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The Finance Bill 2023 proposes in total, 122 Budget amendments, in the Income Tax Act, 1961. Among these 122 budget amendments, one of the significant and critical, yet lesser highlighted and talked about amendment is regarding the substitution of the existing sub-section (2A) in section 142 of the Income Tax Act, with a new sub-section, and thereby inserting the enabling provision, pertaining to the inventory valuation, required at the behest of assessing authority, during the course of regular assessment proceedings, commencing from AY 2022-23 (FY 2021-22) and subsequent assessment years.
The existing sub section (2A) in section 142 contains the enabling provision only in respect of the Special Audit to be done at the behest of AO.
Proposed Amendment in the Finance Bill 2023
The newly inserted clause (ii) of sub section (2A) of section 142 provides that, if at any stage of the assessment proceedings, the assessing officer, having regard to the nature and complexity of the accounts, volume of the accounts, doubts about the correctness of the accounts, multiplicity of transactions in the accounts or specialised nature of business activity of the assessee, and in the interests of the revenue, is of the opinion that it is necessary so to do, then the assessing officer may, with the previous approval of the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner, direct the assessee to get the inventory valued by a cost accountant, nominated by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner in this behalf and to furnish a report of such inventory valuation in the prescribed form duly signed and verified by such cost accountant and setting forth such particulars, as may be prescribed, and such other particulars as the assessing officer may require.
However, the assessing officer can’t direct the assessee to get the inventory so valued without granting the assessee a reasonable opportunity of being heard.
Period of Inventory Valuation at the Behest of AO Excluded from Limitation Period for Completion of Assessment
An amendment has also been proposed in section 153, to exclude the time period starting from the requisition of inventory valuation by the assessing officer u/s 142(2A)(ii), by the department empaneled cost accountant, till the submission of final report of such inventory valuation in the prescribed form and manner, by the assessee, from the limitation period for completion of assessment.
It is also pertinent to mention here that for AY 2022-23 and subsequent assessment years, the limitation period for completion of regular assessment u/s 143(3)/144B has also been extended from the existing 9 months to 12 months from the end of the financial year in which the return of income has been furnished by the assessee. So, for AY 2022-23 (FY 2021-22), the limitation period for completion of regular assessment is 31.3.2024, if the return of income has been filed within the FY 2022-23 by the assessees.
However, if the assessing authority invokes this new enabling power of asking for the inventory valuation, under the newly inserted clause (ii) in subsection (2A) of section 142, then such time period, will get excluded from the mandated limitation period of 12 months.
Even the existing enabling provision of special audit at the behest of AO u/s 142(2A) of the Income Tax Act, has always remained a subject matter of litigation between the revenue authorities and the assesses.
The time tested legal jurisprudence amplifies that different appellate forums on PAN India basis have on considerable occasions, have quashed the requisition of special audit by the assessing officer, u/s 142(2A), on the ground that section 142(2A) is somehow being misused by the assessing authorities just to extend the statutory limitation period for completion of assessments of the otherwise time barring assessments, mandated in section 153 of the Act, by raising the subjective and abstract grounds of complexity of books of accounts, or the nature and volume of assessee’s financial transactions, and without any factual merits.
Ordering of inventory valuation, being more generic in nature than the special audit, is naturally amenable to be resorted more frequently by the assessing authorities now, during the fag end of the time barring assessment proceedings, and thereby increasing the compliance burden and costs of the assesses.
Self-Serving Logic in Explanatory Memorandum Actually Defies any Logic
The Explanatory Memorandum to the Finance Bill 2023, gives the ‘prevention of permanent deferral of taxes through undervaluation of inventory’, as the rationale and objective of insertion of this enabling provision of inventory valuation at the behest of AO in section 142(2A)(ii) of the Income tax Act.
At the outset, this very reason of preventing the permanent deferral of taxes through undervaluation of inventory as given in the Explanatory Memorandum, suffers from the basic fallacy and fails to take into consideration the very basic compensating impact of inventory valuation.
If even for academic considerations, it is assumed that the closing stock, as credited by an assessee, in its Trading or Manufacturing account, in a particular financial year, has been undervalued, with a view to avoid tax, but then, the same closing stock becomes the opening stock of the next financial year. Thus, this undervalued figure of closing stock will naturally be debited as opening stock in the manufacturing or the trading account of the assessee, in the next financial year, and as such will naturally compensate for the understatement of profits in the previous financial year, with the understatement of opening stock (expense) in the current financial year. So, effectively there will be no permanent deferral of taxes, as has been asserted in the Explanatory Memorandum.
The Explanatory Memorandum further states that this new enabling provision in respect of inventory valuation at the behest of AO has been proposed in order to ensure that the inventory is valued in accordance with various provisions of Law like section 148 of the Companies Act 2013, mandating maintenance of cost records and its audit by a cost accountant in certain prescribed cases and the Income Computation & Disclosure Standard (ICDS)- II, relating to inventory valuation.
Ironically, this justification itself raises some questions on the objectivity and practical feasibility of this proposed enabling provision of inventory valuation. This is because of the reason that the Companies which are already compulsorily required to maintain their cost records and get the cost audit done by a cost accountant in accordance with the requirement of section 148 of the Companies Act, will have to do so in any case, and are actually doing so, suo-motto.
So, when the prescribed cost records have already been maintained and the compulsory cost audit has also already been get done by an approved cost accountant, suo motto, by the assessees, to which section 148 of the Companies Act applies, it is quite difficult to comprehend the logic of again making such already audited cost records, subject to an another cost audit/ inventory valuation by an another department empaneled cost accountant at the behest of the assessing officer, during the course of assessment proceedings, and that too only on the basis of some doubt on the part of the AO.
Regarding the logic of ensuring compliance of ICDS-II on inventory valuation, applicable to all assessees, the Tax Auditors of the assessees are in any case, compulsorily required to report any adjustments required to be made to the profit or loss in respect of any variation between the valuation of inventory in the books of accounts with that as required by ICDS-II in Clause No. 13(d) and (e) of Form 3CD of the Tax Audit Reports.
Such reporting of adjustments in clause 13(d) and (e) of the Tax Audit Report is, by default, picked up by the highly effective AI & ML techniques (as proclaimed) being deployed by CPC in the processing of returns of income and are duly added as income in the Intimation Orders issued u/s 143(1) of the Act. So, the compliance of ICDS-II, in respect of inventory valuation, is already being taken, due care by the existing legislative provisions in the Income Tax Act.
Thus, the logic given in the Explanatory Memorandum i.e., ensuring compliance requirement of section 148 of the Companies Act of maintenance of cost records and getting cost audit done, as well as the compliance of ICDS-II of inventory valuation, actually, defies any logic and ironically, comes out, as the reason, in justification of the fact of no lawful requirement of such inventory valuation at the behest of the assessing authority, during the course of assessment proceedings.
Further, it also needs to be appreciated here that unlike the special audit, which is a post-facto validating and authenticating exercise, the cost audit and inventory valuation is a concurrent exercise being done at regular intervals during the tenure of the financial year itself and immediately at the end of the financial year and it also involves a physical verification and stock taking exercise by the business owners.
However, the proposed requisition for inventory valuation by the AO will usually be issued after the lapse of two or more years from the end of the relevant financial year and thus, such a requisition will be against the very basic concurrent nature of the inventory valuation exercise.
Further the proposed safeguard of the requirement of getting a prior approval of the superior income tax authority in hierarchy, i.e., the Chief Commissioner or the Commissioner, by the assessing officer, before requisitioning for the inventory valuation, may eventually become an empty formality and ritual only, as is evidenced by the similar fate of the exactly similar safeguard, available in respect of requisitioning of a special audit presently.
Thus w.e.f. AY 2022-23 and onwards, this additionally imposed requirement of explaining and validating the valuation methodology of business inventory to an external party, completely stranger to the nature, complexities and peculiarities of the business, and that too after the lapse of two long years, from the end of the relevant financial year, is naturally going to be an arduous, strenuous and a herculean task for the business owners, and is definitely not in alignment with the “ease of doing business” philosophy of the Government, and that’s precisely, is the reason for my choice of the title of this present writing piece as,
“Inventory Valuation at AO's Behest Will Make Businesses Busy & Not Easy!!”
This Article has also been published in Taxmann with the citation [2023] 147 taxmann.com 157 (Article).
