The Commissioner of Income-Tax,
Madras. Vs. A. Krishnaswami Mudaliar & Ors  INSC 124 (16 April 1964)
16/04/1964 SHAH, J.C.
CITATION: 1964 AIR 1843 1964 SCR (7) 776
R 1969 SC1053 (7) RF 1984 SC1733 (9) MV 1986
SC 757 (10,15) RF 1991 SC1338 (14,15)
Income-tax-Trading adventure-Profits of
business Computation-Value of stock-in-trade-Inclusion of Value at the end of
year of account-Necessity-Assessee's method of accountancy-Powers in Income-tax
Officer in computing profits-Indian Income-tax Act, 1922 (11 of 1922) s. 13
The assessee firm acquired for Rs. 1,00,000/the
exploitation rights of a cinematograph film which were to enure for four years.
For the period, December 25, 1947 to August 2, 1948, which was the previous
year corresponding to the assessment year 1949-50 the firm filed a voluntary
return declaring that Rs. 28,643/were earned by the exploitation of the film.
In the statement submitted by the firm the total receipts credited in the
firm's books were Rs. 1,46,849/and against that amount were debited Rs.
18,206/as expenditure and Rs. 1,00,000/as the
amount disbursed for acquiring the exploitation rights. The Income-tax Officer
was of the view that from the statement of account which omitted to include at
the close of the account year the value of the right in the film for the
unexpired period, the profits of the firm could not properly be deduced.
Accordingly, he estimated the value of the rights for the unexpired period of
exploitation to which the firm was entitled on August 2, 1948, at Rs. 65,000/and
computed the net profits of the firm as an unregistered firm at Rs. 93,642/and
assessed income-tax and super-tax payable by the firm on that footing. In the
appeals filed against the order or assessment, only the correctness of the
estimated value of the rights of the film at Rs. 65,000/-was challenged, and
the Appellate Tribunal reduced the valuation to Rs. 40,000/-. On reference, the
High Court of Madras took the view that it was the cash system that the
assessee had adopted. that valuation of the closing stock was not an incident
of that system for ascertaining the profits and that the Income tax Officer had
no power under the proviso to s. 13 of the Indian Income-tax Act, 1922, to
force a different system on the assessee either the mercantile system or a
hybrid system of cash plus valuation of closing stock.
Held: In a trading venture, for computing the
true profits of the year, the stock-in-trade must be taken into account,
whatever method of book-keeping was adopted; and the High Court was in error in
holding that because the assessee had maintained his accounts in the cash
system it was not open to the Income tax Officer to add to the receipts from the
business the value of the stock-in-trade at the end of the year for the purpose
of properly deducing the profits of the business for the year in question.
There was not warrant in the case of assuming
that the income-tax Officer sought to displace the method of accountancy
adopted by the assessee it -"-as only by applying the proviso to s. 13 of
the Indian Income-tax Act, 1922, that the Income-tax Officer made the
computation upon the basis and in the manner in which in his opinion profits
could be properly deduced.
CIVIL APPEALLATE JURISDICTION: Civil Appeal
No. 250 of 1963.
Appeal by special leave from the judgment and
order dated February 2, 1960 of the Madras High Court in Case Referred No. 1 of
R. Ganapathy Iyer and R. N. Sachthey, for the
S. Narayanaswamy and R. Gopalakrishnan, for
respondent nos. I and 3-6.
April 16, 1964. The Judgment of the Court was
SHAH, J.-Respondents to this appeal are a
firm constituted under a deed dated December 12, 1947. The firm originally
consisted of three partners: K. N. Damodara Mudaliar, A. Krishnaswami Mudaliar
and v. Thangaraja Mudaliar. K.N. Damodara Mudaliar acquired for the firm for
Rs. 1,00,000/the exploitation rights which were to ensure for four years in a
cinematograph film "Apoorva Chinthamani" for the North Arcot, the
South Arcot and the Chingleput districts and for Pondicherry. For the period,
December 25, 1.947 to August 2, 1948--which was "the previous year"
corresponding to the assessment year 1949-50the firm filed a voluntary return
declaring that Rs. 28,643/were earned by the exploitation of the film. In the
statement submitted by the firm the total receipts credited in the firm's books
were Rs. 1,46,849/-, and against that amount were debited Rs. 13,206/as
expenses and Rs. 1,00,000/as the amount disbursed for acquiring the
exploitation rights. Thereby in the computation of the profits of the business,
the firm debited the amount paid for acquiring the rights of exploitation of
the film, but did not take credit for the value of the unexpired exploitation
rights at the end of the "previous year". On August 15, 1948, a deed
of dissolution of the partnership was executed, and Damodara Mudaliar sold with
effect from August 6, 1948, his half interest in the assets of the partnership
to Krishnaswami Mudaliar for Rs. 2,000/and retired from the partnership. On
August 27, 1948 a trial balance-sheet of the firm's books of account was
prepared showing a cash balance of Rs. 190/12/4, a debit against Krishnaswami Mudatiar
for Rs. 2.641/8/8 and credits in favour of Damodara Mudaliar and Thangaraja
Mudaliar respectively for Rs. 1,888/2/11 and Rs. 944/2/1. Thereafter
Krishnaswami Mudaliar, Thangaraja Muidaliar and V. S.
Lakshmanan (an outsider) formed themselves
into another partnership to exploit the film for the unexpired period.
From this partnership Krishnaswami Mudaliar
retired on February 22. 1949 agreeing to receive Rs. 12000/for his 778 six
sixteenth share in the assets of the firm on the date of retirement.
In the assessment of the respondent firm for
the year 194950 the Second Additional' income-tax Officer, Vellore declined to
accept the statement of account that the firm had earned till August 2, 1948, a
net profit of only Rs. 28,643/as truly representing the profits of the firm.
Fie observed that "no stock valuation of the picture has been taken but
only the excess collection over purchase value has been returned",
indicating thereby that in his view from the statement of account which omitted
to include at the close of the year the value of the rights in the film for the
unexpired period the profits of the firm could not properly be deduced. The
Income-tax Officer estimated the value of the rights for the unexpired period
of exploitation to which the firm was entitled on August 2, 1948 at Rs. 65,000,and
computed net profits of the firm as an unregistered firm at Rs. 93,642/and
assessed income-tax and super-tax payable by the firm on that footing.
In appeal by the firm to the Appellate
Assistant Commissioner, the correctness of the estimated value of the exploitation
rights of the film at Rs. 65,000/ was alone challenged and it was submitted
that the sum of Rs. 4,000/was the true value of the assets at the end of the
previous year. Damodara Mudaliar the retiring partner having relinquished his
rights representing half share for Rs. 2.000/only. The Appellate Assistant
Commissioner rejected the contention, holding that the valuation of the
exploitation rights for the unexpired period in the deed of dissolution dated
August 15, 1948 was "dictated by extracommercial considerations". and
confirmed the valuation of Rs. 65,000/made by the Incometax Officer. Even in
appeal to the Income-tax Appellate Tribunal, Madras, the respondent firm merely
contended that the valuation of the exploitation rights for the unexpired
period was excessive. The Tribunal partially upheld the plea, and reduced the
valuation to Rs. 40.000/as on August 2, 1948, and directed modification of the
assessment on that footing.
Pursuant to an order issued by the High Court
of Madras in a petition under s. 66(2) the Tribunal stated the case and
referred the following question: --"Whether on the facts and circumstances
of this case the Tribunal was justified in applying the proviso to s. 13 of the
Incometax Act and in confirming the assessment on a mercantile basis of
accounting." 779 The High Court held that it was open to the assessee to
maintain accounts according to a recognised system of accounting and the
assessee having adopted the cash system of ,accounting, and the Tribunal having
assigned no reasons for discarding that system in the computation of the
profits the Tribunal was in error in making the assessment on the basis of the
mercantile system of accounting.
The High Court observed:"When we reach
the position that it was the cash system that the assessee had adopted in this
case, and that valuation of the closing stock was not an incident of that
system for ascertaining the profits, it should be obvious that the Income-tax
Officer had no power under the proviso to s. 13 to force a different system 'on
the assessee either the mercantile system or a hybrid system of cash plus
valuation of closing stock." The High Court accordingly answered the
question referred in the negative. Against the order, with special, leave, this
appeal is preferred.
The question to be determined in this appeal
is whether in the computation of the income of the firm under the head
"Profits and gains of business" the Income-tax Officer was bound by
the method of accounting in which the cost of acquisition of the film of which
the exploitation rights were held was debited at the commencement of the year,
but the value of the film at the end of the year was ignored.
Section 10 of the Indian Income-tax Act,
1922, provides that tax -shall be payable by an assessee under the head
"Profits and gains of business, profession or vocation" in respect of
the profits or gains of any business, profession or vocation carried on by him.
Such profits or gains have to be computed -after making the allowances set out
in sub-s. (2).
Section 13 provides that the income, profits
and gains shall be computed, for the purposes of ss. 10 and 12, in accordance
with the method 'of accounting regularly employed by the assessee, provided
that, if no method of accounting has been regularly employed or if the method
employed is such that, in the opinion of the Income-tax Officer, the income,
profits and gains cannot properly be deduced there from, then the computation
shall be made upon such basis and in such manner as the Income-tax Officer may
It may be recalled that the Income-tax
Officer had in the order of assessment observed that the firm had not made a
stock valuation of the film and had merely taken the excess collection over the
purchase value and had submitted its 780 return of income 'on that basis. No
express order was re.
corded by the Income-tax Officer that in his
opinion the income, profits or gains of the business could not properly be deduced
from the method of accounting employed by the firm, but it is implicit in what
is stated by him that without valuation of the unexpired exploitation rights
the profits of the year of account could not be computed. With this view. it
appears, the Appellate Assistant Commissioner agreed.
In appeal to the Appellate Tribunal the only
plea raised was that the Income-tax Officer had erred in estimating the value
of the unexpired exploitation rights at Rs. 65,000/-.
That was partially accepted, and the value
was reduced to Rs. 40,000/-. It is difficult to appreciate how any question
about the regularity of the proceedings of the Income-tax Officer by the
adoption of the mercantile system of accounting and by the application of the
proviso to s. 13 of the Income tax Act arose from the order of the Tribunal.
The High Court has under the Income-tax Act
power to call upon the Appellate Tribunal to state a case' only if the High
Court is not satisfied about the correctness of the decision of the Tribunal
that no question of law arises from the order of them Tribunal. The grounds of
appeal filed before the Tribunal and before the Appellate Assistant
Commissioner make it abundantly clear that the question as to the applicability
of the proviso to s. 13 to the profits disclosed by the respondent firm was
never challenged. Nor can it be said that the Tribunal "forced the x x x
firm to adopt for the purpose of computation of its profits" a .system of
accounting other than the one adopted by the firm. In the title of the order by
the Income-tax Officer it was recited that the, method of accounting adopted by
the firm was "mercantile", but that does not amount to saying that he
proposed to compute the income on the basis that the accounts should be
re-written on the mercantile system.
The question referred to the High Court asks
for advice on the justification for applying the proviso to s. 13, and
computation of the income on the basis of the mercantile, system of accounting.
On neither of these two branches there was any argument raised by the firm
before the Tribunal. But we do not propose to dispose of this appeal on the
limited ground that the question as framed did not arise out of the order of
the Tribunal and need not be answered. The grounds given by the High Court in
support of their answer, to the question referred raise a matter of principle
of some importance in the computation of income of an assessee carrying on a
trading venture with the aid of a wasting asset, and we have heard elaborate
arguments advanced by counsel at the Bar and we deem it necessary, to express
our opinion on the questions debated.
781 It is true that the Revenue authorities
and the Tribunal did take into consideration the stock valuation at the end of
the year of account, but that was not because in their view the system of
accounting adopted was or should be mercantile: the truth of the matter is that
in their view, profits of the firm for the year could not, having regard to the
nature of the business, properly be deduced from the accounts, "unless the
opening and closing stocks were brought into the picture". This is made
clear by the observations of the Tribunal in paragraph-15 of the statement of
"x x x in all trading cases the true
profits cannot be deduced from any system of maintaining accounts whether cash
or mercantile, unless the opening and closing stocks are brought into the
picture at cost or market price whichever is lower; it will not avail an
assessee to say that in his cash system, he had not made any profit on his cash
sales till all his stock is disposed of.
Income-tax is an annual levy and the profits
of each year require to be ascertained for that purpose as accurately as
circumstances permit. It therefore, in any system of accounting maintained by
the assessee, otherwise acceptable, the stocks are left out of account, the
aforesaid proviso, it is humbly submitted, necessarily has to be invoked, even
if it were for the sole purpose of adjusting the book figures for the stock
figures." Correctness of this view especially in the context of a trading
venture by the exploitation of a wasting asset, but which is the assessee's
stock-in-trade, falls to be considered.
Section 13 of the Indian Income-tax Act was
incorporated for the first time in the Income-tax legislation in India by the
Income--tax Act II of 1922, because in a case decide' under the Income-tax Act,
1918, Wallis, C. J.,, delivering the principal judgment of the Full Bench in
Secretary, Board of Revenue, Madras v. Arunachalam Chettiar(1) expressed the
view that whatever may be the system of accounting adopted by an assessee,
income assessable to tax means the income actually or constructively received
and that the words of the charging section placed limits upon the succeeding
sections specifying the different classes of income liable to tax. To supersede
this exposition of the law the Legislature while enacting Act 11 of 1922 found
it necessary to enact s. 13. The section leaves it to the assessee to adopt any
compute of accounting and obliges the Income-tax Officer to compute the income,
profits and gains for the purposes of ss. 10 and 782 12 in accordance with such
method of accounting regularly employed, if profits of the business can
properly be deduced therefrom. The Judicial Committee of the privy Council observed
in Commissioner of Income-tax, Bombay v. Sarangpur Cotton Manufacturing Company
" x x x the section relates to a method
of accounting regularly employed by the assessee for his own purposes x x x and
does not relate to a method of making up the statutory return for assessment to
income-tax. Secondly, the section clearly makes such a method of accounting a
compulsory basis of computation, unless, in the opinion of the Income-tax
Officer, the income, profits and gains cannot properly be deduced therefrom. It
may well be that, although the profit brought out in the accounts is not the
true figure for income-tax purposes, the true figure can be accurately deduced
The Board also observed:"It is the duty
of the Income-tax Officer, where there is such a method of accounting to
consider whether the income, profits and gains can properly be deduced
therefrom, and to proceed according to his judgment on this question."
Again as observed by this Court in Commissioner of Incometax v. Mcmillan &
Co.(2) the expression "in the opinion of the Income-tax Officer" in
the proviso to s. 13 of the Indian Income-tax Act, 1922, does not confer a mere
discretionary power; in the context it imposes a statutory duty on the
Income-tax Officer to examine in every case the method of accounting employed
by the assessee and to see whether or not it has been regularly employed and to
determine whether the income, profits and gains of the assesses could properly
be deduced there from.
But the section only deals with the
computation of income, profits and gains for the purposes of ss. 10 and 12 and
does not purport to enlarge or restrict the content of taxable income, profit
and gains under the Act. Section 2(15) of the Act defines "total
income" as meaning total amount of in. come, profits and gains referred to
in sub-s. (1) of s. 4 computed in the manner laid down in the Act. Section 4(1)
lays down what income shall be included in the total income, and ss. 10(2),
12(2), 12B(2), 14, 15A, 15B, 15C and 16 prescribe the manner of computation of
income, profits and gains in (1) L.R. 65 I.A. 1.
(2) 33 I.T.R. 182.
783 different circumstances, and also
prescribe special exceptions. Section 13 does not directly impinge upon the
application of these provisions: it merely prescribes that the computation of
taxable profits shall be made according to the method of accounting regularly
employed. Where in the opinion of the Income-tax Officer the income, profits
and gains cannot properly be deduced from the method of accounting, it is open
to the Income-tax Officer to compute the income upon such basis in such manner
as he may determine. The section does not compel the Income-tax Officer to
accept a balance-sheet of cash receipts and outgoings prepared from the books
of account; he has to compute the income in accordance with the method of
accounting regularly employed by the assessee.
The only departure made by s. 13 of the
Indian Income tax Act from the tax legislation in England is that whereas under
the English legislation the Commissioner is not obliged to determine the
profits of a business venture, according to the method of accounting adopted by
the assessee, under the Indian Income-tax Act, prima facie, the Income-tax
Officer has for the purpose of ss. 10 and 12 to compute the income, profits and
gains in accordance with the method of accounting regularly employed by the
assessee. If, therefore, there is a system of accounting regularly employed and
by appropriate adjustments from the accounts maintained taxable profits may
properly be deduced, the Income-tax Officer is bound to compute the profits in
accordance with the method of accounting. But where in the opinion of the
Income-tax Officer the profits cannot properly be deduced from the system
accounting adopted by the assessee it is open to him to adopt a more suitable
basis for computation of the true profits.
Among Indian businessmen, as elsewhere, there
are current two principal systems of book-keeping There is, firstly, the cash
system in which a record is maintained of actual receipts and actual
disbursements, entries being posted when money or money's worth as actually
received, collected or disbursed. There is secondly the mercantile system, in
which entries are posted in the books of account on the date of the transaction
i.e. on the date on which rights accrue or liabilities are incurred,
irrespective of the date of payment. For example, when goods are sold on
credit, a receipt entry is posted as of the date of sale, although no cash is
received immediately in payment of such goods; and a debit entry is similarly
posted when a liability is incurred although payment on account of such
liability is not made at the time. There may have to be appropriate variations
when this system is adopted by an assessee who carries on a profession. Whereas
784 under the cash system no account of what are called the out standings of
the business either at the commencement or at the close of the year is taken;
according to the mercantile method actual cash receipts during the year and the
actual outlays during the year are treated in the same way as under the cash
system, but to the balance thus arising, there is added the amount of the outstanding
not collected at the end of the year and from this is deducted the liabilities
incurred or accrued but not discharged at the end of the year. Both the methods
are somewhat rough. In some cases these methods may not give a clear picture of
the true profits earned and certainly not of taxable profits.
The quantum of allowances permitted to be
deducted under diverse heads under s. 10(2) from the income, profits and gains
of a business would differ according to the system adopted. This is made clear
by defining in sub-s. (5) the word "paid" which is used in several
clauses of sub-s (2) as meaning actually paid or incurred according to the
method of accounting upon the basis of which the profits or gains are computed
under s. 10. Again where the cash system as adopted, there is no question of
bad debts or outstandings at all: in the case of mercantile system against the
book profits some of the bad debts may have to be set off when they are found
to be mercantile system, there are innumerable other systems of accounting
which may be called hybrid or heterogeneous-in which certain elements and incidents
of the cash and mercantile systems are combined.
But whatever method of book-keeping is
adopted, in the case of a trading venture, for computing the true profits of
the year the stock-in-trade must be taken into account. If the value of
stock-in-trade is not taken into account, in the ultimate result the profit or
loss resulting from trading is bound to get absorbed or reflected in the
stock-in-trade unless the value of the stock-in-trade remains unchanged at the
commencement of the year and at the end of the year.It must be remembered that
under the Income-tax Act, tax is levied on income, profits and gains, and not
taxable profits therefore cannot ordinarily
be deduced from cash receipts alone. If in the computation of profits of a
trading venture, only the cash receipts and outgoings are taken into account,
in substance emergence of profits would be deferred, till the firm's capital
outlay is completely recouped, thereby transforming what in truth are profits
of the business into capital, by book-keeping entries.
In this case it is unnecessary to consider
whether the method of accounting adopted of ignoring the value of the
stock-in-trade may be regarded as regularly employed by the respondent firm,
when it is the first year of account. It is common ground that the method of
accounting was not mercantile.
but was wholly or primarily cash. The
Income-tax Officer was of the view that in the absence of stock-valuation of
the film which was a wasting asset of the partnership and which was exploited
for earning profits, the income of the firm could not properly be deduced and
with that view the Appellate Assistant Commissioner and the Tribunal have
agreed. The High Court, however, held that the maintenance of account on cash
basis being a recognised method of accounting, the Income-tax Officer was bound
by the choice of the assessee who had adopted that system of accounting, and to
compute the income in accordance with that method, unless the Income-tax
Officer was satisfied that the assessee had not regularly adopted that system.
The High Court also observed that what the Department had done was to make the
assessment on the basis that the system of accounting adopted by the assessee
was mercantile-a system which the assessee had never adopted, and thereby
computed the profits of the assessee, by taking into consideration valuation of
the closing stock which was not an incident of the cash system. The Income-tax
Officer had in the view of the High Court no power under the proviso to s. 13
"to force a different system on the assessee either the mercantile system
or a hybrid system of cash plus valuation of closing stock".
In coming to that conclusion, in our
judgment, the High Court erred. Note the facts: an amount of Rs. 1,00,000/was
paid by the firm for acquiring a wasting asset, which was to be exploited for
the benefit of the partnership. The price paid for acquiring the asset was
debited as an outgoing. At the end of the year there was a total, collection of
Rs. 1,46,849/by the exploitation of the asset. The expenses for carrying on the
business amounted to Rs. 18,206 / -. The result according to the respondent
firm was a net profit of Rs. 28,647/-. This was arrived at by posting the outgoing
for acquiring its stock-in-trade as a proper debit, and ignoring the value of
that asset at the end of the year altogether. Under the Income-tax Act for the
purpose of the assessment each year is a self-contained unit, and if out of the
receipts the cost of the film was to be deducted in the absence of an entry
crediting the value of the asset at the end of the year, for arriving at the
income of the profit of the firm would either wholly or substantially be
absorbed in the amortization of the capital value of the asset. The result of
the accounting would therefore give a false picture of the partnership, however
lucrative the business may in reality be. The methods of computation of taxable
incomes prescribed by the Act of different kinds of income are undoubtedly
highly artificial, but the Act does not compel the Income-tax Officer to accept
a statement of account which is not prepared according to any recognised
786 In Commissioner of Inland Revenue v. Cock
Bussell and Co. Ltd.(1). Croom-Johnson J., in dealing with valuation of'
stock-in-trade for purposes of taxation observed:
there is no word in the statutes or rules
which deals. with this question of valuing stock-in-trade. There is nothing in
the relevant legislation which indicates that in computing the profits and
gains of a commercial concern the stock-in-trade at the start of the accounting
period should be taken in and that the amount of the stock-in-trade at the end
of the period should also be taken in. It would be fantastic not to do it: it
would be utterly impossible accurately to assess profits and gains merely on a
statement of receipts and payments or on the basis of turnover. It has long
been recognised that the right method of assessing profits and gains is to,
take into account the value of the stock-in-trade at the beginning and the
value of the stock-in-trade at the end as two of the items in the computation.
I need not cite authority for the general proposition, which is admitted at the
Bar, that for the purposes of ascertaining profits and gains the ordinary
principles of commercial accounting should be applied, so long as they do not
conflict with any express provision of the relevant statutes ." We have
already said that in England there is no provision which compels the tax
officer to adopt in the computation of income the system of accounting
regularly employed by the assessee. But whatever may be the system-whether it
is cash or mercantile-as observed by Croom-Johnson J.-in a trading venture it
would be impossible accurately to assess the true profits without taking into
account the value of the stock in trade at the beginning and at the end of the
Reference may also be made to Whimster &
Co. v. The Commissioner of Inland Revenue(2) in which Lord President Clyde
observed at p. 823:"In computing the balance of profits and gains for the
purposes of Income Tax, x x x two general and fundamental commonplaces have
always to be kept in mind. In the first place, the profits of any particular
year or accounting period must be taken to consist of the difference between
the receipts from the trade or business during such year or accounting period
and the expenditure laid out to earn those receipts. In the second place, the
(1) 29 T.C. 387. (2) T.C. 813.
787 account of profit and loss to be made up
for the purpose of ascertaining that difference must be framed consistently
with the ordinary principles of commercial accounting, so far as applicable,
and in conformity with the rules of the Income-tax Act, or of that Act as
modified by the provisions-' and schedules of the Acts regulating Excess
Profits Duty as the case may be. For example the ordinary principles of
commercial accounting require that in the profit and loss account a merchant's
or manufacturer's business the values of the stock-intrade at the beginning and
at the end of the period covered by the account should be entered at cost or
market price, whichever is the lower. although there is nothing about this in
the taxing statutes." Similarly in Commissioner of Income-tax and Excess
Profits Tax, Madras v. Messrs. Chari and Ram, Madura(1) Rajamannar C.J.,
observed that stock-in-trade in hand is an essential item in the computation of
the profits for a period.
"Profits" as observed by
Fletcher-Moulton, L.J., in the Spanish Prospecting Company Ltd. in re.(2).
"implies a comparison between the state
of a business at two specific dates usually separated by an interval of a year.
The fundamental meaning is the amount of gains made by the business during the
year. This can only be ascertained by a comparison of the assets of the
business at the two dates.
"We start therefore with this
fundamental definition of profits, namely, if the total assets of the business
at the two dates be compared, the increase which they show at the later date as
compared with the earlier date x x x x represents in strictness the profits of
the business during the period in question." It is true that in that case
Fletcher-Moulton, L.J., made the observations not in dealing with a profit and
loss account in a case relating to taxation, but with a, balancesheet of a
company intended to show the actual financial condition of a business at the
end of a year. The observations however do show that in ascertaining profits
what may be regarded as normal book-keeping practice has to be observed.
Whether in the case of trading in special classes of assets appropriate
adjustments may have to be made it beside the point.
The Income-tax Act makes no provision with
regard to the valuation of stock. It charges for payment of tax the income, (1)
17 I.T.R. 1. (2)  1 Ch. 92.
788 profits and gains which have to be
computed in the manner provided by the Income-tax Act. In the case of a trading
venture these profits have to be adjusted in the light of the provisions of the
Income tax Act permitting allowances prescribed thereby. For that purpose it is
the duty of the Income-tax Officer to find out what profits the business has
made according to true Accountancy practise , in the system adopted, and
thereafter to make request adjustments, and even appropriate modifications on
the rule suggested by Fletcher-Moulton, L.J. to ascertain the taxable profits.
it is true as observed by Lord Buckmaster in The Naval Colliery Co. Ltd. v. The
Commissioner of Inland Revenue(1) that the principle of determining the profits
of the trade by valuing everything at the beginning and the end of the
accounting period and by finding the difference may not be universally
applicable in all cases, and needs material modification.
The formula suggested in the Spanish
Prospecting Company's case(") was sought to be applied to a case in which
Excess Profits duty was assessed. The assessee a mining company was unable to
work its colliery on account of a strike. The assessee sought to introduce into
its account which normally ended on June 30, 1921, the estimated expenses for
repairing the damage (which though arising in the account period was restored
later) on the plea that the expenses were in the nature of liability of business
and properly debitable before they were actually incurred. The House of Lords
rejected that contention. It was in this context that Lord Buckmaster observed
that the accountancy rules, applicable to wise and prudent trading could not be
used in connection with the working of a mining lease.
These observations do not affect the true
character of the profits of a business. Adjustments may have to be made in the
principle having regard to the special character of the assets, the nature of
the business and the appropriate allowances permitted, in order to arrive at
the taxable profits. They do not support the proposition that in the case of a
trading venture. you can arrive at the true profits of a year by ignoring
altogether the valuation of the stock-in-trade at the end of the year, while
debiting its value at the commencement of the year as an outgoing, for
determination of the profits by ignoring the valuation of the stock at the end
of the year and debiting the value of the assets at the commencement of the
year would not give a true picture of the profit for the year of account.
There is no, warrant in this case for
assuming that the Revenue authorities and the Tribunal had sought to displace
the method of accountancy adopted by the assessee. By applying the proviso to
s. 13, they made the computation upon the basis (1) 12 T.C. 1017.
(2)  1 Ch. 92.
789 and in the manner in which in their
opinion profits would be properly deduced. That they were entitled to do. We
are therefore of the view that the High Court was in error in holding that
because the assessee had maintained his accounts in the cash system it was not
open to the Income tax Officer to add to the receipts from the business the
value of the stock-in-trade at the end of the year for the purpose of properly
deducing the profits of the business for the year in question.
The appeal therefore must be allowed and the
answer to the question referred to the High Court will be in the affirmative.
The Commissioner will be entitled to his costs in this Court as well as in the