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TMI Blog1987 (9) TMI 81X X X X Extracts X X X X X X X X Extracts X X X X ..... ge in the method of valuation of the closing stock, the value of the closing stock got reduced by Rs. 9,03,819.34p. The IAC (Asst.) recorded the aforesaid change in the method of valuation as bona fide, and, therefore, accepted the closing figure as per declaration of the assesses. The IAC (Asst.), however, felt that in order to arrive at the correct figure of total income of the assessee, the figure of the opening stock of the securities should also be adjusted on the principle of cost or market value whichever is lower. He, accordingly, worked out the valuation of the opening stock on the basis of cost or market price whichever was lower and found that on that principle the figure of the opening stock should go down by Rs. 2,88,500. The above sum of Rs. 2,88,500 was, therefore, reduced by the ITO from the reduction in the closing stock figure of Rs. 9,03,819.34p. It naturally resulted in the corresponding increase in the total income of the assessee. 3. In support of the above action the IAC (Asst.) relied on the following judgments : (i) CIT v. Ahmedabad New Cotton Mills Co. Ltd. [1930] 4 ITC 245 (PC) ; (ii) K.G. Khosla Co. (P.) Ltd. v. CIT [1975] 99 ITR 574 (Delhi). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to what should be done when the assessee was adopting a change in the system of accounting with regard to the valuation of the closing stock. Referring to the judgment of the Hon'ble Supreme Court in the case of Chainrup Sampatram, the learned D.R. again pointed out that the question before their Lordships in that case was also not as to what should be done when change in the system of account is permitted and closing stock is allowed to be valued on a certain principle, whether in such a case, opening stock should or should also be revalued on the basis of the valuation of the closing stock, was not for the consideration of their Lordships and, therefore, it cannot be said that their Lordships of the Supreme Court had disapproved the proposition laid down by their Lordships of Privy Council in the case of Ahmedabad New Cotton Mills Co. Ltd. In support of the proposition that the same principle should govern the valuation of the opening stock and closing stock in a given year, in order to find out the real profit of the assessee, the learned D.R. relied upon the following orders of the Tribunal : Goodlass Nerolac Paints Ltd. v. IAC [1985] 13 ITD 270 (Bom.), Sandvik Asia Ltd. v. ITO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... authority for the proposition that even when there was a; bona fide change in the method of accounting of the valuation of the closing stock, the opening stock must also be valued on the same principle as the closing stock. 8. The learned counsel for the assessee drew support for his case from the following authorities of the Hon'ble Madras High Court in Indo Commercial Bank Ltd. v. CIT [1962] 44 ITR 22 and CIT v. Carborandum Universal Ltd. [1984] 149 ITR 759. It was pointed out to us that at page 765 the Hon'ble Madras High Court had taken note of the judgment of the Privy Council in the aforementioned case reported in 4 ITC 245 and had yet held that it would not be correct for the ITO to value the opening stock also on the same principle at which the closing stock was valued, when the assessee was seeking to change the method of valuation. In that case our attention was invited to the following observation of their Lordships at page 765 : " The main contention of the revenue in this case is that the change in the method of valuation of the stock should be applied both to the opening stock as well as closing stock, which alone will indicate the true or real profits as has bee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of Indo-Commercial Bank Ltd. 9. We have given our careful consideration to the facts of the case and rival submissions. There is merit in the submission of the assessee's learned counsel that the issue before us is directly and squarely covered by the ratio of the judgment of the Hon'ble Allahabad High Court in the case of Ram Luxman Sugar Mills. There too the dispute was, whether the opening stock could be revalued on the same principle at which the closing stock had been valued. The accounting period of the assessee in that case ended on 30th September, 1949. For the earlier assessment year, i.e., for assessment year 1948-49, for which the relevant previous year closed on the 30th September, 1947, the closing stock of ,sugar was valued by the assesses at market rate at a figure of Rs. 5,39,874. The same amount was shown as value of the opening stock in the relevant previous year, beginning from 1-10-1947 and ending on 30th September, 1948. For the purpose of computing the profits for the assessment year 1949-50, the assessee chose to value his closing stock at the end of the previous year on 30th September, 1948 at cost instead of market rate. In the assessment proceedings t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case, as to in what form the question referred to the Hon'ble High Court in Ram Luxman Sugar Mills' case was framed. The crux of the problem in either situation is the same, namely, whether when the method of valuation of closing stock is changed in a bona fide manner, the same principle of valuation as adopted for the closing stock, should also simultaneously be applied to the valuation of the opening stock. To this question, their Lordships gave a categorical reply that it could not be done. The reasoning of their Lordships was as follows : " The answer to the question referred to us is very plain from the principles recognised by a Bench of this Court in the case of Ram Swarup Bengalimal v. CIT. In that case also, the question that came up for consideration related to the method of valuation of opening and closing stocks. This Court held : ' Two principles have now become well settled : (1) that the assessee is entitled to value the closing stock either at cost price or market value, whichever is lower, and (2) that the value of closing stock must be the value of opening stock in the succeeding year, that is, an assessee cannot close his accounts and value his stock at a p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e date of making up accounts, if that value is less than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect if prices rise again, of attributing to the following year's result a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question." Their Lordships then explained that : " While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as an established rule of commercial practice and accountancy. As profits for income-tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments unrealised profits in the shape of appreciated value of goods remaining unsold at the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he appreciated value of the unsold goods. It will thus be seen that no question of charging the appreciated value of closing stock as " notional profits " can really arise. Their Lordships also explained that it was a misconception to think that any profit ' arises out of the valuation of the closing stock ', that is in fact not the true purpose of bringing the value of the closing stock into the trading account. 13.1 From the aforesaid judgment of the Hon'ble Supreme Court, the following points clearly emerge : (i) That the true purpose of valuing the stock and bringing it in the accounts, both at the beginning of the year and at the end of the year, is not to bring into charge any profits, arising out of the valuation of the closing stock. Its mere purpose is to neutralize in the accounts, the entries regarding the purchases which have earlier been debited, but large part of which remained in hand and have not been sold at the end of the accounting period. The profit arises from purchases and sale and not from the holding of the stock. (ii) To this principle, as explained by their Lordships, there is one exception, namely, that anticipated losses can be brought into accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... distortion in course of time will cancel each other out and that was the purpose of insisting that the closing stock of one year should be the opening stock of the following year, for, that way alone the distorted picture of 1921 would, according to their Lordships, be rectified. Their Lordships of the Hon'ble Madras High Court have brought into sharp focus the above principle enunciated by their Lordships of the Hon'ble Supreme Court reported as Carborandum Universal Ltd.'s case at page 766. Their Lordships of the Hon'ble Allahabad High Court also emphasised this point when they held that the closing stock of one year should be the opening stock of the following year. 14. With regard to the aforesaid insistance, namely, the closing stock of one year should be the opening stock of next year, the aforesaid judgments do make a departure from the implications (not the principle explicitly stated) of the facts and ratio of the Privy Council judgment in the case of Ahmedabad New Cotton Mills Co. Ltd. In that case their Lordships had directed that the opening stock figure should also be revalued to remove the element of under-valuation, because the under-valuation of the closing stock ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the similar under-valuation of the opening stock. Derivation of a general principle of uniform applicability will not in the circumstances be justified. 16. The judgment of the Hon'ble Delhi High Court, relied upon by the learned departmental representative, K.G. Khosla Co. (P.) Ltd.'s case, also does not help the department's case, for, there also the question for determination was not as to whether the opening stock should be revalued, if change in the system of valuation of the closing stock was contemplated, but in that case also the method of valuation of the stock was the same both with regard to the opening stock and the closing stock, namely, the cost price. But while the opening stock was worked out with reference to the cost price plus customs duty and charges, the value of the closing stock was worked out only on the basis of cost price, ignoring the customs duty and the charges. This distortion in the valuation (the method of valuation remaining the same, for both the opening and closing stock) was removed by the income-tax authorities in that case and it was held to be justified. In the present case, we are not concerned with such a situation. Here the assessee is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able value from year to year. During the relevant year the company changed its method of valuing closing stock from the aforesaid method to the last in first out (LIFO) method on the ground that this method produced a more realistic statement of earnings in view of spiralling inflation. The revaluation of the closing stock resulted in a reduction of closing stock of Rs. 58,46,535 compared to the figure of closing stock if the earlier method had been followed. Rejecting the assessee's grounds for adopting the aforesaid change in the method of valuation the IAC added the sum of Rs. 58,46,535 to the assessee's total income. On second appeal, while the Judicial Member held that the addition of the impugned sum was not justified, the Accountant Member held that the assessee was not entitled to change over to the LIFO method and, therefore, the addition was justified. On reference to the Third Member, it was held that the assessee could change its method of valuation from the earlier one, followed by it to the LIFO method, but the Hon'ble Third Member held that, " If for one year he changes the method of stock valuation, the profit of that year has to be recomputed by either revaluing th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that will get adjusted in course of time as the new method of valuation of stock is going to be applied on a permanent basis year after year.On a due consideration of the matter, we are inclined to agree with the view of the Tribunal." Even their Lordships of the Hon'ble Supreme Court had, as noted earlier, visualised the above situation and illustrated it by a specific example discussed by us at great length above, while explaining the ratio of Chengalvaraya Chetti. Their Lordships observed, inter alia, as below : " Thus, while the valuation of the unsold stock at the end of each year at market rate which was less than cost was accepted, the valuation of the unsold goods carried over as opening stock of 1921 at Rs. 6 a piece consistently with their valuation as the closing stock of 1921 was insisted upon in order to rectify the distorted picture of the trading results of 1921, which were not correctly reflected in the accounts by reasons of the assessee having adopted the lower market rate instead of cost as the value of the closing stock in 1921." The principle of real income being reflected as a result of the valuation of the stock was negatived by their Lordships who them ..... X X X X Extracts X X X X X X X X Extracts X X X X
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