The reversal of provision during the year cannot be once again added to the income

IN THE INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH: ‘D’ NEW DELHI

BEFORE SHRI R. P. TOLANI, JUDICIAL MEMBER

AND

SHRI J. S. REDDY, ACCOUNTANT MEMBER

I.T.A. No. 4397/Del/2011

Assessment Years: 2005-06

ACIT

Circle 4 (1), Room No.407,

C.R. Building, I.P. Estate

New Delhi.

(APPELLANT)

Vs.

Johnson Matthey India

Pvt. Ltd. 103, Ashoka

Estate, Barakhamba Road

New Delhi.-110001

PAN: AAACJ2919A

 (RESPONDENT)

Revenue by: Shri D. K. Mishra, CIT. DR.

Assessee by: Shri. Vikash Srivastava, Adv. &

Shri Sumit Mangal, CA.

ORDER

PER J. S. REDDY, AM:

This is an appeal filed by the revenue directed against the order of ld. CIT (A)-VII, New Delhi, dated 01.07.2011 for the A.Y. 2005-06. 2. The facts are brought out at Para 3 page 2-3 of the CIT (A) orders which is extracted for ready reference:

 “3. Briefly stated the facts of the case are that the appellant is a company engaged in the business of manufacturing of auto catalyst. For assessment year 2005-06, the appellant filed its return of income on 31.10.2005, declaring a total income of Rs.12,54,72,645/-. The case of the appellant was selected for scrutiny and an assessment order u/s 143(3) of the Act dated 28.12.2007 was passed wherein the returned income of 12,54,72,645/- was accepted as the assessed income of the appellant. The AO had made a reference under section 92CA of the Act to the Transfer Pricing Officer, who had duly accepted the value of international transactions reported by the company and had passed transfer pricing order under section 92CA (3) of the Act. Thereafter, the AO issued a notice dated 02.02.2010 under section 148  of the Act proposing to re-assess the income for the year under consideration and asking the appellant to file its return of income for the year under consideration. The reasons recorded for issue of notice u/s 148 to the company is reproduced hereunder:

“Assessment in this case was completed under section 143(3) on 18.12.2008 at an income of Rs.12,54,72,650/- at the returned income of Rs.12,54,72,650/-. Scrutiny of income tax assessment records revealed that in the computation of income the assessee had deducted Rs.2,00,84,000 on account of stock written off in earlier years, sold during the year. As the said amount has already been written off in accounts in earlier years the same should not be deducted from the net income of the year. The mistake resulted in under assessment of

income of Rs.2,00,84,000.

In view of the above, I have reasons to believe that the income of Rs.2,00,84,000 chargeable to tax has escaped assessment within the meaning of section 147/ 148 of the Income Tax Act,

1961.

Pursuant to the aforesaid notice, the appellant submitted a letter dated 08.02.2010 requesting the AO to treat the original return for the year as the return filed pursuant to notice under section 148 of the Act. Finally the reassessment order was passed on 08.12.2010 re-assessing the total income of the appellant at Rs.14,55,56,650/- after making addition to the extent of Rs.2,00,84,000/-.”

3. The assessee carried the matter in appeal. The first appellate authority partly allowed the appeal.

4. Aggrieved the revenue is in appeal on the following effective ground:

“2. On the facts and in the circumstances of the case and in law, the learned CIT (Appeals) has erred in deleting the addition of Rs.2,00,84,000/- made by the AO on account of stock written off, despite the fact that the assessee failed to substantiate its contention with supporting evidence before the A.O.”

5. We have heard Mr. D. K. Mishra the ld. DR on behalf of the revenue and Mr. Vikash Srivastava, Advocate, the ld. counsel for the assessee.

6. Rival contentions heard. On a careful consideration of the facts and circumstances of the case and a perusal of the papers on record and the orders of the authorities below as well as the case laws cited, we hold as follows:

The observation by the AO is at page two of the assessment order. The relevant portions are extracted for ready reference.

“The assessee had deducted Rs.2,00,84,000/- on account of stock written off in earlier year, sold during the year. As the said amount had already been written off in accounts in earlier years the same should not be deducted from the net income of the year. Thus, an amount of Rs.2,00,84,000/- was proposed to be disallowed.

The assessee submitted a reply dated 30.11.2010 which was examined and considered and was found to be unsatisfactory. As the said amount had already been written off in earlier years and the same was sold during the year, the same should not be allowed to be deducted from the computation of income. Thus an amount of Rs.2,00,84,000/- is disallowed and added back to the net taxable income of the assessee.”

7. On appeal by the assessee the CIT (A) granted relief by observing that the provisions made in the earlier years, have been added back to the taxable income of that year and that during the year under consideration, the assessee had sold slow moving/obsolete inventory of raw materials, finished goods and residues amounting to Rs.2,00,84,000/- which is shown as sales

and, as the provision created in earlier years, to the tune of Rs.2,76,86,849/- has been added back to the taxable income by the assessee in those years, the reversal of provision during the year cannot be once again added to the income. He granted relief.

8. Aggrieved the revenue is in appeal.

9. The ld. DR Mr. D.K. Mishra vehemently submitted that the first appellate authority has committed an error in deleting the said addition. He submitted as following written submission to explain his point.

“The tabular presentation of the provision made and written back, assubmitted by assessee (kindly Refer pg 10 of CIT (A) order) is made/given below.

A study of the P & L a/c for AY 02-03, AY 03-04, AY 04-05 (annexed hereto) shows that the assessee follows a method whereby increase/decrease in stock is debited to P & L a/c. A look to the corresponding schedule giving the details shows that the closing & opening stock for these years are accounted for in the RHS of P & L a/c without any adjustment. That implies that provisions for these years are simply debited to P & L a/c. For example take the case of AY 03-04. Increase/decrease of stock debited to P & L a/c is (39,157) detailed in such 11.

The manufacturing expenses debited at 793,877 is detailed in such 12 includes the provision for slow moving/obsolete machinery of 15,947/- (found adjusted in inventories in such 5 but we are concerned with items debited to P & L a/c as such here). This provision is added back while making the computation of income and rightly so.

However by reducing this amount from the net profit in the year of sale of this slow moving stock, assessee has depressed the income to that extent which is not permissible. The following example will highlight the method followed by assessee and the suppression to profit done by an accounting subterfuge.

In the following example, we have taken the same cost and realizable value for the slow moving/obsolete machinery. i.e. cost per unit which is now considered obsolete /slow moving Rs.5000/- and realizable value of such unit at Rs.3000/-. Considering only one unit to be obsolete/slow moving which is so considered in year 1 and sold for Rs.3,000/- in year 2 and considering all other things to be constant (ceteris paribus), we draw the P & L a/c as under.

The assessee makes a provision of Rs.2,000/- in year 1 (i.e. provision assumed to be 100% perfect since anticipated realizable value and actually realizable value are taken to be the same i.e. 3,000/-) This is added to NP arrived at for year 1.

YEAR 1

P & L A/C

Since the loss here is notional (actually no loss since the obsolete stock is not sold this year) arising out of making of provision, the same is added back to loss to arrive at the correct figure of NIL income.

Now this obsolete stock is sold for Rs.3000/- next year. The P & L a/c looks as under:

YEAR 2

P & L A/C

The loss is 2,000 and can be claimed correctly as such. However the assessee in the computation further reduces the sale value of 3,000/- from this loss, returning a net loss of Rs.5,000/-. The overall loss from this obsolete unit is Rs.2,000/- only (Cost 5,000 less realizable / sale value of Rs.3,000/-) and not Rs.5,000/- as is wrongly done by assessee.

In the event, it is requested that the CIT (A) order needs to be reversed and AO’s order restored.”

10. He submitted a note as to what the term “Provision” stands for and referred to accounting standard AS 29 and submitted that income arising out of higher valuation is notional. Similarly the expenditure out of lower valuation, as done by the assessee is also notional. He further submitted as follows:

“In the first year the loss if any is notional as the stock is lying with the assessee and since he could not make losses out of a transaction with self, it could not be reduced by any means. However when the stock is sold it has to be accounted for and cannot be reduced. Now stock is a physical concept. Stock book inventories the stock on physical basis in terms of units. Valuation that is relevant for P & L a/c or B/s is an estimate. For the years when provision was made, stock was with the assessee at the end of the year. It should have been estimated at cost value. But if market value/realizable value is lower, that should have been adopted. If lower value is taken, profit goes down to ultimately it should go to sales account. Per contra if assessee has adopted cost value, the profit has been shown more to that extent. But next year the same is shown as opening stock and that year the excess is again squared off. Thus increase/decrease in stock is only to know the truer picture of financial position of a business entity. The assessee can under no circumstances reduce the sales from net profit as it is an actual figure very much part of ultimate determination of profit. By reducing the sales taking the treatment in provision account, he has suppressed profit to that extent for the current year. It is well settled that accounting entries cannot affect the ultimate tax liability.”

10.1 He submitted yet another note which is extracted for ready reference:

“Obsolete stock

Suppose in the first year 1 unit is obsolete. Then cl stock will be Rs.5000/- profit will be 11000. Next year cl stock will be 55000. Op stock will be 5000. Net profit is not affected.

Suppose in the first year 1 unit is obsolete. Then cl stock is taken at 10000/- as such. P & L a/c is debited to the extent of Rs.5000/-. Profit will be 11000. Next year cl stock will be 60000. Op stock will be 10000. Net profit is not affected. In this case first year the profit is less by 5000/-. Suppose this obsolete unit is sold for 3000 in year 2. Then profit is to be enhanced by 3000/- i.e. 33000. Sales here cannot be reduced.

What the assessee has done. Cl stock remaining constant he has made a provision of 2000 (5000 less realizable 3000) and does not debit to P & L a/c any other figure. Profit as per P & L before provision is same but after provision is 14000. He has added 2000 provision in computation. And offers 16000/- Result No effect.

Next year on sale he is not showing this 3000/- in effect. This gives a distorted picture as sales is suppressed to that extent. The logic that he has not debited the loss (notional on such stock) to P & L a/c is misplaced since this has already been debited to P & L a/c as purchase earlier. This purchase has only appeared as stock in the Right side.”

11. The ld. counsel for the assessee, relied on the order of the CIT (A). He filed a paper book 119 pages and sought to demonstrate before this bench that the order of the first appellate authority is correct and that the AO has not understood the accounting entries properly. He disputed the contentions raised by the ld. CIT. DR and that the same are not borne out of record and are against the facts of the case.

12. Rival contentions heard. On a careful consideration of the facts and circumstances of the case and a perusal of the papers on record and the orders of the authorities below, as well as the case laws cited, we hold as follows:

The assessee in its paper book filed the annual accounts of the company as certified by its auditor’s for the year ended 31.3.2005. At schedule 16, notes to the accounts are given. Note no. 18 therein reads as follows:

“18. In prior years, the Company had created provisions for slow moving/obsolete inventory of raw materials, finished goods and residues amounting to Rs.30,299 thousands. During the current year, the company negotiated with its group company for sending back a part of this inventory to the group company for the purposes of refining. Also, the Company negotiated with one of its customer for the sale of part of this provided inventory, which was sold to this

customer during the current year. Accordingly, provision for inventory amounting to Rs.20,084 thousands in respect of aforesaid inventory has been written back to the profit and loss account. The Company is carrying year end provision for inventory amounting to Rs.10,215 thousands as at 31st March 2005 in respect of non-usable inventory.”

13. A perusal of the above clearly indicates that what was written back was a “Provision” for inventory amounting to Rs.2,00,84,000/- from out of the total ‘Provision’ of Rs.3,02,99,000/- in the books of account.

14. Each year the assessee has been making a provision for inventory in the books of account maintained by the company. While filing its return of income, this provision for inventory made in the books of account, is added back to the income under the head “Profits and Gains of business or Profession,” for the reason that it is not allowable under the IT Act. In other words the provision for slow moving/obsolete inventory, which is created each year in the profits & loss account and balance sheet prepared in accordance with the Companies Act, 1956, has been specifically added back while computing taxable income under the IT Act, while filing the return of income of the respective year i.e. the assessee has not claimed deduction on the ‘Provision’ created in its accounts, in its income tax computation in the earlier years.

15. During the year under consideration the provision in question, in respect of slow moving/obsolete inventory was written back in the accounts of the company, on the ground that the said provision to the extent written back is no longer required. The assessee had sold the slow moving stock and disclosed the sale proceeds, in its sales account. The provision was written back as no longer required in the accounts and as the provision was not claimed as an expense in its income tax computation in the year in which it was created, the same need not be added back once again. The action of the AO is a double addition. A figure which was never claimed or allowed as a deduction in the earlier year was added back.

16. The ld. CIT DR has mistook the write back of provision of inventory, as sale proceeds of slow moving/obsolete inventory of raw materials and thus the confusion. The write back of provision is not sale proceeds of slow moving/obsolete inventory. The sale proceeds have been accounted for as income under the head turnover “Gross turnover” in the profits & loss account. It is not a case where sale proceeds of these obsolete stocks are not accounted for at all. Hence we find no merit in the argument of the ld. CIT DR.

17. Thus we find no infirmity in the order of the first appellate authority.

18. In result the appeal of the revenue is dismissed.

Order pronounced in the open Court on 03/07/2013.

Sd/- Sd/-

( R. P. TOLANI ) (J. S. REDDY)

JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated: 03/07/2013

*AK VERMA*

Copy forwarded to:

1. Appellant

2. Respondent

3. CIT

4. CIT (Appeals)

5. DR: ITAT

ASSISTANT REGISTRAR