All about income tax laws related to stock valuations
September, 17th 2013
Generally speaking every person carrying on business is permitted within the parameters of the Income-tax Law to adopt any system of accounting. Broadly speaking there are two systems of accounting generally followed by the business community. Whereas the first system of accounting is known as Mercantile System of Accounting while another system of accounting is popularly known as Cash System of Accounting. Whenever a new business is started, the choice lies with the businessman to adopt the method of accounting as per his desire. There is no compulsion by the Tax Department for keeping the accounts in a particular manner. The above are the main guidelines concerning the method of accounting to be followed by a businessman. However, the corporate tax payers are required to maintain the accounts on Mercantile basis. Section 145 of the Income-tax Act, 1961 provides that in case the accounts are not properly maintained, in that situation the books of account can be rejected by the tax officials and the income will then be computed based on the best judgment of the Assessing Officer.
One of the most important aspects concerning maintenance of the accounts is with reference to the valuation of the closing stock of the business enterprise. Section 145A of the Income-tax further provides that the valuation of the stock should include the amount of any debt, duty, cess or fee paid or incurred to bring the goods to the place of location on the valuation date. Thus, due to the specific provisions to the above effect in the Income-tax Act, all tax payers must value closing stock by including the above mentioned items. Also read: Keep a watch on details of scrutiny of tax returns Another important pertinent question which would come in the minds of the tax payers is how to value the closing stock of the business enterprise.
Well, it is really very simple to value the closing stock. The choice lies with the tax payer to adopt the system of stock valuation as he would like to do. Generally speaking the general rule of valuation of the closing stock is to value the stock at the cost price or the market price which is lower. However, the important point is that whatever system of valuation of closing stock has been adopted by the assessee, in that situation the same should be maintained on the regular basis. If however, the assessee desires a change in the method of valuation of the closing stock, then it is possible for the assessee to change the valuation concept of closing stock provided it is a bonafide one and is followed regularly thereafter. This implies that one cannot change year after year the method of valuation of the closing stock. This has also been the decision of the Honourable High Court in the case of CIT v. Bharat Commerce and Industries Ltd. 240 ITR 256. It may be noted here that keeping of the stock register is of great importance for every business enterprise because it is the stock register which is a means of verifying the assessee’s accounts by having a quantitative tally as opined by the Supreme Court of India in the case of S.N.N. Chetiyar v. CIT 38 ITR 579.
However, sometimes it may happen that there is no stock register and merely because there is no stock register, the Assessing Officer cannot just presume that the account books must be false. In the case of Pandit Brothers v. CIT 26 ITR 159 it was held that the absence of stock register cannot amount to be a material for rejection of the books of account of the assessee. The main purpose of maintaining the stock register from the point of view of the Tax Department is to find out whether the income of the assessee can or cannot be property deducted from the method of accounting regularly employed and followed by the assessee. This was the observation of the Supreme Court of India in the famous case of Chhabildal Das Tribhuvan Das Shah v. CIT 59 ITR 733. The rejection of the accounts by the Tax Officer by invoking the provisions of section 145 would be justified in a situation where the raw material by the assessee is shown in terms of weight while the manufactured goods are shown in terms of the length or the number of goods. This has been the view of the Honourable judges of the High Court in the case of Howrah Trading Company Private Limited v. CIT 67 ITR 582. The Tax Department would also be justified in rejecting the accounts of the assessee where there is no daily stock register and the yield as declared by the assessee in the accounts is comparatively low.
This view is of the Honourable judges of the High Court in the case of Punjab Trading Company Limited v. CIT 53 ITR 335. Likewise, if the stock tallies are not available with the assessee and the sales details are not recorded in the accounts with identifiable details, in that situation the accounts of the assessee can be rejected. This has been the view in the case of Kishinchand Chellaram 114 ITR 671. It may also be noted that various High Courts have held that if no proper books of accounts are kept and no details are maintained regularly, the accounts can be rejected by the Tax Department.
Sometimes a question arises as to what happens in a situation where in the business of the assessee higher wastage takes place. This issue has been answered by the Honourable judges of the High Court in the case of R.B. Bansi Lal Abirchand Spinning and Weaving Mills 75 ITR 260 when it was held that the accounts of the Assessee cannot be rejected merely if higher percentage of wastage has been done by the assessee particularly where the particulars are maintained to the extent possible and feasible.
There may also arise a situation where the assessee maintains regular books of account as also the stock register in which case the accounts cannot be rejected. But it may be noted that sometimes the assessee gives a separate valuation to the bank in respect of the stock of goods and articles. Now the question is whether in such a situation where inflated stock has been given to the bank, can the books of account be rejected.
There have been certain decisions of the High Courts on this point wherein the High Courts have held that merely due to inflation of the stock statement which has been given to the bank, the rejection of the books of account of the assessee will not be justified. The accounts can be rejected only based on the facts and circumstances or the peculiar situation of the assessee. It may be noted here that the valuation of stock is very very important and the Supreme Court of India long back in the case of CIT v. British Paints India Limited 188 ITR 44 opined that the importance of the stock valuation is to find out the correct determination of the profits or loss of the business enterprise. However, a method of accounting as has been adopted by the tax payer consistently and regularly cannot be discarded by the Tax Department. This has been the firm view of the Supreme Court of India in the case of United Commercial Bank v. CIT 240 ITR 325.
Whenever the question arises of the valuation of the closing stock, the tax payers should always remember that as pointed out above, it is possible for the tax payers to adopt any system of accounting as it desires. Similarly, the Assessee can adopt the concept of valuation of the closing stock at cost price or market price whichever is lower. But different methods of closing stock for different items is not permissible under the Income-tax Law. Those doing business sometimes face a problem with regard to valuation of their closing stock which is old one and which is to be discarded and such other stock the value of which has gone down considerably may be because it cannot be used now by the assessee due to technological changes or due to expiry time or due to whatsoever other reason. In such a situation it is also possible to value the stock in trade as Nil.
This was the view of the Honourable judges of the High Court in the case of K. Mohammad Alam 56 ITR 360. Once in a while some of the persons engaged in business find a peculiar problem in their case. They find that at the close of the accounting year their value of the closing stock is at a lower value because they feel that the market price of the closing stock will be lower now but later on finally when the goods were sold, they were sold at a higher price.
And this higher price was subsequently realized for the closing stock which was valued at a lower rate as on the closing date of the accounting year. In that situation also the accounts of the assessee cannot be rejected and merely because closing stock was valued at a lower figure and sold at a higher figure subsequently will be no ground to reject the books of account. This has been the clear cut view of the Honourable judges in the case of Boltamt Transformers Limited v. CIT 217 CTR 254. When we talk of the closing stock, it may also be noted here that all those persons who are engaged in business whether trading or manufacturing and take recourse to the system of computation of income based on the principles of presumptive income, in that situation it is immaterial whether the assessee maintains the books of account or not and whether they maintain the stock register or not.
Thus, small business people having turnover up to Rs. 60 lakhs can easily opt for tax computation based on presumptive system whereby only 8 per cent of the turnover will be treated as the income of the assessee and then there would be no hassles of even maintaining the stock register and also no hassles of having tax audit. In conclusion we may just add here that all those engaged in business must very carefully make it a point to maintain stock carefully so that the account books of the assessee are not rejected by the Assessing Officer by invoking the provisions of section 145 of the Income-tax Act, 1961.