ORDER
A. Kalyanasundharam, Accountant Member
1. The assessee and the revenue are in cross appeals for the same assessment year and accordingly these two appeals have been grouped together, heard on that basis and are being disposed of by this composite order.
2. The assessee has raised several issues in this appeal and the first of the issue in the appeal is in regard to inclusion of custom duty on the imported stocks in the valuation of closing stock.
3. Shri G.C. Sharma, Sr. Advocate appearing for the assessee, a firm, submitted that the assessee is carrying on the business of manufacture and sale of multi-channel, T.V. tuners, deck-mechanism, micro motors etc. for which it imports the necessary raw materials. He submitted that the present controversy is limited to the valuation of such raw materials which are not sold by the assessee in the market but used by it for its own consumption for making the various products in which it deals in. He submitted that right from the earlier assessment years and even in the subsequent assessment years, the assessee has been consistently valuing the stock of raw material in hand at the invoice price not including the element of import duty paid thereon. This method of valuation came to be accepted by the Department all along and it was for the first time that the revenue had sought to disturb this accepted practice and thereafter, the revenue had also disturbed the same and included the element of import duty on the raw materials.
4. The CIT(A) for the assessment year under appeal had upheld the order of the Assessing Officer but the CIT(A) for the subsequent assessment years had upheld the method valued by the assessee i.e. valuing of the raw materials at the invoice value without including any element import duty. He submitted that in so far as the finished goods are concerned, they are valued at the raw material invoice value plus import duty thereon plus incidental expenses which had brought the materials into its condition as a finished products. He submitted that it needs to be appreciated that the raw material is not a stock-in-trade item for the assessee and therefore since it is not saleable item as such the method as followed by the assessee in valuing the closing stock of raw material not including any element of custom duty thereon was proper and has the acceptance of the principle of accountancy as well. He submitted that the consistent method having been accepted over the years is not necessary to be disturbed to bring out the subjective satisfaction of the Assessing Officer i.e. his view that the import duty should also form part of the cost of raw material remaining on hand at the close of the accounting period.
For this proposition he placed reliance on the Supreme Court decision in Investment Ltd. v. CIT [1970] 77 ITR 533. He also made reference to the Bombay High Court decision in Manilal Kher Ambalal & Co. v. A.G. Lulla, Seventh ITO [1989] 176 ITR 253 for the proposition and further also placed reliance on the Calcutta High Court decision in CIT v. Hazaribagh Coal Syndicate (P.) Ltd. [1989] 177 ITR 135. He also made reference to the Delhi High Court decision in K.G. Khosla & Co. (P.) Ltd. v. CIT [1975] 99 ITR 574 for the proposition that if the closing stock has to be disturbed than, it would be necessary to disturb the opening stock as well because it is only then that the true profit can be arrived at. He submitted that since the opening stock of the present year is the closing stock of the last year which has been so accepted as such, it would not be possible to change the opening stock in the year under review as it would tantamount to disturbing the closing stock valuation of the preceding assessment year. He, accordingly, pleaded that the various imported raw materials which are meant for manufacture and not intended for sale, it is not necessary that the custom duty should be made part of the closing stock. He again insisted on the consistent method of valuation should be followed and it should not be disturbed.
5. The Departmental Representative placing reliance on the Supreme Court decision in CIT v. British Paints India Ltd. [1991] 188 ITR 44 submitted that if the method of valuation accepted by the Assessing Officer in the preceding assessment year was not a correct mode of valuation then it is open to the Assessing Officer to correctly value them in the assessment year. He also placed reliance on the Supreme Court decision in CIT v. McMillan & Co. [1958] 33 ITR 182.
6. It was also pointed out to the parties that the issue of consideration of various duty for valuation of the closing stock was the subject matter of difference of opinion between the two Members and the same came to be resolved by the Third Member which was in the case of Raymond Woollen Mills Ltd. v. ITO [1986] 18 ITD 64 (Bom.). It was also brought to the notice of the parties that the Madras High Court in CIT v. Carborandum Universal Ltd. [1984] 149 ITR 759 had considered the aspect that when the closing stock valuation as underwent modification due to proper method of valuation, the Madras High Court had held that the valuation of the opening stock does not require any alteration. The comments of the parties in regard to the above were called for by the Bench.
7. Shri G.C. Sharma, the learned Sr. Advocate again insisted that the various raw materials are not stock-in-trade i.e., they are not sold as such and therefore they could not be valued On the same basis as the finished goods are. In so far as the Madras High Court decision is concerned, he submitted that the Delhi High Court in K.G. Khosla & Co. (P.) Ltd.’s case (supra) which is the decision of the jurisdictional High Court should be followed.
8. The Departmental Representative, however, insisted-that the Supreme Court decision would over-rule every other decisions and since that the Third Member decision that all stocks of material including the raw material on hand would have to necessarily include the element of import duty, is on proper lines, that decision needs to be followed.
9. In addition to the above, the Sr. Advocate also brought out the situation that would be developed in including the element of import duty actually paid by the assessee by including it as part of the closing stock to the extent of raw materials still on hand. He submitted anomalous situation relates to the applicability of Section 43B, which allows deduction of duties etc. on actual payment. He submitted that by including the element of custom duty on imported raw materials still on hand in the valuation of the stock it would tantamount to taking away part of the custom duty and carrying it over to the next year, in which year it will not be allowed as a deduction because it was not so paid in that year. He, accordingly pleaded that it is therefore necessary to avoid this kind anomalous situation and the proper method therefore is not to consider import duty in so far as it relates to the raw materials.
10. We have given our very careful consideration to the rival submissions. The import duty element which is sought to be included is on various raw materials remain to be un-utilised in making of the finished products. It is undisputed by the parties that there is import duty on such raw materials. It is also not disputed that the raw materials when converted into finished products and when it remains on hand, the element of import duty is made part of the finished goods. The counsel for the assessee had sought to make a distinction between the finished goods and the raw materials for purposes of valuation of closing stock. As per commercial practice, the stock-in-trade which is the nomenclature gives consists of stock of raw materials, work in progress and finished goods. The accepted principle of valuation in regard to inventory such as raw material, work in progress and finished goods is that it should be valued at either cost or market price whichever is lower. The element of cost could be either total cost or direct cost which is prevailing is an accepted method of valuation and is also the accounting standard laid down by the Institute of Chartered Accountants of India. The very basis of pronouncing or laying the standard of the valuation is that the raw materials, work-in-progress and finished goods should be valued at a price which has brought the raw material, work in progress and finished goods to its present location and condition. It is an accepted fact by both the parties that the raw materials which are imported have come into possession of the assessee only after payment of import duty, indicating that the expenses which had gone directly to bring the raw material into its present location and condition includes the invoice value, freight and other incidental expenses from the Ports or Air Ports etc. plus the custom duty on such items. If the element of import duty as suggested by the assessee is excluded from the value of the raw materials on hand then in one year, the profit would be lower while in the other year, the profit would be higher, it would be as a consequent of not including the element of custom duty. In other words, the effort of the assessee is to only carry over the profit of one year to the other year, thereby postpone determination of the true income of an year.
11. The reliance placed by the assessee in the Delhi High Court decision in K.G. Khosla & Co. (P.) Ltd.’s case (supra) is of no assistance whatsoever to the proposition advocated by the assessee that the opening stock should also be disturbed along with the closing stock, if there is an effort to disturb the closing stock of the year. The finding of the Delhi High Court was that relating to valuation of opening stock the question does not arise from out of the order of the Tribunal and therefore, they had not expressed any opinion. The observations are “the Tribunal has not applied its mind to the suggestion of a deduction from the opening stock and has said nothing about this in its order”. Therefore, the submission of the assessee that the decision in K.G. Khosla & Co. (P.) Ltd. ‘s case (supra) does put a bar on the assessee to disturb the valuation is clearly unfounded. In so far as the Supreme Court decision in Investment Limited is concerned, it was a case of valuation of securities and shares which were shown as investment by the company. The observation of the Supreme Court was “the method of accounting regularly employed may be disregarded only if the opinion of the Taxing authority income of the trade cannot be proper deduced thereby valuation of stock rest is one of the recognised methods”.
12. The learned Senior Advocate Shri G.C. Sharma referring to this observation of the Supreme Court that there should be a finding that the income could not be deduced properly submitted that neither the Assessing Officer nor the CIT(A) had given any finding to the effect that the true income could not be deduced and therefore the method of valuation as adopted by the assessee cannot be disturbed.
13. In our opinion, the submission of the learned Senior counsel Shri G.C. Sharma has very little merit in it. The Assessing Officer having come to the conclusion that the true income could not be deduced without the closing stock of raw material being valued properly and for the proper evaluation of the income, it was necessary to include the import duty, is clearly indicative of the fact that he formed the basis of disturbing the valuation on stock for determination of the true income otherwise. The stock of raw material is part of the stock-in-trade which ultimately goes into the finished goods which is why it is included or grouped under stock-in-trade by commercial business circles. As already pointed out above, since the basis for valuation is inclusion of all direct costs at least which go into bringing the material into its present location and condition, there is no alternative but to include the element of import duty in the valuation of raw materials. At this juncture, we may also point out that in the case of K.G. Khosla & Co. (P.) Ltd.’s case (supra) the opening stock did include element of custom duty but the closing stock valuation omitted the same and the plea of the assessee was that there being numerous items allocation of the element of import duty was a difficult proposition. The Delhi High Court considering the question as to whether there was any material on which the Tribunal could hold that the closing stock necessarily include the custom duty and incidental charges, have held that there was sufficient material for the Tribunal to hold that the closing stock must necessarily be valued by including the custom duty and the incidental charges. This decision of the Hon’ble Delhi High Court supports the conclusion arrived at by us rather than the proposition advocated by the assessee.
14. The decision relied upon by the Bombay High Court is of no relevance to the present issue because it concerned itself with the amount that was received by an advocate as an advance from his clients. The case that was considered by the Calcutta High Court (supra) is of no relevance because in that case the question was regarding maintaining of accounts of reimbursement basis and did not consider the question of valuation. The Supreme Court decision in British Paints India Ltd.’s case (supra) though was mainly concerned with whether the method of valuation was direct cost or not and the conclusion was that if the system that was followed by the assessee was not direct cost then the Assessing Officer has the right to disturb the valuation by rejecting the valuation. This clearly lays down the principle that if the method Le., followed by the assessee year after year and accepted by the Department, in a later year, the Assessing Officer realises that the method as followed by the assessee and accepted by the Department was improper on the basis that it does not reflect the true value of the stock of material in hand, resulting in not a proper determination of the true income, the Assessing Officer reserves the right to disturb the same. The Third Member decision as was pointed out by the Bench concerning, the aspect of valuation of raw material work in progress and finished goods and whether the various elements of duties such as custom duty, excise duty etc. should form part of the stock of materials, work in progress finished goods etc. or not. The conclusion was that the elements of custom duty which have been incurred bringing the material to its present location and condition, must necessarily form part of the value of the closing stock. The Madras High Court in Carborandum Universal Ltd.’s case (supra) had held that when the closing stock of an year is being disturbed as has been done in the present assessment year, there is no necessity of disturbing the opening stock as well because it would tantamount disturbing the closing stock of the preceding assessment year which is beyond the scope of the assessment for the present assessment year.
15. We are, therefore, convinced that the proposition advocated by the assessee is without any merit and the raw materials as are imported, must necessarily include the element of custom duty and such incidental charges to the extent of raw materials that are still on hand. Since the aspect of quantum and the custom duty included in the closing stock is not challenged as requiring verification or excessive or wrong, we do not express any opinion in so far as the quantum of custom duty is concerned, as it is apparent that the assessee has no objection to those because if had any objection, it could have raised the same in appeal which it did not do. The assessee also had contested the inclusion of the import duty because it would tantamount to disturbing the amount of deduction allowable under Section 43B of the IT Act, 1961. It was accepted by both these parties, during the course of hearing that they would have no objection if the Assessing Officer is directed to value the closing stock of raw materials in accordance with the conclusion of the Special Bench which is confronted with the identical proposition of whether inclusion of the element of duties etc. in the closing stock which are otherwise allowable under Section 43B of the Act was proper or not. The Assessing Officer is also directed to consider the decision of the Special Bench as above, which giving effect to the present order.
16. The next claim related to the losses that the assessee suffered in the riots that took place on 31st October, 1984 resulting in the business premises of the assessee that was burnt which fire damaged the building, gutted various furniture and electrical fittings. The assessee had lodged the claims with the insurance company and the insurance company compensated the assessee for the damaged to the building and cost for repairs at Rs. 2,04,700 while the expenses incurred on repair of building was Rs. 5,22,469. The assessee claimed loss on account of imported material stocks, work in progress at Rs. 10,84,386 and the insurance company compensated to the extent of Rs. 3,12,100. The assessee claimed the balance of Rs. 7,72,286 as loss on account of riots. The total loss on account of furniture and fixture was Rs. 1,17,063 which was compensated to the extent of Rs. 72,500 by the insurance company and the balance of Rs. 44,563 claimed as loss during riots. The assessee claimed that the losses which was not compensated by the insurance company should be allowed to it. It further claimed that the electrical fittings etc. which also got burnt out totally should also have been allowed to it to be written off. The further plea that was raised by the assessee was that consequent to the fire, the building suffered resulting in deduction in its life span and therefore, the assessee claimed reduction in the written down value of the building and also pleaded that the same should be allowed to it as a further deduction.
17. Shri G.C. Sharma, submitted that the authorities have wrongly construed the manner of providing of compensation by the insurance company. He submitted that no insurance company gives 100 per cent compensation but to the extent of a portion of the same it always treat as loss to be borne by the assessee after the Surveyor determined the value thereof and it is given the title as salvage value. He submitted that the salvage value in its true parlance means that value which is given to those insured and is not the same as scrap value. In so far as the scrap value is concerned of burnt out furniture, electrical fittings and things like that, it is zero and that cannot be any salvage value because if there was any salvage value then the insurance company would have taken possession of those items so as to sell them by itself which has not been done in the instant case. Therefore, considering any part of the salvage value was improper. He submitted that the loss that was suffered due to fire of the premises which was gutted should be allowed as such in its entirety, i.e., on materials, finished goods, work-in-progress, furniture and fittingsi electrical fittings and fall in the value of the building due to fire and also the repairs on the building incurred by the assessee.
18. The Departmental Representative placed on the Madras High Court decision in the case of CIT v. Sri Rama Sugar Mills Ltd. [1952] 21 ITR 191 and also in the Rajasthan High Court decision in CIT v. S. Zoraster & Co. [1982] 133 ITR 559 for the proposition that expenditure that are incurred on extensive repairs to building are capital in nature.
19. We have given our very careful consideration to the rival submissions. The claim of the assessee as loss on fire in stock at Rs. 7,72,286 net building repairs at Rs. 3,17,769, Rs. 44,563 on account of furniture and electrical fittings burnt out written off in its entirety and finally claim of reduction in the written down value to the extent of 2/3rd.
20. In regard to the above after considering the rival submissions, in our view, there is considerable merits in the arguments advanced by the learned Sr. advocate in so far as the loss suffered on account of loss which gutted the premises of the assessee and the repairs to the building. It is often said that no one can make a profit out of an insurance contract. This is so stated because the insurance company are normally concerned with the cost and the present market value of the items that are insured. The insurance company evaluates the losses with reference to the cost and also the repairs that are necessary which includes labour, cost of materials etc. from which materials they reduce certain portion equal to the number of years for which the asset was insured was in existence. Further the contract also provides for the insured sharing part of the loss in certain cases, the insurance company does take over the asset in question which is insured and evaluates and gives it salvage value, which value is given to the assessee. In all other cases, where the insured item is not taken by the insurance company it reduces the amount of compensation by a certain percentage which it calls a salvage value. This is normally methodology adopted by the insurance company for compensating loss on on account of fire and various other items. Therefore, the salvage value as mentioned by the insurance company is limited only for arriving at the final amount to be compensated for the loss loses its relevance creditability thereafter. The salvage value is different from scrap value. The salvage value” is the value of the item i.e., still remaining after asset is destroyed or damaged. The scrap value, on the other hand, is the value of the item or the asset which it would fetch after a lapse of time as a mere scrap because of it becoming obsolete or irreparable etc.
21. Therefore, after evaluating of the losses as suffered by the assessee, the insurance company having come forward to compensate partly, the balance of the loss as suffered by the assessee has to be necessarily allowed as a deduction in the year of occurrance of loss. In so far as the expenses that have been incurred on repairs of the building which suffered damage due to fire, its restoration of the building and not a reconstruction resulting in extensive improvement in the life span of the building. The Madras High Court in Sri Rama Sugar Mills Ltd.’s case (supra) had clearly held that repairs which are in the nature of current repairs would be of revenue in nature. In that case, the old boiler was replaced by a new boiler and the question was whether the replacement which in fact had in effect of improving the productive capacity could be treated as revenue expenditure etc. The learned Judge did not agree on the character of the expenses being revenue or capital. The majority of the decisions, however, are indicative of the fact that where any part of the machine which is replaced, the cost of replacement is immaterial and what is necessary to be considered is whether it results in having a new machine or replacement of a part of the machine. Wherever it results in replacement of a part of machine, the conclusion was that it was allowed as revenue expenditure. Therefore, the expenses incurred over and above, the compensation received from the insurance company on the damages to the building i.e., Rs. 3,17,769 has to be necessarily allowed as a revenue expenditure. Similarly, the loss on account of stock furniture, electrical fittings have to be allowed in full. However, in so far as the claim of reduction in the written down value of the building is concerned, though it was an original idea of the counsel as such, we are not in a position to accept the claim and allow reduction to the value of the building. The building was damaged consequent to fire and the Surveyor of the insurance company had compensated the assessee for repairs to be effected on the building and therefore it is a case of partial damage to the building which is capable of restoration after repairs and not a case where the building was beyond repairs. It is only in cases of the asset being beyond repairs that such an asset could be allowed deduction as a terminal allowance of the written down value consequent to damage which is one of the requirements of the Section 32(1)(iii). Therefore, this claim of the assessee is (sic)
22. The assessee had claimed that there could be no disallowance out of Deevali expenses, general expenses, payment to club, disallowance under Section 43B, staff welfare and travelling expenses. In so far as the disallowance out of general expenses and travelling expenses are concerned, the assessee did not press its claim. In so far as the Deevali expenses are concerned, the Tribunal in the case of the assessee for the assessment year 1984-85 had held that the expenses should be allowed by placing reliance on the Board’s circular, which we follow. In regard to the payment to the Club to the extent it repeats to amount of subscription, the same should be allowed the balance is not allowable. The Assessing Officer is directed to allow club subscription. In so far as the disallowance under Section 43B is concerned the Assessing Officer is only directed to allow deduction in the year of actual payment. In so far as the disallowance out of staff welfare expenses are concerned, we do not interfere.
23. The Department in its appeal has raised the issue of the CIT(A) wrongly directing the disturbance of the opening stock in the valuation of the raw materials. As observed above while dealing with the assessee’s claim on valuation of closing stock, the Delhi High Court decision in KG. Khosla & Co. (P.) Ltd.’s case (supra) is not an authority in regard to the valuation of opening stock should also be made in the same basis as the closing stock of the accounting year, we have to reverse this conclusion of the CIT(A). We had also made observations while dealing with the assessee’s claim on the subject that the Madras High Court in Carboran-dum Universal Ltd.’s case (supra) had categorically observed that merely because the closing stock valuation has to be properly done, it does not necessarily mean that the opening stock should also be disturbed because it would tantamount disturbing the closing stock of the preceding assessment year, which is beyond the jurisdiction of the Assessing Officer for the present assessment year. We, therefore, reverse the conclusion of the CIT(A) on this issue.
24. In the result, the appeal filed by the assessee is allowed in part while that of the revenue is allowed.