Gobind Sugar Mills Ltd. & Ors. vs Assistant Commissioner Of Income Tax.

All These appeals involve a common issue. Since the appeals were heard together, they are disposed of by a single order for the sake of convenience.

2. For the sake of convenience, we first take up the case of Bharat Sugar Mills Ltd. in ITA No. 1211 (Cal) of 1992. The appeal is directed against the order of the CIT passed under s. 263 of the Act. The asst. yr. 1987-88 for which the accounting year ended on 30th June, 1986. In this appeal we are concerned with the valuation of the closing stock of finished goods (sugar) and processed stock of sugar. The practice of the assessee for a very long period is to value the stock on "direct cost method". In respect of the asst. yrs. 1977-78 and 1978-79 there was an addition in respect of the valuation of closing stock of sugar, which was deleted by the Tribunal by order dt. 12th December, 1984 in ITA Nos. 1447 and 1448 (Cal) of 1992. In this order the Tribunal in para. 9 referred to and followed another order of the Tribunal in the case of Upper Ganges Sugar Mills Ltd. in ITA No. 1446 (Cal) of 1982 dt. 21st January, 1984. Para. 6 of this order is relevant and is extracted below :

"From the above discussion it would be clear that the valuation of closing stock at cost is not a wrong method of valuation. Moreover, valuation at cost can be made either by including all the direct expenses only or also by including overheads. Both are recognised systems of valuation. The assessee has also been following on particular system uniformly and the rules referred to by the ITO do not compel the assessee to make the valuation by that particular method only after including the overheads. Those provisions in the rules are only for the purpose of exhibiting certain figures in the balance sheet and the schedules. Taking the above mentioned reasons and facts into consideration, we are wholly in agreement with the CIT(A) that the addition of Rs. 20,68,443 was not correct and has been correctly deleted by the CIT(A). The ground taken by the Revenue is rejected."

3. Against the order of the Tribunal deleting the addition made towards the valuation of closing stock for the asst. yrs. 1977-78 and 1978-79, there was no reference to the High Court at the instance of the Revenue on the point. In other words, the decision of the Tribunal relating to the valuation of the closing stock of sugar had become final.

4. Thereafter, the assessee has been consistently following the direct cost method of valuation of closing stock which has been accepted by the Revenue also in the assessments.

5. For the asst. yr. 1987-88 also the ITO had accepted the method of valuation in the assessment made. However, the CIT took proceedings under s. 263 of the Act and issued notice dt. 21st February, 1992 on the question of valuation of closing stock. According to him in arriving at the value of the stock of "finished sugar as well as processed stock of sugar" the items like salaries, employees welfare expenses, insurance, rates and taxes, depreciation had not been considered by the assessee. The CIT also observed that even as per the auditors report the valuation closing stock of sugar and processed sugar was not in accordance with the normally accepted accounting principles as well as the Cost Accounting Records (Sugar) Rules, 1974. He also referred to the judgment of the Supreme Court in CIT vs. British Paint India Ltd. (1991) 188 ITR 44 (SC) and observed that exclusion of overheads for the purpose of valuation of stock would result in a distorted picture of the true profits. He further observed that though in the assessments for the earlier years the assessees method of valuation had been accepted, there was no estoppel in such matters and the ITO should have proceeded to determine the correct profits of the assessee by including the overheads in the value of the stock. He gave a working of the understatement of the valuation of the closing stock in annexure to his order, according to which the figure of underassessment came to Rs. 15,71,089.

6. The assessee submitted its reply dt. 5th March, 1992 to the proposed revision under s. 263. Various objections were taken to the proposed revision. It was pointed out that the valuation was accepted only after a detailed examination, that there was no error or prejudice to the Revenue, that the valuation has been consistently adopted by the assessee and accepted by the IT authorities, that the decision of the Supreme Court cited supra was not applicable to the assessees case and further that the assessee has taken into consideration not only the cost of the raw materials, but also the entire wages which include manufacturing and non-manufacturing wages, stores, power, fuel and repairs which also include both manufacturing and non-manufacturing, in the valuation of the stock of sugar. Certain mistakes in the annexures enclosed with the notice under s. 263 were also pointed out. On these submissions it was prayed that the proposed revision be dropped.

7. The CIT considered the reply but did not accept the same. According to him, the judgment of the Supreme Court was fully applicable. He discussed each and every objection raised by the assessee and overruled the same. Ultimately he came to the following conclusion :

"In view of the foregoing discussion, I am of the opinion that the assessee-company, by not including the overheads of salaries, staff welfare expenses, insurance, rates & taxes and depreciation has reduced its taxable profits for the assessment year under consideration, leading to underassessment. The assessment order, so passed by the AO, is both erroneous and prejudicial to the interest of the Revenue, and it is held so accordingly the assessment order is, therefore, set aside to this extent only and the AO is directed to make suitable and proper adjustment in the stock position by including the aforesaid overheads for the valuation of the stock and modify the assessment accordingly."

8. The above direction is challenged in appeal before us. The question for consideration is whether the assessee was following the direct cost method as claimed by it. In this connection the learned counsel for the assessee has filed the assessees basis for valuation of the closing stock.

The same is as under :

"As per assessee

Rs.

Rs.

1.

Raw materials

2,59,53,831

2.

Wages and bonus

33,83,075

3.

Provident Fund on wages

1,76,717

4.

Stores, chemicals & spare parts

26,38,281

5.

Machinery repairs

4,55,280

6.

Building repairs

1,16,331

7

Power & fuel

8,14,485

3,35,37,550

Less : Realisation from Bye-products

Molasses

1,67,716

Press mud

69,974

2,37,690

3,32,99,860

Sugar manufactured - 96,199.95 Qtls.

Cost per quintal

346.15"

It is this figure of Rs. 346.15 per quintal that is mentioned in the annexure to the notice under s. 263. According to the CIT, the following overheads have not been included in the valuation :

Rs.

Cess

4,36,065

Purchase-tax

15,65,725

Salary

19,83,107

Bonus

4,00,000

Insurance

75,000

Rates & taxes

25,000

Depreciation

13,00,000

58,84,898

It will thus be seen that as per the assessees method not only the cost of raw materials has been taken into account, but also the direct expenses such as wages and bonus in the factory, provident fund on factory wages, stores, chemicals and spare parts, repairs to building and machinery, power and fuel have also been taken into account. There are all direct expenses and, therefore, the assessees claim that it is following the direct cost method has to be accepted.

9. The next question for consideration is whether the judgment of the Supreme Court is against the assessee. In the case before the Supreme Court, the assessee was a company engaged in the manufacture and sale of paints. It contended before the Revenue authorities that it had been consistently valuing the goods in process and finished products exclusively at the cost of raw materials and totally excluding overhead expenditure. The assessee justified this practice by saying that the paints had limited storage life and if they are not disposed of quickly they will lose their market value. The assessee sought to rely on the judgment of the House of Lords in Duple Motor Bodies Ltd. vs. IRC (1961) 1 WLR 739 (HL). The Supreme Court noticed the facts in this case and this appears at p. 51 of 188 ITR 44 (SC) (supra). In the case before the House of Lords, the assessee valued the work-in-progress on the direct cost method which included the cost of raw materials and labour expended on the work. The IT authorities sought to value the work-in-progress at the "on cost method". Under this method various items of overhead expenditure are also taken into account in addition to the direct cost. The House of Lords held that since the assessee has consistently adopted the direct cost method and since the method is more accurate than on cost method under which there is great uncertainty, the direct cost method should be preferred and accepted. After noticing the facts of the case before the House of Lords, the Supreme Court observed at p. 51 of the report as under :

"In the present case, what the assessee contends for is neither the "direct cost" method nor any other method which takes into account the actual or even part of the cost involved in the manufacture of the goods-in-progress and finished products. What it contends for is valuation of the raw material without taking into account any portion of the cost of manufacture. No decision has been brought to our notice in support of such a contention. The question of fact which the AO must necessarily decide is whether or not the method of accounting followed by the assessee discloses the true income."

The above passage brings out the distinction between the case before the House of Lords and the case before the Supreme Court. In the case before the Supreme Court, the cost of raw materials alone was taken into account and, therefore, the Supreme Court held that the method adopted by the assessee is neither the direct cost method nor any other method which takes into account the actual or even part of the cost involved in the manufacture of the goods-in-process/finished goods. Thus, it will be clear from the aforesaid observation that the ratio of the Supreme Court judgment would apply only where neither the direct cost method nor any other recognised method is followed. The facts in the present case before us are not similar. The assessee before us, as already seen consistently values its closing stock on the direct cost method. Various items of expenditure that go to the make-up the direct cost had already been listed out earlier. The assessee does not stop with valuing its closing stock of finished goods and processed sugar at the cost of raw materials alone, but goes further and adds the direct expenditure also in order to arrive at the direct cost. It cannot therefore be stated that the judgment of the Supreme Court is against the assessee as erroneously held by the CIT. It is nobodys case that the direct cost method is not a recognised method. In fact, the international accounting standards which have been filed in pp. 33 and 37 of the paper-book before us recognise the direct cost method as one of the methods of valuation of stock. In fact the basis of the judgment of the Supreme Court cited supra is not that the direct cost method is not one of the recognised methods of valuation of stock, but it is that the assessee before the Supreme Court did not follow the direct cost method or any other recognised method of valuation.

10. The ratio of the judgment of the Supreme Court has been clearly brought out, if we may say so with respect, in para. 8 of the order of the Madras Bench of Tribunal in E.I.D. Parry (India) Ltd. vs. Dy. CIT (1993) 46 ITD 387 (Mad). The relevant paragraph appears at pp. 394-395 of the report.

11. The items of overhead expenditure which according to the CIT have not been taken into account while valuing the closing stock, if added to the value, would result in the "on cost" method being thrust upon the assessee which cannot be justifiably done. The IT authorities are empowered, in fact they are duty bound, to reject the method of accounting, which includes the method of valuation of stock, adopted by the assessee if the method is not a recognised method or is one which is not consistently followed by the assessee or is one which does not enable the true profits and gains of the business to be computed. We have already seen that the direct cost method which has been followed by the assessee consistently for a long period is one of the recognised methods of valuation of stock. The CIT is, therefore, not justified in rejecting the same and substituting the same by "on cost" method. It is no doubt true that the "on cost" method is also one of the recognised methods of valuation of stock but so long as the method of valuation followed by the assessee is a recognised method, consistently followed and from which the true profits and gains can be computed, there is no justification for rejecting the same and substituting the "on cost" method.

12. As far as the payment of cess and purchase tax which are listed in the items of overhead not included in the valuation of stock are concerned, the learned counsel for the assessee made a further point, namely, that these were not debited in the P&L a/c for the year in view of s. 43B of the Act which says that tax or cess will be allowed only on actual payment basis. If the expenditure has not been debited in the profit and loss account, the same cannot also form part of the closing stock valuation. There is force in the point made which is also found to be supported by a decision of the special Bench of the Tribunal in Indian Communication Network (P) Ltd. vs. IAC (1994) 48 TTJ (Del) (SB) 604 : (1994) 206 ITR (AT) 96 (Del) (SB) and the Order of the Calcutta Bench reported as Berger Paints vs. Dy. CIT (1992) 42 ITD 546 (Cal).

13. In the course of the arguments the learned Departmental Representative drew our attention to a decision of the Gujarat High Court in Addl. CIT vs. Mukur Corporation (1978) 111 ITR 312 (Guj) and the Rajasthan High Court in CIT vs. Emery Stone Mfg. Co. (1995) 213 ITR 843 (Raj). We have gone through the judgments but we do not find anything in those judgments which is of any assistance to the Revenue in the present case. In the Gujarat case there was no enquiry into the return by the ITO on certain important issues and, therefore, the CITs jurisdiction was upheld. In the Rajasthan case the ITO had overlooked a statutory provision and, therefore, the CIT was held justified in invoking s. 263. The facts before us in the present case are different and, therefore, these two judgments are not of any assistance to the Revenue.

14. For the aforesaid reasons we set aside the order of the CIT under s. 263 and allow the assessees appeal.

15. The facts in the other two appeals are identical. Therefore, we set aside the orders of the CIT under s. 263 in those cases also and allow the appeals.

16. In the result, all the appeals are allowed.