costs, general administrative costs and marketing costs and, therefore, they had to be shared amongst three projects and had to be considered in the profit and loss account under AS-7 system. The ratio of this judgment, therefore, strictly speaking would not support the case of the revenue - in favour of assessee.

Summary

Issues:
Challenging judgment by ITAT on method of valuation of work in progress & applicability of Accounting Standard No.7 (AS-7).

Analysis:
The appellant, a construction company, challenged ITAT's decision on the valuation of work in progress for the financial year ending 31/03/1996. The appellant argued that they followed AS-7 system for valuation, which was accepted by the revenue post-2000. They contended that the change in valuation method was legitimate due to new projects and not to evade taxes. The appellant cited the Calcutta High Court judgment in Hela Holdings Pvt. Ltd case, supporting the permissibility of changing accounting methods. They highlighted the distinction between their case and the CIT Vs. British Paints India Ltd case, emphasizing the inclusion of financial, marketing, and administrative costs in their valuation method.

The revenue, however, claimed that the change in the accounting system was not bona fide and aimed at tax avoidance. They referred to the K. K. Jalan (HUF) case to support their argument. The appellant countered by citing the subsequent judgment in Hela Holdings Pvt Ltd case, supporting the permissibility of changing valuation methods. They also pointed out the notification by the Central Government mandating builders and developers to follow AS-7 system, which includes costs like financial, marketing, and administrative costs.

The High Court analyzed the arguments and found in favor of the appellant. They noted that the change in the accounting system was bona fide, considering the circumstances. The Court highlighted that the ITAT did not address this crucial fact and erred in setting aside the Commissioner of Income Tax (Appeals) order. The Court emphasized that the costs in question were indirect costs, unlike the trading costs in the British Paints India Ltd case, making the latter inapplicable to the present case. Consequently, the Court allowed the appeal, confirming the Commissioner of Income Tax (Appeals) order and setting aside the ITAT's decision.

In conclusion, the High Court allowed the appeal, answering the substantial question of law in favor of the appellant. The ITAT's decision was set aside, and the Commissioner of Income Tax (Appeals) order was confirmed, disposing of the appeal accordingly.