Holding

When a fall in market price merely reduces prospective profit and does not amount to an anticipated loss, the assessee may write down inventory to its net realizable value below cost, making the ITAT's deletion of the additions erroneous.

Summary

The Commissioner of Income Tax, Udaipur assessed Hindustan Zinc Ltd. for the AY 1996-97, adding Rs 27.08 crore to income because the company wrote down its closing stock of zinc concentrate to the net realizable value based on the London Metal Exchange (LME) price, which was lower than the weighted average cost. The company argued that the stock could not be used domestically, had to be exported, and that the LME price reflected the true market value, so the write‑down represented a reduction in prospective profit, not an anticipated loss. The ITAT deleted the additions, the High Court upheld that decision, and the Revenue appealed. The Supreme Court examined whether the write‑down was permissible under accounting principles and tax law, distinguishing anticipated loss from mere profit reduction, and held that the write‑down was valid. Consequently, the Court allowed the appeal, set aside the High Court judgment, and restored the additions to income.

Issues considered

Whether the assessee could value its closing stock of zinc concentrate at the international LME price below cost in the absence of export sales in the relevant year.
Whether the reduction in inventory value constitutes an anticipated loss or merely a reduction in prospective profit for tax purposes.
Whether the ITAT was correct in deleting the additions made by the Assessing Officer to the assessee's income.
Whether the accounting treatment adopted complies with the Accounting Standards and the principle of prudential accounting.

Legislation cited

Income Tax Act, 1961

Subjects

valuation of closing stocknet realizable valueanticipated lossinventory write‑downIncome Tax assessmentAccounting StandardsLME priceweighted average costgovernment companyexport of inventorytax law

Judgment

A COMMISSIONER OF INCOME TAX, UDAIPUR
v.
MIS. HINDUSTAN ZINC LTD.

MAY 18, 2007

B [S.H. KAPADIA AND B. SUDERSHAN REDDY,JJ.]

.Jncome Tax Act, 1961;

Valuation of closing stock-Exporting of accumulated stock of zinc
C concentrate by assessee-a. Government Company-Fixing of International
Price lower than Weighted Average Cost/domestic price-Additions in income
ofthe assesseefor the accounting year during which such stock accumulated-,-
Correctness of-Held: In the past c.~sessee has been valuing the commodity
in question at net realizable value at the domestic prices-International
D prices of the commodity were lower than the domestic prices-Under the
circumstances, Auditor rightly observed in his report that had the net realizable
value stood estimated in accordance with 1he past accounting policy, the
profit of the Company would have been higher by certain amount-Besides,
there is no anti..:ipated loss but. reduction in the prospective profit in the
present case-Hence, Income Ta-c Appellate Tribunal erred in deleting the
E additions made in the assessment in terms of auditors' report.
Respondent-assessee, a Government Company, was engaged in the
business of production of zinc concentrate and utilizing the same captively.
During the assessment year 1996-97, a huge quantity of zinc concentrate
got accumulated and it was not possible for the assessee to consume the
F accumulated quantity. Since domestic consumption of the accumulated stock
was not possible the assessee decided to explore the possibilities of exporting
the accumulated stock. With the permission of the Government, the assessee
decided to price "zinc concentrate" for the purpose of sale by adopting the
London Metallic Exchange (LME;) Price as on 31.3.1996 however, the LME
G price was lover than the Weighted Average Cost (WAC) by Rs. 27.08 crores.
Auditors also made certain recommendations, accordingly, the Assessing
Officer made in addition to the income of the assessee for the accounting
year ending 31.3.1996. Aggrieved by the order of the A.O. the assesse.e-
.respondent preferred an appeal before he appellate authorities, which was

H 302
COMMNR.OFINCOMETAX,UDAIPURv.HINDUSTANZINCLTD. 303
partly al.lowed by the authorities. The assessee preferred an appeal before A
the ITAT which was allowed by the tribunal by directing Revenue to delete the
additions made to the income of the assessee. Aggrieved, the Revenue
preferred an appeal before the High Court which was dismissed by the High
Court. Hence this appeal.

Revenue contend that on the facts and circumstances of the case there B
was no reason for the assessee to change the method accQunting; that in the
... financial year ending 31.3.1996 there were no export sales, therefore, there
...- was no question of taking into account the factum of export sales in the next
accounting year ending 31.3.97; that there was no allegation that the
accumulated stock and zinc concentrate was a junk which had no market in
India; that the Auditors' Report clearly indicated that ifthe accounting policy
c
of the earlier years was to be followed then in that event the profits would
have increased by Rs. 27.08 crores; that in view of the Auditors' Report,
Department was right in add back to the income of the assessee and that while
valuing the closing stock it was not open to the assessee to say that the net
realizable value estimated on the basis of LME price resulted in a loss that it D
was lower than WAC and that there was reduction in value; and that even
~· under the accounting principles though reduction in value was admissible,
the same was possible only in the year in which the same took place and since
in the present case there were no export sales in the financial year 1995-96,
the assessee was not entitled to claim reduction in value on the basis of LME
price.
E

On behalf of the assessee-respondent it was submitted that the
accumulated stock had no market for sale in India; that the assessee was a
Government company; that the accumulated stock of zinc concentrate had low
metal content and it had high impurity level of silica and, therefore, it was F
not fit for captive consumption; that under the circumstances with the
permission of the Government, the assessee had to segregate the quantity
which was capable of captive consumption and the balance of the stock which
was not capable of captive consumption and which had to be sold; that, there
were no buyers in India for the accumulated stock; that the Auditors failed to
recognize such segregation. In the circumstances, a new commodity came G
into existence during the financial year 1995-96 which had to be given a new
accounting treatment; that, in accordance with the principles of prudential
-:I accounting the assessee did not carry forward the current assets in excess
of the amount expected to be realiud in the ordinary course of business and,
therefore, the quantity identified for sale was valued at net realizable value H
304 SUPREME COURT REPORTS (2007) 7 S.C.R ..

A from exports on the basis of LME (London Mettallic Exchange) Price; that
the assessee has, therefore, acted on the accepted accounting practice
recognized by the Institute of Chartered Accountants in India by way of
Accounting Standards; that LME price was the best estimate of the market
value of the said commodity as on 31.3.96; that the Revenue has failed to take ,'

into account the principle of anticipated loses which valuing the closing stock;
B and that it was open to the assessee to value the inventory in the present case
at below cost.
.Jr
Allowing the appeal, the Court ....
HELD: 1.1. The narrow controversy involved in the present case is
c whether the assessee was right in writing down the inventory (zinc
concentrate) below the cost price by estimating its net realizable value at
London Mettalic Exchange Price and not by estimating its itet realizable value
at the domestic price. [Para 10) [309-A, BJ

1.2. There is no dispute in the present .case that as on 31.3.96, the
D
international prices of zinc concentrates were lower than the domestic price
thereof. Further, in the past the assessee has been valuing zinc concentrates
at net realizable value at the domestic prices. It is for this reason that Auditors "'-
in their Report have categorically stated that if the net realizable value stood
estimated in accordance with the past accounting policy (at domestic prices)
E the profits of the company would have been higher by Rs. 27.08 crores. This
Report of the Auditors is not erroneous as sought to be urged on behalf of
the assessee. [Para 10) [309-B, CJ

1.3. It is not the case of anticipated loss, it is the case of reduction in
the prospective profits. Hence, the ITAT had erred in deleting the additions
F made in the assessment. [Paras 10 and 11) [309-D, E]
v
Chainrup Sampatram v. Commissioner of Income Tax, West Bengal,
(1953) 24 ITR 481 SC and Commissioner ofIncome-Tax v. British Paints India
Ltd, (1991) 188 ITR 44 SC, relied on.

G CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1179 of2007.

From the Final Judgment and Order dated 14.11.2005 of the High Court
of Judicature for Rajasthan at Jodhpur, in D.B. Income Tax Appeal No. 25 of
\-
2003.
H P.P. Malhotra, ASG., K.K. Senthivelan, Chetan Chawla and B.V. Balaram
COMMNR. OF INCOME TAX, UDAIPUR 1•. HINDUSTAN ZINC LTD. [KAPADIA,J.] 305
~
?-·
Das for the Appellant. A
K. Sampath, Lakshmi Iyengar R.K. Raghavan, S. Krishnan and Rani
Chhabra for the Respondent.

. The Judgment of the Court was delivered by
B
KAPADIA, J. I. A Short question which arises for determination in this
civil appeal is : Whether ITAT was justified in Law, on the facts and
_, circumstances of this case, in holding that the method adopted by the assessee
for valuation of closing stock of "zinc concentrate" at the international rate,
was in order, particularly when there was no export during the financial year
ending 31.3.96 and particularly when in the past the assessee has been c
valuing the closing stock of zinc concentrate for captive consumption at the
weighted average cost. The facts giving rise to this civil appeal briefly are as
follows.

2. At the relevant time respondent-assessee was a Government Company.
D
In this civil appeal we are concerned with the assessment year 1996097.
Assessee was engaged in the business of producing zinc concentrate which
.J
was utilized by the assessee captively. During the assessment year 1996-97,
zinc concentrate got accumulated to the extent of 84000 metric tones
(approximately). It was not possible to consume the said quantity as the
accumulated stocks contained low metal content and high impurity level of E
silica. Further, no other plant in India had the ability of producing zinc
concentrate in a viable manner. Since domestic consumptiOn of the accumulated
stock was not possible the assessee decided to explore the possibilities of
exporting the accumulated stock. Further in 1991, on account of economic
reforms, globalization came to India. Therefore, the assessee-company took F
the decision in consultation with the Government to export the accumulated
-~
quantity of zinc concentrate. With the permission of the Government, the
assessee decided to price "zinc concentrate" for the purpose of sale by
adopting what is called as the London Metallic Exchange Price (for short,
'LME price) as on 31.3.1996 the LME price was lower than the weighted
Average Cost (for Short, 'WAC' by Rs. 27.08 crores. However, the A.O. took G
the view that during the financial year 1995-96 there was no export sale of zinc
concentrate; that in the Auditors' Report there was a categorical observation
that the decrease in the value of inventory by Rs. 27.08 crores was not in
~
accordance with the accounting policy of the company and if the invent~ry
would have been valued at the domestic price then the company's profit H
would have been higher than by Rs. 27.08 crores. According to the A.O., in
306 SUPREME COURT REPORTS [2007) 7 S.C.R.

A view of the above Auditors'Report, an addition was inquired to be made to
the income of assessee for the accounting year ending 31.3 .96. According to
the assessee-respondent, the allegation made by the A.O. that there was no
export sale during the said year was not relevant as the goods were lying in
stock and they were supposed to be sold out in the succeeding years.
B According to the assessee, the goods were actually exported out of India in
subsequent years.

3. Aggrieved by the order of the A.O. the assessee-respondent preferred
an appeal before CIT (A) which was partly allowed. The assessee further
carried the matter in appeal before the ITAT which deleted the additions made
C to the income of the assessee.

4. Aggrieved by the decision of the ITAT, Department preferred an
appeal before the Division Bench of the High Court which was of the opinion
that no substantial question of law as suggested by the Department arose for
consideration. Hence this civil appeal.
D
S. Mr. P.P. Malhotra, Additional Solicitor General, appearing on behalf
of the Department submitted that on the facts and circumstances of the case
there was no reason for the assessee to change the method of accounting.
It was urged that in the financial year ending 31.3.96 there were no export
sales and, therefore, there was no question of taking into account the factum
E of export sales in the next accounting year ending 31.3. 97. Learned counsel
submitted that in the present case there was no allegation that the accumulated
stoc~ and zinc concentrate was a junk which had no market in Ind!a. Learned
counsel urged that the Auditors' Report in the present case clearly indicated
that if the accounting policy of the earlier years was to be followed then in
F that event the profits would have increased by Rs. 27 .08 crores. Learned
counsel urged that in view of the said Auditors' Report the Department was
right in add back to the income of the assessee for the financial year ending
313.96.

6. Mr.K. Sampath, learned advocate appearing on behalf of the assessee-
G respondent, on the other hand submitted that the accumulated stock had no
market for sale in Iridia. He urged that the assessee was a Government
Company; that· the accumulated stock of zinc concentrate had low metal
content and it had high impurity level of silica and, therefore, it was not fit
for captive consumption. Learned advocate submitted that tinder the above
H circumstances with the permission of the Government, the assessee had to
segregate the quantity which was capable of captive consumption and the
COMMNR.OFINCOMETAX, UDAIPUR 1•. HINDUSTAN ZINCLTD. [KAPADIA,J.] 307
---.,. balance of the stock which was not capable of captive consumption and A
which had to be sold. however, there were no buyers in India for the
accumulated stock. Learned advocate urged that the portion of the stock
which had to be sold constituted a new commodity. Learned advocate
submitted that the Auditors failed to recognize such segregation. In the
circumstances, according to the assessee, a new commodity came into existance
during the financial year 1995-96 which had to be given a new accounting B
treatment. In this connection, l~amcd advocate for the assessee placed reliance
.,I
on the letter dated 10.8.98 in which the assessee had stated that the
• international rate showed a declining trend in the prices of zinc concentrate
and, therfore, it became necessary to write down the inventory to the net
c
realizable value. That, in accordance with the principles of prudential accounting
the assessee did not carry forward the current assets in excess of the amount
expected to be realized in the ordinary course of business and, therefore, the
quantity identified for sale was valued at net realizable value from exports on
the basis of LME price. Learned advocate urged that the assessee has,
therefore, acted on the accepted accounting practice recognized by the Institute
of Chartered Accountants In India by way of Accounting Standards. This D
_-(
letter has been noted in the Assessment Order (at Page 47 of the S.L.P. paper
book). In this connection learned counsel placed reliance on the authorities
mentioned hereinbelow. It was further urged that LME price was the best
estimate of the market value of the said commodity on 31.3.96. Learned
advocate also relied upon the circular of the Board of Direct Taxes which E
stated that the Department was not entitled to deviate from the Accounting
Standards. According to learned advocate for the assessee, the Department
has failed to take into account the principle of anticipated losses while
valuing the closing stock. Learned advocate submitted that it was open to the
assessee to value the inventory iD the present case at Below Cost.
F
7. In rejoinder Mr. P.P. Malhotra, learned ASG appearing on behalf of
the Department Urge.d that the Auditors' Report is the basis of the Assessment
Order. It was pointed out that while valuing the closing stock it was not open
to the assessee to say that the net realizable value estimated on the basis of
L~E price resulted in a loss; that it was lower than WAC and that there was
reduction in value. Learned counsel submitted that even under the accounting G
principles though reduction in value was admissible, the same was possible
only in the year in which the same took place and since in the present case
........, there were no export sales in the financial year 1995-96, the assessee was not
entitled to claim reduction in value on the basis of LME price.
H
308 SUPREME COURT REPORTS [2007] 7 S.C.R.

A 8. In the Case of Chainrup Sampatram v. Commissioner ofIncome Tax,
West Bengal, (1953) 24 ITR 481 SC, it has been held by this Court that
valuation of unsold stock at the close of the accounting period was a
uecessary part of the process of determining the trading results of that period.
It cannot be regarded as a source of profits. Profits can be correctly ascertained
B only after bringing into the trading account the closing stock wherever it may
exist. It was further held that the true purpose of crediting the value of unsold
stock is to balance the cost of the goods entered on the other side of the
account at the time of their purchase so that on cancelling out of the entries
relating to the same stock from both sides of the account would leave cnly
the transactions in which actual sales in the course of the year have taken.
C place and thereby showing he profit or loss actually realized on the years
trading. The entry for stock which appears in a trading account is merely
intended to cancel the charge for the goods purchased which have not been
should necessarily represent the cost of the goods. If it is more or less than
the cost, then the effect is to state the profit on the goods actually sold. From
the doctrine there is one exception,. namely, the adoption of market value at
D the date of making up of accounts, if that value is less than the cost. This
is in anticipation of the loss that may be made on the goods in the following
year. While anticipated loss is taken into account, anticipated profit in the
shape of appreciatecJ value of the closing stock is not brought into the
account as no prudent trader would care to show increased profits before
E actual realization. This theory that the closing stock is to be valued at cost
or market price whichever is the lower, is now generally accepted as an
established rule of commercial practices and accountancy.

9. To the same effect is the judgment of this Court in the case of
commissioner ofIncome Tax v. British paints India Ltd (1991) 188 ITR44 SC.
F In the said judgment it has been held that is a well-recognized principle of
commercial accounting to enter in the profit and loss account the value of the
Stock-in-trade at the beginning and at the end of the accounting year at cost
on market price, whichever is the lower. where the market value has fallen
before the date of valuation and where the market value of the article on that ·
G date is less than its actual cost, the assessee is entitled to value the articles
at market value and thus anticipate the loss which he may incur at the time
of the sale of the goods. It was further held that the correct principle of
accounting is to enter the stock in the books of account at cost unless the
value is required to be reduced by reason of .the fall in the market value of
the goods below the original cost. Ordinarily, therefore, the goods should not
H be written down below the cost price except where there is an actual or
COMMNR. OF INCOME TAX. UDAIPUR "· HINDUSTAN ZINC LTD. (KAPADIA. J.) 309
anticipated loss. On the other hand, if the fall in the price is only such as it A
would reduce merely the prospective profit, there would be no justification
to discard the initial valuation at cost.

I0. The narrow controversy involved in the present case is whether the
assessee was right in writing down the inventory (zinc concentrate) below the·'
cost price by estimating its net realizable value at LME price and not by B
estimating its net realizable value at the domestic price. There is no dispute
in the present case that as on 31.3.96 the international prices of zinc
concentrates were lower than the domestic prices thereof. Further, in the past
the assessee has been valuing zinc concentrates at net realizable value at the
domestic prices It is for this reason that Auditors in their Report have C
categorically stated that if the net realizable value stood estimated in
accordance with the past accounting policy (at domestic prices) the profits
of the company would have been higher by Rs. 27.08 crores. This Report of
the Aud itors is not erroneous as it sought to be urged on behalf of the
assessee. There is no rectification of the said Report. In the case of British
Paints (Supra) it has held by this out that it the fall in the price has the effect D
of merely reducing the prospective profits (which appears to be the case if
one looks at the Auditors' Report) there would be no justification to discard
the valuation at Cost. Therefore, in our view, the present case in not the case
of anticipated loss, it is the case of reduction in the prospective profits.

11. For the aforestated reasons, we are of the view that the ITAT had E
erred in deleting the additions made in the assessment. Accordingly, the
appeal is allowed and the impugned judgment of the High Court is set aside
with no order as to costs.

S.K.S.· Appeal allowed.

_ .. ---i