Income-tax--

----Valuation of stock--Method of valuation adopted consistently and regularly must be accepted ---Assessee following one method in accounts and a different method for tax purposes only---Claim for loss based on national valuation of stock-in-trade only for tax purposes---Can be rejected ---Res judicata---Not applicable in income-tax matters---Fact that defective method of valuation of stock had been accepted in earlier years---Not a ground for not rejecting it in a later year---Income-tax Act, 1961, S.145.

Section 145(1) of the Income Tax Act, 1961, casts an obligation upon the Income-tax Officer to compute the income of an assessee falling under the head "Profits or gains of business or profession" as well as under the head "Income from other sources" in accordance with such method of accounting as is regularly employed by him. Valuation of stock-in-trade is a part of the method of accounting and a trader is permitted to value his trading stock at the end of each year at cost or market price, whichever is lower. If an assessee follows a particular method of stock valuation consistently year after year and draws his trading account on this basis, there can be no dispute that his taxable income will have to be computed accordingly. However, an assessee cannot be permitted to claim a national basis of stock valuation only for tax purposes without following and adopting the same in its books of account. The mere fact that this system has not been questioned in the past is no ground to say that it should be accepted all along.

The assessment of a bank for the assessment year 1982-83 had been completed and a loss of more than Rs.7 crores had been allowed. The Commissioner of Income-tax found that the loss on revaluation of shares and securities was never provided by the assessee-bank in its final accounts; but for arriving at the taxable income, it had deducted a national loss from the book profits by working out the difference between the book value of shares as shown in its final accounts and the market price as prevailing on the last day of the previous year. The Commissioner of Income-tax revised the assessment holding that the assessee-bank could not claim a loss which was not taken into account while preparing the final accounts, particularly when this loss related to notional revaluation of shares and securities. The Tribunal found that the loss arising on such revaluation had always been accepted by the Department in earlier years in completing the income-tax assessment of the bank. The, Tribunal cancelled the order of the Commissioner of Income-tax. On a reference:

Held, (i) that the Income-tax Officer was not bound by the method of stock valuation accepted by him in making the assessment in the earlier years;

CIT v. British Paints India Ltd. (1991) 188 TTR 44 SC fol.

(ii) that the assessee in this case had not valued its stock of shares and securities in its books of account in accordance with the method "cost or market price, whichever is lower". This was as an admitted position. A claim for loss based on a notional valuation of stock-in-trade only for tax purposes could not be permitted. The Tribunal was not justified in cancelling the order of the Commissioner of Income-tax and allowing the loss.

Chainrup Sampatram v. CIT (1953) 24 ITR 481(SC); Investment Ltd. v. CIT (1970) 77 ITR 533 (SC); State Bank of India v. CIT (1986) 157 ITR 67 (SC); State Bank of Travancore v. CIT (1986) 158 ITR 102 (SC) and Whimster and Co. v. IRC (1925) 12 TC 813 (C. Sess) ref.

JUDGMENT

AJIT K. SENGUPTA, J: --In this reference at the instance of the Revenue, the following questions have been referred by the Tribunal for the opinion of this Court under section 256 (1) of the Income-tax Act, 1961, for the assessment year 1982-83:

"(1) Whether, on the facts and in. the circumstances of the case, the Tribunal is justified in law in cancelling the order of the Commissioner of Income-tax under section 263 of the Income-tax Act holding that the case of State Bank of Travancore v. CIT (1986) 158 ITR 102 (SC) is not applicable to the facts of the present case?

(2)Whether, on the facts and in the circumstances of the case, the Tribunal is correct in law in holding that the notional loss in the investment trading (India) to the extent of Rs.7,45,35,029 by working out a difference between the book value of shares as shown in the final accounts and their market price as on the last date of the accounts, is admissible to be deducted from the book profits of the assessee- bank?"

The facts leading to this reference are as under:--

The assessee is a banking company. The assessment of the assessee bank was originally completed by the Inspecting Assistant Commissioner (Assessment), Range-III, Calcutta, on March 19, 1985, on a total income of Rs.2,57,59,020. Subsequently, the Commissioner of Income-tax initiated proceedings under section 263 of the Income-tax Act, 1961. The Commissioner found that, in completing the assessment of the assessee bank, the Inspecting Assistant Commissioner had allowed loss to, the extent of Rs. 7,45,35,029 on account of revaluation of shares and securities appealing under the heading "Investments" in the balance-sheet of the assessee-bank.

The Commissioner found that the loss or profit on revaluation is never provided by the assessee-bank in its final accounts; but, for arriving at the taxable income, it has deducted a notional loss from the book profit by working out the difference between the book value of shares as shown in its final accounts and the market price as prevailing on the last day of the relevant previous year. This, according to the Commissioner, was purely a hypothetical and/or contingent loss which was neither provided nor reflected in the books of account and the same was being claimed only for the purposes of income-tax assessment on notional basis. The Commissioner felt that since the taxable income has to be computed in accordance with the method of accounting consistently employed by an assessee, the assessee-bank could not claim a loss which was not taken into account while preparing the final accounts, particularly when this loss related to notional revaluation of shares and securities.

The Commissioner also observed that it was not possible in law to prepare final accounts by valuing the shares and securities on one basis and to claim a deduction in respect of loss on revaluation of shares and securities only in the course of income-tax assessment on another basis without reflecting the same in the final accounts. The Commissioner, therefore, set aside the assessment order passed by the Inspecting Assistant Commissioner and directed fresh assessment, to be made in accordance with law after giving an opportunity to the assessee-bank of being heard. The assessee appeared .to the Tribunal. 1n the course of hearing before the Tribunal, it was contended on behalf of the assessee that the investments held by the bank were its stock-in- trade and, for income-tax purposes, the assessee-bank was consistently valuing its investments at cost or market value, whichever is lower, although without reflecting the same in its final accounts. The Tribunal found that the loss arising on such revaluation has always been accepted by the Department in earlier years in completing the income-tax assessment of the bank. In this view of the matter the Tribunal held that the assessment order passed by the Inspecting Assistant Commissioner was neither erroneous -nor prejudicial to the interests of the Revenue within the meaning of section 263 of the Income tax Act, 1961.

The assessee-bank has been consistently following the mercantile system of accounting: Its final accounts are drawn up in accordance with the provisions of section 29 of the Banking Regulation Act, 1949. The stock ~of shares and securities has been shown by the bank in its final accounts consistently under the heading "Investments" and the method of valuation has been shown as "at cost or below cost". In other words, the assessee-bank does not value the shares and securities held by it as stock-in-trades "at cost or market value whichever is lower" for the purposes of preparing accounts under section 29 of the Banking Regulation Act, 1948.

It is an admitted fact that the investments in shares and securities are shown in the balance-sheet "at or below cost". The notes to the audited accounts as are relevant for the purposes of this reference read as under:

"7. (a) The Central Government has issued a notification exempting the bank from disclosing the market value of Government/trustee securities. Depreciation in the value of Government/trustee securities has not been fully provided for in the accounts.

(b) Book value has been taken as market value of investments in the cases where quotations are not available."

It is by now well-settled that the method of valuation of stock is part of the method of accounting followed by an assessee. Section 145(1) of the Income-tax Act, 1961, clearly provides that income falling under the heads "Profits or gains of business or profession" and "Income from other sources" should normally be computed in accordance with the method of accounting regularly employed by an assessee, if the assessee has maintained accounts. This section leaves it to the assessee to adopt any method of accounting. It obliges the Income-tax Officer to compute the income, profits and gains in accordance with such method of accounting as is regularly employed by the assessee if the profits can be properly deducted therefrom.

In Investment Ltd. v. CIT (1970) 77 ITR 533), the Supreme Court observed that a taxpayer is free to employ, for the purpose of his trade, his own method of keeping accounts and, for that purpose, to value his stock-in-trade either at cost or at market price. A method of accounting adopted by the trader consistently and regularly cannot be discarded by the Departmental authorities on the view that he should have adopted a different method in keeping accounts.

Learned counsel appearing for the assessee relied on the decision of the Supreme Court in Chainrup Sampatram v. CIT (1953) 24 ITR 481) in support of his contention that, in order to ascertain the true profits of a commercial person, the closing stock is permitted to be valued at cost or market price, whichever is lower, and even the notional loss arising on such valuation of closing stock is required to be deducted in computing the taxable profits.

There, the Supreme Court observed (at page 485) as follows:

"As pointed out in paragraph 8 of the Report of the Committee on Financial Risks attaching to the holding of Trading Stocks, 1991, `As the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure... From- this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the 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 results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question (extracted in paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to British Parliament in April 1951). While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock in 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 the 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 end of an accounting year and carried over to the following year's account in a business that is continuing are not brought into the charge as a matter of practice, though, as already stated, loss due to fall in price below cost is allowed even if such loss has not been actually realised. As truly observed, by one of the learned Judges in Whimstei & Co. v. Commissioners of Inland Revenue (1925) 12 TC 813, 827), `Under this law (Revenue law), the profits are the profits realised in the course of the year. What seems an exception is recognised where a trader purchased and still holds goods or stocks which have fallen in value. No loss has been realised. Loss may not occur. Nevertheless, at the close of the year he is permitted to treat these goods or stocks as of their market value."

There cannot be any dispute with the proposition laid down by the Supreme Court in the aforeasaid decision. The valuation of stock-in-trade is a part of the method of accounting and a trader is permitted to value his trading stock at the end of each year at cost or market price whichever is lower. If an assessee follows the aforesaid method of stock valuation consistently year after year and draws up his trading account on this basis, there can be no dispute that his taxable income will have to be computed accordingly. But, we fail to appreciate how an assessee can be permitted to value the stock in his books of account on one basis and to claim a different method of valuation solely for tax purposes, without adopting the same in his books of account and/or for the purpose of preparing his trading account and balance-sheet. If the assessee bank had followed the same basis of stock valuation both in writing up its books of account and in drawing up the trading account therefrom for income tax purposes as well, there would have been no difficulty in accepting the assessee's claim. But, in our view, no assessee can be permitted to claim a notional basis of stock valuation only for tax purposes without following and adopting the same in its books of account. Not only that, the fact remains that the assessee has adopted an entirely different method of stock valuation in its books of account and for the purposes of preparing its trading account and balance-sheet. In these circumstances, a claim for loss based on notional valuation of stock-in-trade only for tax purposes, in our view, cannot be permitted. The decision of the Supreme Court in Chainrup Sampatram (1953) 24 ITR 481) does not help the assessee in this respect which recognises the commercial accounting principle of permitting the stock valuation at the date of making the accounts on the principle "cost or market value, whichever is lower".

Learned counsel appearing for the assessee also drew our attention to another decision of the Supreme Court in State Bank of India v. CIT (1986) 157 ITR 67) in support of his contention that the way in which entries are made by an assessee in its books of account is not determinative of the question whether the assessee had earned any profit or suffered any loss and, therefore, the entries made by him cannot be regarded as conclusive one way or the other. There the Supreme Court observed as follows (at page 71):

"The important question to be considered is the true nature of the transaction and whether in fact it had resulted in profit or loss to the assessee. In that context, it is well-settled that the way in which entries are made by the assessee in its books of account is not determinative of the question whether the assessee had earned any profit or suffered any loss. The assessee might, by making entries which were not in conformity with the proper principles of accountancy, have concealed profit or showed loss and the entries made by him would not, therefore, be regarded as conclusive one way or the other."

There cannot be any controversy with this principle laid down by the Supreme Court time and again. But the position in this case is entirely different. Section 145(1) of the Income-tax Act, 1961, clearly lays down that income falling under the heads "Profits or gains of business or profession" as well as "Income from other sources" shall be computed in accordance with the method of accounting regularly employed by the assessee. The expression used in this section is "method of accounting regularly employed by the assessee". As indicated, stock valuation is part of the method of accounting. In other words, section 145(1) clearly casts an obligation upon the Income-tax Officer to compute the income of an assessee falling under the head "profits or gains of business or profession" as well as under the head "Income from other sources" m accordance with such method of accounting as is regularly employed by him. The method of accounting clearly postulates the method of book-keeping. There is nothing notional about it. An assessee keeping books on the mercantile basis cannot claim to be assessable to tax on cash basis. Since stock valuation is part of the method of accounting, an assessee is free to adopt any proper method of stock valuation provided the method is consistently and regularly followed by him. The said section, therefore, clearly postulates the valuation of stock to be made in maintaining and preparing accounts on a consistent basis year after year.

The assessee, in this case, has not valued stock of shares and securities in its books of account in accordance with the method "cost or market price, whichever is lower". This is an admitted position. If this method is not followed in writing and preparing accounts consistently, the assessee cannot claim a notional method of stock valuation only for computation of income by the tax authorities without following the same method in writing and preparing accounts. Section 145(1) of the Act, 1961, clearly goes against the submissions made on behalf of the assessee.

As we have indicated, the assessee's method of accounting as well as the system of stock valuation adopted by him consistently for the purposes of preparing his accounts has to be accepted by the tax authorities. The book results can be rejected by the tax authorities only if the method adopted by the assessee is either defective or if the system adopted does not disclose a proper and true income.

Our attention has been drawn to a decision of the Supreme Court in State Bank of Travancore v. CIT (1986) 158 ITR 102). There the Supreme Court held that income has to be computed on the basis of the regular method of accounting followed by the assessee and the income for tax purposes should not in any way be different from the income arrived at according to the regular method followed by the assessee. There, however, the Supreme Court was concerned with the question as to whether the interest on "sticky" advances which had accrued to the assessee according to the mercantile system of accounting and which had not been given up but credited to the "Interest Suspense Account" was assessable as the income of the assessee. This is not the case here in this case, the question is the method of valuation of stock-in-trade. The finding of the Tribunal was that the investment of the assessee was nothing but stock-in-trade and as such the assessee was required to follow the same method of accounting for income-tax purposes for the purpose of making its balance-sheet and trading account as well.

Our attention has also been drawn to a decision of the Supreme Court in CIT v. British Paints India Ltd. (1991) 188 ITR 44). In that case, the Supreme Court quoted the following observations of the Lord President in Whimster & Co. v. Commissioner of Inland Revenue (1925) 12 TC 80,823 (C Sess) (at page, 51 of 188 ITR):

" ....In computing the balance of profits and gains for the purposes of income-tax .... two general and fundamental common places have always to be kept in mind. In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income-tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower, although there is nothing about this in the taxing statutes..."

Thereafter, the Supreme Court held thus (at page 52 of 188 ITR):

"Where the market value has fallen before the date of valuation and on that date, the market value of the article is less than its actual cost, the assessee is entitled to value the articles at market value and thus anticipate the loss which he will probably incur at the time of the sale of the goods. Valuation of the stock-in-trade at cost or market value, whichever is the lower, is a matter entirely within the discretion of the assessee. But whichever method he adopts, it should disclose a true picture of his profits and gains. If, on the other hand, he adopts a system which does not disclose the true state of affairs for the determination of tax, even if it is ideally suited for other purposes of his business, such as the creation of a reserve, declaration of dividends, planning and the like, it is the duty of the Assessing Officer to adopt any such computation as he deems appropriate for the proper determination of the true income of the assessee. This is not only a right but a duty that is placed on the officer, in terms of the first proviso to section 145, which concerns a correct and complete account but which, in the opinion of the officer, does not disclose the true and proper income.

The correct principle of accounting is to enter the stock in the books of account at cost unless the value is required to be reduced by reason of the fall in the market value of those goods below their original cost. Ordinarily, therefore, the goods should not be written down below the cost price except where there is an actual or anticipated loss. On the other hand, if the fall in the price is only such as would reduce merely the prospective profit, there would be no justification to discard the initial valuation at cost.-

After referring to several decisions of the Supreme Court, the Supreme Court proceeded to hold as follows (at page 56 of 188 ITR):

"Section 145 of the Income-tax Act, 1961, confers sufficient power upon the officer nay it imposes a duty upon him to make such computation in such manner as he determines for deducting the correct profits and gains. This means that where accounts are prepared without disclosing the real cost bf the stock-in-trade, albeit on sound expert advice in the interest of efficient administration of the company, it is the duty of the Income-tax Officer to determine the taxable income by making such computation as he thinks fit.

Any system of accounting which excludes, for the valuation of the stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products, is likely to result in a distorted picture of the true state of the business for the purpose of computing the chargeable income. Such a system may produce a comparatively lower valuation of the opening stock and the closing stock, thus showing a comparatively low difference between the two. In a period of rising turnover and rising prices, the system adopted by the assessee, as found by the Tribunal, is apt' to diminish the assessment of the taxable profit of a year. The profit of one year is likely to be shifted to another year which is an incorrect method of computing profits and gains for the purpose of assessment. Each year being a self-contained unit, and the taxes of a particular year being. payable with reference to the income of that year, as computed in terms of the Act, the method adopted by the assessee has been found to be such that income cannot properly be deduced therefrom. It is, therefore, not only the right but the duty of the Assessing Officer to act in exercise of his statutory power, as he has done in the instant case, for determining what, in his opinion, is the correct taxable income.

The Tribunal's order, affirming that of the Assessing Officer, was based on findings of fact made on cogent evidence and in accordance with correct principles. The High Court was clearly wrong in interfering with those findings."

The Supreme Court thus reiterated in British Paints India Ltd. (1991) 188 ITR 44), that it is a well-recognised principle of commercial accounting to enter in the profit and loss account the value of stock-in-trade at the beginning and at the end. of the accounting year at cost or market price, whichever is lower. It is not permissible for any assessee to adopt a system of stock valuation notionally for income-tax purposes alone when such method is different from the one which has consistently been followed by it in preparing and presenting its final accounts.

The mere fact that this system has not been questioned in the past is no ground to say that it should be accepted all along. There is no estoppel in these matters as laid down by the Supreme Court in British Paints India Ltd. (1991) 188 ITR 44) and the Income-tax Officer is not bound by the method of stock valuation accepted by him in making the assessments in the earlier years.

Since stock valuation is admittedly a method of accounting, the assessee-bank can claim the benefit of stock valuation "at cost or market value, whichever is lower" only if such method is actually followed and adopted by him in preparing the final accounts. Without following this method in preparing the accounts, which are required to be prepared and presented under section 29 of the Banking Regulation Act, 1949, in the form set out in the Third Schedule thereto, the assessee-bank cannot be permitted to claim a loss on revaluation by claiming a different method of stock valuation notionally for income-tax purposes only.

For the reasons aforesaid, we answer both the questions in the negative and in favour of the Revenue. .

There will be no order' as to costs.

M.BA./2372/TQuestion answered in negative.