Income Tax Appellate Tribunal - Raipur
M/S Avinash Developers Pvt. Ltd., ... vs Deputy/Assistant Commissioner Of ... on 19 February, 2024
आयकर अपील य अ धकरण यायपीठ रायपुर म।
IN THE INCOME TAX APPELLATE TRIBUNAL,
RAIPUR BENCH, RAIPUR
BEFORE SHRI RAVISH SOOD, JUDICIAL MEMBER
AND
SHRI ARUN KHODPIA, ACCOUNTANT MEMBER
आयकर अपील सं. / ITA No.157/RPR/2022
नधारण वष / Assessment Year : 2017-18
M/s. Avinash Developers Pvt. Ltd.
Avinash House, Maruti Business Park,
G.E. Road, Raipur (C.G.)
PAN: AADCA4060E
.......अपीलाथ / Appellant
बनाम / V/s.
The Deputy/Assistant Commissioner of Income Tax,
Circle-2(1), Raipur (C.G)
...... यथ / Respondent
Assessee by : S/ssshri Vijay Mehta, CA
Amit M. Jain, Advocate, Bikram
Jain, & Dinesh Jain, CAs
Revenue by : Shri S.K Meena, CIT-DR
सुनवाई क तार ख / Date of Hearing : 01.12.2023
घोषणा क तार ख / Date of Pronouncement : 19.02.2024
2
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur
ITA No. 157/RPR/2022
आदे श / ORDER
PER RAVISH SOOD, JM:
The present appeal filed by the assessee company is directed against the order passed by the Commissioner of Income-Tax (Appeals)-3, Bhopal, dated 25.07.2022, which in turn arises from the order passed by the A.O under Sec.143(3) of the Income-tax Act, 1961 (in short 'the Act') dated 31.12.2019 for the assessment year 2017-18. The assessee company has assailed the impugned order on the following grounds of appeal:
"1. On the facts and circumstances of the case, the CIT(A) had erred in sustaining the order of the A.O, wherein the A.O. has erred in making addition u/s.56(2)(viib) r.w.r 11UA of Rs.8,16,58,500/- on account of excess premium charged. The addition made by the A.O. and sustained by the CIT-Appeal is unjustified, unwarranted and uncalled for.
2. On the facts and in the circumstances of case, the CIT(A) has erred in sustaining order of the A.O., where in the Ld. Assessing Officer has erred in invoking provision section 56(2)(viib) r.w.r.11UA of the Income Tax Act. The Invoking provision of section 56(2)(viib) r.w.s. 11UA(1) by the A.O sustained by the CIT-A is unjustified, unwarranted and uncalled for.
3. On the fact and Circumstances of the case, the CIT(A) has erred in sustaining the order of the A.O, wherein the A.O. has erred in making addition, without issuing the show cause notice which is against the principle of natural justice. The order passed against the principle of natural justice as well as proper opportunity of being heard is bad in law and deserves to be annulled.
4. The appellant reserves the right to add, amend or alter any grounds of appeal at any time of hearing."
2. Succinctly stated, the assessee company which is engaged in the business of a builder and developer, had e-filed its return of income for A.Y.2017-18 on 31.10.2017 declaring an income of Rs.11,84,54,270/-. The return of income filed by 3 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 the assessee company was processed as such u/s. 143(1) of the Act. Subsequently, the case of the assessee company was selected for scrutiny assessment u/s. 143(2) of the Act.
3. Survey proceedings u/s.133A of the Act were conducted at the business premises of the assessee company on 29.07.2016. The A.O., observed, that during the course of the survey proceedings statement of Shri Mukesh Singhania, director of the assessee company was recorded u/s. 131 of the Act, wherein, he was directed to produce evidence regarding the identity and creditworthiness of the persons from whom share capital/premium was received during the year, and also the genuineness of the respective transactions. However, as the assessee company had failed to substantiate the identity, creditworthiness, and genuineness of certain investors, therefore, it had offered an amount of Rs.37.02 crore as its undisclosed income during the course of the aforesaid proceedings, as under:
F.Y. A.Y. Amount disclosed Remarks
(in Rs.)
2013-14 2014-15 1.45 crore
2014-15 2015-16 25.08 crore Declared in the hands of
Luminious Infra Properties for
A.Y.2014-15 and A.Y.2015-16
2016-17 2017-18 10.49 crore Rs.10.49 crore represents only the
premium amount. Total share
capital and premium received is of
Rs.11.55 crore
Total 37.02 crore
4
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 Apart from that, the assessee company made a further voluntary disclosure of Rs.4 crore on account of other discrepancies in its books of account for the year under consideration, i.e. A.Y.2017-18.
4. During the course of the assessment proceedings, the A.O., observed that the assessee company had failed to offer in its return of income an amount of Rs.10.49 crore that was surrendered by it on account of share premium received during the year under consideration. Based on the aforesaid facts, the A.O. directed the assessee company to provide details as regards the share capital/premium that was received by it during the subject year. Also, the assessee company was called upon to provide details as regards the method of valuation of the shares issued during the year along with a valuation certificate in support of the same. In reply, the assessee company furnished the following details:
Sr. Name of Type of No. of Face value Premium Total Value
No. allottee share shares @Rs.10/- amount
per share @Rs.100/-
per share
1. Adarsh Equity 2,73,000 27,30,000 2,73,00,000 3,00,30,000
Tradecom shares
Pvt. Ltd.
2. Anand Preference 5,72,700 57,27,000 5,72,70,000 6,29,97,000
Singhania shares
3. Priyank Preference 2,05,000 20,50,000 2,05,00,000 2,25,50,000
Singhania shares
10,50,700 1,05,07,000 10,50,70,000 11,55,77,000
5
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 The A.O, on a perusal of the details, observed, that though the assessee company as per Rule 11UA of the Income Tax Rules, 1962 had furnished a valuation certificate of the equity shares issued by it but had not furnished any such details/certificate for the preference shares that were issued by it. On being queried, the assessee submitted that since no specific method of valuation of preference shares in the case of a private company was prescribed in the Act, hence the value of equity shares had been taken as the value for the preference shares. However, the A.O. did not find favor with the aforesaid explanation of the assessee company. Referring to Rule 11UA of the Income Tax Rules, 1962, the A.O. observed that the "Net Asset Value"
("NAV", for short) method that was used by the assessee company for valuing the equity shares could not have been adopted for valuing the preference shares that were issued during the year. Also, the A.O observed that as the assessee company had issued preference shares to Shri Anand Singhania, director and Shri Priyank Singhania, Ex-director of the assessee company, therefore, the value at which the said related persons would have invested in the shares could by no means be taken as a true market value of the preference shares.
5. The A.O, thereafter, referred to terms and conditions based on which preference shares were issued by the assessee company, which reads as under (as extracted from the assessment order):
"The company has allotted 100% Non-Cumulative Redeemable Preference Shares of Rs.10/- at a premium of Rs.100/- each. The said preference shares are redeemable within 20 years of allotment at a premium of not less than Rs. 100/- each or shall be converted into similar number of equity shares (on consent of all equity shareholders). The said non-cumulative Redeemable 6 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 Preference Shares shall carry no fixed cumulative preferential dividend. The said shares shall rank for dividend in priority to the equity shares for the time being of the company. The said shares in the event of winding up shall be entitled to rank as regards repayment of capital and arrears of dividend, if any declared, upto the commencement of winding up in priority to the equity shares, but shall not be entitled to any further participation in profit or assets. The voting rights of the persons holding the said shares shall be in accordance with the provisions of the Companies Act, 2013."
Observing, that as the preference shares were 'quasi debt instruments', the A.O. was of the view that the same would stand on a different footing vis-à-vis equity shares, and, thus, the tests applicable to equity shares could not be applied to the preference shares. Elaborating on his aforesaid view, the A.O. observed that while the equity shareholders were the real owners of the company, while for the preference shareholders were only vested with preference over the equity shareholders on repayment of equity. Based on his aforesaid observations, the A.O. was of the view that the "net asset value" of the assessee company represented the value of the equity shares and not that of preference shares. Accordingly, the A.O. rejected the adoption of the value of preference shares as that of equity shares by the assessee company.
6. After rejecting the value of the preference shares that was disclosed by the assessee company, the A.O reworked out their value @ Rs.5/- per share as against that taken by the assessee @110/- per share, observing as under:
"14. In light of the above discussion, the valuation taken by the assessee for the preference shares issued to Sh. Anand Singhania and Sh. Priyank Singhania cannot be accepted. Valuation of the preference shares is being calculated on the following basis:7
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 The following assumptions have been made to arrive at this valuation.
a) That looking at the history of dividend payment which is nil in the last so many years, and also the fact that as per the subscribed conditions that dividend would be paid to the preference shareholders only when it is also paid to the equity shareholders, it is assumed that the assessee pays 10% dividend every alternate year
b) That it is redeemed at the end of 20 years at the same value i.e. 110
c) That the discounting is made at 12%, which is the risk-adjusted rate for preference share which is non-cumulative and it is not secured against assets. The going rate for secured debt is about 10-11% and that for equity is about 14-15%. Therefore, adoption of 12% is appropriate.
d) By adopting this, we get the FMV as Rs. 5/- (rounded off).
15. Accordingly, the fair market value of the Preference Shares works out to be Rs. 5/- per share, whereas shares have been issued at Rs.110/- per share.
16. In light of the above, the excess premium amounting to Rs. 8,16,58,500/- [computation as per Annexure A] is added back to the returned income of the assessee for A.Y. 2017-18 as income from other sources under section 56(2)(viib) read with Rule 11 UA."
The A.O., observing that the assessee company had issued 7,77,700 preference shares at a premium of Rs.105/- per share, made a consequential addition of Rs.8,16,58,500/- u/s.56(2)(viib) r.w. Rule 11UA of the Income-tax Rules, 1962 in the 8 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 hands of the assessee company. After making the aforesaid addition of Rs.8,16,58,500/- (supra), the A.O vide his order passed u/s.143(3) of the Act dated 31.12.2019 determined the income of the assessee company at Rs.20,01,12,770/-.
7. Aggrieved the assessee carried the matter in appeal before the CIT(Appeals) but without success. Although the assessee company had based on its multi-facet contentions tried to impress the CIT(Appeals) that the subject preference shares were issued at the Fair Market Value (FMV) but the same did not find favor with him. For the sake of clarity, the observations of the CIT(Appeals) are culled out as under:
"3.1.1 I have considered the facts of the case, plea raised by the appellant and findings of the AO. The brief facts are that the appellant during the year under consideration has issued equity and preference shares having face value of Rs.10 and at a premium of Rs.100/- per share. The appellant has issued 100%. non-cumulative convertible redeemable preference share. The brief detail of preference shares issued are as under:-
As evident from the assessment order, the AO has observed that the preference shares issued by the appellant are quasi-debt in nature and on the flip side the appellant has contended that the same are in the nature of equity shares having more preference than equity shares in terms of redemption. Before moving a step ahead, it is important to have a understanding of definition of equity shares and preference shares. Equity shares are long-term financing sources of any company. These shares are issued to general public and are non-redeemable in nature. The share holders reserves the right to vote, share profit and claim assets of the company. On the other hand the preference shares are shares with dividends that are paid out to shareholders before common stock dividends are issued. Preference shares are securities which can be thought of as being mid-way between debt and equity. Preference shareholders do not get a variable 9 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 return. Rather they get a fixed rate of return like debt holders. Thus, a preference share holder does not face the risks of an equity shareholder and also does not get the slow return of a bond holder. It is somewhere in between these two extremes. For that reason, payments to preference shares are not legally mandatory. If the company makes a profit, they must receive their fixed dividend before the ordinary shareholders are paid. Dividends, in case of preference shareholders are fixed. Hence, there need not be any speculation as to what the pattern of dividend payouts will. Whether, it will be constant as in the case of the dividend discount model or whether they will grow at a constant rate like in Gordon growth model. The cash flow timings and amounts are almost certain in case of preference shares.
Thus, the claim of the appellant that the preference shares partakes characteristics of equity shares is unacceptable. However, the same are quasi debt in nature as discussed by the Id AO.
3.1.2 The AO has invoked provisions of section 56(2)(viib) r.w.r 11UA of the Act. Provisions of section 56(2)(viib) of the Act have been inserted via Finance Act, 2012. For ready reference the relevant extract of the section 56(2)(viib) of the Act is reproduced hereunder:-
(vilb) 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 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, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;10
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
(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; ] :
The objective of introducing the section was to deter 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. By virtue of section 56(2)(viib) of the Act, it states that, 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 shall be deemed to be the income of the concerned company chargeable to tax under the head Income from other Sources for the relevant financial year. Further, the FMV shall be determined as per the methods prescribed under Rule 11UA(2) of the Income-tax Rules, 1962 (Rule). For ready reference, the relevant extract of Rule 11UA(2) is reproduced 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:--
(a) fair market value of unquoted equity shares = (A-L) *(PV)/(PE) A= book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of fax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortized amount of deferred expenditure which does not represent the value of any asset.
L= book value of liabilities shown in the balance-sheet. but not including the following amounts, namely:--
(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 of 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;11
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
(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 payable in respect 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
(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.
Clearly the statue provides two methods for calculating FV of unquoted equity shares (i) the Book value Method (NAV) and (ii) Discounted Free Cash flow method [DCF] (Allowed to a Merchant Banker or to CA Only).
3.1.3. In the instant case, the appellant has adopted NAV method and on the other side the ld. AO has adopted DCF method. The moot question arises out is which method is widely adopted for valuation of preference shares. The valuation of preference shares is a very straightforward exercise. Usually preference shares pay a constant dividend. This dividend is the percentage of the face value of the share. The dividend discount model is generally used to measure the value of preference equity in addition to forecasting the value of ordinary equity. Thus, the AO was fully justified in placing secured debt instruments on same footings with preference shares. Therefore, DCF method is most appropriate one for determining true value as per characteristic of the preference shares. This method should have been adopted by the appellant. But the appellant adopted NAV method which is not meant for valuation of preference shares. During the appellant proceedings, the appellant has also furnished valuation of preference shares as on 31.03.2016 & 05.04.2016 by adopting NAV method but not submitted the value as per DCF method as adopted by the AO. Thus, the appellant failed to prove that the valuation done by the AO was incorrect. 3.1.4 Furthermore, the Act does not specify any specific method for determining face value of preference shares, however, provisions of section 11UA(1)(c) of the Act defines that the fair market value of unquoted shares shall be estimated at a price which it would fetch in a open market on the valuation date. To determine that, the best and mostly adopted method for valuation of preference shares is DCF method which has been adopted by the AO. Further, provisions of section 56(2)(viib) does not make any 12 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 distinction between equity shares and preference shares. For valuation of preference shares, as per Rule 11UA(1)(c), the appellant is required to obtain a report from a merchant banker or CA to determine price which preference shares would fetch if sold in open market as on the valuation date. However, no such report have been furnished by the appellant for determining fair market value of preference shares by DCF method. Per contra, the appellant has furnished a report of CA determining value of preference shares by NAV method. The appellant by placed reliance on decision of Hon'ble ITAT, Jaipur in the case of Ginni Global Pvt Ltd, ITA No 1009/JP/2018 order dated 02.05.2019 has claimed that NAV method is to be adopted for preference shares. For ready reference, the operative part of the decision is reproduced hereunder:-
6. We have heard the rival contentions and perused the material available on record. We have gone through the provisions of section 56(2)(viib) and it dosen't make any distinction between equity shares and preference shares and therefore, the first contention of the ld. AR cannot be accepted. Regarding the valuation of the preference shares, the valuation should be determined as per Rule 11 UA(1)(c) which requires the assessee to obtain a report from a merchant banker or a Chartered Accountant to determine the price which preference shares will fetch if sold in the open market on the valuation date....
7. The Revenue has not disputed the adoption of the NAV method by the assessee. Therefore, once the NAV method has been accepted, what has to be determined is the valuation of the preference shares' based on net asset value as on the date of issue of such preference shares. The valuation date thus has to be the date of issuance of preference shares and not as per the last balance sheet date as has been adopted currently. The net asset value is determined by applying the formula where difference between the total assets and total liabilities as on the date of issuance of shares is divided by total amount of paid up capital of the company and multiplied by paid up value of new shares. In the instant case, given that there are existing equity and preference share capital, paid capital in respect of both of these category of shares shall be considered for determining total paid up capital of the company. In the result, we set-aside the matter to the file of the AO who shall determine the value of the preference shares as per the NAV method based on formula discussed above and such valuation has to be determined as on the date of issuance of such preference shares. In the result, the ground of appeal is allowed for statistical purposes.
3.1.5 Form the above cited decision, it is abundantly clear that the Hon'ble ITAT has directed the AO to determine value of preference shares as per NAV method for the reason that the NAV method was never disputed in the said case, however, in the case of the appellant the NAV method has been rejected from the grass root level i.e. by the AO itself. Therefore, the facts of 13 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 the case of M/s Ginny Global (supra) are entirely different and distinguishable from the case of the appellant. It is settled legal proposition that in the case of dispute arising out in any situation, the widely used concept should be adopted. As discussed herein above, the preference shares hold nature of debt instrument, therefore, the DCF method which is widely used and most appropriate for determining fair market value is to be adopted in the case of appellant, as adopted by the Id AO.
3.1.6 The appellant has also contended that the AO has not doubted the genuineness of money brought into preference shares. Therefore, in view of various judicial pronouncement provisions of section 56(2)(viib) of the Act cannot be invoked. In this regard, it has been found that survey u/s 133A of the Act was carried out at the business premises of the appellant on 29.07.2016. Statement on oath u/s 131 of the Act was recorded, wherein, the appellant failed to produce the documentary evidence regarding the identity, creditworthiness and genuineness of transaction in relation to equity shares and preference shares. Accordingly, during the course of survey proceedings the appellant disclosed additional income of Rs. 37.02 crores in the AYs 2014-15, 2015-16 & 2017-18. This voluntary disclosure amount includes disclosure of Rs.10.49 crores on account of share premium amount. But the appellant has not offered this amount for taxation in the return of income. The disclosure made by the appellant during the course of survey proceedings was based upon certain findings which proved the share premium amount non-genuine. Thus, the AO had sufficient ground to doubt the genuineness of money introduced in the garb of premium amount on preference shares. Therefore, the AO was justified in invoking provisions of section 56(2)(viib) taxing the unaccounted money which is per the intentions of legislature. In view of the above facts, ratio laid down in the judicial pronouncements relied upon by the appellant cannot be applied here. Thus, the contention of the appellant has no merit they are hereby rejected.
3.1.7 Another contention raised by the appellant is that the method adopted by the appellant cannot be changed by the AO. The appellant has placed reliance upon various judicial pronouncements in this regard. As discussed in foregoing paras the appellant has not adopted the method of valuation of valuation of preference shares which is being generally used. Therefore, the AO was correct in adopting DCF method as prescribed in Rule 11UA(2)(b). The method adopted by the appellant was found Faulty, therefore, change of method by the AO is found justified. For these reasons, the judgments relied upon by the appellant are not applicable in its case.
3.1.8 In view of the discussion, the AO was fully justified in determining fair market value of preference shares by DCF method and I do not find any infirmity in the order of the AO. Thus, the addition made by the AO amounting at Rs.8,16,58,500/- is confirmed. Therefore, appeal on these grounds is dismissed."
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M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
8. The assessee being aggrieved with the order of the CIT(Appeals) has carried the matter in appeal before us.
9. We have heard the ld. Authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the Ld. AR to drive home his contentions.
10. Controversy involved in the present appeal lies in a narrow compass, i.e. as to whether or not the preference shares issued by the assessee company to S/shri Anand Singhania and Priyank Singhania (supra) @ Rs.110/- per share was at Fair Market value (FMV)?
11. Before proceeding any further, we deem it fit to cull out the provisions of Section 56(2)(viib) of the Act, which at the relevant point of time read as under:
"56(2) In particular; and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income tax under the head "income from other sources" namely :-
*********** (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:
****************** 15 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 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, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;
(aa) xxxxxxxx (ab) xxxxxxxx
(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-1 to clause (23FB) of section 10;"
Also, Rule 11UA of the Income Tax Rules, 1962 which will have a strong bearing on the adjudication of the issue before us is culled out as under (relevant extract):
"11UA [(1)] For the purposes 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) Xxxxxxxx
(b) Xxxxxxxx
(c) Xxxxxxxx [(b) the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner, namely:--
(A-L) the fair market value of unquoted equity shares = (PE) X (PV), where, A = book value of the assets in the balance-sheet as reduced by any 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 and any amount shown in the balance-sheet as asset including the 16 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 unamortized amount of deferred expenditure which does not represent the value of any asset;
L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:--
(i) the paid-up capital in respect of equity shares;
(ii) the amount set apart for payment of dividends on preferences 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 payable in respect 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;]
(c) the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation.] [(2) Notwithstanding anything contained in sub-clause (b) or sub-clause (c), as the case may be, 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 the 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 shall be determined under sub-clause (a), sub-clause (b), sub-clause (c) or sub-clause (e), at the option of the assessee, where the consideration received by the assessee is from a resident ; and under sub-clauses (a) to (e) at the option of the assessee, where the consideration received by the assessee is from a non-
resident, in the following manner:--"
(a) the fair market value of unquoted equity shares =(A-L)× [PV/PE], where, 17 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 A = book value of the assets in the balance-sheet as reduced by any 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 and any amount shown in the balance-sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;
L= book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:--
(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 payable in respect 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
(b) the fair market value of the unquoted equity shares determined by a merchant banker as per the Discounted Free Cash Flow method;"
(emphasis supplied by us)
12. Shri Vijay Mehta, Ld. Authorized Representative (for short 'AR') for the assessee company to buttress his claim that both the lower authorities had grossly erred in dislodging the valuation of the preference shares which was rightly disclosed 18 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 by the assessee company, had come forth with multi-facet contentions, viz., (i). that as Section 56(2)(viib) of the Act was as a counter tax evasion provision that was made available on the statute to prevent the laundering of unaccounted income, therefore, the allotment of preference shares by the assessee company to Shri. Anand Singhania, director and Shri. Priyank Singhania, Ex-director, which were genuine transactions, wherein the assessee company had established that both the said respective investments were sourced from the legitimate funds of the respective investors and, thus, could not have been subjected to the rigors of the said provision.
(ii). that both the lower authorities had grossly erred in law and facts of the case in discarding the determination of the FMV of the subject preference shares by the assessee company as per the "Net Asset Value" (NAV) Method, which was strictly as per the mandate of "Explanation(a)(ii)" of Section 56(2)(viib) r.w. Rule 11UA(1)(c) of the Income Tax Rules, 1962; AND (iii). that the determination of the FMV of the subject preference shares by the A.O. based on the "Dividend Discounting Model"
suffered from certain serious glaring perversities which rendered the working of the FMV based on the said method as erroneous.
13. Elaborating further on his aforesaid contentions, the Ld. AR submitted that the A.O. who had approached the issue as regards the valuation of the subject preference shares with a prejudiced mind, had wrongly invoked the provisions of Section 56(2)(viib) of the Act. Carrying his contention further, the Ld. AR submitted that clause (viib) of sub-section (2) of Section 56 of the Act was inserted by the Finance Act, 2012 to curb the practice of closing held companies from introducing 19 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 undisclosed money of promotors/directors by issuing shares at a high premium, i.e over and above the book value of the shares of the company, and, thus, by so doing escape the rigors of Section 68 of the Act. Our attention was drawn by the Ld. AR to the Budget Speech, 2012 of the Finance Minister which underlined the objects behind the introduction of Section 56(2)(viib) of the Act, which, inter alia, had put a heavier onus on the closely held companies as regards the funds received from shareholders as well as taxing share premium received more than the FMV. The Ld. A.R., taking us through the Budget Speech of the Finance Minister while introducing the Finance Bill, 2012, wherein the purpose behind the insertion of Section 56(2)(viib) of the Act was explained, submitted that the Hon'ble Supreme Court in the case of K.P Varghese Vs. ITO (1981) 131 ITR 597 (SC), had held, that the intent and purpose for making available a statutory provision can safely be gathered by referring to the Budget Speech of the Finance Minister while introducing the finance bill. The Ld. AR submitted that as in the present case, the subject preference shares had been allotted by the assessee company to its director and ex-director, viz. S/shri Anand Singhania and Priyank Singhania, wherein the identity and creditworthiness of both the shareholders, as well as the genuineness of the transactions of allotment of shares were proved beyond doubt therefore, the provisions of Section 56(2)(viib) of the Act, i.e. an anti-abuse provision could not have been triggered and brought into play for drawing adverse inferences in the hands of the assessee company.
14. Shri Vijay Mehta, Ld. A.R, submitted that now when the transactions of allotment of subject preference shares by the assessee company to its aforesaid 20 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 director/ex-director had been tested and found to be genuine business transactions, i.e. without any element of tax avoidance, therefore, there remained no occasion to test the FMV of the said shares by triggering the provisions of Section 56(2)(viib) of the Act. The Ld. AR to fortify his aforesaid contention had pressed into service the order of the ITAT, Delhi in the case of Clearview Healthcare (P) Ltd. Vs. ITO, 181 ITD 141 (Delhi). Also, the Ld. AR had drawn support from the order of the ITAT, Mumbai in the case of Impact Retain Tech Fund Pvt. Ltd. Vs. ITO, ITA No.2050/Mum/2018 dated 05.03.2021, Page 142 to 157 of APB. Taking us through the aforesaid order, the Ld. AR submitted that the Tribunal while deprecating the practice of the department in failing to bring on record all those events which attracted the deeming provision, read along with the purpose for which, the same was made available on the statute, had after relying on a host of judicial pronouncements, concluded that the mechanical invocation of Section 56(2)(viib) without verifying whether the assessee had indulged in any money laundering activity could not be approved.
15. Based on his aforesaid contention, the Ld. AR at the threshold of hearing of the appeal had tried to impress upon us that the provisions of Section 56(2)(viib) of the Act could not have been brought into play by the A.O concerning the transaction of allotment of subject preference shares by the assessee company to S/shri Priyank Singhania and Anand Singhania, director and ex-director of the assessee company, as the identity and creditworthiness of the share applicants as well as genuineness of the transaction were established beyond doubt.
21
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
16. Also, the Ld. AR, in his attempt to fortify his aforesaid contention, i.e the rigors of Sec. 56(2)(viib) could not be applied to genuine transactions of allotment of shares to promoter directors, had by way of an analogy drawn support from the CBDT Circular No.10/2018 dated 31.12.2018, Page 132 of APB, wherein it was stated that the legislative intent for inserting clause (viia) of Section 56(2) of the Act, an anti- abuse provision, was never intended to apply the said provision to fresh issuance of shares by the specified company. At the same time, the Ld. AR in all fairness took us through the CBDT Circular No.02/2019 dated 04.01.2019, Page 133 of APB as per which, the aforesaid CBDT Circular No.10/2018 (supra) was withdrawn.
17. Also, the Ld. AR had pressed into service the order of the ITAT, Delhi in the case of BLP Vayu (Project -1) (P) Ltd. Vs. PCIT (201 ITD 283) (Del.), Page 158 to 165 of APB. It was submitted by the Ld. AR that as in the case before the Tribunal shares were allotted by the assessee company to its 100% holding company, therefore, it was observed that based on a schematic interpretation the deeming provisions of Section 56(2)(viib) of the Act could not have been triggered in such a situation. The Ld. AR had further drawn our attention to the order of the ITAT, Raipur in the case of Chhattisgarh Metaliks and Alloys (P) Ltd. Vs. ITO, ITA No.102/RPR/2019 dated 26.07.2022, Page 166 to 185 of APB. In the aforesaid order, the Tribunal after taking cognizance of the CBDT Circular No.10/2018 dated 31.12.2018 which was thereafter withdrawn, had observed, that as the aforesaid statutory provision was introduced as an anti-abuse measure to prevent the laundering of unaccounted money, therefore, the same being a counter tax evasion 22 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 mechanism to prevent the laundering of unaccounted money could not have been triggered in the case of issuance of bonus shares, allotting of shares to existing shareholders in proportion to their existing shareholding (akin to the issue of right shares).
18. The Ld. AR adverting to the second facet of his contentions, submitted that both the lower authorities had grossly erred in law and facts of the case in discarding the valuation of the preference shares by the assessee company based on "Net Asser Value" Method. Elaborating on his contention, the Ld. AR submitted that as per "Explanation" to Section 56(2)(viib) of the Act, the FMV of the shares is to be determined, viz. (i) as may be determined by such method as may be prescribed in Rule 11UA/11U of the Income Tax Rules, 2961; or (ii) as may be substantiated by the company to the satisfaction of the A.O, based on the value on the date of issue of shares of its assets, whichever is higher. Carrying his contention further, the Ld. AR submitted that Rule 11UA of the Income Tax Rules, 1962 though prescribed the methods for the determination of FMV of unquoted equity shares, i.e. (i) book value method; or (ii) discounted free cash flow method, but for the determination of the FMV of unquoted shares and securities other than equity shares in an unlisted company it is merely stated that the same shall be estimated to be the price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. The Ld. AR submitted that as there was no specific method prescribed in Rule 11UA for determining the FMV of preference shares, therefore, the recourse available to the 23 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 assessee company for valuing the same as per "Explanation (a)(ii)" of Section 56(2)(viib) of the Act was to determine the same based on the value of assets on the date of issue of shares. The Ld. AR submitted that as the assessee company as per "Explanation (a)(ii)" of Section 56(2)(viib) had correctly determined the FMV of the preference shares based on the value of its assets on the date of issue of the said shares, which was as per the mandate of law, therefore, there was no justification for the A.O to have discarded the same and substituted it by the FMV determined by him as per the "dividend discounting method". The Ld. AR submitted that the determination of the FMV of subject preference shares as per the "Net Asset Value"
(NAV) method had been accepted by the department in certain cases that have been adjudicated by various benches of the Tribunal. The Ld. AR in support of his aforesaid contention had drawn our attention to the order of the ITAT, Bengaluru in the case of Information Technology Park Ltd. Vs. ITO, ITA Nos. 1357 and 1358/Bang/2018 dated 24.08.2022, Page 194 to 205 of APB. Referring to the aforesaid judicial pronouncement, the Ld. AR submitted that in the said case, the "Net Asset Value" (NAV) method that was adopted for valuing the preference shares was not disputed by the Transfer Pricing Officer (TPO), who had applied the same method to work out the valuation. In fact, the controversy before the Bench had arisen only concerning the value of land and building that was considered by the TPO for arriving at NAV. The Ld. AR submitted that the Tribunal in the aforesaid case, had observed that on a conjoint reading of sub-clause (b) and (c) of Section 11UA(1)(c), it can safely be gathered that for valuation of preference shares, the 24 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 guideline value of the immovable property was to be adopted since the same represented economic and commercial value of the preference shares on the date of value. Also, the Ld. AR submitted that the aforesaid observation of the Tribunal read a/w. the fact that the A.O/TPO had adopted NAV method for determining the FMV of preference shares left no ambiguity on the aspect that the valuation of the preference shares could safely be carried out as per "Net Asset Value" method as was so done by the present assessee company.
19. The Ld. AR had further submitted that the factual observation of the A.O who had determined the FMV of the preference shares as per the "dividend discounting method" suffers from certain serious perversities which had resulted in a distorted figure of FMV of the preference share that was arrived at by him at Rs. 5/- per share. Elaborating on his contention, the Ld. AR submitted that the A.O. had grossly erred in losing sight of the fact that the assessee company had issued "Optionally Convertible Preference" shares which could either be redeemed or converted into equity shares as per the terms and conditions set forth by the Board of Directors. Carrying his contention further, the Ld. AR submitted that though the aforesaid preference shares were redeemable within 20 years of allotment at a premium of not less than Rs.100/- each; or shall be converted into a similar number of equity shares (1:1), but the A.O had wrongly construed the same by observing that the said preference shares were to be redeemed at the end of the 20 years at a same value, i.e. Rs.110/-, and, thus, by so doing had grossly misdirected himself. Apart from that, the Ld. AR submitted that the A.O had also erred in failing to appreciate that the 25 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 aforesaid shareholders viz, S/shri Anand Singhania and Priyank Singhania were vested with the right to redeem the preference shares and receive back the entire consideration so paid by them or opt to convert the shares into a similar number of equity shares (1:1), which, thus, would put them in the same shoes as that of equity shareholders. The Ld. AR further submitted that the A.O. had though referred to the fact that the preference shares were convertible but had not considered the said material aspect while determining the FMV of the same.
20. The Ld. AR in support of his aforesaid contention, submitted that now when the preference shares were convertible into equity shares, therefore, the FMV of such shares would be more than the non-convertible shares or debt instruments, a material fact the A.O had ignored while determining the FMV of the same. The Ld. A.R, adverting to the assumption of the A.O. that the assessee company would pay 10% dividend, submitted that now when the terms of allotment of preference shares in itself provided for 100% dividend (i.e. coupon rate of 100%), and the assessee company had a substantial amount of divisible profits of Rs.27 crore as on 31.03.2016, therefore, there was no justification for the A.O to have assumed payment of 10% dividend. Also, the Ld. AR pointed out perversity in the assumption of the A.O. that the dividend would be paid by the assessee company every alternate year. The Ld. A.R, referring to the observation of the A.O. that the assessee company had no dividend payment history, submitted that it was incomprehensible as to how the same would be relevant regarding the dividend that would be payable by the assessee company in the future period. The Ld. AR, to fortify his aforesaid 26 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 contention, submitted that an investor at the stage of investing looks at the potential of the company as to whether or not it can pay a dividend in the future, and also, certain other factors like convertibility into equity shares, redemption premium, etc. The Ld. AR submitted that the A.O. had as per his convenience failed to consider all the aforesaid factors, and most arbitrarily, and rather without any basis assumed that the assessee company would pay a 10% dividend every alternate year.
21. Apropos the discount rate of 12% that was adopted by the A.O. while determining the FMV of the subject preference shares, the Ld. AR submitted that no basis for the adoption of the said rate is discernible from the record. The Ld. AR submitted that the A.O. had grossly erred in not pointing out any comparable instance that would have justified the adoption of the discounting rate at 12%. Referring to the observation of the A.O., the Ld. AR submitted that he had merely compared the discounting rate with secured debt and equity which was an unrealistic and baseless assumption on his part. Carrying his contention further, the Ld. AR submitted that merely for the reason that some of the terms of the preference shares matched with the debt instruments, the same on the said standalone basis could not be treated as a debt for certain purposes like discounting rate. The Ld. AR submitted that even otherwise in absence of any comparable instance the A.O could have fairly adopted the then FDR rate offered by a nationalized bank as a proper yardstick. To sum up, the Ld. AR submitted that the A.O. had grossly erred in treating the preference shares as debit or quasi-debt and considering the discounting rate on that basis for estimating the FMV of the subject preference shares. Based on his 27 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 aforesaid multi-facet contentions, the Ld. AR vehemently submitted that as the A.O had taken recourse to a most arbitrary approach that was not backed by any judicious basis, wherein he had assumed certain factors which were not correct; and also, ignored certain material aspects, therefore, the determination of the FMV by him suffered from serious infirmities and, thus, could not be accepted.
22. Per contra, the Ld. Departmental Representative (for short 'DR') relied on the orders of the lower authorities. It was submitted by the Ld. DR that as the assessee company had grossly erred in law and facts of the case in adopting the FMV of the equity shares for valuation of the preference shares, therefore, the A.O had rightly rejected the said method of valuation and taken recourse to the "dividend discounting method" for determining the FMV of the subject preference shares that were allotted by the assessee company to S/shri Anand Singhania and Priyank Singhania (supra). The Ld. DR submitted that the CIT(Appeals) had rightly upheld the view taken by the A.O, and the contentions advanced by the Ld. AR in his attempt to dislodge the well- reasoned observations of the lower authorities being devoid and bereft of any merit, therefore, did not merit acceptance and were liable to be rejected.
23. We have heard the ld. authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the Ld. AR to drive home his contentions.
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M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
24. As observed by us hereinabove the controversy involved in the present appeal boils down to the solitary issue, i.e. as to whether or not the A.O is right in law and facts of the case in rejecting the valuation of the preference shares that were issued by the assessee company to S/shri Anand Singhania and Priyank Singhania, i.e director and ex-director by adopting the "Net Asset Value" method, and substituting the same by "dividend discounting method"?. Also, as a corollary flowing thereto, another aspect that emerges from the aforesaid controversy is as to whether or not, the A.O while determining the FMV of the subject preference shares as per the "dividend discounting method", i.e., at Rs.5/- per share as against that issued by the assessee at Rs.110/- per share had properly considered all the material facts.?
25. As the Ld. AR based on his multi-facet contentions had assailed the determination of the FMV of the preference shares as per the "dividend discounting method" at Rs.5 per share by the A.O., therefore, we shall chronologically deal with the same as under:
A). Re : Anti-tax abuse provision :-
26. As observed by us hereinabove, the Ld. AR at the threshold of hearing of the appeal had assailed the triggering of provisions of Section 56(2)(viib) of the Act for valuing the subject preference shares that were issued by the assessee company to S/shri Anand Singhania and Priyank Singhania, i.e. director and ex-director of the assessee company. It is claimed that now when the identity and creditworthiness of the shareholders, and genuineness of the transaction of allotment of shares by the 29 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 assessee company to the aforementioned persons had been established to the hilt, therefore, there was no justification for the A.O to have tested the aforesaid transactions by triggering the deeming provisions of Section 56(2)(viib) of the Act, i.e, a counter tax evasion provision that was made available on the statute vide the Finance Act, 2012 with a specific purpose to deter the generation and use of unaccounted money. As observed by us hereinabove, the Ld. AR in support of his aforesaid contention had pressed into service certain judicial pronouncements. Also, the Ld. AR had taken us through the "Memorandum" explaining the purpose behind the insertion of an analogous provision, i.e Section 56(2)(vii) of the Act vide the Finance Bill, 2010.
27. Admittedly, it is a matter of fact borne from the record that the legislature in all its wisdom had inserted the provisions of Section 56(2)(viib) of the Act as a part of its counter-tax evasion mechanism to deter the generation and use of unaccounted money. Although the contention of the Ld. AR that now when the genuineness of the transactions of issuance of preference shares by the assessee company to its director/ex-director had been proved to the hilt, therefore, there was no justification for the A.O to have triggered the deeming provisions of Section 56(2)(viib) of the Act, i.e a counter tax evasion provision, at first blush appeared to be convincing, but going by the rule of strict literal interpretation that has to be adopted while construing the scope and gamut of a statutory provision the same does not merit acceptance. As Section 56(2)(viib) does not carve out any exception as regards the applicability of the same in a case where the shares are issued to the 30 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 directors of the company, therefore, the aforesaid contention of the Ld. AR that the same would not apply to the preference shares issued by the assessee company to its director/ex-director cannot be accepted. Apropos the support drawn by the Ld. AR from the judgment of the Hon'ble Supreme Court in the case of K.P Varghese Vs. ITO (supra) to impress upon us that the scope of applicability of Section 56(2)(viib) of the Act that has been made available on the statute vide the Finance Act, 2012 w.e.f. 01.04.2013 should be gathered in the backdrop of the budget Speech of the Finance Minister while tabling the Union Budget for 2012-13, the same, we are afraid would not carry the case of the assessee company any further. The Hon'ble Apex Court in the case of K.P Varghese Vs. ITO (supra) had, inter alia, held that the speech made by the mover of the Bill explaining the reason for introducing a statutory provision can certainly be referred to for ascertaining the mischief sought to be remedied by the legislature and the object and purpose for which the said legislation is enacted. Admittedly, the aforesaid statutory provision, i.e. 56(2)(viib) of the Act had been enacted as a part of a counter-tax evasion mechanism to prevent the laundering and deter the generation and use of unaccounted money, but in the absence of any exception having been made available on the statute as regards the applicability of the same to any specific class of persons, the aforesaid claim of the Ld. AR, wherein he had sought a concession as regards the application of the aforesaid statutory provision in a case of issuance of preference shares to the director/ex-director of the assessee company before us, cannot be accepted. Our aforesaid conviction that a statutory provision has to be 31 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 construed as per the rule of strict literal interpretation is supported by the judgment of the Hon'ble Supreme Court in the case of M/s. New Noble Educational Society Vs. The Chief Commissioner of Income Tax-1 and Anr., CA No.3793 to 3795 of 2014 dated 19.10.2022. The Hon'ble Apex Court had observed, that if the language is unambiguous and capable of one meaning, that alone should be applied and not any other, based on the surmise that the Parliament or the legislature intended it to be so. In other words, it is only in cases of ambiguity that the court can use other aids to discern the true meaning but where the statute is clear and the words plain, the legislation has to be given effect in its own terms.
28. Based on our aforesaid observations, we are unable to concur with the Ld. AR, who had tried to circumscribe the applicability of Section 56(2)(viib) of the Act by reading in it an exception as regards the applicability of the same to a specific class of persons, which, in the absence of anything to the said effect having been made available on the statute by the legislature cannot be accepted on our part. The Ground of appeal No. 2 is dismissed.
B). Re: Factually perverse observations of the A.O while determining FMV of preference shares as per "dividend discounting model":
29. As observed by us hereinabove, the Ld. AR had though assailed the rejection of the "Net Asset value" (NAV) method that was adopted by the assessee company for determining the FMV of the subject preference shares, but at the same time, he had vehemently assailed the observations/assumptions based on which the A.O. 32 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 had determined/estimated the FMV of the preference shares as per "dividend discounting method" at Rs.5/- per share. Because the assessee company had called into question the factual observations of the A.O while determining the FMV as per the "dividend discounting method", therefore, we shall chronologically deal with the same as under:
(i). Redemption of preference shares at the end of 20 years at the same value i.e. Rs.110/-
30. As observed by us hereinabove, the A.O., in the body of the assessment order, while determining the FMV of the subject preference shares had proceeded on the basis that the said shares were redeemable at the end of 20 years at the same value of Rs.110/-. Before us, it is the claim of the Ld. AR, that the aforesaid observation of the A.O. is fallacious and incorrect. Elaborating on his aforesaid contention, the Ld. AR had submitted that the subject 7,78,000 nos. of 100% non- cumulative redeemable preference shares issued by the assessee company were redeemable not later than 20 years from the date of allotment. Our attention was drawn by the Ld. AR to the observations recorded by the A.O (Page 4 - Para 12 of the assessment order), and the copy of the "Special Resolution" that was passed in the extraordinary general meeting of the assessee company, Page 69-70 of APB.
31. We have thoughtfully considered the aforesaid claim of the Ld. AR and find substance in the same. As stated by the Ld. AR, and rightly so, a perusal of the "Special Resolution" passed in the extraordinary general meeting of the assessee company on 04.04.2016, Pages 69-70 of APB reveals that the subject 7,78,000 nos. 33
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 of non-cumulative redeemable preference shares were redeemable not later than 20 years from the date of allotment. For the sake of clarity, the relevant extract of the resolution is culled out as under:
"RESOLUTION:
"RESOLVED THAT pursuant to section 55 of the Companies Act, 2013 7,78,000 100% Non-Cumulative Redeemable preference shares of Rs.10/- each be issued at a premium of Rs.100/- each at time to be fixed by the Board of Directors hereafter upon the following terms and conditions and subject to the following rights:-
1. The said 100% non-cumulative redeemable preference shares shall carry no fixed cumulative preferential dividend and shall be redeemable not later than 20 years from the date of allotment.
2. ..............
(emphasis supplied by us) We find that the A.O while referring to the allotment and conditions based on which, the preference shares were issued by the assessee company, had categorically acknowledged the fact that the subject preference shares were redeemable within 20 years of allotment at a premium of not less than Rs.100/- each; or shall be converted into similar nature of equity shares. In fact, the period of 20 years is the maximum statutory period for redemption and as per the terms of allotment of preference shares, the entire premium is redeemable. Accordingly, we concur with the claim of the Ld. AR that the observation of the A.O. that the subject preference shares under consideration were redeemable at the end of 20 years at the same value, i.e, Rs.110/- per share is factually incorrect and contrary to the facts discernible from the records.34
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
(ii). Convertibility of preference shares into equity shares not considered by the A.O:
32. On a perusal of the terms and conditions based on which the subject preference shares have been issued by the assessee company, it transpires that as per the "Special Resolution" passed in the Extraordinary General Meeting of the assessee company on 04.04.2016, it was specifically provided that the said preference shares shall be redeemed on not less than Rs.110/- each; or it shall be converted into a similar number of fully paid up equity shares by obtaining permission from all preference shareholders. For the sake of clarity, the relevant extract of the resolution is culled out as under:
"6. The said shares shall be redeemed on not less than Rs.110/- each or it shall be converted into a similar number (i.e. number of preference shares to be issued) of fully paid-up Equity shares by obtaining permission from all preference shareholders."
(emphasis supplied by us) As in a case where the preference shares are convertible into equity shares, the fair market value of such shares would be more than the non-convertible preference shares or debt instruments, therefore, we find substance in the claim of the Ld. AR that the A.O. had grossly erred in losing sight of the material fact that the subject shares were optionally convertible non-cumulative redeemable preference shares, which, thus, had a strong bearing on the determination of the FMV vis-à-vis. non- convertible preference shares or debt instruments.
(iii). Observation of the A.O that the assessee company will pay a 10% dividend:
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33. Although the A.O. while framing the assessment had assumed that the assessee company would pay a 10% dividend but we are unable to comprehend the very basis for such an assumption. The A.O. had supported his aforesaid view on the ground that the assessee company in the past years had not made any dividend payment, and also that the dividend would be paid to the preference shareholders only when it is paid to the equity shareholders. We are unable to persuade ourselves to subscribe to the aforesaid observation of the A.O. As the terms of issuance of the preference shares itself provide for a 100% dividend, i.e. the coupon rate is 100%, therefore, there could have been no justification for the A.O. in assuming payment of 10% dividend every alternate year by the assessee company. Because the terms of preference shares itself provide for a 100% dividend, thus, the aforesaid assumption of the A.O. that the assessee company would pay a 10% dividend being devoid and bereft of any basis cannot be accepted. Also, we are unable to comprehend on what basis the A.O. had assumed that the dividend would be paid by the assessee company every alternate year. Once again, as the aforesaid assumption of the A.O. is not backed by any concrete basis, therefore, the same cannot be subscribed on our part.
(iv) Discounted rate of 12% taken by the A.O:
34. As is discernible from the assessment order, the A.O., had adopted a discounting rate of 12%. Ostensibly, the A.O. had observed that as the going rate for secured debt was about 10-11% and that for equity was about 14-15%, therefore, a 36 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 discount rate of 12% could safely be adopted. At the threshold, we may herein observe that the A.O. had not referred to any comparable instance and had arrived at his aforesaid view based on a general observation. Apart from that, we concur with the Ld. AR that the assumption of the A.O. wherein he had compared the discount rate for secured debt and equity is not only without any basis but also unrealistic. Although, some of the terms of the preference shares match with the debt instruments, but the same on the said standalone basis could not be treated as a simpliciter debt instrument. Accordingly, we find substance in the contention of the Ld. AR that there is no justification for the A.O. in treating preference shares as a debt or a quasi-debt instrument, and thus, consider the discounting rate on that basis for estimating the FMV of the subject preference shares. Also, we find substance in the Ld. AR's contention that the bank FDR rate as was prevailing during the year in question should have been taken as the appropriate rate of return.
(v). Subscription of the preference shares by the promoters of the assessee company
35. On a perusal of the assessment order, it transpires that the A.O while framing the assessment had, inter alia, observed that as the subject preference shares have been issued by the assessee company to S/shri Anand Singhania and Priyank Singhania, i.e. Managing director/Ex-director of the assessee company, therefore, the value at which they have subscribed to the shares could not be taken to be a market value of the preference shares.
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36. We have thoughtfully considered the aforesaid observation of the A.O, and though concur with him that subscription of the shares by related persons may not reveal the true market value of the shares but on the said standalone basis it can also not be inferred that the said respective investors would not consider their interests and outcome of the investment while subscribing to the shares. Be that as it may, the A.O., without placing on record any material could not have merely on the ground that the subject preference shares were issued to related parties, drawn adverse inferences as regards the price at which they were subscribed by the aforementioned persons
37. Because the factual observations and assumptions of the A.O., as observed by us hereinabove, suffer from certain serious lapses/infirmities that had crept in while determining the FMV of the subject preference shares based on the "dividend discounting method" by the A.O., therefore, we are of the view that the matter in all fairness requires to be revisited by the A.O who is directed to redetermine the FMV of the subject preference shares in the backdrop of our aforesaid observations as regards the respective issues. Needless to say, the A.O., in the course of set-aside proceedings shall afford a reasonable opportunity of being heard to the assessee company which will remain at liberty to substantiate its claim based on fresh documentary evidence, if any.
(C) Re: A.O erred in rejecting the "Net Asset Value" method adopted by the assessee company for determining FMV of the subject preference shares:
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M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
38. As observed by us hereinabove, the assessee company had determined the FMV of the subject preference shares that were issued on 04.04.2016 to S/shri Anand Singhania and Priyank Singhania, director/ex-director at Rs. 121.58 per share based on the "Net Asset Value" (NAV) method, i.e the same method that was adopted for valuing the equity shares, Page 101 of APB. The aforesaid factual position can safely be gathered from the valuation certificate dated 05.04.2016 obtained by the assessee company from its Chartered accountant, and also, the latter's "affidavit" dated 04.12.2023 that was filed in the course of the proceedings before us.
39. Ostensibly, the A.O was of the view that as the equity and preference shares could not be placed on the same pedestal, therefore, determination of the FMV of the preference shares based on the "Net Asset Value" (NAV) method by the assessee company did not merit acceptance. The A.O., observed, that as the preference shares were quasi-debt instruments, which were differently placed in comparison to equity shares, therefore, the FMV of the same could not be determined in the manner that applied to equity shares. The A.O. was of the view that unlike the preference shareholders while the equity shareholders were the real owners of the company, the preference shareholders who had no stake over the assets of the company were only vested with a preference over the equity shareholders on repayment of equity. Accordingly, the A.O. was of the view that the "Net Asset Value" (NAV) method which represented the value of equity shares could not be adopted for determining the FMV of the preference shares. 39
M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022
40. We shall now look into the sustainability of the aforesaid view of the A.O. by carrying out a conjoint reading of Section 56(2)(viib) of the Act and Rule 11UA of the Income Tax Rules, 1962.
41. As per the "Explanation" to Section 56(2)(viib) of the Act the FMV of the shares shall be the value, viz. (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. On a perusal of Rule 11UA, we find that the same, inter alia, contemplates the determination of the FMV of the unquoted equity shares as per two methods, viz. (i) book value method; and (ii) discounted free cash flow method. On the other hand, as per Rule 11UA(c)(c) the determination of the FMV of unquoted shares and securities other than equity shares in a company that are not listed in any recognized stock exchange shall be estimated to be the price it would fetch if sold in the open market on the valuation date, and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. As such, the determination of the FMV of the preference shares can be traced in Rule 11UA(c)(c) of the Income Tax Rules, 1962, i.e. the estimated price that it would fetch if sold in the open market on the valuation date, as supported by a report from a specified accountant or a merchant banker. As submitted by the Ld. A.R, as per "Explanation(a)(i)" to Section 56(2)(viib) of the Act, in the absence of any 40 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 method having been prescribed for the determination of the FMV of the preference shares in Rule 11UA, the determination of the same shall be regulated by the "Explanation (a)(ii)" of Section 56(2)(viib) of the Act, i.e.- 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 of the assessee company. Admittedly, as stated by the Ld. AR, and rightly so, Sec. 56(2)(viib) -
"Explanation (a)" only refers to the valuation of the FMV of shares and does not discriminate between equity shares and preference shares. Also, we concur with the Ld. AR that though Rule 11UA(2)(a) and Rule 11UA(2)(b) prescribe two methods at the option of the assessee for determination of FMV of the unquoted equity shares, viz. (i) book value method; and (ii) discounted free cash flow method; but no method is prescribed for determination of FMV of preference shares, which, as per Rule 11UA(1)(c)(c) shall be estimated to be the price it would fetch if sold in the open market on the valuation date and is supported by a report obtained from a merchant banker or a specified accountant. Accordingly, there is merit in the Ld. AR's contention that the applicability of "Explanation (a)(i)" to Sec. 56(2)(viib) which provides that the FMV of the shares be determined in accordance with the methods as may be prescribed is confined to the determination of FMV of unlisted equity shares, and, the same fails as regards determining the FMV of preference shares.
Based on his aforesaid contention, the Ld. AR has claimed that the determination of FMV of preference shares would be as per the mandate of "Explanation (a)(ii) of 41 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 Sec. 56(2)(viib), i.e.- 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 of the assessee company. The Ld. A.R, based on his aforesaid contention had supported the determination of FMV of the subject preference shares by the Chartered Accountant of the assessee company, i.e, as per "Net Asset Value"
(NAV) method. As observed by us hereinabove, the Ld. A.R. had submitted that now when the determination of FMV of the subject preference shares as per NAV method by the assessee company was as per the mandate of "Explanation (a)(ii)" of Sec. 56(2)(viib) of the Act; therefore, the A.O had grossly erred in most arbitrarily discarding the same and substituting it by the FMV that was determined by him based on the "dividend discounting method" while framing the assessment.
42. Although at first blush the aforesaid contention of the Ld. A.R. appeared to be very convincing but we are afraid that the same does not merit acceptance. As observed by the A.O., and rightly so, the preference shares unlike the equity shares do not carry any stake in the ownership of the company. The preference shares commonly known as preferred stocks are those shares that enable their holders to receive dividends announced by the company before the same is received by the equity shareholders. If the company decides to pay out its dividends to investors, then the preference shareholders are the first to receive payouts from the company. Also, in the case of liquidation, the preference shareholders have priority over non- preferential shareholders. The preferred stock is a type of hybrid security; one that 42 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 has the features of both debt (as receiving a fixed income in the form of dividends), and equity (preferential treatment over common shareholders in the case of a company buyout). Unlike common shares which stake a claim in the ownership of a company, preferred shares provide incentives for outsiders to invest in the company, including fixed dividends and preferential treatment upon the exit of the company. In fact, the equity shares are mainly owned by the founders and employees, whereas preferred shares are usually owned by investors in the company. We concur with the A.O. that as the preference shares do not carry any stake in the ownership of the company, therefore, the net asset value of the company represents the value of equity shares and not that of preference shares. We, thus, are persuaded to subscribe to the view taken by the A.O. that the "Net Asset Value" (NAV) could not have been adopted for determining the FMV of the subject preference shares issued by the assessee company to S/sh. Anand Singhania and Priyank Singhania. At the same time, we may herein observe, that the discount rate is to be calculated based on the inherent risk, or is to be obtained from the public market for similar types of financial securities. Although the assessee claims that as the subject preference shares are optionally convertible preference shares, convertible into a similar number of equity shares of the assessee company, therefore, essential characteristic on the exercise of the conversion option is that of equity shares, and hence Net Asset value (NAV) method for valuation of these shares need to be considered, but we are unable to accept the said contention. As the subject shares are optionally convertible non-cumulative redeemable preference shares, which, as 43 M/s. Avinash Developers Pvt. Ltd. Vs. DCIT/ACIT, Circle-2(1), Raipur ITA No. 157/RPR/2022 observed by the A.O in the body of the assessment order, as per the terms and conditions on which they have been issued by the assessee company, inter alia, in the event of winding up shall not be entitled to its assets, therefore, their FMV in our view cannot be safely determined based on the "Net Asset Value" (NAV) method. At the same time, we are of the view that the fact that the subject shares are optionally convertible preference shares would in itself be a primary factor to be considered in the backdrop of the unlisted equity shares, and thus, will have a strong bearing while determining of their FMV by an analyst. As regards the orders of the coordinate benches of the Tribunal that have been pressed into service by the Ld. A.R, viz. (i). ITAT, "C" Bench, Bengaluru in the case of Information Technology Park Ltd. Vs. ITO, ITA Nos. 1357 and 1358/Bang/2018 dated 24.08.2022, Page 194-205 of APB; and
(ii). ITAT, Jaipur in the case of Ginni Global (P). Ltd. Vs. ACIT, 177 ITD 278 (Jaipur), we are of the view that as in neither of the case, the Tribunal was seized of the core issue as is there before us, i.e., whether or not the determination of the FMV of preference shares can be validly based on "Net Asset Value" (NAV) method, therefore, the same would not assist the case of the assessee company before us. We, thus, in terms of our aforesaid deliberations direct the A.O to redetermine the FMV of the subject preference shares subject to our observations recorded as regards the mistakes/infirmities that had crept in the determination of the same. The Ground of Appeal No. 1 is partly allowed for statistical purposes in terms of our aforesaid observations.
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43. In the absence of any contention having been advanced by the Ld. A.R., as regards the grievance of the assessee company that the CIT(Appeals) had erred in sustaining the order of the A.O., wherein the latter had made the addition without issuing any show cause notice (SCN), the Ground of appeal No. 3, is dismissed as not pressed.
44. The Ground of appeal No. 4 being general is dismissed as not pressed.
45. Resultantly, the appeal filed by the assessee is partly allowed for statistical purposes in terms of our aforesaid observations.
Order pronounced in open court on the 19th day of February 2024.
Sd/- Sd/-
ARUN KHODPIA RAVISH SOOD
(ACCOUNTANT MEMBER) (JUDICIAL MEMBER)
रायपुर/ RAIPUR ; दनांक / Dated : 19th February, 2024
**#SB
आदे श क त ल प अ े षत / Copy of the Order forwarded to :
1. अपीलाथ / The Appellant.
2. यथ / The Respondent.
3. The CIT(Appeals), Bhopal
4. The Pr. CIT, Raipur-1 (C.G)
5. वभागीय त न ध, आयकर अपील य अ धकरण, रायपुर बच,
रायपरु / DR, ITAT, Raipur Bench, Raipur.
6. गाड फ़ाइल / Guard File.
आदे शानुसार / BY ORDER,
// True Copy //
नजी स चव / Private Secretary
आयकर अपील य अ धकरण, रायपरु / ITAT, Raipur.