This question was answered by the Supreme Court in United Commercial Bank vs CIT, 240 ITR 355 (SC). In effect, the court has held that if the assessee has been following a well-established principle of valuation of stocks consistently and that method has been accepted by the department over a period of time, the mere fact that statutorily the assessee has to follow a different method for the purposes of his accounts, would not mean that the method followed in the accounts would supersede the practice being followed in all the earlier years.

The facts were that the assessee bank had returned a notional loss on account of valuation of the closing stock of securities at the market value.

In the accounts, however, the assessee bank had not followed this method in respect of its investment trading account of securities. The department did not accept the plea of the assessee and held that unless the bank itself accepted the position by incorporating such loss or profit in the final accounts, it would have no right to put across the hypothetical loss for the purpose of assessment under the Act. It also held that the practice was entirely contrary to the decision in State Bank of Travancore vs CIT 158 ITR 102 (SC).

At the Supreme Court, it was pointed out that the preparation of the balance sheet by the assessee bank was governed by the provisions of Banking Regulations Act, 1949. One of the requirements was that where the valuation of investments shown in the outer column of the balance sheet was higher than the market value, the market value was required to be shown separately in brackets.

This provision has been dispensed with by the RBI subsequently, whereby standard investment in securities other than approved securities are to be valued at market price or at cost whichever is less and depreciation is to be provided for the shortfall, if any. The court summed the facts as under: the Government had permitted the assessee bank not to disclose (the market value of the investment under the sub-heads in the inner column; it was the nationalised bank governed by the BRA of 1945; the appellant followed the mercantile system of accounting both for book keeping purpose as well as for tax purposes; and it had consistently for over 30 years, prior to assessment in dispute been valuing its stock-in-trade (investments) "at cost" in the balance-sheet whereas for the same period of time, it had been valuing the very same investment "at cost of market value whichever is lower" for income-tax purposes.

The court then referred to the decision in the case of Chainrup Sampatram vs CIT, 24 ITR 481 (SC), in which it had, inter-alia, been accepted that anticipated losses on stocks are to be taken into account whereas anticipated profits on stocks are not to be brought into account as no prudent trader would care to show increased profit before its actual realisation. This was the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as an established rule in commercial practice and accountancy.

With reference to the decision in State Bank of Travancore vs CIT, 158 ITR 102 (SC), the court pointed out that decision had been delivered as the relevant circular of the board had not been pointed out and the court itself had in Uco Bank vs CIT, 237 ITR 889 (SC), considered and differentiated judgment in the earlier case. In fact, even in that decision, it had been held that whichever method the assessee adopts, it should disclose a true picture of the profits and gains.

Hence, the court held that for the purpose of income-tax whichever method is adopted by the assessee, the true picture of profits and gains, that is to say, the real income is to be disclosed. For determining the real income, the entries in the balance-sheet, required to be maintained in the statutory form, may not be decisive or conclusive. In such cases, it is open to the assessing officer as well as the assessee to point out the true and proper income while submitting the income-tax returns.

Since the assessee was consistently following the principle of valuation of stock in trade at cost on market value whichever was lower for over 30 years, which practice was accepted by the department and which practice was in consonance with the generally accepted principles of valuation, the court held that the mere fact that the assessee had, in its statutory accounts, valued the stock on a different method, did not preempt it from valuing it on the right basis for the purposes of income-tax.

The author is a Mumbai-based chartered accountant