Per Shri V. S. Gaitonde, Accountant Member - This appeal is filed by the assessee against the order of the Commissioner under section 263 of the Income-tax Act, 1961 (the Act) dated 10-4-1984 for the assessment year 1979-80 holding that "the ITOs omission to examine above aspects of the case and accepting the adjustment in toto without verify in the accounts is found to be incorrect, erroneous and prejudicial to the interests of revenue". In the operative part (paragraph 6), the Commissioner set aside the order of the ITO dated 29-1-1983 with directions to make de novo assessment bringing on record the full details of the spares and assess the appropriate value thereof.
2. The factual position is given briefly as below. The assessee is a public limited company engaged in the manufacture of cutting tools. It filled a return on 28-6-1979 which was revised on 19-12-1981. The ITO scrutinised the return and other statements, and framed an assessment on 29-1-1983 under section 143(3) of the Act discussing 19 aspects of the variations to the returned income. These 19 items did not include the question of allowance of deduction claimed under machinery spares for which the directors and auditors report and notes were staring at him. It is not clear whether the ITO has applied his mind to this aspect. The directors report dated 9-4-1979 is as under : "10 Write off of machinery spares. - In their report, auditors have referred to Note No. 18 on the profit and loss account, which deals with the writing off of machinery spares. Your directors wish the state that the method now adopted by the company in this report is in line with the modern accounting practice already followed elsewhere".
"From the year 1978, the company has adopted the practice or writing on machinery spare parts to Repairs to plant and machinery at the time of their purchase instead of charging them to consumption at the time of their issue from stocks.
The figures for repairs to plant and machinery for the year therefore include - Consequently, the charge for repairs to plant and machinery in the profit and loss account for the year is higher by Rs. 44, 21,741 which represents the value of stocks of spares as on 31st December, 1978, written off, which otherwise would have been carried forward, and, the profit stands reduced to that extent." 4. To make the story complete it may be mentioned that the auditors report dated 9-4-1979 is not an unqualified report indicating that the auditors themselves had reservations. The extract is as below : "(iv) In our opinion, and to the best of our information and according to the explanation give to us, the accounts give the information required by the Companies Act, 1956, in the manner so required and give a true and fair view : (b) in the case of profit and loss account, subject to Note 18 - regarding the write off of machinery spares, of the profit for the year ended on that date." 5. The Commissioner examined the above records and issued the notice under section 263 (page 1 of the compilation) dated 27-2-1984.
According to him, prima facie the profits are understated to the extent of Rs. 44,21,741. The assessees reply dated 30-3-1984 is at pages 2 and 3 of the compilation. It was contended that the auditors Note 18 does not warrant a conclusion regarding understatement or error and prejudice to the revenue. The spares range from screws to specialised parts for imported machinery and are not dealt in by the assessee. Its realisable value would, therefore, be scrap, i.e., what dealers in secondhand machinery items would offer the assessee. That specialised items would be of no use to anybody else and have no readily realisable value. This position was duly considered by the management which decided to adopt the method indicated in their report. If this method were not adopted, it would, lead to valuation of current assets higher than their value of realisation. The new method is the appropriate method and has been consistently followed in later years. Thus, Note 18 does not reflect any understatement.
6. The Commissioner was not impressed by the above arguments. In para 5 of his order, he held that the items have not been proved to be of nil value. They have not been proved to have become even obsolete individually or collectively. He also held that the spares are used for day-to-day working and have also not been shown to be of no use to other parties collectively or individually. Without prejudice the Commissioner held that at least the scrap value or secondhand value should have been reflected. Accordingly, he set aside the order of the ITO with the observations mentioned in paragraph 1 above. The question whether the ITO in the fresh assessment is going to add Rs. 44,21,741 or lesser figure is, thus not germane to the issues before us.
7. Shri Dastur did not dispute the basic facts. He, however, contended that the method adopted by the management takes into consideration certain well recognised principles of accountancy approved by the profession. Whilst the assessee-company has given the reason for its departure, though, it was not bound to give, there are other public limited companies having a similar line of thinking. For example, MICO Bangalore, though not referring to it specifically in the directors report have adopted this method as seen from item 3 of the auditors report as below : "From the current year, the method of accounting of consumable stores and machinery spares has been changed and these items are charged to production at the point of procurement. This change in the method of accounting has the effect of lowering the profit by approximately Rs. 7 million during the year as mentioned in Note 9.
"Note 9. From the current year, the method of accounting of consumable stores and machinery spares is changed and these items are now charged at the point of procurement. This has the effect of lowering the profit by approximately Rs. 7 million during the year." The final auditors certificate dated 8-5-1979 is unqualified and does not refer to Note 9. The other distinguishing feature is that the assessee has changed the method only for machinery spares whereas MICO appears to have affected the change for stores and machinery spares.
The fate of the assessment proceedings in MICO is not known.
Similarly Sandoz India Ltd. without referring to its specifically in directorss report have adopted this method as seen from item 6(b) of auditors report as below : "The company had in previous years, charged consumable stores to profit and loss account on the basis of consumption. This year, the company had charged consumable stores to profit and loss account on the basis of purchase, and further, no stocks have been carried forward as at the end of the year. As a result, an additional amount of Rs. 1,051 has been charged to the profit and loss account".
8. No expert testimony of auditors was placed either before us or before the Commissioner. Before us certain accounting standards suggested by the Institute of Chartered Accounts in AS-2 were placed.
On valuation of inventories this monogram states that inventories include consumables other than machinery spares. It is argued on this basis that the assessee is not obliged to value machinery spares as part of inventory. This monogram approves write down of other inventory to net realisable value on accordance with the principles of conservatism which requires that the current assets should not be carried in the financial statements in excess of amounts expected to be realised in the ordinary course of business.
9. Mainly on the strength of the above opinion, Shri Dastur argued that the method of accounting adopted by the assessee has a sound scientific basis and that the ITO is bound to accept the same unless he doubts the bona fides or finds that the new method is not consistently followed up in later years. There are no such allegations in this case. Relying on certain observations in Challapalli Sugars Ltd. v. CIT  98 ITR 167 (SC) at p. 175 Shri Dastur submitted that it is proper to refer to manual of auditing and other accountancy literature. He then referred to certain Tribunal judgments regarding a similar item, viz., import entitlements purchase price. It has been held that the utilised portion of such entitlements need not appear in closing stock. Valuation of stock-in-trade is a necessary requirement of proper accounting but this principle does not apply to spares, packing material etc., which are not intended for sale as such. He further referred to the case of CIT v. Kusum Products Ltd.  149 ITR 250 (Cal), at page 252, regarding valuation of import entitlements remaining unutilised. He then explained his point with reference to case of film distribution rights.
Without prejudice, as the assessees method is cost or market whichever is less, and that the unused spares have no market, as the sale in respect of items imported under actual users licence is illegal, there could be no point in carrying forward such items which have no worth in the market (sic). Whilst admitting that the past practice of the assessee was different, Shri Dastur submitted that the past practice was no ground for perpetrating the distortion all along. If the assessee does not get the deduction this year, when can he get it In future there will be no second debit for these very items and if these are not allowed this year, it would cause avoidable hardship. In support of his contention that the open in stock and closing stock need not be valued in the same manner, Shri Dastur referred to a number of cases in particular - Indo Commercial Bank Ltd. v. CIT  44 ITR 22 (Mad.) and Forest Industries Travancore Ltd. v. CIT  51 ITR 329 (Ker.). In the former it was held that the new method cannot be rejected merely because it would lead to reduction of tax liability. In the case before us now if one takes an overall view there is really no reduction of liability. Accordingly, it was pleaded that the order of the Commissioner should be cancelled.
10. In reply Shri Walvekar defended the order of the Commissioner. He pointed out that whether auditors themselves have certified the profit and loss account subject to Note 18 it is clear that the auditors themselves were not satisfied that the new method discloses true profits. The monogram on AS-2 is an authority merely for the proposition that spares on machinery may not form part of inventory but not for the proposition canvassed, viz., permitting full write off.
Besides, AS-2 is one of the serval methods contemplated. From this, it cannot be straightway assumed that the institute of chartered accountants is of the opinion that for the purpose of section 145 of the Act income can be properly declared of this system is adopted. Shri Walvekar then referred to company law provisions and the proforma referred to in A. Ramaiya on Company Law, pp. 1444 and 1456. According to this all stores and spares loss account should show consumption of stores and spares. Shri Walvekar then took us through the past history.
In 1970 or so the assessee changed it method of stock valuation which was not objected to by the ITO, who was then not aware of the later events. In 1975 the assessee switched from FIFO or average cost and LIFO and the observations of the Third Member in IT Appeal No. 143 of 1979 in paras 15-22 would clearly show that although the assessee is entitled to choose initially any approved method, subsequently changes, if any, in the method have to answer the test prescribed in section 145 particularly as to how the old method which was giving true profits admittedly, would no longer do so. Computation of income cannot be allowed to be distorted beyond the legitimate needs of the occasion.
Apart from bona fides, the assessee has to prove the circumstances which warrant distortion and the extent to which section 145 proviso would not apply. Relying on Minister of National Revenue v. Anaconda American Brass Ltd.  30 ITR 84 (PC), Shri Walvekar contended that a method of accounting not disapproved by accountancy profession does not ipso facto make it a regular method of accounting from which the profits can be deducted.
11. Shri Walvekar then invited our attention to the fact that the assessee has picked only one item for such overstatement of consumption. Why has the assessee not adopted the same system for packing materials also The assessee has not been consistent even in adopting AS-2 standard.
12. Coming to the case, law, Shri Walvekar cautioned against equating import entitlements with actual consumption of spares. The Commissioner does not require the assessee to value the items as part of closing stock-in-trade as these are not intended for trade. But the debit to manufacture account has to conform to the realities of the situation when everything about the actual utilisation of the spares is known and there is no saving in accounting expenditure at all primary records of issue of shares have been continued to be kept even under the new method, there can be no point in permitting such calculated and motivated distortions in the profits, however bona fide. The import entitlements do not constitute physical stocks as in the case of machinery spares. Mere entitlements are thus illusory and, hence, unutilised portion may not have to be written back. The case of Indo-Commercial Bank Ltd. (supra) is regarding valuation of stocks and securities by a bank and not debit to profit and loss account. Forest Industries Travancore Ltd.s case (supra) and Bank of Cochin Ltd. v. CIT  94 ITR 93 (Ker.) are distinguishable. In the former certificate of an engineer was available in support of the write off in respect of stores which were thus valued at market price. There was no ad hoc 100 per cent write off of the type adopted in the case before us. There was, thus, no claim of debiting spares as a method of accounting. Bank of Cochin Ltd.s case (supra) also deals with the question of valuation of stock at market. In his order under section 263, the Commissioner has not prevented the assessee from proving the market value and accounting for the same on that basis.
13. Shri Walvekar then took us through the facts of IT Appeal No. 1767 dated 22-9-1984. The facts of this case are deceptively similar to the fact of the present case. In IT Appeal No. 1767 from paragraph 3, it is clear that the tools were items of small value and the finding was that they could in any event be written of during the year since they are valued at less then Rs. 750 each. IT was also held that taking into consideration the turnover and income, the total cost of tools and packing materials was nominal. There is no such finding in the case before us. Reliance on Manual of Auditing by Cooper and other literature shows that the Bench was concerned with items of small value. The Bench was also concerned more with capitalisation then with determination of the legitimate outgoings in respect of the current year. Paragraph 5 of the Tribunals orders shows that the nominal value of the material weighed in the mind of the Tribunal. In the case before us page 21 of the compilation gives classification (broad) below as on 31-12-1978.
From this Shri Walvekars contention was that full write off at the price of purchase cannot be canned a regular and acceptable method of accounting and even if it does, the ITO is duly bound to make adjustments in accordance with the powers vested in him under section 145 proviso.
14. In his rejoinder Shri Dastur contended that the allegation of understatement of profit is more easily made then proved.
Recommendations of the institute cannot be lightly brushed aside. What applies to spares in general does not apply to machinery spares. The fact that the assessee has not extended the new system to other items like stores and packing materials proves the bona fide of the assessee and cannot be a ground for rejecting the method. The myth regarding the valuation of opening and closing stock on exactly identical basis has been exploded in a number of cases in particular - CIT v. Caborandum Universal Ltd.  16 Taxman 25 (Mad.). The Third Member judgment in the assessees own case for 1976-77 to the extent of what it goes contrary to the above is not to be considered good law particular in view of Indo-Commercial Bank Ltd.s case (supra), Forest Industries Travancore Ltd.s case (supra) and Ram Luxman Sugar Mills v. CIT  63 ITR 51 (All). The Supreme Court judgment of Challapalli Sugars Ltd.s case (supra) is a clear authority for the proposition that accountancy principles are binding. Reference to Ramaiya by the departmental representative is off the mark as it applies only to stores otherwise includible. The sores are consumed for production but it cannot be said that machinery spares are consumed. They are only utilised but the date of actual utilisation is immaterial particularly because there is no obligation to value them in the closing inventory. From the practical point of view the distinction between import entitlements and machinery spares is a distinction without material difference. 30 ITR 298 (sic) being a case of the Privy Council is to be rejected in preference to the view held by the various High Courts in India as explained above.
The ratio of IT Appeal No. 1767 is squarely applicable in this case.
15. We have examined the facts and the arguments. This is the third occasion when the assessee-company has introduced refinements in its accounts. Such an action would doubtless show dynamism on the part of management. It may also represent an effort to keep abreast of the latest innovations in accountancy. We are, however, concerned not so much with accountancy principle as with income computation principles.
The provisions of Companies Act as held in Shri Meenakshi Mills Ltd. v.CIT  31 ITR 28(SC) are primarily meant for the protection of the shareholders and do not affect the tax liability. That book-keeping is not conclusive as established by a number of judgments, e.g., CIT v.Shoorji Vallabhdas & Co.  36 ITR 25(Bom.) (write-back of credit by managing agents and Associated Banking Corpn. of India Ltd. v. CIT  56 ITR 1 (SC). Summary of the case is given in Sampath Iyengars Law of Income-tax, Vol. 1, 7th end., p. 55.
16. Section 145 is worded in a manner different from the corresponding section 13 of the Indian Income-tax Act, 1922, insofar as the proviso is concerned. The relevant part of the proviso to section 13 is as under : ".... If the method employed is such that, in the opinion of the Income-tax Officer the income, profits and gains cannot properly be deducted therefrom, then the computation shall be made upon such basis and in such manner ....." The corresponding provision applicable (to the facts of this case) in section 145 is as below : "... where the accounts are correct and complete to the satisfaction of the Income-tax Officer, but the method employed is such that, in the opinion of the Income-tax Officer the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner ........" The pre-1961 provision did not specify in express terms that where accounts are correct and complete the ITO could still give a finding as to whether income can be properly deducted therefrom. In the new provision this point becomes clear. As long as all the transactions affecting the income are reflected in accounts, accounting entries made by any method approved by accountancy profession would not enable the ITO to hold that the accounts are not correct and complete. The Act makes it clear that even where the accounts are drawn in accordance with one or more of the method not disapproved by the accountancy profession so as to be qualified to be marked correct and complete, the ITO has to examine whether such accounting entries to enable him to deduce the income therefrom. It is not, therefore, possible to accept, as a general principle, proposed by Shri Dastur that as long as the accounts are drawn on the basis of one or more of the disapproved principles of accountancy, the ITO is bound to accept the same because income can and should be deduced from such accounts. It is true that charge in the method of accounting even under the Act is not prohibited. The new method has to be accepted if bona fide and consistently followed later, but subject to the rider that the ITO should also be in a position to record his satisfaction that the new method enables him to deduced as true profits as in the past. We cannot also accept as a general principle that the assessee can change his method at any time, without mentioning the occasion or the reasons, because it is these factors, along with others which will enable the ITO to give a finding about the bona fide, which is admittedly one of the tests to be applied for permitting the change.
17. The position is summarised in Commentaries on the Law of Income-tax in India, Eleventh end., Vol. 3 by V. S. Sundaram as below : "It is, the duty of the Income-tax Officer, even if there is a regular method of accounting, to consider whether the true income can be deduced therefrom .... The method of accounting referred to in this section relates to the method used by the assessee for his own purposes and not to that of making the return of income. Even though the profit as shown in the accounts is not true profit for income-tax purposes it may be possible to deduce it from the accounts and the judgment of the Income-tax Officer must therefore be properly exercised .... Where, therefore, an assessee had built up a secret reserve by systematic under valuation of stocks over a period of years and the Income-tax Officer ..... merely took the profits as shown in the assessee-companys profit and loss account and balance sheet by which he held it to be bound, the Income-tax Officer was directed by the Privy Council to make a reassessment. Obviously, he could not conclude that the true profits could be ascertained on the basis of a gross undervaluation - CIT v.Sarangpur Cotton Co.  6 ITR 36(PC) . . .." (pp. 2413) 18. The question, thus, is not whether change of method can be permitted but whether the changed method takes the case out of section 145 proviso. Indeed the changed method is also to be examined from the point of view whether it enables the ITO to determine whether the outgoings claimed in the accounts all qualify for deduction under section 28 to 37 of the Act. Although 30 ITR 298(sic) can have only a pursuasive value, there is no decision of the Indian Courts directly conflicting with the principles laid down therein. The case law cited at the bar regarding import entitlements, closing stock valuation, etc., it clearly distinguishable on facts. Even IT Appeal No. 1767 is to be taken as confined to the facts of that case. Import entitlements are mere enabling documents and cannot be compared with physical goods like spares. The case law mentioned in paras above dealing with arguments of Shri Dastur is regarding valuation of closing stock and write off of obsolete and show moving parts either on specific items basis or collective basis, on the ground that the market value has come down. This is not the issue before us. Arguments were addressed in a general way about the absence of marketability of specific items usable exclusively by the assessee or about the legal bar to sale of items imported on actual users licence. The real issue here is not about the valuation of closing stock of machinery spares but the correctness of the debit entry under manufacturing and other expenses. Obviously, when the auditors themselves have expressed reservations and the alleged accountancy practice is not proved with the clarity required, the Commissioner cannot be said to be wrong on facts before him. Neither before the Commissioner nor before us was any expert evidence laid on this point. We have already mentioned above the inadequacy of the evidence tendered in there form of other companys accounts and AS-2 standard of the institue. The formers income-tax assessments are not available. The latter whilst stating that machinery spares are not included inventory has not indicated anywhere that all the purchases particularly bigger items of the type specified above can or should be debited to manufacturing expenses irrespective of their actual utilisation. In this connection, it is to be noted that the Commissioner has not shut the doors for furnishing proper proof before the ITO. Paragraph 6 of the Commissioners order is quite clear. We agree with Commissioner that as a method of accounting the assessees new system is not immune from scrutiny by the ITO for determining whether the conditions of section 145 are applicable. It is also to be noted here that this is the third innovation in accounting. The second one adopted for the assessment year 1976-77 was rejected by the revenue and this rejection appears to have been accepted by the assessee as seen from the fact that for this year (assessment year 1979-80) the assessee had claimed and obtained a deduction of Rs. 1,84,100 on the basis of the pre-1976-77 assessment method. We, therefore, see no way of reversing the decision of the Commissioner. It is not for us to say how the alleged hardship referred to in paragraph 9 is to be overcome.