SUBRAMANIA IYER, J. - This is reference made by the Income-tax Appellate Tribunal, Trivandrum, under Section 113(1) of the Travancore Income-tax Act (XXIII of 1121) corresponding to Section 66(1) of the Indian Income-tax Act and questions of law referred are as follows :- (1) (a) When a actual price of the closing stock is known or is easily ascertainable from the records which the assessee was keeping, whether that stock should be valued at the average cost price for the year or at its actual cost price for the purpose of ascertaining the real profits earned during the year (b) Whether the method of valuation of stock followed by the assessee company is correct on the facts and circumstances of this case (2) (a) When the Appellate Assistant Commissioner dismissed a particular objection stating that the assessees agent or advocate had abandoned it and said that he did not wish to press the same and the statement in the order was not proved or shown to be incorrect, was it open to the Tribunal to disregard the statement the Appellate Assistant Commissioners order (b) Whether in the circumstances of this case, particularly in view of the abandonment of the objection to it at the time of the hearing before the Appellate Assistant Commissioner, the adding back of Rs. 2,000 on account of shortage in tins can be said to be arbitrary 3. The asssessee at whose instance this reference has been made is a public limited company with its place of business at Quilon and will hereafter in this judgment be referred to as the company. The company started business only in February, 1944. Its main business is the purchase of raw cashew nuts and after subjecting the stuff to certain process sell the kernels by export to America. Whether the manufacture of kernels is against orders dies not appear. It might be wholly or partly or to no extent against orders. The year of account is the first year of the companys existence. There was, therefore, no opening stock.
In the return made by the company the closing stock of 953 bags of raw nuts was valued at Rs. 38 per bag as was done in the profit and loss account made up by the company for the year, which was the average price of th total quantity purchased during the entire period. The Deputy Commissioner of Income-tax who was the assessing officer revised this valuation and fixed it at Rs. 56 per bag which was the average price of purchases made by the company, not for the entire period of account but limited to the latter half of March, 1945, and added back Rs. 17,154. Under the head "shortage of tins" the said officer added back an amount of Rs. 2,000 which was the amount estimated by him in the absence of proper details. The company appealed to the Commissioner challenging the direction of the officer to add back the aforesaid two amounts. The Appellate Assistant Commissioner who heard and disposed of the appeal scrutinised the accounts of the company and found that the entire closing stock could be traced to purchases made on and after March 20, 1945, as all the issues for processing were anterior thereto.
The average price of the purchases last made which accounted for the closing stock was found to be Rs. 57 per bag. He, therefore, confirmed the conclusion of the officer valuing the said stocks at Rs. 56 per bag as it was a fair valuation being one rupee less than the average value.
He also supported the officers conclusion on the ground that as the company does not deal in raw nuts but is only manufacturing kernels "it is but reasonable to presume that the nuts are roasted and processed in the order of purchases." As regards the Rs. 2,000 the Appellate Assistant Commissioner stated in his order thus :- "Mr. George (representative of the company) says that he does not wish to press his objection regarding the estimate of Rs. 2,000 treated as undervaluation of closing stock in tins." 4. Having failed before the Appellate Assistant Commissioner, the company appealed to the Income-tax Appellate Tribunal and repeated the contentions upon both the heads. On the question of valuation of the closing stock the Tribunal was of the view that the department "could not have a stronger case" and confirmed the onclusions reached by the authorities below. The direction to add back Rs. 2,000 was also confirmed on the basis of the aforesaid statement made the Appellate Assistant Commissioner on behalf of the company. There was no ground taken in the memorandum of appeal challenging the truth of that record.
Mr. George who is stated to have made the concession had sent in a statement in the form of, but without the formalities requisite for, an affidavit. There was thus no affidavit by Mr. George denying what he is stated to have said before the Appellate Assistant Commissioner. In its absence the Appellate Tribunal felt bound to accept the record made by the Appellate Assistant Commissioner as to what transpired before him and regarded the question as not open to be canvassed before it.
5. The first question that has been referred for decision has not, it seems, come previously before the Courts precisely in this manner. The principle of valuing stock as at cost or at market price whichever is in lower for ascertaining the profits of a business for purposes of the trader or manufacturer is well-established. Its applicability for the ascertainment of profits for purposes of revenue, that is income-tax, is equally well-established. Indeed its applicability is not convassed before us. It is clear from the records of the assessment proceedings that the cost at which the sto ck was valued was less than the market price. The only point on which the the Department disagreed with the assessee is as to the method of valuation of the closing stock. Whereas the assessee valu ed the said stock at the average price of the aggregate purchases made at the end of the year which last purchases constituted the clo sing stock, the actual cost whereof was ascertainable.
6. The point for decision therefore lies in a very narrow compass and is limited to the question as to the proper mode of valuation of the closing stock. Section 17 of the Travancore Income-tax Act, corresponding to Section 13 of the Indian Act, provides :- "17. Income, profits and gains shall be computed for the purposes of Section 13, 14 and 15 in accordance with the method of accounting regularly employed by the assessee : Provided that if no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income-tax Officer, the income, profit and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax Officer may determine." 7. This section leaves the choice of the method of calculation of the stock to the assessee. It only enjoins upon the assessee the obligation of employing the method chosen, regularly after the choice. The question of the regularity of the employment of that met hod will arise only after the first year of account. The year in this case is the first year of account, and the assessee was free to adopt his method of valuation. The right of the Department to interfere with the assessees method of account arises under the pro viso only if no method of accounting has been regularly employed or if the method employed is such that in the opinion of then come-tax Officer, the income, profits and gains cannot be properly deduc ed therefrom. The first part of the proviso has obviously no application, the period in question being the first year of the companys account, nor is the second part of the proviso applicable because there is no relevant material omitted to be regarded in making up the accounts to ascertain the profits. The liberty reserved to the assessee to choose his method of accounting by this section is not confined to adopting the mercantile or the cash basis but extends to adopting a method of valuation of the stock according to cost or market price whichever is lower for purpose of ascertaining the profits of the business.
"The word profit, I think, is to be understood in its natural and proper sense, in a sense which no commercial man would misunderstand.
Profits and gains must be ascertained on ordinary principles of commercial trading" said Lord Halsbury, Lord Chancellor, in Gresham Life Assurance Society v. Styles. In the undertaking of a manufacturer the ascertainment of the average cost of raw materials purchased is necessary to determine the profits. Raw material would be purchased from day to day or at intervals at varying prices. The price at which the manufactured product is sold will depend upon the market or, if the manufacture is against a previous contract, on the terms thereof. An agreement, for instance, for supply of kernels to America for a period of 12 months in the future can be entered into only on an estimated average of the price of raw materials during the period. Often there will be no parity between the price of raw materials and the market price of the finished product. Raw materials purchased for the purpose of manufacture would be appropriately stored against issues for purposes of processing. The same commodity of raw materials would usually be stocked in bulk without distinction of dates or prices of purchases. When a quantity there out is issued for processing the issue is from out of the entire stock. The principle, "Presumably, it is the sum first paid in, that is first drawn out. It is first item on the debit side of the account that is discharged, or reduced, by the first item on the credit side" enuciated by the Master of the Rolls in Claytons case (1816 Ch. 1 Merivale 572 at p. 608; 15 Revised Report s 161 at p. 166) as regards appropriation of payments, cannot be applied to the issue of raw materials for purposes of manufacture out of an accumulated homogenous stock. The Appellate Assistant Commissioner thought that such a presumption applies and with that view the Appellate Tribunal agreed.
When a stock of cashew or other raw material of a similar kind is kept against issue for processing or other purposes of manufacture, to talk of the stock as so many bags ought not to be understood as meaning that the stock is kept in bags. Reference to the bags in that connection can only be understood as referring to a unit for purposes of calculation of the quantity. Nor can it be supposed that each purchase is earmarked and retained separately, a procedure which is as unnecessary and impossible as it is unreal. Suppose for instance raw cashewnuts are purchased every day and stored in a room of sufficient capacity and such of it as is required for the purpose of processing is taken out on occasions, how can it be ascertained which is the nut that is being taken out You cannot distinguish the nuts. Suppose there have been issues out of the stock for processing every day of the year of account, it will be impossible to attribute the issues to this or that purchase. In valuing the closing stock in such a case the only appropriate and available method would be to value it at the average cost taking into account all the purchases made during the period. The same is the case with reference to a stock, say for instance, of fuel, wood, coal or oil all of which would be stored in one lump or lot and issue thereout can be and would be made without regard to the date or the price of each purchase. It is unnecessary to multiply instances. It is sufficient to say that the point appears to be so obvious that a doubt was first entertained as to whether the point stressed by the Department was at all properly understood.
8. The fact that in th present case it has been possible to ascertain the actual cost of the closing stock, there having been no issue for processing during the period of the purchase of the said closing stock, and which accounted for the entire quantity of the closing stock, is an accident, a circumstance peculiar to this case. A principle or a rule or method or accounting cannot be built upon or deduced from such an accident or peculiarity. The method of accounting chosen by the assessee for valuing the stock at average cost during the period covered by the account which was less than the market price cannot be interfered with on account of the facility that exists in the particular year for ascertaining the actual cost of the closing stock.
Suppose in the next year or the year after the next such facility does not obtain how is the closing stock to be valued The answer obviously is at the average cost or market price whichever is lower. If such a valuation is proper even for the purpose of the income-tax as reflecting the income of the assessee it cannot be any the less so for another year notwithstanding the existence of an extra facility for ascertaining the actual cost of the closing stock.
9. Learned counsel for the Department relied upon the following passage at page 585 of Sampath Iyengars Commentary on the Indian Income-tax Act (1951, Vol. II) :- "Adverting to the other method, viz., calculation of profits for domestic purposes : the balance-sheet is prepared by an accountant in order to show to his client or the proprietor of a business his financial position. If a portion of the profits were merely in kind, it is but proper for the accountant to say so in the balance-sheet.
Similarly, it would be proper for a company to exclude this profit in kind when distributing to its shareholders. The accountant would be giving wise advice and information to his clients thereby. But when the rights of a third party, viz., the Revenue, intervenes, the profits should have to be calculated strictly; not in a wise manner, or prudent manner. Arguments of convenience or the expert view of accountancy in regard to calculation of profits have no place in the Income-tax Act.
The conventional mode adopted in accountancy of disregarding profits in kind is merely a latitude that is permitted in a domestic valuation, e.g., valuation of a company vis-a-vis its shareholders or of a traders business for the traders own information and knowledge, and not for tax purposes." The above passage has no application to the present case, for here the company does not seek to ignore the existence of any of its assets at the end of the period of account for purposes of ascertaining the profits and seek to limit the profits to profits made in cash excluding "profits in kind". In In re The Spanish Prospecting Company Limited referred to by the learned author in foot-note (b), Fletcher Moulton, L.J., lays down the principle as follows :- "Profits implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates" (page 98).
"To render the ascertainment of the profits of a business of practical use, it is evident that the assets, of whatever nature they may be, must be represented by their money value. But as a rule these assets exist in the shape of things or rights and not in the shape of money : The debts owed to the company may be good, bad or doubtful. The figure inserted to represent stock-in trade must be arrived at by a valuation of the actual articles. Property, of whatever nature it be, acquired in the course of the business has a value varying with the condition of the market. It will be seen, therefore, that in almost every item of the account a question of valuation must come in. In the case of a company like that with which we have to deal in the present case, this process of valuation is often exceedingly difficult, because the property to be valued may be such that there are no market quotations and no contemporaneous sales or purchases to afford a guide to its value. It is not to be wondered at, therefore, that in many cases companies that are managed in a conservative manner avoid the difficulty thus presented and content themselves by referring to assets of a speculative type without attempting to affix any specific value to them. But this dies not in any way prevent the necessity of regarding them as forming a part of the assets of the company which must be included in the calculation by which de facto profits are arrived at.
Profits may exist in kind as well as in cash. For instance, if a business is so far as assets and liabilities are concerned in the same position that it was in the year before with the exception that it has contrived during the year to acquire some property, say mining rights, which it had not previously possessed, it follows that those mining rights represent the profits of the year, and this whether or not they are specifically valued in the annual accounts.
"But though there is wide field variation of practice in these estimations of profit in the domestic documents of a firm or a company, this liberty ceases at once when the rights of third persons intervene.
For instance, the Revenue has a right to a certain percentage of the profits of a company by way of income-tax. The actual profit and loss accounts of the company do not in any way bind the Crown in arriving at the tax to be paid. A company may wisely write off liberally under the head of depreciation, but they will be only allowed to deduct the sum representing actual depreciation for the purpose of calculating the profits for income-tax. The same would be the case if a person had a right to receive a certain percentage of the profits made by the company. In the absence of the special stipulations to the contrary, profits in cases where the rights of third parties come in, mean actual profits, and they must be calculated as closely as possible in accordance with the fundamental conception or definition to which I have referred" (Pages 100-101).
"The option lies with the trader to adopt the same method of valuation which he likes. He need not adopt the same method of valuation for all the articles he deals in. It is open to him to value each article separately according to cost or market, whichever is lower. This is well recognised commercial practice." 10. In Commissioner of Income-tax, Madras v. Chari & Ram, the Madras High Court held that the assessee who was a dealer in dyestuffs was entitled to take the average cost or market value, whichever is lower, in respect of each separate article of stock, that is to say, he was entitled to apply the method of valuation item-war and was not obliged to apply the same method of valuation to all the various items he was dealing in. In that case the value that was fixed was the average cost of the purchase for the whole period of the account.
11. The answer to question (1)(a) therefore is that the stock may be valued at the opinion of the assessee at the average cost price of the entire stock purchased in the course of that year and need not be at the actual cost of the closing stock for the purpose of ascertaining the real profits earned during the year.
12. The answer to question (1)(b) follows and it is that the method of valuation of the stock adopted by the assessee company is correct on the facts and circumstances of this case.
13. The answer to question (2)(a) is obvious and it is that it is not open to the Tribunal to disregard the statement in the Appellate Assistant Commissioners order. Reference may be made to T. V. Krishna Iyer v. C. S. Lakshmanan Pillai.
14. The answer to question (2)(b) and (2)(c) is in the negative and the answer to question (2)(d) is in the affirmative. Questions numbered as (2) and sub-divisions after no difficulty and deserve no discussion.
15. In view of the fact that the main question referred for decision which is question No. (1) was res integral the parties are directed to pay themselves their respective costs of this reference.