Facts of the Case

The respondent-assessee, National Fertilizers Ltd., a public sector undertaking engaged in manufacturing and distribution of fertilizers, maintained substantial inventory including stores and spare parts. During the audit for Assessment Year 2004-05, the Comptroller and Auditor General (CAG) raised observations regarding diminution in value of obsolete, surplus, and non-moving inventory and recommended proper valuation assessment.

Pursuant to such observations, the assessee obtained an item-wise valuation from an independent engineering valuer and revised the valuation of its slow-moving stock to ₹47.76 crores.

However, during assessment proceedings for Assessment Years 2006-07 to 2009-10, the Assessing Officer rejected the revised valuation and made additions on the ground that valuation at 5% of original cost was not based on scientific methodology.

The Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s view. On further appeal, the ITAT accepted the assessee’s valuation methodology, leading the Revenue to file appeals before the Delhi High Court.

 

Issues Involved

  1. Whether the assessee was justified in changing its method of valuation of slow-moving stock?
  2. Whether valuation based on an independent engineering expert’s report could be rejected by the Assessing Officer without contrary material?
  3. Whether such revised valuation was permissible under Section 145 and Section 145A of the Income Tax Act?

 

Petitioner’s Arguments (Revenue’s Contentions)

  • The Revenue contended that the ITAT erred in affirming the valuation adopted by the assessee.
  • It was argued that valuing slow-moving inventory at 5% of original cost lacked scientific basis.
  • The Revenue submitted that the change in valuation methodology was unjustified and resulted in under-reporting of taxable income.
  • The Assessing Officer maintained that the write-down was arbitrary and unacceptable for tax purposes.

 

Respondent’s Arguments (Assessee’s Contentions)

  • The assessee argued that the change in valuation was necessitated due to CAG observations.
  • It was submitted that valuation was carried out by an independent qualified engineering valuer after detailed physical inspection.
  • The assessee relied on Accounting Standard-2 (AS-2), requiring inventory to be valued realistically.
  • It was argued that Section 145 permits change in accounting method if regularly followed thereafter and justified by circumstances.

 

Court Findings / Court Order

The Delhi High Court dismissed the Revenue’s appeals and upheld the ITAT’s order.

The Court held:

  • The revised valuation was based on expert assessment and was bona fide.
  • The Assessing Officer could not reject the valuation without producing any alternative valuation or establishing flaws in the adopted method.
  • Section 145 does not prohibit change in accounting method where circumstances justify such change.
  • The adoption of AS-2 pursuant to CAG observations was valid and legally sustainable.
  • There was no substantial question of law arising in the matter.

 

Important Clarification by the Court

The Court clarified that:

“Regularly followed” under Section 145 does not mean “permanently followed.”

A method of accounting can be changed where warranted by factual circumstances, provided the change is bona fide and consistently followed thereafter.

Further, valuation based on expert evidence cannot be arbitrarily discarded by tax authorities without contrary evidence.

 

Sections Involved

  • Section 145 – Method of Accounting
  • Section 145A – Valuation of Purchase, Sale and Inventory
  • Accounting Standard-2 (AS-2) – Valuation of Inventories

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2017:DHC:9034-DB/SRB08022017ITA7832016_143829.pdf

 

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