Vildirect: IncomeTax-caselaws-2001-VIL-158-ITAT-AHM

2001-VIL-158-ITAT-AHM

Income Tax Appellate Tribunal AHMEDABAD

IT APPEAL NO. 5248 (AHD.) OF 1995

Date: 31.05.2001

KRUTI MARKETING LTD.

ASSISTANT COMMISSIONER OF INCOME-TAX

For the Appellant : Tushar Hemani
For the Respondent : M.D. Soyantar.

BENCH

B.M. KOTHARI, ACCOUNTANT MEMBER AND S.K. YADAV, JUDICIAL MEMBER JJ.

JUDGMENT

R.K. Bali, A.M. - This is an appeal by the assessee against the order dated 22nd July 1998 passed by the CIT(Appeals)-IV, Baroda. The assessee has taken the following substantive grounds:

(i)The CIT(Appeals) has erred in upholding the addition of Rs. 68,89,089 made by the Assessing Officer on account of alleged under valuation of the closing stock;

(ii)The CIT(Appeals) has erred in upholding the disallowance of Rs. 2,73,682 on account of foreign travel undertaken for the purpose of inspection of the machinery to ascertain whether the second hand machinery which the assessee intended to purchase was in order or not.

(iii)The CIT(Appeals) has erred in upholding the action of the Assessing Officer in including the excise duty paid in computation of turn over for the purpose of working out the deduction allowable to the assessee under section 80HHC.

2. Briefly the facts are that the assessee is a public limited company and it filed its return of income for the assessment year 1995-96 on 30th Nov. 1995 declaring an income of Rs. 7,88,39,962. The assessee derives income from manufacture of worsted woollen fabrics, woolen felt and it also has a chemical division named as Platewel Processes & Chemicals.

3. During the course of assessment proceedings, the Assessing Officer required the assessee-company to submit complete details in respect of valuation of various types of finished goods and came to the conclusion that the assessee has not properly valued the closing stock. During the course of assessment proceedings, it was explained by the assessee-company that it has been valuing its closing stock by "Direct Costing Method" and the same method was being followed this year. In the notes forming part of the company’s published accounts at p 37 while dealing with the question of valuation of inventories it was indicated as under:

(i)Materials in process is valued at cost. Cost is arrived at considering direct material, direct labour and direct factory overheads upto the stage of manufacture.

(ii)Finished goods are valued at cost or market value whichever is lower. Cost is arrived at considering direct material, direct labour and direct factory overheads. Finished stocks lying in the factory are valued exclusive of excise duty except the stock lying in duty paid godowns and company’s retail shop which are valued inclusive of excise duty.

(iii)Material in customs bonded warehouse and in transit are stated at cost upto the date of balance sheet.

The above method of valuation was the same as was adopted in the earlier preceding years and is confirmed by the Audit Report in Form No. 3CD furnished under the provisions of section 44AB of the Act which also accompanied company’s return of income. At p 16 of the Annual Report it is indicated as under:

(d)We have examined and verified the stock verification records of the company and also wherever necessary, we have physically verified stocks with the assistance from the technical staff of the company. On the basis of such examination and verification and also considering the accounting method adopted for accounting of excise and customs duty referred to in Note 11 to the accounts. We are satisfied that the valuation of stocks is fair and proper in accordance with the normally accepted accounting principles and is on the same basis as in the preceding year".

The Assessing Officer however, held that the method adopted by the assessee for the valuation of closing stock was not correct as according to the Assessing Officer certain items of cost ought to have been taken into consideration by the assessee-company. The Assessing Officer has referred to those items of cost which according to the Assessing Officer ought to have been considered for the purpose of valuation of closing stock as per the details given at pp 11 to 13 of the assessment order according to which costs to the extent of Rs. 12,85,00,701 have not been taken into consideration for the purpose of valuation of closing stock which have been debited to the P&L a/c which according to the Assessing Officer ought to have been considered by the assessee-company for the purpose of valuation of closing stock as these are relevant for the purpose of valuation of closing stock in view of the decision of the Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108: [1991] 188 ITR 44 (SC). Such items debited to the P&L a/c are as under:

Description	Total as per P&L a/c	Pertaining to Platewel Division (Chemicals Dvn.)	Balance
	Rs.	Rs.	Rs.
Depreciation	3,67,92,309	2,55,142	3,65,37,167
Machinery	2,24,08,230		2,24,08,230
Repairs
Building	44,85,278	1,65,379	43,19,899
Repairs
Other repairs	9,49,052	1,20,779	8,28,273
Technical fees	71,01,302		71,01,302
Employees emoluments:
Total: 6,95,82,272
Less: Considered by the Co. 2,26,07,852
Less: Considered by the Co. 2,26,07,852	4,69,74,420	43,13,059	4,26,61,361
Travelling and Conveyance	37,80,416	4,60,644	33,19,773
Rent	4,78,328	24,416	4,53,912
Rates and taxes	4,87,280	62,509	4,24,771
Insurance	17,46,328	1,63,772	15,82,556
Directors’ Remuneration	9,25,000		9,25,000
Interest-other	80,63,899	1,25,442	79,38,457
Total			12,85,00,701

On the basis of the aforesaid stand, the Assessing Officer make an addition of Rs. 68,89,089 to the company’s returned income on the ground that the company having not considered the above items of cost, for the purpose of valuation, its closing stock of finished goods were undervalued by that amount and as such true profit of the company could not be worked out and technically the proviso to section 145(1) was applicable to the case of the assessee.

4. The assessee appealed to the CIT(Appeals) and pleaded that a perusal of the assessment order passed by the Assessing Officer clearly indicates-

(i)that the Assessing Officer has not found any fault with the books of accounts as such and those have been accepted;

(ii)it is not the case of the Assessing Officer that the assessee-company is not following regular method of accounting including method of valuation of stock; and

(iii)that the Assessing Officer has made the addition only because in his view the aforesaid items of cost ought also to have been considered by the company for the purpose of valuing its closing stock of finished goods.

It was pleaded before the CIT(Appeals) that although the disputed addition of Rs. 68,89,089 has been made by invoking the relevant provisions of section 145(1), it is only to the aforesaid limited extent and even the quantum of addition has been arrived at on the basis of these very amounts which have been duly accounted in the books of accounts and also in the P&L a/c. It was pleaded by the assessee before the CIT(Appeals) that the Assessing Officer has misinterpreted the ratio of Supreme Court decision in the case of British Paints India Ltd. case (supra) and further that the Assessing Officer has not correctly appreciated that the case of the assessee was squarely covered by the decision of the Hon’ble Madras High Court in the case of CIT v. Carborandum Universals Ltd. [1984] 39 CTR (Mad.) 272: [1984] 149 ITR 759 (Mad.). The CIT(Appeals) however upheld the action of the Assessing Officer for the reasons given in the impugned order and he agreed with the findings of the Assessing Officer that in terms of the decision of the Supreme Court in the case of British Paints India Ltd. case (supra) all costs whether direct or indirect have to be taken into consideration for the purpose of valuation of closing stock. The CIT(Appeals) accordingly upheld the addition of Rs. 68,89,089.

5. The assessee is aggrieved and has challenged the action of the CIT(Appeals) by taking a specific ground No. 1. Before us, Shri J.P. Shah, the learned representative of the assessee submitted that the CIT(Appeal) has failed to appreciate that for the last several years not only the assessee had regularly followed "Direct Costing Method" but the same was approved by the Department also and as such there is no justification for the Department to suddenly take a U-turn and say that the method adopted by the assessee is defective and therefore a huge addition of Rs.. 68,89,089 is required to be made. It was submitted that the CIT(Appeals) has failed to appreciate that in the cost method of valuation of closing stock there are two options available to the assessee viz., "direct cost method" and "indirect or total or on cost method", or "absorption cost method". It was pleaded that the assessee had been following the "Direct Costing Method", a method which has not been disapproved even by the Supreme Court in the case of British Paints India Ltd. case (supra) on which the Assessing Officer as well as the CIT(Appeals) have relied upon. It was submitted that the "Direct Costing Method" is also approved by the Hon’ble Madras High Court in the case of CIT v. Carborandum Universal Ltd. case (supra) and the Department’s SLP against the above decision of the Madras High Court has since been dismissed by the Hon’ble Supreme Court reported in [1991] 187 ITR (St.) 38. It was pleaded that the "Direct Costing Method" apart from being a recognised method is also a scientific method of valuation of closing stock. It was submitted that the CIT(Appeals) has erred in not appreciating the distinction between the "Direct Costing Method" and "Indirect Costing Method" and has wrongly pointed out that so many indirect expenses as enumerated in para 2.4 of his order were not included. It was submitted that in the "Direct Costing Method" these expenses are not to be included and were never included in the past and the earlier Assessing Officer’s have never disputed the action of the assessee-company in this regard.

5.1 Shri J.P. Shah, the learned representative of the assessee has referred to Accounting Standard "AS-2 - Valuation of Inventories" issued by the Institute of Chartered Accountants of India and in particular paras 6.5 to 6.8 which are as under:

"6.5 Direct Costing is the method whereby the cost of inventories is determined so as to include the appropriate share of variable costs only, all fixed costs being charged against revenue in the period in which they are incurred.

6.6 Absorption Costing is the method whereby the cost of inventories is determined so as to include the appropriate share of both variable and fixed costs, the letter being allocated on the basis of normal level of production.

6.7 Variable Costs are those costs of production which vary directly, or nearly directly, with the volume of production.

6.8 Fixed Costs are those costs of production which by their very nature remain relatively unaffected in a defined period of time by variations in the volume of production."

It was submitted that as far as the assessee-company is concerned, it has been regularly following the "Direct Costing Method" which is recognised by the Institute of Chartered Accountants of India as per the Accounting Standard "AS-2" referred to supra. It was submitted that in terms of section 227(4A) of the Companies Act, 1956 the auditors of the company have certified that the method of valuation of closing stock employed by the assessee is "fair" and proper in accordance with the normally accepted accounting principles". It was further submitted that the Income-tax Act, 1961 does not contain any prescription in the matter of valuation of stock of finished goods by an assessee and the Assessing Officer has wrongly invoked the proviso to section 145(1) for making this addition, it was submitted that the "Direct Costing Method" adopted by the assessee-company envisaged the valuation of stock after taking into account only the following elements of costs:

(a)Cost of materials;

(b)Direct labour and direct expenses (if any); and

(c)Variable production overheads.

Thus the above method of "Direct Costing" envisages total exclusion of fixed costs and it also excludes overheads other than variable production overheads such as:

(a)Selling and distribution expenses;

(b)General administration overheads;

(c)Research and development cost; and

(d)Interest.

It was submitted that at the cost of repetition it may be emphasized that the "Direct Costing Method" considers only those production overheads which are variable in nature whereas the other recognised method of valuation viz., "Absorption Costing" considers all production overheads, whether fixed or variable. However, it was emphasized that even the "Absorption Costing Method" does not consider overheads other than the production overheads.

5.2 In view of the above discussion it was pleaded that none of the items of costs listed in para-3 above on which the Assessing Officer has insisted for being considered, has really to be considered. Itemwise submissions were made by the learned representative of the assessee as under:

(i)Depreciation being an item of fixed overheads, there can be no question for considering the same under "Direct Costing".

(ii)Machinery repairs being an item of fixed overheads, there can be no question for considering the same under "Direct Costing". However, it was submitted that out of the total amount of Rs. 2,24,08,230 debited in the P&L a/c under the head "machinery repairs", it is made up of the following items :

	Rs.
Consumption of machinery spares	1,96,46,978
Computer maintenance	4,07,200
Machinery repairs and maintenance	23,54,052
	2,24,08,230

It was submitted that computer maintenance Expenses, being part of general administration expenses, cannot be included in the "Direct Costing Method". Similarly, the machinery repairs and maintenance expenses, being an item of fixed overheads, it cannot be considered under the "Direct Costing Method" and accordingly the assessee itself has taken into consideration consumption of machinery spares amounting to Rs. 1,96,46,978 (which varies in sympathy with the level of production activity of the assessee-company) into consideration for the purpose of valuation of stock of finished goods

(iii)Building repairs, being an item of fixed overheads, there can be no question of considering the same under "Direct Costing".

(iv)Other repairs being an item of fixed overheads, there can be no question for considering the same under "Direct Costing".

(v)As regards technical fees, the assessee-company has entered into an agreement dated 14th Nov. 1989 with the Albany International, Canada. Inc., and the technical fees payable thereunder being a fixed annual payment not at all dependent upon the level of production or, for that matter, whether there is or there is not any production, is an item of fixed overheads and therefore it cannot be considered for the purpose of valuing the closing stock under "Direct Costing Method".

(vi)Similarly total amount debited to the P&L a/c on account of employees’ emoluments is Rs. 6,95,82,272. Out of this, the company has taken into account direct labour cost of Rs. 2,26,07,852 for the purpose of valuation of stock of finished goods and the figure has been arrived at as under :

Total employees’ emoluments :	6,95,82,272
Less : Amount pertaining to Platewel Division	43,13,059
	4,26,61,361
Salaries in general and wages of service deptt.	2,26,07,852

(vii)Travelling and conveyance not being an item of production overheads, there can be no question for considering the same under "Direct Costing".

(viii)Similarly, rent, rates and taxes, insurance and directors" remuneration being all items of fixed overheads cannot be considered under "Direct Costing".

(ix)Interest being a finance cost, being an item of period cost by definition and in any case not being part of production overheads (much less, of variable provision overheads), cannot be considered for valuation under the "Direct Costing".

5.3 It was submitted that the above submissions are being supported by the decision of the Madras High Court in the case of CIT v. Carborandum Universal Ltd. (supra) which is a direct authority not only showing that "Direct Costing" is a recognised method of valuing stocks but showing also that where valuation is done under that method, specific items viz. depreciation, rent, rates and taxes, repairs and maintenance, insurance, salaries and perquisites of supervising and ancillary staff, travelling expenses and technical fees are not to be considered for the purpose of valuation. Accordingly it was submitted that the Assessing Officer was not justified in applying proviso to section 145(1) for making the addition when the assessee was employing recognised method of valuation of closing stock. It was submitted that even the decision of the Supreme Court in the case of British Paints Ltd. (supra) on which reliance has been placed by the Assessing Officer as well as the CIT(A) in fact supports the case of the assessee because that decision does not say in so many words that even recognised method of valuation of stocks can be rejected by the Departmental authorities. In deed, in the case of British Paints Ltd. (supra) it was not the case of the assessee that the method of valuation of stocks adopted by it was a recognised method because in that case the assessee’s method of valuation of stocks took into account only the cost of raw materials and excluded every other costs and as such it could not have been suggested/argued by the assessee that it was a recognised method and in fact the finding of the Assessing Officer in that case was that the method adopted by the assessee was not a recognised method. Accordingly it was pleaded that if the true ratio of the decision of the Supreme Court in the case of British Paints Ltd. (supra) is applied to the case of the assessee, it has to accounting known as "Direct Costing" which categorically envisages that certain production overheads, even if connected with the production, are not to be considered for the purpose of valuation of stocks if they are fixed in nature as different from being variable in nature and further that some of the items being part of the general administration or finance charges and that too being fixed in nature, there can be no question for considering them under the "Direct Costing Method". Accordingly it was pleaded that for all the aforesaid reasons, the addition of Rs. 68,89,089 made by the Assessing Officer as sustained by the CIT(A) on account of alleged undervaluation of the closing stock of finished goods deserves to be deleted.

6. The learned senior Departmental Representative strongly relied on the orders of the Assessing Officer as well as the CIT(A) and further submitted that there is a distinction between the terms "Costs" and "Price". It was submitted that the term "Cost" includes something more than the price and since the items of expenditure taken into consideration by the Assessing Officer in the assessment order are relatable to the production of goods by the assessee-company these ought to have been taken into consideration while determining the cost of finished goods for the purpose of valuation of closing stock. Reliance was placed on the decisions in the cases of Arvind Mills Ltd. v. CIT 1978 CTR (Guj.) 90 : [1978] 112 ITR 64 (Guj.) and CIT v. Nirlon Synthetic Fibres & Chemicals Ltd. [1981] 25 CTR (Bom.) 155 : [1982] 137 ITR 1 (Bom.) and on the decision of the Supreme Court in the case of British Paints Ltd. (supra). The learned senior Departmental Representative read extensively from pp 10 to 13 of the assessment order and submitted that various items of expenditure considered by the Assessing Officer are related to the production and as such were rightly considered by the Assessing Officer for the purpose of valuation of closing stock. It was submitted that as noted by the CIT(A) the decision of the Supreme Court in the case of British Paints Ltd. (supra), the relevant portion of which has been extracted by the CIT(A) in his order referred to all costs other than the cost of raw materials for the purpose of valuation of closing stock and as such since the action of the Departmental authorities was in accordance with the decision of the Supreme Court in the case of British Paints Ltd. (supra) as well as the Gujarat High Court in the case of Arvind Mills Ltd. (supra), the addition made by the Assessing Officer as sustained by the CIT(A) should be upheld.

7. We have considered the rival submissions and have also gone through the relevant portions of the orders passed by the Assessing Officer as well as the CIT(A) relating to the addition of Rs. 68,89,089 on account of alleged undervaluation of closing stock. In this connection, it will be useful to extract the relevant portion of Accounting Standard "AS-2-Valuation of Inventories" issued by the Institute of Chartered Accountants of India :

"6.2 Historical Cost represents an appropriate combination of the-

(a)Cost of purchase;

(b)Cost of conversion; and

(c)other costs incurred in the normal course of business in bringing the inventories upto their present location and condition.

6.3. Cost of purchase consists of the purchase price including duties and taxes, freight inwards and other expenditure directly attributable to acquisition, less trade discounts, rebates, duty drawbacks and subsidies, in the year in which they are accounted, whether immediate or deferred, in respect of such purchase.

6.4. Cost of conversion consists of

(i)costs which are specifically attributable to units of production i.e., direct labour, direct expenses and sub-contracted work; and

(ii)production overheads, ascertained in accordance with either the direct costing or absorption costing method.

Production overheads exclude expenses which relate to general administration, finance, selling and distribution.

6.5. Direct Costing is the method whereby the cost of inventories is determined so as to include the appropriate share of variable costs only, all fixed costs being charged against revenue in the period in which they are incurred.

6.6. Absorption Costing is the method whereby the cost of inventories is determined so as to include the appropriate share of both variable and fixed costs, the latter being allocated on the basis of normal level of production.

6.7. Variable costs are those costs of production which vary directly, or nearly directly, with the volume of production.

6.8. Fixed Costs are those costs of production which by their very nature remain relatively unaffected in a defined period of time by variations in the volume of production.

On the basis of the above guidelines given by the Institute of Chartered Accountants of India, it is clear that the "Direct Costing Method" employed by the assessee-company is one of the recognised methods of valuation which includes-

(1) Cost of purchase;

(2) Cost of conversion which are specifically attributable to units of production, i.e., direct labour, direct expenses and sub-contracted works and variable production overheads ascertained in accordance with the Direct Costing although all fixed costs which remain unaffected in a defined period of time by variations in the volume of production are excluded as those could be taken into consideration only in the Absorption Costing Method and not the "Direct Costing Method".

The Income-tax Act, 1961 does not contain any specific provision/prescription in the matter of valuation of stocks of finished goods by an assessee. The relevant portion of section 145(1) which the Assessing Officer has invoked in the present case (as it applied to assessment year 1995-96) read as under :

"145. Method of accounting.-(1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall be computed in accordance with the method of accounting regularly employed by the assessee :

Provided that in any case where the accounts are correct and complete to the satisfaction of the Assessing Officer but the method employed is such that, in the opinion of the Assessing Officer, the income cannot properly be deduced therefrom, the computation shall be made upon such basis and in such manner as the Assessing Officer may determine :"

The above provisions of section 145 have since been substituted by a new section by the Finance Act, 1995 w.e.f. 1st April, 1997 as under :

"Method of Accountings :

(1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.

(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may, make an assessment in the manner provided in section 144."

The relevant portion of the Finance Minister’s speech rendered while moving the Finance Bill, 1995 reads as under :

"73. I propose to amend the provisions of the Income-tax Act to provide that the taxable income may be computed only on cash or mercantile basis. It is also being provided that the taxpayers shall follow accounting standards as may be notified by the Central Government from time to time for various businesses. This provision is being made applicable from accounting year starting from 1st April, 1996."

The relevant portion of the Memorandum explaining the provisions of the Finance Bill, 1995 reads as under :

"Methods of accounting and accounting standards for computing income-The existing section 145(1) of the Income-tax Act provides for computation of income from business or profession or income from other sources in accordance with the method of accounting regularly employed by the assessee. Income is generally computed by following one of the three methods of accounting, namely, (i) cash or receipts basis, (ii) accrual or mercantile basis, and (iii) mixed or hybrid method which has elements of both the aforesaid methods. It has been noticed that many assessees are following the hybrid method in a manner that does not reflect the correct income. It is proposed to amend section 145 to provide that income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall be computed only in accordance with either the cash or the mercantile system of accounting, regularly employed by an assessee.

The Institute of Chartered Accountants of India (ICAI) have directed its members to ensure that the Accounting Standards formulated by it are followed in the presentation of financial statements covered by their audit reports. It is seen that there is a flexibility in the standards issued by ICAI which makes it possible for an assessee to avoid the payment of correct taxes by following a particular system. Therefore, there is an urgent need to standardise one or more of the alternatives in various standards so that the income for tax purposes can be computed precisely and objectively.

The Bill proposes to amend the Income-tax Act, to empower the Central Government to prescribe by notification in the Official Gazette, the accounting standards which an assessee will have to follow in computing his income under the head "Profits and gains of business or profession" "Income from other sources".

The proposed amendments will take effect from 1st April, 1997 and will accordingly, apply in relation to assessment year 1997-98 subsequent years."

It is pertinent to note that even as of today, the Government has not issued any standard direction on the subject of valuation of closing stock pursuant to the provisions of sub-section (2) of section 145 and yet the Finance (No. 2) Act, 1998 has inserted a new section 145A for the specific purpose of making some provision, though limited in scope, on the subject of valuation of stocks. That section reads as under and has been made effective from 1st April, 1999 :

"145A. Method of accounting in certain cases.-Notwithstanding anything to the contrary contained in section 145 (as it stood immediately before the 1st day of April, 1995) the valuation of purchase and sale of goods and inventory for the purpose of determining the income chargeable under the head "Profits and gains of business or profession" shall be-

(a)in accordance with the method of accounting regularly employed by the assessee; and

(b)further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation.

Explanation : For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment".

Thus, it has to be concluded that the assessee who is following the "Direct Costing Method" for the purpose of valuation of closing stock, is not only following the method recognised by the Institute of Chartered Accountants of India statutorily constituted under the Chartered Accountants Act, 1949 and in the absence of any accounting standard in that behalf notified by the Central Government pursuant to the provisions of the newly inserted section 145 w.e.f. 1st April, 1997, it continues to be a recognised method even today and shall continue to be so till such time as the Central Government prescribes an Accounting Standard pursuant to the provisions referred to supra, disapproving the "Direct Costing Method". Thus out of the various items of expenditure listed in the assessment order which have also been reproduced by us in para 3, it is pertinent to note that the assessee itself has taken into consideration direct labour and direct expenses along with variable production overheads into consideration while valuing the closing stock. For example, out of the total amount of Rs. 2,24,08,230 debited in the P&L a/c under the head "machinery repairs" the assessee has considered the amount of Rs. 1,96,46,978 on account of machinery spares for the purpose of valuation of stocks as this expenditure on spares varies directly with the level of production activity. On the other hand, other repairs and maintenance expenses are items of fixed overheads and as such were rightly not considered as a part of the "Direct Costing Method" although they could be considered if the method of accounting adopted is "on cost" or absorption cost method. Similarly out of the employees’ emoluments debited to the P&L a/c at Rs. 6,95,82,272, the company has considered wages cost amounting to Rs. 2,26,07,852 for the purpose of valuation of stocks of finished goods as it represents direct labour cost. On the other hand, the expenditure relating to the Platewel Division (which was excluded by the Assessing Officer also) as well as staff salaries being an item of general administration overheads and not being part of direct labour as also wages of service department which are not directly related to the production were rightly not considered by the company under the "Direct Costing Method" although they could have been considered if valuation is to be done on the basis of "Absorption Cost Method". Similarly various other items of expenditure which are not directly related to the production on quantum basis, were not considered for the purpose of valuation of closing stock under the "Direct Costing Method". In this connection, it will be relevant to refer to the observations of the Madras High Court in the case of CIT v. Carborandum Universal Ltd. (supra) which has been relied upon by the assessee-company in its submissions before the Assessing Officer as well as the CIT(A), wherein it has been clearly held that the "Direct Costing" is a recognised method of valuing the stocks and it also shows that where the valuation is done under this method, specific items viz. depreciation, rent, rates, taxes, repairs and maintenance, insurance, salaries and perquisites of supervising and ancillary staff, travelling expenses and technical fees are not to be considered for the purpose of valuation. The relevant portion of the judgment at pp 761 to 763 in the case of Carborandum Universal Ltd. (supra) reads as under :

".........The assessee by its letter dated 22nd Dec. 1973, had stated that the basis of the valuation of the closing stock was as follows :

(1)	Raw materials	at cost
(2)	Work-in-progress	at direct cost
(3)	Finished goods	at direct cost
(4)	Other goods	at cost

In that letter the assessee also pointed out that it has been following the mercantile system of accounting, and that there is no change in the said method of accounting followed by it, but that it has changed only the manner of valuation of certain items (of closing stock), that while the valuation of closing stock in respect of all items in the earlier years was being done at cost, which term was understood to be "total cost" the valuation in respect of the accounting year ended 31st August 1970, has been changed in respect of "work-in-progress" and "finished goods" from "total cost" to "direct cost" and that the difference between the total cost and the direct cost is that in the cost, the overheads such as administrative department expenses are excluded, while in the total cost such overheads are included. The ITO sought further elucidation from the assessee as to what is meant by "total cost" and "direct cost" and as to what was the difference between the method of ascertaining the cost. The assessee by its letter dated 1st January 1974, submitted that the "total cost" would include the following 16 items :

(1)Depreciation;

(2)Rent;

(3)Rates and taxes;

(4)Repairs and maintenance (supplies and services);

(5)Insurance;

(6)Shipping;

(7)Packing; and

(8)Salaries and perquisites-Supervisory and ancillary staff.

While "direct cost" would include only the following components :

(1)Raw materials;

(2)Power;

(3)Fuel;

(4)Direct labour, wages;

(5)Direct labour and overtime;

(6)Holiday pay;

(7)Fringe benefits, bonus, ESI, PF; and

(8)Production department : supervisory staff : salary, overtime and fringe benefits (bonus and PF) :

that it has bona fide valued the closing stock at "direct cost" and that this new method of valuation is not for any casual period but it would be adopted consistently in future from year to year and that the new basis adopted is based upon accepted principles of commercial practice.

As noted earlier, the Revenue’s SLP against the above decision of the Madras High Court in the case of Carborandum Universal Ltd. (supra) has since been dismissed by the Hon’ble Supreme Court as reported in 188 ITR (St.). We may point out that although the Assessing Officer has made the addition of Rs. 68,89,089 by application of the proviso to section 145(1), yet (i ) he has not found fault with the books of account as such and these have been accepted, and (ii ) it is not the case of the Assessing Officer that the assessee-company is not following regular method of accounting including the method of valuation of stock and the addition has been made only on account of the fact that according to the Assessing Officer certain items of costs which are in the nature of indirect costs ought also to have been considered by the assessee for the purpose of valuation of its closing stock. The Hon’ble Supreme Court in the case of P.M. Mohammed Meerakhan v. CIT [1969] 73 ITR 735 (SC) which been referred with approval by the Supreme Court in the case of British Paints India Ltd. (supra), has held that the IT Act does not contain specific provision for the valuation of stocks. Income, profit and gains must, however, be computed in the manner provided by the Act. It is the duty of the officer to determine the profits and gains of a commercial adventure according to the correct principles of accounting. Thus any method of accounting which is in conformity with the well recognised principles of accountancy, cannot be regarded as such that income can not be properly deduced therefrom. The Assessing Officer as well as the CIT(A) have not correctly appreciated the true ratio of the Supreme Court decision in the case of British Paints India Ltd. (supra) because in the above said judgment a regular system of accounting has been referred to as a system regularly employed by the assessee from year to year. There is nothing in the decision which says that even a recognised method of valuation of stock can be rejected by the Assessing Officer. The true ratio of the Supreme Court decision is that the Assessing Officer is not prevented from rejecting a particular method of valuation of stock merely because it was accepted by the Department in earlier years. The Assessing Officer is fully entitled to and in fact duty bound to reject the method if, in his opinion, the method employed is such that income cannot properly be deduced therefrom. However, what is significant to note is that the Supreme Court has nowhere said that it would be open to the Assessing Officer to reject even a recognised method of valuation. In deed, the Supreme Court could not have said so for the simple reason that it cannot at all be open to the Assessing Officer to say, in the context of a recognised method of valuation, that it is such that income can not be properly deduced from its employment. In the case of British Paints India Ltd. (supra) it was not argued by the assessee that the method of valuation of stock adopted by it was a recognised method. In fact, the Assessing Officer in that case held that the method adopted by that assessee (British Paints India Ltd.) though regularly employed was not a recognised method" (p 48).

From the above discussion it is clear that neither the Assessing Officer nor the CIT(A) has considered as to whether the method of valuation employed by the assessee which is the "Direct Costing Method" was a recognised method and if so whether the company was justified in not considering the items of costs in dispute under that method and has wrongly invoked the proviso to section 145(1). The Assessing Officer as well as the CIT(A) have proceeded on the assumption that certain items of costs which had not been considered by the company for the purpose of valuation of stocks, ought to have been considered and there is no particular basis for their saying so except that they thought that these items of costs are related to the production and therefore, ought to have been considered. The Assessing Officer as well as the CIT(A) have failed to appreciate that there was a recognised method of valuation of stock, "Direct Costing Method" which categorically envisages that certain production overheads, even if connected with the production, are not to be considered for the purpose of valuation of stock if they are fixed in nature as distinguishable from those expenditure which are variable in nature and also the fact that some of the items being part of general administration overheads or finance charges and that too being fixed in nature, there should be no question of considering them under the "Direct Costing Method". Thus taking into consideration the totality of the facts and circumstances of the case, we are of the opinion that the addition of Rs. 68,89,089 made by the Assessing Officer as sustained by the CIT(A) for alleged under valuation of closing stock of finished goods, is not justified and is directed to be deleted because the assessee has been regularly following a recognised method of accounting known as "Direct Costing Method" which is approved by the Institute of Chartered Accountants of India and it has not been subsequently disapproved by any notification by the Central Government in the Official Gazette as envisaged in section 145(2). Accordingly ground of appeal No. 1 is allowed.

8. Coming to ground of appeal No. 2, Shri J.P. Shah, the learned representative of the assessee submitted that the issue in dispute is squarely covered in favour of the assessee as per the decision of the Bombay High Court in the case of Bralco Metal Industries (P.) Ltd. v. CIT [1994] 206 ITR 477 (Bom.) as the expenditure was incurred on foreign travel for the purpose of inspection of machinery to ascertain whether second-hand machinery was in order or not and then to decide whether to purchase or not and on what terms and conditions. The learned Departmental Representative on the other hand submitted that the issue in dispute is covered by the decision of the Gujarat High Court in the case of McGaw Ravindra Laboratories v. CIT [1994] 207 ITR 239 (Guj.). Reliance was also placed on the decisions in the cases of Ciba of India Ltd. v. CIT [1993] 114 CTR (Bom.) 105 : [1993] 202 ITR 1 (Bom.) and Shree Digvijay Woollen Mills Ltd. v. CIT [1993] 114 CTR (Guj.) 396 : [1993] 204 ITR 398 (Guj.).

9. We have considered the rival submissions. It is undisputed that the expenditure has been incurred by the assessee on foreign travel of various officials of the company in respect of purchase of new machinery which were subsequently purchased by the assessee. As such the expenditure has been incurred for acquiring the fixed assets and is in the nature of capital expenditure which forms a part of the actual costs of the fixed assets i.e., machinery as and when it is installed by the assessee. In any case the matter is covered by the decision of the jurisdictional High Court in the case of Mc Gaw Ravindra Laboratories (supra) and Shree Digvijay Woollen Mills (supra). Therefore, respectfully following the aforesaid decision of the jurisdictional High Court, we will adjudicate this issue in favour of the Revenue and against the assessee by holding that the foreign travel expenditure incurred by the company in connection with the purchase of new machinery is an expenditure of capital nature and were rightly capitalised by the Assessing Officer under section 43(1) to find out the actual cost of those machineries.

10. Coming to ground of appeal No. 3, the dispute is as to whether the excise duty paid by the assessee is to be considered as a part of the turnover for the purpose of working out the deduction under section 80HHC.

10.1 The learned representative of the assessee submitted that the issue is squarely covered in favour of the assessee and against the Revenue as per the decision of the Tribunal in the case of Sudarshan Chemical Industries Ltd. v. Dy. CIT [1997] 57 TTJ (Pune) 718 : [1997] 60 ITD 629 (Pune). The learned Departmental Representative on the other hand relied on the orders of the Assessing Officer as well as the CIT(A) and submitted that in view of the decision of the Supreme Court in the case of Chowringhee Sales Bureau v. CIT 1973 CTR (SC) 44 : [1973] 87 ITR 542 (SC), Sinclair Murray & Co. (P.) Ltd. v. CIT 1974 CTR (SC) 283 : [1974] 97 ITR 615 (SC) and McDowell & Co. Ltd. v. CTO [1985] 47 CTR (SC) 126 : [1985] 154 ITR 148 (SC) the excise duty should be considered as a part of the turnover and as such the Departmental authorities were justified in including the excise duty in the turnover for working out the deduction admissible under section 80HHC.

11. We have considered the rival submissions. The Tribunal Pune Bench in the case of Sudarshan Chemicals Ltd. (supra) has considered all the three cases relied upon by the learned Departmental Representative while dealing with the computation of deduction under section 80HHC in the context of determining the total turnover and has held as under :

"The formula laid down to arrive at the profit derived from the export in section 80HHC is :

Profit of business × export turnover\ total turnover

The only intention of the legislature in applying the aforesaid formula is to find out the profits derived from the export. Therefore, the turnover should be restricted to such a receipts only which have elements of profit in it. It is the only actual sale price which is relevant and, therefore, anything charged by the assessee by way of statutory levies, such as excise duty and sales-tax, in addition to the sale price has to be ignored because these statutory levies collected by the assessee have no element of profit. According to the accounting principles also, it does not form part of the trading and P&L a/c, inasmuch as these levies are charged separately in addition to the price and the same are separately credited to their respective accounts. Such amounts whenever paid to the Government are debited to such accounts and the balance amount is shown in the balance sheet as liability. Therefore, these statutory levies have no effect on the determination of profit of the business. Therefore, the word "turnover" cannot include the element of exercise duty and sales-tax. Such interpretation would advance the object to be achieved by the legislature. The meaning given to the word "turnover" in various sales-tax enactments cannot be imported into the provision of section 80HHC as the object of the sales-tax enactments and provision of section 80HHC are entirely different.

Therefore, CIT(A) was not justified in holding that the total turnover should include the amount of excise duty and sales-tax."

12. Applying the ratio of the decision of the Pune Bench of the Tribunal in the case of Sudarshan Chemicals Ltd. (supra we will hold that the Departmental authorities were not justified in holding that the total turnover should include the amount of excise duty for the purpose of calculating the deduction under section 80HHC. Accordingly this ground of appeal No. 3 is adjudicated in favour of the assessee and against the Revenue.

13. In the result, the appeal is partly allowed.

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