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Income Tax Appellate Tribunal, DELHI BENCH “C” DELHI
Before: SHRI KUL BHARAT & SHRI PRADIP KUMAR KEDIA
PER PRADIP KUMAR KEDIA, A.M.: The captioned appeal has been filed by the Revenue against the order of the Commissioner of Income Tax (Appeals)-V, New Delhi [‘CIT(A)’ in short] dated 30.08.2019 arising from the assessment order dated 18.12.2018 passed by the Assessing Officer under Section 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2016-17.
The grounds of appeal raised by the Revenue read as under:
“1. That on the facts and circumstances of the case and in law, the ld. CIT(A) has erred in deleting the addition of Rs.36,03,10,674/- made by Assessing Officer under Section 56(2)(viib) by holding that addition with respect to change in the method of valuation is not accordance with law. 2. That on the facts and circumstances of the case and in law, the Assessing Officer has rightly rejected the DCF methodology adopted by the appellant company for the purpose of arriving at the FMV of equity shares.
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That on the facts and circumstances of the case and in law, the Assessing Officer has rightly applied NAV methodology for determining the FMV of equity shares.” 3. Briefly stated, the assessee-company is engaged in the business of financing including financing against warehouse receipts primarily for agricultural commodities and advancing of loans etc. The assessee company filed its return of income for Assessment Year 2016-17 declaring total income at Rs.6,42,34,840/-. The return filed by the assessee was subjected to scrutiny assessment. In the course of assessment, the Assessing Officer has inter alia observed that the assessee-company has issued Rs.3,37,68,573/- shares to its holding company, M/s. Sohan Lal Commodities Management Pvt. Ltd. of Rs.22.21 per shares against the face value of Rs.10/- per share. The assessee company submitted valuation report of Chartered Accountant for determining fair market value per share at Rs.22.21/- adopting discounted cash flow (DCF) Method. The Assessing Officer disputed the fair market value determined on the basis of DCF Method which methodology is predominantly based on projected growth in the ensuing financial years over certain period of time. The Assessing Officer compared the projected growth/sales and other data for two financial years, i.e., 2016-17 and 2017-18 with the actual figures available at the time of the assessment and found wide variance. The Assessing Officer rejected the valuation report provided on the basis of projected figures supplied by the management and consequently rejected the FMV determined as per the valuation report. The Assessing Officer discarded the FMV of Rs.22.21 per share determined in the valuation report of CA by applying DCF method holding the same to be devoid of substance. The Assessing Officer invoked NAV method as provided in Rule 11UA of the Income Tax Rules for the purposes of determination of FMV under Section 56(2)(viib) of the Act. The Assessing Officer worked out the fair market value as per NAV at Rs.11.54 per share and substituted the same with Rs.22.21 per share determined by Assessee under DCF method. The Assessing Officer thus
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invoked the provisions of Section 56(2)(viib) and made an addition of Rs.36,03,10,674/- by applying difference of Rs.10.67 per share [Rs. 22.21 (minus) 11.54] per share as excess premium received over the fair market value.
Aggrieved by the additions made under Section 56(2)(viib) of the Act, the assessee preferred appeal before the CIT(A). Before the CIT(A), the assessee filed detailed submission assailing the action of the Assessing Officer. On consideration of submissions made and material placed before him, the CIT(A) found merit in the case made out by the assessee and thus reversed the action of the Assessing Officer. The relevant operative paragraph of the order of the CIT(A) is reproduced hereunder:
“Findings & determination: 6.1 I have gone through the assessment order, submission made by the appellant, facts and details brought on record and various case laws relied upon by the appellant. 6.2 Ground no. 1 is general in nature and subsumes with specific grounds of addition, hence no separate adjudication required. 7. In ground nos. 2 to 11, the appellant has challenged the addition made amounting to Rs. 36,03,10,674/- u/s 56(2)(viib). Since these grounds are interlinked, therefore taken together. As mentioned earlier, the appellant has issued 3,37,68,573 shares to its existing holding company M/s Shoan Lal Commodity Management Pvt. Ltd. (SLCMPL) for the face value of Rs. 10/- at a premium of Rs. 22.21/-. A valuation report by the auditor has also been submitted to substantiate its action regarding higher premium. However, the AO did not accept the DC method employed in the report of auditor and adopted the NAV method as per book value which comes to Rs. 11.54/- per share. Accordingly, the difference of two (22.21 - 11.54) i.e. Rs. 10.67/- per share has been added as income u/s 56(2)(viib) of the Act. 7.1 It has been vehemently argued, as reproduced earlier that the provisions of section 56(2)(vilb) are not applicable in the case of appellant. It is contended that the valuation report has been prepared by the expert valuer/auditor and in accordance with the provisions of section 56(2)(viib), where as per Rule 11UA(2), the appellant is entitled for the valuation of fare market value (FMV) as per the DC method. It is also stated that the total investment has been made by the existing holding company where the appellant is fully owned subsidiary company. It is also mentioned that these funds have been received from holding company through foreign investments
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and indirectly can be termed as FDI. It is argued that the intent of legislature is to curb the black money and there cannot be involvement of any such unaccounted money as the funds have been sourced from abroad through its holding company and has passed necessary test of foreign remittance and other exchange regulations. There is no proof or evidence that this money is actually appellant's funds and has been routed through the different entities. 7.2 It is further argued that the valuation has been done as per DCF method which is duly acceptable as per the prescribed Rules. It is further stated that as per explanation (a)(i) of the section 56(2)(viib), the fair market value of the share shall be the value, as may be determined in accordance with the prescribed method. In the present case, the appellant has gone by the prescribed method i.e. DC method which is supported by the report of independent auditor and is in accordance with law. Therefore, it is not open to the AO to change the method, adopted by the appellant. Further, no cogent reasoning has been submitted while rejecting the valuation adopted by the appellant. 7.3 The contention of the appellant has been examined. The fair market value as given by the appellant has been rejected which was based on the DC method of valuation without any cogent material on record. The AO has mentioned that the projected value does not commensurate with the actual performance of the company, later. The AO has taken the book value (NAV) as fair market value and also applied the ratio laid down by the Hon'ble ITAT in the case of M/s Agro Portfolio Pvt. Ltd. in ITA No. 2189/Del/2018. 7.4 On going through the contentions of the appellant, it is seen that the working has been made by an independent valuer, submitting the valuation of share as per discount cash flow method. Further, as per the provisions of law, the appellant can take higher of the amount between the working as per Rule 11UA (DC method) or on the basis of the value of shares considering the market value of assets, intangible assets and projected profit (NAV method). 7.5 In the present case, the working given by the appellant has been based on the value of the shares taking into account the projected business and other parameters as per auditor's report. 7.6 The working provided as per Rule 11UA(2) has 2 limbs either at FMV of unquoted equity share as per formula (A-L)*(P)/(PE) or as per the FMV worked out for the unquoted shares determined by a valuer/CA/merchant banker etc as per discount free cash flow method. It is at the option of assessee to choose between two whichever is higher. In the present case, the appellant has opted for the second option for working out the fair market value of shares duly supported by report of a Chartered Accountant. 7.7 On the other hand, AO has not provided any sound reasoning or not brought on record any material to counter the argument or to negate the submissions of the appellant. He has rejected the projection with the contention that this projection has not been turned out to be reality or actual performance and hence not regarded the DCF method and applied NAV
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method. It is pertinent to note that projections of future profits are only the estimates and not the exact working of future profits. This has also been held by Hon'ble ITAT Delhi Bench in the case of India Today Online Pvt. Ltd. (Supra) that DCF method is a recognized method where future projections of various factors by applying hindsight view and it cannot be matched with the actual performance. Further, the appellant has provided elaborate reasons for such projections not coming to the reality due to various factors, which was not envisaged at that point in time. 7.8 Therefore it is clear that as per the provisions of law, the appellant has worked out the FMV, taking into consideration the future projections, using DCF method duly supported with reason and accompanied by the report of CA, which is higher than the NAV, worked out by the AO. Therefore, the appellant is entitled to take higher amount, as provided in the law. 7.9 Section 56(2) (vii)(b) read with Explanation has specifically provided that the fair market value of the unquoted shares shall be determined as per the prescribed methods and shall be taken whichever is higher. 7.10 In the following case, the Hon'ble ITAT, Jaipur has held that AO cannot force the appellant to select a different method, especially when conditions are fulfilled for method of valuation. M/s Rameshwaram Strong Glass Put Ltd Vs ITO; 2018-TIOL- 1358-ITAT-JAIPUR Whether when in terms of Rule 11UA(2)(b), if the assessee is entitled to choose a particular method of valuation of his unquoted equity shares, the A can still force the assessee to select a different one - NO: ITAT. 7.11 The appellant has heavily relied upon the case of M/s Cinestaan Entertainment Pvt. Ltd. (Supra), where the Hon'ble ITAT, Delhi in the recent judgment held that: - 31........... Any businessman or entrepreneur, visualise the business based on certain future projection and undertakes all kind of risks. It is the risk factor alone which gives a higher return to a businessman and the income tax department or revenue official cannot guide a businessman in which manner risk has to be undertaken. Such an approach of the revenue has been judicially frowned by the Hon'ble Apex Court on several occasions...Commercial expediency has to be seen from the point of view of businessman. Here in this case if the investment has made keeping assessee's own business objective of projection of films and media entertainment, then such commercial wisdom cannot be questioned. Even the prescribed Rule 11UA(2) does not give any power to the Assessing Officer to examine or substitute his own value in place of the value determined or requires any satisfaction on the part of the Assessing Officer to tinker with such valuation.
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Section 56(2) (viib) is a deeming provision and one cannot expand the meaning of scope of any word while interpreting such deeming provision. If 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 assessee, then Assessing Officer has to accept the same and in case he is not satisfied, then we do not we find any express provision under the Act or rules, where Assessing Officer can adopt his own valuation in DCF method or get it valued by some different Valuer. There has to be some enabling provision under the Rule or the Act where Assessing Officer has been given a power to tinker with the valuation report obtained by an independent valuer as per the qualification given in the Rule 110. Here, in this case, Assessing Officer has tinkered with DC methodology and rejected by comparing the projections with actual figures. The Rules provide for two valuation methodologies, one is assets-based NAV method which is based on actual numbers as per latest audited financials of the assessee company. … These projections are based on various factors 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. 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... 33.In any case, if law provides the assessee to get the valuation done from a prescribed expert as per the prescribed method, then the same cannot be rejected because neither the Assessing Officer nor the assessee have been recognized as expert under the law. 7.12 It is clear from the above judgment by the Hon'ble Jurisdictional ITAT that neither AO has any power or expertise to change the method of valuation nor it can reject a valid valuation by a competent person say a CA in this case. The law has to be followed in later and spirit. The facts and ratio laid down by the Hon'ble ITAT in the above referred case are squarely applicable to the appellant and hence respectfully foliowing the same, it is held that the addition with respect to change in the method of valuation is not in accordance with law. 7.13 It is also seen that AO has relied upon the case law of Agro Portfolio Pvt. Ltd. (Supra). The Hon'ble Delhi ITAT in the said case has held the change of method as valid, which is adopted by AO as per NAV method/book
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value, rejecting the projections by a CA for DCF method. The appellant has elaborately disputed and distinguished the facts of the said case from that of the case of appellant. In the said case, the Hon'ble ITAT allowed the AO's working of NAV value on the ground that no cogent reasoning was provided in the report and the veracity of the data supplied was also not justified. In the case of appellant as well as in the case of M/s Cinestaan Entertainment Pvt. Ltd. the valuation report is duly supported by the facts and figures and during appellate proceedings, the appellant has provided elaborate justification of the projections, showing positive results and cogent reasons for deviation. It is trite law that the projections cannot be equated with 100% actual performance which is also confirmed by Hon'ble ITAT Delhi in the case of India Today Online Pvt. Ltd (Supra). 7.14 Therefore, looking to the facts and circumstances of this case, considering appellant's submissions and in law, which is further supported by the judgment of Hon'ble ITAT Delhi in the case of Cinestaan Entertainment Pvt. Ltd (Supra) and other case laws and as discussed in detail in foregoing paragraphs, it cannot be said that the value adopted by the appellant is liable to be rejected or subjected to tax u/s 56(2) (vilb) of the Act, enforcing the change of method of valuation of FMV of shares. Accordingly, the valuation done by appellant is found to be in accordance with law. Therefore in view of above discussions and considering the extant law, this addition is directed to be deleted. Thus the appellant gets a relief of Rs. 36,03,10,674/-. These grounds of appeal are allowed.”
Aggrieved by the relief granted by the CIT(A), the Revenue is in appeal before the Tribunal.
The ld. DR for the Revenue reiterated the observations made by the Assessing Officer and contended that the Assessing Officer has found on facts that the FMV determined by the assessee based on untenable projection is prima facie incorrect and consequently left with no option but to advert to more reliable NAV Method for determination of FMV. The ld. DR thus contended that CIT(A) has misdirected himself on law and on facts in brushing aside the action of the Assessing Officer without appreciating the factual nuances. The ld. DR thus urged for reversal of the order of the CIT(A) and restoration of the action of the Assessing Officer.
The ld. counsel for the assessee, on the other hand, supported the action
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of the CIT(A) and reiterated the detailed submissions made before the CIT(A) in this regard to justify the action.
We have heard the parties in length and perused the assessment order as well as the first appellate order. The documents referred to and relied upon has been taken cognizance in terms of Rule 18(6) of the Income Tax (Appellate Tribunal) Rules, 1963.
8.1 In the case in hand, the solitary question presented for determination is whether the consideration received by the assessee towards premium on issue of equity share represents the fair market value or exceeds the fair market value, and whether deeming provisions of Section 56(2)(viib) of the Act are attracted in the facts of the case. 8.2 The legal fiction inserted by Section 56(2)(viib) seeks to deem premium received from subscribers being Indian entities in excess of Fair Market Value as the chargeable income in the hands closely held company issuing such share at premium in excess of its Fair Market Value. 8.3 To set the context, the assessee company in the instant case, received consideration of Rs.10/- towards face value of each equity share at a premium of Rs.12.21 as premium thereon towards issuance of 337,68,573/- equity shares to M/s. Sohan Lal Commodities Management Pvt. Ltd. (SLCMPL) who happens to be holding company of the assessee. The assessee-company adopted DCF method for determination of Fair Market Value as per valuation report of the independent valuer filed to support and vindicate the share premium on issue of equity share. The Assessing Officer however found fallacy in the quantification of
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FMV so determined by DCF method and observed that the FMV determined as per DCF method is without any sound factual basis and the projected figures of the ensuing years widely vary with the actual figures reported and presently available at the time of assessment for Financial Years 2016-17 and 2017-18. 8.4 The Assessing Officer essentially alleged that the valuation derived by the valuer is unconnected to the ground realities and cannot be relied upon. The Assessing Officer thus rejected the valuation of Rs.22.21/- per share determined as per DCF method to be FMV of the equity shares in terms of Section 56(2)(viib) r.w. Rule 11UA. The Assessing Officer computed the FMV by applying NAV method for the purposes of Section 56(2)(viib) and found the FMV at Rs.11.54/- per share, i.e., face value of Rs.10/- per share at a premium of Rs.1.54/- per share. The difference between the FMV as per DCF method qua NAV method was thus considered a chargeable income of the assessee under Section 56(2)(viib) of the Act. The excess consideration received by way of premium was thus determined at Rs.36,03,10,674/- arisen on issue of equity shares on the touchstone of Section 56(2)(viib). 8.5 To contradict the action of the Assessing Officer, the assessee broadly submits that; (i) the provisions of Section 56(2)(viib) introduced by Finance Act, 2012 are anti-abuse provisions with a sacrosanct object to curb the practice of ploughing back its unaccounted money by issuing shares at a price which is higher than its FMV. Thus, provisions of Section 56(2)(viib) cannot be applied mechanically to a genuine transaction which also has the backing of the report of independent
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valuer in accordance with Rules 11U and 11UA of the Income Tax Rules. (ii) the Assessing Officer has disputed the application of DCF method in the instant case by taking a hindsight by comparing the projections made at the time of issuance of shares with the subsequent events and actual financial results despite the legal proposition that valuation cannot be judged in the light of the subsequent events or hindsight. A reference was made to the decision of Hon’ble Delhi High Court in the case of Pr.CIT vs. Cinestaan Entertainment Pvt. Ltd. (ITA No.1007/2019) & CM Application No.54134/2019 judgment dated 01.03.2021. (iii) the assessee further contends that the DCF method adopted by independent valuer seeks to value the equity shares of a company by discounting its free cash flows for explicit forecast period and the perpetuating value thereafter. The free cash flow represents the cash available for distribution to the owner of the business. Such free cash flows are discounted by appropriate cost of capital. The present value of the free cash flows during the discrete period and the perpetuity value indicate the fair value of the business. The DCF method thus attempts to estimate the FMV future cash flows based on projection of how much money that the proposed investment is likely to generate in future. The assessee thus contends that FMV as per DCF method is determined on the basis of projected figures of cash flow in the future years which is bound to be at variance with the actual revenue and cash flow of the subsequent years as the projected figures cannot be gauged
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with any arithmetical precision. The valuation of the cash flow in future years cannot be visualized at the time of projections having regard to the many imponderables which may enter with the passage of time. The valuation determined under DCF is only an estimate of potential of establishment and any comparison of such projections with actual figures at a later stage to reject the valuation would totally frustrate the intended outcome from DCF method of valuation recognized by the statute. (iv) the Assessing Officer has failed to take note of the most significant fact existing in the present case that the assessee is a wholly owned subsidiary company of the holding company, namely, SLCMPL. The shares have been issued at premium to its holding company who owns the assessee. The holding company raised the requisite fund with intent to make further investment into its downstream entities by means of foreign direct investment after compliance of all formalities with Reserve Bank of India. The holding company submitted the group projections including projections related to the assessee-company to the foreign investors are based on the same, the investment was procured by the holding company from the foreign investors which were further invested into its subsidiaries including the assessee-company. (v) Since holding company invested funds raised through foreign direct investment in the assessee company, under such circumstances, the investment by holding company to the assessee-company and consequent issuance of shares by the assessee-company to holding company is similar to
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issuance of share to itself and therefore, in such a case, the anti-abuse provision of Section 56(2)(viib) cannot be visualized. 9. On conspectus of the plea raised on behalf of the assessee, we find substantial force and plausibility therein. The assessee company in the instant case has proceeded to issue equity shares at a premium to none other than its wholly owned holding company and that too on the basis of independent valuer report where FMV was determined as per DCF method which is one of the prescribed method for determination of valuation under Rule 11UA r.w. Section 56(2)(viib) of the Act. The Assessing Officer has disputed the DCF method on account of variation in the projected figures used by the valuer with the actual figures available subsequently at the time of assessment. The Assessing Officer discarded the FMV method as per DCF method and replaced the same with the NAV method which action runs totally contrary to the ratio laid down in Cinestaan Entertainment (supra) 10. In Cinestaan (supra), the Hon’ble Delhi High Court took cognizance of the identical situation, i.e., the Assessing Officer had disregarded the valuation report of the assessee primarily on the ground that the projections of revenue considered for the purpose of valuation do not match with the actual revenue arose in the subsequent years. The Hon’ble Delhi High Court in the fact situation observed that the assessee company has adopted a recognized method of valuation and the revenue could not show that assessee has adopted demonstrably wrong approach. It was observed that valuation is not an exact science and therefore cannot be done with arithmetic precision. It is a technical and complex issue which should best be appropriately left to the
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consideration and wisdom of experts in the field, having regard to the imponderables which enter the process of valuation of shares. The Hon’ble High Court thus upheld the action of the ITAT and consequently the additions made under the deeming provisions of Section 56(2)(viib) made by the Assessing Officer were reversed. 11. Similar view has been taken by the Hon’ble Co-ordinate Bench in Intelligrape Software Pvt. Ltd. vs. ITO, ITA No.3925/Del/2018 Assessment Year 2014-15 order dated 30.09.2020 wherein it was observed that the valuation based on future projections at the time of issue of shares cannot be inferred as the actual figures may vary depending on the market conditions and host of other factors. 12. This apart, as pointed out on behalf of the assessee, the shares have been subscribed by the holding company, i.e., the existing shareholders only. Pertinent to say, section 56(2)(viib) creates a legal fiction whereby the scope and ambit of expression ‘income’ has been enlarged to artificially tax a capital receipt earned by way of premium as taxable revenue receipt. Hence, such a deeming fiction ordinarily requires to be read to meet its purpose of taxing unaccounted money and thus needs to be seen in context of peculiar facts of present case. The legal fiction has been created for definite purpose and its application need not be extended beyond the purpose for which it has been created. Bringing the premium received from holding company to tax net under these deeming fictions would tantamount to stretching provision to an illogical length and will lead to some kind of absurdity in taxing own money of shareholders without any corresponding benefit.
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In totality, governed by the view taken by the Hon’ble Delhi High Court as well as the Co-ordinate Bench in similar fact situation coupled with the fact of the issue of shares to its holding company, we are unable to see any infirmity in the first appellate order on the point under determination. We thus decline to interfere with the order of the CIT(A). 14. In the result, the appeal of the Revenue is dismissed.
Order was pronounced in the open Court on 15.03.2023.
Sd/- Sd/- . [KUL BHARAT] [PRADIP KUMAR KEDIA] JUDICIAL MEMBER ACCOUNTANT MEMBER DATED: .03.2023 Prabhat