In a recent judgment, Deli High Court has expressed doubts over the regrouping of the previous year’s figure in the current year’s financial statements in view of the fact that such regrouping is done after the signing of audited accounts for such previous year. The Court observed that income tax authorities, ought to strictly scrutinise such claims as to regrouping.

Case Details:
ITA-947/2011 AY: 2005-06
Commissioner of Income Tax (Appellant) vs Morgan Securities & Credit Pvt Ltd. (Respondent)
Date of Order : 23-09-2015
Coram: Justice S. Muralidhar and Vibhu Bakhru

Facts of the Case(s):
The Assessee was a private limited company engaged in the business of trading and finance. The return of income for AY 2005-06 was picked up for scrutiny by u/s 143 (2) of the Income Tax Act 1961. The AO noticed from Clause 11 of the tax audit report (TAR) in Form 3CD that there has been a change in the method of accounting affecting the profitability of the company. The inventory of shares valued at Rs. 9,83,45,399 had been treated as investment in the current year. Although the TAR stated that Annexure-3 thereto contained a note on the effect to the profitability of the Assessee, the AO found no such annexure. The AO held that the basis of the valuation of the opening stock and closing stock of shares shown as investment was not clear. The AO relying on CBDT circular dated 15th June 2007 and decided cases concluded that there was no justification for the change in the method of accounting during the current year by treating the stock of shares as investment instead of stock in trade. According to the AO, the only motive for this undue change in this year (AY 2005-06) appeared to be lowering the tax incidence and taking undue benefit of the exemption from tax on long term capital gains under Section 10(38) of the Act and concessional rate of tax @ 10% on short term capital gains under Section 111A which had been brought into the Act with effect from 1st April 2005. Consequently, AO Treated the entire shares held by the Assessee as stock in trade and the resultant profit from the sale of shares Rs.10,22,58,060 as business profit.

Before CIT(A), the Chartered Accountant (CA) of the Assessee filed a reply with Annexure-3 which was referred to in the TAR. The CA stated that “shares valued at Rs.9,83,45,399 shown as stock in trade in the Asst. Year 2004-05 have been regrouped under the head investment in the accounts for the Asst. Year 2005-06.” Annexure-3 contained the manner of regrouping illustrated in a table with two columns for entries in the P&L account and the balance sheet (as regards reserve and surplus, investment and inventory) with the “old” and “revised” figures.

CIT(A) however allowed the assessee’s appeal holding that the transactions were on investment account and not stock in trade and directed the AO to amend the computation of total income accordingly.

ITAT observed that the AO had accepted the stand of the Assessee that shares were held as investment for AY 2004-05 as well. According to the ITAT, the AO could not have taken a different view for AY 2005-06 particularly since there was no material on record to justify it.

Held: Case remanded back to ITAT for fresh consideration of the aspects of regrouping made.

Excerpts from the Judgment:

The record of the AO for AY 2005-06 reveals an important fact concerning the regrouping of the investment by the Assessee for the year ending 31st March 2004. It is seen that the audited balance sheet of the Assessee for the year ending 31st March 2005 which was signed by its Directors and by its CA on 5th July 2005 contains two columns giving the figures as on 31st March 2004 and 31st March 2005. It is seen that in this balance sheet the figures given for the “inventory” as on 31st March 2004 have sought to be shown as per 'regrouping' as indicated in Annexure-3 to the TAR, a copy of which was enclosed by the CA in its letter dated 24 ^th February 2009 addressed to the Additional Commissioner of Income Tax, which has been referred to earlier. It is obvious that the 'regrouping' of the figures of the inventory of shares for the year ending 31st March 2004 took place subsequent to the finalization of the balance sheet for the financial year ending 31st March 2004. What is not on record, however, is a copy of the signed audited balance sheet of the Assessee for the year ending 31st March 2004 which alone would indicate whether the figures shown in the balance sheet for the year ending 31st March 2005 under the column concerning the position as on 31st March 2004 is the same as the original signed audited balance sheet for the year ending 31st March 2004 or has been changed.

It is, therefore, not clear whether after the signing of the audited balance sheet as on 31st March 2004 by Directors and CA any resolution was passed by the Board of Directors of the Assessee deciding to treat as investment the shares shown therein as stock in trade. This is an important aspect which does not appear to have merited attention by the CIT (A) or even the ITAT.

The Court would like to observe at this stage that it is inconceivable that after an audited balance sheet of a company for a financial year is signed by its Directors and statutory Auditors, and submitted to the statutory authorities, including the Registrar of Companies (RoC) and the income tax authorities, the figures in such balance sheet for the closing stock of shares can simply be altered subsequently by adopting the device of “regrouping” by the Assessee, even by a Board resolution. That is a process unknown to the law. Even from the point of view of principles governing statutory accounts, such change cannot be simply given effect to in the balance sheet and P&L account for a subsequent year. For instance, such a change, as was sought to be made by the Assessee in the instant case, to the value of the closing stock of shares by treating it as investment instead of stock-in-trade, would affect (and perforce necessitate changes) in the balance sheet and P&L accounts for at least two financial years. It is doubtful if this can at all be done particularly if the statutory authorities including the RoC and the income tax authorities have already been provided with (and perhaps acted upon or accepted) such signed audited accounts for a particular financial year.

The authorities concerned, and in particular the income tax authorities, ought to strictly scrutinise such claims as to 'regrouping' of figures appearing in the audited and signed accounts by an Assessee subsequent to such signing. In other words, the decision regarding such change in the figures, like for e.g., the 'regrouping' of shares in the present case, if at all permissible, has to be preceded by a legally acceptable procedure adopted by the Assessee, and in any event prior to the finalization and signing of the audited balance sheet for a particular financial year.

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