2024 (11) TMI 171 - HC - Income Tax

Constitutionality and legally of Income Computation and Disclosure Standards ICDS II and the Notification 87/2016 dated 29.09.2016 and Section 145A - as prescribed that the cost of inventories shall be computed by using the First In First Out (FIFO) or Weighted Average Cost method, to the exclusion of other methods relating to valuation of inventory, such as the Last In First Out (LIFO) method, while computing income under the head of Profits and Gains of Business or Profession under the Income Tax Act HELD THAT - It is not in dispute that FIFO, LIFO and Weighted Average Cost are methods recognised by the Accounting Standards for the purposes of Inventory/Stock valuation. As per those standards inventories are valued at the lower of cost or net realisable value, the latter term being a reference to 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. The principle behind valuing stock at the lower of cost or realisable value is that no prudent trader would care to show increased profit before its actual realisation and hence, while anticipated loss is taken into account, anticipated profit in the shape of appreciated value of closing stock is not brought into the account Chainrup Sampatram v. Commissioner of Income-Tax, West Bengal 1953 (10) TMI 2 - SUPREME COURT . The adoption of any particular method of stock valuation is towards ensuring that it reflects the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. Whatever be the method of valuation adopted, it is a misconception to think that any profit arises out of the valuation of closing stock. As noticed in Chainrup Sampatram (supra), the valuation of unsold stock at the close of an accounting period is a necessary part of the process of determining the trading results of that period, and cannot be regarded as the source of such profits. Thus, the issue canvassed in these appeals in the context of Article 14 of the Constitution, essentially boils down to whether the appellants herein can be said to be legally prejudiced, either on account of a law that is manifestly arbitrary or on account of any discrimination meted out to them through a validly enacted law. The term manifest arbitrariness, in the context of plenary or subordinate legislation, refers to something done by the legislature capriciously, irrationally and/or without adequate determining principle. It also takes in situations where something is done which is excessive and disproportionate Shayara Bano v. Union of India and Others 2017 (9) TMI 1302 - SUPREME COURT Can the amendment to Section 145A r/w the prescriptions under ICDS II, be seen as manifestly arbitrary in the light of the principles enumerated above ? - We think not. The ICDS II was issued with the objective of providing for a uniform method of inventory/stock valuation for assessees whose income was computed under the head profits and gains of business or profession , and Section 145A was amended so as to remove the basis of The Chamber of Tax Consultants ( 2017 (11) TMI 465 - DELHI HIGH COURT There was, therefore, a determining principle that informed both the statutory amendment and the ICDS II. It is also significant that the ICDS is applicable only for computation of income chargeable under the specified heads of income and not for the purpose of maintenance of books of accounts. Thus, while the assessees have the freedom to maintain their books of accounts using any of the methods recognised by the accounting standards, Section 145A only mandates that they shall follow the specified methods of inventory/stock valuation while computing their income under the head Profits and gains of business or profession . Aspect of discrimination - It is trite that there is no infringement of the equal protection rule if the law deals alike with all of a certain class, as the legislature has the right of classifying persons and placing those whose conditions are substantially similar under the same rule of law, while applying different rules to persons differently situated. It is only if the classification is unreasonable and bears no rational relation to the object sought to be achieved by the legislative measure that it will be struck down as discriminatory and unconstitutional Kerala Hotel Restaurant Association Others v. State of Kerala Others 1990 (2) TMI 259 - SUPREME COURT On the facts of the instant appeals, since the prescription in ICDS II, with regard to the method of valuation of inventory/stock, is applicable to all assessees whose income is chargeable to tax under the head Profits and gains of business or profession , we do not find any unreasonable classification as having been effected among persons who are similarly situated. Further, the prescription under the ICDS II being one that is directed towards achieving the object of uniformity and consistency in the computation of income of assessees falling under the specified categories, we fail to see how the same would offend the equality clause under the Constitution. As a matter of fact, we also fail to see what pre-existing right of the appellants has been taken away by the prescription imposed through the amended Section 145A of the IT Act read with ICDS notified under Section 145 (2) of the Act ? Surely, the appellants cannot be heard to contend that they have a right, fundamental or otherwise, to follow a particular method of inventory/stock valuation that would prevail over a contrary statutory prescription under the IT Act. At best, the appellants could have contended that for the period upto 01.04.2018, they had already valued their stock/inventory in accordance with the LIFO method and their vested right to do so in accordance with the law as it stood then could not be retrospectively taken away. We find, however, that this contention of the appellants was accepted by the learned Single Judge who declared the retrospective operation of the provisions w.e.f. 01.04.2017 to be bad in law, and the revenue has not chosen to impugn the said finding of the Single Judge in any appeal preferred by it before us. Thus, we find that the decision to amend Section 145A of the IT Act and make the ICDS II applicable to a certain category of assessees while computing their income for the purposes of the IT Act, was taken by the legislature after considering the opinions and recommendations of expert financial bodies. We therefore do not think it necessary to interfere with the findings of the learned Single Judge in the judgment impugned in these appeals - Writ appeal dismissed.

Summary

Issues Involved:

1. Constitutionality of Section 145A of the Income Tax Act, ICDS II, and Notification 87/2016.
2. Retrospective application of Section 145A.
3. Exclusion of LIFO method for inventory valuation.
4. Alleged discrimination and arbitrariness in the prescribed methods of inventory valuation.
5. Impact of legislative changes on established accounting practices.

Comprehensive Issue-wise Analysis:

1. Constitutionality of Section 145A of the Income Tax Act, ICDS II, and Notification 87/2016:

The appellants challenged the validity of Section 145A of the IT Act, para 16 of ICDS II, and Notification 87/2016, arguing they violated Articles 14, 19(1)(g), and 265 of the Constitution. They contended these provisions unconstitutionally restricted inventory valuation methods to FIFO or Weighted Average Cost, excluding LIFO, which disregarded established accounting principles. The court upheld the constitutionality of these provisions, indicating that legislative intervention can validly prescribe specific methods for income computation under the IT Act, especially when aimed at uniformity and consistency in tax assessments. The court emphasized that the legislative changes were made with a determining principle and did not constitute manifest arbitrariness.

2. Retrospective Application of Section 145A:

The appellants argued that the retrospective effect of Section 145A, introduced by the Finance Act, 2018, effective from 01.04.2017, was unjust, as it would apply different valuation methods to opening and closing stock within the same financial year, creating notional income. The Single Judge found merit in this contention, ruling that the retrospective application was invalid for the assessment year 2017-18, as it would disrupt the consistency required in stock valuation. The appellate court agreed with this finding, noting that the revenue did not challenge the Single Judge's decision on this point.

3. Exclusion of LIFO Method for Inventory Valuation:

The appellants contended that excluding LIFO from recognized valuation methods was arbitrary, as LIFO was an accepted accounting practice. They argued that the exclusion violated the principle of consistency in accounting and was not justified by any intelligible differentia. The court, however, noted that legislative bodies have the authority to prescribe specific methods for tax purposes, and the exclusion of LIFO was part of a broader policy decision aimed at standardizing tax assessments. The court found no arbitrariness in the exclusion, as it was based on a legitimate policy objective.

4. Alleged Discrimination and Arbitrariness in the Prescribed Methods of Inventory Valuation:

The appellants claimed that the mandatory use of FIFO or Weighted Average Cost methods resulted in discrimination, as it imposed an unequal tax burden on those previously using LIFO. They argued this classification lacked a rational basis and violated Article 14. The court rejected this argument, stating that the classification was reasonable and applied uniformly to all assessees under the specified tax category. The court emphasized that the legislative changes were intended to achieve uniformity in tax computation and did not infringe upon the appellants' rights.

5. Impact of Legislative Changes on Established Accounting Practices:

The appellants relied on past judicial precedents to argue that established accounting practices should be respected in tax assessments. They cited the Delhi High Court's decision in The Chamber of Tax Consultants case, which emphasized the importance of consistent accounting standards. However, the court noted that the legislative amendment to Section 145A addressed the issues raised in that case and provided a clear statutory mandate for inventory valuation methods. The court reiterated that legislative changes can override established practices if they are made with a legitimate policy objective.

In conclusion, the court dismissed the appeals, affirming the constitutionality of the legislative changes and the prescribed methods for inventory valuation. The court highlighted the importance of legislative freedom in economic policy and upheld the amendments as a valid exercise of legislative authority aimed at achieving uniformity and consistency in tax assessments.