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Income Tax Appellate Tribunal, ‘B’ BENCH, CHENNAI
Before: SHRI V. DURGA RAO, HON’BLE & SHRI G. MANJUNATHA, HON’BLE
आदेश /O R D E R
PER G. MANJUNATHA, ACCOUNTANT MEMBER:
This appeal filed by the assessee is directed against the order passed by the learned Commissioner of Income Tax (Appeals)-4 (i/c), Chennai, dated 28.08.2019 and pertains to assessment year 2015-16.
:-2-: ITA. No: 3067/Chny/2019 2. The assessee has raised the following grounds of appeal: “1. The order of the Commissioner of Income Tax (Appeals) - 4, Chennai dated 28.08.2019 in I.T.A.No.177/17-18/CIT(A)- 4/AY:2015-16 for the above mentioned Assessment Year is contrary to law, facts, and in the circumstances of the case. 2. The CIT (Appeals) erred in sustaining the addition of Rs. 2,07, 15,240/under section 56(2)(viib) of the Act, being the amount received on account of share premium on shares and compulsory convertible debentures without assigning proper reasons and justification. 3. The CIT (Appeals) failed to appreciate that the appellant would squarely fall under the definition of Venture Capital Undertaking as provided u/s 56(2)(viib) read with explanation (c) of Section 10(23FB) of the Act and hence the addition made under section 56(2)(viib) was completely erroneous and not justifiable, thereby to be reckoned as bad in law. 4. The CIT (Appeals) failed to appreciate that there was no legal bar against outsourcing of activities involved in manufacturing or processing of goods while the requirement of the Appellant should be engaged in the manufacturing or processing of goods, either itself, or through some agency under its supervisory control or direction to qualify/to fall within the definition of Venture Capital Undertaking, thereby fortifying the exclusion canvasssed for the non applicability of the relevant provisions under consideration. 5. Without prejudice to the above, the CIT (Appeals) ought to have appreciated that the Discounted Cash Flow method adopted by the Appellant through an independent valuer was as per the provisions of Rule 11UA of the Income Tax Rules, 1962 and hence ought to have appreciated that the valuation of share premium would get fortified while vitiate the applicability of the provisions in section 56(2)(viib) of the Act. 6. The CIT (Appeals) further should have appreciated that the rejection of the valuation report by the Assessing Officer based on the actual performance while the said report was prepared on the projected performance inasmuch as ought to have appreciated that the said approach of the Revenue in rejecting the valuation report to apply the provisions of section 56(2)(viib) of the Act should be reckoned as bad in law while there was no such power/reason for rejecting the valuation
:-3-: ITA. No: 3067/Chny/2019 report, thereby vitaiting the consequential additon made in the computation of taxable total income. 7. The CIT (Appeals) failed to appreciate that the rejection of the valuation report by the Assessing Officer should be reckoned as excessive use of jurisdiction within the scope of Rule 11UA of the Income tax Rules, 1962 while the said rule provided the option on the method of valuation, thereby vitiating the value adopted based on the book value method and consequently vitiating the addition made on various facets. 8. The CIT (Appeals) failed to appreciate that the misreading of the documents leading to the receipt of share premium and the erroneous understanding of the applicability of section 56(2)(viib) of the Act in the erroneous rejection of the valuation report for coming to the conclusion on the receipt of excessive share premium should be reckoned as bad in law on various counts and ought to have appreciated that the addition made in this regard was completely wrong, erroneous, unjustified, incorrect and not sustainable in law. 9. The CIT (Appeals) failed to appreciate that there was no proper opportunity given before passing of the impugned order and any order passed in violation of the principles natural justice would be nullity in law. 10. The Appellant craves leave to file additional grounds/arguments at the time of hearing.”
The brief facts of the case are that, the assessee company filed its return of income for the assessment year 2015-16 on 22.09.2015, declaring a loss of Rs. 2,33,27,290/-. The case was selected for scrutiny and during the course of assessment proceedings, the AO noticed that during the year under consideration the assessee company has received share premium of Rs. 1.75 crores and Rs. 2.05 crores from M/s. Fulcrum Venture India Trust (Trustee – IL & FS Trust Company
:-4-: ITA. No: 3067/Chny/2019 Ltd) for allotment of equity shares with a premium of Rs. 22/- per share. The assessee has justified issue of share premium at Rs. 22/- per share with the help of valuation report from an independent auditor. The AO, rejected explanation furnished by the assessee and according to the Assessing Officer, the assessee could not justify value of shares at Rs. 32/- per share. Although, it has followed discounted cash flow (DCF) method to determine the share price, but there are some infirmities in projections considered by the assessee to arrive at a free cash flow, where the projected turnover and profit before tax considered by assessee for assessment year 2016- 17 & 2017-18 is much higher than the actual turnover achieved for two assessment years. Therefore, rejected valuation report submitted by the assessee and determined fair value of equity shares under rule 11UA of the I.T. Rules, 1962 by adopting Net Asset Value (NAV) method and determined per equity share price at Rs. (-)6.15. Since, the face value of equity shares issued by the assessee is at Rs. 10 per share, excess consideration received over and above face value of Rs. 22/- per share has been treated as income of the assessee in terms of provisions of section 56(2)(viib) of the Act and made additions of Rs.2,07,15,240/-.
:-5-: ITA. No: 3067/Chny/2019 4. Being aggrieved by the assessment order, the assessee preferred an appeal before the CIT(A). Before the CIT(A), the assessee reiterated its arguments made before the AO and submitted that the assessee is a venture capital company and has received share capital from venture capital funds and thus, provisions of section 56(2)(viib) of the Act does not apply. Therefore, no addition can be made towards excess consideration over and above the face value u/s. 56(2)(viib) of the Act. The assessee, further contended that the AO is erred in determining share price under NAV method even though, the assessee has followed DCF method for determining share price, without appreciating fact that it is for the assessee to choose a particular method at his discretion and method selected by the assessee is one of the permissible method. The AO, on the basis of financials of actual for next two financial years came to the conclusion that projections has not been met by the assessee and thus, valuation report submitted for determination of share price is incorrect, ignoring fact that it is not necessary actual performance of a company should be equal to projected financials.
:-6-: ITA. No: 3067/Chny/2019 5. The Ld. CIT(A), after considering relevant submissions of the assessee and also taking note of various reasons given by the AO rejected arguments of the assessee and sustained additions made towards disallowance of share premium u/s. 56(2)(viib) of the Act, by holding that the assessee could not justify valuation of shares under DCF method with necessary financials. The relevant findings of the Ld. CIT(A) are as under: “N0w, l have considered the submissions of the AR. The appellant is only a trading company and therefore it cannot be considered as a venture capital undertaking. The AR has submitted that it had entered into an agreement with M/s Puneet Laboratories Pvt Ltd. for manufacture of goods. Copy of the agreement was provided by the AR in the CD. The Clause in the agreement reads as under:- BRIO BLISS is desriouts of purchasing the products manufactured by PUNEET for the purpose of marketing the products in the Temtorty under trademarks of generic names, on the terms and conditions as hereinafter provided.” It may be seen from the above that the appellant is only purchasing the products manufactured by Puneet for marketing. Thus. the appellant is not manufacturing any goods on its own but only intended to market the products manufactured by another entity called PUNE:ET. The appellant cannot therefore be considered as a manufacturer of any goods and would not fall within the definition of Venture Capital undertaking and consequently the provisions of section 56(2l(viib) would apply. As already stated supra, the AR has not given any valid reasons against the rejection of the DCF method and its valuation given in the valuer’s report and therefore the same has to be upheld. The AR has relied on the decision of the Mumbai Bench in the case of
:-7-: ITA. No: 3067/Chny/2019 M/s Ozoneland Agro P Ltd.. In this case, the ITAT has held that the AO cannot compel an assessee to adopt a particular method of valuation. Under Rule 11UA, an assessee can opt either the value as per Net asset value or discounted cash flow method (DCF). ln the appellant's case, the AO has not adopted a different method for valuing the shares. In other words, the AO has not adopted the net asset value while rejecting the value shown by the appellant under DCF method. He has only stated that the value adopted under DCF method is not correct and cannot be relied upon. He has only adopted the face value of the share as the fair market value o! the shares and added the difference. Hence, the decision relied on by the appellant would not help its case. Considering the above facts, I hold that the AO was justified in adding Rs.2,07,15,240/- being excess premium received for allotment of shares as come from other sources under section 56(2)(viib) of the Act. The addition is confirmed and the grounds are dismissed.”
The Ld. Counsel for the assessee, submitted that the ld. AO and the CIT(A) erred in sustaining additions made towards share premium u/s. 56(2)(viib) of the Act, without appreciating fact that the assessee has justified premium charged on issue of shares with the help of valuation report issued by an independent auditor. The ld. Counsel for the assessee, referring to valuation report submitted that the assessee has followed DCF method for valuation of shares and has considered certain projections. The AO, rejected DCF method followed by the assessee only on the ground that actual performance of the company for two assessment years is not equal to projected financials, ignoring fact that it is not
:-8-: ITA. No: 3067/Chny/2019 necessary actual performance of a company should be equal to projected financials, because DCF method of valuation of shares comes on the basis of projected financials of future years, which depends upon various factors including certain estimations and assumptions. Therefore, when actual financials differentiates with projected figures, it may not be the reason for the AO to change the method adopted by the assessee. Therefore, he submitted that the matter may be set aside to the file of the AO to re-examine valuation report submitted by the assessee to determine correct amount of share price and premium charged on the issue of shares.
The Ld. DR, on the other hand supporting the order of the AO and the CIT(A) submitted that, when assessee could not able to justify valuation method adopted for determination of share price, the AO can very well determine share price on the basis of rule 11UA of the IT Rules, 1962. In this case, the AO has given valid reasons to reject valuation report submitted by the assessee under DCF method. Therefore, there is no error in the reasons given by the CIT(A) to sustain additions made towards disallowance of share premium u/s. 56(2)(viib) of the Act. In this regard, he relied upon the
:-9-: ITA. No: 3067/Chny/2019 decision of ITAT, Chennai Benches in the case of S.A. Metro Plots (P) Ltd vs ITO [2022] 144 Taxmann.com 173.
We have heard both the parties, perused materials available on record and gone through orders of the authorities below. The assessee has received share premium for allotment of equities and such share premium has been justified with the help of valuation report submitted by an independent auditor. The assessee has followed DCF method for determination of share price. The AO made additions towards excess premium over and above face value u/s. 56(2)(viib) of the Act, on the ground that the assessee could not justify valuation of shares under DCF method with necessary financials. According to the AO, there is a big difference between projected financials for assessment year 2016-17 & 2017-18, when compared to actual financials for these two assessment years. Therefore, he has rejected DCF method and has adopted NAV method and determined fair value per share at Rs. (-)6.14 per equity share. Since, the assessee has charged premium over and above fair value of equity shares, excess consideration received over and above the face value has been added as income of the assessee.
:-10-: ITA. No: 3067/Chny/2019 9. We have given out thoughtful consideration to the reasons given by the AO in light of various arguments advanced by the ld. Counsel for the assessee, and we ourselves do not subscribe to the reasons given by the AO for the simple reason that, the DCF method followed by the assessee is one of the permissible method of valuation of shares in terms of rule 11UA of IT Rules, 1962 and said method is based on free cash flow of future years on the basis of projected financial statements. Further, the projected financials under DCF method need not be equal to the actual performance of the company in subsequent years. However, there should be some degree or fair estimation and assumption while arriving at projected free cash flow. In this case, the AO has not accepted method adopted by the assessee and projected free cash flow considered for arriving at fair value of equity shares, but he has rejected valuation report submitted by the assessee only on the ground that there is a vast difference between projected financials and actual performance of the company for two assessment years. In our considered view, the AO is completely erred in arriving at a conclusion that DCF method followed by the assessee is incorrect only on the basis of one element, difference in
:-11-: ITA. No: 3067/Chny/2019 projected financials and actual performance of the company for two financial years, because DCF method is mainly on the basis of projected financials of future years and depends upon various estimations and assumptions. Further, projected free cash flow considered by the assessee need not be equal to the actual performance of the company in subsequent years, because actual performance may be different with projected financials for various reasons. Therefore, on that basis alone, method selected by the assessee cannot be rejected. However, the AO is free to examine correctness of DCF method and method followed by the assessee to arrive at a free cash flow and relevant ratios considered for arriving at projected revenue and expenditure. In this case, the AO has failed to carry out necessary enquiries to ascertain correctness of DCF method followed by the assessee, but simply went on to reject the method only on one ground that there was a difference in two financial years when compared to projected free cash flow and actual cash flow. Therefore, we are of the considered view that the issue needs to go back to the file of the AO to re-examine method followed by the assessee to arrive at fair market value of equity shares and this view is supported by the decision of ITAT, Chennai Benches in the
:-12-: ITA. No: 3067/Chny/2019 case of S.A. Metro Plots (P) Ltd vs ITO (supra), where the Tribunal under identical set of facts which is held as under: “6. After careful consideration of factual matrix, it could be gathered that during this year, the assessee has converted compulsory convertible preference shares (CCPS) into equity shares of Rs.100/- each along with hefty premium of Rs.1500/- per share. The book value of the shares, as computed by Ld. AO work out to around Rs.103/- per share and hence, the differential has been added to the income of the assessee u/s 56(2)(viib). In support of valuation, the assessee has furnished valuation report wherein valuation has been done on the basis of DCF valuation. The valuation has been found to be flawed since the projections grossly vary with actual financial results. The Ld. AO observed that the projection was purely based on surmises and guesswork only and the valuation was far from realty. The Ld. CIT(A) also noted that the premium was exorbitantly high. The valuation report was not supported by technical report, revenue and cost projection, cash flow justification, historical data, management plan, details of orders from potential customers etc. The projections were not justified and it did not contain empirical data which should be the basis for projected future financials. The relevant economic factors and basis for making assumptions were not discussed in the valuation report. It could thus be seen that both the authorities have questioned the valuation made by valuer. In our considered opinion, it was the onus of the assessee to justify the valuation by furnishing an acceptable valuation report which is duly corroborated by relevant material. This onus, in our opinion, has remained undischarged by the assessee. 7. The Ld. AR has submitted that the shares have been converted pursuant to investor agreement dated 23.02.2012 and at that point of time, the provisions of Sec.56(2)(viib)
:-13-: ITA. No: 3067/Chny/2019 were not in force and therefore, no such addition could have been made. Another submission is that actual money has been received in earlier years and in this year, there is mere conversion of shares. However, both the arguments are not acceptable. The CCPF issued earlier has been discharged in this year and new equity shares have been issued in this year. Therefore, there is constructive payment and the money is constructively received by the assessee in this year and the provisions of Sec.56(2)(viib) are very much applicable and the assessee would be obligated to justify the valuation of the shares. 8. The Ld. AR has also submitted that the right to choose a particular method of valuation has been vested with the assessee and DCF method of valuation is one of the prescribed methods. The said argument could be accepted only if the assessee discharges the onus of furnishing an acceptable valuation report. The valuation report is not mere empty formality rather the same should be based on valid assumptions and supported by empirical data which would justify adoption of projections. In the present case, the valuation lacks all these features. The actual financials of the assessee are nowhere near to the projections made in the valuation report. Accordingly, the case laws being relied upon by assessee and placed on record would have no application. 9. In the above background, we deem it fit to provide another opportunity to the assessee to justify the valuation of shares in terms of Sec.56(2)(viib). Accordingly, the matter stand restored back to the file of Ld. AO to provide another opportunity to the assessee to justify valuation of the share and re-adjudicate the issue after affording reasonable opportunity of hearing to the assessee.”
:-14-: ITA. No: 3067/Chny/2019
In this view of matter and by following the decision of co- ordinate bench of ITAT, Chennai in the case of S.A. Metro Plots (P) Ltd vs ITO (supra), we set aside the issue to the file of the AO and direct the AO to re-consider the issue of addition towards share premium u/s. 56(2)(viib) of the Act, in light of various arguments made by the assessee, including valuation report submitted under DCF method. The AO is free to examine method followed by the assessee, however, he does not have power to change method followed by the assessee from DCF method to NAV method, and to decide the issue in accordance with law.
As regards other arguments advanced by the ld. Counsel for the assessee, on the issue of whether the assessee is a venture capital company and has received share subscriptions from venture capital fund, we left open the issue to be decided at appropriate stages, because the issue of addition towards share premium has been set aside to the file of the AO for re- consideration and thus, this issue at this stage becomes academic in nature.
:-15-: ITA. No: 3067/Chny/2019 12. In the result, appeal filed by the assessee is treated as allowed for statistical purposes. Order pronounced in the court on 22nd February, 2023 at Chennai. Sd/- Sd/- (वी दुगा� राव) (मंजुनाथ. जी ) (V. DURGA RAO) (MANJUNATHA.G) �ाियकसद�/Judicial Member लेखासद�/Accountant Member चे�ई/Chennai, �दनांक/Dated: 22nd February, 2023 JPV आदेश क� �ितिलिप अ�ेिषत/Copy to: 1. अपीलाथ�/Appellant 2. ��यथ�/Respondent 3. आयकर आयु� (अपील)/CIT(A) 4. आयकर आयु�/CIT 5. िवभागीय �ितिनिध/DR 6. गाड� फाईल/GF