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Income Tax Appellate Tribunal, ‘G’ BENCH, MUMBAI
Before: SHRI G.S.PANNU, AM & SHRI RAVISH SOOD, JM
आदेश / O R D E R
PER RAVISH SOOD, JUDICIAL MEMBER
1. The present set of cross appeals filed both by the assessee and the revenue are directed against the order passed by the CIT(A)-7, Mumbai, dated 08.03.2013, which in itself arises from the assessment order passed by the A.O under Sec. 143(3) of the Income tax Act, 1961 (for short ‘Act’), dated 30.12.2011. The assessee had assailed the order of the CIT(A) on the following grounds of appeal:
“Being aggrieved by the order passed by the Asst. Commissioner of Income Tax, Range 3(3), Mumbai ('AO', for short), your appellant submits the following grounds of appeal for your sympathetic consideration:
1. On the facts and circumstances of the case and in law, the learned A.O erred in disregarding method of valuation of inventory at lower of cost or net realizable value and thereby erred in not allowing deduction of Rs.14,40.81,661/- being difference between cost and net realizable value of certain inventory items. The learned AO further erred in considering adding the said amount to the book profits u/s 115JB by wrongly concluding it as provision for diminution in value of asset.
2. On the facts and circumstances of the case and in law, the learned A.O erred in disallowing expenses u/14A to the tune of Rs.7,17,832/- comprising of Rs.6,60,623/- out of interest expenses and Rs.57,209/- out of other expenses by applying Rule 8D and wrongly attributing to earning of exempt income. The learned AO further erred in adding the said amount to book profits u/s 115JB.
3. On the facts and circumstance of the case and in law, the learned A.O erred in not allowing carry forward and set off of business loss and unabsorbed depreciation to the tune of Rs.9,02,66,242/- pertaining the amalgamated company in terms of section 72A. Your appellant reserves the right to add to, alter or amend the above ground if necessary.” The revenue on the other hand had challenged the order of the CIT(A) by raising before us the following effective grounds of appeal:
“1. Whether on the facts and in the circumstances of the case and in law the Ld. CIT (A) erred in deleting the addition of Rs.12,55,44,413/- on account of inventory written off
P a g e | 3 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) without appreciating the fact that the write off wasdone after giving effect of amalgamation in the consolidated book of account and filing of original return having done any due diligence in this regard, as per the scheme approved by the Hon‟ble Mumbai High Court.”
That as a common issue is involved in the respective appeals, therefore, these are being taken up and disposed of together.
Briefly stated, the facts of the case are that the assessee company which is a Manufacturer, Trader and Exporter of Bulk Drugs, Speciality chemicals and Formulation had e-filed its return of income declaring total income of Rs.1,18,14,186/- on 30.09.2009. The assessee revised its return of income on 31.03.2010, declaring current year loss at Rs.13,22,67,477/-. The return of income filed by the assessee was processed as such under Sec. 143(1) of the Act. The case of the assessee was thereafter taken up for scrutiny assessment under Sec. 143(2).
3. That as per the scheme of amalgamation approved by the Hon’ble High Court of Bombay vide its order dated 16.06.2009, M/s Sequent Scientific Ltd. was amalgamated with the assessee company i.e. M/s PI Drugs Pharmaceuticals Ltd. (for short ‘PIDPL’) with effect from 01.04.2008. That subsequent to the amalgamation the name of the assessee company was changed to M/s Sequent Scientific Ltd. As per the scheme of amalgamation the assets and liabilities of the amalgamating company were to be taken as per the valuation report or at a value as determined by the assessee company. The accounts of both the companies were adopted on standalone basis for the purpose of the Companies Act, 1956. That as the order of the Hon’ble High Court of Bombay approving the amalgamation was received by the assessee on 14.09.2009 i.e before the due date of filing of the return of income for A.Y 2009-10, therefore, the assessee while filing its return
P a g e | 4 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) of income prepared consolidated accounts incorporating the assets and liabilities of the amalgamating company, viz. M/s Sequent Scientific Limited at their respective book values. However, the assessee after identifying and writing off the value of certain dead, non-moving and obsolete inventory of the amalgamating company, revised its return of income.
The A.O during the course of the assessment proceedings called upon the assessee to explain as to on what basis the inventories were written off by an amount of Rs.14,40,81,661/- in the revised return of income. The assessee in its reply submitted before the A.O that though it was following the conventional method of valuation of inventory at ‘Cost or net realizable value, whichever is lower’, however, due to paucity of time and in the backdrop of the fact that it was occupied with completing merger formalities including preparation of combined accounts of the two entities, compiling tax audit report of the consolidated accounts and filing of return of income before the due date, i.e 30.09.2009, therefore, in the return of income had taken over and recorded the assets and liabilities of the amalgamating company at their carrying values appearing in the books of account of the amalgamating company. It was submitted by the assessee that after filing the return of income it had analysed and tested each item of inventory of the amalgamating company, and on the basis of the said technical/chemical analysis and exploring other commercial viability of the products had valued the same at lower of cost or net realizable value. The assessee by placing reliance on the Accounting standard-2 (for short ‘AS-2’) supported its claim of having written off the value of the inventories and bringing the same to their net realizable value. Still further, the assessee in order to impress upon the A.O that the inventories written off for the reason that they were P a g e | 5 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) damaged, expired or rendered obsolete and had no realizable value, therein submitted that it being in the business of manufacturing of pharmaceuticals products was subject to the stringent FDA norms, which placed strict prohibitions as regards sale of such obsolete or damaged stock either in the market or as scrap.
The A.O after deliberating on the contentions of the assessee was however not persuaded to subscribe to the same and observed as under: i. At the outset it is worth to mention here that the SSL-E and SSL (assessee company) has separately prepared its accounts, wherein it has properly considered the valuation of stock as per their accounting policy. Moreover, nowhere in the accounts or notes to account about the stock which has been now written off by f iling the revise d return has been mentioned. Thus, it can be said that both the entities do not have any obsolete or non-moving stock, which has 'Nil' value. ii. As the assessee has taken fixed assets based on valuation report of the registered valuer, whereas inventory no such valuation has been made, which has been taken based on the practice followed by the assessee. Thus, the onus is upon the assessee to prove that how the stock has become obsolete. iii. Since the assessee itself has stated in the notes to account that the inventory have been valued at lower of cost or net realizable value, one fails to understand, how the obsolete stock was not valued at Rs. Nil, as on the preparation of the financial accounts based on which the original return of income was filed. iv. On examination of details of stock written off attached with the submission dated 20.11.2011, it can be seen that the inventory which has been manufactured in the year 2009 has also been considered as obsolete (namely i.e, item No.5 - Triazine Stage -3 valuing Rs.90,64,548/-, item No.9 – Acitretin - Rs.24,84,024/-, etc.). Similarly, the stock which is not older than even 2 years has also been identified as obsolete stock for filing the revised return. These also raise the question as to the application of the accounting policies by the assessee over the years in respect of inventories. v. Though the assessee in it submission contended that they have stringent FDA norms and the company is prohibited to sold the expires stock either in the market or as a scrap, however, the assessee failed to bring on record anything about the FDA norms and how the company has been prohibited to do so about the obsolete stock. Importantly, how the said obsolete stock
P a g e | 6 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) has been destroyed after taking necessary approvals from the authorities, certificates if any issued in this behalf, etc. In absence of any evidences, the contention of the assessee that it has followed the FDA norms is not maintainable. vi. As per the AS-2, if the inventory are damaged or partly or wholly obsolete or if the selling price is declined then the cost of the inventory may not be recovered and therefore the practice of writing down inventory is consistent with the view that it should not be carried in excess of amount expected to be realized from their sale or use. In this regard the assessee has not discharged its onus as to. a. how the inventory has damaged.... no evidence. Or b. how the inventory partly or wholly obsolete….no evidence. Or c. how the inventory, if the selling price is declined... no evidence. The A.O in the backdrop of his aforesaid observations had serious doubts as regards the veracity of the claim of the assessee that as against its total turnover of Rs.170,19,65,025/- it had acquired obsolete stock of Rs.14,40,81,661/-of the amalgamating company. The A.O in order to verify the authenticity of the claim of the assessee and to dispel his doubts, therefore, called upon the assessee to place on record the report of due diligence made before acquiring the assets and liabilities of the amalgamating company, but however, was informed by the assessee that no due diligence was carried out as regards the status of stock of the amalgamating company and the same was acquired at its book value. That still further the assessee on being called upon to produce the copy of the resolution of the board of directors wherein it was resolved to write off the inventories (stock) received from the amalgamating company, however, failed to furnish the same for the reason that writing off the inventories was done as per the scheme of amalgamation and no separate resolution to the said effect was made. The A.O after giving a thoughtful consideration was however not persuaded to subscribe to the unsubstantiated claim
P a g e | 7 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) of the assessee for multiple reasons, viz. (i) that now when the stock of the amalgamating company had a value at the time of amalgamation, therefore, it was beyond comprehension that as to how the same had become obsolete; (ii) that it was beyond comprehension that the inventory comprising of raw material, capital work in progress and finished products which were taken over by the assessee from the amalgamating company had been considered by the assessee as obsolete and non-moving and written off after 10 months of obtaining the approval of scheme of amalgamation by the Hon’ble High Court; (iii) that in the standalone amalgamated financials of the amalgamating company the inventory was certified and physically verified by the management and valued at Rs.14,40,81,661/- and nowhere it was mentioned that any part of the inventory was either obsolete or non-moving; (iv) that during the course of the assessment proceedings the certificate of physical verification by the management of the amalgamating company was placed on record, therefore, now when the said amalgamating company was also valuing its inventory at the lower of the cost or net realizable value, therefore, there was no justification for the assessee to have valued the inventory at Rs. Nil; (v) that now when a perusal of the notes to accounts of the stand alone financials of the assessee company revealed that the amalgamating company even prior to amalgamation was under the control of the same management, therefore, it was beyond understanding as to why the management on one hand had physically certified the inventories at a specific value in the case of the amalgamating company, while for on the other hand had decided to write it off as obsolete and non- moving items; (vi) that as the accounting policies followed by the amalgamating company and the assessee company revealed that both of them were recording the value of inventory as per the same method, as well as were under the same management even before the P a g e | 8 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) amalgamation, therefore, the valuation of inventory of the amalgamating company at nil could not be accepted; (vii) that despite sufficient opportunity the assessee had failed to demonstrate as to what treatment was provided to alleged obsolete and non-moving items in the subsequent years, and as to whether the same had been disposed off as per the FDA norms or had been recycled for production of other products; (viii) that though the inventory was valued at lower of cost or net realizable value, however, the assessee had failed to justify as to why the obsolete inventory was valued at Nil at the time of filing the revised return of income; (ix) that contrary to the claim of the assessee that obsolete stock pertaining to 1 to 5 years had been written off, the facts revealed to the contrary that even the stock for the year 2009 was also considered as obsolete; (x) the assessee had failed to place on record any documentary evidence in respect of the stringent FDA norms which were followed by the assessee in respect of the obsolete stock; (xi) that neither any proper justification in respect of valuation of inventory as per AS-2 was filed by the assessee, nor any such disclosure in this behalf was provided in the notes to accounts of its statutory audit report. The A.O on the basis of his aforesaid observations concluded that the unsubstantiated claim of the assessee of having written off the inventory of Rs.14,40,81,661/- acquired on amalgamation could not be accepted.
6. The A.O further observed that the assessee had during the year under consideration made substantial investments of Rs.6,08,36,459/- in exempt income yielding investments. It was observed by the A.O that though the assessee had made investments for earning exempt income, but however, no disallowance of expenses incurred for earning such tax free income was made by the assessee under Sec. 14A of the Act in its return of income. The A.O in the P a g e | 9 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) backdrop of the aforesaid facts worked out the disallowance under Sec. 14A r.w Rule 8D at Rs.7,17,832/- in the hands of the assessee.
7. Aggrieved, the assessee carried the matter in appeal before the CIT(A). The assessee assailed the rejection of its claim of writing off the inventory of Rs.14,40,81,661/- by the A.O. The CIT(A) after deliberating on the contentions of the assessee in the backdrop of the facts of the case, though was in agreement with the claim of writing off by the assessee of the top 10 items of the value of Rs.12,00,67,368/-, which accounted for 83% of total inventory written off, but however, was not persuaded to subscribe to the claim of the assessee as regards writing off the inventories of less than one year of age of a value aggregating to Rs.1,85,37,248/-. The CIT(A) while partly allowing the claim of the assessee, observed as under:
7.8 I have considered the A.O‟s order as well as the appellant‟s A/R submission and also the documents placed on record. I find that the claim of the appellant is that inventories whose values are written down to „nil‟ are old/obsolete/non-usable/non-salable items. Therefore as per the provisions of the Accounting Standard 2 „valuation of inventories‟, it had written down inventory to its net realizable value. The appellant has also given aging analysis of the product, which were written off to make the justification of its claim, which clearly suggests that 87% of inventory written off is more than 1 year old. The appellant's such analysis is also extracted in its submission as referred above. The perusal of the aforesaid analysis of the inventory clearly denotes that the appellant has written off stock of nearly 25 items, which were having life of less than one year, which mainly includes viz-a-viz TRIAZINE STAGE III of Rs. 90,65,548/-, Quent 19 of Rs. 47,14,488/- and ACITRETIN of Rs. 24,84,024/- 5 which is of total of Rs.1,62,64,060/-, which is nearly 87% of total inventory written off of this category, which are less than of one year. The appellant claim's of inventory written off of such stock, which has less than one year of age of total Rs.1,85,37,248/-. To this claim the appellant has try to justify its claim through different submission as extracted above. I find that the appellant in the case of Triazine Stage III submitted that the customer on whose order the product was manufactured has cancelled the order and being proprietary product cannot effect sale to the other party and hence the appellant prefer to write it off the stock of the same, which is value of 90,65,548/-. Further to that in respect of Quent 19, which is value of Rs.47,14,488/-, the appellant submitted that product is P a g e | 10 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) antioxidant meant for polymerization and anti-corrosive reaction. The appellant submitted that since the product was not meeting customer specifications, it was written off by the appellant Further in respect of ACITRETIN, the appellant's explains that it is a development product for psoriasis. It is written off after checking the stability data for research purpose. Similarly, the appellant had provided justification along with supporting documents for top 10 items valuing Rs. 12,00,67,368/-. The top ten items account for 83% of total inventory written off amounting to Rs. 14,40,81,661/-. 7.9 However taking note of appellant's submission and even after taking note of Accounting Standard AS-2, I am of the considered view that the justification given by the appellant in respect of inventory written off which is of less than 1 year of age cannot be held justified, as the reasoning given are not at all acceptable in a normal business parlance of the trading. The appellant's this argument that customer cancel the order cannot be held justifiable as in the present era of communication and also awareness of trading interest the appellant's submission is not at all acceptable. If the appellant was going for new product venture, he has to ensure its business interest and not only this, the appellant can also sue the party in the court on whose order such product was manufactured, if the said customer has not complied with terms and conditions of business agreement. Besides this, the appellant cannot write off its stock without even ascertaining its marketability and usefulness with some prospective customer. Further to that even in respect of Quent- 19 and ACITRETIN, the appellant cannot merely write off stock without ascertaining and examining the possibility of realization of such product in the market even if such product were made with customer specification. The following AS-2 does not mean that the appellant will not take note of normal business expediency as well as its business interest. Thus, I consider it proper and appropriate to hold that the inventory in respect of product, which is less than 1 year of age, the A.O.'s action is completely justified and correct in denying claim of write off of the appellant. Accordingly the addition to the extent of Rs.1,85,37,248/- is confirmed. However for the remaining inventory, which is of the value of Rs.12,55,44,413/-, the appellant has given a detailed justification for making such claim. I find that the appellant company has given specific reasons for claiming the write off of such inventory. 7.10 Further I find that the appellant company has provided specific reasons for majority of items of inventory. In balance cases, the explanation is that it is obsolete and non-usable inventory considering their aging analysis. Process of identification of obsolete or damaged stock is backed by technical analysis and judgment of the management based on commercial considerations. Thus, the AO's observation that the appellant could not explain as to how inventory is obsolete or its selling price is declined is not justified as the appellant has discharged its burden by providing explanation and necessary documents. Accounting Standard 2 (AS 2) 'Valuation of inventory' issued by the ICAI mandates that inventories should be valued at lower of cost or net realizable value. Net realizable P a g e | 11 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) value is defined as the estimated selling price in the ordinary course of business less estimated cost of completion and the estimated cost necessary to make the sale. AS-2 provides that the cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. It further recognizes that the practice of writing down inventories below cost to net realisable value is consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or, use. The appellant's accounting policy for valuation is in line with the requirements of AS 2 and it has applied the above principles in valuation. However, it needs to be examined the application of the policy in the context of revised return as the claim of write off is made in the revised return. 7.11 Admittedly inventory valuation policy of SSL-E is same as of the appellant company i.e. lower of cost or net realisable value. The observation of the AO is that SSL-E has valued the same stock at cost and only in the revised return it was written down to its net realizable value. The AO has also argued that the whole arrangement was to reduce taxable income of the appellant company. I am inclined to agree with the appellant's explanation that it would not make a difference if inventory was valued lower by Rs. 14.40 crores in the books of SSL-E or in the books of the appellant company after amalgamation. Even if the inventory had been written off in the books of SSL-E before amalgamation, it would form part of carry forward losses of SSL-E. The appellant company submitted valuation report for determining share exchange ratio in the amalgamation. Enterprise value of both the companies is computed on Discounted Cash Flow basis which takes into account future cash flows. Thus, inventory write off has no impact of share exchange ratio. The appellant submitted that claiming inventory write off would only affect the resultant goodwill arising on amalgamation for which no tax benefits were claimed by the appellant company. Therefore, the AO's observation that the whole arrangement is to reduce taxable income is not tenable. I find that the AO has raised a doubt as to how the same management can certify the stock in the standalone accounts of SSL-E and later on write off. The AO has stated that how the physically verified and confirmed stocks can be written off by filing the revised return. However, I agree with the submissions of the appellant that it had carried out detailed study and considering the commercial viability had concluded that the inventories would not fetch any value. The appellant had given detailed explanation for major value of items which concurs its explanation. The impugned inventory has been written off in the books and not physically. It is write down of value of inventory as per AS 2. The stock may be physically lying in the appellant's premises. The AO has misunderstood accounting write off as physical write off. The appellant's AR also argued that it was submitted to the AO during the assessment proceedings that the appellant could not sell any of the obsolete stocks. However, after the completion of the assessment, the appellant could sell few Inventory items and could realize Rs. 88 lakhs. The same is offered to tax. The appellant submits that method of valuation is consistently followed in the subsequent years also. The AO has not rejected the method P a g e | 12 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) of inventory valuation. He has challenged the process and timing of write off. These observations of the A.O have been rebutted by the appellant in its submissions.
8. That as regards the disallowance of Rs.7,17,832/- made by the A.O under Sec.14A r.w. Rule 8D, the CIT(A) after deliberating on the contentions of the assessee in the backdrop of the observations of the A.O, was however not persuaded to subscribe to the same and upheld the disallowance.
9. That both the assessee and the revenue being aggrieved with the order of the CIT(A) had carried the matter in appeal before us. The ld. Authorized Representative (for short ‘A.R’) for the assessee at the very outset of the hearing of the appeal drew our attention to the details of the stock of Rs.14,40,81,661/- which was written off by the assessee company during the year under consideration. It was submitted by the ld. A.R that the inventories of the amalgamating company which were found by the assessee to be non-moving/obsolete or whose shelf life had expired were written off by the assessee. The ld. A.R submitted that the assessee which was following the conventional method of valuing its stock at ‘cost or net realizable value, whichever is lower’, had rightly as per AS-2 scaled down the value of the inventory to its net realizable value. The ld. A.R submitted that the claim of writing off the value of the inventories by the assessee was absolutely in conformity with the conventional method of valuation of inventories at ‘cost or net realizable value, whichever is lower’, as was followed by the assessee. The ld. A.R submitted that no infirmity did emerge from such writing off the inventories, which was duly substantiated in the course of the assessment proceedings before the A.O. The ld. A.R in support of his contention relied on the order of the coordinate bench of the Tribunal, viz. M/s Kopran Drugs Ltd. vs. ACIT (2010) 35 DTR 380 (Mum). The ld. A.R further placed reliance on the order of the P a g e | 13 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) ITAT, Mumbai in the case of DCIT Vs. Beck India Ltd. (2010) 127 TTJ 410 (Mum). That as regards the disallowance made by the A.O under Sec. 14A of the Act, it was submitted by the ld. A.R that as the assessee had substantial self owned funds which were sufficient enough to explain the source of the investments made in the exempt income yielding investments, therefore, no disallowance under Sec. 14A r.w. Rule 8D(2)(ii) in respect of the interest expenditure was called for in the hands of the assessee. The ld. A.R further submitted that as during the year under consideration the assessee had not received any dividend income, therefore, in the absence of there being any exempt income the issue of making any disallowance under Sec. 14A did not arise. The ld. A.R in support of his contentions placed reliance on the judgment of the Hon’ble High Court of Bombay in the case of Commissioner Of Income-tax Vs. HDFC Bank Limited. (2013) 366 ITR 505 (Bom). The ld. A.R further submitted that though no disallowance under Sec. 14A r.w. Rule 8D was called for in its hands, however, even otherwise the disallowance, if any, made under Sec. 14A would not lead to making of an addition in the ‘book profit’ for the purpose of computing the MAT liability under Sec. 115JB of the Act. The ld. A.R in support of his aforesaid contention placed reliance on the order of the ITAT, Special bench in the case of ACIT Vs. Vireet Investment Pvt. Ltd. (ITA No. 502/Del/2012); dated. 16.06.2017. Per contra, the ld. Departmental representative (for short ‘D.R’) submitted that the assessee had failed to substantiate the writing off the inventories of the value of Rs.14,40,81,661/-. The ld. D.R submitted that the claim of the assessee that the order of the Hon’ble High Court was received late did not appear to be logical and was nothing better than a claim raised in the thin air. The ld. D.R further submitted that even in the audit report of the assessee there was no whisper as regards writing off the inventories by the assessee. The ld.
P a g e | 14 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) D.R further submitted that a perusal of the revised schedule forming part of the consolidated balance sheet (Page 7 of ‘APB’) was found to be at variance as in comparison to the original consolidated balance sheet (Page 26 of ‘APB’). The ld. D.R further took us through the original and revised Schedule ‘L’ forming part of the consolidated balance sheet at Page 8 – Page 27 of APB. The ld. D.R further drew our attention to the ‘Notes to accounts’ forming part of the financial statements of the assessee for the year ended 31.03.2009 (Page 13-15 of ‘APB’). The ld. D.R supporting the order passed by the A.O, took us through the observations recorded by the A.O at Page 2-6 wherein the latter after deliberating at length had concluded that as the writing off the inventories of the value of Rs.14,40,81,661/- by the assessee were not backed by any evidence, therefore, the same were liable to be rejected. The ld. D.R took us through Page 3 –Para 5.4 of the assessment order where the A.O had given various reasons for rejecting the claim of writing off the inventory by the assessee. The ld. A.R in his rejoinder submitted that the order of the Hon’ble High Court dated 16.06.2009 was delivered to the assessee only as on 14.09.2009. The ld. A.R in order to support his aforesaid claim drew our attention to the copy of the order of the Hon’ble High Court at Page 122 of ‘APB’, which revealed the fact as was averred by the assessee before us. The ld. A.R submitted that despite the fact that the assessee had explained the reason for writing off each and every item of the inventory, however, the CIT(A) had without assigning any cogent reason sustained the disallowance as regards the inventory with an age of less than one year and had wrongly upheld the addition to the extent of Rs.1,85,37,248/-. The revenue on the other hand had assailed the order of the CIT(A) as regards the deletion of an addition of Rs. 12,55,44,413/- by partly accepting the writing off the inventory of an age of more than one year by the assessee.
P a g e | 15 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3)
10. We have heard the authorized representatives for both the parties, perused the orders of the lower authorities and the material available on record. We find that our indulgence in the present appeals is sought for adjudicating two issues, viz. (i) that as to whether the writing off the inventory acquired by the assessee on amalgamation was in order, or not; and (ii) that as to whether the disallowance made by the A.O under Sec. 14A r.w. Rule 8D had rightly been sustained by the CIT(A). We shall first advert to the issue of writing off the inventories of Rs.14,40,81,661/- by the assessee, which as claimed by the assessee had arisen because of the reassessing of the value of the inventory of the amalgamating company acquired by the assessee. We find that as per the approval of the Hon’ble High Court of Bombay vide its order dated 16.06.2009 the company M/s Sequent Scientific Ltd. was amalgamated with the assessee company with effect from 01.04.2008. We are persuaded to be in agreement with the ld. A.R that as the order of the Hon’ble High Court approving the amalgamation was received by the assessee only as on 14.09.2009, therefore, the assessee due to paucity of time could not carry out analysis of the net realizable value of the inventory of the amalgamating company and the same was carried as per the book values while filing of the return of income for the year under consideration, viz. A.Y. 2009-10 on 30.09.2009. We find that now when it is a conceded fact that the assessee was consistently valuing the inventories as per the conventional method of ‘cost or net realizable value, whichever is lower’, therefore, the valuation of the inventory of the amalgamating company by the assessee as per the said method is principally admitted by the revenue and is not in dispute. We find that the controversy as regards the issue under consideration pertains to the authenticity of the claim of the assessee P a g e | 16 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) that the net realizable value of the inventory on an analysis was found to be lower than the book value carried from the accounts of the amalgamating company. We find that the assessee after claiming that the net realizable value of the inventory was lower than its book value by an amount of Rs. 14,40,81,661/-, had thus written off the inventory to the said extent and revised its return of income. We are of the considered view that keeping in view the limited time that was available with the assessee at the time of filing of the return of income, the claim of the assessee that it had only subsequent to the filing of the return of income carried out the technical/chemical analysis, verified the shelf life and explored other commercial viability of the inventory items and valued the same at lower of cost or net realizable value, carries substantial force and could not have been summarily rejected. We find that the claim of the assessee that non-moving, unusable and expired stocks forming part of the inventory of the amalgamating company were written down to its net realizable value while filing the revised return of income was rejected by the lower authorities without placing on record any irrefutable material which could go to conclusively disprove the veracity of the said claim. We have deliberated on the facts and find that the assessee had claimed that the primary reason for writing off the top 10 items of the value of Rs.12,00,67,369/- which accounted for 83.33% of the total stock written off, was that either the item was not produced/procured as per the required quality or had lost its shelf life due to non-usability for a considerable period, as under:
Sr. CATG Product Name Written off Year of Justification for write No. stock Many/year off details of value procurement P a g e | 17 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3)
1 WIP OSELTAMIVIR 36,280,604 2006 This drug was meant PHOSPHATE for Tamilflu (Bird flu.) CRUDE We have procured material in 2005 and converted into crude anticipating order from customer. The order did not materialize and the crude lost its shelf life and could not be sold hence written off. Not moved for more than 3 years. Stock pertains to prior to 31.03.2008 2. RM LSMN CRUDE 22,869,352 29,11.2007 Being drug for human consumption as a neutraceutiacal product (food Supplement) got rejected due to quality. Non moving for more than 2 years and could not be salvaged.
3. WIP MCPP CRUDE 20,870,733 2008 This is an intermediate for Bupropiane (anti depressant). During crystallisation process the product become lump and could not processed further for sale Hence written off.
4. RM BETA 12,692,064 11.08.2007 It’s a raw material for THYMIDINE Zudovidine. Imported in 2007. Because of non usage of material P a g e | 18 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) for longer time the product quality got deteriorated.
5. FG TRIAZINE 9,064,548 2009 Polymer Additive. STAGE III Customer cancelled the order. As it is proprietary product it could not be sold to any other party.
WIP OSELTAMIVIR 6,656,855 2006 This drug was meant PHOSPHATE for Tamilflu (Bird flue). CRUDE We have procured material in 2005 and converted in to crude anticipating order from customer. The order did not materialize and the crude lost its shelf life and could not be sold. Hence written off not moved for more than 1.5 years. Stock pertains to prior to 31.03.2009.
FG Quent 19 4,714,488 2009 This is antioxidant meant for polymerisation and anti corrosive reaction. The product was not meeting the customer specification and hence written off.
RM BETA 8,900,111 26.12.2006 It’s a raw material for THYMIDINE Zudovidine. Imported in 2007. Because of non usage of material for longer time the P a g e | 19 ITA Nos. 4902 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) product quality got deteriorated.
WIP ACITRETIN 2,484,024 2009 Its used as drug for psoriasis. This is a development product. Written off after checking the stability data for research purpose.
FG STAVUDINE 1,534,590 2005 Its used as Anti Retro Viral drug. This is development product for regulated market and for human consumption. The further development work was stopped due to high cost involved and non viable.
We further find that the balance 70 items of the value of Rs.2,40,14,292/- (i.e 16.67% of the total value) were more than 2 years old and had been written off by the assessee due to their non- usability and non-saleability. It was the claim of the assessee before the lower authorities, as well as before us, that as the said items were proprietary products that had lost their shelf life, therefore, they had become completely obsolete and could not be sold even as scrap, which thus left the assessee with no other alternative but to value the said stock at nil value.
We have given a thoughtful consideration to the contentions of the ld. A.R and find substantial force in the same. We are of the considered view that before adverting to the issue under consideration, it would be relevant to observe that the assessee during P a g e | 20 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) the year under consideration was engaged in the business of manufacturing of bulk drugs, speciality chemicals and formulations, as a result whereof the mode and manner as per which the obsolete and damaged materials were to be disposed off at the prescribed disposal facility was strictly regulated by the stringent rules and regulations regarding handling and disposing of the products and raw materials under the statutory enactments, viz. Hazardous Wastes (Management and handling) Amendment Rule, 2000. We find that the assessee had during the course of the assessment proceedings furnished complete details of its inventory which was written off, along with its month and year of manufacturing and justification for writing off the same. We further find that the A.O had misdirected himself by observing that the assessee had written off the entire inventory taken over from the amalgamating company, viz. Sequent Scientific Ltd, as the fact as it so remains is that the inventory which was taken over by the assessee on amalgamation was of the value of Rs.23,64,84,548/-. We find substantial force in the claim of the assessee that having received the order of the Hon’ble High Court on 14.09.2009, the assessee before filing of its return of income for A.Y 2009-10, being left with limited period for analysing and assessing the realisable value of the inventory of the amalgamating company, had thus recorded the same at the book value and prepared the accounts accordingly. We further are of the considered view that as observed by us hereinabove, there is no reason for us to doubt the claim of the assessee that it had after filing the return of income valued the inventory acquired from the amalgamating company and after making necessary adjustments shown the same at the correct realisable value in the books of account. We further are persuaded to subscribe to the claim of the assessee that keeping in view the fact that the assessee was valuing its inventory at cost or net realisable value, whichever was lower, P a g e | 21 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) therefore, even if the stock would have been written off in the books of accounts of the amalgamating company, viz. Sequent Scientific Ltd. before the amalgamation, the assessee would have been eligible for carry forward of the loss on account of such write off. We thus are of the considered view that though the amalgamating company, viz. Seqeunt Scientific Ltd, had in its stand alone financial statement carried the inventory at its cost, however, the assessee based on the detailed study and considering the commercial viability had concluded that as there was no chance of realising some of the inventories, therefore, written off the same while filing the revised return of income. That as regards the observations of the lower authorities that the assessee had also written off stocks of the year 2009 by characterising them as obsolete, we find that the same comprises of only three items aggregating to an amount of Rs.1,62,63,060/- i.e. 11% of total stock written off. We further find that the assessee had furnished a plausible explanation as regards writing off the said three items, as under:-
Sr. Item Particular Amount No.
Triazine Stagek-3 The assessee explaining the Rs.90,64,548/- writing off the stock of the aforesaid item, viz. Triazine stage-3, submitted that the amalgamating company, viz. Sequent Scientific Ltd, had purchased the said polymer additive to cater to the specific requirements of a customer. The assessee had submitted before the lower authorities that as the aforesaid customer had cancelled the order of the P a g e | 22 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) product which were purchased to meet out the specific requirement of the aforesaid customer, therefore, the said item which was specific to the requirement of the aforesaid customer could not be sold to any other party. It was thus submitted by the assessee that in the backdrop of the aforesaid compelling circumstances the value of the aforesaid item which was found to be non- saleable was written off by the assessee.
2. Quent 19 The assessee submitted before Rs.47,14,488/- the lower authorities that the aforesaid product which was an antioxidant meant for polymerization and anti coresive reaction, was found not meeting the specifications of the customer, therefore, the same was written off by the assessee.
Acit Retin It was submitted by the Rs.24,84,024/- assessee that it had incurred expenditure for purchase of Acit Retin in the course of its research for a drug for psoriasis, however, as the research revealed that the expenditure incurred on the development of the drug was not commercially viable, therefore, the said item remained with the assessee as such, with no realizable value.
P a g e | 23 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) We find that the assessee had given a detailed explanation as regards the reason for writing off the aforesaid three items that were purchased during the year 2009 itself, aggregating to a value of Rs. 1,62,63,060/-. We find ourselves to be in agreement with the claim of the assessee that as the criteria of products in the nature of chemicals, drugs and other pharmaceutical items becoming obsolete not only depend upon the period, but also on various factors, such as condition of the product and obsolescence due to technology changes etc. which changes the proprietary of the product with the passage of time, therein rendering such items as no longer usable even after one or two years, therefore, the veracity of the claim of the assessee as regard writing off the aforesaid products, viz. (i). Triazine Stage-3; (ii). Quent 19; and (iii). Acitretin and other such items which were purchased in the year 2009, could not be summarily dismissed.
We have given a thoughtful consideration to the issue before us and are of the considered view that the main thrust of the assessee for justifying the writing off the inventories was that as the same were rendered as old, obsolete, non-usable and non-saleable items having no realisable value, therefore, the assessee who was valuing its inventories as per the ‘cost or net realizable value, whichever was lower’, had thus as per the provisions of AS-2 brought down the value of the said inventory to its actual realisable value. We further find that the assessee had given an ageing analysis of the products which were written off to justify its claim, which reveals that 87% of the inventory written off was more than one year old, while for the stock of nearly 25 items which were included in the list of the inventories written off by the assessee were having life of less than one year, out of which three items as observed by us hereinabove, viz. (i) Triazine Stage-III of Rs.90,65,548/-; (ii) Quent 19 of Rs.47,14,488/- and Acit Retin of P a g e | 24 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) Rs.24,84,024/- aggregating to an amount of Rs.1,62,64,060/- accounted for 11% of the total stock written off.
We have deliberated at length on the orders of the lower authorities and the material available on record and find that the assessee had demonstrated at length the specific reasons for writing off each and every item of the inventory forming part of the aggregate alue of Rs.14,40,81,661/- during the year under consideration. We are of the considered view that as the assessee company had carried the value of the assets and liability as appearing in the books of the amalgamating company, viz. Sequent Scientific Company while filing its return of income, but however, the value of the said assets and liabilities were thereafter reassessed and the fixed assets were valued as per the valuation report, while for the inventory was valued at lower of cost or net realisable value, as per the accounting policy which was followed by the assessee. We are of the considered view that the lower authorities had dislodged the claim of the assessee as regards the writing off the inventories of the amalgamating company, without placing record any material which could go to conclusively disprove the said claim of the assessee. We are of the considered view that now when the assessee had given specific reasons for having written off the stock inventories, therefore, in case if the A.O had a conviction that there was no justification for the assessee to have raised such a claim or that the same was found to be incorrect, then he remained under an obligation to have rebutted the explanation of the assessee by placing on record concrete material which would have conclusively disproved beyond doubt the authenticity of the claim of the assessee. However, we are afraid that no such exercise had been done by the lower authorities and no such material had been placed on record which could persuade us to conclude that the claim of writing off the P a g e | 25 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) inventory by the assessee was not found to be in order. Before parting, we may herein observe that our aforesaid view is fortified by the order of the coordinate bench of the Tribunal in the case of M/s Kopran Drugs Ltd. vs. ACIT (2010) 35 DTR 380 (Mum), as relied upon by the ld. A.R., wherein the Tribunal adjudicating on the issue as is there before us in the present case, had in the backdrop of similar facts involved in the said case observed as under:
“4. On going through the above clauses of the scheme of arrangement, it clearly transpires that this arrangement was effective from 1st Jan., 1998 and the assets of the bulk drugs division were to be transferred on the book value and further from the appointed date, the business was to be carried on by Kopran Ltd. on behalf of the assessee- company. It was pursuant to the approval granted by the Hon‟ble Bombay High Court on 24th Dec., 1998 that the assessee took over the possession of assets and liabilities together with its business operations w.e.f. 1st Jan., 1998. It means that by virtue of the subsequent approval, the assessee became the owner of the assets of the bulk drugs division w.e.f. 1st Jan., 1998 and the entire business after 1st Jan., 1998 upto the date of actual taking of possession carried on by Kopran Ltd. was to be considered as having been done on behalf of the assessee. That is the reason that the said business was adopted by the assessee in its books of account as having been done by it and was accordingly reflected in the books of account before filing the revised return of income. The AO has doubted about the valuation of obsolete items on the ground that Kopran Ltd. could not have reflected the obsolete items in its books of account as on 1st Jan., 1998 and hence the assessee, as a prudent businessman, would not have accepted these obsolete items of stock at their full value. We observe from cl. 3.3 of the agreement that all the assets and liabilities of the bulk drugs division were to be transferred on the basis of the value as reflected in the books of account of Kopran Ltd. The AO has not disputed the fact that Kopran Ltd. had recorded the inventory at the higher value by considering it as a good stock and not an obsolete one. This brings us to the position that the assessee received inventory of this division w.e.f. 1st Jan., 1998 which was not a good stock but also consisted of the obsolete items. Only pursuant to the approval granted by the Hon‟ble Bombay High Court in December, 1998 the assessee took the physical possession of the assets including inventory and started the process of identifying the obsolete items in 1999. The learned CIT(A) has not controverted the valuation of the obsolete items. He has sustained the addition only on the ground that these losses on reprocessing resulted in the subsequent year when the reprocessing P a g e | 26 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) was completed and not in the year in question. We are not convinced with the view canvassed by the learned CIT(A) on the ground that such inventory was acquired by the assessee after the close of the year by virtue of the order passed by the Hon‟ble Bombay High Court but w.e.f. 1st Jan., 1998. In this scenario the assessee became the owner of all the assets and became liable for the liabilities of this division of Kopran Ltd. w.e.f. 1st Jan., 1998 and that is the reason that the business transacted by Kopran Ltd. in the bulk drugs division from 1st Jan., 1998 to 31st March, 1998 was recorded by the assessee in its account. In other words, all the assets and liabilities of the bulk drugs division of Kopran Ltd. were deemed to have been received by the assessee on 1st Jan., 1998. Now, when the closing stock was to be valued as on 31st March, 1998. it was supposed to have been valued at its regular method of valuation, being "at cost or net realisable value whichever is less". The realizable value of this stock as on 31st March, 1998 was less by Rs. 3.54 crores though the process of determination of the diminution in the value of inventory was undertaken at a later date. If the scheme had been approved by the Hon‟ble Bombay High Court in the month of, say February, 1998, then the assessee would have recorded all the assets and liabilities of bulk drugs division in its books of account on that very date and the valuation of inventory as on 31st March, 1998 could have done accordingly as was done subsequently. What is material is the value of the stock as on the closing date of the financial year and not when it was actually valued. Such valuation done at a later date would have effect from the earlier date. The scheme of arrangement cannot be split into two parts, viz., one part taking effect from 1st Jan., 1998, i.e., appointed date by means of which the assessee reflected the entire business dealing for three months in its books of account and the second part about the valuation of inventory taking place after the approval granted by the Hon‟ble Bombay High Court. The entire scheme of arrangement has to be taken as one composite scheme effective from the appointed date. That being the position, the value of inventories was required to be shown „at net realizable value‟ as on the close of the financial year, which was less than the actual cost. We, therefore, do not find any reason for the sustenance of this addition and order for its deletion.”
We thus not finding any infirmity in the order of the CIT(A), to the extent he had deleted the addition of Rs. 12,55,44,413/-, therefore, uphold the order of the CIT(A) to the said extent. The Ground of appeal No. 1 raised by the revenue before us is dismissed.
We are further unable to persuade ourselves to subscribe to the view of the CIT(A) that the claim of the assessee as regards the writing P a g e | 27 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) off the inventories of Rs.1,85,37,248/- was not to be accepted, for the reason that the items falling under the said bracket had less than one year of age. We are of the considered view that the CIT(A) while arriving at the aforesaid view had lost sight of the fact that the assessee who is engaged in the business of manufacturing of bulk drugs, speciality chemicals and formulations, had specifically explained the reason for having written off the said inventories. We are persuaded to be in agreement with the claim of the assessee that certain items being in the nature of pharmaceutical formulations, chemicals etc., due to their peculiar nature had a shelf life of even less than one year, prone to getting damaged due to changes in the environment and would also be rendered as obsolete due to change in technology. We are of the considered view that the lower authorities merely by adopting a general view had summarily rejected the claim of the assessee, without even pointing out a single instance as to how and on what basis the said claim in respect of items of an age of less than one year was not to be accepted. We are also not persuaded to be in agreement with the view of the lower authorities that the claim of the assessee that certain proprietary goods which were purchased against specific orders of a customer had to be written off as the sale transactions did not materialize, was not to be accepted because the conduct of the assessee did not reveal business prudence on his part. We are of the considered view that the allowability of the aforesaid claim of the assessee would not be dependant on the satisfaction of the test of business prudence of the assessee. We are of a strong conviction that now when there was every justification on the part of the assessee to have reassessed the value of the inventory and thereafter written off the items acquired on the amalgamation of M/s Sequent Scientific Ltd, and valued the same as per its conventional method of valuation at the lower of cost or net realisable value, P a g e | 28 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) therefore, are of the considered view that the revenue had failed to dislodge the said claim of the assessee by proving to the contrary on the basis of any concrete evidence, thus are unable to persuade ourselves to subscribe to the view of the CIT(A) that the writing off the inventory of Rs.1,85,37,248/- which was less than one year of age was not to be accepted. We thus in the backdrop of our aforesaid observations, not finding ourselves as being in agreement with the view taken by the CIT(A) that the claim of the assessee for writing off the inventory of Rs.1,85,37,248/- was not to be accepted, therefore, set aside his order to the said extent and delete the addition of Rs. 1,85,37,248/- sustained by him. The Ground of appeal No. 1 raised by the assessee is allowed.
16. We now advert to the disallowance of expenditure made by the A.O under Sec. 14A r.w. Rule 8D. We find that the assessee had during the year under consideration made investments of Rs.6,08,36,459/- in exempt income yielding investments. We find that the A.O observing that the assessee had not offered any voluntary disallowance under Sec. 14A in its return of income, had made a disallowance of Rs.7,17,832/- in the hands of the assessee. Before us, the ld. A.R had averred that no such disallowance under Sec.14A r.w. Rule 8D(2)(ii) in respect of interest expenditure was called for in the hands of the assessee, for the reason that the assessee had substantial own funds of Rs.96.55 crore consisting of share capital of Rs.21.23 crore and reserves and surplus of Rs.75.31 crores, which sufficiently explained the source of making of investment of Rs.6,88,36,409/- in the exempt income yielding investments by the assessee during the year under consideration.
P a g e | 29 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) 17. We find substantial force in the contention of the ld. A.R that now when the assessee had sufficient own funds of Rs. 96.55 crores available with it, therefore, it could safely be presumed that the said amount was utilized for making investment in the exempt income yielding investments of Rs.6,08,36,459/- by the assessee during the year. We find that our aforesaid view stand fortified by the judgment of the Hon’ble High Court of Bombay in the case of Commissioner Of Income-tax Vs. HDFC Bank Limited. (2013) 366 ITR 505 (Bom). We further find that the ld. A.R had averred before us that as the assessee had not received any exempt dividend income during the year under consideration, therefore, there was no occasion for making any disallowance under Sec.14A. We are persuaded to be in agreement with the aforesaid claim of the ld. A.R, and are of the considered view that now when there was no exempt income received or receivable by the assessee during the year under consideration, therefore, there remained no occasion for having disallowed any expenditure under Sec.14A of the Act. We find that our aforesaid view is supported by the judgment of Hon’ble High Court of Delhi in the case of Joint Investment Pvt. Ltd. Vs. CIT (ITA No. 117/Mum/2005, dated 25.02.2015), wherein the Hon’ble High Court had held that the disallowance of expenditure under Sec. 14A has to be worked out in the backdrop of the exempt income of the assessee. We are of the considered view that as in the case of the present assessee no dividend income on the shares was received or receivable by the assessee during the year under consideration, therefore, no disallowance under Sec. 14A was called for in its hands. That without prejudice to our aforesaid observations that no disallowance under Sec. 14A is called for in the hands of the assessee, we find that the contention of the assessee that the lower authorities had erred in failing to appreciate that the disallowance under Sec. 14A is not to be considered for P a g e | 30 ITA Nos. 4902 & 5263/Mum/2013 AY: 2009-10 Sequent Scientific Limited Vs. ACIT Range 3(3) computing the MAT liability of the assessee under Sec. 115JB is no more res integra in light of the judgment of the Hon’ble High Court of Bombay in the case of CIT Vs. Bengal Finance & Investments Pvt. Ltd. (ITA No. 337 of 337 of 2013; dated. 10.02.2015) , wherein the Hon’ble High Court relying on its earlier order passed in the case of M/s Essar Technologies Ltd. Vs. DCIT (ITA No. 3850/Mum/2010; dated 07.08.2014), had held that amount disallowed under Sec. 14A cannot be added to arrive at the book profit for the purposes of Sec. 115JB of the Act. The Ground of appeal No. 2 raised by the assessee before us is thus allowed.
The appeal of the assessee is allowed.
The appeal of the assessee, viz. is allowed, and the appeal of the revenue, viz. is dismissed.
Order pronounced in the open court on 10/01/2018.