Sabyasachi Mukharji, J. - (1.) In order to appreciate the question involved in this reference it would be necessary to narrate briefly the facts leading up to the making of this reference. The assessee is a company engaged in the business of manufacture and site of paints. This reference arises out of assessment orders for the years 1963-64 and 1964-65, for which the relevant accounting years ware the calendar years 1962 and 1963, respectively. The assessee had valued raw materials at cost in the closing stock inventory. However, the goods in process and the finished products had been valued at the cost of raw materials only, which, according to the assessee, formed 84.49% representing overheads. The assessee had contended that it had been the practice to uniformly value the goods-in-process and the finished products at the cost of raw materials only. It was submitted that the paints had a limited storage life and if these were not sold within a certain period these lost their market value. The Income-tax Officer did not accept the said reasoning and contention. He was of the opinion that the basis of valuation of stocks, according to the well-known principles of accountancy, should have been, either cost or market price, whichever was less. The Income-tax Officer, therefore, valued such stock of goods-in-process and finished products at 100% of cost including the overheads as against 84.49% as shown in the books of account of the assessee. On the aforesaid basis the Income-tax Officer revalued the closing stock and also the opending stock and made an addition of Rs. 1,04,417 in the assessment year 1963-64, and allowed a deduction of Rs. 3,338 in the assessment year 1964-65, by adjustment of valuation of stocks. There was an appeal before the Appellate Assistant Commissioner. The Appellate Assistant Commissioner, for the reasons mentioned in his order, upheld the Income-tax Officer's order.
(2.) There was a further appeal before the Tribunal. It was urged before the Tribunal that the basis of valuation adopted by the assessee was in accordance with the recognised, system of accounting. It was urged that the practice of valuing the closing stocks at only the value of raw material had been followed consistently over the years and, therefore, the same should not be disturbed by the departmental authority. Reliance was placed on certain books of accountancy in support of the method followed by the assesses. It, was reiterated that depending upon the life of a particular kind of paint which was described as "shelf-life ", that is to say, the period during which the paint could reasonably be stored without losing its quality, experience had shown that, irrespective of the actual cost, the writing down of it in the manner it was done was necessary for the purpose of balancing the profits on sale of such products. The. Tribunal was of the opinion that the goods-in-process as well as the finished products had been arbitrarily taken below the cost, that is, the cost of raw materials and other overheads. The Tribunal was of the opinion that in this case there was no evidence that the stocks had either become obsolete or slow-moving. In the premises there was, according to the Tribunal, no justification for writing down the value of the stocks. It was noted by the Tribunal that in none of these years the assessee had claimed deduction for depreciation of stocks remaining unsold over a stated period. The Tribunal, therefore, came to the conclusion that, apart from a mere possibility of the paint losing its quality, there was nothing to show that the goods-in-stock had actually deteriorated in value. The Tribunal noted that in this case it was not merely the cost of raw material that was debited in the account but the cost of overheads had also been debited in the account. The Tribunal thought that if the entire revenue expenditure was to be claimed as deduction, then, it could only be on the basis that either the sales were accounted for or the closing stock accounted for the full value, that is, the cost and overheads. The Tribunal, therefore, was of the opinion that the assessee's method of accounting was such from which true profits could not be deduced. In the premises, the Tribunal upheld the order of the Income-tax Officer. The Tribunal in the aforesaid facts and circumstances of the case has referred to this court the following question under Section 256(1) of the Income-tax Act, 1961 : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in rejecting the method of valuation of the goods-in-process and the finished products on the basis of cost of raw material adopted by the assessee, and taking their valuation on the basis of cost of the finished goods ?"
(3.) It is, therefore, necessary in order to determine the question before us, to examine the purpose of valuation of stocks in computing the tax liability of an assessee. In the case of Chainrup Sampatram v. Commissioner of Income-tax , the Supreme Court observed that it was a misconception to think that any profit arose out of the valuation of the closing stock ; valuation of unsold stock at the close of an accounting period was a necessary part of the process of determining the trading result of that period, and could in no sense be regarded as the source of such profit. At page 485 of the report the Supreme Court observed as follows: "It is wrong to assume that the valuation of the closing stock at market rate has, for its object, the bringing into charge any appreciation in the value of such stock. The true purpose of crediting the value of unsold stock is to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions on which there have been actual sales in the course of the year showing the profit or loss actually realised on the year's trading.";