Facts of the Case

National Fertilizers Ltd., a public sector undertaking engaged in manufacturing and distribution of fertilizers, maintained substantial inventories including slow-moving and obsolete stock items.

During Assessment Year 2004-05, the Comptroller and Auditor General (CAG) made observations regarding the absence of proper detailed analysis for obsolete and non-moving inventory items and their valuation impact.

Pursuant to such audit observations, the assessee obtained an independent engineering valuation report for item-wise valuation of such stock. Based on this expert report, the assessee revised the value of slow-moving stock to Rs. 47.76 crores.

The Assessing Officer rejected the revised valuation, treating the valuation at 5% of original cost as unscientific and made corresponding additions.

The Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s findings.

The ITAT reversed the findings and accepted the assessee’s valuation methodology, leading to the Revenue filing appeals before the Delhi High Court.

 Issues Involved

  1. Whether the assessee was justified in changing its method of stock valuation based on Accounting Standard-2 (AS-2)?
  2. Whether valuation of slow-moving and obsolete stock based on an independent engineering report was valid?
  3. Whether the Assessing Officer could reject such valuation without any alternative valuation exercise?
  4. Whether change in valuation method violated Section 145 of the Income Tax Act?

 Petitioner’s Arguments (Revenue’s Contentions)

  • The Revenue argued that the assessee’s revised valuation of stock at 5% of original cost lacked scientific basis.
  • It was contended that the change in valuation methodology was arbitrary and designed to reduce taxable income.
  • The Assessing Officer argued that merely adopting AS-2 could not justify reduction in stock valuation without sufficient material evidence.
  • The Revenue sought restoration of additions made during assessment proceedings.

 Respondent’s Arguments (Assessee’s Contentions)

  • The assessee submitted that the change in valuation was made due to CAG audit remarks.
  • The revised valuation was based on a detailed item-wise report by an independent engineering expert.
  • The assessee argued that AS-2 required realistic valuation of obsolete and slow-moving inventory.
  • The valuation method was consistently followed in subsequent years.
  • It was argued that Section 145 permits change in accounting method if justified by circumstances.

Court Findings / Court Order

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

The Court held:

  • The revised valuation was based on expert engineering valuation and was bona fide.
  • The Assessing Officer had no alternative valuation or evidence to discredit the expert report.
  • Adoption of AS-2 pursuant to audit observations was justified.
  • Section 145 does not prohibit change in accounting method when circumstances justify such change.
  • The Revenue’s objection to valuation at 5% was without merit.

Accordingly, the Court held that no substantial question of law arose for consideration and dismissed all appeals.

Important Clarification by Court

The Court clarified that:

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

An assessee is legally entitled to change its accounting or valuation method when justified by factual circumstances, provided such change is bona fide and supported by evidence.

Further, stock valuation based on expert assessment cannot be rejected merely on assumptions without contrary material.

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

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