No man can make a profit out of himself- SC
Section 145 of the Income Tax Act pertains to method of accounting. According to the said section, income chargeable under the head” Profits and gains of business or profession” or” Income from other sources” shall be computed in accordance with the method of accounting regularly employed by the assessee.
In any case where the accounts are correct and complete to the satisfaction of the Assessing Officer but the method employed is such that, in the opinion of the Assessing Officer, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Assessing Officer may determine
Where the Assessing Officer is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting, has been regularly employed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.
The method of valuing stocks has a direct impact on taxable profits. The recognised and settled practice of accounting is that the closing stock of a business has to be valued on cost basis or on the market value basis, provided the market value of the stock is less than its cost. The apex court laid down the principle that if the market value of stock is taken into consideration while arriving at chargeable income, where such value of the stock is more than the cost of the stock, the profit earned would be notional.
This is for the reason that there is no transfer of goods and the closing stock remains the opening stock of the next accounting year. Thus, the income which has not been earned by the assessee cannot be said to be income chargeable to tax. In short, no man can make a profit out of himself.
Let us refer to the case of Sir Kikabhai Premcahnd v. CIT (1953), where the issue under consideration was whether an act of withdrawal resulted in income, profit or gain either to the assessee or to his business?
Facts of the Case:
- The assessee dealt in silver and shares and a substantial part of his holding were kept in silver bullion and shares.
- His business was run and owned by himself and his accounts were maintained according to the mercantile system.
- The stocks of silver bars and shares were valued at cost.
- In the course of the year the appellant withdrew some bars and shares from the business and settled them on certain trusts.
- The assessee credited the business with the cost price of the bars and shares withdrawn.
Contention of Attorney General
- The Attorney-General raised two contention.
- First, he said that as the bars and shares were brought into the business any withdrawal of them from the business must be dealt with along ordinary and well-known business lines, namely, that if a person withdraws an asset from a business, he must account for it to the business at the market rate prevailing at the date of the withdrawal.
- He said that the mere fact that the appellant was the sole owner of the business can make no difference, for under the Act income is assessable under distinct beads and when we are working out the income of a business the rules applicable to business incomes must be applied whoever is the owner.
- His second contention was that if the act of withdrawal is at a time when the market price is higher than the cost price, then the State is deprived of a potential profit.
- He conceded that had the market rate been lower than the cost price, then the appellant would have been entitled to set off the loss on those transactions against his overall profit on the other transactions and thus obtain the advantage of a lower tax on the overall picture.
Observations of the Supreme Court (SC)
- The act of withdrawing silver bars and shares was not a business transaction and by that act the business made no profit or gain, nor did it sustain a loss, and the appellant derived no income from it.
- The assessee could have stored up a future advantage for himself but as the transactions were not business ones and as the assessee derived no immediate pecuniary gain the State cannot tax them, for under the Income-tax Act the State had no power to tax a potential future advantage.
- The State could tax only income, profits and gains made in the relevant accounting year.
- The business was owned and run by the assessee himself.
- It was wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact was non-existent.
Therefore, it was held that a person cannot make a profit from dealing with himself.