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Facts
The assessee company issued shares at a premium. The Assessing Officer (AO) rejected the Discounted Cash Flow (DCF) method used by the assessee to value the shares and used the Net Asset Value (NAV) method instead, leading to an addition under Section 56(2)(viib) of the Income Tax Act, 1961. The CIT(A) upheld the AO's action.
Held
The Tribunal held that the assessee had provided sufficient justification and supporting documents for the projections used in the DCF method. The AO's rejection of the DCF method and adoption of the NAV method was not justified.
Key Issues
Whether the Assessing Officer was justified in rejecting the Discounted Cash Flow (DCF) method for valuing shares and adopting the Net Asset Value (NAV) method, leading to an addition under Section 56(2)(viib) of the Income Tax Act.
Sections Cited
143(3), 263, 56(2)(viib), 11UA, 131
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Income Tax Appellate Tribunal, D” BENCH, MUMBAI
order
: 06.05.2025 O R D E R
Per Rahul Chaudhary, Judicial Member:
1. The present appeal preferred by the Revenue is directed against the order dated 05/07/2024, passed by the National Faceless Appeal Centre (NFAC), Delhi, [hereinafter referred to as the ‘CIT(A)’], whereby the Ld. CIT(A) had dismissed the appeal of the Assessee against the Assessment Order, dated 21/09/2017, passed under Section 143(3) read with Section 263 of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) for the Assessment Year 2013-2014.
2. The Assessee has raised following grounds of appeal : “Addition of securities premium of Rs. 8,10,00,000/- under section 56(2)(viib) of the Act
1. On the facts and circumstance of the case and in law, the Assessment Year: 2013-2014 order passed by the learned Commissioner of Income Tax (Appeals) ('CIT(A)') is invalid and bad in law as being in violation of the principle of natural justice and without considering the written submissions filed by the appellant.
2. On the facts and circumstances of the case and in law, CIT(A) erred in upholding the action of the learned AO in making an addition of Rs.8,10,00,000 under section 56(2)(viib) of the Income-tax Act, 1961 ('the Act') alleging excess receipt of share premium on issue of Non- Cumulative Compulsory Convertible Preference Shares(NCCCPS) for reasons which are wrong, contrary to the facts of the case and against provisions of law.
3. On the facts and circumstance of the case and in law, the CIT(A) erred in upholding the action of the AO in rejecting the fair market value of NCCCPS computed by an independent chartered accountant using the Discounted Cash Flow Method.
4. On the facts and circumstance of the case and in law, the CIT(A) erred in upholding the action of the AO in applying the Net Asset Value (NAV)/ Book Value Method for determining the value of the NCCCPS without appreciating that the same could not have been applied when the assessee has applied the Discounted Cash Flow Method ('DCF').
5. On the facts and circumstance of the case and in law, the CIT(A) failed to appreciate that NAV/Book Value method could not be applied to the facts of the present case.
6. The above grounds of appeal are without prejudice to each other.”
3. The relevant facts in brief are that the Assessee-Company was engaged, at the relevant time, in the business of trading in commodities. The Assessee had filed its return of income for the Assessment Year 2013-2014 on 24/09/2013 declaring a total income of INR.3,00,35,920/-. Thereafter, the Assessee filed a revised return of income on 15/10/2013. The case of the Assessee was selected for regular scrutiny. The Assessing Officer completed the Assessment under Section 143(3) of the Act vide 2 Assessment Year: 2013-2014 Assessment Order, dated 23/03/2016.
4. Subsequently, the Principal Commissioner of Income-Tax 3, Mumbai (hereinafter referred to as ‘the PCIT’) noticed that during the relevant previous year the Assessee issued and allotted 6,00,000 Non-Cumulative Compulsory Convertible Preference Shares (for short ‘the Shares’) of INR.10 each fully paid up at a premium of INR.240 per share. According to the Learned PCIT the book value of the Shares was far less than the price computed as per the DCF Method by the independent valuer. The case of the Assessee was selected for scrutiny assessment with a mandate to specifically verify the aforesaid transaction. However, the Assessing Officer had not carried out any inquiry in relation to the valuation adopted and the basis of the valuation report. Thus, the PCIT, vide order dated 08/12/2016, passed under Section 263 of the Act, set aside the Assessment Order, dated 23/03/2016, as erroneous and prejudicial to the interest of the Revenue and directed the Assessing Officer to make fresh assessment after conducting detailed enquires and verification into the valuation of the Shares. The appeal preferred by the Assessee against the aforesaid order of revision passed under Section 263 of the Act was dismissed by this Tribunal vide its order, dated 28/04/2017, passed in ITA No.421/Mum/2017.
5. As per the directions of the Ld. PCIT, the Assessing Officer carried out inquiry/verification and passed fresh Assessment Order, dated 21/09/2017, under Section 143(3) read with Section 263 of the Act assessing total income of INR.11,14,08,530/- after making addition of INR.8,10,00,000/- under Section 56(2)(viib) of the Act. The Assessing Officer rejected the value of INR.250/- per Share determined by the independent valuer using Discounted Cash Flow (DCF) Method 3 Assessment Year: 2013-2014 adopted by the Assessee and used Net Asset Value (NAV) Method to determine the Fair Market Value of the Shares at INR.115 per Share invoking the provisions contained in Rule 11UA of the Income Tax Rule, 1962 [for short ‘IT Rules’]. Thus, the Assessing Officer arrived at a difference of INR.135/- per Share, and brought to tax in the hands of the Assessing Officer brought tax INR.8,10,00,000/- (INR.6,00,000/- x INR.135/-) being aggregate payment received by the Assessee in excess of the Fair Market Value determined by the Assessing Officer using NAV Method.
Being aggrieved the Assessee preferred appeal before the CIT(A) challenging the above addition made by the Assessing Officer under Section 56(2)(viib) of the Act.
Being aggrieved, the Assessee has preferred the present appeal before the Tribunal on the grounds reproduced at Paragraph 2 above.
The Assessee has challenged the addition of INR. INR.8,10,00,000/- made by the Assessing Officer under Section 56(2)(viib) of the Act which was confirmed by the CIT(A) in appeal. As per Section 56(2)(viib) of the Act where a company [not being a company in which the public are substantially interested], receives 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 taxable as income in the hands of the such company under the head ‘Income From Other Sources’. The stand taken by the Assessee is that no excess payment received since the payment received does not exceed the value of INR.250/- per Share determined by the independent valuer using DCF Method. The Learned Authorized Representative 4 Assessment Year: 2013-2014 for the Assessee appearing before us vehemently submitted that the authorities below had failed to appreciate the correct facts. It was submitted the Assessing Officer was not correct in rejecting the method of valuation adopted by the Assessee since the choice to select the method of valuation vested with the Assessee in terms of provisions contained in Rule 11UA of the IT Rules. He submitted that the CIT(A) had accepted the aforesaid contention of the Assessee and had observed that in the case of Vodafone M. Pesa Vs. PCIT, dated 01/03/2020 reported in 92 taxmann.com 73, the Hon’ble Bombay High Court had held that as per the Rule 11UA of the IT Rules the Assessee has the option to choose either of the two methods of valuation - DCF Method or NAV Method, for valuation of fair market value of the Shares and the Department should not interfere in the selection of method of valuation adopted by the Assessee. In the present case the Assessee adopted the valuation done by the independent valuer using the DCF Method and the Assessing Officer changed the valuation method from DCF Method to NAV Method since the valuation of the Shares as per NAV Method was resulting at a lower value and higher income taxable in the hands of the Assessee. He further submitted that the CIT(A), having made the aforesaid observations, proceeded to dismiss the appeal preferred by the Assessee on the incorrect understanding that the Assessee had failed to provide the basis of the cash flow projections adopted to determine the value using DCF Method. It was vehemently contended that the observations made by the authorities below that the valuation report was prepared merely on the basis of management projection without any supporting documents was factually incorrect.
Per contra Learned Departmental Representative placed reliance upon the Paragraph 6 to 6.2.5 of the Assessment Order and 5 Assessment Year: 2013-2014 submitted that the Assessing Officer had recorded the statement of independent valuer and asked her to explain the basis on which free cash flows were estimated. In her reply letter, dated 04/09/2017, the independent valuer had stated that free cash flows for the future years provided by the management were used for determining the value of the Shares using DCF Method. Thus, it is clear that no verification was not carried out by independent valuer. Further, no documents and details were furnished by her is support of the valuation report.
In rejoinder the Learned Authorized Representative for the Assessee submitted that the independent valuer had clearly stated that due diligence was undertaken and the management projection were not blindly relied upon. The observations made by the Assessing Officer in Paragraph 6.1.2 of the Assessment Order that no corroborating evidence in this regard brought on record were factually incorrect. Placing reliance upon the letter, dated 26/02/2016 filed, during the assessment proceedings, the Learned Authorized Representative for the Assessee submitted that the basis of projections and supporting documents were furnished during the assessment proceedings.
We have given thoughtful consideration to rival submission and have perused the material on record.
We note that that the CIT(A) had dismissed the appeal preferred by the Assessee holding as under:
“4.6. However, in the case of TUV Rheinland NIFE v. ITO [IT Appeal No. 3160 (Bang.) of 2018 dated 27-2-2019] while dealing with this issue, the Hon'ble Bangalore Income-tax Appellate Tribunal (ITAT) upheld the order of the ld. AO, who had rejected the DCF method of valuation adopted by the taxpayer-company and made addition under section 56(2) (vib) of the IT Act, on the basis of the NAV method.
6 Assessment Year: 2013-2014 In the facts of this case, the taxpayer-company had issued shares to its parent Company at a premium and it had relied on the OCF method to determine FMV for justifying the premium. The ld. AO-upon examining the valuation report concluded that the valuation report had solely relied on the values provided by the Management of the taxpayer-company which were adopted to arrive at the FMV to justify the high premium. The ld. AO recomputed the FMV of the shares of the taxpayer-company using the NAV method and made relevant additions, which were upheld by the ld. Commissioner of Income-tax (Appeals) (CIT(A)). The Hon'ble ITAT paid heed to the argument of the taxpayer-company that it has the statutory right to select either one of the two methods prescribed for the purposes of section 56(2) (viib), one of them being the DCF method. In addressing this argument as well as the contention that the right of a ld. AO was limited to verifying the arithmetical accuracy of the method selected by the taxpayer-company, the Hon'ble ITAT clarified that the Id. AO had not questioned the right of the taxpayer-company to choose the method of valuation, but after examining the projections, he had questioned the projections/numbers - its basis, veracity, accuracy. The Hon'ble ITAT noted that the estimates and projections used by the taxpayer- company were a long distance from reality and the taxpayer-company, despite repeated requests, had failed to produce and substantiate the basis for such estimates and projections. Thus, in absence of any valid and meaningful justification for the projections considered and adopted in determining FMV under the DCF method, the Hon'ble ITAT agreed with the decision of the ld. AO to deploy NAV method. In doing so, the Hon'ble ITAT thus upheld the authority of the ld. AO to override the choice of valuation method adopted under certain circumstances. 4.7. Again, Hon'ble Delhi ITAT in case of Agro Portfolio (P.) Ltd. v. ITO [2018] 94 taxmann.com 112/171 ITD 74, held that, in the facts of this case in the event the ld. AO had any inhibition or doubt about the valuation adopted by the taxpayer, he may make a reference to the Valuation Officer of the Department to verify the veracity of such valuation. However, in a situation where the taxpayer-company fails to substantiate the projections adopted to determine the FMV as per DCF method, it may not be possible even for the Departmental valuation officer to verify the correctness of such valuation adopted. Accordingly, the Hon'ble ITAT 7 Assessment Year: 2013-2014 held that in such cases, the ld. AO may be forced to reject the DCF method, since the same cannot be verified and instead, could adopt the NAV method to determine the liability of the taxpayer under section 56(2)(viib) of the IT Act. 4.8. Respectfully following the decisions discussed above, I hold that the action of the AO, after following the direction of the PCIT given u/s. 263 is justified and the addition made by the AO in the assessment order is held to be correct.
The appeal of the assessee is, therefore, dismissed.”
Thus, the CIT(A) had accepted the contention of the Assessee that as per Rule 11UA Assessee has option to chose for DCF Method or NAV Method. However, the CIT(A) confirmed the action on the Assessing Officer having reasoned that the Assessee had failed to substantiate the basis of cash flow projections. In this regard, on perusal of record we find that during the assessment proceedings the Assessing Officer had carried out inquires and had recorded statement of independent valuer under Section 131 of the Act and confronted the Assessee with the same. Both, the Assessee and independent valuer had filed reply/submission before the Assessing Officer. It is admitted position that as per the valuation report, the value of INR.250/- per share using DCF Method was arrived in the following manner:
Particulars % Mar 13 Mar 14 Mar 15 Mar 16 Mar 17 Free Cash Flow for 5.30 4.01 6.67 9.41 223.46 Equity Discounting Factor 15.01 0.93 0.81 0.70 0.61 0.53 Discounting Cash 4.93 34.79 4.69 5.75 118.80 Flow Discounting DCF 168.96 Value Terminal Value 100.13 Total Value of 269.09 Company No. of Shares 1,07,60,003 outstanding Value per share 250.08
The independent valuer was called upon to provide the basis 8 Assessment Year: 2013-2014 valuation using DCF Method by the Assessing Officer and her statement was recorded under Section 131 of the Act. She was also asked to explain the huge surge in the projected cash flows post Financial Year 2012-2013 and onwards. In response, the independent valuer stated that while valuing the Shares, she had adopted the DCF Method by considering the EBIDTA (Earnings Before Interest, Depreciation and then analyzed the working capital). The cash flow projections were prepared on the basis of estimation, assumptions, judgments and business acumen of management. However, reasonable due diligence was undertaken and the management projections were not relied upon blindly. The management had assumed that there would be a steady growth of revenues as also that the Assessee would earn income from divestments of equity stake in Entercoms Inc. and Onprocess Technology Inc. held by the Assessee Company through its wholly own subsidiary (i.e. Madhurima Holding Mauritius Ltd.). It was further clarified, that the surge in the cash flows in Financial Year 2013-2014 and Financial Year 2016-2017 was on account of estimated gains to be earned by proposed disinvestment of Entercoms Inc. and Onprocess Technology Inc., respectively. We note that in paragraph 6.1.3., the Assessing Officer has recorded that alongwith reply dated 04/09/2017, filed by the independent valuer following documents were annexed (a) Projections, (b) Profit & Loss Account and Balance Sheet for the Financial Years 2012-2013 to 2017-2018 and (c) Sheet depicting the basis for valuation of proposed divestment of assessee’s holding in Entercom Inc. and Onprocess Technology Inc.
We find that the Assessee had also explained the surge in projected cash flows and the deviation in the estimated vis-à-vis the actual cash flows vide letter, dated 26/02/2016, wherein it was stated as under:
9 Assessment Year: 2013-2014 “With reference to above and under instructions from our aforesaid client, and as regards your query regarding the projections in the valuation report, we submit as under.
The revenue of the assessee has steadily grown from Rs.1.07 Crores in FY 2010-11 to Rs.34.77 Crores in FY 2011-12 in FY 2012-13 the revenue of the assessee grew by 18% i.e. from Rs. 34.77 Crores in FY 2011-12 to Rs.41.17 Crores in FY 2012-13 (vs. FY 2012-13 projected revenue growth 28% to Rs.38.85 Crores). However in FY 2013-14, the assessee achieved total revenue (from operation only) of Rs.16.81 Crores against a projection of Rs.58.28 Crores and also projected gains from divestment to the tune of Rs.42.20 Crores. The reasons for the deviation are:
Commodity Trading: The global commodity market has been in turmoil post 2012 crisis. Moreover, the uncertainty in the Indian market during the run-up to elections further played a deflating role. Due to these macro factors, the assessee could not grow as aggressively as projected and achieve its targeted revenue and thus profitability targets.
Divestment from Portfolio Company. Investments in unlisted companies are illiquid in nature but offers high risk / high reward. However the exit is highly dependent on conducive market environment and various external factors apart from performance of the Company. While, the enterprise value of the assessee investments through its wholly owned subsidiary has continued to appreciate, the subsidiary (MHML) could not divest / exit as planned due to volatility in global market including recessionary scenario in the US, making it difficult to attract investors at fair valuation and provide exit to MHML. The assessee continues to hold its investment and their enterprise values have continued to appreciate vis-a-vis the cost at which they were acquired. In FY 14 projections, while the gain from divestment was projected at Rs. 42.20 Crores, the fair value as per FY 14 Audited Balance Sheet of MHML is Rs. 51.06 Crores. Under IFRS, the Fair Value reserves in the books of MHML on account of its Investments in US as on 31.03.2014 is $7.94 Mn. (Rs. 47.5 Cr.). Hence, the value of investments is actually more that the projections considered in the valuation. The assessee has only not sold these investments at present, as he expects to realize a better realization on divestments 10 Assessment Year: 2013-2014 We are also enclosing working of projected cash flow used in valuation of shares alongwith copy, of financials of MHML for the year ended 31 March 2014 and fair value working in Indian Rupees.” (Emphasis Supplied)
To support the enterprise value of its wholly owned subsidiary (i.e. Madhurima Holding Mauritius Ltd), the Assessee had furnished the financial statements for the Financial Year ended 31/03/2014. On perusal of the same we find that ‘Available-For- Sale Investment’ held by the wholly own subsidiary of the Assessee Company had a Fair Market Value of USD.2,93,15,638/- (INR.51.06 Crores approx) as on 31/03/2014. 2014 2013 AVAILABLE-FOR-SALE INVESTMENT USD USD Cost At end of year 21,376,348 21,376,348 Fair Value Adjustment At start of year 7,939,290 6,918,090 Fair value adjustments - 1,021,200 At end of year 7,939,290 7,939,290 Fair values as at year end 29,315,638 29,315,638 Notes To The Financial Statements For The Year Ended 31 March 2014 AVAILABLE-FOR-SALE INVESTMENT (Cont’d) Details of investments:
Name of company xx No. of xx % Holding Cost Fair Value Shares USD USD 2014 2013 Entercoms, Inc. xx 10,00,000 xx 100% 100% 10,00,000 90,00,00 Entercoms, Inc. xx 1,10,000 xx 100% 100% 4,70,800 9,90,000 Onprocess xx 1,08,571 xx 47.34% 47.5% 1,99,05,548 1,93,25,638 Technology Inc. (i) 2,13,76,348 2,93,15,638
We find that vide letter, dated 26/02/2016, the Assessee had 11 Assessment Year: 2013-2014 provided following details of the investments held through its wholly owned subsidiary to show that the estimated projections had a reasonable basis and the same were not far away from reality: Investment as per audited financials for the period ended 31/03/2014 Downstream Investments (USD) Cost Fair Value Appreciation Entercom – Tranche 1 (A) 1,000,000 9,000,000 8,000,000 Entercom – Tranche 2 (B) 470,800 990,000 519,200 OPT 19,905,548 19,325,638 (579,910) Total 21,376,348 29,315,638 7,939,290 Fair Value Reserves accounted in the books of MHML as on 31/03/2014 under IFRS – USD 7,939,290 Working showing appreciation of the Investments As on 31/03/2014 Appreciation Exchange Appreciation (USD) Rate (INR in Cr.) Appreciation in the investments as per 8,519,200 59.9376 51.06 audited financials – Entercom – (A+B) Projected Gain Investment – Entercom 42.20
From the above it can be seen that the projections for future cash flows were corroborated by the supporting documents and explanation furnished by the Assessee and the independent valuer. We note that while the Assessing Officer had rejected valuation done by DCF Method adopted by the Assessee by stating that the projections were not independently verified by the valuer, no infirmity was pointed out in the projections apart from the surge in the projected cash flows which was explained by the Assessing Officer and the independent valuer. The CIT(A) had confirmed the order of the Assessing Officer observing that the Assessee had failed to produce documents and substantiate the basis of cash flow estimates/projections. However, on perusal of record we find the aforesaid finding to be factually incorrect. As noted hereinabove in paragraph 14 to 17 above, the valuation report was supported/corroborated by the (a) projected cash 12 Assessment Year: 2013-2014 flows, (b) Profit & Loss Account and Balance Sheet of the Assessee for the Financial Years 2012-2013 to 2017-2018 (c) Sheet depicting the basis for valuation of proposed divestment of assessee’s holding in Entercom Inc. and Onprocess Technology Inc. and (d) Financial Statements of wholly owned subsidiary as on 31/03/2014. During the assessment proceedings it was explained that for the purpose of preparing projections it was assumed that there would be a steady growth of revenues. The surge in the cash flows in Financial Year 2013-2014 and Financial Year 2016-2017 was on account of estimated gains from the proposed disinvestment of Entercoms Inc. and Onprocess Technology Inc., respectively. The fair market value of the investments as recorded in the Financial Statements of the wholly owned subsidiary as on 31/03/2014 supported the proposed estimated gains. Thus, we find that in the present case the Assessee had provided justification for the projections adopted while computing the value using DCF Method and no infirmity [other than surge in cash flows which was explained by the Assessee and the independent valuer] was highlighted by the Assessing Officer or the CIT(A). Therefore, the reliance placed by the Learned CIT(A) on the decision of Delhi Bench of the Tribunal in the case of Agro Portfolio (P) Ltd. (supra) and the Bangalore Bench of the Tribunal in the case of TUV Rheinland NIFE Vs. ITO 27/02/2019] was misplaced. [ITA No.3160/Bang/2018, dated Accordingly, we hold that in the facts and circumstances of the present case the Assessing Officer was not justified in rejecting the DCF Method adopted by the Assessee for valuing the Shares. Therefore, addition of INR.81,00,000/- made by the Assessing Officer under Section 56(2)(viib) of the Act is deleted. Ground No.2 to 5 raised by the Assessee are allowed, and Ground No.1 raised by the Assessee is dismissed as having been rendered infructuous.
13 Assessment Year: 2013-2014
During the course of hearing the Learned Departmental Representative had also relied upon legal submissions made before the CIT(A). However, since we have adjudicated the issue in favour of the Assessee as above, the occasion to deal with the same does not arise.
In result, in terms of Paragraph 19 above, the present appeal preferred by the Assessee is allowed.
In result appeal preferred by the Assessee is Allowed.