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Tinkering with the method is unjustified when the exercise does not materially alter the profits.
An important observation was made by Delhi ITAT in the case of Hero Moto Corp Ltd Vs DCIT (ITAT Delhi) wherein it was categorically mentioned that if a particular accounting system has been followed and accepted and there is no acceptable reason to differ with it then the doctrine of consistency would come into play.
The method of accounting cannot be rejected in such cases.
Tinkering with the method is unjustified when the exercise does not materially alter the profits. Petty additions should be avoided on the ground of materiality, as AS-1 which talks about materiality, consistency, prudence etc. is part of the I.T. Act after it is notified under section 145(2).
Present appeal was filed against the assessment order under section 143(3) of the Income-tax Act, 1961.
One of the ground was relating to addition of freight inward/import clearing expenses to cost of closing inventory amounting to Rs. 3,17,000. Assessee purchased raw material on CIF basis and included the freight cost for delivery of goods in purchase price and were factored in the value of closing inventory.
In exceptional circumstances viz. material shortage, wherein assessee had to immediately lift material, transport charges are paid, which were not included to the purchase price, but were separately debited to profit and loss account, because the invoices of transporters were received after consumption of material. Such freight amount was not included in the valuation of closing stock, as per regularly and consistently followed method of valuation of stock accepted by the Revenue in the past.
The AO held that the assessee’s contention that as the method was regularly followed year after year its impact will be revenue neutral, cannot determine the income of the assessee correctly for the year under consideration.
AO further held that the Revenue aspect keeps on changing on year to year basis & impact on non inclusion of freight inward and clearing charges at Rs 3,17,000/- has to be added to the income of the assessee.
The AR submitted that this issue was decided in favour of the assessee by the recent consolidated order dated 24.10.2016 passed by the Delhi bench of the Tribunal in assessee’s own case for A.Y. 2010-11 and 2011- 12, wherein the Tribunal, following the order of the coordinate benches of the Tribunal passed in assessee’s own case for the A.Y. 2007-08 and 2008-09, deleted the aforesaid addition on the ground that in those years it has been held that the assessee was following consistent system of accounting, which was unnecessarily disturbed by the Revenue, without change in facts. It was further held that tinkering with the accounting method was unjustified when the exercise did not materially alter the profits of the assessee company.
The DR relied upon the Assessment Order and Order of the TPO, but could not distinguish the decision of the Tribunal.
The learned Members of the ITAT, Delhi heard both the parties and perused the material available on record.
The Tribunal in assessee’s own case for A.Ys. 2010-11 & 2011-12 held as under:
“11) We have carefully considered the rival contentions. The company is a corporate entity therefore it has to value its closing stock according to the accounting standard 2 ‘valuation of inventories’ issued by the Ministry of corporate affairs and ICAI. According to that accounting standard the closing stock of the finished goods is required to be valued including all cost of the finished goods is required to be valued including all cost of purchases, cost of conversion and other cost incurred in bringing the inventory to their present location and conditions. The contentions of the appellant is that that it’s all purchases are accounted for on CIF basis and therefore the suppliers are required to provide the goods at the factory location and therefore in the closing stock of inventory there cannot be any element of freight etc., this issue has been considered by the coordinate bench in appellant’s own case for A Y 2007-08 where in it has been held that :-
“7.13. We have considered the submissions and the material filed by both the parties. The issue in question is regarding method of valuation of closing stock. The primary contention of the assessee is that it had to make emergency purchases and that these stocks so purchased were immediately consumed. In such exceptional situations, the assessee has directly accounted the freight and import clearing charges to the profit and loss account. This means that such raw material stocks are not part of closing stock at all. Further this fact is not rebutted by the DR.
7.14 Though technically it can be argued that the value of closing inventory must include freight/ import clearing charges, the facts explained by the assessee are that the purchases in question are done under exceptional circumstances (which are well known in this type of industry) for immediate consumption. They are in fact consumed immediately i.e. as soon as raw material enters the factory premises which is not disputed by assessing officer, hence the question of such purchases being part of closing stock does not arise at all. In such a situation, when freight/ import charges are directly debited to the P& L A/c along with the value of the purchases, naturally the question of treating them as part of closing inventory does not arise. The assessee has acted and accounted in a proper and acceptable method. Therefore, the relief should be granted on this count alone.
7.15 Alternatively, the undisputed fact remains that the assessee has consistently following the said method of accounting in the last many years and the Revenue has been accepting these facts and method of accounting without any demur.
7.16 The contention of the DRP that, the principle of res-judicata does not apply in Income tax proceedings and therefore, the Assessing officer is correct to come to independent conclusion and is not bound by past acceptance of a factual legal point by the department is untenable. Technically the principle of res judicata may not apply to the income tax proceedings as each year is an independent year, yet there ought to be uniformity in treatment and consistency as propounded by Hon’ble Supreme Court in the case of Radhasoami Satsang vs. CIT 193 ITR 321, when the facts and circumstances are identical. It is a judicially accepted principle that when the facts are same, a uniform view should be adopted for the subsequent years in the income tax proceedings. Unless there is a material change in the facts, which is neither demonstrated by assessing officer nor DRP, the view which is taken earlier, should not be changed, as held by various courts. We now discuss some of the case laws.
7.17 The Hon’ble Supreme Court in the case of Radhasoami Satsang (supra), on the theory of consistency, has held as under: “….Strictly speaking, res judicata does not apply to the income tax proceedings. Though, each assessment year being a unit, what was decided in one year might not apply in the following year, where a fundamental aspect permeating through different assessment years has been found as a fact one way or the other and parties have allowed that position to ne sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year.”
7.18 This view has been followed by the Hon’ble Delhi High Court in the case of CIT vs. Neo Ploy Pack (P) Ltd.  245 ITR 492 and the Hon’ble Bombay High Court in the case of CIT vs. Gopal Purohit  336 ITR 287.
7.19 Further, the Hon’ble Supreme Court in the case of CIT vs. Realest Builders and Services Limited (2008) 307 ITR 202 held as :
“In case where the department wants to tax an assessee on the ground of the liability arising in a particular year, it should always ascertain the method of accounting followed by the assessee in the past and whether change in method of accounting was warranted on the ground that profit is being underestimated under the impugned method of accounting. If the Assessing Officer comes to the conclusion that there is underestimation of profits, he must give facts and figures in that regard and demonstrate to the Court that the impugned method of accounting adopted by the assessee results in underestimation of profits and is, therefore, rejected. Otherwise, the presumption would be that the entire exercise is revenue neutral. In the instant case, that exercise had never been undertaken. The Assessing Officer was required to demonstrate both the methods, one adopted by the assessee and the other by the department. In the circumstances, there was no reason to interfere with the conclusion given by the High Court.”
7.20 The Hon’ble Supreme Court in the case of CIT vs. Bilahari Investment P. Ltd. 299 ITR 1 (SC) held as follows: “Every assessee is entitled to arrange its affairs and follow the method of accounting, which the Department has earlier accepted. It is only in those cases where the Department records a finding that the method adopted by the assessee results in distortion of profits that the Department can insist on substitution of the existing method.”
7.21 In the case of CIT vs. Jagatjit Industries Ltd. (2011) 399 ITR 382 (Del.), the Hon’ble Jurisdictional High Court has held as follows:
“If a particular accounting system has been followed and accepted and there is no acceptable reason to differ with it, the doctrine of consistency would come into play. The method of accounting cannot be rejected. The assessee was following the mercantile system of accounting. According to past business practice, the expenditure spilled over the next year and was debited in the second year and was allowed by the Assessing Officer. The Assessing Officer for the assessment year in question disallowed Rs.13,46,299 claimed as expenditure of prior period allowable in the current year. The Commissioner (Appeals) deleted the disallowance and this was upheld by the Tribunal. On appeal to the High Court: Held, dismissing the appeal, that the assessee had claimed prior period expenses on the ground that the vouchers for such expenses from the employees/ branch employees were received after March 31st of the financial year. It had branch offices throughout the country. It debited the expenditure spill over the subsequent years and the Assessing officer had been allowing it in the past. The accounting practice had been consistently followed by it and accepted by the Revenue. Nothing had been brought on record to show that there had been distortion of profits or that the books of account did not reflect the correct picture. In the absence of any reason whatsoever, there was no warrant or justification to depart from the previous accounting system which was accepted by the Department in respect of the previous years.”
7.22 In the present case, the Revenue has rejected the method of accounting which is consistently followed by the assessee on the ground that there may be chance where in a particular year, the method adopted by the assessee may result in underestimation of profits. However, the Revenue failed to demonstrate with facts and figures that the impugned method of accounting may result in material underestimation of profits. On the contrary, the assessee has demonstrated that the change in the method of accounting for year under appeal would result in loss to the revenue as the opening stock would also require similar adjustment and the cascading effect will be loss to revenue. We observe that in many of the additions made in this case by the revenue, the consistent method of accounting is unnecessarily disturbed, though it has been accepted in many years. In our view such tinkering with the method is unjustified when the exercise does not materially alter the profits. The facts and figures in many additions demonstrate that the issue raised is revenue neutral in the long run. Such petty additions should be avoided on the ground of materiality, as AS-1 which talks about materiality, consistency, prudence etc. is part of the I.T. Act after it is notified under section 145(2).
7.23 In view of the foregoing and proposition laid down by the Hon’ble Supreme Court and the Hon’ble High Courts, we are of the opinion that adjustment of Rs. 31.18 lacs made to total value of closing stock of Rs. 275 crores and consumption of stocks of Rs. 7178 crores is uncalled for. If valuation of closing stock is changed then the value of opening stock should also be changed on the same basis or method. The closing stock of a particular year is the opening stock of the subsequent year. It is not the case of the revenue that the method of valuation of closing stock is materially affecting the accounts and profits disclosed by the assessee. This adjustment sought to be made is revenue neutral and at best may result in preponment or postponement of revenue. The issue is whether such exercise is at all required on the ground of materiality. Materiality is a concept which is well recognized both in accountancy and law. Accounting standards notified by the CBDT under section 145(2) mandate that the concept of materiality be taken into consideration when finalizing the accounts of an assessee.
7.24 Further, the Hon’ble Supreme Court in the case of Berger Paints India Ltd. vs. CIT (2004) 266 ITR 99 at page 103(SC), has noted with approval, the observations of the Special Bench of the ITAT in the case of Indian Communication Network Pvt. Ltd. vs. IAC (1994) 206 ITR (AT) 96 (Delhi). At page 114 it observed that: “Before we part with the ground, we cannot help feeling that the litigation between the parties could have been avoided since it was quite immaterial, whether full deduction was allowed in one year or partly in one year and partly in the next, since the assessee is a company and rate of tax is uniform. The gain to one and the loss to the other is illusory since what is deferred in one year, would have to be discharged in the next In that sense, nobody has won and nobody has lost.”
7.25 Even on this plea also, the assessee succeeds. We have dealt with this issue elaborately as, in a number of grounds, this issue would become applicable. In view of above discussion, we allow this ground of the assessee.”
12) Before us, the Ld. Departmental representative could not point out any changes in the facts and circumstances of the case for this year compared to the year in which the tribunal has decided this issue. He also did not point out any contrary decision and therefore, respectfully following the decision of the coordinate bench we allow ground no. 2 of the appeal of the assessee.”
The learned Members of the ITAT Delhi held that in the earlier years the above mentioned addition was deleted by the Tribunal for A.Y. 2010-11 and 2011-12 as well as that of A.Y. 2012-13, therefore, the issue is squarely covered in favour of the assesse