Taxation Law | Mandatory FIFO Method Ensures Consistency and Prevents Manipulation, Kerala High Court

Legislative and Expert Consensus Validates Change, Rejects Claims of Arbitrariness

The Kerala High Court has upheld the mandatory adoption of the First-In-First-Out (FIFO) method for inventory valuation as stipulated under Clause 16 of the Income Computation and Disclosure Standards (ICDS-II). The judgment, delivered by Justice Dinesh Kumar Singh on May 20, 2024, rejected the challenges posed by various petitioners, including prominent jewellers, who argued that the mandatory FIFO method was arbitrary and unconstitutional. The court affirmed the legislative competence and reasonableness of the classification made by the statute.

The batch of writ petitions, led by W.P.(C) No. 30318/2019, involved multiple petitioners, including individuals and businesses in the jewelry trade, who were historically using the Last-In-First-Out (LIFO) method for inventory valuation. The petitioners challenged the notification dated September 29, 2016, which made the FIFO method mandatory from April 1, 2017. They argued that this change led to an artificial increase in taxable income and was arbitrary, violating Article 14 of the Indian Constitution.

Justice Dinesh Kumar Singh underscored the importance of legislative authority in determining economic policies. "It is well settled that courts do not substitute their views on policy matters," he stated. The court recognized that the Parliament, after extensive consultations with stakeholders and based on expert recommendations, had the competence to mandate a uniform method of stock valuation to maintain consistency and transparency in financial reporting.

The court referred to established legal principles for testing the constitutionality of legislation under Article 14. It reiterated that a classification is valid if it is founded on an intelligible differentia and has a rational nexus with the objective sought to be achieved. The court held that the mandatory FIFO method met these criteria as it applied uniformly to all assessees, thereby not discriminating against any particular class.

The court acknowledged the petitioners' argument that adopting the FIFO method resulted in higher taxable income. However, it emphasized that changes in tax liability arising from standardized accounting practices did not amount to constitutional violations. The court noted that the primary aim of the amendment was to eliminate discrepancies and ensure uniformity in accounting standards across the board.

Justice Singh extensively discussed the principles of legislative delegation and the scope of judicial review. He cited previous rulings, including the Delhi High Court's decision in Chamber of Tax Consultants, to support the view that excessive delegation without guidelines would be unconstitutional. However, in this case, the court found that the legislative guidelines for ICDS-II were adequate and not arbitrary.

Justice Singh remarked, "The mandatory adoption of FIFO or weighted average cost method ensures consistency and prevents manipulation in stock valuation. This change, backed by legislative and expert consensus, does not suffer from manifest arbitrariness or unreasonable classification".

The Kerala High Court's ruling reinforces the legislative authority to implement standardized accounting methods and upholds the constitutionality of the ICDS-II provisions. This decision underscores the judiciary's deference to legislative policies aimed at ensuring uniformity and transparency in financial reporting. The judgment is expected to have significant implications for the accounting practices of businesses across India, particularly in how they value their inventories for tax purposes.

Date of Decision: May 20, 2024.