'REPORTABLE' IN SUPREME COURT OF INDIA CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 815 OF 2007 COMMISSIONER OF INCOME TAX-GUJARAT-II ... Appellant VERSUS KWALITY STEEL SUPPLIERS COMPLEX ... Respondent WITH CIVIL APPEAL NO. 4923 OF 2007 JUDGMENT respondent-assessee was registered firm engaged in business of sale of scrap of ship materials. firm was constituted with two partners, i.e., mother and son. During period under consideration, firm was dissolved on 01.02.1993 on account of death of one of partners. At time of dissolution, firm had valued closing stock at cost price. respondent-assessee filed return of income showing total income of Rs.16,41,760/- for assessment year 1993-1994. relevant previous year is financial year 1992-1993. On this return, assessment order was passed Signature Not Verifiedby Assessing Officer on 24.02.1995 under section 143(3) Digitally signed by NIDHI AHUJA Date: 2017.05.23 17:32:15 IST Reason: of Income Tax Act, 1961 (hereinafter referred to as 'Act') accepting method of valuation adopted by 1 CIVIL APPEAL NO. 815 OF 2007 etc. respondent-assessee. Subsequently, Commissioner of Income Tax (CIT) in exercise of his revisional jurisdiction under section 263 of Act issued show cause notice dated 27.02.1997 and directed Assessing Officer to value closing stock at time of dissolution at market price. He further observed in his order that Assessing Officer had erred while passing assessment order for year 1993-1994. According to him, during accounting year under consideration, firm was dissolved, and therefore, closing stock was to be valued at market rate in view of decision of this Court in case of 'A.L.A. Firm v. Commissioner of Income Tax [(1991) 189 ITR 285]. So, he added average gross profit of 15 per cent to disclosed value of closing of Rs.12 crores and same resulted in addition of Rs.1,82 crores. respondent-assessee questioned validity of order passed under Section 263 of Act taking plea that revisional jurisdiction could not be exercised in this manner. However, CIT rejected contention of assessee and set aside assessment order with direction to Assessing Officer to pass fresh order in accordance with direction given in order passed by CIT. This order of CIT is dated 20.03.1997. assessee challenged said order dated 20.03.1997 by filing appeal before Income Tax Appellate Tribunal (ITAT). ITAT dismissed 2 CIVIL APPEAL NO. 815 OF 2007 etc. appeal on 28.04.2000. This order of ITAT was challenged before High Court in form of statutory appeal under Section 260A of Act. High Court has accepted contention of assessee and, thereby, set aside revisional order dated 20.03.1997 passed by CIT. Against this order, instant appeal arises. We have heard learned counsel for parties. Though detailed submissions are made, it is sufficient to note that learned counsel for Revenue has basically rested his arguments adopting reasons given by ITAT whereas learned counsel for assessee submitted that having regard to discussion contained in judgment of High Court, same should be upheld. It is clear from above that this Court is concerned with validity of exercise of jurisdiction by CIT under Section 263 of Act. Whereas CIT, while exercising this power, relied upon judgment of this Court in A.L.A. Firms (supra), High Court while upsetting said order referred to judgment of this Court in 'Sakthi Trading Co. v. Commissioner of Income Tax [(2001) 250 ITR 871]. perusal of judgment of High Court would reveal that two substantial questions of law were considered by High Court, which are as follows: i. Whether in facts and circumstances of case, ITAT was right in law, in holding that CIT has validly exercised revisional 3 CIVIL APPEAL NO. 815 OF 2007 etc. jurisdiction under section 263 of Income Tax Act, 1961? ii. Whether, in facts and circumstances of case, ITAT was right in law, in holding that closing stock was to be valued at market price on ratio of decision of Supreme Court in ALA Firm v. CIT reported in 189 ITR 285 though business was continued after dissolution of firm? Since, validity of exercise of powers under Section 263 of Act is involved, we reproduce that provision hereunder: 263. Revision of orders prejudicial to revenue.- (1) Principal Commissioner or Commissioner may call for and examine record of any proceeding under this Act, and if he considers that any order passed therein by Assessing Officer is erroneous in so far as it is prejudicial to interests of revenue, he may, after giving assessee opportunity of being heard and after making or causing to be made such inquiry as he deems necessary, pass such order thereon as circumstances of case justify, including order enhancing or modifying assessment, or cancelling assessment and directing fresh assessment. Explanation. For removal of doubts, it is hereby declared that, for purposes of this sub-section, (a) order passed on or before or after 1st day of June, 1988 by Assessing Officer shall include (i) order of assessment made by Assistant Commissioner or Deputy Commissioner or Income-tax Officer on basis of directions issued by Joint Commissioner under section 144A; (ii) order made by Joint Commissioner in exercise of powers or in performance of functions of Assessing Officer conferred on, or assigned to, him under orders or directions issued by Board or by Principal Chief Commissioner or Chief Commissioner or Principal Director General or Director General or Principal Commissioner or Commissioner authorised by Board in this behalf under section 120; 4 CIVIL APPEAL NO. 815 OF 2007 etc. (b) record shall include and shall be deemed always to have included all records relating to any proceeding under this Act available at time of examination by Principal Commissioner or Commissioner; (c) where any order referred to in this sub-section and passed by Assessing Officer had been subject matter of any appeal filed on or before or after 1st day of June, 1988, powers of Principal Commissioner or Commissioner under this sub-section shall extend and shall be deemed always to have extended to such matters as had not been considered and decided in such appeal. Explanation 2.- For purposes of this section, it is hereby declared that order passed by Assessing Officer shall be deemed to be erroneous in so far as it is prejudicial to interests of revenue, if, in opinion of Principal Commissioner or Commissioner,- (a) order is passed without making inquiries or verification which should have been made; (b) order is passed allowing any relief without inquiring into claim; (c) order has not been made in accordance with any order, direction or instruction issued by Board under section 119; or (d) order has not been passed in accordance with any decision which is prejudicial to assessee, rendered by jurisdictional High Court or Supreme Court in case of assessee or any other person. (2) No order shall be made under sub-section (1) after expiry of two years from end of financial year in which order sought to be revised was passed. (3) Notwithstanding anything contained in sub-section (2), order in revision under this section may be passed at any time in case of order which has been passed in consequence of, or to give effect to, any finding or direction contained in order of Appellate Tribunal, National Tax Tribunal, High Court or Supreme Court. Explanation. In computing period of limitation for purposes of sub-section (2), time taken in giving opportunity to assessee to be 5 CIVIL APPEAL NO. 815 OF 2007 etc. reheard under proviso to section 129 and any period during which any proceeding under this section is stayed by order or injunction of any court shall be excluded. This provision has come for interpretation time and again before this Court. Such power given to Commissioner to revise order of Assessing Officer is held to be constitutionally valid having regard to fact that Department has no right of appeal to CIT (A) against any order passed by Assessing Officer. It is for this reason, Section 263 is enacted to empower Commissioner with authority of revising order of Assessing Officer, where order is erroneous and error has resulted in prejudice to interests of Revenue. As is clear from language of provision, there has to be proper application of mind by Commissioner to come to firm conclusion that order of Assessing Officer is erroneous and prejudicial to interests of Revenue. Thus, two conditions need to be satisfied for invoking such power by Commissioner, which are: (i) order of Assessing Officer sought to be revised is erroneous; and (ii) it is prejudicial to interests of Revenue. (See 'Malabar Industrial Co. Ltd. v. Commissioner of Income Tax' [(2000) 243 ITR 83]) At same time, this Court has also laid down that 6 CIVIL APPEAL NO. 815 OF 2007 etc. this provision cannot be invoked to correct each and every type of mistake or error committed by Assessing Officer. While interpreting expression 'prejudicial to interests of Revenue', it is also held that order of Assessing Officer cannot be termed as prejudicial simply because Assessing Officer adopted one of courses permissible in law and it has resulted in loss of revenue, or where two views are possible and Assessing Officer has taken one view with which Commissioner did not agree. (See CIT v. Arvind Jewellers [(2003) 259 ITR 502]) It is clear from above that where two view are possible and Assessing Officer has taken one view and the CIT again revised said order on ground that he does not agree with view taken by Assessing Officer, in such circumstances assessment order cannot be treated as order erroneous or prejudical to interest of Revenue. Reason is simple. While exercising revisionary jurisdiction, CIT is not sitting in appeal. This has been so eloquently explained in case of 'Malabar Industrial Co. Ltd. v. Commissioner of Income Tax' [(2000) 243 ITR 83] in following words: bare reading of this provision makes it clear that prerequisite to exercise of jurisdiction by Commissioner suo moto under it, is that order of Income Tax Officer is erroneous in so far as it is prejudicial to interests of Revenue. Commissioner has to be satisfied of twin conditions, namely, (i) order of Assessing 7 CIVIL APPEAL NO. 815 OF 2007 etc. Officer sought to be revised is erroneous: and (ii) it is prejudicial to interests of Revenue. If one of them is absent if order Income Tax Officer is erroneous but is not prejudicial to Revenue to if it is not erroneous but is prejudicial to Revenue-recourse cannot be had to section 263(1) of Act. There can be no doubt that provisions cannot be invoked to correct each and every type of mistake or error committed by Assessing Officer, it is only when order is erroneous that section will be attracted. incorrect assumption of acts or incorrect application of law will satisfy requirements of order being erroneous. In same category fall orders passed without applying principles of natural justice or without application of mind. phrase 'prejudicial to interests of Revenue' is not expression of art and is not defined in Act. Understood in its ordinary meaning it is of wide import and is not confined to loss of tax. scheme of Act is to levy and collect tax in accordance with provisions of Act and this is entrusted to Revenue. If due to erroneous order of Income Tax Officer, Revenue is losing tax lawfully payable by person, it will certainly be prejudicial to interests of Revenue. phrase 'prejudicial to interests of Revenue' has to be read in conjunction with erroneous order passed as consequence of order of interests of Revenue. For example, when Income Tax and it has resulted in loss of Revenue; or where two views are possible and Income Tax Officer has taken one view with which Commissioner does not agree, it cannot be treated as erroneous order prejudicial to interests of Revenue, unless view taken by Income Tax Officer is unsustainable in law. In instant case, as already noted above, assessee-firm was constituted with two partners viz., mother and son and it came to be dissolved during assessment year because of demise of one of partners. assessee 8 CIVIL APPEAL NO. 815 OF 2007 etc. in return had valued closing stock at cost price. This method of valuation was accepted by Assessing Officer. According to CIT, aforesaid method could not be adopted in case of dissolved firm as in such situation closing stock is to be valued at market rate. If approach of Assessing Officer in accepting cost based valuation of closing stock was totally impermissible, then CIT was perhaps right inasmuch as in such situation, order of Assessing Officer becomes erroneous and also prejudicial to interest of Revenue. moot question therefore is as to whether view taken by Assessing officer in accepting valuation of closing stock at cost price was plausible view in circumstances of this case. If it was so, then CIT could not exercise his revisionary jurisdiction under Section 263 of Act. For this purpose, we may first discuss judgment in case of A.L.A. Firm (supra) which has been referred to by CIT while revising order of Assessing Officer. In ALA Firm's case, this Court discussed judgment of Madras High Court in 'Ramchari (G.R.) and Co. v. Commissioner of Income Tax [(1961) 41 ITR 142] and pointed out that in said case, High Court had held that privilege of valuing opening and closing stocks in consistency manner is available only to continuing business 9 CIVIL APPEAL NO. 815 OF 2007 etc. and that it cannot be adopted where business comes to end and stock-in-trade has to be disposed of in order to determine exact position of business on date of closure. Madras High Court has also held that partnership concern which dissolves its business in course of accounting year forms close parallel to case of firm which goes into liquidation. In both cases all assets and stock-in-trade of business will have to be sold and their value realised for purposes of ascertaining true state of profits to losses of business. Following discussion of this Court in ALA Firm's case, in aforesaid process, becomes relevant: Even in continuing business, valuation at market value is permissible only when it is less than cost; it is not quite certain whether rules permit assessee if he so desires to value closing stock at market value where it is higher than cost. But, in either event, it is allowed to be done because its effect can be offset over period of time. But here, where business comes to close, no future adjustment of over or under valuation is possible . X X X We, however, find substance in second considerations that prevailed with High Court. decision in Muhammad Ussain Sahib v. N. Abdul Gaffor Sahib, AIR 1950 Mad 758; [1950] 1 ML J 81 correctly sets out mode of taking accounts regarding assets of firm. While valuation of assets during subsistence of partnership would be immaterial and could even be national, position at point of dissolution is totally different.(at p. 759): But situation is totally different when firm is dissolved or when partner retires. 10 CIVIL APPEAL NO. 815 OF 2007 etc. settlement of his account must be not on national basis but on real basis, that is every asset into money and account of each partner settled on that basis... assets have to be valued of course, on basis of market value on date of dissolution... This applies equally well to assets which constitute stock-in-trade. There can be no manner of doubt that, in taking accounts for purposes of dissolution, firm and partners, being commercial men, would value assets only on real and not at cost or at their other value appearing in books. It is clear from above that judgment in ALA Firm's case proceeds on basis that with dissolution of firm, business of firm comes to end and in that situation, cost method of valuing stock was not permissible. question is as to whether this situation would apply in instant case where partnership firm stood dissolved by operation of law in view of death of one of partners, i.e., mother, but business did not come to end as other partner, viz., son, who inherited share of mother, continued with business. In situation like this, there was no question of selling assets of firm including stock-in-trade and, therefore, it was not necessary to value stock-in-trade at market price. purpose of adopting particular valuation of closing stock is succinctly explained by this Court in case of 'Sampatram v. Commissioner of Income Tax, West Bengal' [1953 (24) ITR 481] as follows: 11 CIVIL APPEAL NO. 815 OF 2007 etc. It is wrong to assume that valuation of closing stock at market rate has for its object, bringing into charge any appreciation in value of such stock. true purpose of crediting value of unsold stock is to balance cost of those goods entered on other side of accounts at time of their purchase, so that cancelling out of entries relating to same stock from both sides of account would leave only transaction on which there have been actual sales in course of year showing profit or loss actually realized on year trading. As pointed out in paragraph 8 of Report of Committee Financial Risks attaching to holding of Trading Stocks 1919, as entry for stock which appears in trading account is merely intended to cancel charge for goods purchased which have not been sold, it should necessarily represent cost of goods. If it is more or less than cost, then effect is to state sold at incorrect figure... From this rigid doctrine one exception is very generally recognized on prudential grounds and is now fully sanctioned by custom, viz., adoption of market value at date of making up accounts, if that value is less than cost. It is of course anticipation of loss that may be made on those goods in following year, and may even have effect, if prices rise again, of attributing to following year's results greater amount of profit than actual cost price of good in question (extracted in paragraph 281 of report Committee of Taxation of Trading Profits presented to British Parliament in April 1951). While anticipated loss is thus taken into account, anticipated profit in shape of appreciated value of closing stock is not brought into account, as no prudent trader would care to show increased profit before it actual realization. This is theory underlying rule that closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as established rule of commercial practice and accountancy. As profits for income tax purposes are to be computed in conformity with ordinary principles of commercial accounting. Unless of course, such principles have been superseded or modified by legislative enactments, unrealized profits by legislative enactment, unrealized profits in shape of appreciated value of goods remaining unsold at end of accounting year and carried over to following year's account in business that is continuing are not brought into charge as matter 12 CIVIL APPEAL NO. 815 OF 2007 etc. of practice, though as already stated loss due to fall in price below cost is allowed even if such loss has not been actually realized. It is this legal position which was reiterated in Sakthi Trading Co. (supra). position which emerges from aforesaid is that when business continues, it may not be necessary to follow market rate to value closing stock as reasons because of which same is to be done are not available. When this position becomes clear, it follows that in instant case view taken by Assessing Officer in accepting book value of stock-in-trade was plausible and permissible view. In this scenario, CIT could not exercise his powers under Section 263 of Act. We, thus, do not find any fault with judgment of High Court. appeals are dismissed with costs. ........................., J. [ A.K. SIKRI ] ........................., J. [ ASHOK BHUSHAN ] New Delhi; March 21, 2017. 13 CIVIL APPEAL NO. 815 OF 2007 etc. ITEM NO.21 COURT NO.8 SECTION IIIA S U P R E M E C O U R T O F I N D I RECORD OF PROCEEDINGS Civil Appeal No. 815/2007 COMMISSIONER OF INCOME TAX-GUJARAT-II Appellant(s) VERSUS KWALITY STEEL SUPPLIERS COMPLEX Respondent(s) (With interim relief and office report) WITH C.A. No. 4923/2007 (With office report) Date : 21/03/2017 These appeals were called on for hearing today. CORAM : HON'BLE MR. JUSTICE A.K. SIKRI HON'BLE MR. JUSTICE ASHOK BHUSHAN For Appellant(s) Mr. Y. P. Adhyaru, Sr. Adv. Mrs. Anil Katiyar, Adv. For Respondent(s) Mr. Haresh Raichura, Adv. UPON hearing counsel Court made following O R D E R appeals are dismissed in terms of signed reportable judgment. (Nidhi Ahuja) (Madhu Narula) Court Master Court Master [Signed reportable judgment is placed on file.] 14 Commissioner of Income-tax, Gujarat-II v. Kwality Steel Suppliers Complex