Facts of the Case

National Fertilizers Ltd., a public sector undertaking engaged in manufacturing and distribution of fertilizers, maintained inventory including stores and spare parts. During the financial year relevant to Assessment Year 2004-05, the Comptroller and Auditor General (CAG) made observations regarding diminution in the value of obsolete, surplus, and non-moving inventory and advised proper valuation assessment.

Pursuant to such observations, the assessee appointed an independent engineering valuer for item-wise valuation of slow-moving stock. Based on the valuation report, the value of such stock was determined at ₹47.76 crores.

The Assessing Officer rejected this valuation on the ground that the valuation at 5% of original cost lacked scientific basis and made additions to income. The Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s findings.

However, the Income Tax Appellate Tribunal (ITAT) accepted the assessee’s valuation methodology and deleted the additions, 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 under Section 145?
  2. Whether valuation based on an independent engineering expert’s report was legally sustainable?
  3. Whether the Assessing Officer could reject the revised stock valuation without conducting an alternative valuation exercise?
  4. Whether adoption of AS-2 for inventory valuation constituted a bona fide accounting change?

 Petitioner’s Arguments (Revenue Department)

  • The Revenue contended that the ITAT erred in accepting the revised valuation method.
  • It argued that valuation at merely 5% of original cost lacked scientific justification.
  • The Revenue asserted that the assessee’s change in accounting method was arbitrary and impermissible.
  • It was submitted that such reduction in stock value artificially suppressed taxable income.

Respondent’s Arguments (Assessee)

  • The assessee argued that the valuation change was compelled by CAG observations.
  • It contended that AS-2 mandated realistic inventory valuation.
  • The revised valuation was based on an independent engineering expert’s item-wise report.
  • The change was bona fide and consistently followed in subsequent years.
  • Section 145 permits change in accounting method where justified by factual circumstances.

 

Court Findings / Court Order

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

The Court held:

  • The assessee had acted bona fide in changing the method of valuation based on CAG observations.
  • The valuation was supported by an expert engineering valuation report.
  • The Assessing Officer failed to bring any contrary valuation evidence on record.
  • Mere rejection without an alternative scientific valuation was unjustified.
  • Section 145 does not prohibit change in accounting method if the change is regular, bona fide, and justified by circumstances.

The Court concluded that no substantial question of law arose in the appeals.

 Important Clarification by the Court

The Court clarified an important principle:

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

An assessee is entitled to change the method of accounting or valuation when circumstances justify such change, especially when it aligns with recognized accounting standards and bona fide commercial realities.

This is a significant clarification for inventory valuation disputes and accounting method changes under tax law.

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

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