Opening And Closing Stock Of The Year Is To Be Valued By Applying Same Methodology: Kerala High Court

The Kerala High Court has held that the stipulation under Clause 16 of the Income Computation and Disclosure Standards (ICDS) for the adoption of first-in, first-out (FIFO) or weighted average cost for valuation of the stock or inventory cannot be applied in the Assessment Year 2017-2018 for the valuation of the opening stock, as the opening and closing stock of the year are to be valued by applying the same methodology.

The bench of Justice Dinesh Kumar Singh has observed that the substitution of Section 145A with retrospective effect from April 1, 2017 by the Finance Act, 2018 is to give relief to those assessees who had adopted the FIFO to value their stock in the Assessment Year 2017-18 and to save their returns from being declared incorrect or invalid. This retrospective operation has the same purpose and objective. However, if an assessee did not apply the FIFO to value its opening and closing stock, as it was not mandatory, requiring such an assessee to apply the FIFO to value their stocks for the assessment year 2017–18 would result in an uncalled-for outcome.

The bench noted that the retrospective amendment in substituting Section 145A would not apply to those assessees who had not applied FIFO for valuing their stock in the Assessment Year 2017-18, as these assessees have been following LIFO consistently and had filed their returns before the Finance Act 2018 was enacted.

The petitioner/assessee is in the business of trading jewelry and articles of gold. The petitioner established and commenced its business operation in 1978. The petitioner has been maintaining regular books of accounts since the inception of its business venture in 1978.

The petitioner has been following the mercantile system of accounting and has been consistently valuing its stock or inventory at a lower cost or market value, determining cost using the Last-In-First-Out (LIFO) method.

The Department had been regularly accepting the books of accounts of the petitioner. The petitioner would value the stock-in-trade under the LIFO method at the start of the accounting period.

The petitioner applied the same method to value the stock-in-trade for the financial year 2016–17 relevant to the assessment year 2017–18, commencing with effect from April 1, 2016 and ending March 31, 2017. The Central Government notified the Income Computation and Disclosure Standards (ICDS), in exercise of powers under Section 145(2) of the Income Tax Act 1961, for application and adoption with effect from Assessment 2017-18. The ICDS so notified were made applicable from the Assessment Year 2017-18 to assessees who are liable to get accounts audited under Section 44AB of the Act, following the mercantile system of accounting for computation of income chargeable under the heads 'Profits and Gains of Business or Profession' (PGBP) or 'Income from Other Sources'.

In Clause 16 of the ICDS (II), a change has been made with respect to the methodology of valuation of the stock or inventory. It has been mandated that 'Cost of Inventories... shall be assigned by using First-In-First-Out (FIFO), or weighted average cost formula'. Clause 22 provides that the value of the opening stock shall be the closing stock of the immediately preceding year.

Section 145 of the Income Tax Act was amended by the Finance Act 1995 with effect from April 1, 1997, which was intended to restrict the options available to an assessee following a system of accounting other than mercantile or cash. The Legislature felt the need to provide accounting standards for income computation. The Central Government could, thus, by notification in the Official Gazette, notify from time to time Accounting Standards (AS) to be followed by any class of assessees or in respect of any class of income'. The Central Government notified the Accounting Standards on January 25, 1996.

Clause (i) of Section 145A provides that to determine the income chargeable to tax under the heading “Profits and Gains of Business or Profession," the valuation of inventories shall be made at the lower of the actual cost or net realizable value computed in accordance with the Income Computation and Disclosure Standards (ICDS) notified under Section 145(2).

The petitioner contended that by the substitution of the provisions of Section 145A with retrospective effect from 01.04.2017, the closing stock of the petitioner for the Financial Year 2016-17, relevant to the Assessment Year 2017-18, which was valued as per the LIFO at Rs. 1,92,44,87,015/-, has been revalued, applying the FIFO at Rs. 2,43,52,03,645/-, resulting in an enhancement in the value of the stock at Rs. 51.07 crores, which is sought to be taxed in the hands of the petitioner for the Assessment Year 2017-18.

The petitioner argued that Clause 16 of ICDS (II) is ultra vires Article 14 of the Constitution of India, inasmuch as it provides an unreasonable classification. By virtue of the application of the provisions of Clause 16 of ICDS (II), the revaluation of the closing stock of the petitioner applying the FIFO or weighted average cost method as opposed to the LIFO method earlier followed by the petitioner is manifestly contrary to the fundamental principle of practice of real income, which is the bedrock of the application, operation, and implementation of the provisions of the Act.

The department contended that the Legislature is well within its power to amend the statute to mandate one or more methods of stock valuation. There is no legislative incompetence in providing one or more methods of valuation of the stock by amending the Income Tax Act. A uniform method of valuation of the stock has been provided by substituting Section 145A of the Income Tax Act, with effect from April 1, 2017, for all the assessees.

The court directed that the respondent department either accept the valuation of both opening and closing stock for the assessment year 2017-2018 based on the LIFO method or permit the petitioners to value their stocks by applying the FIFO or weighted average cost method.

Counsel For Petitioner: Ajay Vohra

Counsel For Respondent: P. R. Ajith Kumar

Citation: 2024 LiveLaw Ker 311

Case Title: P. A. JOSE Versus UOI

Case No.: WP(C) NO. 30318 OF 2019

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