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India Motor Parts And Accessories Ltd. (P.) v. Commissioner Of Income-Tax
Structured Summary of the Opinion — P. Chandra Reddy, C.J.
Factual and Procedural Background
This reference under Section 66(2) of the Indian Income-tax Act arises from the assessment of the petitioners for the assessment year 1958–1959 (accounting year ended 31-3-1958) and concerns the valuation of motor spare parts taken over by the assessee from General Motors. The assessee adopted a method of valuing opening and closing stock at cost but made an aggregate deduction of Rs. 1,00,015 to reflect declining demand; within that approach some stock was treated as obsolete (notionally written down by 100%) and some as slow moving (notionally written down by 50%).
The Income-tax Officer disallowed part of the valuation (added back an amount) by applying "pricing back" — a decision influenced by the fact that the assessee had declared the stock's value as Rs. 24,86,207 to the State Bank of India when applying for an overdraft and had insured the stock for the same amount. On appeal the Appellate Assistant Commissioner deleted the addition, relying on stock cards showing obsolescence or slow movement and that the items remained included in inventory. The department appealed to the Income-tax Appellate Tribunal, which reversed the Appellate Assistant Commissioner in respect of the slow moving parts because some of those items were later sold at a profit, indicating to the Tribunal that the market had not fallen. The present reference challenges the Tribunal's conclusion.
Legal Issues Presented
- Whether on the facts and in the circumstances the Tribunal was justified in sustaining the revision in valuation of closing stock by enhancing the value by Rs. 45,433?
Arguments of the Parties
Assessee's Arguments (as presented through counsel, Mr. Swaminathan)
- The assessee had adopted the contested method of valuation consistently for a number of years and the department had not objected to it in previous years.
- The system of accounting and valuation used (notional reductions for obsolete and slow moving items) is a recognised method of accounting, used in other countries (example given: United States) and recommended by industrial accountancy authorities.
- The Tribunal's reasoning was inconsistent: it disallowed the 50% reduction for slow moving items because some items later sold at a profit, yet it did not disturb the valuation adopted for items treated as obsolete even though some of those also fetched more than cost when sold. This inconsistency undermines the Tribunal's conclusion.
Revenue / Income-tax Officer's Position
- The Income-tax Officer applied a "pricing back" adjustment to add back part of the valuation because, when the assessee applied for an overdraft, it declared a substantially higher value to the State Bank of India and had insured the stock for that amount.
- The Tribunal relied on the fact that some slow moving items, when sold in subsequent years, yielded a profit — this was used to infer that the market had not declined and to justify reversing the deletion made by the Appellate Assistant Commissioner.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income-tax v. Chari and Ram, 1949-17 ITR 1 (AIR 1949 Mad 580) | Under Section 13 of the Income-tax Act, an assessee is entitled to compute income in accordance with the method of accounting regularly employed; ordinarily the department must accept such method in the absence of anything to suggest it is improper or patently false. | The court relied on this Division Bench authority to support the proposition that the assessee's long‑established method should be respected unless shown to be improper or patently false; it helped justify refusal to disturb the assessee's valuation method. |
| Commissioner of Income-tax, Madras v. Krishnaswami, 1964-53 ITR 122 (AIR 1964 SC 1843) | Affirmed and expressed more emphatically that an assessee may adopt any regularly employed system of accounting and the Income-tax Officer is obliged to compute income according to that method if profits can properly be deduced from it; the Officer must examine whether the method has been regularly employed. | The court applied this Supreme Court pronouncement to hold that the proviso to Section 13 was not attracted and that the Income-tax Officer could not re-compute the assessee's income simply because the assessee had given different figures to a bank; the decision reinforced the entitlement to continue the adopted method. |
Court's Reasoning and Analysis
The court proceeded in a stepwise manner, applying statutory text, fact findings and established authorities:
- Statutory framework: The court examined Section 13 of the Income-tax Act (quoted in the opinion), which generally requires income to be computed "in accordance with the method of accounting regularly employed by the assessee" but contains a proviso permitting the Income-tax Officer to compute otherwise if no regular method has been employed or if the method is such that the Officer is of the opinion that income cannot properly be deduced from it.
- Regularity and past practice: The court found it indisputable that the assessee had employed the contested method for several years (and that the method was in use when General Motors dealt in these parts). Because a regular method existed, the proviso could operate only if the Officer demonstrated that profits and gains could not properly be deduced from the method.
- Proviso not attracted: The court determined that the proviso did not apply. The Revenue did not assert that the method was being used to disguise income or that it prevented determination of true profits and gains. Stock remained in inventory; when items were sold the proceeds were brought into account and differences were shown as profits. Thus, there was no practical difficulty in ascertaining profit under the method.
- Recognition of the method: The court observed that the method of writing down obsolete or slow moving stock is a recognised method of valuation, cited a passage from an industrial accountant's handbook describing procedures for identifying and dealing with inactive inventory and obsolescence, and noted that a fifty per cent reduction for slow movement is an accepted form of adjustment in declining markets.
- Relevance of occasional higher sales: The court held that occasional solitary items selling for more than cost do not negate the nature of the overall valuation system. The fifty per cent reduction was applied because of inertia and slow sales, not because every sale would necessarily fetch below cost.
- Irrelevance of bank and insurance figures: The court rejected the Income-tax Officer's reliance on the higher valuation shown by the assessee to the bank and the amount for which the stock was insured, holding that figures furnished for obtaining an overdraft or for insurance are not determinative of stock valuation for computing trading results under Section 13.
- Tribunal's oversight: The court observed that the Tribunal failed to apply its mind to a related point — that in the previous year slow moving articles had been reduced by Rs. 22,046 whereas in the relevant year the flat 50% reduction amounted to Rs. 45,583; the court noted an argument before the Tribunal concerning corresponding revaluation of opening and closing stock but declined to rely on that detail to change its conclusion because the proviso was not attracted.
- Conclusion of analysis: Because the method was regularly employed, not shown to be improper or patently false, and because the proviso was not engaged, the court found no justification for interfering with the Appellate Assistant Commissioner's acceptance of the assessee's method; the Tribunal's reversal in respect of slow moving items was thereby set aside.
Holding and Implications
Core Holding: The reference is answered in favour of the assessee and against the department; the addition made by the Income-tax Officer is unsustainable.
Direct effect on the parties: The court restored the outcome favourable to the assessee — the valuation method regularly followed by the assessee for obsolete and slow moving spare parts is acceptable for the purposes of computing income under Section 13 and the specific addition of Rs. 45,433 (sustained by the Tribunal in respect of slow moving stock) cannot be upheld. The court ordered costs (counsel's fee Rs. 250).
Broader implications: The opinion applies and reaffirms the established rule that, under Section 13, an assessee's regularly employed method of accounting is to be accepted unless it is shown to be improper or patently false or unless the proviso is otherwise attracted. The decision does not purport to lay down a novel precedent beyond applying existing authorities; the court relied on prior decisions (Chari and Ram; Krishnaswami) and accepted recognized industry practice for valuing obsolete and slow moving inventory.
Answer accordingly.
P. Chandra Reddy, C.J:— The question we are called upon to decide under Section 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?”
2. This reference arises out of the assessment of the petitioners for the assessment years 1958–1959 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 31-3-958, the assessee made a return under Section 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 100 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. 24,86,207, and also insured these stocks for the same amount. 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 of 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 Section 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 contentiens are well founded.
4. At this, stage it will be convenient to read the terms of Section 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”.
5. 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 since this is not a case of no method of accounting having been regularly employed, if at all, tills 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 fee profits and gains could not be properly deduced from the method followed by the assessee.
6. 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.
7. 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).”.
8. Various steps to be taken in the disposal pi 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, file procurement officials can keep alert as to materials which might be affected in the future”.
9. What caused the obsolescence or the inactivity of these spare parts in the instant case of the ban on the import and assembly of these ears 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.
10. 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 pasts of the older models had diminished year to year and the sales thereof “were few and far between”.
11. That being the position we do not think that there was any 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 Section 13 of the Act.
12. It has been laid down by a Division Bench of this court in Commissioner of Income-tax v. Chari and Ram, 1949-17 ITR 1 : (AIR 1949 Mad 580) that under Section 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 Commissioner of Income-tax, Madras v. Krishnaswami, 1964-53 ITR 122 : (AIR 1964 SC 1843). 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.
13. 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.
14. 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.
15. 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.
16. 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”.
17. 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 Section 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
18. Answer accordingly.
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