DCIT CIR 8(2), MUMBAI vs. HARNAM SYNTEX P. LTD, MUMBAI

The aforesaid appeals have been filed by the assessee by the revenue against separate impugned orders of even date, 17th January, 2011 passed by CIT(A)-17, Mumbai for the quantum of assessment passed u/s 143(3) for the assessment year 2005-06 & 2006-07.

However, Ld. AO rejected the assessee’s contention and held that assessee itself had mentioned in the aforesaid reply that unutilized modvat credit of Rs. 70,34,659/- was not included in sales and further, Rs. 81,09,075/- was only notional excise duty shown as sales as the assessee was exempted from excise duty. That apart, the assessee was still maintaining a separate excise account for export sales which has not been passed through the profit & loss account even after the changing the method of accounting during the year. Thus, he held that, assessee had not included excise duty in all his purchases and sales and hence he added back a sum of Rs. 1,25,24,122/- which was the effect of change of method by the assessee.

Before the CIT(A), the assessee submitted that the actual amount of the credit was at Rs. 1,15,47,370/- and the figure noted by the Auditor was a mistake. Regarding maintaining of separate excise duty for accounting of exports sales, it was submitted that the assessee had excise duty element in two capacities; first, as a 6 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 manufacturer and second, as an exporter. As far as modvat is concerned, it has effect only as a manufacturer. Accordingly, once the assessee had switched over to inclusive method of accounting, it had to reflect opening stock, purchases, sales and closing stock and after taking into account excise effect. As far as excise refund on account of export is concerned, the same benefit is on the exports which have been separately reflected in the profit and loss account. Thus, the AO has completely erred himself in concluding that, the change of accounting to inclusive method have not been reflected. It was further submitted that, the assessee had taken into account brought forward amount of excise duty of Rs. 70,34,659/- which comprised of Rs. 30,49,426/- in relation to the goods in the opening stock and the balance represented unadjusted MODVAT credit brought forward from the earlier years. This amount of Rs. 70,34,659/- was adjusted against MODVAT credit with reference to the sales of Rs. 1,51,44,409/- and the balance of Rs. 81,09,950/- was credited to the accounts. Thus, this was not a notional amount as held by the AO. Further, it was stated that the amount of Rs. 1,96,57,120/- was deposited being MODVAT benefit on account of purchases and the net impact would be Rs. 1,15,47,370/- which was in the following manner:- Sr.No. Heads of MODVAT credit Amount in Rs 1 Brought forward Modvat Credit 17,34,659 2 Modvat Credit on Purchases 1,96,57,120 3 Less: Modvat Credit on sale 1,51,44,409 Balance 1,15,47,370 8. The Ld. CIT(A) after calling for the remand report and the considering the assessee’s submission, partly sustained the addition of Rs. 39,74,140/- and deleted the balance amount of Rs. 85,59,982/- after observing and holding as under:- The submission has been carefully considered and materials on record perused. The change in method of accounting made by the appellant is claimed to be in line with provisions of section 145A. The AO did not accept that the appellant had in fact changed the method of 7 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 accounting as the AO misunderstood the adjustments made to the MODVAT credits of the year by the brought forward and unutilized MODVAT credit and credit to the sales only of the balance of Rs. 81,09,750/-, The AO also referred to excise duty refund which had been separately accounted for to support the stand that there was violation of section 145A. When the appellant changed the method of accounting to inclusive method, naturally it had to account the purchase and sales including excise duty element. The excise duty of the opening stock which according to the appellant amounting to Rs. 30,60,519/- had also to be considered. The appellant has stated that it pays duty at 24% when purchases are made and gets 10% rebate on processing of fabrics. Therefore it follows that there would always be more debits of excise duty than credits during a year and when purchase and sales are accounted with or without excise duty the profits would be different. It being less in a situation where excise duty portion is included and also where an assessee gets a rebate as claimed by the appellant. The appellant has explained that the actual amount of difference was Rs. 1,15,47,370/- and not Rs. 1,25,34122/- The amount of Rs. 1,15,47,370/- being amount of profit reduced with the appellant changed its method of accounting comprises of brought forward MODVAT Credit of Rs 70,34,659/- and Rs. 45,12,711/- being the difference towards excise duty paid of Rs.1,96,57,120/- and MODVAT Credits Rs. 1,51,44,409/- of the current year as regards the amount of Rs. 45,12,711/-, there is no dispute as it is a net effect of the change in method of accounting in the year under consideration. Regarding the brought forward MODVAT Credit of Rs.70,34,659/- the appellant has stated that an amount of Rs. 30,60,519/- relates to excise duty portion of the opening stock and therefore has to be considered while arriving at the profit of the year. Thus issue boils 8 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 down to the balance value of Rs. 39,74,140/-. The appellant has argued that this cannot be brought to tax as this amount has already suffered tax in earlier years on account of purchase price of those years being less. The appellant's plea cannot be accepted on account of the fact that appellant should have changed the method of those years too as the provisions of section 145A were in force w.e.f. 1.4.99. Thus, if the adjustment is required then in those years the assessment of every assessment year being separate and takes into account the effect of transactions of that particular year, the effect of adjustment required in earlier years cannot be brought into in a different assessment year though it is as per accounting principle. Hence, out of total disallowance of Rs. 1,25,34,122/- amount of Rs. 39,74,140/- is sustained and balance of Rs. 85,59,982/- is deleted”.

Before us, the Ld. Counsel, Ms. Ritika Agarwal after explaining the entire facts submitted that, firstly, the impact on the profit was at Rs. 1,15,47,370/- and not Rs. 1,25,47,370/- as noted by both the AO. This aspect was made amply clear before the CIT(A). The figure of Rs. 1,15,47,370/- included sum of Rs. 70,34,659/- which relates to the opening stock and unutilized credit for earlier years, because it got accumulated on the excise duty which is at 24%, whereas, the duty payable on the finished goods was at 10% leading to a margin of 14%. This amount is further divided into 2 parts; first, relatable to opening stock of Rs. 30,60,599/- and other part, relatable prior to year, of accumulation of Rs. 39,74,140/-. The other component of the figure of Rs. 1,15,47,370/- i.e. (1,15,47,370 – 70,34,659) included sum of Rs. 45,12,711/- which is on account of current years’ difference in excise duty paid on inputs less payable on sales claimed in the profit and loss account due to change in the method of accounting u/s 145A. As regards the finding of the CIT(A) for confirming the balance amount of Rs. 39,74,140/- out of sum of 9 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 Rs. 70,34,659/- which is to be adjusted in the relevant assessment year, she submitted that the said amount had already suffered tax in the earlier years when the amount of purchases had been suffered taxed in the earlier years as it had been claimed at the figure exclusive of excise duty though paid but not been claimed due to exclusive method. So far as his observation that the provisions of section 145A came into force w.e.f. 01.04.1999, therefore, adjustment cannot be made in the impugned year, she submitted that Ld. CIT(A) had himself accepted that the change of method of accounting is as per the accounting principle and once that is so then logical effect have to be given in the year of change. Here in this case already this amount has suffered tax in the earlier years by not claiming it. Thus, no disallowance is called for. Sum and substance of her arguments put forth before us can be summarized as under:-

On the other hand, ld. DR reiterated the stand taken by the AO that the change in the method of accounting was not proper and the entire disallowance made by the AO deserves to be sustained. He thus, strongly relied upon the order of the AO.

We have carefully considered the rival contentions and also perused the relevant finding given in the impugned orders. So far as the change in method of accounting for the excise duty from exclusive method to inclusive method the same is purely bona fide and is in line with provision of section 145A, which provides that 11 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 the valuation of purchase and sale of goods and inventory shall be further adjusted to include amount of any tax, duty, cess or fee actually paid or incurred by the assessee to bring the goods to its location and the condition as on the date of valuation. In the earlier years the assessee had been assessed under scrutiny proceedings right from assessment year 2001-02 to 2004-05, wherein, the assesee’s exclusive method for accounting excise duty has been accepted. If the change in the accounting has been made bona fidely then, there would definitely be some impact in this year but it gets revenue neutral in the subsequent years. In the “inclusive method” of accounting, now the assessee had to account for the excise duty stock of Rs.30,60,519/- in the opening stock and also consider the unutilized credit for the earlier years. The assessee had pointed out that, excise duty on purchases were at 24% and 10% on the processing of fabrics which results into more element of excise duty margin by 14%. This prior period accumulation has to be given credit during the year, when purchases and sales are accounted with or without excise duty, and if such exercise is carried out there would be difference in profits. So far as the amount of Rs. 81,09,050/- which the AO held it to be a notional duty, the Ld. CIT(A) on a correct appreciation of facts has given correct finding, which can not be interfered with as the total excise duty payable on the sale during the year was at Rs. 1,51,44,409/- and after reducing the opening credit of Rs. 70,35,659/- the balance remaining payable on the sale was Rs. 81,09,750/-. This was further reduced from the amount of the excise duty paid on inputs during the year for sales aggregating to Rs. 1,96,74,139/-. The balance remaining on current purchases is Rs. 1,15,47,370/- and this has been duly accounted for in the manner provided u/s 145A in this year. The Ld. CIT(A) already given relief on account excise portion of the opening stock of Rs. 30,60,519/- as it was part of the brought forward MODVAT credit of Rs. 70,50,659/-. However, the sum of Rs. 39,74,140/- which 12 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 has been confirmed by the CIT(A) cannot be upheld in principle because these are accrual over the years and when there is change in the method of accounting in the assessment year 2005-06, the entire amount gets due in this year which has to be allowed. However such an allowance is subject to limited verification by the AO, whether the assessee has forgone the MODVAT credit as per Excise law and rules and instead availed the benefit under the Income-tax Act in this year and further if the said amount has already subjected to tax in the earlier years in a way that the assessee had not claimed the benefit of excise duty on this amount in the earlier year and hence relief has to be given in this year. Thus, with this limited direction of verification the issue raised vide revenue’s ground are treated as dismissed whereas the amount of Rs. 39,74,140/- as confirmed by the CIT(A) is treated as partly allowed for statistical purposes.

In the result, the revenue’s grounds are treated as dismissed and assessee’s grounds are treated as partly allowed for statistical purpose.

Now we will come to ground no. 4 and 5 of the assessee whereby, the assessee have challenged deduction u/s 80IB of Rs. 59,60,478/-.

The brief facts are that, the assessee is engaged in the business of manufacturing of fabrics with a small scale unit at Valsad District, Gujarat where it carries out the activities of crimping, twisting, sizing, warping and weaving work. In response to the show cause notice as to why such activity should be treated as “manufacturing” and claim for deduction u/s 80IB be allowed, the assessee submitted that, it has started its manufacturing activity way back in the year 1998 and claimed deduction u/s 80IB in AY 2001-02. The assessee has been undertaking the activities from the earlier years which had been accepted to be manufacturing. In support, certain decisions were also relied upon. However, the AO rejected the assessee’s claim after analyzing the 13 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 usage of raw materials and the finished products and the process as given in para 5.5 of the order and held that the activity carried out by the assessee cannot be treated as manufacturing.

Before the CIT(A), exhaustive submissions were made which are dealt and incorporated by CIT(A) in para 5.2 to 5.5. The sum and substance of assessee’s contention before the CIT(A) that the assessee has used huge electricity charges on running of machines which was at Rs. 1,13,95,513/- and fuel and oil charges of Rs. 45,81,112/-. Apart from that, the assessee has claimed huge deprecation on plant and machinery and the value of gross block as on 01.04.2004 was Rs. 2,69,31,301/-. It was submitted that, only weaving and final processing was outsourced, otherwise all the other activities like, crimping, sizing, warping is done by the assessee from its own plant and machinery and labours. The assessee was also claimed excise duty and is registered as SSI unit itself shows that manufacturing activity is being taken place. However, the CIT(A) upheld the action of the AO after observing and holding as under :- “The submission of the appellant has been carefully considered and the material on records perused. As per the Audit report and statement attached to the reports the appellant had machineries on which depreciation had been claimed as also expenses on account of factory, oil and fuel expenses. In the normal course this should point to the appellant having being involved in manufacturing but, as per the Audit report in Schedule N notes forming part of accounts in Point 6 It is stated Product description "Trading in Fabrics" It is also stated in report u/s. 44AB that Nature of Business or Profession -" Export and Trading of fabrics". The appellant in its submission has not stated clearly what the manufacturing process was, the details of machinery involved, the nature of products produced as a result of the process. The appellant should have produced Central excise registers or some other records /to support the claim that manufacture was involved. The appellant has stated that had a small scale unit in Sarigam (Valsad Dist.) where it is involved in crimping, twisting, sizing, warping and weaving . It was also stated that after raw fabrics were produced it was sent to process houses outside for further processing. If that was the case, the appellant could have produced records to show that after raw fabrics was manufactured these were sent outside for further processing. In the absence of to proof and the categorically statements of auditors referred to above the denial of deduction u/s. 801B by the AO is correct”.

Apart from that, various decisions were also relied upon, the compilation of which have been filed in the separate paper book, along with the synopsis thereof. She drew our attention to the decision in the case of CIT vs Bipali Textiles Pvt Ltd, reported in [1991] 189 ITR 61, wherein, Hon’ble Bombay High Court after referring to CBDT Circular dated 22.11.1955 which had clarified that the activities of twisting and crimping of yarn is to be treated as manufacturing activity, held that such a question of law, whether activities of twisting and crimping of yarn can be treated as activity of manufacturing or not should not be referred. She also relied upon two other decisions of Hon’ble Bombay High Court in the case of CIT vs. Emptee Poly-Yarn P. Ltd. [2008] 305 ITR 309 and in the case of CIT v. Penwalt India Ltd. [1992] 196 ITR 813.

On the other hand, Ld. DR submitted that most of the processing were done through job work, because weaving is a major part which has been outsourced. Crimping and twisting is only a minor part. Therefore, it has been rightly held that, assessee is not engaged in manufacturing and sales and therefore the deduction u/s 80IB should not be allowed.

After considering the rival contentions and on perusal of the relevant finding given in the impugned order, we find that it is an undisputed fact that the assessee has a SSI Unit in the District of Walsad, Gujarat. The activities carried out by the assessee for processing the yarn are crimping, twisting, sizing, warping and weaving. It is also undisputed fact that it has been registered under Excise Department and excise duty is payable on the 16 Harnam Syntex P Ltd. Mum/2011 ITA No.4459/ Mum/2011 manufactured product by the assessee. It has also incurred huge expenses like, electricity, fuel under the head “manufacturing expenses” and has substantial investment in plant and machinery used for this purpose which as on 01.04.2004 were approximately 2.07 crores. As clarified by the CBDT on 22.11.1995, even the activities of twisting and crimping of yarn has been treated as manufacturing activities and this Circular has been referred and relied upon by the jurisdictional High Court as stated above. The finished product here is definitely a different product having different value: Even if the weaving part has been outsourced, it does not ipso facto leads to conclusion that assessee is not engaged in manufacturing. The other activities are the vital process through which the raw material is converted into finished products. Time and again, various Courts have held that, if the original commodity undergoes a change which is a commercially different product and no longer is regarded as original commodity and is recognized a distinct article, then it has to be held that “manufacturing” had taken place. Moreover, as pointed by Ld. Counsel right from assessment years 2001-02 to 2004-05, assessee has been allowed deduction u/s 80IB continuously in 3 years by the department even when, the assessee’s case has been assessed under scrutiny proceedings u/s 143(3). If similar facts are permeating in this year also, then as a matter of consistency different view cannot be taken in this year. The fundamental aspect of allowing deduction u/s 80IB has been examined and granted earlier, then without any change in the material facts a different view should not be taken. Accordingly, we hold that, the activities carried out by the assessee amounts to manufacturing and accordingly, the assessee is entitled for claim of deduction u/s 80IB. Thus, the ground raised by the assessee is allowed.

For the AY 2006-07, the assessee has raised following grounds of appeal:-

In doing so the ld. CIT(A) failed to appreciate that the appellant owned Plant & Machinery of substantial value and was incurring expenses under the head Wages and Electric Expenses for carrying out various manufacturing activity”. The only issue raised by the assessee in the above grounds of appeal