CROWN CHEMICALS PVT LTD.,NAVI MUMBAI vs. ACIT 15 (1)(2), MUMBAI

आदेश / O R D E R PER M. BALAGANESH (A.M):

This appeal in ITA No. 7876/Mum/2019 for A.Y.2015-16 arises out of the order by the ld. Commissioner of Income Tax (Appeals)-24, Mumbai in appeal No.CIT(A)-24/DCIT-15(1)(2)/IT-221/2017-18 dated 31/10/2019 (ld. CIT(A) in short) against the order of assessment passed u/s.143(3) of the Income Tax Act, 1961 (hereinafter referred to as Act) dated 28/11/2017 by the ld. Asst. Commissioner of Income Tax- 15(1)(2), Mumbai (hereinafter referred to as ld. AO).

2 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd.,

a) Name and address of the investor b) PAN and income tax assessment particulars of the investor c) Valuation report under Rule 11UA of the Income Tax Rules using discounted cash flow method given by an independent valuer. d) Balance sheet as on 31/03/2016 and 31/03/2017.

3.1. The ld. AO observed that in the valuation report, the valuer had considered future cash flow as certified by the management together with the projections and assumptions adopted by the management. The valuer had stated that he had not made any verification of the projections and assumptions adopted by the management. The assessee submitted that for valuing the shares using discounted cash flow method, the future cash flows together with the projections and assumptions are to be adopted and these projections, assumptions and future cash flows could only be certified by the management of the assessee company as ultimately it is the assessee company’s management who would be knowing the future prospects of the business of the company. Hence, it was submitted that

3 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., there was nothing wrong in the independent Chartered Accountant mentioning in his valuation report that he had not made any verification of assumptions and projections adopted by the management. The ld. AO on verification of the share valuation report observed that the projected net cash flow used in share valuation report did not come even near to the actual cash flow for financial years 2015-16 and 2016-17 and accordingly, concluded that the share valuation report using DCF method is not reliable and hence, rejected the same. The variance brought out by the ld. AO on the net cash flow between projections and actuals are tabulated as under:-

FY 2015-16 FY 2016-17 Net Projected Actual Projected Actual Cash Flow 50.70 -18.06 4242.14 3.1 All figures in Rs.lacs

3.2. The value per share determined using DCF method by the independent valuer was Rs.9,600/- per share. The workings of the DCF method of share valuation is reproduced in page 7 of the assessment order. The assessee in response to the allegation made by the ld. AO supra filed a reply vide letter dated 10/11/2017 explaining anomalies of the ld. AO in his conclusions as under:-

i. In the table given in the above referred notice for FY 2015-16, the Net Cash Flow (Actual) is stated at Rs. (18.06) lakhs. Kindly note that this figure of Rs. (18.06) Lacs pertains to “ Net increase in cash and cash equivalent". The Net Cash Flow (Actual) from operating activities as per Accounting Standard-3 (AS 3) was Rs 312.15 lakhs.

4 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., ii. In the table given in the above referred notice, for FY 2016-17, the Net Cash Flow (Projected) is stated as Rs. 4,242.14 lakhs. Kindly note that this figure of Rs. 4,242.14 pertains to "Horizon value" (also known as Terminal Value (TV), which captures the value of a business beyond the projection period in Discounted Cash Flow analysis and is the present value of all subsequent cash flows), and the Net Cash Flow (Projected) as per the Discounted Cash FLOW for FY 2016-17 was in fact Rs. 216.05 lakhs. iii. The Net Cash Flow (Actual) from Operating activities as per AS-3 was Rs. 491.89 lakhs. iv. We humbly state that the comparison between Projected and Actual cash flows from operations from activities is as below:

Particulars FY 2015-16 FY 2016-17 Net Cash Flow Projected (INR. Lakh) Actual Projected Actual (INR. Lakh) (INR.Lakh) (INR. Lakh) 50.70 312.15 216.05 491.89

Therefore the Company has achieved higher Net Cash Flows in FY 2015- 16 and FY 2016-17 in comparison to the Cash Flows (Projected).

In this regard, it is further submitted as follows:

a) The Cash flow statements in audited financial is prepared as per Accounting Standard mandated in Companies Act, 2013. The objective, scope and definition of cash flows and presentation and reporting methodology is prescribed in AS 3.

b) The net cash flow as envisaged in AS-3 methodology and in Discounted cash flow method are on totally different basis. This is

5 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., because the objective, scope and definition of cash flows and presentation and reporting methodology as prescribed in AS 3 are having different objective, scope and definition from cash flows and presentation and reporting methodology as prevalent in Discounted Cash flow method. The Discounted cash flow methods internationally recognized and also in consonance with Rule 11UA of income Tax Rules, 1962 read with Section 56(2) (viib) and its explanation.

3.3. The assessee also explained the legal provisions of Section 56(2)(viib) together with 11UA of the Income Tax Rules and submitted that the aforesaid provisions recognize Discounted Cash Flow Method (DCF Method) as one of the methods approved for doing the share valuation. Accordingly, it was submitted that the fair value of Rs.9600/- per share using DCF method was reliable value and assessee had allotted shares at a premium of Rs.9500/- per share by relying on the said valuation report and hence, the provisions of Section 56(2)(viib) of the Act had been duly complied with by the assessee. The ld. AO in para 5.6 of his assessment order observed that though the assessee had followed one of the prescribed methods (DCF method), however, just following the prescribed method of valuation of a share will not make the premium justified and explained. The ld. AO arrived at the book value per share using Net Asset Value (NAV) method and arrived the fair market value at Rs.2603/- per share as against Rs.9600/- per share arrived by the assessee using DCF method. The ld. AO reproduced the entire cash flow statement for the year ended 31/03/2017 in page 8 of his assessment order. From the said cash flow statement, the following facts are evident:-

6 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., Particulars 31/03/2017 (Amount in 31/03/2016 (Amount in Rs.) Rs.) Positive cash flow from 4,91,89,392 3,12,15,019 operating activities (A) Negative cash flow (3,67,85,163) (2,80,00,383) from investing activities (B) Negative cash flow (1,20,92,552) (50,20,726) from financial activities (C ) Net increase in cash 3,11,677 (18,06,191) and cash equivalents (A+B+C)

3.4 The assessee pointed out that it had achieved free cash flow of Rs.312.15 lakhs as on 31/03/2016 and Rs.491.89 lakhs as on 31/03/2017 as against the projected free cash flow of Rs.50.70 lakhs. Hence, the figure mentioned in the show-cause notice of the ld. AO that assessee had negative cash flow of Rs.18.06 lakhs is incorrect. The ld. AO in para 5.10 of his order observed that assessee company had compared the net increase or decrease in the cash flow from operating activities with the projected change in the total cash flow just to present a better financials. The ld. AO observed that the net cash flow projections of a company are based on operating activities along with non-operating activities like investing and financial activities. The share valuation of a company is done for the entire company as a whole entity. The assessee also submitted that the free cash flow figure of Rs.4,242.14 lakhs projected for the year pertain to “Horizon Value” which captures the value of business beyond the projection period in a DCF analysis and is the present value of all subsequent cash flows. The assessee also submitted that the

7 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., projected free cash flow for 31/03/2017 was Rs.216.05 lakhs as against which the assessee had actually achieved cash flow from operating activities at Rs.491.89 lakhs as on 31/03/2017.

3.5 The ld. AO however disregarded the contentions of the assessee and based on the above observations, proceeded to determine the fair market value per share based on NAV method at Rs.2603/- per share. Since the premium amount received by the assessee was Rs.5,93,75,000/- (6250 shares * Rs 9500 per share), the ld. AO added the sum of Rs.4,37,31,250/- (Rs.6,00,00,000 - 1,62,68,750) by considering the fair market value of the share at Rs.2603/- as against Rs.9600/- adopted by the assessee by making the following conclusions:-

5.18. Based on the above facts, following emerges: (i) Assessee has charged premium on the basis of valuation report which is based on DCF method. The real picture is far beyond the projections and therefore, the valuation of share price is not correct. (ii)To substantiate the above, the assessee filed the internal valuation report which was obtained prior to issuance of equity shares on premium, however, the premium charged on allotment of shares is not justified. (iii) The assessee company wishfully compared the net increase or decrease in the cash flow from operating activities with the projected change in the total cash flow just to present a better financials. It is important to mention that net cash flow projections of a company are based on operating activities along with non-operating activities like investing activities and financial activities. iv) In its three page valuation report, assessee company has not provided the projections for future profit and loss account and in page one there is a mention that for the purpose of valuation the valuer had relied upon financial projections provided by the company from 31.03.2014 to 31.03.2018. But, surprisingly, the same doesn't forms part of the valuation report. The same were also not provided during the assessment proceedings.

8 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., Assessee in its valuation report or further submissions has not given any working of the how terminal value of Rs. 4026.09 lacs for FY 2016-17 was calculated. Also, various sensitivity analysis has shown that the DCF method is very vulnerable to changes in the underlying assumptions. Role of terminal value/ horizon value is significant in pushing the valuation towards a higher side. Compared to Rs. 216.05 lacs of projected free cash flow prior to introduction of Horizon value, the projected cash flow enhanced to Rs.4242.14 lacs after introduction of the Terminal Value. vi) Thus, the premium charged by the assessee is unscientific and unjustified. It is pertinent to mention here that various higher judicial forum regarding colourable devices used for the purpose of tax evasion and in particular the decision of the Hon'ble Supreme Court in the case of Mc Dowell and Co. Ltd., (1985) 154 ITR 148. vii) Reliance is also placed on the decision of the decision of Mumbai ITAT in the case of Madhurima International Pvt. Ltd. Vs Pr.CIT-3, (2017) ITA No. 421/Mum/2017, in the said case the AO did not looked into the aspect that explanation to the Rule IIUA(1)(c) refers to value of assets also as per clause (ii) as well method prescribed as per clause (i) of the said explanation as is contained in explanation to Section 56(2)(viib) of the 1961 Act as to the fact that manner of computing fair value of shares for the purposes of Section 56(2)(viib) of 1961 Act is provided in above explanation of being higher of the two sub-clauses in the said case, the AO merely accepted the valuation report dated 15-10-2012 of the valuer submitted by the assessee without going into all these aspects. Thus, the ITAT stated that, the ld Pr.CIT had rightly invoked the provisions of section 263 of the Act as the AO failed to make proper enquiry and verification as required for completion of the assessment u/s 143(3) of 1961 Act, which made the said assessment order dated 23-03-2016 as erroneous in so far as prejudicial to the interest of Revenue. Thus, the ITAT laid down that the valuation report cannot be accepted by the AO on its face value and all aspects regarding correctness of the same needs to be verified by the AO on its face value and all aspects regarding correctness of the same needs to be verified by the ld.AO. viii. I place reliance on the decision of the decision of Hon'ble Supreme court in the case of Commissioner of Income Tax Vs. Durga Prasad More 82 ITR 540. It is to state that there is reason to believe that the apparent is not real then taxing authorities are entitled to look into surrounding circumstances to find out the reality and the matter has to be considered by applying the test of human probability. ix). Reliance is also placed on the decision of Hon'ble Supreme Court in the case Sumati Dayal Vs. Commissioner of Income Tax 214 ITR 801.

9 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., x) Further, the Hon'ble Supreme Court in the case of Sreelekha Banerjee & Others Vs. Commissioner of Income Tax held that if explanation is unconvincing and one which deserves to be rejected, the Department can reject and draw the inference that the amount represents income either from the source already disclosed by the assessee or from some undisclosed source.

3.7. The ld. AO determined the taxable income of the assessee at Rs.4,37,31,250/- without giving the set off of unabsorbed depreciation which was available in the return itself in the sum of Rs.3,75,61,475/- and completed the assessment. The action of the ld. AO was upheld by the ld. CIT(A) in respect of the addition made u/s.56(2)(viib) of the Act and in respect of non-granting of set off of unabsorbed depreciation with the addition made by the ld. AO, the ld. CIT(A) directed the ld. AO to verify the same and allow deduction as per law. Aggrieved, the assessee is in appeal before us for both the issues.

3.8. At the outset, we find that 6250 shares were allotted by the assessee company to DRT-Anthea Aroma Chemicals Pvt. Ltd., at Rs.9600/- per share. The assessee received total sum of Rs.6,00,00,000/- from the said investor, out of which Rs.6,25,000/- was credited to the share capital account and Rs.5,93,75,000/- was credited to share premium account, The identity of the investor, creditworthiness of the investor and genuineness of the investor making investment in the assessee company are not in dispute. The only dispute to be decided in the instant appeal is that the assessee company had justified the share premium of Rs.9500/- per share. We find that assessee had justified its share premium of Rs.9500/- per share by placing reliance on the independent share valuation report using DCF method. The revenue had rejected the said DCF method and had re-determined the share value at Rs.2603/- per share using NAV method. Under NAV method, the value per share is determined based on book values reflected in the balance sheet.

10 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., Under DCF method, the financials of the company are projected with various assumptions and beliefs of the management based on their business plans and business prospects and accordingly, projected free cash flows and terminal value would be considered and fair market value per share would be arrived. Hence obviously what would be relevant is the cash flow received from the operating activities, as the future operations of the company are projected. The assessee in the instant case had valued the parameters that are normally used under DCF method for arriving at the fair market value per share. It is not in dispute that DCF method is one of the prescribed methods under Rule 11UA of the Income Tax rules for arriving at the fair market value per share for the purpose of Section 56(2)(viib) of the Act.

3.9. We find that assessee had submitted before the ld. CIT(A) that it is a joint venture company with shareholding of two Indian companies incorporated in India and one company incorporated in France. The ld. AO in para 5.8 of his order had alleged that assessee company had not provided the projections for future profit and loss account. It was submitted by the assessee that the ld. AO had not sought for these details during the course of assessment and whatever the details that were called for by the ld. AO had been duly submitted by the assessee. In support of this contention, the assessee drew the attention of the ld. CIT(A) to the various notices issued by the ld. AO and the replies filed by the assessee in response thereto. It was also submitted that assessee had an option to chose either NAV method or DCF method for the purpose of arriving at the fair market value of an equity share as per law. The assessee also pointed out that the provisions of Section 56(2)(viib) of the Act and Rule 11UA of the Rules gives an option to the assessee either to use the book value of shares as on the date of valuation or the fair market value as determined by the independent valuer as per the

11 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., discounted cash flow method, whichever is higher. The assessee also submitted before the ld. CIT(A) that the ld. AO failed to appreciate that the projected net profit before tax for 31/03/2016, 31/03/2017, 31/03/2018 and the audited net profit before tax for the same period fully justified the basis of valuation adopted in the valuation report using DCF method. The said comparison is as under:-

Financial Year Net Profit Before Tax Net Profit Before Tax in Rs. lakhs as per in Rs. lakhs as per audited valuation report] profit and loss statement ) 2015-16 83.87 145.70

2016-17 115.96 307.04

2017-18 132.45 333.47

3.10. The assessee also submitted before the ld. CIT(A) that the ld. AO failed to appreciate the projected cash flow for F.Y.2015-16 & 2016-17 and the audited cash flow for the same period which fully justified the basis of valuation adopted in the valuation report which is tabulated as under:-

Financial Year Projected cash flow in Rs. lakhs Audited operating cash flow Rs. (as per valuation report) lakhs (as per audited profit and loss statement) 2015-16 50.7 312.15 2016-17 216.05 491.89

3.11. The assessee also placed reliance on the decision of the Hon’ble Jurisdictional High Court in the case of Vodafone M-Pesa Ltd vs. PCIT reported in 92 Taxmann.com 73 wherein it was held that as per the Income Tax Rules, the method of valuation namely NAV method or DCF

12 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., method to determine the fair market value of shares in terms of Section 56(2)(viib) of the Act has to be done or adopted at the assessee’s option and that does not open to the ld. AO to change the method of valuation which the assessee has opted. These arguments were reiterated by the ld. AR before us. Per contra, the ld. DR submitted that the ld. AO has every right to examine the discrepancies in the projections used by the assessee and entitled to change the method of valuation adopted by the assessee.

3.12. At the outset, we find that the various discrepancies pointed out by the ld. AO are not discrepancies at all. It was factually incorrect appreciation of facts. As stated supra, the assessee had indeed achieved the actual figures which are much more than the projections used in the DCF method. Moreover, the DCF method is certainly one of the prescribed methods provided in Rule 11UA of the Rules and assessee is given an option either to use the DCF method or NAV method. In the instant case, the assessee has chosen to adopt DCF method. The aforesaid facts which are mentioned in various tables reproduced supra goes clearly to prove that the independent valuer had relied on various projections and free cash flow provided by the management for the purpose of share valuation, the said projections had indeed become true and assessee could achieve more than the projections in the subsequent years. Hence, so called non-existing discrepancies pointed out by the ld. AO which have been duly met by the assessee are hereby dismissed as factually incorrect.

3.13. The question whether the ld. AO could change the method of share valuation was subject matter of consideration by the Hon’ble Jurisdictional High Court in the case of Vodafone M-Pesa Ltd. vs. Principal

13 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., Commissioner of Income Tax reported in 92 taxmann.com 73 wherein it was held as under:-

“9. We note that, the Commissioner of Income-Tax in the impugned order dated 23rd February, 2018 does not deal with the primary grievance of the petitioner. This, even after he concedes with the method of valuation namely, NAV Method or the DCF Method to determine the fair market value of shares has to be done/adopted at the Assessee's option. Nevertheless, he does not deal with the change in the method of valuation by the Assessing Officer which has resulted in the demand. There is certainly no immunity from scrutiny of the valuation report submitted by the Assessee. Therefore, the Assessing Officer is undoubtedly entitled to scrutinise the valuation report and determine a fresh valuation either by himself or by calling for a final determination from an independent valuer to confront the petitioner. However, the basis has to be the DCF Method and it is not open to him to change the method of valuation which has been opted for by the Assessee. If Mr. Mohanty is correct in his submission that a part of demand arising out of the assessment order dated 21st December, 2017 would on adoption of DCF Method will be sustained in part, the same is without working out the figures. This was an exercise which ought to have been done by the Assessing Officer and that has not been done by him. Infact, he has completely disregarded the DCF Method for arriving at the fair market value. Therefore, the demand in the facts need to be stayed. (Emphasis supplied by us)

3.14. We further find that the Co-ordinate Bench of this Tribunal in the case of DCIT vs. Credtalpha Alternative Investment Advisors (P) Ltd. reported in 134 taxmann.com 223 (Mumbai Trib.) had also addressed the issue that DCF method adopted by the assessee cannot be rejected merely on the basis of comparing projections with actuals. The relevant operative portion of the said decision is reproduced hereunder:-

14 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., of valuation is always the option of the assessee. The learned Assessing Officer is authorised to examine whether assessee has adopted one of the available options properly or not. In the present case, the learned Assessing Officer has thrust upon the assessee, net asset value method rejecting discounted cash flow method for only reason that there is a deviation in the actual figures from the projected figures. It is an established fact that discounted cash flow method is always based on future projections adopting certain parameters such as expected generation of cash flow, the discounted rate of return and cost of capital. In hindsight, on availability of the actual figures, if the future projections are not met, it cannot be said that the projections were wrong. To prove that the projections were unreliable, the learned Assessing Officer must examine how the valuation has been done. In a case future cash flow projections do not meet the actual figures, rejection of discounted cash flow method is not proper. If projected future cash flow and actual result matches, such situation would always be rare. For projecting the future cash flow certain assumptions are required to be made, there needs to be tested and then such exemptions becomes the base of estimation of such projected future cash flows. If there are no assumptions, there cannot be an estimate of future projected cash flows and then discounted cash flow method becomes redundant. For exercise of valuation, assumption made by the valuer and information available at the time of the valuation date are relevant. As the exercise of valuation must be viewed as on the date of the valuation looking forward and cannot be reviewed in retrospect. Further, the valuation is always made based on review of historical data and projected financial information provided by the management. Further report of expert will always include limitation and responsibilities but that does not make his report incorrect. Of course, if there are errors in the working of projected cash flow, estimating the projected revenue and projected expenditure as well as in adoption of cost of equity and discount factor, the learned Assessing Officer is within his right to correct it after questioning the same to the assessee. The learned Assessing Officer can also question the basic assumptions made by the valuer. If they are unreasonable or not based on historical data coupled with the management expectation, the learned Assessing Officer has every right to question it and adjust the valuation so derived at. However, if he does not find any error in those workings, he could not have rejected the same. Further the reason given by the learned Assessing Officer that the net asset value method and the discounted cash flow method for valuation of the shares of the company gives a wide variation between them, we do not find any reason to find fault with the assessee in such cases. Both these methods have different approaches and methodologies therefore there are bound to be differences, but it does not give any authority to the learned Assessing Officer to pick and choose one of the method and make the addition. It is the assessee who has to exercise one of the options available under the provisions of the law for valuing the shares. The learned Assessing Officer needs to examine that method. Naturally, if the discounted cash flow method and net asset value method gives the same result, where would have been the need to prescribe the two methods in the law. In view of above facts, we do not find any infirmity in the order of the learned CIT - An in deleting the addition of Rs. 69,000,000 made by the learned Assessing Officer u/s. 56 (2) (viib) of the Act. Accordingly, ground numbers 3 and 4 of the appeal of the learned Assessing Officer are dismissed.

15 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd., (Emphasis supplied by us) 3.15. The assessee’s case herein stands at a much better footing than the facts prevailing in the case of Credtalpha Alternative Investment Advisors (P) Ltd. referred to supra.

3.16. In view of the aforesaid observations and respectfully following the aforesaid judisical precedents, we direct the ld. AO to delete the addition made u/s.56(2)(viib) of the Act. Accordingly, the ground Nos.1-3 raised by the assessee are allowed.

Order pronounced on 23/12/2022 by way of proper mentioning in the notice board.

Sd/- Sd/- (KAVITHA RAJAGOPAL) (M.BALAGANESH) JUDICIAL MEMBER ACCOUNTANT MEMBER Mumbai; Dated 23/12/2022 KARUNA, sr.ps

16 ITA No.7876/Mum/2019 M/s. Crown Chemicals Pvt. Ltd.,

Copy of the Order forwarded to : The Appellant 1. The Respondent. 2. The CIT(A), Mumbai. 3. CIT 4. DR, ITAT, Mumbai 5. 6. Guard file. //True Copy//

BY ORDER,

(Asstt. Registrar) ITAT, Mumbai