No TDS done on the audit fees provision for the reason that it is payable only after the signing of the report- Whether disallowable u/s 40(a)(ia) ?

Assessee made provision for audit fees and claimed the same as deduction. Assessee’s case was that the provisions of section 194J would not apply to audit fees, as the question of payment to the auditor would arise only after the signing of the accounts which took place after the year end. AO, however, proceeded to disallow the same under section 40(a)(ia).

Held:

Assessee had made provision for audit fees to the account of the payee which had clearly attracted the provisions of section 194J and non-deduction of tax at source would automatically invite disallowance under section 40(a)(ia).

Citadel Fine Pharmaceuticals (P.) Ltd. v. Asstt. CIT

Decision:    Against the assessee.

The copy of the judgment is as under:

Income Tax Act, 1961, Section 40(a)(ia)

Business disallowance under section 40(a)(ia)–Non Payment of TDS–Provision for audit fees

Conclusion: Since assessee had made provision for audit fees to account of payee, provisions of section 194J were clearly attracted and non-deduction of tax at source would automatically invite disallowance under section 40(a)(ia).

Assessee made provision for audit fees and claimed the same as deduction. Assessee’s case was that the provisions of section 194J would not apply to audit fees, as the question of payment to the auditor would arise only after the signing of the accounts which took place after the year end. AO, however, proceeded to disallow the same under section 40(a)(ia). Held: Assessee had made provision for audit fees to the account of the payee which had clearly attracted the provisions of section 194J and non-deduction of tax at source would automatically invite disallowance under section 40(a)(ia).

Decision: Against the assessee.

IN THE ITAT, CHENNAI ‘A’ BENCH

N.R.S. GANESAN, J.M. & M. BALAGANESH, A.M.

Citadel Fine Pharmaceuticals (P.) Ltd. v. Asstt. CIT

IT Appeal Nos. 2027 & 2028 (Chny) of 2017

A.Ys. 2005-06 and 2006-07

8 February, 2018

Appellant by: S. Sundararaman, CA

Respondent by: ARV Sreenivasan, JCIT

M. Balaganesh, A.M.

These appeals by the assessee arise out of the common orders of the learned Commissioner (Appeals)-5, Chennai [in short the learned CIT(A)] in Appeal Nos.72 & 73/Commissioner (Appeals)-5/13-14, dt. 20-6-2017 against the orders passed by the ACIT, Circle-I(3), Chennai [in short the learned AO] under section 143(3) of the Income Tax Act, 1961 (in short “the Act”) dated 11-12-2007 and 15-12-2011 respectively for the assessment years 2005-06 and 2006-07 respectively. Both the appeals are taken up together and disposed off by this common order for the sake of convenience.

ITA No. 2027/CHNY/2017 — Assessment Year 2005-06 — Assessee Appeal

2. The first issue to be decided in this appeal is as to whether the learned Commissioner (Appeals) was justified in upholding the disallowance of Rs. 1,18,23,353 towards sales promotion expenses in the facts and circumstances of the case.

2.1 The brief facts of this issue is that the assessee company is a manufacturer of pharmaceutical goods. It incurred a sum of Rs. 1,18,23,353 as Sales Promotion expenses in respect of its products. The assessee entered into a Joint Venture Agreement dated 27-3-2002 with another company by name Citadel Aurobindo Biotech Limited (CABL in short) as a result of which it had sold its brands to the said company. It was agreed between the assessee and CABL, that they would reimburse the assessee certain sales promotion expenses incurred in respect of its branded products and therefore, the assessee had not debited the related sales promotion expenses to the profit and loss account in the year of its incurrence. The fact that these expenses were genuinely incurred and that it was recoverable from CABL was not in dispute at all. The assessee was having various correspondences with CABL for over three years. Ultimately, CABL refused to reimburse the said sum of Rs. 1,18,23,353 during the assessment year 2005-06. In other words, the refusal was made by CABL in assessment year 2005-06 and accordingly the assessee decided to write off the said claim in its books of accounts and accordingly wrote off the same in assessment year 2005-06 and claimed the same as a deduction. The learned assessing officer observed that the assessee had furnished the entire list of expenses made on account of sales promotion expenses. The assessee submitted that these were expenses incurred by it in assessment year 2002-03 immediately before the assessee’s brands were sold to its Joint Venture Company CABL. The assessee actually incurred the expenditure towards promotion of its brands for various products and since the said brands were sold by the assessee to CABL, it was decided by the assessee to treat the same as recoverable from CABL and accordingly reflected in the same under the head ‘Current Assets’ in the Balance Sheet of Brand division. These current assets were also subject to be taken over by CABL on actual historical cost. The assessee pleaded that since CABL refused the claim of assessee to take over the sales promotion expenses of Rs. 1,18,23,353 incurred towards Brand division, and that this refusal came to light only in the assessment year 2005-06, the assessee had no other option but to write off the same in the books of accounts and claim as deduction. The assessee also pleaded that no deduction was claimed by the assessee with regard to these sales promotion expenses in the year of actual incurrence. It was only due to take over of Brand division and repeated correspondences that were exchanged to resolve the dispute with regard to take over of this claim of sales promotion expenses, no deduction was claimed in the earlier years. Since the dispute could not be resolved for over three years and that the same got resolved only in assessment year 2005-06 by clearly knowing from CABL that they are not willing to absorb this expenditure, it was decided to write off in the books of assessee as irrecoverable loss incidental to business in assessment year 2005-06 and deduction was claimed accordingly in the return.

2.2 The learned assessing officer went through the entire correspondences between the assessee and CABL that were placed on record before him. He came to a conclusion that the reply of the assessee cannot be accepted for the reasons that as per the letter issued by CABL on 31-1-2005, it is observed that CABL has rejected the payment of the above claim of the assessee for the following reasons :–

“(a) The expenses for the cited amount was never mentioned in the Agreement for purchase a Brands and taken over of Current Assets, dated 27-3-2002.

(b) The argument that Compliments of Gift articles constitute a part of the Current Assets taken over cannot be applied to your claim for the simple reason that there was no proper accounting available for the same and all have been reported to have been distributed well before the formation of the JV Company.

(c) Also, we feel that since promotion of products constitute a daily routine there is nothing extra-ordinary in giving compliments/gifts to doctors. As far as we can foresee, this is akin to paying the salary to your staff.

(d) More importantly, the talk of forming a JV was initiated only sometime in November-December, 2001 and when the items were ordered there was no linking that a JV company was in the anvil.

(e) Your claim looks like an additional levy on us for the purchase of your brands and we are unable to appreciate the points referred to in your letter dated 3-2-2003.

(f) Books like Ha Ha Therapy’ though authored by a renowned doctor is more a book on ‘humour during medicine practice’ rather that giving any insight into technicalities. However, since, you had your own strategies we do not want to comment further on this.

(g) Again, Diary for 2002 definitely is not for any product promotion and can be only for the sake of corporate image.

(h) Samples and compliment being treated in the same plane for the sake of the agreement cited above is rather amusing. First of all, we cannot treat them alike for the simple reason that the compliments/gifts have been distributed, already.

(i) We have considered samples that were available as current assets. You should understand that we have not considered samples given away prior to the formation of the JV as current assets nor even what is available with the Field Staff during the change-over.”

Based on the aforesaid reasons, the learned assessing officer held that the expenses were not related to CABL as claimed by the assessee. The learned assessing officer further held that the sales promotion expenses were incurred during the assessment year 2002-03 and hence were not related to earning of income for the assessment year 2005-06. The learned assessing officer held that claim of the assessee is wrongly placed and cannot be accepted as expenditure of the current year and disallowed sales promotion expenses of Rs. 1,18,23,353 in the assessment.

2.3 Before the learned Commissioner (Appeals), the assessee narrated the facts of the case together with the various correspondences that were submitted before the learned assessing officer and submitted that the loss got crystallized only during the assessment year 2005-06 and it is akin to loss incidental to the business and should be allowed as deduction under section 28 of the Act. The learned Commissioner (Appeals) placed reliance on the CBDT Circular No. 5/2012, dt. 1-8-2012 wherein it was held that business expenditure incurred in providing freebies to medical practitioner by pharmaceutical and allied health sector industry is not an allowable deduction under section 37(1) of the Act. He stated that as per Medical Council of India (MCI) regulations dated 10-12-2009 imposes a prohibition on the medical practitioner and their professional associations from taking any gift, travel facility, hospitality, cash or monetary grant from the pharmaceutical and allied health sector industries. The learned Commissioner (Appeals) based on this circular concluded that the subject mentioned sales promotion expenses incurred by the assessee would be hit by prohibition imposed by Medical Council of India and hence the explanation to section 37(1) of the Act would come into play. The learned Commissioner (Appeals) held that the expenditure incurred by the assessee in assessment year 2002-03 would be in the nature of freebies, gifts etc given to doctors which is prohibited as per statute (i.e., MCI regulations). Accordingly, he held that the disallowance had been rightly made by the learned assessing officer.

2.4 Aggrieved, the assessee is in appeal before us on the following grounds :–

“2. The Commissioner (Appeals) erred in treating a disputed claim written-off by the Appellant amounting to Rs. 1,18,23,353 on the ground that: (a) the expenditure not incurred wholly and exclusively for the purpose of the business; and (b) the expenditure is even otherwise disallowable in terms of the CBDT Circular No. 5/2012 in F.No. 225/142/2012-ITAT.II, dt. 1-8-2012.

3. The Commissioner (Appeals) erred in disregarding to the basic fact that the appellant had made a legitimate claim in pursuance of an Agreement with an company (Citadel Aurobindo Biotech Limited) to which it had sold its brands and that both the amount incurred and the claim made were never in dispute.

4. The Commissioner (Appeals) erred in not taking into consideration that the amount written off is a disputed claim between two parties and the decision to write off was justifiably taken during the year of account and hence, the amount written off should be allowed as a loss incidental to the business.

5. The Commissioner (Appeals) erred in disregarding the fact that even-though Citadel Aurobindo Biotech Limited had initially (as per the terms of the agreement) agreed that they would reimburse the Appellant certain sales promotion expenditures incurred by it (during the year of sale of the brands, i.e., assessment year 2002-03) they subsequently did not reimburse the expenditure incurred and hence the amount written off partook the nature of a claim and not of a sales promotion expenditure as concluded by the Commissioner (Appeals).

6. The Commissioner (Appeals) erred in considering the fact that the aforesaid claim is not an expenditure of the Appellant, and, hence, the CBDT Circular has no application.

7. Even assuming the loss claimed by the Appellant were to be treated as an expenditure incurred of the appellant, the Commissioner (Appeals) erred in not considering the fact that the aforesaid CBDT Circular (relied by him) was issued only on 1-8-2012 consequent to the amendments made (on 10-12-2009) in the provisions of Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (the “Regulation”) and since the expenditure incurred by the Appellant was much prior to the date of the Circular of the CBDT/amendment in the Regulations, Circular of the CBDT has no application.”

2.5 We have heard the rival submissions and perused the materials available on record. We find that the assessee had entered into a joint venture agreement dated 27-3-2002 with another company by name CABL as a result of which, it had sold its brands to the said company for a total sum of Rs. 19 crores. As per para 5 of the said agreement for purchase of brands and take over of current assets, it was agreed that CABL would reimburse the assessee certain sales promotion expenses incurred in respect of branded products and, therefore, the assessee had not debited the related sales promotion expenses incurred by it during the assessment year 2002-03 to its profit and loss account. We find that the fact of incurrence of these expenses for the purpose of business and its genuinity thereon were not disputed by the revenue. The assessee was trying to resolve the dispute with regard to absorption of these expenditure in the books of CABL and various correspondences in this regard were entered into over a period of three years which are part of the records. We find that CABL however refused to pay the amount claimed by the assessee and the decision with regard to non-payment was communicated to the assessee only during the assessment year 2005-06 and hence the assessee had no other option but to write off the same as irrecoverable loss in its books of accounts and claim deduction for the same. Even though the learned assessing officer accepted the facts relating to the claim made by the assessee and that it was genuine business expenditure, he disallowed merely on the ground that the same were incurred in the earlier previous year relating to assessment year 2002-03 and cannot be allowed in assessment year 2005-06. In other words, the disallowance was made by the learned assessing officer by treating the said expenditure as prior period expenses. But we find that the necessity to absorb the said expenditure in assessment year 2005-06 (i.e., the year under appeal) got crystallized only pursuant to the letter rejecting the claim dated 31-1-2005 by CABL, which falls in assessment year 2005-06. As long as the necessity of the business expenditure and genuinity thereon had not been disputed by the revenue and more so in view of the fact that no deduction towards the same were claimed by the assessee in the year of its incurrence, we have no hesitation to hold that the said expenditure would be allowable as a deduction pursuant to rejection by CABL vide letter dated 31-1-2005 and by appreciating the fact that the irrecoverability of the expenditure leading to loss got crystallized only in assessment year 2005-06 in the hands of the assessee herein. Moreover, the learned assessing officer had given a categorical finding that the subject mentioned disputed expenditure does not pertain to CABL. It is not the case of the revenue that the said sales promotion expenses were incurred for non-business purposes of the assessee. The only reason for disallowance by the learned assessing officer was that it pertains to prior period, which aspect has already been addressed by us hereinabove. We would like to place reliance on the allowability of prior period expenses as deduction on the following decisions :–

(a) Hon’ble Delhi High Court in the case of CIT v. Jagatjit Industries Ltd. (2010) 339 ITR 382 (Delhi)

(b) Delhi Tribunal in the case of Sony India (P.) Ltd. v. Dy. CIT (2008) 114 ITD 448 (Delhi)

2.5.1 Coming to the alternative argument taken by the learned Commissioner (Appeals) in his order that expenses incurred by the assessee would be hit by the CBDT Circular No. 5/2012, we hold that the aforesaid CBDT Circular No. 5/2012 in F.No. 225/142/2012-ITA.II was issued on 1-8-2012 pursuant to MCI regulations dated 10-12-2009, whereas the expenditures were incurred in the instant case were incurred much prior to it. We find that the decision relied upon by the learned DR in the case of Confederation of Indian Pharmaceutical Industry (SSI) v. CBDT (2013) 353 ITR 388 (HP) actually advances the case of the assessee. The only ground raised before the court was that Circular No. 5/2012, dt. 1-8-2012 issued by CBDT is to be quashed as it goes beyond the section itself. The Hon’ble Court in its decision was not required to decide on the nature of expenditures which all are in violation of the regulations framed by the MCI. Infact, the Hon’ble Court has held that —

“The regulation of the medical council prohibiting medical practitioners from availing of freebies is a very salutary regulation which is in the interest of patients and the public. This court is not oblivious to the increasing complaints that the medical practitioners do not prescribe generic medicines and prescribe branded medicines only in lieu of the gifts and other freebies granted to them by some particular pharmaceutical industries. Once this has been prohibited by the Medical Council under the powers vested in it, section 37(1) comes into play. The Petitioner’s contention that the circular goes beyond the section is not acceptable. In case the assessing authorities are not properly understanding the circular then the remedy lies for each individual assessee to file an appeal but the circular which is totally in line with section 37(1) cannot be said to be illegal. If the assessee satisfies the assessing authority that the expenditure is not in violation of the regulations framed by the medical council then it may legitimately claim a deduction, but it is for the assessee to satisfy the assessing officer that the expense is not in violation of the Medical Council Regulations.”

In the instant case, it is not the case of the learned assessing officer that the expenditures incurred in the form of giving diaries, medical planners, medical representative bags etc were in the nature of expenditure prohibited by MCI regulations. In any event, these expenditures were incurred much prior to the introduction of the CBDT Circular and MCI regulations itself. We have already held that the genuinity of the expenditure and business purposes thereon were not doubted by the revenue herein. Hence we hold that the decision relied upon by the revenue supra actually supports the case of the assessee. We further hold that the applicability of the Circular No. 5/2012 could only be prospective in nature and cannot be made applicable for the assessment year under dispute before us. Reliance in this regard has been rightly placed by the learned AR on the co-ordinate bench decision of ITO v. Sunflower Pharmacy [IT Appeal No. 2495 (Ahd.) of 2016, dt. 22-12-2017], wherein it was held that the Circular No. 5/2012 is applicable only from assessment year 2013-14 only. We also find that the co-ordinate bench of this tribunal in the case of Vasantha Subramanian Hospitals (P.) Ltd. v. Dy. CIT [IT Appeal No. 2345 (Mad.) of 2015, dt. 22-4-2016] had held as under :–

“16. After hearing both sides, we find merit in the contention of the learned Authorized Representative. There is no prohibition in the Act to make payments to Doctors for the services rendered by them. In the case of the assessee, gifts were given to Doctors by way of gold coins in appreciation to their services. It can be construed as the fees paid in kind for the services rendered by the Doctors in the hospital. The presumption of the learned assessing officer that these payments are made to Doctors for canvassing patients cannot be accepted without any cogent evidence. Further the Revenue has not quantified the amount for which invoices, bills are not available for the expenditure incurred and the nature of unexplained expenses. Hence, it appears to be a passing remark. Therefore, in the interest of justice, we hereby direct the learned assessing officer to delete the addition made on account of disallowance of Rs. 71,62,741.”

The aforesaid decision also supports the facts of the instant case.

2.5.2 In view of our aforesaid facts and findings and respectfully following the judicial precedents relied upon hereinabove, we allow the claim of write off of the assessee in the sum of Rs. 1,18,23,353 as deduction in assessment year 2005-06. Accordingly, the Grounds 2 to 7 raised by the assessee for assessment year 2005-06 are allowed.

3. The next issue to be decided in this appeal is as to whether the learned Commissioner (Appeals) was justified in confirming the addition made under section 41(1) of the Act in the sum of Rs. 39,90,797 in the facts and circumstances of the case.

3.1 The brief facts of this issue is that the assessee showed amounts payable to M/s. Citadel Aurobindo Biotech Ltd. (CABL in short) in its balance sheet as on 31-3-2005. The learned assessing officer observed that CABL is a group concern of the assessee. The learned assessing officer observed that since CABL had ceased its business operations, he came to a conclusion that the assessee would not pay the dues to CABL and accordingly invoked the provisions of section 41(1) of the Act by stating that the said liability ceased to exist. The assessee pleaded that CABL is also assessed by the very same assessing officer assessing the assessee herein. The assessee pleaded that CABL had reflected the very same balance as has been reflected by the assessee and there is no dispute regarding the same. The assessee stated the amount of Rs. 39,90,797 is the net amount due to CABL which is also reflected as receivable in the books of CABL. The confirmation to this effect from CABL was also filed before the learned assessing officer. Hence it was pleaded that there is no intention to terminate the liability and that the said liability had not ceased to exist so as to invoke the provisions of section 41(1) of the Act. The learned assessing officer however proceeded to invoke section 41(1) of the Act by ignoring the submissions of the assessee and made an addition to the tune of Rs. 39,90,797 in the assessment.

3.2 The learned Commissioner (Appeals) placed reliance on the decision of the Hon’ble Punjab & Haryana High Court in the case of Mrs. Adarsh Sood v. CIT (2014) 225 Taxman 67 (P&H) and confirmed the addition on the ground that the assessee did not disagree or disprove the fact brought on record by the learned assessing officer that CABL ceased to exist.

3.3 Aggrieved, the assessee is in appeal before us on the following ground :–

8. The Commissioner (Appeals) erred in sustaining an addition under section 41(1) of the Act amounting to Rs. 39,90,797 due by the Appellant to Citadel Aurobindo Biotech Limited on the ground that the liability ceased to exist even though the Appellant proved to the Commissioner (Appeals) Citadel Aurobindo Biotech Limited continues to exist even till date and that there is nothing on record to show that Citadel Aurobindo Biotech Limited had waived its claim.

3.4 We have heard the rival submissions. The learned AR argued that the learned assessing officer had only brought on record the fact that operations of CABL had been ceased and not that CABL itself ceased to exist. We find lot of force in this factual submission made by the learned assessing officer as is evident from the wordings used by the learned assessing officer in his order. Accordingly, we hold that the decision relied upon by the learned Commissioner (Appeals) is squarely distinguishable on facts. When the entire balance outstanding in the sum of Rs. 39,90,797 is reflected as receivable in the books of CABL, which is also assessed by the very same assessing officer, there cannot be any cessation of liability on the part of the assessee. We find that the learned assessing officer had only forced the assessee to cease the liability payable to CABL. Had the learned assessing officer verified the records of CABL which is also assessed in his office/circle only, he could have understood the truth. Without doing the same, the action of the learned assessing officer by making an addition under section 41(1) of the Act is not warranted and accordingly deserves to be deleted. Accordingly, the Ground No. 8 raised by the assessee is allowed.

4. The last issue to be decided in this appeal is as to whether the learned Commissioner (Appeals) was justified in upholding the disallowance made under section 40(a)(ia) of the Act towards audit fees in the facts and circumstances of the case.

4.1 The brief facts of this issue is that the assessee made provision for audit fees of Rs. 2,52,909 and claimed the same as deduction. But this expenditure was not subjected to deduction of tax at source. Accordingly, the learned assessing officer sought to disallow the same under section 40(a)(ia) of the Act for violation of provisions of section 194J of the Act. The assessee replied that the audit fees, though expenses, of the year of account, the amount is payable only after the signing of the report by the auditor, and therefore, till it is signed, it will not be known as to whom the amount has to be paid. It was submitted that the provisions of section 194J of the Act would not apply to audit fees, as the question of payment to the auditor would arise only after the signing of the accounts which takes place after the year end. The learned assessing officer however proceeded to disallow the same under section 40(a)(ia) of the Act which was upheld by the learned Commissioner (Appeals). Aggrieved, the assessee is in appeal before us on the following ground :–

“9. The Commissioner (Appeals) erred in sustaining an addition on account of provision of audit fees without considering the fact that audit fees, though an expense, of the year of account, the amount is payable only after the signing of the audit report by the auditors and, therefore, till it is signed, the amount provided in only a provision and not a liability and therefore the provisions of section 40(a)(ia) of the Act would not apply in such a case.”

4.2 We have heard the rival submissions. On perusal of section 194J of the Act, we find that tax is deductible at source either at the time of credit of expenditure to the account of the payee or at the time of payment whichever is earlier. In the instant case, the assessee had made provision for audit fees to the account of the payee which fact has been mentioned by the learned Commissioner (Appeals). Hence the provisions of section 194J of the Act are clearly attracted and non-deduction of tax at source would automatically invite disallowance under section 40(a)(ia) of the Act. The statutory auditor is appointed in the annual general meeting of the company by the shareholders and would hold office till the conclusion of the next annual general meeting. Hence the name of the payee (i.e., the auditor) is very well known to the assessee in order to make provision for audit fees by crediting to the said auditor’s account. Admittedly the audit fees is an item of expenditure claimed by the assessee as an expenditure incurred on accrual basis during the year under appeal and this is made only based on the auditor’s appointment made in the annual general meeting or in any other extraordinary general meeting, as the case may be. Hence we are not inclined to accept the arguments of the learned AR that the audit report is signed after the end of the year. Accordingly, the Ground No. 9 raised by the assessee is dismissed.

ITA No. 2028/Mds/2017 — Assessment Year 2006-07

5. The assessee has challenged the validity of reopening of assessment made by the learned assessing officer in this appeal apart from challenging the addition made thereon on merits. Before we go into the merits, we deem it fit to addresses this preliminary issue of validity of reopening the assessment. The assessee has raised the following ground in this regard :–

“6. The Appellant submits that the reopening of the assessment made by the assessing officer is not correct for there was no fresh material available with the assessing officer to reopen the assessment for the reopening has been made based on the documents filed with the return of income.”

6. The brief facts of this issue is that the assessee company filed its return of income for the assessment year 2006-07 electronically on 16-8-2007 admitting loss of Rs. 73,832. No assessment was framed on the said return under section 143(3) of the Act. This assessment was later sought to be reopened by issuance of notice under section 148 of the Act on 24-2-2011 on the following reasons :–

“During the year, the assessee has offered Long Term Capital Gains of Rs. 1,77,106. The same is set off against business losses of Rs. 2,50,938. The assessee company had shut down its business and the return of income electronically filed exhibits lack of business activity and hence, the expenditure akin to business cannot be allowed and the entire capital gains of Rs. 1,77,106 needs to be taxed.”

The reassessment was framed under section 143(3) read with section 147 of the Act on 15-12-2011 by making an addition of Rs. 11,09,690 to the closing stock of raw materials and taxable income of Rs. 10,35,860 determined as under :–

	Rs.
Business loss	– (-) 2,50,938
Capital Gains	– 1,77,106
Loss Returned by the assessee	(-) 73,832
Add: Addition made in reassessment	– 11,09,690
Income Assessed in Reassessment	10,35,858
Rounded off to	10,35,860

6.1 During the re-assessment proceedings, the learned assessing officer took the value of closing scrap for the current assessment year on the basis of scrap sales made in the assessment years 2008-09 and 2009-10 of raw materials and packing materials at Rs. 11,09,690 and added the above sum to the taxable income of assessment year 2006-07. The assessee submitted that during the assessment year 2006-07, the stock values of its raw materials and packing materials have been valued at Rs. Nil applying the principle of cost or net realizable value whichever is lower as enumerated in Accounting Standard (AS) 2 issued by The Institute of Chartered Accountants of India (ICAI). It was pleaded that in pharmaceutical industry, every product has a pre-determined expiry date and since the products were expired, the net realizable value of such stocks has been considered at Rs. Nil. As regards packing materials, since there is no sale of finished goods, the packing materials consisting of cardboard boxes, aluminium foil wrappers, blister packing sheets etc can be only sold as scrap. The assessee submitted that it is an admitted fact that the sale value of Rs. 11,09,690 appearing in assessment years 2008-09 and 2009-10 is scrap sales realized and not on sale of finished goods. The scrap value of any stock cannot be ascertained on an earlier date and can be only known upon actual realization of scrap sales since they don’t have any pre-set market readily available for sale. It is also an admitted fact that the assessee was able to sell the scrap only after 3 years. According the assessee objected to the adoption of value of closing stock based on information which is actually available in assessment years 2008-09 and 2009-10 and not relevant for assessment year 2006-07 (i.e., the year under appeal). The learned assessing officer however, did not heed to these contentions of the assessee on merits and made an addition of Rs. 11,09,690 in the re-assessment, which was also confirmed by the learned Commissioner (Appeals). Aggrieved, the assessee is in appeal before us.

6.2 The learned AR argued that the dispute in this appeal is in respect of the following: (i) reopening of assessment under section 147 of the Act; (ii) bringing to tax a new source of income without even discussing in his order the issue for which the assessment has been reopened and (iii) valuing closing stock (classified as scrap) based on scrap sales made in assessment years 2008-09 and 2009-10. The learned AR further argued that there was no fresh material for reopening and the learned assessing officer had initiated proceedings under section 147 of the Act merely on change of opinion on matters already considered which is not valid in law as held by the Hon’ble Supreme Court in the case of CIT v. Kelvinator of India Ltd. (2010) 320 ITR 561 (SC). He pleaded that no disallowance/addition was made in the reassessment in respect of reasons recorded (i.e., disallowance of business loss) by the learned assessing officer. Hence he argued that the entire re assessment deserves to be quashed. In response to this, the learned DR vehemently relied on the orders of the lower authorities.

6.3 We have heard the rival submissions. At the outset, we find that the reopening was made for the assessment year 2006-07 for disallowance of business loss of Rs. 2,50,938 as in the opinion of the learned assessing officer, the assessee did not carry on any business activity and hence the business expenditure incurred thereon leading to arising of business loss is to be disallowed and once the same is done, the Long Term Capital Gain of Rs. 1,77,106 returned by the assessee would get taxed separately. But we find from the re-assessment order, the learned assessing officer had accepted the claim of business loss of Rs. 2,50,938 accepting the fact that the assessee had carried on business activity and no disallowance was made to that effect. We find that the provisions of Explanation 3 to section 147 of the Act empowers the learned assessing officer to reopen the assessment, if, he has reason to believe, that any income chargeable to tax has escaped assessment for the relevant year, ‘and also bring to tax’, any other income, which may attract assessment, though, it is brought to his notice, subsequently, albeit, in the course of reassessment proceedings. We would like to lay emphasis on the expression ‘and also bring to tax’ appearing in the main part of section 147 of the Act in relation to the right of the learned assessing officer to assess taxable income discovered during reassessment proceedings. Thus in the reassessment proceedings, it is not permissible for the learned assessing officer to tax any other source of income unless the learned assessing officer assesses to tax that income with reference to which the learned assessing officer had formed reason to believe that it had escaped assessment. In the instant case, the purported income, i.e., valuing the closing stock of scrap which was discovered subsequently during the course of reassessment proceedings, can be brought to tax, only if the escaped income, i.e., business loss claimed by the assessee, which triggered, in the first instance, the issuance of notice under section 148 of the Act, is assessed to tax. As stated above, during the reassessment proceedings, the learned assessing officer agreed with the contentions of the assessee that it had indeed done business activity and hence the business loss was allowed to be set off with other income. In this scenario, the learned assessing officer would be precluded from making any other addition towards the new source of income as prima facie his reason to believe that income had originally escaped assessment had failed. We draw support from the following decisions of various High Courts in this regard :–

(a) Hon’ble Bombay High Court in the case of CIT v. Jet Airways (I) Ltd. (2011) 331 ITR 236 (Bom)

(b) Hon’ble Delhi High Court in the case of Ranbaxy Laboratories Ltd. v. CIT (2011) 336 ITR 136 (Delhi)

(c) Hon’ble Calcutta High Court in the case of CIT v. Infinity Infotech Parks Ltd. [ITAT No. 60 of 2014, G.A. No. 1736 of 2014, dt. 10-9-2014]

(d) Hon’ble Jurisdictional High Court in the case of Martech Peripherals (P.) Ltd. v. Dy. CIT (2017) 394 ITR 733 (Mad.)

6.4 Even on merits, from the facts narrated and explanations given hereinabove, we find that the learned assessing officer is not justified in valuing the closing stock of packing materials representing scrap based on the scrap sales made in subsequent years ignoring the principles of valuation of stock as enumerated in AS 2 issued by ICAI which is also mandated to be followed under section 145A of the Act. Hence no addition towards valuation of closing stock could be validly made in the reassessment even on merits in the instant case.

6.5 In view of our aforesaid findings in the facts and circumstances of the case and respectfully following the various judicial precedents relied upon hereinabove, we hold that the re-assessment proceedings framed for the assessment year 2006-07 deserves to be quashed. Accordingly, the grounds raised by the assessee for the assessment year 2006-07 are allowed.

7. In the result, the appeal of the assessee in ITA No. 2027/Mds/2017 for assessment year 2005-06 is partly allowed and appeal of the assessee in ITA No. 2028/Mds/2017 for assessment year 2006-07 is allowed.

 

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