Amid spiralling gold prices, some of the jewellers have played around with accounting rules to suppress profits and pay lower tax.
The income tax (I-T) department has spotted a few units which violated regulations by changing the way they value their inventories-a trick that let them record lower profits, sources told ET. This, they said, has been going on for the past five to six years. Indeed, one of the jewellery houses has forked out close to ₹100 crore tax on the suppressed earnings.
These jewellers are found to have switched the valuation strategy from FIFO (first-in-first-out) to LIFO (last-in-first-out) to lower the valuation of closing stock, comprising unused gold purchased as raw material, semi-finished products and unsold, finished jewellery. A closing stock value directly impacts profits-lower stock means lower profits and therefore lower tax.
Suspecting that several jewellers, taking advantage of the surge in gold price, have used the ploy to escape tax, the department has directed its officials to look for cases where LIFO has been used.
Since older inventory is sold first under FIFO, the value of the balance depends on the more expensive gold which was bought or stocked later. With the cost of goods sold lower in FIFO, the pre-tax profit is higher. The reverse is true under LIFO: since gold bought last is sold first, the remaining inventory consists of less expensive gold. Here, a higher cost of goods sold lowers the profit.
Using LIFO is a breach of the I-T Act which requires businesses to follow either the FIFO or ‘weighted average cost’ method for inventory valuation since 2016-17.
“Before the amendment applicable from the assessment year 2017-18, taxpayers could account for their inventory (including precious metals like gold and silver) based on the methods they consistently used. However, following the introduction of ICDS II (Income Computation and Disclosure Standards), the inventory accounting method, except in certain specified cases, was required to follow either the or the weighted average cost method. The constitutionality of this mandate was challenged by a jeweller, arguing for the right to use the LIFO method, but the court upheld the validity of ICDS II and rejected the plea. In a rising market, choosing one method over another (such as opting for LIFO instead of FIFO) can impact the timing of profit recognition, particularly since gold prices have been steadily increasing in recent years. That said, it may not be correct to say that profits are generated from the closing stock itself. Valuing unsold inventory at the end of an accounting period is simply a necessary step in calculating the trading results for that period and does not in itself create profit,” an tax expert said.
With gold surging since the pandemic, and later fuelled by tensed geopolitics and large purchases by central banks, several jewellers may have found the LIFO valuation tactic irresistible. The price of gold in India rose from ₹31,000 per 10 gms, to ₹35,000 in 2019, and later surging from ₹48,720 in 2021 to ₹77,913 in 2024. It is currently at ₹97,681.
“The I-T office has the liberty to examine assessees’ accounting systems to determine whether it is appropriate and correct profits can be deduced from the account books maintained by the assessee. While the ICDS II permits a third methodology for non-interchangeable items and project-specific goods, it clearly prohibits where large numbers of ordinarily interchangeable inventory items like jewellery exists. The chosen formula should represent the fairest approximation of actual costs incurred in bringing inventory to present location and condition, maintaining consistency in application across financial periods,” another tax expert said.
Source #ET
