Income Tax Appellate Tribunal - Hyderabad
Joint Commissioner Of Income Tax (Osd) ... vs Mlr Auto Limited , Hyderabad on 28 December, 2023
आयकर अपीलीय अधिकरण , है द राबाद पीठ में
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCHES "B", HYDERABAD
BEFORE
SHRI R.K. PANDA, VICE PRESIDENT
AND
SHRI LALIET KUMAR, JUDICIAL MEMBER
आ.अपी.सं / ITA No.115/Hyd/2021
(निर्धा र ण वर्ा / Assessment Year: 2017-18)
Joint Commissioner of Income M/s.MLR Auto Limited,
Tax (OSD), Circle - 5(1), Vs. 41/1A IDA, Balanagar,
Hyderabad. Hyderabad.
PAN : AAGCM1053L
अपीलधर्थी / Assessee प्रत्य र्थी / Respondent
निर्धा ररती द्वधरध /Assessee by: Shri Pawan Kumar
Chakrapani
रधजस्व द्वधरध /Revenue by: Ms. Sheetal Sarin, Sr.AR.
सु ि वधई की तधरीख /Date of hearing: 19.12.2023
घोर्णध की तधरीख /Pronouncement on: 28.12.2023
ORDER
PER LALIET KUMAR, J.M.
The captioned appeal is filed by the Revenue feeling aggrieved by the order of Commissioner of Income Tax (Appeals)
- 4, Hyderabad dt.11.01.2020 invoking proceedings under sections 143(3) of the Income Tax Act, 1961 (in short, "the Act"), for the A.Y 2017-18.
22. The captioned appeal was filed by the Revenue with a delay of 125 days along with letter for condonation of delay stating therein the reasons for belated filing of appeal. The relevant portion of the said letter reads as under :
"......
The said appeal order was received in the office of the Commissioner of Income Tax - 4, Hyderabad on 14.08.2020 and the due date of filing appeal before the Hon'ble ITAT was 05.11.2020. However, due to the prevailing Covid pandemic, and restructuring of Income Tax Department and merger of erstwhile Circle - 16(2), Hyderabad with Circle - 5(1), Hyderabad, the appeal could not be filed on or before the due date. The appeal is being filed now with a delay of 125 days. Hence, it is requested that the delay in filing the appeal may kindly be condoned and appeal may kindly be admitted."
2.1. On the other hand, ld.AR reported no objection.
2.2 We have heard both the parties on this preliminary issue. There is no dispute that under section 253(5) of the Act, the Tribunal may admit an appeal filed beyond the period of limitation where it is satisfied that there exists a sufficient cause on the part of the assessee / Revenue for not presenting the appeal within the prescribed time. The moot point is as to whether such a long delay deserves condonation. In the letter Revenue has mentioned that it was failed to appear due to Covid - Pandemic situations prevailing in the country. At this stage, it is relevant to note the judgment of the Hon'ble Bombay High Court in Vijay Vishin Meghani Vs. DCIT & Anr (2017) 398 ITR 250 (Bom) holding that none should be deprived of an adjudication on merits unless it is found that the litigant deliberately delayed the filing of appeal. As the Revenue has sufficient cause for not filing the appeal within the prescribed time limit and after respectfully following the above said decision, we condone the delay and admit the appeal for hearing.
33. The only ground raised by the Revenue reads as under :
"The Ld CIT (A) erred in deleting the addition made u/s 56(2)(viib) made by the Assessing Officer when the assessee could not substantiate the FMV adopted as per DCM method to the satisfaction of the Assessing Officer as per the Explanation of Section 56(2)(viib) of the Income Tax Act." both in law and on facts of the case."
3.1. Thereafter, Revenue has filed the following additional grounds :
"1. Whether on the facts and circumstances of the case, the CIT(A) was justified in holding that the Discounted Cash Flow (DCF) valuer, M/s Machiraju and Associates has not included a disclaimer in the valuation Report that the truthfulness, accuracy and completeness of the information and financial data has been provided by the Company, when the said value, M/s Machiraju and Associates had duly included the said disclaimer, as evident from the valuation Report.
2. Whether the observation of the CIT(A) while referring the judgment of the Hon'ble ITAT, Delhi in case of M/s Agro Portfolio that the assessee's valuer, M/s Machiraju and Associates, have not portfolio that the assessee's valuer, M/s Machiraju and Associates, have not made any disclaimer and the conclusion/direction that the addition be deleted is tenable when, in fact, the disclaimer is included in the valuation Report and the Assessing Officer has rightly relied on the said judgment in the case of M/s Agro Portfolio to justify the additions".
4. The brief facts of the case are that the assessee is a company engaged in the business of manufacturing Three Wheelers. It filed its return of income for A.Y. 2017-18 on 30.10.2017 and thereafter, revised it on 28.03.2018 declaring income of Rs. Nil after carrying forward of business losses of Rs 14,32,93,315/-. The return of income was processed u/s 143(1) of the I.T. Act, 1961 (hereafter called 'Act'). Subsequently, the case was selected for scrutiny assessment under CASS and notice u/s 143(2) dated 16.08.2018 was served on the assessee company.
4.1. During the assessment proceedings, assessee was requested to furnish the details of increase in share premium along with confirmation from the investors, ITRs, bank statements reflecting the transactions, MoUs, Shares Valuation Report etc 4 vide show cause notice dt.04.12.2019. In response, assessee company filed the documents as called for. Thereafter, Assessing Officer also issued show notice dt.13.12.2019 questioning as to why DCF method adopted should not be rejected. The contentions of the assessee company are examined and found untenable by the Assessing Officer as he found that the assessee Company has issued 35,00,000 shares of face value of Rs 10/- at the price of Rs19.90 per share thus receiving share premium of Rs. 3,46,50,000/-. Hence, the AO rejected the DCF method opted by the assessee. The AO used the NAV method and computed the fair market value of the share of the Company as Rs 10.87/-. Thus, the AO concluded that provisions of section 56(2)(viib) are attracted and he assessed the excess share premium of Rs.3,16,05,000/- received by the assessee company as its income from other sources. The AO also found that the employees' contribution to ESI of Rs 18,79,427/- were deposited after the due date and therefore, added the same as income of the assessee company under section 36(1)(va) read with section 2(24)(x) of the Act. Thus, the AO assessed the income of the appellant Company at Rs (-) 10,98,08,887/- and passed assessment order u/s 143(3) of the Act on 16.12.2019.
5. Feeling aggrieved with the order passed by the assessing officer, assessee filed appeal before the ld.CIT(A), who granted part relief to the assessee.
6. Aggrieved with the order of ld.CIT(A), Revenue is now in appeal before us on the grounds mentioned hereinabove.
7. Before us, ld. DR has drawn our attention to the order passed by the Assessing Officer and our attention was drawn to para 3.1 and 3.2 of the order passed by the Assessing Officer. Ld. 5 DR had also submitted that the ld.CIT(A) in Para 5.1 to 5.3 had decided the issue in favour of the assessee by holding as under :
"5.1 The section 56(2)(viib) has been brought into effect with effect from 01 April 2013 i.e. Assessment Year 2013-14 pertaining to Fiscal Year (FY) 2012-13 through the Finance Act, 2012. The objective of introducing section 56(2)(viib), as stated by the Hon'ble Finance Minister while introducing the Union Budget for FY 2012-13, was to discourage the generation and use of unaccounted money done through subscription of shares of a closely held company, at a value which is higher than the Fair Market Value (FMV) of shares of such company. However, in the instant case the AO has failed to establish that the share premium received by the appellant Company was its own unaccounted money which was laundered and received back by it in the form of share premium.
5.2 The AO has rejected the DCF valuation mainly because the projected turnover of the appellant Company was much below the actual turnover for financial years 2016-17, 2017- 18, and 2018-19. But the AO is applying the benefit of the hindsight since he is making this comparison in FY 2019-20 or more precisely in the third quarter of FY 2019-2020 whereas the Valuer was doing the valuation in FY 2016-17. The Hon'ble ITAT, Jaipur Bench, in the case of M/s Rameshwaram Strong Glass Pvt Ltd vs ITO, Ward 2(1), Ajmer [TS-8114-ITAT-2018 (Jaipur)-O] held that DCF method is essentially held on estimations and projections which cannot be subsequently compared with the actuals.
A projection of the turnover and profits of an enterprise for the future is made on the basis of various key factors, which include expectations regarding macro-economic conditions, technological factors, government policies, state of competition, demand factors, supply of raw materials, efficiency of the management etc. How close a projection comes to actual performance is dependent on various factors and a DCF valuation cannot be merely rejected based on the observation that projections were below actuals. In the appellant's case, the AO has failed to point out any outlandish assumption made by the valuer in the DCF computation which has given an absurd DCF value far removed from the FMV of the share. The AO has relied on the decision of Hon'ble ITAT, Delhi in case of Agro Portfolio Private Ltd vs. ITO, ITS-7311-ITAT- 2018(Delhi)-O] wherein it was held that in case the valuation under DCF is done on the projections provided by the Company management and the valuer who is doing the DCF valuation has categorically mentioned in the report as a disclaimer that the truthfulness, accuracy and completeness of the information and financial data has been provided by the Company and the valuer has relied on the same, the assessing officer can reject the DCF method and go by NAV method to determine the FMV of the shares. However, in the case of the appellant the DCF valuer, M/s Machiraju & Associates have not made any such disclaimer.
5.3 The AO has rejected the DCF method and adopted the NAV method but the latter is also far from perfect for the appellant. The Net Asset Value method for computing the value of a share of a Company has its own typical limitations. As per the 6 Rule 11UA sub-rule 2 the method of calculation of net asset value (NAV) of the unquoted share is as under.
[(2) Notwithstanding anything contained in sub-clause (b) of clause
(c) of sub-rule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:--
*table - left intentionally.
(i) the paid-up capital in respect of equity shares;
(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
(iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
(iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
(v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
(vi) any amount representing contingent liabilities other than arrears of dividends pay a in.4gspect of cumulative preference shares;
PE = total amount of paid up equity share capital as shown in the balance-sheet;
PV = the paid up value of such equity shares; or • Thus, the figures of book value of assets and liabilities and total paid up equity shares and value of paid up share have to be taken as on the date of valuation. The NAV method wherein book value of assets has to be taken may not present a correct picture of the fair market value of the assets since it will fail to capture the correct fair market of the lands owned by a Company. In the instant case, the appellant Company was running a manufacturing facility at IDA Balanagar, Hyderabad, and a new plant was constructed in 2015 in 25 acres of land at Toopran which is approximately 35 kms from Hyderabad. The circle rates of these areas were revised upwards in the FY 2016-17 itself by the Sub-Registrar Office. In addition, the appellant Company has since the year 2002, when it launched its brand name `Teja', invested significantly in the development of a brand name and the value of the intangible asset thus created is not included in the balance sheet at all. Hence, the price at which the Company agrees to issue its shares to the equity investor is a decision based on numerous factors and the NAV method of computation is too simple a mathematical formula to cover all relevant concerns of a 7 prudent business decision-maker. Therefore, the use of NAV method for valuing the share equity of the appellant Company was correctly found unsuitable by the appellant Company. The AO while computing the NAV of the shares of the appellant Company would have failed to do anything to overcome the above-mentioned limitations since the Rule 11UA does not give him any scope to do so.
Secondly, since the purpose is to value the fair market value of the shares issued by the appellant, it is logical that AO should take book value of assets & liabilities, paid up equity shares and value of paid-up equity, i.e. A, L, PE, PV in the above formula, immediately prior to the issuance of shares, whereas the AO has taken the values as on 31.03. 2016.
It is due to these limitations that the method of calculation of NAV of unquoted shares was amended by the Finance Act, 2018, and CBDT issued Notification no. 61 of 2017 dated 12.07.2017 whereby the formula given in Rule 11UA was changed. In the new formula the value of immovable property adopted for payment for stamp duty has to be taken instead of the book value. Even though the new formula prescribed by the said notification is not effective for the relevant AY 2017-18 it acknowledges the shortcomings of the old formula of NAV in pre-amended Rule 11UA."
8. The ld. DR had submitted that the order passed by the ld.CIT(A) is bad in law and the entire finding of the ld.CIT(A) is based on incorrect understanding of the facts and law.
9. In support of his case, ld. DR had filed written submissions. The relevant portion of the written submissions reads as under :
C. SUBMISISONS OF THE DEPARTMENT:
I On legislative intent
1. The Finance Bill, 2012 amended Section 56(2) by including a new clause (viib). Clause (viib) states that if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income-tax under the head "Income from other sources". (Amended section at Pg. 2 of the material paper book)
2. The memorandum to Finance Bill, 2012 goes on to clarify that the claim of the company regarding the fair market value must be substantiated based on value of its assets, goodwill, patents, copyrights etc. (Pg. 3 of the material paper book) 8
3. The department submits that Section 56(2)(viib) places an onus on the assessee to substantiate the valuation of shares to the satisfaction of the AO.
4. If the assessee is not able to substantiate the valuation before the AO, the excess of consideration received over the fair market value is taxable as income from other sources u/s 56(2)(viib) of the I.T. Act.
5. While granting relief to the assessee, Ld. CIT(A) at Para-5.1 erred in holding that addition u/s 56(2)(viib) is not sustainable unless the AO establishes that the share premium received by the assessee was out of its own unaccounted money which was laundered and received back by it in form of share premium.
6. The department submits that the requirement to establish that the share premium was out of unaccounted money is nowhere stipulated in the Finance Bill, 2012.
7. A requirement on the AO, during the course of scrutiny, to first prove the existence of unaccounted money, and then only go on to apply provisions of Section 56(2)(viib), will only render the statute inoperative, futile and defunct.
8. The department prays to draw the attention of the Hon'ble ITAT to the ratio laid down by the Hon'ble Supreme Court in H.S. Vankani vs. the state of Gujarat, wherein the Hon'ble Court noted that:
"It is a well-settled principle of interpretation of statutes that construction should not be put on a statutory provision that would lead to manifest absurdity, futility, palpable injustice, and absurd inconvenience or anomaly."
9. The department submits that the interpretation of the Section 56(2)(viib) as brought out in Para-5.1 of the order of the Ld. CIT(A) is therefore incorrect.
II. On contents of the valuation report
1. The department prays to draw attention of the Hon'ble Bench to the Technical guide on valuation (revised edition 2018) published by the ICAI, a statutory body, responsible for standards of accounting applied for Indian financial statements.
2. The ICAI in the guide, lists the general principles to be borne in mind, which must find place in the valuation report (Pg. 16 to Pg. 19 of the material paper book).
3. As a general principle, the relevant sources of information must be clearly spelt out in the valuation report. (Para (e) of ICAI Technical guide).
4. Kind attention of the Hon'ble Bench is drawn to Pg. 11 of the material paper book, where the valuer states that:
9"In preparing our valuation, we had access to and relied on information based on:
• Discussions with the management of MLR Auto Limited. • Publicly available prices for raw materials and demand supply position of power generation industry and market research on the outlook of the industry."
5. It is pertinent to note that the assessee is a manufacturer of three wheelers and compact commercial vehicles. What relevance the market outlook of the power generation industry bears on the share valuation of the assessee company is beyond comprehension.
6. At Para(g) of the Technical guide, the ICAI lists the key valuation considerations, first among them being, a discussion on the financial projections of the company, highlighting main assumptions and management representations.
7. At this juncture, the department prays to draw attention of the Hon'ble Bench to the comparison of financial projections and the actual financials of the assessee company for the F.Ys. 2016-17, 2017-18 and 2018-19:
Table --1 : Turnover comparison F.Y. Projected Turnover Actual turnover Difference % Achieved 2016-17 Rs. 45,11,00,000 Rs. 13,75,06,063/- Rs. 31,35,93,937/- 30.48% 2017-18 Rs. 120,01,50,000/- Rs. 13,43,35,218/- Rs. 106,58,14,782/- 11.19% 2018-19 Rs. 210,69,88,000/- Rs. 14,83,84,703/- Rs. 195,86,03,297/- 7.04%
8. As is clear from the tabulation, there is a vast difference between the financial projections and the actual financials of the company.
9. The vast divergence of the projections from actuals raises pertinent questions with regard to the assumptions made by the valuer and representations made by the management, on basis of which the projections were arrived at.
10. The department prays to draw the attention of the Hon'ble Bench to Pg. 13 of the material paper book, where the valuer states that:
Assumptions for valuation
1. The Turnover of the company considered based on the Expected Market Prices as per available information with the company."
"Future Projections We have made the future projections for a period of 5 years from 2016 based on through discussions with the management of the MLR Auto Limited. We have not carried out any feasibility study on the projects to substantiate these projections. We do not give any assurance on the achievability of these projections."10
11. Further on Pg-14 material paper book, the valuer goes on to say that:
"In analysing information provided to us by the management, we have not carried out any tests to establish the accuracy of the statements and information provided by them. The statements and opinions included in this report are given in good faith and in the belief that such statements and opinions are not false or misleading.
12. The department submits that the valuation report is based only on the self serving statements furnished by the assessee company and the valuer has not made an independent application of mind.
13. The department submits that, the valuer, has blatantly violated the general principles considered critical for valuation, by the ICAI.
14. The department submits that in a catena of judgements, it has been held that, though share valuation is a technical exercise, courts must scrutinize the scheme for reasonableness, fairness and justifiability.
15. In particular, the department prays to draw attention of the Hon'ble Bench to the judgment of The Hon'ble High Court of Calcutta in Carron Tea Co. Ltd. (1966) 2 Comp U: 278 (Cal)], wherein it was held that:
"Although the question of valuation of shares and fixation of exchange ratio is a matter of commercial judgment and not for the court to judge it, yet the court cannot abdicate its duty to scrutinise the scheme with vigilance. It is not expected of the court to act as a rubber stamp simply because the statutory majority has approved the scheme and there is no opposition to it. The court is not bound to treat the scheme as a fait accompli and to accord its sanction merely upon a casual look at it. It must still scrutinise the scheme to find out whether it is a reasonable arrangement which can, by reasonable people conversant with the subject be regarded as beneficial to those who are likely to be affected by it."
[Emphasis supplied]
16. The same view was upheld by the Hon'ble Supreme Court in case of Hindustan Lever Employees Union vs. Hindustan Lever Ltd., (1994) 4 Comp U 267 (SC) where the court held that:
"It cannot be said that the internal management, business activity or institutional operation of public bodies can be subjected to inspection by the court. It is incompetent and improper to do so and, therefore, out of bounds. Nevertheless, the broad parameter of fairness in administration, bona fides in action and the fundamental rules of reasonable management of public business, if breached, will become justiciable. The court's obligation is to satisfy that the valuation has been in accordance with the law and the same has been carried out by an independent body"
[Emphasis supplied]
17. The department submits that the valuation report fails miserably in establishing the reasonableness and fairness of share valuation and hence ought to be rejected.
11III. On decision of Hon'ble ITAT, Delhi Bench in case of Agro Portfolio vs. ITO.
1. The department submits that the AO at Para-3.1 of his order, had placed strong reliance on the judgement in case of M/s Agro Portfolio vs. ITO, wherein the Hon'ble Bench had upheld the stance of the AO in rejecting the valuation based on DCF and re-computing the FMV using NAV method.
2. The department prays to draw the attention of the Hon'ble Bench to the similarities between the instant case and the case of M/s Agro Portfolio vs. ITO:
• No independent enquiry caused to verify the truth or otherwise for the figures furnished by the assessee.
• No evidences furnished to substantiate the basis of projections in cash flow • No reasonable connectivity between the projections and reality evidenced by material.
• The valuer solely relied upon assumptions without independent verification with regards to the truthfulness, accuracy and completeness of information and financial data provided by the company.
• The valuer did not do anything reflecting their expertise, except merely applying the formula to the data provided by the assessee.
3. While considering the reliance placed by the AO on the judgment in case of M/s Agro Portfolio, the Ld. CIT(A) erred in holding that, the valuer in assessee's case, has not made any disclaimer that the truthfulness, accuracy and completeness of the information provided by the company has not been verified independently and the valuer has relied on the same.
4. The department submits that, at more than one occasion, the valuer has reiterated that the valuation has been arrived based on the information supplied by the management and that no independent study/analysis has been made by it. (Pg. 13 and Pg. 14 of the material paper book).
5. The department submits that, on similar facts, ITAT Bangalore in its recent decision in case of M/s MobiCom Technolgies vs. ITO, Ward-4(1)(4) dismissed the appeal of the assessee and confirmed the addition made by the AO u/s 56(2)(viib). (Pg. 20 to Pg. 32 of the material paper book) IV. On efficacy of NAV method
1. The assessee has stated that NAV method lacks in not considering:
i. Valuation of Intangible asset in brand name 'Teja', which is not included in the balance sheet.12
ii. Revision of circle rates in Balanagar where the new plant of the assessee is located.
2. The department submits that, these considerations don't find mention in the assumptions made for purpose of valuation in the report of the valuer.
3. The valuation report is silent on the valuation of the intangible asset 'Teja' and the impact of revision of circle rates in Balanagar.
4. The department submits that, perusal of the valuation report raises legitimate concerns about the valuation arrived at, using DCF method. Finding faults with valuation using NAV is only a diversionary tactic to draw attention away from the faults of DCF.
V. On subsequent amendment of the Act
1. Vide Notification No. 61/2017 dated 12.07.2017, Rule 11UA was modified to consider the value of immovable property adopted for payment of stamp duty instead of the book value.
2. The amendment of the Act was prospective and hence does not apply to the year in question."
10. The ld. DR has drawn our attention to the valuation report submitted by the assessee, which was filed along with the written submissions, based on the report it was contended, valuation report prepared by the auditor, was not in accordance with the law and he has drawn our attention to the valuation report dt.01.07.2016, which is to the following effect :
"Valuation of equity shares :
Selection of Valuation Methodology It is our opinion that the DCF approach would be an extremely appropriate valuation methodology for the Auto and Motor Industry as it captures the revenue streams based on the actual output and hence revenue streams of the company and linked costs (both variable and fixed) taking into consideration the future estimated demand and prices.
Further, the project is under implementation and yet to commence commercial operations, we have adopted discounted cash flow method for the valuations of shares of M.L.R. Auto Limited. Future projections:
We have projected the revenue streams and cash flow requirements for the purpose of the valuation 6 years Projections considered based on in-depth and thorough research with the company.
• Discussions with the management of MLR Auto Limited.13
• Publicly available prices for raw material and demand supply position of power generation industry and market research on the outlook of the industry."
11. The ld. DR had also drawn our attention to page 13 wherein it was mentioned as under :
"Future projections:
We have made the future projections for the period of 5 years from 2016 based on through discussions with the management of the MLR Auto Limited. We have not carried out any feasibility study on the projects to substantiate these projections. We do not give any assurance on the achievability of these projections"
12. The ld. DR had also drawn our attention to page 14 wherein it was mentioned as under :
"Exclusions and Limitations of the Study :
• The study did not include the followings :
▪ An audit of the financial of the company.
▪ Financial Restructuring of the Business ▪ Carrying out a market survey / financial feasibility for the business.
▪ Financial and Legal due diligence.
• In analyzing information provided to us by the management, we have not carried out any tests to establish the accuracy of the statements and information provided by them. The statements and opinions included in this report are given in good faith and in the belief that such statements and opinions are not false or misleading. This report has been prepared solely for the purpose set out in this report and is valid only for a limited period of time. The information contained in this report may not be relied upon by anyone other than the management of MLR Auto Limited in any matter or reproduced (in part or otherwise) in any other document whatsoever without the prior written consent of Machiraju & Associates.
• The Conclusions reached by us are dependent on the information provided to us being complete and accurate in all material respects. Our scope of work is in the nature of equity / business valuation only.14
• Though prospective investors may have knowledge of the contents of this report, they need to exercise their judgment and may get their own due diligence done prior to making an investment."
13. The ld. DR further submitted that the valuation report prepared by the assessee at the time of allotting shares was not in accordance with law due to the following reasons :
• as there is no independent verification of the variables / terminal values made by the auditor at the time of submitting the valuation report.
• In fact, the valuation report was based on mere discussion with the management of the assessee, and no empirical data of the industry or growth trend of the assessee was considered.
• Report was based on prices for raw material, demand and supply position of power generation industry and comparable industry, industrial growth that was examined by the auditor.
14. Therefore, in the absence of these data, it is not possible to accept the valuation report prepared by the assessee. It was submitted that the Assessing Officer rightly rejected the valuation report prepared by the assessee. Once the Assessing Officer rejected the valuation report prepared by the assessee, then the only option left with the Assessing Officer was to follow the NAV method as per 11U r.w. 11UA. The ld. DR submitted that the appeal of the revenue is required to be allowed.
14.1 Per contra, ld. AR has drawn our attention to the order passed by the ld.CIT(A). It was submitted that the ld.CIT(A) has rightly held that as per the scheme of the Act, the assessee was given the option to do valuation either by DCF method or NAV 15 method. Once the assessee has opted for DCF method then the revenue authorities have no authority to twinkle or challenge the method applied by the assessee. In fact, in the present case, it is the contention of the assessee that the Revenue has not brought out any reasons, much less plausible, now raised before the Tribunal by challenging the valuation report in the assessment order. The ld. AR has drawn our attention to para 3 of the assessment order wherein the reasons were given by the Assessing Officer, which read as under :
"3.1.......
The contentions of the assessee company are examined and found untenable as the DCF method it has adopted is quite unrealistic and inapplicable to the terms and provisions of the Income Tax Act and Rules, the same can be envisaged from the working results of sales it has projected for future years as already discussed above. Hence, I deem fit to discard the DCF method adopted by the assessee company as per Explanation (a)(ii) to Section 56(2)(viib) on the grounds that the method is totally impracticable, inapplicable, unreliable and unrealistic to the present case basing on the ground reality of its financials and that the assessee- Company has presently incurred losses. Accordingly, the FMV has to be calculated as per the provisions of Section 56(2)(viib) of the Act read with Rule 11UA(2)."
15. The contention of the ld. AR is that the valuation report prepared by the assessee was in accordance with the guidelines issued by the Institute of Chartered Accountants and the objections raised by the ld. DR are vague and nothing has been specifically pointed out with respect to violation of the guidelines issued by the ICAI. The ld. AR also filed the written submissions in support of the case of the assessee at page 1 to 16 of the paper book which was mentioned as under :
"1. The Respondent is a company registered under the Companies Act, -20.13; The Respondent is in the business of manufacturing Three Wheelers under the brand name "TEJA". The Respondent for the impugned assessment year 2017¬18, had filed-the return of income on 30/10/2017; admitting Rs. NIL as income and carrying forward current year loss of Rs. 14,32,93,315/-. The Respondent revised the return of income on 16 28/03/2018, admitting Rs. NIL as income and _carrying forward current year loss, of Rs. 14,32,93,315/-, the acknowledgment copies of the original return and revised return are enclosed herewith and marked as Annexure - 1 Et 2.
2. The Respondents case was selected for scrutiny and statutory notices under section 143[2] and 142[1] of the Act, was issued and served on the Respondent. In response to notices issued by the learned Assessing Officer, the Respondent submitted information and explanation through ITBA portal.
3. After examining the information and details furnished by the Respondent, the learned Assessing Officer completed the assessment and .passed the order under Particulars Amount (Rs.) Returned income NIL Additions
i) Excess premium treated as income from other sources u/s 56(2)(viib) of the Act. 3,16,05,000
ii) Employee PF Contribution 18,79,427 disallowed u/s 2(24)(x) of the Act Total additions 3,34,84,427 Losses of current year to be carried forward (14,32,93,314) Loss assessed (10,98,08,887)
4. The Respondent aggrieved by the order of the learned Assessing Officer preferred an appeal before the Honorable Commissioner of Income-tax (Appeals) - 4, Hyderabad, (hereinafter referred to as Honorable CIT(A)'s). The Honorable CIT(A)'s, partly allowed the appeal preferred by the Respondent and disposed of the order vide Appeal No. 10650/19-20/DCIT, Cir-16[2]/CIT[Aj-4/Hyd/20-21, dated 14/08/2020.
5. Aggrieved by the order passed by the Honorable CIT(A)'s, Revenue has preferred an appeal, before the Honorable Tribunal on 19/02/2021.
6 The brief facts of the case are as under:
a. During the impugned assessment year 2017-18, the Respondent had issued 35,00,000 shares.
b. The Respondent issued shares. "at Rs. 19.90/- per share, the face value of share is Rs. 10/-, and premium of Rs. 9.90/- per share.17
c. The Respondent arrived at the share value of Rs. 19.90/- per share by applying Discounted Cash Flow method (hereinafter referred to as DCF method).
d. The learned Assessing Officer discarded, the DCF method adopted by the Respondent and 'applied Net Asset-Value method (hereinafter referred to as - NAV method) and arrived at Rs. 10.87/- per share.
e. The learned , Assessing Officer arrived at the excess 'premium of Rs. -.3,16,05,0001-, being difference between the: valuation as per DCF and NAV method and charged as income under section 56[2][viib] of the Att.
f. The Honorable CIT(A)'s deleted the' addition of Rs. 3,16,05,000/-
7. Whether the learned Assessing Officer is justified in making an addition of Rs. 3,16,05,000/- by invoking the provision of section 56(2)(viib) of the Act. 7.1 'The Respondent is a company registered under the Companies Act 2013, the Respondent is in the business of manufacturing Three Wheelers under the, name and style TEJA. The Respondent during the impugned assessment year 2017-18, had issued 35,00,000 shares for a consideration of Rs. 19:90/- per share. The Respondent had received a total consideration of Rs. 6,96,50,000/-.
7.2 For the impugned assessment year 2017-18, the - Income Tax Rule 11UA[2][b] provides for determination by an accountant fair market value of the unquoted equity shares as per thee DCF method. The Respondent had appointed an independent
-accountant who vide report dated 01/07/2016, 'had determined the fair market value of the share of the Respondent company by applying DCF. method and arrived at a value of Rs. 19.90/- per share, the copy of the report is enclosed herewith and marked as Annexure - 3, 7.3 The Respondents case was selected for scrutiny and statutory notices under section 143[2j and 14211] of the Act; was issued and served on the Respondent. The learned Assessing Officer completed the assessment by dismissing the DCF method applied by the Respondent. The learned Assessing Officer applied the NAV method and arrived at the value of share at Rs. 10.18/- per share. The difference in the value of Rs. 9.03/7 (i.e.) Rs. 19.90
- Rs. 10.87/-, was charged by the learned assessing officer as income under the head other sources by invoking the provisions of section 56[2][viib] of the Act. The learned Assessing Officer justified-the, disallowance. by observing that:
"The contentions of the assessee company are examined and - found- untenable as the DCF method it has adopted is quite unrealistic and inapplicable to the terms and provisions of the - Income 'Tax Act and Rules, the same can be envisaged from the working results of .sales it has projected for future years as already discussed above. Hence, I deem fit to discard the DCF method adopted by, the assessee company as per Explanation
(a),(ii) to section 56(2)(viib) on the grounds ,that the method is totally impracticable, inapplicable, unreliable and unrealistic to the present case basing on the ground reality of its financial 18 and that , the assessee-Company has presently incurred losses.
Accordingly, the FMV has to be calculated as per the provisions of Section 56(2)(viib) of the Act read with Rule 11UA(2)." (Emphasis Supplied) 7.4 'The learned Assessing Officer by observing the above, disallowed the amount of Rs. 3,16,05;000/-, the share premium received and treated the amount of Rs. 3,16,05,000/-, as "Income from Other sources" by invoking the provisions section 56[2][viib] of the Act. Aggrieved by the order of the learned Assessing Officer the Respondent had preferred an appeal before the Honorable CIT(A), who deleted the addition by observing that:
"Hence, the price at which the Company agrees to issue its shares to the equity investor is a decision based on numerous factors and the NAV method of Computation is too simple a mathematical formula to cover all relevant concerns of a prudent business decision-maker. Therefore, the Use of 'NAV method for valuing the share equity of the appellant Company was correctly found unsuitable by the appellant Company.- The AO while computing the NAV of the shares of the appellant Company would have failed to do anything to overcome the above-mentioned limitations since the Rule 11UA does not give him any scope to do so.
Secondly, since the purpose is to value the fair market value of the shares issued by the appellant it is logical ,that AO should take book value of assets & liabilities paid up-equity shares and value of paid-up .equity, i.e. A, L, PE, PV in the above formula, immediately prior to the issuance of shares, whereas the Assessing Officer has taken the values as on 31/03/2016.
Therefore, in view of the above discussion, it is held that the AO has erred in rejecting the. DCF valuation of FMV of the shares as submitted the appellant company and computing the FMV using NAV method. Accordingly, the addition of Rs.3,16,05,000/-, made by the AO u/s. 5612R-viibj is hereby deleted" (Emphasis Supplied) 7.5 Aggrieved by the order the Honorable CIT(A), the Department has preferred this appeal by raising various grounds. The Respondent files this- written submission denying the allegations levied' by the learned Assessing Officer and supporting the order of the Honorable CIT(A).
7.6 The Respondent submits that, the valuation report was obtained from Shri Machiraju Ramesh, of M/s. Machiraju & Associates, Chartered Accountants, Hyderabad, where the value of the shares of the Respondent Company was recommended at Rs.19.90/-, per share as per DCF method but the learned Assessing Officer adopted NAV method.
7.7 The learned Assessing Officer has discarded the valuation report of, the - Chartered Accountant mainly On the ground that valuation of the equity, shares carried out by the Responded was based on projection of revenue which did not match With the actual-revenues of the subsequent years. The learned Assessing Officer further held that the Respondent could 19 not provide any satisfactory explanation for allowing excess share premium received under the year consideration over and above the FMV other than submitting the certificate issued by the Chartered Accountant.
7.8 The learned Assessing Officer is trying to evaluate the accuracy of the valuation at the time of assessment, this is hot proper and also the factual is based on so many facts subsequent to adoption of projections and valuation.
7.9 The Respondent had submitted before the learned Assessing Officer all the details of the shares issued such as confirmation, information and documents pertaining to transaction, of issuance of shares. The investors made the investment after they have gone by the projections and satisfied with the potentials and credentials of future growth of the Respondent company, based on the potentials and credentials the investors have made such huge investment in the Respondent. Company. Thus, neither the identity nor the creditworthiness of the investors nor the genuineness of the transactions can be doubted arid in fact the same stands fully established to which the learned Assessing Officer has also not raised any doubt or disputed this fact. Thus, under the deeming provisions of Section 68, the test of proving the nature and source of the credit received stood accepted.
7.10 The Respondent humbly submits to reproduce the object behind section 56[2][viib] of the Act as under:
"14. Section 56(2)(vilb) 'was introduced vide the Finance Act, 2012 with effect from the A.Y. 2013-14 with an intent to deter the generation and use of unaccounted money. In this regard, - reliance is placed on the Finance Minister's-'Budget Speech given at the time of introduction of the Finance Bill, 2012. Para 155 of the Budget Speech is reproduced-
155. I propose a series of measures to deter the generation and use of -unaccounted money. To this-end, I propose increasing the onus of proof on closely held companies for funds received from shareholders as well as taxing share premium in excess of fair market value."
7.11 Your Honors may consider the spirit and intentions of the legislature in introducing such a deeming provisions and submitted that such a provision cannot be invoked on a normal business transaction of issuance of shares unless it has been demonstrated by the Revenue authorities that the- entire motive for such issuance of shares an higher premium was for the tax 'abuse with the laundering the Respondents own unaccounted money.
7.12 The Respondent wishes to reproduce Rule 11UA of the Income-tax ,Rules, 1962, as under:
Rule 11UA of the Income-tax Rules, 1962, prescribes the following method for determining the valuation of unquoted shares:
(1) For the purpose of section 56 of the Act, the fair market value of a property, other' than immovable property shall be determined in the following manner, namely:-
(a).........20
(b)........
(2) Notwithstanding anything contained in sub-clause
(b) of clause (c) of sub-rule (1) the fair market value of 'unquoted equity shares for the purposes of sub-clause (i) of clause (1) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b) at the option of the assessee, namely:-
(a).........
(b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.] 7.13. Section 56[2][viib] of the Act, is a deeming provision and one cannot expand the meaning of scope of any word while interpreting such deeming provision. The statute provides that the valuation has to be done as per the prescribed method and if one of the 'prescribed methods has been adopted by the Respondent, then the learned Assessing Officer has to accept the same, and in a case he is not satisfied, then there is no express. Provision under the Act or Rules, where the learned Assessing Officer can adopt his own valuation. There has to be some enabling provision under the Rule or the Act where the learned Assessing Officer has been given a power to tinker with the valuation report obtained from an-
independent valuer as per the qualification given in the Rule 11U. 7.14 In the Respondents case, the learned Assessing Officer has disapproved the DCF method and rejected by comparing the projections with actual figures. It is submitted, that the Rules. provide for two valuation methodologies, One is asset-based NAV method Which is based on actual numbers as per latest audited financials of the 'Respondent. Company, the other is DCF method, the value is based on estimated future projections. These projections are based on various facts and projections made by the management and the valuer, like growth of the company, economic / market conditions, business conditions, expected demand and supply, cost of capital and host of other factors. 7.15 These factors are considered based on some reasonable approach and they cannot be evaluated. purely'-based on arithmetical precision as value is always worked out based on approximation and catena of underline facts and assumptions:
Nevertheless, at the time when valuation is made,, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and thus, the value which is relevant today may not be relevant after certain period of time.
7.16 Reliance is placed on the judgment of the Honorable Bombay High Court in the case of Securities and Exchange Board of India arid Other in Company Application No. 124, 125 of 2013, dated 10/09/2015, where it was held that:
"48.6 Thirdly, it is a well settled position of law with regard to valuations, that valuation is not an exact science and can never be done :with arithmetic precision. The attempt on- the part of SE81 to challenge the valuation which is by its very nature based on projections by applying what is essentially a hindsight 21 view that the performance did not match the projection is unknown to the law on valuations.. Valuation being an exercise required to be conducted at a particular point of time has of necessity to be carried out on the basis-Of whatever information is available on the date of the valuation and a projection of future revenue that 'the valuer May fairly make on the basis of such information."
(Emphasis Supplied) 7.17 Reliance is 'placed on the judgment of the Honorable Income Tax Appellate Tribunal, Delhi Bench in the case of Mantram Commodities (P) Ltd., Vs. ITO [2021] 188 ITD 687, where it was held that :
"However, in the instant case, the assessee has issued the shares at fair market value computed in accordance with Rute,11UA(a) of the Income Tax Rules, 1962 and no fault has been found in the method applied by the assessee and the lower authorities .have made the addition under section 56(2)(viib) purely on presumptions and surmises. Therefore, in my considered opinion, Such action of the .lower authorities, being not in accordance with law is unsustainable I, therefore; - set' aside the order. of the Commissioner (Appeals) and direct the assessing, officer to delete the addition. The grounds raised by the assessee are accordingly allowed.
18. In the result, the appeal filed by the assessees is allowed."
(Emphasis Supplied) 7.18 Reliance is. placed on the judgment of the Honorable Income Tax-Appellate Tribunal, Mumbai Bench, in the case of Vodafone M- Pese Limited Vs. DCIT [2020] 181 ITD 242, where it was held that:
"20. Corning to the findings of. learned Commissioner (Appeals), We notice that learned Commissioner (Appeals) has accepted the DCF method adopted by the assessee and he analyzed the factual performance of the assessee subsequent to issue of shares. The valuation of shares are for that matter any Valuation is itself is a projection of future events or activities and no doubt it has to be done with some accuracy, however no person in the world at the time of projecting events or result to project with 100% of accuracy and actual events are highly volatile and highly dependent on so many factors. Assessee has projected based on the fact-that software of wallet and association of ICICI bank will increase the market shore and accordingly, they have projected the figures and further the valuer has adopted the projection figures provided by the assessee and it is left to the 'wisdom of Valuer 'to accept or reject or to carry out independent investigation raised with the valuer and legislature in more than one plate depends on the skills of the professionals like merchant banker only to value the valuation of shares or other volatile securities. Since, learned Commissioner (Appeals) has compared the factuals with projections and assessee has; achieved, 40% of 'the actual results-is too. harsh to the assessee and the valuation is done 'in order to-carry out certain activities by the Management. In this case, the valuation was used to issue of right shares. The assessing officer or learned Commissioner (Appeals) is trying to 22 evaluate the accuracy of the valuation at the time of assessment, factors subsequent adoption of projection and valuation. Accordingly, we are not in a position to accept the - method adopted by learned Commissioner (Appeals)."
(Emphasis Supplied) .
7:19 Reliance is placed on the judgment of the Hon'ble Income Tax Appellate Tribunal Jaipur Bench, in the case of Rameshwaram Strong Glass Private Limited Vs. ITO 2018 TaxPub (DT) 5780 (Jp- Trib), where it held that :
"4.5.2 Before examining the fairness or reasonableness of valuation report submitted by the, assessee, we have to bear in mind that the DCF Method, and is essentially based on the projections (estimations) only and hence these projection cannot be. compared with the actuals, to expect the same figures as were projected. The valuer has to make forecast on the-basis of some material but to estimate the exact figures is beyond its control. At the time of making a valuation for the purpose of determination of the fair Market value, the past, history may or may not be available in a given case and therefore, the other relevant factors may be considered. The projections are affected by various factors .hence in the case of company where, there is no commencement of production or of the business, does not mean that its share cannot command any premium. 'For such cases, the concept of startup is a good example and as submitted, the Income Tax Act has also recognized and is encouraging the startups for which, a separate deduction under section 80IAC has been provided."
(Emphasis Supplied).
7.20 Reliance is placed on the judgment of the Honorable jurisdictional Tribunal in the case of DQ (International) Ltd. Vs. 'ACTT 2016 Tax Pub (DT) 3650, where it was held that:
"10. In our considered view, for valuation of an intangible asset, only the future projections along can be adopted and such valuation cannot be reviewed with actuals after 3 or 4 years down the line. Accordingly, the grounds raised by the assessee are allowed."
(Emphasis Supplied) 7.21 It is further submitted that the Respondent had during the impugned assessment year 2017-18 issued 35,00,000 shares of face value of Rs.10/- at Rs.19.90/- per share which include premium of Rs.9.90/- per share. The fair market value as per valuation in accordance with Rule 11UA(2)(b) was Rs.19.90/- per share and the Respondent had issued shares at Rs.19.90/-, which is at par with the fair market value, hence, no amount was required to be taxed as income from other sources under section 56[2][viib] of the Act. It is humbly submitted 'that it' is prerogative of the Respondent to estimate the fair Market value of shares issued by the company by adopting one method out of two methods. In the case on hand the Respondent had determined the fair market value as per discounted free cash flow method as prescribed under rule 11 UA[2] [b] of the Act.
237:22 Reliance is placed on the judgment of the Honorable income Tax Appellate Tribunal Cuttatk Bench, in the case of ITO Vs. Ashoka Industries Limited (2020) 185 ITD 629, where it was held that :
"9. We have heard the rival submissions and perused the relevant materials placed on the record of the Tribunal. In this case, the assessee had issued 2,00,000 equity shares of face value of Rs. 10 to One M/s. Enbee Resources (P) Ltd., on 7-1- 2003 at Rs.180 per share which included premium of Rs.170 per share. It is 'the explanation of the assessee that since the fair market value as per the valuation in accordance with rule 11UA (2)(B) was Rs.189 and the assessee had issued shares at Rs.180 including premium of Rs.170, which is less than the fair market value, no amount was required to be taxed as income from other sources 'under section 56(2)(viib) of the Act. As per rule 11UA(1)(c)(b) of the Rules, it is the prerogative of the assessee to estimate the fair market value of the shares issued by it adopting one method out of two methods i.e. discounted cash flow method or book value, method. The, revenue authorities cannot force the assessee to adopt particular method for valuing the fair market value of the, share especially when rule 11UA(1)(c)(b) provides that it is the option of the assessee to chase any method-either discounted or book value 'method for estimating the fair Market value of the shares issued by it during the relevant financial period. In this case, the assessee has adopted the discounted free cash flow, method as prescribed under rule 11 UA(2)((b) of the Act."
(Emphasis Supplied) 7.23 - Without prejudice to the above, the Respondent submits that the land Available. in the books of account maintained by the Respondent is shown on historical cost at Rs. 2,87,48,985/-, as at 31/03/2007. The land at Toopranad measuring 25 acres was allotted / purchased on 30/06/2011, for a total consideration of Rs. 2,87,48,985/-, the fair market value as per the Government circle, rate is Rs.5,000/- per square meter the total cost of land came to Rs.50.58 crores and, therefore, the value per share comes to Rs.25.16, the details of which are tabulated as under:
Particulars Amount in (Rs.)
FMV of the assessment (land at Toopran) 50,58,55,000
Other assets 69,18,62,249
Total assets 119,77,17,249
Total liabilities 31,27,16,662
Net assets 88,20,01,587
Equity Shares 3,65,00,000
Value of shares 24.16
24
7.24 The Respondent further submits that as against the fair market value of shares' at Rs. 24.16 per share, the respondent has issued the shares at Rs. 19.90 per share, Which 'include share value at par of Rs. 10/- per Share and a premium of Rs. 9.9.0 per share. Therefore, no addition under section 56[2][viib] Of the Act, is called for. The Explanation to provisions of section 56[2][viib] reads as under:-
"Explanation--For the purposes of this clause,--
(a) the fair market value of the shares shall be the value-
(i) as may be determined in accordance with such method as may be prescribed; or
(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value; on the date of issue of shares, Of its assets, including intangible assets being goodwill, know.-how, patents, copyrights, trademarks, -
licenses, franchises or any other business or commercial rights of similar nature, whichever is higher-;"
7.25 As per clause [a] of the Explanation, the fair market value of shares shall be value as may be determined in accordance 'with the methods prescribed. The method for this purpose is prescribed under Rule 11 UA of the Income-tax Rules. Sub-rule [2] of Rule 11 UA of the Income-Tax Rules, prescribes two methods of computing the 'fair market value of shares and an option is given to the Respondent for adopting the value by applying either of the two methods. The first method is based on the net worth of the company and the second method is based on the fair market value as determined by a Merchandise banker or an Accountant as per the Discount Free Cash Flow Method.
7.26 Thus, as per the first method, the assets are to be taken as per the book value of the assets shown In the Balance Sheet and, therefore, this method does not prescribe the fair market price of the asset. The fair market value of the shares as per clause [ii] of Explanation [a] to section 56[2][viib] of the Act; has to be taken based on the value .of -the .assets including intangible assets of the company as on the date of issue of shares which connotes that the value as on the date of issue and not as per the book value or at cost. Hence, the fair market value of the shares has to be computed by taking the market value of the assets of the Respondent company as on the date of issue of shares. 7.27 As per the statement tabulated supra as against the fair value of share at Rs. 24.16 per share, the-Respondent has issued the shares at Rs. 19.90 per share which includes Rs. 10/- per share as par value and 'a premium of Rs.9.90 per share, therefore, no addition under section 56[2][viib] of the Act, is called for. It is further submitted that valuation of shares has to take into consideration various facts and not simply on the basis of financial statements of the Respondent company. The fair market value of 'the shares has to be taken based on the assets as on the date of issue of shares which connotes that the Value as on the date of issue and not as per the book value., 25 7.28 It is humbly submitted that the substantiation of the fair market value of the shares has to be first decided on the basis of the valuation done by the Appellant; and it cannot foe decided from the lens of section 11.11A which can be applied in case sub- clause [1] has been exercised, It has been held that fair market value can be determined in either of the two manners whichever is higher so as 'to demonstrate that the value of shares does 'not exceed the fair market value and then the learned Assessing Officer cannot insist upon to follow-only one particular method. 7.29 Reliance is placed on the judgment of the 'Honorable Income Tax Appellate Tribunal, Delhi bench, in the case of M/s. India Convention and Cultural Centre Private Limited Vs ITO in ITA No. 7262/Del/2017, dated 27/09/2019, where it was held that:
"We, therefore, find merit in the argument of the Id. counsel for the assessee that the valuation of the shares should be made on the basis of various factors and not merely on the basis of financials and the 'substantiation of the fair market value on the basis of the valuation done by the assessee simply cannot be rejected where the assessee has demonstrated with evidence that the fair market value of the asset is much more than the value shown in the balance sheet. The order of the CIT(A) is accordingly set aside, and the grounds raised by the assessee are allowed. 13. In the result, the appeal filed by the assessee is allowed."
(Emphasis Supplied) 7.30 Wherefore in view of the above submissions it is humbly prayed before your Honors to uphold the order of the Honorable CIT(A), in which the Honorable CIT(A)'s has deleted the addition of Rs. 3,16,05,000/-, made by the learned Assessing Officer -by invoking the Provisions of section 56[2][viib] of the Act, for substantial cause of justice and relief.
8. It is humbly prayed before your Honors to hold that:
a. the Assessee Company is given all option of determining the value on valuation date of an unquoted equity share as per NAV method or DCF method;
b. the Assessee Company's shares were valued by an independent Chartered Accountant who had given the valuation report by opting-DCF method;
c. the shares of the assessee company were issued at a rate of Rs. 19.90 per share, which is as per the valuation report;
d. It is the prerogative of the Assessee Company to adopt one method out of two methods, the learned. Assessing Officer cannot force the Assessee to adopt particular method for valuing the fair market value nor the learned Assessing Officer can adopt different method to arrive at the addition of Rs.3,16,05,000/-, by invoking the provisions of section 56[2][viib] of the Act, the addition made by the learned Assessing Officer is wrong and does not have legs to stand the test of law;
26e. the Honorable CIT(A)'s has rightly deleted the addition made by the learned Assessing Officer of an amount being Rs. 3,16,05,000/-, by invoking the provisions of section 56[2][viib]of the Act;
f. without prejudice to the above, the valuation of shares should be made on the basis of various facts and 'not merely on the basis of financials;
g. the value of the land has to be calculated as per the current fair market value and not on the historical cost shown in the balance sheet;
h. the assessee company has rightly arrived at the value of share at Rs. 24.16 per share, after considering the value of land at Rs.50.58 crores, the shares allotted by the Assessee Company is at Rs. 19.90 per share, which is less than the fair market value derived by NAV method, hence, the addition of Rs. 3,16,05,000/-, by invoking the provisions of section 56[2][viib] of the Act, is bad in law and needs to be deleted.
9. The appellant craves leave of this Hon'ble Tribunal to file the details and -documents in .support of the case of the appellant at the time of hearing of the appeal by this Hon'ble Tribunal in the interest of justice and equity."
16. In support of the case of assessee, the ld. AR has relied on the following decisions :
1. Mantram Commodities (P) Ltd Vs. ITO - (2021) 188 ITD 687.
2. Vodafone M-Pese Limited Vs. DCIT - (2020) 181 ITD 242.
3. Rameshwaram Strong Glass Private Limited Vs. ITO - 2018 Tax Pub (DT) 5780 (Jaipur Tribunal)
4. DQ (International) Ltd. Vs. ACIT - 2016 TaxPub (DT) 3650.
5. ITO Vs. Ashoka Industries Limited - (2020) 185 ITD 629.
6. India Convention and Cultural Centre Private Limited Vs. ITO (ITA No.7262/Del/2017)
17. We have heard the rival submissions and perused the material on record. The present case determines the FMV of the shares issued to the assessee. The relevant provision of section 56(2)(viib) and Rule 11U and 11UA of Income Tax Rules provides as under :
27"Income from other sources.
56(2) (viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:
Provided that this clause shall not apply where the consideration for issue of shares is received--
(i) by a venture capital undertaking from a venture capital company or a venture capital fund; or
(ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.
Explanation.--For the purposes of this clause,--
(a) the fair market value of the shares shall be the value--
(i) as may be determined in accordance with such method as may be prescribed9; or
(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;
(b) "venture capital company", "venture capital fund" and "venture capital undertaking" shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause (23FB) of section 10;"
"Meaning of expressions used in determination of fair market value.
11U. For the purposes of this rule and rule 11UA,--
1** ** **
(b) "balance-sheet", in relation to any company, means,--
17.1. The conjoint reading of Section 56(2)(viib) and Rule 11U and 11UA makes it abundantly clear that in case assessee exercised his option for determination of the fair market value of the shares and exercise then such decision of the assessee shall be final and binding on the assessing officer. The option was given by the Act to the assessee either to apply the DCF method or net asset valuation method, this option is not available to the 28 assessing officer. Rule 11UA provides the method of determining the FMV of a property other than the immovable property. Rule 11UA(2) reproduced hereinabove provides the method of providing the FMV of unquoted shares to be determined at the option of the assessee.
17.2. Once the assessee applied particular method of valuation, (in the present case DCF method), then it is the duty of the Assessing Officer / ld.CIT(A) to scrutinize the valuation report within the four corners or parameters laid down while making the valuation report under DCF method only. It is not permissible for the Assessing Officer to reject the method opted by the assessee and apply a different method of valuation and the Assessing Officer can definitely reject the valuation report but not the method. In case, the AO rejected the valuation report, then the AO has to carry out a fresh valuation report by applying the same valuation method and determine the fair market value of the unquoted shares.
18. Therefore, in our view, the Assessing Officer was incorrect in concluding that the DCF method is "quite unrealistic and inapplicable" to the terms of the Income Tax Act. On the contrary, the DCF method is quite applicable and was required to be applied by the Assessing Officer to determine the FMV of the unquoted shares. Our above conclusion is based on the bare reading of the provisions reproduced hereinabove and also on account of the decision referred by the Tribunal in the case of Innoviti Payment Solutions Pvt. Ltd. Vs. ITO reported in (2019) 102 taxmann.com 59 (Bangalore Trib), [ wherein one of us is the cosignatory] wherein the said Tribunal has held as under :
29"6. We have considered rival submissions and gone through the material available on record. We find that there is no dispute on this factual aspect that the certificate issued by the Chartered Accountant is on the basis of information about future projections provided by the management and it could not be conclusively established by the assessee that such projection/estimation by the management is on a scientific basis although an attempt was made in this regard.
7. In view of this factual position, we first examine the law on this issue and also take note of the guidelines issued by research committee of The Institute of Chartered Accountants of India (ICAI) as reproduced by CIT (A) in Para 4.6 of his order. We first reproduce the provisions of section 56 (2) (viib) and Rule 11U & 11UA as under:--
"Income from other sources.
56(2) ---
..........
8. Now we reproduce Para 4.6 from the order of CIT (A) because in this Para, learned CIT (A) has reproduced the relevant portion of 'Technical guide on Share valuation (issued in 2009) by research committee of The Institute of Charted Accountants of India (ICAI). The same is as under:--
"4.6 In order to examine this issue of valuation, it is important to know as to what is Discounted Cash Flow method. Relevant part of the information available on this issue in 'Technical Guide on share valuation' (Issued in 2009) by research committee of the institute of chartered accountants of India is reproduced as follows:
"1.1 The valuation of the shares of a company involves use of judgement, experience and knowledge. The accountant undertaking this work should possess knowledge of the analysis and interpretation of financial statements backed by a practical appreciation of business affairs and investments. A valuation based on quantitative information alone will not be adequate for a real valuation. It should also be recognised that the method of valuation of shares would vary, depending on the purpose for which it is to be used.
1.2 A clear understanding of the purpose of valuation is undoubtedly important, but an equally important imperative is to have a full appreciation of the 'value' emanating from common principles. This 'general purpose value' may be suitably modified for the special purpose for which the valuation is done. The factors affecting that value with reference to the special purpose must be judged and brought into final assessment in a sound arid reasonable manner.30
1.4 Valuation, being a complex subject, is limited to experts and is surrounded by a number of myths. Some of the very common generalities about valuation are discussed below:
(a) Valuation models are quantitative and focus on earnings, assets, etc. However, it does not necessarily imply that valuation is free from the subjectivity and bias of a valuer. The fact is that valuation models are driven by the inputs that are prone to subjective judgments and the bias of a valuer. For instance, a target company may typically tend to overvalue itself while valuing.
(b) Valuation is riddled with a commonplace notion that a detailed valuation exercise will provide a precise estimate of value. The truth is that any valuation is as good as its underlying assumptions, which, in turn, are the function of a number of present arid forward-looking factors. A careful valuation exercise, at best, can give an indicative range of value subject to the reasonableness of the assumptions.
(c) Valuation is pertinent to a particular point of time and varies with changes in business, industry and macroeconomic environment. E.g., the movement of US Dollar against Indian Rupee has led to a substantial change in the valuation of IT and other export-driven companies.
2.1 The potential earning power of a company is generally a paramount factor for valuation of share but there may be occasions, especially in valuations for compensation, where other considerations become relatively more important. In the absence of any other special motive, an investor is principally interested in a company's ability to continue earning profits.
2.4 The Income Approach indicates the value of a business based on the value of the cash flows that a business is expected to generate in future. This approach is appropriate in most going concern situations as the worth of a business is generally a function of its ability to earn income/cash flow and to provide an appropriate return on investment.
2.5 The Income approach includes a number of models/techniques, such as Discounted Cash Flow, Maintainable Profits Basis, Dividend Discount Model, and others, which are discussed in detail in the following paragraphs. 2.6 Discounted Cash Flow model indicates the fair market value of a business based on the value of cash flows that the business is expected to generate in future. This method involves the estimation of post-tax cash flows for the projected period, after taking into account the business's requirement of reinvestment in terms of capital expenditure and incremental working capital. These cash flows are then discounted at a cost of capital that reflects the risks of the business and the capital structure of the entity.
312.7 Discounted Cash Flow is the most commonly used valuation technique, and is widely accepted by valuers because of its intrinsic merits, some of which are given below:
(a) Theoretically, it is a very sound model because it is based upon expected future cash flows of a company that will determine an investor's actual return.
(b) It is based on expectations of performance specific to the business, and is not influenced by short-term market conditions or non-economic indicators.
(c) It is not as vulnerable to accounting conventions like depreciation, inventory valuation in comparison with the other techniques/approaches since it is based on cash flows rather than accounting profits.
(d) It is appropriate for valuing green-field or start-up projects, as these projects have little or no asset base or earnings which render the net asset or multiple approaches inappropriate. However, it is important that valuation must recognise the additional risks in such a case (e.g. project execution risk, lack of past track record, etc.) by using an appropriate discount rate.
2.8 Though the Discounted Cash Flow model is one of the widely used models for valuation because of its inherent benefits, it still has its share of drawbacks. Major shortcomings of this model are as follows:
(a) It is only as good as its input assumptions. Following the "garbage in, garbage out" principle, if the inputs - Cash Flow Projections, Discount Rate, and Terminal Value - are wide off the mark, then the value generated by using this model does not reflect the fair value.
(b) It does not take into account several other factors, such as investment risk associated with opportunity cost, i.e. investments that could return greater cash flow yields would add an unrealised element of risk, unforeseen variations in future cash flow, and other non-financial factors.
2.9 In this technique valuation of shares is based on three things:
Cash Flow Projections, Discount Rate and Terminal Value. 2.10 The first and most critical input of the Discounted Cash Flow model is the cash flow projections. As stated earlier, the Discounted Cash Flow value is as good as the assumptions used in developing the projections. These projections should reflect the best estimates of the management and take into account various macro and micro- economic factors affecting the business. Some of the important points to be kept in mind with regard to cash flow projections based on the projection of the profitability are stated below:
(a) Cash flow projections should reasonably capture the growth prospects and earnings capability of a company. The earning margins of a company should be determined based on its past performance, any 32 envisaged savings, pressure on margins due to competition, etc.
(b) Discontinuation of a part of the business, expansion programmes and any major change in the policies of the company may provide occasions for making a break with the past.
(c) The discontinuation of a part of the business can be easily dealt with by a valuer. A part of the profits earned by such business in the past will have to be excluded from the projections.
(d) The effect of expansion schemes can present more complex problems.
For these, the valuer will have to use his judgment about their profitability. The state of execution at the time of valuation should be given due consideration. Mere paper plans for expansion should not be taken into account. If reasonable indications of expected future profit are available, then such profits taken on a reasonable basis -- to take care of the risk and uncertainty involved - may be included in the projections of the company. If, however, the profits are expected to be realised after a lapse of some years or if material amounts have yet to be incurred before profits are realised, due consideration will have to be given to these circumstances. In such circumstances, separate value may be given to such new investments and the same is added to the value of the existing stream of business.
(e) In turnaround cases, the uncertainty of higher profits is much greater.
Careful evaluation of the steps actually taken to implement a turnaround strategy must be undertaken before a valuer accepts management's claims that in future the company will earn profits. If necessary, reports of technical or other consultants should be called for.
(f) In case of companies witnessing cyclical fluctuations, care should be taken to select the forecast period, which should necessarily cover the entire business cycle of a company.
(g) Effects of change in the policy of the company may be taken into account if such changes are known in advance and the effects are capable of being quantified. Changes in the utilisation of the productive capacity, changes in the organisational set-up, changes in the product-mix, changes in the financing policy are some examples of the situation that may have to be faced by a valuer. Their treatment in the projection of future profits will depend entirely upon the effect which in the opinion of the valuer, such changes will have on such future profits.
(h) An appropriate allowance must be made for capital expenditure in projections. They should not include capital expenditure only for capacity expansion or growth but also for maintenance of the existing capacity.
(i) Working capital requirement forms another important component.
Projections should appropriately account for working capital needs of the business in its different phases.
(j) Income tax outflow also impacts the value of a business and should incorporate any tax benefits like tax holiday, accumulated losses, etc. In making projections, notional tax calculated at the rates expected to be 33 applicable to the company in future should normally be deducted. For instance, the rate may change if the company is planning to undertake activities on which tax incidence is lower. Where such rates are not available, the current rates of taxes may be considered a good indicator. Tax benefits due to accumulated losses, accumulated development rebates or allowance, investment allowance, unabsorbed depreciation etc. should not generally be adjusted to the tax rate; instead, these should be considered separately. The past unabsorbed tax shelter is valued by using discounted cash flow method, for the actual years in which the tax shelter would be availed of a reduction in the effective tax rate due to exemptions for new industrial unit relief export profits etc., should be very carefully considered, depending on the period for which they would be available. A cautious valuer would perhaps compute an effective tax rate each year for the forecast period, based on the current year's tax rate and statutory deductions available and a reasonable view of profits.
Discount Rate 2.11 The next step in the Discounted Cash Flow model is the determination of an appropriate rate to discount future cash flows. Discount rate is the aggregate of risk-free rate and risk premium to account for riskiness of the business. Key inputs or adjustments for calculating the discount rate are discussed below:
(a) Theoretically, risk-free rate is the rate of return on an asset with no default risk. In practice, long-term interest rates on government securities are used as a benchmark.
(b) It is quite natural to assume that the riskier investments should have a higher return. This necessitates the incorporation of an appropriate risk premium in the discount rate. There exist a number of models for determination of risk premiums, such as the capital asset pricing model, arbitrage pricing model, multi-factor model, etc. Risk premium is also adjusted to incorporate risks associated with the stage and size of business and other company or project-specific risks.
(c) The rate estimated by using the above will provide the discount rate, assuming only equity financing or the cost of equity. For a leveraged company, discount rate should be adjusted for leveraging. Practically speaking, discount rate for a leveraged company is the weighted average cost of capital with appropriate weightages to cost of equity and post-tax cost of debt, considering existing or targeted debt-equity ratio, industry standards and other parameters.
(d) In the case of a company carrying on two or more different businesses, their cash flow projections should be estimated separately, and apply the discount rates appropriate to the individual businesses.
Terminal Value 2.12 Since a business is valued as a going concern, its value should account for the cash flows over the entire life of a company, which can be assumed to be infinite. Because the cash flows are estimated only for the forecast period, a terminal value is estimated to reflect the value of the cash flows arising after the forecast period. Terminal value can be computed in a number of ways; some prominent ones are discussed below:
34(a) Perpetual growth model assumes that a business has an infinite life and a stable growth rate of cash flows. Terminal value is derived mathematically by dividing the perpetuity cash flows (cash flows which are expected to grow at a stable pace) with the discount rate as reduced by the stable growth rate. Estimation of the stable growth rate is of great significance because even a minor change in stable growth rate can change the terminal value and the business value too. Various factors like the size of a company, existing growth rate, competitive landscape, profit reinvestment ratio, etc. have to be kept in mind while estimating the stable growth rate.
(b) Multiple approach involves the determination of an appropriate multiple to be applied on perpetuity earnings or revenues. Multiple is estimated by an analysis of the comparable companies. Though this approach is simpler and brings in the advantages of market approach, it does not qualify as a preferred approach because it mixes the discounted cash flow approach which provides intrinsic or company-specific valuation with the market approach.
(c) In valuations that assume a finite life of a business, terminal value is estimated to be the liquidation value, which is based on the book value of the assets adjusted for inflation. But this does not reflect the earning power of the assets. Alternatively, discounting expected cash flows from sale of such assets at an appropriate discount rate would provide a better estimation of liquidation value.
** ** ** 6.1 Selection of an appropriate approach - Income, Market, or Net Assets - as well as the technique/model within the selected approach by a valuer is dependent on the facts and circumstances of the case. In practice, however, a combination of all the approaches is used by assigning appropriate weightage to each approach.
6.6 While valuing shares, a number of situations may arise in which special consideration has to be given to several important factors.
** ** ** 6.24 Though valuation is mainly driven by financial factors like earnings, assets, etc., some other factors require careful evaluation as an integral part of the mechanics of share valuation. The most noteworthy of these are:
(a) The nature of a company's business A company's business may depend on the success of other industries (as with the producer of raw materials for other manufacturers), seasonal conditions, etc.
(b) The caliber of managerial personnel A business managed by professional managers allied to people with similar ability would command a premium when compared to another which is crucially dependent for its success on a single executive, 35 however outstanding he might be.
(c) Prospects of expansion A case in point would be that of ancillary small-scale units, which have the potential for growth as they can supply inputs to large companies that are dependent on their products.
(d) Competition A business may prosper when nurtured under sheltered circumstances (e.g. import restrictions), but may flounder under 'open market' conditions.
(e) Government policy Government policy in general and in relation to particular industry (as with restriction or banning of manufacture of alcohol in the case of alcohol based chemical industries).
(f) Prevailing political climate Political climate in an area can affect the prosperity of a business, e.g. tourism trade is directly affected due to breakdown in the law and order situation in a state.
(g) Risk of obsolescence of items manufactured In case the products manufactured by an enterprise face a higher risk of obsolescence, it may influence the value of its shares adversely.
(h) Existence of convertible rights Existence of convertible rights would also affect the value of a share.
(i) The effect of other external factors The value of shares is also affected by factors such as war, embargo or other restrictions on international trade or disruptions in international trade.
9.2 While preparing a Report, it is important that one states its purpose explicitly and ensures that the facts are presented with clarity so that the reader of the Report appreciates it in that context.
9.3 The factors that have been considered for arriving at the ultimate valuation should be clearly spelt out. 9.4 While it is difficult to specify the exact form of the Report, the following illustrative outline may be useful.
(a) Introduction/purpose of valuation 36 This may contain background information about the report and its purpose, say, merger. share buy back, etc.
(b) Valuation date The valuer may state the valuation date clearly at the outset. As the valuation is time-specific, this information is critical for the reader of the report.
(c) History This section may deal with the history of a company (or companies, in case of merger). The matter may be divided into sub-sections that deal with the date of incorporation, whether listed or not, authorised, and paid up capital, turnover, profits, dividend and asset base.
(d) Business of the company This part would explain the business of a company, i.e., whether trading or manufacturing, the items dealt in or manufactured, the location of the factory, factors peculiar to the business, and such other matters.
(e) Sources of information This section may state the sources of information obtained for the purpose of valuation, such as Articles of Association, audited accounts, profit projections, realisable value of assets, other secondary sources of information, period for which or date on which data is obtained, and other relevant sources.
(f) Methodology This part may contain the methodology adopted for valuation. It should also include the rationale for appropriateness or otherwise of a particular approach(s) used.
(g) Key valuation considerations This part may deal with the valuation considerations critical to the valuation process. Some of the factors considered in valuing the shares which may be included in the report are:
(i) Discussion on the financial projections of a company, highlighting main assumptions and management representations.
(ii) Discussion on discount rate, growth rate used for computing terminal value considered in the valuation, including the methodology for arriving at the discount rate, sources of information, etc.
(iii) Any adjustment on account of accumulated losses/unabsorbed depreciation.37
(iv) Any adjustment for valuing a controlling or minority stake, discount for illiquidity, etc.
(v) Brief analysis of the peer set companies used in relative valuation.
(vi) Adjustments to the multiples based on the peer set company, including rationale for the same.
(vii) Details of the surplus assets and treatment thereof in the valuation.
(viii) Any other special factors, such as government subsidy, tax breaks, etc.
(h) Fair Value This paragraph should deal with the valuation of shares on the basis of discussion in the preceding part of the Report (and in case of amalgamation, also the exchange ratio). This paragraph should also offer justification for the approaches actually adopted. It could also deal with the justification of adjustments considered necessary for arriving at the value, for example, of the discounting due to restriction on transfer of shares; reduction made in the net maintainable profit due to changed circumstances; or weightage given to certain recent years in arriving at the fair value, etc.
(i) Computation Usually, the report should also contain annexures giving information regarding the working of the approaches employed for valuation.
(j) Limiting conditions This paragraph should contain the appropriate caveats which limit the scope of valuation. Few indicative caveats are; (i) The valuer should state any scope limitations and also the non-availability of any pertinent information and its possible effect on valuation. (ii) It is important to draw reader's attention to the fact that the valuation is specific to the time and purpose of valuation. It should also be mentioned that the valuation is not an exact science and the conclusions arrived at in many cases will be subjective and dependent on the exercise of individual judgment.
(iii) It is also important to mention the extent of reliance placed by the valuer on the information provided by the management and information available in the public domain.
(iv) Under appropriate circumstances, a valuer should also limit his liability by restricting distribution of report to the management/company.
(v) A valuer should highlight the fact that valuation does not include the auditing of financial data provided by the management and, therefore, does not take any responsibility for its accuracy and completeness. Further, valuation should not be considered as 38 an opinion on the achievability of any financial projections mentioned in the report."
9. As per Para 2.10 of this report of research committee of (ICAI) as reproduced above, the first and most critical input of DCF model is the Cash Flow Projections. It is also noted in the same Para of this report that the DCF value is as good as the assumptions used in developing the projections. It is also noted that these projections should reflect the best estimates of the management and take into account various macro and micro economic factors affecting the business. In the same Para of this report, some important points to be kept in mind with regard to cash flow projections are also noted. At this point, we feel it proper to take note of two judgments of Hon'ble apex court rendered in the case of Bharat earth Movers v. CIT [2000] 112 Taxman 61/245 ITR 428 and in the case of Rotork Controls India (P.) Ltd. v. CIT [2009] 180 Taxman 422/314 ITR 62. In the first case, the issue in dispute was regarding estimation of future liability of leave encashment and it was held by Hon'ble apex court in this case that the liability should be capable of being estimated with reasonable certainty though the actual quantification may not be possible. It was held that if this is satisfied than the liability is not a contingent liability. In the second case, the issue in dispute was about provision of warranty expenses to be incurred in future. Para 10 of this judgment is very relevant and therefore, it is reproduced herein below:--
"10. What is a provision ? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when : (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized."
10. From this Para of this judgment, it is seen that it was held that if a reliable estimate cannot be made than the provision cannot be recognized. In the present case in connection with DCF, we have seen that estimate/projection of future cash flow has to be made and as per Para 2.10 of this report of research committee of (ICAI) as reproduced above, the first and most critical input of DCF model is the Cash Flow Projections. Hence, in our considered opinion, by the same analogy, it has to be seen and ensured that such projection is estimated with reasonable certainty and if it is not established by the assessee that this is a reliable estimate achievable with reasonable certainty, the same cannot be recognized and if the future cash flow cannot be recognized than the DCF method is not workable.
11. As per various tribunal orders cited by the learned AR of the assessee, it was held that as per Rule 11UA (2), the assessee can opt for DCF method and if the assessee has so opted for DCF method, the AO cannot discard the same and adopt other method i.e. NAV method of valuing shares. In the case of Rameshwaram Strong Glass (P.) Ltd. (supra), the tribunal has reproduced relevant portion of another tribunal order rendered in the case of ITO v. Universal Polypack (India) (P.) Ltd. in ITA No. 609/JP/2017 dated 31.01.2018. In this case, the tribunal held that if the assessee has opted for DCF method, the AO cannot 39 challenge the same but the AO is well within his rights to examine the methodology adopted by the assessee and/or underlying assumptions and if he is not satisfied, he can challenge the same and suggest necessary modifications/alterations provided the same are based on sound reasoning and rationale basis. In the same tribunal order, a judgment of Hon'ble Bombay High Court is also taken note of having been rendered in the case of Vodafone M-Pesa Ltd. v. Pr. CIT [2018] 92 taxmann.com 73/256 Taxman
240. The tribunal has reproduced part of Para 9 of this judgment but we reproduce herein below full Para 9 of this judgment.
"9. We note that, the Commissioner of Income-Tax in the impugned order dated 23rd February, 2018 does not deal with the primary grievance of the petitioner. This, even after he concedes with the method of valuation namely, NAV Method or the DCF Method to determine the fair market value of shares has to be done/adopted at the Assessee's option. Nevertheless, he does not deal with the change in the method of valuation by the Assessing Officer which has resulted in the demand. There is certainly no immunity from scrutiny of the valuation report submitted by the Assessee. Therefore, the Assessing Officer is undoubtedly entitled to scrutinise the valuation report and determine a fresh valuation either by himself or by calling for a final determination from an independent valuer to confront the petitioner. However, the basis has to be the DCF Method and it is not open to him to change the method of valuation which has been opted for by the Assessee. If Mr. Mohanty is correct in his submission that a part of demand arising out of the assessment order dated 21 st December, 2017 would on adoption of DCF Method will be sustained in part, the same is without working out the figures. This was an exercise which ought to have been done by the Assessing Officer and that has not been done by him. In fact, he has completely disregarded the DCF Method for arriving at the fair market value. Therefore, the demand in the facts need to be stayed."
12. As per above Para of this judgment of Hon'ble Bombay High Court, it was held that the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a final determination from an independent valuer to confront the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee. Hence, in our considered opinion, in the present case, when the guidance of Hon'ble Bombay high Court is available, we should follow this judgment of Hon'ble Bombay High Court in preference to various tribunal orders cited by both sides and therefore, we are not required to examine and consider these tribunal orders. Respectfully following this judgment of Hon'ble Bombay High Court, we set aside the order of CIT (A) and restore the matter to AO for a fresh decision in the light of this judgment of Hon'ble Bombay High Court. The AO should scrutinize the valuation report and he should determine a fresh valuation either by himself or by calling a final determination from an independent valuer and confront the same to the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee. In our considered opinion and as per report of research committee of (ICAI) as reproduced above, most critical input of DCF model is the Cash Flow Projections. Hence, the assessee should be asked to establish that such projections by the assessee based on which, the valuation 40 report is prepared by the Chartered accountant is estimated with reasonable certainty by showing that this is a reliable estimate achievable with reasonable certainty on the basis of facts available on the date of valuation and actual result of future cannot be a basis of saying that the estimates of the management are not reasonable and reliable.
13. Before parting, we want to observe that in the present case, past data are available and hence, the same can be used to make a reliable future estimate but in case of a start up where no past data is available, this view of us that the projection should be on the basis of reliable future estimate should not be insisted upon because in those cases, the projections may be on the basis of expectations and in such cases, it should be shown that such expectations are reasonable after considering various macro and micro economic factors affecting the business.
14. In nutshell, our conclusions are as under:--
(1) The AO can scrutinize the valuation report and the if the AO is not satisfied with the explanation of the assessee, he has to record the reasons and basis for not accepting the valuation report submitted by the assessee and only thereafter, he can go for own valuation or to obtain the fresh valuation report from an independent valuer and confront the same to the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee.
(2) For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual result of future cannot be a basis to decide about reliability of the projections.
(3) The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method. Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, scientific study and applicable Guidelines regarding DCF Method of Valuation.
15. In the result, the appeal of the assessee is allowed for statistical purposes. Order pronounced in the open court on the date mentioned on the caption page."
19. In the light of the above, if we examine the case of parties before us, then it is quite clear that the Assessing Officer was incorrect in rejecting the DCF method adopted by the assessee.
20. Now, if we come to the second aspect of the matter that once we hold that the DCF method is correct method, which is required to be applied by the Assessing Officer to determine FMV, our duty is to see whether the valuation report based on which the 41 valuation was arrived by the assessee was in accordance with law or not. As pointed out by the ld. DR that there are some patent defects in the valuation report, which are reproduced above, as there is no verification of the facts or financial projection by the auditor before giving the valuation report. Further, the valuation report was conspicuously silent about the financial projection and industrial norms. In the absence of this, it is difficult to understand on what basis the auditor assumed the terminal value and future cash flow. It is the bounden duty of the auditor while giving the reports on the valuation, he has to first understand, verify the facts, examine the industrial trend based on empirical data and thereafter, bring on record what would be growth projections of the industry and thereafter suggest the future cash flow and then determine FMV of the unquoted shares of the assessee. Nothing has been brought on record by the assessee / auditor in the valuation report. Therefore, in our view, the valuation report given by the auditor cannot be sustainable and was required to be rejected.
21. The ld.CIT(A) while granting relief has glossed over the above said aspect and after concluding that the option is given to the assessee to determine the FMV after adopting the DCF method. The ld.CIT(A), neither rejected the DCF method nor examined the valuation report of the auditor based on that fair market value was determined.
22. The ld.CIT(A) instead of examining the valuation report and the fair market value of the shares by applying the DCF method, had resorted to examining the functionality and working of the NAV method and thereafter, came to the conclusion that FMV has to be determined by the NAV method based on the CBDT Circular dt.12.07.2017 whereby it was envisaged that the value of the shares shall be determined by the Assessing Officer by taking into account 42 the value of the intangible asset for the purpose of working of the net value.
23. In our considered opinion, this approach of the ld.CIT(A) was not in accordance with law. As we have held hereinabove that the option is not available to the Assessing Officer, then the exercise carried out by ld.CIT(A) became futile and of no consequence. Further, the determination of FMV on the basis of NAV by the Ld. CIT(A) was otherwise not sustainable and is bad in law as per Rule 11U(j), which defined valuation date and Rule 11U(b), which defined Balance Sheet. The conjoint reading of the above-mentioned Rules make it clear that the valuation of the asset as per the NAV method is required to be determined while making a valuation of the assets mentioned in the balance sheet.
24. In any case, the CBDT Circular dt.12.07.2016 cannot be made available and applied retrospectively to the facts of the case as the valuation report in the present case was prepared on 01.07.2016, i.e., one year prior to the issuance of the CBDT Circular. The valuation report is dated 01.07.2016. In that view, the NAV method adopted by the ld.CIT(A) is of no help to the assessee. In light of the above, the approach of the Assessing Officer as well as the ld.CIT(A) cannot be sustained.
25. Having held that both the approach of the Assessing Officer as well as the ld.CIT(A) were incorrect, hence, we deem it appropriate to remand back the matter to the file of the Assessing Officer with a direction to determine the FMV after exercising the power conferred under the Act and after applying DCF method on the valuation date dt.01.07.2016 based on the balance sheet or any other material as available on that day, after granting due opportunity of hearing to the assessee. Accordingly, the appeal of the Revenue is remanded back to the file of Assessing Officer with a 43 direction to pass a fresh speaking order after granting due opportunity of hearing to the Revenue in accordance with law. The assessee shall be at liberty to file documents, if any, as required for proving its case and the AO shall consider such pieces of evidence, if any, filed by the assessee. Needless to say the Assessing Officer shall examine those documents / evidence filed by the parties and also the other documents available on record. Accordingly, the appeal of Revenue is allowed for statistical purposes.
26. In the light of the above, the appeal of the Revenue is allowed for statistical purposes.
Order pronounced in the Open Court on 28th December, 2023.
Sd/- Sd/-
Sd/- Sd/-
(R.K. PANDA) (LALIET KUMAR)
VICE PRESIDENT JUDICIAL MEMBER
Hyderabad, dated 28th December, 2023.
TYNM/sps
Copy to:
S.No Addresses
1 M/s.MLR Auto Limited, 41/1A IDA, Balanagar,
Hyderabad.
2 Joint Commissioner of Income Tax (OSD), Circle - 5(1),
Hyderabad.
3 Pr.CIT - 4, Hyderabad
4 DR, ITAT Hyderabad Benches
5 Guard File
By Order