I.T.A. NO.1727/KB OF 1986-87, DECIDED ON 27TH APRIL, 1992. VS I.T.A. NO.1727/KB OF 1986-87, DECIDED ON 27TH APRIL, 1992., 1993 PTD-INCOME-TAX-APPELLATE-TRIBUNAL-PAKISTAN 1134 (1992)

Income Tax Ordinance (XXXI of 1979)---

---S. 32---Method of accounting---Change by assessee--Effect---Assessee can change his method of accounting or valuation of stock but if it is proved that any change in method of accounting has been effected with mala fide intention to prejudice the interest of Revenue or has rendered the accounts inaccurate so that true profits and gains cannot be ascertained from such accounts, then the I.T.O. can interfere---Held, where, however, no change in method of valuation of stock was permitted in immediate two preceding years and also in the two succeeding years, it would create confusion if the assessee was allowed to change the method of valuation for this year only.

Method of valuation of stock is directly related to the method of accounting within the meaning of section 32 of the Income Tax Ordinance, 1979, as no correct picture of P & L Account can emerge if the opening stock and closing stock are valued differently. The method of valuation of stock is at any rate an integral part of the method of accounting known as the mercantile system of accounting, therefore, any change in valuation in the method regularly employed by the assessee would definitely be subject to scrutiny of the I.T.O. and if the I.T.O. is of the opinion that profits and gains cannot be properly ascertained due to change in method regularly employed by the assessee then he can refuse to accept the change in method of valuation of stock or indirectly the change in method of accounting. In case of adoption of method of accounting it is the assessee and not the department which has the choice in terms of section 32 of the Ordinance and the Income Tax Officer can interfere only when such change is likely to prejudice the interest of the department or the change in method of accounting is such that true income, profits and gains cannot be truly deducted therefrom. The department is bound to accept the choice of the assessee in the matter of adoption of method of accounting or any change therefrom subject to condition laid down above.

An assessee can follow any method of accounting subject to subsection (2) of section 32 if the same is regularly followed and true profits, income and gains can be deducted therefrom.

The method of valuation of stock is also an integral part of the method of accounting and the valuation of closing stock would also be deemed to be part of the method of accounting.

The assessee would be permitted to change his method of accounting or valuation of stock, but if it is proved that any change in method of accounting was effected with mala fide intention to prejudice the interest of Revenue or has rendered the accounts inaccurate so that true profits and gains cannot be ascertained from such account>> then the I.T.O. can interfere.

Following is the summary of principles:--

(i)The assessee is entitled to value his closing stock it whatever regularly employed method, but the value of the closing stock must be the value of the opening stock in the succeeding years;

(ii)the assessee is also to follow a specific procedure prescribed under any law for the maintenance of books of accounts or method of accounting; and

(iii)the deviation from regularly employed method of accounting is permissible if it is proved to the satisfaction of the assessing officer that such change has been made with bona fide intention, not intended to evade taxes and such change is not for a casual period.

The assessee is entitled to change the method of accounting provided same is done with bona fide intention, not intended to Ode taxes and such change is not for a casual period.

In the present case, however, the Departmental Representative pointed out that in two preceding years i.e. 1982-83 and 1983-84 the change in method of valuation of stock was not allowed by the assessing officer and also the fact that in two succeeding years i.e. 1985-86 and 86-ti7 the assessee was following the same method and no change was permitted by the assessing officer, therefore, if change in method of valuation 'of stock was allowed in the year under discussion then it would affect the accounts relating to assessment year 1985-86, because the closing stock of this year would be taken as the opening stock of the assessment year 1985-86. 1n earlier years no doubt appeals were filed but the issue of valuation of stock was not pressed and about succeeding years this issue was set aside by the C.I.T. (A) but the I.T.O. had followed the same method of valuation of closing stock and no appeals were filed against that order of the I.T.O.

Held, since no change in method of valuation of stock was permitted in immediate two preceding years and also in the two succeeding years, therefore, it would create confusion if the assessee was allowed to change method of Valuation for this year only. Therefore, notwithstanding the principles stated above the contention on this point was accepted by the Tribunal, the order of the C.I.T. (A) was vacated and. that of the I.T.O. was restored on this point.

(1965) 11 Taxation 176; Ramaswarup Bengalimal v. C.I.T., U.P. & V.P., Lucknow (1954) 25 ITR. 17 and Indo Commercial Bank Ltd. v. CIT, Madras (1962) 44 ITR 22 ref.

Khalid Siddiqui, D.R: for Appellant. M.D. Gangat, I.T.P. for Respondent.

Date of hearing: 16th March, 1993.

ORDER

SYED KABIRUL HASAN (JUDICIAL MEMBER).---In this departmental appeal relating to assessment year 1984-85, the main grievance of the department is against the directions of learned C.I.T. (A) to value the closing stock at lower of the average cost and net realisable value for the purpose of adjustment of opening stock.

2. The brief facts necessary for the disposal of this appeal are that during the assessment year the assessee changed the method of stock valuation from realisable market price to lower of average cost and net realisable value at this change in valuation was not accepted by the I.T.O. because of the fact that the assessee was following the method of valuing the closing stock at net realisable value for so many years and this change was certainly made without consent of the I.T.O. and according to I.T.O. change in valuation had considerably reduced the profit margin. The I.T.O., therefore, did not allow the change in valuation of closing stock and made an addition of Rs.1,60,65,194 in the trading account. The learned C.I:T. (A) did not agree with the I.T.O. and directed him, on appeal preferred by the assessee to accept the method of valuation of stock adopted by the assessee.

3. In support of this appeal, the learned D.R. has contended that the method of valuation of stock is a part of accounting system and, any change in valuation should be in accordance with the changes permissible in method of accounting and the assessee cannot be permitted to change invariably his 1993 method of valuation. i n short there must be consistency in the valuation of stock. In reply the learned A. 1z. has contended as follows:

(i)The assessee changed the method of valuation of stock in this year because of the fact that there was change in accounting procedure prescribed by International Accounting Standard (in short known as I.A.S.). This change by [A.S. Is binding on the assessee-company in view of section 234 of the Companies Ordinance, 1984;

(ii)there is no binding on the assessee that he should not change his method of valuation unless it is done with mala fide intention and is not regular in support of above he has relied on a case-law reported as (1965) 11 Taxation 176.

4. Before dilating upon the factual controversy it would be pertinent to reproduce the relevant findings of the I.T.O. and the learned C.I.T. (A) on this issue. The I.T.O. has observed while dealing on this issue as under:

"Valuation of closing stock.

Note No.1.6 at page No.15 of the Annual Report indicates that the stock of sugar has been valued at average cost price or realisable value whichever is less. Excepting assessment years 1983-84 and 1982-83, the assessee-company used to value closing stock at sale price.

For this year however, value of closing stock has been taken at average cost price. The valuation based on average cost price has reduced the income of the assessee considerably. This aspect has also been dealt with in the assessment order for the earlier year. The deviation made by the assessee to value the closing stock at average cost price as against the sale price/realisable value taken for so many years is found as deviation from consistent system of valuation of closing stock followed for several years which has resulted in reducing the profit of the assessee for the year under consideration and as such the Government's revenue is affected adversely.. According to normal accounting procedure and rules regarding valuation of stock, it is held in various judicial pronouncements that the valuation of stock should be based on uniform basis year to year. The uniformity of policy of valuation of stock has not been followed by the assessee for which no satisfactory explanation has been offered. The undervaluation in closing stock made by the assessee is therefore disallowed. The closing stock of finished sugar of 8,071.85 M.T ons valued at realisable price of Rs.6,801 per M.T on will yield value of finished sugar at Rs.5,49,00,688 '"' as against value declared at Rs.4,88,29,275. This will therefore result in undervaluation in closing stock at Rs.60,71,413. Addition to the declared value of closing stock for these reasons was made during the last year at Rs.2,21,36,607 which on principles stands added to the value of opening stock of this year. The assessee has claimed set off of this addition of Rs.2,21,36,607. The addition worked out for this year on account of undervaluation of the closing stock amounts to Rs.60,71,413 only and accordingly set-off allowable for revalution of closing stock for the year under consideration will stand as under:

On the basis of working given above, the income of the assessee, for the year under consideration will stand reduced by a sum of Rs.1,60,65,194."

The learned C.I.T.(A) has observed on this issue as under:

"Regarding the issue dealing with stocks valuation and as raised in Ground No.3, it has been explained that in the income year relevant to assessment year 82-83 the appellant changed the basis of stock valuation from the realisable market price (Government fixed price) to lower of average cost and net realisable value. The I.T.O. however did not approve of this change and adjusted the stock valuation at market price instead of the lower of the average cost and net realisable value as disclosed by the appellant in the statement of accounts. It has also been pointed out that in this very case no doubt appeals have been filed for the earlier years i.e. 1982-83 and 1983-84 but due to oversight this issue was not pressed and as each year is an independent year the appellant thinks that it has right to raise and press this issue in the assessment year 1984-85.

After relying on various facts and figures and also judicial decisions it has been claimed that the presumption of the I.T.O. that the appellant has no right to make a change in the regular method of valuation of stock in trade is not justified taking into consideration the international accounting standards which require that inventories should be valued at lower of average cost and net realisable value. Therefore, taking into consideration the international accounting standard and various judicial decisions the I.T.O. should be directed to take the closing stock of sugar at lower of cost and not realisable value.

After scrutiny of records and going through the various facts and taking into consideration the case-laws that have been quoted by the learned counsel I find that the claim of the appellant is justified. The action of the I.T.O. in valuing the closing stock and opening stock to be taken into consideration for the subsequent year is accordingly set aside. The I.T.O. is directed to take the valuation of the stock at lower of the average cost and net realisable value for the purpose of adjustment for opening stock."

5. After having necessary facts before us, we would like to observe that method of valuation of stock is directly related to the method of accounting within the meaning of section 32 of the Income Tax Ordinance, 1979, as no correct picture of P & L account can emerge if the opening stock and closing stock are valued differently. The method of valuation of stock is at any rate an integral part of the method of accounting known as the mercantile system of accounting, therefore, any change in valuation in the method regularly employed by the assessee would definitely be subject to scrutiny of the I.T.O. and if the I.T.O. is of the opinion that profits and gains cannot be properly ascertained due to change in method regularly employed by the assessee then he can refuse to accept the change in method of valuation of stock or indirectly the change in method of accounting. We would also like to observe that in case of adoption of method of accounting the assessee and not the department which has the choice in terms of section 32 of the Ordinance and the Income Tax Officer can interfere only when such change is likely to prejudice the interest of the department or the change in method of accounting is such that true income, profits and gains cannot be truly deducted therefrom. In view of this it appears that the department is bound to accept the choice of the assessee in the matter of adoption of method of accounting or any change therefrom subject to condition laid down above. It would be pertinent to reproduce section 32, which reads as under:

"32.Method of accounting--(1) Income-profit and gains (except income from dividends) shall be computed for purposes of sections 17, 19, 22, 27 and 30 in accordance with the method of accounting regularly employed by the assessee.

(2)Notwithstanding anything contained in subsection (1), the Central Board of Revenue may, in the case of any business or profession, or class of business, or profession, o: any other source of income or any class of persons---

(a)require, by a general or special order published in the official Gazette that the accounts shall be maintained in such form and in such manner as may be prescribed; and

(b)prescribe the manner in which payments of commercial nature shall be made or commercial transactions recorded,

and thereupon, the income, profits and gains of assessee shall be computed on the basis of the accounts or records maintained or payments made accordingly.

(3)Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income 'fax Officer, the income, profits and gains cannot be properly deducted therefrom, or where in any case to which subsection (2) applies, the assessee fails to maintain accounts, make payments or record transactions in the form or manner, as the case may be, prescribed under the said subsection then the income, profits and gains of the assessee shall be computed on such basis and in such manner as the I.T.O. thinks fit."

From the bare reading of above section it would appear that an assessee can follow any method of accounting subject to subsection (2), if the e same is regularly followed and true profits,income and gains can be deducted therefrom.

6. As we have already observed that the method of valuation of stock is also an integral part of the method of accounting and in support of this view we would like to refer a case reported as (1954) 25 I.T.R 17, wherein it is held that the valuation of closing stock would also be deemed to be part of the method of accounting. .

7. In view of the above, we do not subscribe to the view presented by the learned D.R. that the assessee would not be permitted to change his method of accounting or valuation of stock, but we agree with the contention that if it is proved that any change in method of accounting was effected with mala fide intention to prejudice the interest of revenue or has rendered the accounts inaccurate so that true profits and gains cannot be ascertained from such accounts, then the I.T.O. can interfere.

8. Now having the above proposition of law before us we refer to submission of the learned A.R. of the assessee. The learned A.R. has submitted that there was change in international accounting standard and the companies were directed to value the inventories at the lower of historical cost and net realisable value. A copy of the report of International Accounting Standards Committee has been produced before us for examination and in this report it is mentioned in para. 20 as under:---

"20.Inventories should be valued at the lower of historical cost and net realisable value."

The learned A.R. has invited our attention to section 234 and has emphasised that the assessee being a listed company has to follow the International Accounting Standard and other standards as notified by the Corporate Law Authority, therefore, any change effected by the assessee was permissible under the Companies Ordinance and the .ITO was not justified to refuse the change in method of valuation of closing stock effected by the assessee.

10. In order to understand the viewpoint of the learned A.R. it would be pertinent to reproduce the section 234, which is as under:

"234. Contents of balance-sheet.---(1) Every balance-sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of its financial year, and every profit and loss account or income and expenditure account of a company shall give a true and fair view of ,the profit and loss of the company for the financial year so, however that every item of expenditure fairly chargeable against the year's income shall be brought into account and, in case there were any item of expenditure which may in fairness be distributed over several years has been incurred in any one financial year, the whole amount of such item shall be stated, with the addition of the reasons why only a portion of such expenditure is charge against the income of the financial year.

(2)The balance-sheet and profit and loss account or the income and expenditure account shall,---

(i)in the case of a listed company, comply with the requirements of the Fourth Schedule so far as applicable thereto; and .

(ii)in the case of any other company, comply with the requirements of the Fifth Schedule so far as applicable thereto:

Provided that, except to the extent otherwise notified in the official Gazette by the Authority, this subsection shall not apply to an insurance or banking company or to any other class of companies for which the requirements of balance-sheet and profit and account are specified in the law regulating such class of companies.

(3)Subject to the provisions of this, Ordinance in the case of a listed company---

(i)such International Accounting Standards and other standards shall be followed in regard to account and preparation of the balance-sheet and profit and loss account as are notified for the purpose in the official Gazette by the Authority.

(Only relevant portion has been reproduced).

From the reading of above provisions it would appear that the contention of the learned A.R. for the assessee is correct because the listed companies under the Companies Ordinance, 1984 are to follow the International Accounting Standards and other standards which are notified by the Corporate Law Authority.

The case relied upon by the learned A.R. and reported as (1965) 11 Taxation 176 is also supporting the case of the assessee. In the said citation the word "regularly" used in section 32 (section 13 in the Repealed Income Tax Act) has been explained. On page 179 it is observed:

" .The word "regularly" has nowhere been explained. But certainly it is not synonymous with the word "perpetual" or "permanent". In our view it seems the intention underlying this expression is that if it appears that the assessee concerned means to adopt the changed method of accounting for the year under assessment as also for subsequent years at the relevant time then it cannot be contended that it would be a departure from the rule underlying the principal clause of section 13. The section does not indicate by an express language or by implication that the assessee is not permitted to adopt a changed method of accounting provided he does not mean to adopt such a changed course only for a casual period and he does not mean to evade collection of taxes. The proviso under section 13 is there to safeguard the interest of the department concerned. If by reason of such changed mode or method of accounting it becomes unintelligible to the ITO and if in his opinion the income profit and gains cannot properly be deduced therefrom then it will be in his discretion to make the computation upon such basis and in such manner as the ITO may determine."....

It is also observed on page 180 in the said citation as under:---

"It goes without saying that it is the assessee and not the department which has the choice on the method of accounting in terms of section 13 of the Income Tax Act, and the ITO can interfere only when it is likely to prejudice the interest of the department concerned and the changed method of accounting may not furnish proper materials upon which the income, profits and gains are to be ascertained. The, department seems to be bound by the choice of the assessee in the matter of changing the method of accounting subject to the conditions as indicated above ...."

It is further observed:

"We are, therefore, of the opinion that the Tribunal was not right in observing that, `The modification now wanted by the assessee would be a departure from the method of accounting and cannot be permitted under section 13 of the Income Tax Act.' The only test which would make a change in the method of accounting permissible is that it should be bona fide, not intended to evade taxes and that it should be intended to be employed regularly and not for a casual period."

11.Same is the view expressed in (1954) 25 ITR 17 Ramaswarup Bengalimal v. CIT, U.P. & V.P., Lucknow and (1962) 44 ITR 22. Indo Commercial Bank Ltd. v. CIT., Madras.

12.The upshot of the above discussion can be summarised as follows:---

(i) .The assessee is entitled to value his closing stock at whatever regularly employed method, but the value of the closing stock must be the value of the opening stock in the succeeding year;

(ii)the assessee is also to follow a specific procedure prescribed under any law for the maintenance of books of accounts or method of accounting; and

(iii)the deviation from regularly employed method of accounting is permissible if it is proved to the satisfaction of the assessing officer that such change has been made with bona fide intention, not intended to evade taxes and such change is not for a casual period. '

13. In view of the above we are of the opinion that the assessee is entitled to change the method of accounting provided same is done with bona fide intention, not intended to evade taxes and such change is not for a casual period. But the learned D.R. has pointed out that in two preceding years i.e. 1982-83 and 1983-84 the change in method of valuation of stock was not allowed by the assessing officer and also the fact that in two succeeding years i.e. 1985-86 and 1986-87 the assessee is following the same method and no change was permitted by the assessing officer, therefore, if change in method of valuation of stock is allowed in this year then it would affect the accounts relating to assessment year 1985-86, because the closing stock of this year would be taken as the opening stock of the assessment year 1985-86. The learned A.R. on this point has submitted that in earlier years no doubt appeals were filed but the issue of valuation of stock was not pressed and about succeeding years he has pointed out that this issue was set aside by the learned CIT(A) but the ITO had followed the same method of valuation of closing stock and no appeals were filed against that order of the I.T.O. Lastly he has submitted that from assessment year 1987-88 the assessee has been allowed to effect the change in method of valuation of closing stock. .

14. We have considered the contentions of the learned D .R. as well as the learned A.R. on this point and are of the view that since no change in method of valuation of stock was permitted in immediate two preceding years and also in the two succeeding years, therefore, it would create confusion if the assessee is allowed to change method of valuation for this year, only. Therefore, notwithstanding our above observations, we are in agreement with the contention of the learned D.R. on this point and we, therefore, vacate the order of the learned CIT(A) and restore the order of the ITO on this point.

15. Resultantly the Departmental appeal is allowed.

M.B.A./2353/T Appeal allowed.