Income Tax Dept warns public against cash dealings of Rs 2 lakh or more saying that the receiver of the amount will have to cough up an equal amount as penalty.

No addition on ex-parte basis under sec. 145 if AO failed to find defects either in books or in accounting method

Where Assessing Officer did not point out any specific defect in books of account or method of accounting consistently followed by assessee and no inflated purchases or suppressed sales or expenses not incurred for business purposes were found, provisions of section 145(3) were not applicable


IN THE ITAT JODHPUR BENCH
Drillcon (Raj) (P.) Ltd.
v.
Additional Commissioner of Income-tax*
HARI OM MARATHA, JUDICIAL MEMBER
AND N.K. Saini, ACCOUNTANT MEMBER
IT Appeal Nos. 400 & 401 (Jodh.) of 2012
[ASSESSMENT YEARS 2008-09 & 2009-10]
APRIL  30, 2013 

Section 145 of the Income-tax Act, 1961 - Method of accounting - Rejection of accounts [Valuation of stock] - Assessment years 2008-09 and 2009-10 - Assessing Officer rejected books of account of assessee on ground that proportionate expenses incurred by assessee on account of insurance on goods in transit, fright and handling, etc., were to be added in computation of closing stock - Whether since Assessing Officer did not point out any specific defect in books of account or method of accounting consistently followed by assessee and no inflated purchases or suppressed sales or expenses not incurred for business purposes were found, provisions of section 145(3) were not applicable - Held, yes - Whether further, all expenses which were added by Assessing Officer on proportionate basis for valuation of closing stock were already included in purchase and method of valuation of assessee was cost or market price, addition in closing stock was not correct - Held, yes [Para 9][In favour of assessee]

FACTS


The Assessing Officer having found that the assessee had not proportionally disallowed expenses relating to insurance on goods in transit, freight and handing entry-tax (purchase, and channel finance bank interest, rejected books of account maintained by the assessee and made upwards adjustment in closing stock.

The Commissioner (Appeals) confirmed addition made by the Assessing Officer and also upheld the rejection of books of account under section 145(3).

On second appeal :

HELD

Valuation of closing stock

It is noticed that the Assessing Officer made the impugned addition by invoking the provisions of section 145(3) however, no specific defects have been pointed out in the books of account maintained by the assessee in regular course of its business. The Assessing Officer did not point out any inflated purchase or suppressed sales. The claim of the assessee was that the expenses considered by the Assessing Officer for increasing the value of the closing stock had already been debited in the books of account and those expenses were directly related with the purchases because insurance on goods in the transits was incurred to cover the transit risk and the expenses were already debited as part of the purchase, therefore, not to be added while valuing the closing stock. Similar was the position with regard to freight and handling expenses. The assessee incurred freight and handling charges at the time of purchase of goods so it was directly connected with the cost of goods purchased, it was not to be again added while valuing the closing stock. As regards to the entry tax, the explanation of the assessee that it was paid to the State Govt. when the goods specified in the list under VAT Act were brought to the local area for consumption or use, so it was directly related to the purchases and not to be added again while valuing the closing stock, appears to be plausible. Similarly Channel Finance Bank Interest was charged by the Bank and in this regard the assessee has submitted that its principal companies collected their receivables from channel finance banks and it is mandatory. The principal companies provided 30 days credit facility against purchase of goods and at that stage it was part of the trading expenses which were already recorded by the assessee in its books of account.

All the expenses which were added by the Assessing Officer on proportionate basis for the valuation of closing stock were already included in the purchase and the method of valuation of the assessee was cost or market price whichever was less. This fact is also clear from col. 12(a) in form 3 CD which is part of tax audit report under section 44AB. In the said column the auditor mentioned that the valuation by the assessee is "at cost including direct expenses or market value whichever is less". It is also mentioned in Col. 12(b) that there was no deviation in the above method. It is also an admitted fact that the department has accepted the tax audit report and pointed out no discrepancy in the said report. Therefore, the Assessing Officer was not justified in making the addition in the valuation of the closing stock particularly when the same valuation of the stock had also been accepted by VAT authorities and Commercial Tax Officer in their respective assessment orders.

In the present case, it is also noticed that for assessment year 2004-05 the assessment was framed under section 143(3) after making proper scrutiny and valuation of the closing stock was accepted, during the year under consideration, there is no deviation in valuing the closing stock from the method of valuation accepted by the Department in assessment year 2004-05, so there was no occasion to make addition in the year under consideration as expenses pointed out by the Assessing Officer were already included by the assessee in the cost of purchase and the stock available with the assessee was out of purchase. Therefore, the proportionate amount of the expenses which was already recorded in the books of account as those were directly linked to the purchase, added by the Assessing Officer in the valuation of closing stock, was not correct.
Rejection of books of account

In the present case, the Assessing Officer while rejecting the books of account of the assessee by invoking the provisions of section 145(3) had not given any other reason except the observation that the proportionate expenses incurred by the assessee on account of insurance on goods in transit, freight and handling, entry tax (purchase) and channel finance interest, were to be added. The Assessing Officer did not point out any specific defect in the books of account or the method of accounting consistently followed by the assessee. It is also not the case of the Assessing Officer that there was a deviation in valuing the closing stock in comparison to the earlier year, no inflated purchases or suppressed sales or expenses not incurred for the business purposes was found. Even the gross profit declared by the assessee on turnover which was higher in comparison to earlier year, has not been doubted by the Assessing Officer. Therefore, the provisions of section 145(3) were not applicable to the facts of this case and Commissioner (Appeals) was not justified in confirming the impugned addition made by the Assessing Officer.[Para 9]

CASES REFERRED TO

CIT v. British Paints India Ltd. [1991] 54 Taxman 499 (SC) (para 4).
Shailendra Bardia  for the Appellant. G.R. Kokani  for the Respondent.

ORDER

N.K. Saini, Accountant Member - These two appeals by the assessee are directed against the common order of CIT(A), Udaipur dt. 22nd Aug., 2012.
2. First we will take ITA No. 400/Jd/2012 for asst. yr. 2008-09.
3. In this appeal the assessee although has raised six grounds but only grievance relates to confirmation of addition of Rs. 4,76,573 made by the AO on account of valuation of closing stock by rejecting the books of account under s. 145(3) of the IT Act, 1961 (herein referred as "the Act").
4. The facts of the case in brief are that the assessee filed return of income on 29th Sept., 2008 showing total income at Rs. 82,21,290 which was processed under s. 143(1) of the Act. The case was selected for scrutiny. The AO noticed that the assessee had shown closing stock of Rs. 3,80,85,778 as on 31st March, 2008. However, proportionate related expenses had not been taken into account by the assessee for valuing the closing stock as under :

(i)
Insurance—Goods in transit
19,010

(ii)
Freight & inward handling
6,59,161

(iii)
Entry-tax (purchase)
1,23,490

(iv)
Channel finance bank interest
10,18,292

(v)
Insurance—Goods in stock
94,342
The assessee explained that it was consistently following the same method as in the earlier years and that insurance for goods in transit is for covering transit risk purchase while freight and handling expenses had been incurred at the time of purchasing the goods. It was further stated that entry-tax had to be paid when the goods were brought into the local area for consumption and sale as per VAT Act. As regards to the channel finance bank interest, it was explained that the principal company provided 30 days against purchase of goods while Channel Finance Bank provided 60 days credit and the principal companies collect their receivables from the Channel Finance Bank, the interest was linked to the purchase of goods and that insurance of the goods in stock was taken for safety of the stock. The AO did not find merit in the submissions of the assessee and was of the view that proportionate amount of expenses had to be taken into consideration for valuing the closing stock so that correct profits may be determined. Reliance was placed on the judgment of' Hon'ble Supreme Court in case of CIT v. British Paints India Ltd. [1991] 54 Taxman 499. Accordingly, the AO made an addition of proportionate account of related expenses i.e., Rs. 4.,76,573 (25 per cent of total expenditure of Rs. 19,06,295) which was worked out on the basis of ratio of total purchases with the closing stock after rejecting the books of account under s. 145(3) of the Act.
5. The assessee carried the matter to the learned CIT(A) and the submissions made as incorporated in para 4.2 of the impugned order are reproduced verbatim as under :
"(A) As per the second ground of appeal there is no change in the method of accounting or basis of valuation of the closing stock as dealt with by AO in para 9 at page Nos. 7 to 12 of the assessment order for asst. yr. 2008-09.
The closing stock has been valued as per normal accounting principles at cost or market price, whichever is less. The said facts have also been stated in the audited balance sheet appearing in accounting policies of the company and notes on account. The same practice has been consistently followed since inception of the company.
(B) The said facts were also accepted in the earlier assessment order under s. 143(3) for income-tax asst. yr. 2004-05 of the same appellant. The appellant company is maintaining stock records which were produced during the assessment proceedings on 26th Oct., 2010 along with books of account for the relevant assessment year.
(C) It is the company's practice to take the physical stock at the end of the year and being tallied with the records maintained thereof. The said facts have also been stated by the auditors in their audit report. The AO while completing the assessment has overlooked the auditor's report. The audit report is not an empty formality which has never been controverted by the AO for valuation of the closing stock.
(D) The assessee is assessed under Rajasthan VAT Act, 2003 and CST Act, 1956 and the trading results have been accepted by them as per copy of the assessment filed herewith for asst. yr. 2007-08 (1st April, 2007 to 31st March, 2008). The accounts are subject to VAT audit in which the trading results have been accepted by the Commercial Taxes Department. (Annex. 10)
The contentions of the assessee are supported by CIT v. Anandha Metal Corporation [2005] 273 ITR 262 (Mad.). (Case law 2)
The AO has relied on the case CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108 : [1991] 54 Taxman 499 (SC). The same is not applicable in the instant case because appellant is a trading concern. Whereas the above judgment referred the valuation of stock in processed and finished goods which has no relevance and the facts are totally different and the case was of a manufacturer and here is the case is of a trader and service provider and also backed by the earlier assessment of the AO under scrutiny for asst. yr. 2004-05 duly supported by citation in the case of I.G.E. (India) Ltd. v. Jt CIT [2008] 26 SOT 367 (Mumbai) and decision of High Court of Allahabad CIT v. Ema India Ltd. (Case law 3)
(E) The observation made by the learned AO for increase in the value of the closing stock in the light of certain expenses narrated in para 9 of the assessment order, the said items for valuation have already been considered in the closing stock and clearly appearing in the Sch. 3 of the audited P&L a/c. In addition to this the said fact was also mentioned in submissions made vide letter dt. 9th March, 2010.
(F) That on the facts and circumstances of the case and in law, the learned AO grossly erred in making upward adjustment of the closing stock valuation amounting to Rs. 4,76,573 without pointing out any defect in the method of accounting and merely on hypothetical basis based on suspicion. Without appreciating that the assessee's case is factually supported by all the records for purchases, sales, sale bills, etc. and legally backed by Supreme Court (five Judge bench order) in the case of Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC) upheld in Voltamp Transfomers Ltd. v. CIT [2008] 217 CTR (Guj.) 254 : [2008] 7 DTR (Guj.) 84 : [2008] 327 ITR 360 (Guj.).
Here it was worth noting that neither it is the case of learned AO that what assessee did was palpably incorrect (that is, what the assessee adopted was plausible valuation rate, but learned AO suggested higher/better rate) nor it is the case of learned AO that assessee's valuation is totally unrecognized as per accounting/tax pronouncements.
It is well settled by the Hon'ble Supreme Court of India in the case of Investment Ltd. v. CIT [1970] 77 ITR 533 (SC) (at p. 537) as well as in the case of United Commercial Bank v. CIT [1999] 156 CTR (SC) 380 : [1999] 240 ITR 355 (SC) (at p. 367) that it is always open to an assessee to adopt any method of keeping accounts for the purpose to value his stock-in-trade either at cost price or market price. It has been held that the method of accounting regularly employed can be discarded by the Department only if, in the opinion of the taxing authorities, income of the trade cannot be properly deduced thereform. Similarly, it has been held that if the Department has accepted the practice so adopted for previous year, then there must be justifiable reason for not accepting the same in particular year. That is, as noticed in above Supreme Court orders it is specifically held that it is open to an assessee to adopt any of the methods for computation of the value of the stock and interference in such method, adopted by the assessee, can only be made if it is found that the income of the trade cannot be properly deduced therefrom.
The appellant has further relied on decision in case of Bombay High Court in CIT v. Tata Iron & Steel Co. Ltd. 1975 CTR (Bom.) 80 : [1977] 106 ITR 363 (Bom.); Gujarat High Court in Voltamp Transformers Ltd. v. CIT [2008] 217 CTR (Guj.) 254 : [2008] 7 DTR (Guj) 84 : [2008] 327 ITR 360 (Guj); The Supreme Court in case of CIT v. Bilahari Investment (P) Ltd. [2008] 215 CTR (SC) 201 : [2008] 3 DTR (SC) 329 : [2008] 299 ITR 1 (SC) : Bombay High Court in CIT v. Tata Iron & Steel Co. Ltd. (supra), and High Court of Rajasthan in Malawi Hamjivan Jagannath v. Asstt. CIT [2007] 207 CTR (Raj.) 19.
The appellant further mentioned as under : In the light of above for valuation of closing stock, rejection of audited accounts under s. 145(3) by the learned AO is not correct being whole thing is appearing on the face of the P&L a/c. Further, in addition to accounting principles and details, the arrived results matched with the earlier year results matching as per comparative GP chart enclosed. (Annexure 13)
The AO has grossly erred in applying the provisions of s. 145(3) of the Act, without pointing out any specific defect in the books of account, method of accounting followed by the assessee during the preceding years based on hypothesis particularly when the gross profit for the year was reasonable. The valuation of the closing stock cannot be changed by the AO. As such the provisions of above section have been wrongly applied without considering the merits of the case and the case laws mentioned above."
6. The learned CIT(A) after considering the submissions of the assessee observed that the main contention of the assessee was that the value of closing stock had been taken at cost or market price, whichever was less, the books of account had been audited and this method had been consistently followed since inception of the company and accepted by the Department. The learned CIT(A) confirmed the addition made by the AO and upheld the rejection of books of account under s. 145(3) of the Act by observing in para 4.3 of the impugned order as under :
"(i) In this context, it may be mentioned that it has been held by the Supreme Court in CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108 that it is not only the right but the duty of the AO to consider whether or not the books disclose the true state of accounts and the correct income can be deduced therefrom. It is incorrect to say that the officer is bound to accept the system of accounting regularly employed by the assessee, the correctness of which had not been questioned in the past. There is no estoppel in these matters and the officer is not bound by the method followed in the earlier years.
It is seen that assessee has submitted trading account to the AO which is as under :
Trading account for the year ended 31st March, 2008

Particulars




Amount
Particulars
Amount

Opening Stock




2,36,56,555
Sales
15,71,28,177

Total purchase cost


15,48,74,802
%

Closing
Stock
3,80,85,778

Less : Addl. discount which
is received from purchases

24,15,579






Less input credit

4,37,697
28,53,276
1.84




Net purchase value as per point No. 2


15,20,21,526





Add : Expenses incurred during the year
Insurance-Goods
in transit
19.010







Freight & inward
handling
6,59,161







Entry tax
1,23,490







Channel Finance
Bank interest
10,18,292
18.19,955
1.18




Gross total








Net purchase cost




15,38,41,481



Gross profit




1,77,15,919



Total




19,52,13,955
Total
19,52,13,955
From the above trading account, it is apparent that assessee has debited all these above expenses directly related to purchases of the goods while these expenses have not been taken into consideration while valuing the closing stock. The chart submitted for valuing the closing stock by the assessee is as under:
Drillcon (Reg) (P.) Ltd., Udaipur Stock statement :

Month : March 2008

Date :
31-03-2008

Item : Description
Model
Type
Value

Spare parts and accessories for all Atlas Cocpco Products.
AC
Assorted
64,78,160

Spare parts and accessories for all Ingersoll-Rand Products
IR
Assorted
13,12,637

Spare parts and accessories for all Escorts Construction Eqpt. Products
ECE
Assorted
31,22,739

Spare parts and accessories for all Volvo Products (trucks and buses)
VLV
Assorted
1,17,96,570

Spare parts and accessories for all Volvo RMD Products
VLV
Assorted
60,65,170

Spare parts and accessories for all Volvo VCE Products
VLV
Assorted
66,39,564

Spare parts and accessories for all Doosan Products
DO
Assorted
26,70,938

Total value of parts and accessories


3,80,85,778
From this, it is apparent that assessee has only taken the cost of goods in the closing stock and not incidental expenses incurred by the assessee relating to purchase of goods which is not as per AS 2 and the AO has in detail pointed out that in such cases correct taxable profits for the year cannot be determined by the method followed by the assessee.
Further, it is also relevant to note that as per s. 145A of the IT Act, all the taxes, duties or fees are to be included while determining the closing stock for the inventory valuation which has not been done by the assessee regarding entry-tax. Further, the Accounting Standards for the valuation of inventory required that all the incidental expenses of purchases are to be included into the closing stock.
The case laws relied upon by the assessee are not applicable in the facts and circumstances of the case under consideration. In fact, in the case of I.G.E. India Ltd. v. Jt. CIT [2008] 26 SOT 367 (Mumbai), it has been held that the valuation of closing stock has to be done by adding direct cost and overheads to the raw material cost and the above finding is in favour of the Revenue. Moreover, the addition has been made by the AO following the decision of Hon'ble Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108: [1991] 188 ITR 44.
Accordingly, rejection of books of account of the assessee under s. 145(3) of the IT Act and the addition made of Rs. 4,76,573 on account of closing stock is upheld. Both the above grounds of appeal are dismissed."
Now the assessee is in appeal.
7. The learned counsel for the assessee reiterated the submissions made before the authorities below and further submitted that the AO did not point out any defect in the books of account maintained by the assessee in the course of its regular business and also did not doubt the method of accounting consistently followed by the assessee. It was further stated that the learned CIT(A) also had not appreciated the facts and the evidences of the case produced by the assessee and just confirmed the addition by relying on a single case i.e. British Paints India Ltd. (supra) which in fact was not applicable to assessee's case because the said judgment referred the valuation of stock while in assessee's case the matter was related to the trading concern. It was contended that the learned CIT(A) had also overlooked the assessee's contention by not considering the relating expenses in closing stock valuation and since such expenses had already been included in the purchases, there was no question for its further addition, therefore, the said addition has been made merely on the basis of conjectures and surmises. It was submitted that the closing stock had been valued as per normal accounting principles at cost or market price, whichever is less and the said fact was also stated in the balance sheet appearing in the books of account. It was emphasised that the same, practice had been consistently followed by the assessee without any change since its inception, therefore, there was no justification for making the addition particularly when gross profit declared by the assessee at 11.274 per cent was almost in consonance with the earlier year's at 11.28 per cent even when the turnover had increased to Rs. 1,571.28 lakhs in comparison to sales in earlier year at Rs. 1,131.94 lakhs. It was also pointed out that the method of valuation of closing stock has been accepted by the Revenue while completing the assessment under s. 143(3) of the Act for asst. yr. 2004-05 and even the valuation of stock had also been accepted by the VAT and sales-tax authorities in their respective assessments. Therefore, the learned CIT(A) was not justified in confirming the arbitrary addition made by the AO.
8. In his rival submissions, the learned Departmental Representative for the Revenue strongly supported the orders of authorities below and reiterated the observations made by the AO in the assessment order dt. 29th Oct., 2010.
9. We have considered the submissions of both the parties and carefully gone through the material available on record. In the present case, it is noticed that the AO made the impugned addition by invoking the provisions of s. 145(3) of the Act, however, no specific defects have been pointed out in the books of account maintained by the assessee in regular course of its business. The AO did not point out any inflated purchase or suppressed sales. The claim of the assessee was that the expenses considered by the AO for increasing the value of the closing stock had already been debited in the books of account and those expenses were directly related with the purchases because insurance on goods in the transits was incurred to cover the transit risk and the expenses were already debited as part of the purchase, therefore, not to be added while valuing the closing stock. Similar was the position with regard to freight and handing expenses. The assessee incurred freight and handling charges at the time of purchase of goods so it was directly connected with the cost of goods purchased, it was not to be again added while valuing the closing stock. As regards to the entry-tax, the explanation of the assessee that it was paid to the State Government when the goods specified in the list under VAT Act were brought to the local area for consumption or use, so it was directly related to the purchases and not to be added again while valuing the closing stock, appears to be plausible. Similarly channel finance bank interest was charged by the bank and in this regard the assessee has submitted that its principal companies collected their receivables from channel finance banks and it is mandatory. The principal companies provided 30 days credit facility against purchase of goods and at that stage it was part of the trading expenses which were already recorded by the assessee in its books of account. All the expenses which were added by the AO on proportionate basis for the valuation of closing stock were already included in the purchase and the method of valuation of the assessee was cost or market price, whichever was less. This fact is also clear from col. 12(a) in Form 3CD which is part of tax audit report under s. 44AB of the Act. In the said column the auditor mentioned that the valuation by the assessee is "at cost including direct expenses or market value, whichever is less". It is also mentioned in col. 12(b) that there was no deviation in the above method. It is also an admitted fact that the Department has accepted the tax audit report and pointed out no discrepancy in the said report. Therefore, the AO was not justified in making the addition in the valuation of the closing stock particularly when the same valuation of the stock had also been accepted by VAT authorities and CTO respective assessment orders (copies of which are placed in assessee's paper book). In the present case, it is also noticed that for asst. yr. 2004-05 the assessment was framed under s. 143(3) of the Act after making proper scrutiny and valuation of the closing stock was accepted during the year under consideration, there is no deviation in valuing the closing stock from the method of valuation accepted by the Department in asst. yr. 2004-05, so there was no occasion to make addition in the year under consideration as expenses pointed out by the AO were already included by the assessee in the cost of purchase and the stock available with the assessee was out of purchase. Therefore, the proportionate amount of the expenses which was already recorded in the books of account as those were directly linked to the purchase, added by the AO in the valuation of closing stock, was not correct. In the present case, the AO while rejecting the books of account of the assessee by invoking the provisions of s. 145(3) of the Act had not given any other reason except the observation that the proportionate expenses incurred by the assessee on account of insurance on goods in transit freight and handling, entry-tax (purchase) and channel finance interest, were to be added. The AO did not point out any specific defect in the books of account or the method of accounting consistently followed by the assessee. It is also not the case of the AO that there was a deviation in valuing the closing stock in comparison to the earlier year, no inflated purchases or suppressed sales or expenses not incurred for the business purposes were found. Even the gross profit declared by the assessee on turnover which was higher in comparison to earlier year, has not been doubted by the AO. We therefore, considering the facts of the present case, are of the view that the provisions of s. 145(3) of the Act were not applicable to the facts of this case and the learned CIT(A) was not justified in confirming the impugned addition made by the AO delete the addition made by the AO and sustained by the learned CIT(A).
10. For the asst. yr. 2009-10 in ITA No. 401/Jd/2012, the facts are Identical as in ITA No. 400/Jd/2012 for asst. yr. 2008-09. Therefore, our findings given in the former part of this order for asst. yr. 2008-09 shall apply mutatis mutandis for asst. yr. 2009-10.
11. In the result both the appeals of the assessee are allowed.

[2013] 40 taxmann.com 83 (Jodhpur - Trib.)


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