Citation Codes

Equivalent Citations

citation codes

Case Number

I.T.R.C Nos. 180 & 181 of 1982

Attorney(S)

For the Appellant: H. Raghavendra Rao, K. Srinivasan Indrajeeth Shah, Advocates.

Judges

S.A Hakeem
S. Rajendra Babu, JJ.

Acts

Section 256(1) of the Income-tax Act, 1961, the Income-tax

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Smart Summary

Structured Summary of the Provided Legal Opinion

Factual and Procedural Background

These are references under Section 256(1) of the Income-tax Act, 1961, made by the Income-tax Appellate Tribunal (ITAT) to the Court. The Tribunal referred two common questions of law to the Court:

Whether the ITAT was right in law in holding that interest of Rs. 4,15,343/- taken directly to the interest suspense account is not assessable to income-tax?
Whether the ITAT was right in law in approving the system of valuation of stock-in-trade adopted by the assessee for the present assessment?

The second question arises out of the assessment year 1975-1976 (accounting year ended 31-12-1974) concerning a banking company (the assessee). In a revised return the assessee sought to write off Rs. 17,12,230 as depreciation due to a fall in market value of investments. The Income-tax Officer (ITO) disallowed the claim because the assessee had historically valued investments at cost. On appeal the Commissioner (Appeals) allowed the claim, holding that securities being stock-in-trade of a bank can be valued at cost or market value, whichever is lower, and that a bona fide change in method of valuation is permissible. The Tribunal upheld the Commissioner (Appeals) on the valuation issue. The Revenue referred the two questions above to the Court.

Legal Issues Presented

Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in holding that the interest of Rs. 4,15,343/- taken directly to the interest suspense account is not assessable to income-tax?
Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in approving the system of valuation of stock-in-trade adopted by the assessee for the present assessment?

Arguments of the Parties

Revenue's Arguments (as recorded)

Main contention (advanced by Mr. K. Srinivasan for the Revenue) was that the change by the assessee from valuing securities at cost to valuing closing stock at market value (or cost, whichever is lower) was not justified because the assessee had consistently used cost in the past and the change was effected only in the revised return.
The Revenue argued that the assessee cannot adopt one method for opening stock and a different method for closing stock in the same year because that would distort the true profits for the year.
The Revenue contended that there should be a definite method of valuation carried through from year to year and that an arbitrary change in accounting method to suit the assessee's purpose should not be permitted.

Assessee / Appellate Commissioner / Tribunal Position (as recorded)

The Appellate Commissioner held that securities being stock-in-trade of a bank may be valued at cost or market value, whichever is lower, and that the assessee may change the method of valuation provided the change is bona fide and followed thereafter.
The Commissioner noted that in preceding years the market value had generally been higher than cost, and that the substantial fall in market value on 31-12-1974 justified adopting the lower valuation for closing stock so as to reflect real income of the bank.
The Tribunal upheld the Appellate Commissioner's acceptance of the method of valuation adopted by the assessee for the assessment year in question.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
State Bank of Travancore v. C.I.T (158 I.T.R 102)	Addressed the issue whether interest taken directly to an interest suspense account is assessable.	The first question was held to be wholly covered by this ruling; the question was answered in the negative and in favour of the Revenue (i.e., ITAT's view that such interest was not assessable was rejected).
Chainrup Sampatram v. C.I.T (24 I.T.R 481) [also cited as 22 I.T.R 481 in the opinion]	Assessee entitled to value closing stock either at cost or market price, whichever is lower; closing stock must be the value of opening stock in the succeeding year; change of method permissible if bona fide and followed thereafter.	The Court applied these principles to recognise the assessee's option to change valuation method provided the change is bona fide and continued; this was central to answering the second question in favour of the assessee's valuation method.
British Paints India Ltd. v. C.I.T., Calcutta (111 I.T.R 53)	Set out commercial accounting principles concerning valuation of closing stock (purpose of valuation, that valuation is not for charging depreciation, necessity to determine cost by commercial tests, absence of statutory rules so ordinary commercial accounting follows, requirement of consistency, and that method must be recognised by accounting practice).	The Court relied on the principles enumerated in this decision to assess whether the change in valuation method was commercially justified and bona fide; these principles informed the conclusion that the valuation method adopted should be fair and in consonance with accounting practice.
Kedaranath Jute Mfg. Co. Ltd. v. C.I.T. (S.C) (82 I.T.R 363)	Where a liability (or deduction) has accrued during the period, the assessee under mercantile system is entitled to deduct it even if the assessee failed to make the entry in the books; entitlement depends on law not solely on book entries.	Used to support the proposition that failure to debit the loss in books of account does not necessarily bar the claim in assessment if, in law, the deduction is allowable; applied to the assessee's failure to debit the loss in profit and loss account.
C.I.T v. Shoorji Vallabhdas & Co. (46 I.T.R 145)	Where subsequent agreement alters the amount really accruing to the assessee, the taxable amount is that lesser amount actually received (substance over book entries).	Applied to reinforce the principle that book entries do not conclusively determine taxable income and that the real accrual or non-accrual of income governs tax liability.
Bank of Cochin Ltd. v. C.I.T (94 I.T.R 93)	Dealt with whether a bank could value securities at market price lower than cost where previously valued at cost; loss not debited to profit and loss account but adjusted elsewhere.	Held that non-debit in profit and loss did not invalidate the claim; cited by the Court to support allowing loss where market value was lower than cost though books did not show a standard debit.
Indo Commercial Bank Ltd. v. C.I.T (44 I.T.R 22)	Losses on securities chargeable to reserve and not debited to profit and loss are still allowable in appropriate circumstances.	Relied upon to support that absence of a specific debit in profit and loss does not automatically disallow a legitimate valuation loss claimed in assessment.
149 I.T.R 757	Referenced as authority supportive of the proposition that a bona fide change in valuation method may be acceptable and that short-term anomalies will be ironed out over time.	Used by the concurring judge (Rajendra Babu, J.) as supporting authority for allowing a change in valuation method applied to closing stock even though opening stock in the same year may have been valued on a different basis.

Court's Reasoning and Analysis

The Court considered the two referred questions separately.

For Question 1 (interest of Rs. 4,15,343/- taken to interest suspense account): the Court held that the question was wholly covered by the Supreme Court ruling in State Bank of Travancore v. C.I.T (158 I.T.R 102). Applying that ruling, the Court answered the first question in the negative and in favour of the Revenue — meaning the ITAT was not correct in holding that such interest was not assessable.

For Question 2 (valuation of stock-in-trade): the Court examined the factual matrix: the assessee bank, accounting year ending 31-12-1974, revised return claiming Rs. 17,12,230 as depreciation due to fall in market value of investments, ITO's disallowance on grounds that (i) assessee had historically valued at cost and had no compelling reason to depart, (ii) adopting different methods for opening and closing stock in the same year would distort true profits, and (iii) the loss had not been written off in the books.

The Court applied established authorities and accounting principles to these facts:

It reiterated the settled principle from Chainrup Sampatram that an assessee may value closing stock at cost or market value whichever is lower, and that a change of method is permissible provided it is bona fide and thereafter followed consistently.
The Court relied on the commercial-accounting principles summarized in British Paints India Ltd. v. C.I.T., which emphasize that valuation should reflect commercial practice, aim to determine true profits, and be fair to both taxpayer and revenue; anticipated losses are permissible where supported by market and accounting practice.
Regarding the absence of a bookkeeping debit for the loss, the Court invoked Kedaranath Jute and Shoorji Vallabhdas to explain that entitlement to a deduction depends on substantive law and the economic reality of accruals, not merely on whether an entry was made in the statutory books; prior decisions (Bank of Cochin and Indo Commercial Bank) held similar losses allowable despite not being debited to profit and loss.
The Court noted the factual findings: the balance sheet disclosed the lower market value; the loss was not disputed by the Department in quantum; the Commissioner (Appeals) and the Tribunal had found the change to be bona fide and that the method was followed in subsequent years; the fall in value was attributable to events (change in bank rate) consistent with precedent.

On this basis the Court concluded that, in the facts and circumstances and in the light of the precedents, the Tribunal was justified in approving the valuation method adopted by the assessee for the assessment year in question.

In a concurring but supplementary note, Rajendra Babu, J. explained that the effect of Chainrup Sampatram is that there is no rule requiring opening and closing stock of the same accounting year to be valued on the same basis; a bona fide change applied initially only to closing stock will create a one-year anomaly which will get ironed out in later years when the new method is applied consistently. He also emphasised that failure to adjust the loss in statutory accounts alone is not decisive where the balance sheet and other facts indicate that the loss was genuinely incurred and the Revenue did not dispute bona fides.

Holding and Implications

Holding (core rulings):

On Question 1: The Court answered the question in the negative and in favour of the Revenue — the ITAT's conclusion that interest taken directly to an interest suspense account was not assessable was not sustained in view of the State Bank of Travancore authority.
On Question 2: The Court answered the question in the affirmative and against the Revenue — the Tribunal was justified in approving the method of valuation of stock-in-trade adopted by the assessee for the relevant assessment year.

Implications:

Direct effect on the parties: The Revenue succeeds on the first referred question (interest in suspense account issue) and fails on the second referred question (valuation of securities/stock-in-trade). The Tribunal's order upholding the valuation method of the assessee is sustained.
The decision applies and follows established precedents rather than creating a novel principle: the Court repeatedly relied on earlier authorities (including Chainrup Sampatram, British Paints, Kedaranath Jute, Bank of Cochin and others) to justify its conclusions. The opinion therefore affirms the existing law on: (a) the assessability of interest in suspense (as governed by State Bank of Travancore), and (b) the circumstances in which a bona fide change in the method of stock valuation is permissible and the allowance of related losses even if not debited to profit and loss in statutory books.
No broad new precedent was formulated in this opinion beyond application and clarification of prior authorities; the ruling resolves the two referred questions on the facts and law presented.

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Commissioner Of Income-Tax, Bangalore v. The Corporation Bank Ltd., Mangalore

1. In these references under Section 256(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal, has referred the following common questions of law for the opinion of this Court:

“1. Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in holding that the interest of Rs. 4,15,343/- taken directly to the interest suspense account is not assessable to Income-tax?”

2. Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in approving the system of valuation of stock-in-trade adopted by the assessee for the present assessment?”

2. In our opinion the first question is wholly covered by the ruling of the Supreme Court in State Bank of Travancore v. C.I.T (158 I.T.R 102). Accordingly it is answered in the negative and in favour of the Revenue. The second question relates to the valuation of the stock-in-trade of the banking business of the assessee. The assessee is a banking company. The matter has arisen out of the order in respect of the assessment year 1975-1976 for which the accounting year ended on 31-12-1974. In the revised return filed by the assessee a sum of Rs. 17,12,230-00 was sought to be written off as the depreciation on account of market fall in the value of investments made by the assessee. The ITO found that all along the assessee was valuing the investments at cost. There was no departure from this method at any time in the past. He disallowed the assessee's claim to write off the difference between the cost of investment and the market value of the same amounting to Rs. 17,12,230/- against the closing stock value of investment adopted in the published balance sheet. On appeal by the Assessee the CIT (Appeals) upheld his claim and held that the securities being Stock-in-trade of the banking business, it is open for the assessee to value the stock at cost or market value, which ever is lower. It was further held by him that even if the method of valuation in the past had been different, the assessee had the right to change over to the present method, provided such change is bona fide and followed thereafter. It is noticed by the Commissioner that in all the immediately preceding five years wherein the assessee had valued the securities at cost the market value was higher than the cost in four years and only in one year it was less. It is because of the huge difference between the market value and the cost on 31-12-1974 that the assessee must have thought fit to switch over to the method of valuing the securities at cost or market price whichever is lower. The Commissioner further held that it is not necessary to value the opening and closing stock of a year on the same basis. Holding that what is to be assessed is the real income of the Bank he directed allowance as claimed. In further appeal by the Revenue regarding the valuation of the stock-in-trade the Tribunal upheld the order of the Appellate Commissioner in accepting the method of valuation of closing stock adopted by the assessee. Aggrieved by this order of the Tribunal the Revenue has brought up this reference on the question set forth earlier in this order.

3. The main contention of Mr. K. Srinivasan, learned counsel for the Revenue is regarding legality of change in the method of valuation of closing stock from the cost value to market value. It is not disputed that the assessee is at liberty to adopt either cost value or market value for the purpose of valuation. However, the grievance of the department was that the assessee who had been adopting only cost price had changed the method of valuation by the revised return and in the absence of such change being bona fide, there is no justification in the Tribunal approving the changed method of valuation of stock-in-trade adopted by the assessee for the first time. It is further urged by the learned counsel that the ruling of the Supreme Court in the case of Chainrup Sampatram v. C.I.T (24 I.T.R 481) relied upon by the Appellate Commissioner and the Tribunal is only an authority to say that the assessee is at liberty to adopt either the cost price or market price, but the same cannot be read to justify the view that he can adopt cost price for opening stock and market price in respect of the closing stock in the same year. It is furter urged that there should be a definite method of valuation of stock which would be carried through from year to year and the assessee cannot be allowed to arbitrarily change the method of accounting as regards the basis for stock valuation to suit his purpose.

4. In British Paints India Ltd. v. CIT, Calcutta, (111 ITR 53) on a review of various earlier decisions the Calcutta High Court has evolved the following principles on the question of valuation of closing stock:

(1) The true purpose of valuation of the unsold stock is to balance the cost of these goods entered on the other side of the account at the time of their purchase or production, so that cancelling out of the entries relating to the same stock from both sides of the account, would leave only the transactions on which there have been actual sales in the course of the year showing profit or loss actually realised on the year's trading.

(2) For the purpose of Income-tax, the object of valuation of unsold closing stock is not to bring into charge any depreciation in the value of such stocks.

(3) For the purpose of the aforesaid valuation, it is necessary to determine what in all circumstances represent the costs of stock-in-trade and work-in-progress. What is and what is not profit or gain in these circumstances must necessarily be one of fact and fact to be ascertained by the tests of ordinary business.

(4) There are no statutory rules for making this valuation and the ordinary method of commercial accounting must be followed except in so far as there is any specific statutory provision requiring otherwise. The method must be fair to the tax payer and fair to the revenue. Traders are allowed to value their unsold stock and work-in-progress either ‘at cost or market price, whichever is lower’. This is, however, a shorthand way of expression; it is not a rule of law. It must be adopted in commercial sense in consonance with accounting practice. Anticipated losses and profits for the aforesaid purpose are permissible, provided however, there is a market in the ordinary sense, and the anticipation is backed by consistency of the method followed and the method followed is supported by recognised accounting principles and

(5) Whatever is the method, it must be one recognised by accounting practice and sanctioned by commercial practice. The method adopted and regularly followed over the periods and accepted by the revenue should not be departed from unless there is good reason for the same. If, however, the method adopted and regularly followed by the assessee does not result in the determination of the true profits for tax purposes, even for one particular year, or there is some other good reason, the revenue is entitled to reject the method followed and value the stock upon such basis as will result in the determination of true profits.

5. In the present case the Income-tax Officer has disallowed the assessee's claim regarding valuation on three grounds viz., (i) that all along the assessee had valued the investments in the securities at cost and there were no compelling reasons for departure from established practice; (ii) to adopt one method for opening stock and a different method for valuing the closing stock would result in distortion of the true profits earned by the assessee; and (iii) that the loss had not been written off in the assessee's books of accounts.

6. On the application of the principles laid down by the Supreme Court in the leading case of Chaninrup Sampatram v. C.I.T (22 I.T.R 481) two principles appear to be well settled i.e, that the assessee is entitled to value the closing stock either at cost price or market value whichever is lower and that the closing stock must be the value of the opening stock in the succeeding year. It is thus clear that irrespective of the basis adopted for valuation in the earlier years the assessee had the option to change the method of valuation of the closing stock at cost or market price whichever is lower at any time provided the change was bona fide and followed regularly thereafter.

7. Although the I.T.O had taken that stand in the assessment order, the aforesaid propositions were not disputed either in the first appeal or before the Tribunal. The Department also did not dispute the quantum of loss claimed by the assessee which is also indicated in the balance sheet as on 31-12-1974, in which after stating the face value of the securities and bills, the approximate market value is also mentioned which is lower than the cost. However this loss was not debited to the profit and loss account. The fact that the securities formed part of stock-in-trade of the assessee bank and that it was a trading loss, was also not disputed at any point of time. Hence, the only question that remains for consideration is whether the assessee is entitled to value the stock at cost or market value whichever is lower notwithstanding the fact that the assessee had failed to debit the anticipated trading loss in its books of accounts.

8. In Kedaranath Jute Mfg. Co. Ltd. v. C.I.T (S.C) (82 I.T.R 363), where the assessee had made no provision in its books with regard to certain tax liability and the claim for allowance having been made in a revised return, it was held thus:

“An assessee who follows the mercentile system of accounting is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being computed.

The main contention of the learned Solicitor-General is that the assessee failed to debit the liability in its books of accounts and therefore, it was debarred from claiming the same as deduction either under Sec. 10(1) or under Sec. 10(2)(xv) of the Act. We are wholly unable to appreciate the suggestion that if an assessee under some mis-apprehension or mistake fails to make an entry in the books of account and although under the law, a deduction must be allowed by the Income-tax Officer, the assessee will lose the right of claiming or will be debarred from being allowed that deduction. Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights, nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter…”

9. In C.I.T v. Shoorji Vallabhdas & Co. (46 I.T.R 145) where the assessee had claimed that it was not taxable on the entire amount even though credit entry for them had been made in the books of accounts, it was entitled to a lesser amount by virtue of a subsequent agreement, it was held thus:

“The subsequent agreement had altered the rate of commission in such a way as to make the income which really accrued to the assessee different from what had been entered in the books of account …….. The assessee had in fact received only the lesser amount inspite of the entries in the account books, and this lesser amount alone was taxable.

10. Income tax is a levy on income. Though the Income Tax Act takes into account two points of times at which the liability to tax is attracted., viz., the accrual of the Income or its receipt, yet the substance of the matter is the income. If the income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a ‘hypothetical income’, which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of accounts.”

11. In Bank of Cochin Ltd. v. C.I.T (94 ITR 93) the question that arose for consideration was whether the Bank could value its security on market price which was lower than cost when it had been valuing them at cost in the past. For the year in question the assessee had claimed certain loss by valuing closing stock of the securities at market price which was lower than the cost to that extent. This loss was not debited to the profit and loss account, but it was directly adjusted against devaluation profit made by the assessee. Still it was not taken to be a valid ground for disallowing the claim of the assessee and the loss was held to be allowable. Similarly in Indo Commercial Bank Ltd. v. C.I.T (44 I.T.R 22), the loss had been charged to reserve and there was no debit for it to the profit and loss account. Still it was not held to be a valid ground for disallowing the claim of the assessee and the loss was allowable. In the instant case it is not disputed that as on the valuation date the market value of the securities was less than cost price to the extent of the loss claimed by the assessee which is indicated in the balance sheet itself. As such it is rightly held by the Appellate Commissioner that the bank had incurred substantial loss by the fall in value of its securities, which is an important factor to be considered in debiting the income of the bank. Ignoring this loss would certainly distort the real income of the year. The appellate authority has also taken note of the fact that these losses had arisen due to change in bank rate during the year - a similar position as in Indo Commercial Bank v. C.I.T (44 I.T.R 22).

12. In the facts and circumstances of the case and the rulings referred to above, I am of the opinion that the Tribunal was justified in approving the method of valuation adopted by the assessee for the relevant asssessment year. In that view of the matter, question No. 2 referred is answered in the affirmative and against the Revenue.

13. Rajendra Babu, J.:

14. I concur and wish to supplement what has already been stated by my Lord, as follows:

The contention of the Revenue is that in order to reflect the true profits, change in the method of valuation of stock should be applied to both opening stock as well as closing stock and it is not open to the assesse to apply new method to closing stock alone without reference to opening stock. The value of the closing stock in the previous year must be the value of opening stock in the succeeding year and therefore if the argument of the Revenue is accepted, there cannot be change in the valuation at all. However, the effect of the ruling in Chainrup Sampatram v. C.I.T (24 I.T.R 481) is that there is no rule that the opening stock and closing stock of the same accounting year must necessarily be valued on one and the same basis. It is permissible therefore for the assessee to adopt either market value or at cost price to value the closing stock as long as such change in the method of valuation is adopted bona fide and is thereafter continued year to year. In a year where opening stock value adopted is on one method and closing stock in another there is bound to be some anamoly in the year of change, but that will get ironed out and absorbed in course of time as new method of valuation of stock is going to be applied on a permanent basis thereafter in coming years. I derive support for this view from 149 I.T.R 757 and 111 I.T.R 53.

15. It was submitted for the Revenue that the loss had not been adjusted in the books of account and it is only at the time of assessment that such a stand of change in method of valuation of stock has been taken by filing a revised return. Merely beause assessee has to maintain statutory accounts and they do not contain entries regarding this loss will not by itself be sufficient to dicard this stand of the assessee. The assessee had, in fact, incurred substantial lossess, as found by the Commissioner (Appeals) and the Tribunal, by the fall in the value of its securities and ignoring this loss would not have given rise to correct trading results and the balance sheet also indicated this position correctly and so this objection to allow change in the method of valuation of stock has no substance. The Commissioner (Appeals) found that the Revenue had not questioned the bona fide of assessee in adopting the change in the method of valuation and the same had been followed in subsequent years also and this finding has been reiterated by the Tribunal.

16. These findings and the position of law as set out above will reveal that the contentions raised by the Revenue have to fail and the view of the Tribunal has to prevail

Commissioner Of Income-Tax, Bangalore v. The Corporation Bank Ltd., Mangalore

Structured Summary of the Provided Legal Opinion

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Revenue's Arguments (as recorded)

Assessee / Appellate Commissioner / Tribunal Position (as recorded)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax, Bangalore v. The Corporation Bank Ltd., Mangalore

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