RAJAGOPALAN J. - With reference to the assessment of the assessee bank in the assessment year 1952-53 and 1953-54 -the corresponding years of account were the calendar years 1951 and 1952 - the Tribunal referred two questions under section 66 (I) of the Income-tax Act for the determination of this court. The first question ran :
'The assessee having followed regularly the cost basis for valuing its securities and shares till December 31, 1950, whether the aforesaid losses of Rs. 5,91,250 and Rs. 18,471 arising out of writing them down to the market price shown as item B in paragraph 5 supra are deductible for assessment years 1952-53 and 1953-54 respectively ?'
The relevant facts for the determination of this question were never in dispute. The assessee which carries on a banking business held securities and shares as part of its stock-in-trade or circulating capital. These securities and shares were all along valued at cost both at the commencement and at the close of each year of account. In 1950 the assessee bank claimed a loss on the basis of the fall in the market prices, but without changing the basis of valuation it had all along adopted and without any entries in its books of account. That claim was disallowed in the assessment year 1951-52. The fall in the market prices of the securities which began in 1950 continued in 1951, and to a lesser extent in 1952. To meet that abnormal fall the Reserve Bank allowed the scheduled banks to value their holdings of securities at the current market prices and adjust the resulting loss against the current profits or against the amounts permitted to be drawn from the statutory reserves. The assessee bank valued the securities at cost at the commencement of 1951, but valued them at the market value was considerably lower at the end of 1951. The difference was Rs. 5,91,250, which the assessee bank claimed as a trading loss in the assessment year 1952-53. Consistent with the valuation at the end of 1951 the valuation at the commencement of the next year of account 1952 was at the market value. At the end of 1952 the securities were valued again at the market value, which had registered a further fall during the year. The difference between the opening valuation and the closing valuation in 1952 was Rs. 18,491, which the assessee claimed as a loss in the corresponding assessment year 1953-54. Both items were shown as trading losses in the books of account.
The department declined to deduct these losses in computing the assessable income of the assessee bank under section 10, mainly on the ground that the assessee bank was not entitled to change the basis of valuing the closing stock of securities from cost to market value, as that was highly detrimental to the revenue. The Tribunal agreed with the department and recorded :
'Any system of accounting maintained by the assessee must include an acceptable basis for valuing its stock-in-trade too. If an assessee goes on altering his basis from time to time, the profits of the year cannot correctly be determined and will become distorted. In this case, the differential basis of valuation of opening an closing stocks will create an anomaly to the extent that a part of the previous years loss would become included in the year of account...... the loss claimed cannot be allowed as a deduction.......'
It should be taken as well settled that a person engaged in business, who adopts the mercantile system of accounting is bound to value his unsold stock at the end of this year of account to balance his books. But he has the option of valuing the closing stock either at cost or at market value, if the market value is lower than the cost price. The theory that underlies the accepted principle, that the closing stock could be valued at the option of the assessee at cost or market value, whichever was lower, was explained by the Supreme Court in Chainrup Sampatram v. Commissioner of Income-tax. Their Lordships quoted with approval an extract from the report of the committee constituted in England :
'As the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure...... From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following years results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question.'
Their Lordships proceeded :
'While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy. As profits for income-tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following years account in a business that is continuing are not brought into the charge as a matter of practice, though, as already stated, loss due to a fall in price below cost is allowed even if such loss has not been actually realised. As truly observed by one of the learned Judges in Whimster and Co. v. Commissioner of Inland Revenue, Under this law (Revenue law) the profits are the profits realised in the course of the year. What seems an exception is recognised where a trader purchased and still holds goods or stocks which have fallen in value. No loss has been realised. Loss may not occur. Nevertheless, at the close of the year he is permitted to treat these goods or stocks as of their market value.'
Why an assessee has been given such an option was explained by Coutts-Trotter C.J. in Commissioner of Income-tax v. Chengalvaraya Chettiar, which was quoted with approval in Commissioner of Income-tax v. Chari and Ram :
'I should add that the accepted rule is that the assessee in crediting the closing stock figure is to take either cost price or the market value whichever be the less - a provision obviously intended to be in favour of the trader and which enables him more evenly to distribute his loss.'
That the option exercised by an assessee is detrimental to revenue can never be the basis for denying him that option :
The learned counsel for the department could not an did not deny that the assessee bank had an option to value its closing stock at market value, whichever was lower. He pointed out that the assessee bank had exercised its option to value the closing stock of its securities at cost, which was the method of valuation adopted by the bank all through up to the end of 1950. The learned counsel submitted that the option once exercised was final and that the assessee bank could not claim a second opportunity to exercise was final and that the assessee bank could not claim a second opportunity to exercise its option, and thereby change the basis of valuation.
The same plea, that a mode of valuation once adopted can never be changed, was presented in a different form. The learned counsel for the department submitted that the mode or method of valuing the closing stock was a method of accounting within the meaning of section. Section 13 permitted an assessee to choose his method of accounting. But what section 13 required was that that method of accounting should be regularly employed. The further submission of the learned counsel was that arbitrary changes at the will of the assessee would be inconsistent with the statutory requirement of regular employment of the chosen method of accounting, and therefore no change from a system of accounting regularly employed in the past was ever permissible.
We accept as correct the contention of the learned counsel for the department, that the method an assessee adopts for valuing his closing stock is a 'method of accounting' within the meaning of section 13. At any rate, it is an integral part of the method of accounting known as the mercantile system of accounting, as it is normally understood. It was the mercantile system of accounting that the assessee bank consistently adopted. It was on that basis the accounts were maintained in the relevant years of account 1951 and 1952. Therefore, as part of that system or method of accounting the assessee bank had to value its closing stock on one or other accepted basis of valuation, cost or market value, if that was lower than cost.
Though not in express words, the method of valuing the closing stock adopted by an assessee was equated to a method of accounting in Commissioner of Income-tax v. Ahmedabad New Cotton Mills Co. Ltd. Their Lordships of the Privy Council observed :
'The method of introducing stock into each side of a profit and loss account for the purposes of determining the annual profits is a method well understood in commercial circles and does not necessarily depend upon exact trade valuations being given to each article of stock that is so introduced. The one thing that is essential is that there should be a definite method of valuation adopted which should be carried through from year to year, so that in case of any deviation from strict market values in the entry of the stock at the close of one year it will be rectified by the accounts in the next year.'
The position was made even clearer in Commissioner of Income-tax v. Chari and Ram. It was the acceptance of the method of valuation of the closing stock adopted by the assessee in that case that was in issue. The learned Chief Justice said :
'We consider that the question must be decided on the provisions of section 13 of the Income-tax Act. Under that section, the assessee is entitled to compute the income, profits and gains in accordance with the method of accounting regularly employed by him, and ordinarily this method must be accepted by the department. It is only if in the opinion of the Income-tax Officer the method employed is such that the income, profits and gains cannot properly be deducted therefrom that he can disregard it altogether. No doubt, in cases of gross undervaluation of stock, the Income-tax Officer may refuse to accept the valuation of the assessee. Equally, the assessee will not be allowed to arbitrarily change the method of accounting to suit his purposes.'
The valuation of the Closing stock at cost instead of at market value was the method adopted by the assessee bank down to the end of 1950. It was a method of accounting within the meaning of section 13. The question is, whether section 13 or any other concept of revenue law bars an assessee from changing his method of accounting.
As has been repeatedly pointed out by courts, it is the assessee and not the department that has the choice of the method of accounting, The department is bound by the choice of the assessee, except in the cases specified in the proviso to section 13. The method of accounting chosen by an assessee can be rejected by the department if it was not regularly employed. Even if it was established to have been regularly employed by an assessee, the department can reject the accounts as the basis for the computation of the income of the assessee, if the income cannot be properly deduced from the accounts based on the system of the assessees choice. Section 13, however, does not expressly or impliedly sanction a rejection of the assessees accounts, if nothing more is established than that the assessee has changed his method of accounting. If an assessee bona fide changed his method of accounting and satisfied the requirement of regular employment thereafter of that changed method of accounting, the only basis for the rejection of the accounts would be that the income, profits and gains could not be properly deducted from the accounts maintained on the basis of the changed method of accounting.
In Sarupchand v. Commissioner of Income-tax the learned judges held :
'An assessee is entitled to change the method of accounting regularly employed by him. What he must alter, however, is his regular method, that is to say, he must abandon what up to that time has been his regular method, and start a new regular method and not merely a new method for a casual period.'
In that case the assessees claim to change over from the mercantile method to the cash basis was upheld by the court.
In Law and Practice of Income-tax by Kanga and Palkhivala, fourth edition, volume I, page 449, the learned authors summarised the position with reference to the decision in Sarupchand v. Commissioner of Income-tax :
'Sarupchand v. Commissioner of Income-tax is a clear authority for the proposition that it is open to an assessee to make a clean change of the regular method adopted by him up to that time, provided he satisfies the department on proper evidence that he has in fact changed the regular basis of accounting and has not merely abandoned of changed it for a casual period to suit his own purposes. A bona fide change of the regular basis of accounting must be accepted by the department and may be given effect to on such terms as may be necessary for preventing escape from taxation or double taxation. But even bona fide changes, if too frequent, would disentitle the assessee to have his yearly income computed in accordance with his own changing methods and would justify an assessment under the proviso; for under this section the assessees method of accounting prevails only if it has been regularly employed. The intention of the legislature in enacting section 13 was that for income-tax purposes the assessee should be entitled to make use of any method of accounting that he chooses to adopt, but he must follow the selected method regularly, and is not to be allowed to change his system of book-keeping from year to year or so frequently as to prevent a fair estimate of his income, profits and gains, de anno in annum from being ascertained.'
In Commissioner of Income-tax v. Chari and Ram to which we have already adverted, there was no express decision on the question whether an assessee could change his method of valuation. In that case the method of valuation was changed and the right to effect that change was not challenged. The assessees claim to have his profits assessed on the changed basis of valuation was upheld by the court.
The learned counsel for the department relied on the observations of the Privy Council in Commissioner of Income-tax v. Ahmedabad New Cotton Mills Co. Ltd. and extracts from which we set out earlier in another context. That however is not authority for the proposition for which the learned counsel contended, that no change is ever permissible, in the sense that a change in the method of accounting with nothing more brings into play the proviso to section 13.
The learned counsel for the department next referred to a decision of the Hyderabad High Court, Vithal Reddi v. Hyderabad Government. The same learned judges reaffirmed their views in Commissioner of Income-tax v. Sri Kishenlal Badrilal. In Vithal Reddi v. Hyderabad Government the method of valuation of the closing stock adopted by the assessee was changed in the last of the chargeable accounting periods, the fifth, with reference to which he had to be assessed to excess profits tax. The learned judges held that the assessee was not entitled to change the basis of his valuation. Though some of the observations may appear to be couched a little widely, if we may say so with respect, it should be obvious that no question of a system of accounting 'regularly' adopted could arise, if that system of valuation was to serve its purpose only for that chargeable accounting period, which, as we pointed out above, was the last for purposes of assessment to excess profits tax. The principle applied in Vithal Reddi v. Hyderabad Government really fell within the scope of what was pointed out in Commissioner of Income-tax v. Chengalvaraya Chetti and reaffirmed by this court in Commissioner of Income-tax v. Chari and Ram that an assessee would not be permitted to change his method of accounting arbitrarily to suit his purposes. When Vithal Reddis case is closely examined, it seems clear to us that it is not authority for the absolute proposition advanced by the learned counsel for the department for our acceptance, that under no circumstances can an assessee change his method of valuation.
No doubt in Sampath Iyengars Commentaries on the Income-tax Act, fourth edition, volume II, at page 586, the learned author stated :
'Once having adopted a system of valuation, he should have adhered to the same in later years also.'
When the subsequent passages are examined, they do not support the proposition, that no change in the method of valuation is ever permissible.
The principle laid down in Sarupchand v. Commissioner of Income-tax if we may say so with respect, is sound. When an assessee bona fide changes his method of accounting and satisfies the department that he intends to adopt the changed method of accounting thereafter or that he has in fact adopted it thereafter, that satisfies the requirement of section 13. Unless the books maintained on the basis of the method of accounting so changed bona fide fall within the mischief of the proviso to section 13, the assessee is entitled to have his charged method of accepted by the department under the mandatory provisions of section 13. Neither principle nor authority bars an assessee from substituting one method of accounting for another at his choice. The effect of section 13 is not that the choice of the method of accounting can be made only once by an assessee. Is there anything then to differentiate the method of valuation of the closing stock, viewed either as a method of accounting by itself or as an integral part of a method of accounting In other words, while the assessee can exercise more than once his option to choose his method of valuing his closing stock, provided, of course, the change is bona fide and he further satisfied the statutory requirement of section 13 that the new or changed system of valuation is for regular adoption and not merely for purposes of assessment in the year in question ?
As we said, we accept as sound the principle laid down in Sarupchand v. Commissioner of Income-tax. Extending that principle to changes in the method of valuation of closing stock, the position we reach is that an assessee is entitled to change his method of valuation, provided it is bona fide and provided further it is a method of valuation for regular employment by the assessee and not merely for the year in question. In other words, a change in the method of valuing the closing stock under such circumstances does not entail a rejection of the method of the assessees choice on the application of the proviso to section 13.
In the case of the assessee bank its good faith, when it valued its unsold stock at the close of 1951 at market value, was never challenged. It was only on the basis of such valuation that the assessee could avail itself of the permission accorded by the Reserve Bank to adjust the resulting loss by drawing upon the statutory reserves. Factually, Rs. 5 lakhs were drawn out of the reserves to balance a portion of the loss resulting from the valuation of the securities. Next year also the securities were valued at their market value. The learned counsel for the assessee bank represented that the system of valuing securities at market value was continued thereafter.
The Income-tax Officer disallowed the claim on the ground that the change in the method of valuation was detrimental to the revenue. That was not a relevant factor in deciding whether the assessee bank had the right to change the basis of valuing the closing stock. Another ground set out by the Income-tax Officer was that 'the aggregate loss spread over a number of years could not be allowed in one year, 1951, and that the losses would have been staggered over the years had the assessee bank from the beginning valued the unsold securities at the market value, whenever it fell below cost.' An actual loss sustained by the sale of securities below the cost price cannot obviously be disallowed on such a ground. A notional or anticipatory loss resulting from a valuation of the closing stock, which an assessee is permitted to take into account in ascertaining his trading profits, stands on no different footing. It is a concession given to the assessee based on the well recognised usage of the trade, and the principle underlying that concession is in no way violated when the assessee changes his method of valuation from cost to market value, if the latter was less than the cost price. If the revised basis of valuation is continued thereafter the profits and losses thereafter would be correctly computed. We shall illustrate our point by an example. Suppose the bank valued its unsold securities at cost, Rs. 100 in 1948, 1949 and 1950, despite the fact that in 1949 the market value fell to Rs. 90 and to Rs. 80 in 1950. Suppose the market value at the close of 1951 was Rs. 70 and the bank valued its closing stock at Rs. 70, Rs. 30 would be the anticipatory loss, on which a claim for deduction could be based. If in 1952 there is a further fall from Rs. 70 to Rs. 60 and the securities are sold at the market value of Rs. 60 all that could be claimed as loss is Rs. 10, the difference between Rs. 70 and Rs. 60. If, however, the market value registers a rise, and the security is sold at a market value of Rs. 110, the assessee bank would be assessed to a realised profit of Rs. 40 the difference between Rs. 110 and the book value, Rs. 70. If the sale is at a market value of Rs. 75, five rupees which constituted the difference would be treated as a profit in 1952 though the sale was below the original cost price. It should be remembered that stock-in-trade are not held permanently but are held only for sale. When securities are treated as part of the stock-in trade of a bank, that they are not so quickly sold makes no difference in principle. The hypothetical example we have given above would show that neither the department nor the assessee really loses by a change in the system of valuation when the trading operation of a series of years is taken into account, as they should be.
The Tribunal held that a change in the method of valuation was not permissible, because the loses of the previous years would also enter into the claim made by the assessee for 1951. That, as we have endeavoured to explain above, is not a correct approach in deciding whether the changed method of valuation of the closing stock attracted the application of the proviso to section 13. Apart from the proviso to section 13, there was no legal basis for rejection the method of valuation adopted by the assessee. The question at issue really turns on the scope of section 13 and the proviso thereto. But for section 13, with reference to the stock-in-trade, whether an assessee claimed an actual or anticipatory loss made no difference. In neither case is he bound to distribute his loss over the period during which the stock remained unsold. What section 13 requires is that the method of valuation should be regularly employed. If that test is satisfied, there can be no objection in principle to allowing the whole of the loss in the year in which it arises. In the case of an actual loss, it arises at the point of sale. In the case of an anticipatory loss, it arises on the occasion of the valuation of the unsold stock at the close of the year of account. Both are permissible claims. The Tribunal, in our opinion, failed to address itself to the real question at issue, and neither the department nor the Tribunal was justified, in the circumstances established in this case, in disallowing the claim of the loss based on the valuation of the closing stock at the market value. In our opinion, the requirements of section 13 were satisfied, though the assessee changed his method of valuing the closing stock of unsold securities in 1951.
We answer the first question in the affirmative and in favour of the assessee.
The second question ran :
'Whether the dividends of Rs. 40,856 and Rs. 10,690 received from India Cements Ltd., a company no part of whose income has been specifically exempted under section 15C, is exempt in the hands of the assessee under section 15C (4) ?'
On the shares the assessee bank held in the India Cements Ltd., the assessee bank received Rs. 40,856 and Rs. 10,690 respectively as dividends in 1951 and 1952. The specific claim of the assessee bank, that these amounts were exempt from taxation under section 15C (4) was advanced for the first time before the Appellate Assistant Commissioner. He rejected it. Independently of section 15C (4), the Appellate Assistant Commissioner directed a deduction of Rs. 7,122 from Rs. 40,856 in the assessment year 1952-53. It was really the claim for the balance that could have been in issue before the Tribunal. In rejecting the assessees claim the Tribunal recorded :
'The exemption granted under section 15C (4) should in our opinion originate from the company in whose proceedings alone the question of any application of the benefits of section 15C (4) to which it may be due, could be considered on its merits.... So long as the assessee is unable to obtain a proper certificate from the cement company the that its dividends or any part thereof was exempted under section 15C the benefit conferred by section 15C (4) is not available to it.'
In our opinion the Tribunal was not right in holding that unless the company that declared the dividends took the initiative to claim relief under section 15C (I), no shareholder could claim the benefit conferred on him by clause (4) of section 15C. Nor is the production of a certificate granted by the company that it had in fact obtained relief under section 15C (I) a statutory requirement for the grant of relief to the shareholder under section 15C (4).
From the order of the Appellate Assistant Commissioner it is clear that there was no occasion to grant India Cements Ltd. any relief under section 15C (I), as it had no assessable income at all in the relevant years, though its accounts disclosed profits from out of which the dividends could have been declared. When the depreciation allowance to which the company was entitled were taken into account, it was found that it had no assessable income. When the company had no assessable income there could have been no occasion to claim that the statutory six percent. of the capital employed for its industrial activities was exempt from taxation under section 15C (I).
Section 15C (4) provides :
'The tax shall not be payable by a shareholder in respect of so much of any dividend paid or deemed to be paid to him by an industrial undertaking as is attributable to that part of the profits or gains on which the tax is not payable under this section.'
What is exempted by section 15C (4) is dividends paid out of or attributable to profits which are themselves exempted from taxation under section 15C (I). The expression 'profits or gains on which the tax is not payable under this section' in section 15C (4) can refer only to assessed profits, the assessed profits attributable to the industrial undertaking, whose profits are exempt from tax under section 15C (I). When the India Cements Ltd. as an industrial undertaking on which the tax was not payable under section 15C. The assessee bank therefore failed to satisfy the requirements of section 15C (4).
Independent of the line of reasoning adopted by the Tribunal its conclusion was right, that the assessee bank was not entitled to any relief under section 15C (4). We answer the second question in the negative and against the assessee.
As neither side has wholly succeeded on this reference, we direct the parties to bear their respective costs.
Reference answered accordingly.