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Judgment
P. Chandra Reddy, C.J.
(1) The question we are called upon to decide under S. 66(2) of the Indian Income Tax Act is framed in the following terms:
Whether on the facts and in the circumstances of the case the Tribunal is justified in sustaining the revision in valuation of closing stock by
enhancing the value by Rs. 45,433?
This reference arises out of the assessment of the petitioners for the assessment years 1958-59 corresponding to the accounting year ended 31-3-
1958 and concerns the valuation of certain motor spare parts. The assessee is one of a few companies started to take over all spare parts of the
makes of cars from the General Motors on their giving up their Indian branches. Since the import and assembly of these makes in India were
banned, the demand for these spares of the older models already on the road began to decline from year to year. For the purpose of assessment
for the year ended 31-3-1958, the assessee made a return under S. 22 of the Act showing an income of Rs. 3,15,995. In valuing their opening and
closing stock of the spare parts taken over by the assessee company from the General Motors they adopted the following method. The entire
stock was valued at cost and out of this a deduction of Rs. 1,00,015 was made in view of the fact that the demand for these parts was declining.
The assessee treated a part of this stock as obsolete and some other stock as slow moving and valued them notionally at 10 per cent and 50 per
cent less than the cost price as the case may be. The Income Tax Officer added this under pricing back, taking into account the circumstance that
when the assessee applied for an overdraft to the State Bank of India, they declared the value of these goods at Rs. 24,96,207, and also insured
these stocks for the same amount.
(2) On an appeal preferred by the aggrieved assessee the Appellate Assistant Commissioner deleted this addition on the ground that the write off
was supported by stock cards which clearly showed that either the stock had become obsolete or slow moving and that the stock of spare parts
involved in such write off was not excluded from the inventory. In his opinion the reference to the declaration of stock to the insurance company
and the Bank had nothing to do with the actual stock valuation for determining the true results. There was an appeal by the department to the
Income Tax Appellate Tribunal. The Tribunal reversed the decision of the Appellate Assistant Commissioner so far as the value of the slow moving
parts was concerned for the reason that some of the slow moving items sold in the subsequent years were at a profit which, according to the
Tribunal, indicated that the market had not fallen. It is this conclusion of the Appellate Tribunal that is assailed in this reference under S. 66(2) of
the Act.
(3) It is urged by Mr. Swaminathan, learned counsel for the assessee, that the assessee has adopted this method consistently for a number of years
and that no exception was taken to it by the department all these years. It is also his contention that this system of accounting is a well recognised
one, and, in fact, is in vogue not only in this country but in various other countries like the United States of America. He further Maintains that the
reasoning of the Tribunal relating to the surplus stocks or the slow moving articles is irreconcilable with that bearing on the spare parts treated as
obsolete. The last limb of the argument is based upon the decision of the Tribunal not to disturb the value adopted by the assessee in respect of the
spare parts or stocks treated as obsolete although some of the items out of this category also, when sold brought a price higher than the cost. We
are satisfied that these contentions are well founded.
(4) At this stage it will be convenient to read the terms of S. 13 of the Indian Income Tax Act which has a bearing on this enquiry.
Income, profits and gains shall be computed for the purposes of Ss. 10 and 12, in accordance with the method of accounting regularly employed
by the assessee;
Provided that, if no method of accounting has been regularly employed or if the method employed is such that in the opinion of the Income Tax
Officer, the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such
manner as the Income Tax Officer may determine"".
Indisputably the assessee has employed this method of computation for several years. We are told that this method was in vogue even when the
General Motors Co. was dealing in these spare parts. If that were so, the department could not disturb it unless the proviso was attracted to it.
Since this is not a case of no method of accounting having been regularly employed, if at all, this could fall only within the ambit of the latter part of
the proviso. In other words, before the Income Tax Officer could make a re-computation of the stock he should find that the profits and gains
could not be properly deduced from the method followed by the assessee.
(5) We do not think that the proviso is attracted to this case. For one thing, it is not asserted on behalf of the Revenue that by resorting to this
method the assessee was attempting to disguise their income or that there was difficulty in ascertaining the true profits and gains derived by the
assessee from his business. Admittedly these stocks were not excluded from the inventory, and, whenever any individual item was sold from either
of the two categories, the entire sale proceeds were brought into account, and, the difference between the value as disclosed in the books and the
price realised was shown as profits. There is, therefore, no difficulty in determining the profits and gains earned by the assessee in regard to this
stock in trade.
(6) It may also be mentioned that this is one of the recognised methods of valuation. In a comparison of various inventory methods in regard to
falling market, in the Industrial Accountant''s Hand-book edited by Wyman P. Fiske and John A Beckett, we find that some articles for which
there was a falling market could be reduced to selling price ""less fifty per cent market off"". The suggestion made in regard to disposal of obsolete
material is contained in the following words in this book:
A constant review of storeroom inventory record cards should be made, and periodically lists should be prepared showing items that have been
inactive for specific periods, which will depend on the basic stock groups and nature of the industry. Sometimes items are also listed where the
inventory is in excess of sales or disbursements for the last six months or year. The lists of inactive items should be reviewed by proper officials for
decision as to action to be taken (pp 739, 740).
(7) Various steps to be taken in the disposal of these materials are enumerated, one of them being disposing of them by scrapping and selling as
scrap. This is what is stated with regard to prevention of obsolescence.
The extent of obsolescence can be reduced to a certain degree by proper procedures. When a design change or engineering change is
determined, the material control division should be immediately notified, so that outstanding purchase orders of affected parts or raw materials can
be cancelled where possible. Sometimes, when engineering changes are contemplated, the available inventory and firm commitments of applicable
materials are first determined to ascertain the probable extent of resultant obsolescence due to the proposed change. If a serious degree of
obsolescence would result from an immediate engineering change, the effective date of change or ""breaking point"" may be delayed. However, if an
engineering change must be made as a safety factor or to prevent any serious competitive market losses, material obsolescence must follow as a
necessary evil. Other factors that might cause obsolescence, such as faulty procurement practices, inefficient records, inefficient storekeeping and
lack of standardisation, should also be watched and corrected before they cause serious obsolescence losses. Also, if material control is kept
informed of the company''s future designing plans, research activities, and projects, the procurement officials can keep alert as to materials which
might be affected in the future"".
What caused the obsolescence or the inactivity of these spare parts in the instant case is the ban on the import and assembly of these cars in India.
Whatever might be the cause therefor, undoubtedly there has been a gradual decline of market for these spares. In this petition it is difficult to
postulate that the value put by the assessee on this stock is arbitrary or that it could be regarded as an undervaluation. At any rate, this is a method
that finds currency in other countries, and in fact, recommended in some of the industrial accountant''s handbooks.
(8) The mere fact that occasionally a solitary item is sold for a price higher than the cost price would not detract from the nature of this system. In
fact, a fifty per cent reduction was made not for the reason that as and when any of the items is sold it would fetch a price less than the cost, but
that the sale of these items is very slow. It is the inactivity of these items that has led to this valuation in question. Moreover, although the situation is
similar in regard to articles classified as obsolete, this class of articles when sold brought a price higher than the cost price, the Tribunal was not
inclined to sustain the addition made by the Income Tax Officer in that behalf. It is interesting to note that the tribunal found that by reason of the
ban the demand for spare parts of the older models had diminished year to year and the sales thereof ""were few and far between"".
(9) That being the position we do not think that there was only justification for the Tribunal to interfere with the conclusion of the Appellate
Assistant Commissioner. It is not shown to us that this method is either improper or patently false. There is therefore no justification requiring the
assessee to change the method which has been consistently followed, especially to claim the protection of S. 13 of the Act.
(10) It has been laid down by a Division Bench of this court in COMMISSIONER OF Income Tax AND EXCESS PROFITS TAX, MADRAS
Vs. MESSRS. CHARI AND RAM, MADURA., that under S. 13 of the Income Tax Act, an assessee is entitled to compute the income, profits
and gains in accordance with the method of accounting regularly employed by him, and ordinarily this method must be accepted by the department
in the absence of anything to suggest that it is improper or patently false. The proposition is contained in more emphatic terms in the latest
pronouncement of the Supreme Court in The Commissioner of Income Tax, Madras Vs. A. Krishnaswami Mudaliar and Others, . The rule stated
there is that it was left to the option of the assessee to adopt any system of accounting and oblige the Income Tax Officer to compute the income,
profits and gains in accordance with such method of accounting regularly employed, if profits of the business can properly be deducted therefrom.
It means that it imposes a statutory duty on the Income Tax Officer to examine in every case the method of accounting employed and to see
whether or not it has been regularly employed.
(11) In the instant case, indisputably the present method of accounting has been employed for a long number of years and no attempt was made by
the assessing authority to bring it within the scope of the proviso. It has to be mentioned that the Income Tax Officer has not asserted that the
method adopted by the assessee is subject to the objection indicated in the proviso. In fact, the only reason adduced by him for rejecting the
valuation in question was that in the valuation of these stocks furnished by the assessee to the State Bank of India, a different mode of calculation
was adopted by them.
(12) We think that this difference would not justify the rejection of the method followed by the assessee for ascertainment of his income under the
Income Tax Act. What S. 13 contemplates is the method of accounting for purposes of disclosing his income and profits. The figures furnished by
him to the State Bank of India for purposes of obtaining an overdraft are not concerned with the actual stock valuation for determining the trade
results for purposes of ascertaining the profits and gains derived from that business. For all these reasons we must hold that the addition made by
the Income Tax Officer is unsustainable.
(13) There is also another aspect of the matter to which the Tribunal has not applied its mind. It appears that in the previous accounting year the
value of the slow moving articles was reduced by Rs. 22046, and, in the relevant assessment year by reducing flatly the value of these very articles
by 50 per cent the reduction was computed at Rs. 45583. That this is so appears from the argument advanced before the Appellate Tribunal as
could be gathered from the statement of the case:-
It was also contended alternatively that by a corresponding re-valuation of the items both in the opening and closing stock, at least to the extent of
the difference between Rs. 1,00,015 and Rs. 66140 the addition made by the Income Tax Officer should be sustained"".
It should be incidentally mentioned that Rs. 68140 referred to in the sentence in the year 31-3-1957 made up of the value of stock treated
obsolete at Rs. 46094 and slow moving stock reduced by 50 per cent at Rs. 22046. If that were so, the addition in regard to the slow moving
articles could be sustained only to the extent of the difference between Rs. 45584 and Rs. 22046. But this need not detain us any longer having
regard to our conclusion that this is not a case in which the proviso to Sec. 13 could be invoked. The assessee is entitled to adopt the method
which he was regularly following in the previous years by reason of the terms of S. 13 of the Act. In the circumstances, we answer the question in
favour of the assessee and against the department. Counsel''s fee Rs. 250.
BJ/VRB/D.V.C
(14) Answer accordingly.