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Income Tax Appellate Tribunal, “D” BENCH, MUMBAI
Before: SHRI ABY T. VARKEY, JM & SHRI AMARJIT SINGH, VP
PER ABY T. VARKEY, JM: This is an appeal preferred by the revenue against the order of the Ld. Commissioner of Income Tax (Appeals) -24, Mumbai [hereinafter referred to as the “CIT(A)”] dated 18.11.2019 for AY. 2016-17. 2. The grounds of appeal of the revenue reads as under: - “1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in allowing the appeal and deleting the additions of Rs.19,46,21,075/- made u/s 56(2)(viib) of the Act.
The appellant prays that the order of the Ld. CIT(A) on the above ground be set aside and that of the AO be restored.”
The sole issue is against the action of the Ld. CIT(A) deleting the addition of Rs.19,46,21,075/- made by the AO u/s 56(2)(viib) of the Income Tax Act, 1961 (hereinafter “the Act”).
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Brief facts of the case is that the assessee is a company engaged in the business of dealing in properties buying land and construction of farm houses and selling the same. The return for the year under appeal was e-filed on 10.10.2016 declaring total loss at Rs.1,56,203/-. The case was selected for scrutiny under CASS. During the assessment proceeding, the AO noted that assessee company has allotted on 15.07.2015, 3,77,905 equity shares of face value Rs.10/- each at a premium of Rs.515/- per share for total consideration of Rs.19,46,21,075/-. The aforesaid allotment was done by the assessee by claiming that it has complied with the provision of Section 56(2)(viib) of the Act r.w. Rule 11UA of the Income Tax Rule, 1962 (hereinafter “the Rules”) and accordingly the fair market value of the share was calculated at Rs.525/- on the basis of discounted cash Flow Method (DCF Method). The AO show-caused the assessee vide notice dated 19.12.2018 as to why the DCF method adopted by the assessee company for valuation of equity should not be rejected. The assessee furnished valuation report of Chartered Accountant (CA) under Rule 11UA of the Rules. However, assessee’s contentions were not accepted by the AO and made an addition of Rs 19,46,21,075/- u/s 56(2)(viib) of the Act for the following reasons as stated under: - “4.2 The assessee company was asked to comply with the above show- cause notice by 24.12.2018 on 11:00 am. However, the assessee failed to submit its explanation till the passing of this order. Therefore, the undersigned is of the opinion that the assessee company has nothing to say in this regard. Accordingly, the assessment is hereby completed on merits.
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3 During the course of assessment proceedings, the assessee company has submitted the certificate of valuation of share under rule 11UA. On perusal of the same, the following facts have been emerged out:
In its valuation report, the chartered accountant of SLM & CO LLP (FRN No:W-100030), has given a caveats/disclaimer as under:
"This report is based on the information provided to us by the management of the Company and on a going concern basis. We have relied on the representations made to us by the management. We have assumed such representations to be reliable and our conclusion are dependent on such information bring complete and accurate in all material respects. Our work was not designed to verify the accuracy, reliability or achievability of the information provided to us and nothing in this report should be taken to imply that we have conducted procedures, audit or investigation in an attempt to very or confirm any of the information supplied to us." Keeping in mind the above disclaimer and from the perusal of Valuation Report, it appears that the valuation of shares is not realistic keeping in view the growth and stature of the assessee company. Further, in the valuation report, the figures have been put up without giving any reasons, as to how these assumptions have been made.
In the DCF method first step is to forecast expected cash flow based on assumptions regarding the company's revenue growth rate, net operating profit margin, income tax rate, fixed investment requirement, and incremental working capital requirement. The revenue growth rate as well as the net profit margin of the assessee company, since inception, is negative and the losses are being carried forward. Even in the subsequent years i.e. A.Y.2017-18, for which data is available, the assessee company has shown loss of Rs.1,27,565/-. Therefore, as per the computation of valuation, the free cash flow to equity figures is found unrealistic. Accordingly, the assessee was requested vide show-cause
4 A.Y. 2016-17 DPN Reality Deals notice to submit actual free cash flow (FCF) from AY 2016-17 to till date, the same were not submitted.
Similarly, with regard to the calculation of Cost of Capital, it was requested to the assessee to clarify whether weighted average has been taken or otherwise. However, the assessee failed to give any explanation in this regard. Further, from the Valuation Report, it was understood that the assessee's use of BSE 500 return data is uncalled for Practically for assumption purpose this is a very long period for a company which is incorporated in the year 2014. Therefore, the assessee has not taken the realistic figure as deduced from the associate company investments. Further, the Terminal Growth Rate is computed @3% without giving any assumption of risk factor or risk free rate Beta figure is also not discussed in the valuation report
Also, the discounting factor @55% for a company whose returns are continuously in negative which is an unrealistic approach to calculate the value of shares. Accordingly. the assessee was asked to give details of Values which have been taken to arrive at a discounting figure @ 5% and also the basis behind such assumption for a company whose return have consistently been negative. Also, whether sector specific study has been carried out to reach the rate of return of growth. However, the assessee has not submitted any response in this regard.
Further, the assessee was requested to submit financial Statement of six months ended on September 30, 2015, and to explain as why the DCF method of Valuation employed by the assessee company for valuation of shares under Rule 11UA should not be rejected and, therefore, the book value method as per RULE 11UA (2)(a) should not be taken for the purpose of Section 56(2)(viib) of the IT. Act, 1961. 4.4 During the proceedings, the assessee company has neither submitted its response nor any explanation in reply to the detailed show-cause notice dated 19.12.2018. Therefore, the undersigned is of the considered opinion that the DCF method adopted by the assessee is required to be rejected and the difference between the premium value of share of Rs.515/- over and above the face value of share of Rs.10/- i.e. Rs. 19,46,21,075/- shall be considered as income from other source as provided under the provision of section 56(2)(viib) of the I.T.Act, 1961. 5 A.Y. 2016-17 DPN Reality Deals
5 Further, the valuation report of the CA is perused, the undersigned is of the view that the assessee failed to justify their taking the terminal value at Rs.9226.84/- and terminal growth rate @3% without any sufficient reasoning that too for a newly incorporate company running into losses since its inception. So, also the assessee has failed to justify in taking the discounting factor at 5% which is quite unrealistic on the face of their performance for the initial year of their business. Also, the BSE 500 return is not available to the assessee.
6 Kind attention is also invited to the basis and method of valuation paragraphs written by Chartered Accountant in their reports (as mentioned in para (a) of 4.2)and perusal of the above, makes it clear that the valuation of shares is not a realistic one keeping in view the growth and stature of the company as well as forecast and the assumptions of the assessee on which they are based and the figures in the Valuation Report have been cooked up without providing any reliable basis as to how the assumptions took place
7 In so far as DCF method is concerned it is always possible for the company to decide the proposed value of the shares first and then travelling back to tailor the figures with the reverse engineering process, to suite their convenience.
8 In view of the above, unless and until the assessee provides the evidence justifying the facts and figures provided to the charted accountant with their justification it would not be possible for the undersigned to consider the merits of the DCF method adopted by the assessee or to make suitable adjustments to the time for correct determination of the share price.
9 However, the assessee failed to the offer any explanation and remained silent on the show-cause notice dated 19.12.2018. By not producing the evidences supporting the figures furnished by the assessee to the Valuer for obtaining the report, the assessee leave no option to the undersigned below to consider the merits of DCF method adopted by the assessee, as such, the undersigned is constrained to reject the DCF method which could not be verified in the absence of material.”
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Aggrieved by the aforesaid action of the AO, the assessee preferred an appeal before the Ld. CIT(A) who was pleased to allow the same by holding as under: - “5.2.14 Therefore, I hold that the Assessing Officer erred in disregarding the method of valuation adopted by the appellant company i.e. Discounted Cash Flow Method. 5.2.15 Now comes the question as to why the Ld AO disregarded the valuation method. The Ld AO states as under in his assessment order: In the DCF method first step is to forecast expected cash flow based co assumptions regarding the company's revenue growth rate, net operating profit margin, income tax rate, fixed investment requirement and incremental working capital requirement. The revenue growth rate as well as the net profit margin of the assessee company, since inception, is negative and the losses are being carried forward. Even in the subsequent years i.e. AY 2017-18 for which data is available. the assessee company has shown loss of Rs 1,27,565/ Therefore, as per the computation of valuation, the free cash flow to equity figures is found unrealistic Accordingly, the assessee was requested vide show cause notice to submit actual free cash flow (FCF) from AY 2016-17 to till date the same were not submitted Also, the discounting factor @5% for a company whose returns are continuously in negative which is an unrealistic approach to calculate the value of shares. Accordingly, the assessee was asked to give details of values which have been taken to arrive at a discounting figure @ 5% and also the basis behind such assumption for a company whose return have consistently been negative Also whether sector specific study has been carried out to reach the rate of return of growth. However, the assessee has notsubmitted any response in this regard.
7 A.Y. 2016-17 DPN Reality Deals 5.2.16 During the course of the hearing, the ld. AR was asked to explain reasons for deviation between projections and actuals. The ld. AR stated that the assessee being a start-up company having lot of projects in hand had adopted DCF method to value its shares. Under the DCF Method, the fair market value of the share is required to be determined either by the Merchant Banker or by the Chartered Accountant. The valuation of shares based on DCF is basically to see the future year's revenue and profits projected and then discount the same to arrive at the present value of the business. 5.2.17 The Id. AR also stated that the ld. AO was basically looking in hindsight in order to disregard valuation mechanism and that since the appellant company was in the business of buying and selling of properties and building construction materials through online and offline aggregator model, factors such as demonetisation, GST and RERA have hit their business to a greater extent, which could not have been visualised at the time of making projections. 5.2.18 I find considerable force in the arguments advances by the AR in undenied that the investments in shares are made by a creditworthy party and that the transaction is genuine. That is the reason why the ld. AO does not invoke provisions of section 68 and instead relies on section 56(2)(viib). Further, the appellant companies business was affected by several factors which could not have been visualised at the time when investment was received/projections were made. The ld. AO should have considered these factors before disregarding the valuation altogether by mechanically relying on comparison between projections and actuals and directed deletion of the addition.”
Aggrieved the revenue is before us and has preferred the aforesaid grounds of appeal (supra) against the action of Ld. CIT(A).
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We have heard both the parties and perused the records. Though we agree with the Ld. CIT(A) that the AO did not had an option to adopt a different method than the one adopted by the assessee in this case i.e. DCF Method, however, since the AO has brought out certain infirmities regarding valuation made by the assessee to value the share of face value of Rs.10/- at a premium of Rs.515 per shares (Rs.525) per share, we do not countenance the action of the Ld. CIT(A) to have not scrutinized the DCF Method adopted by the Chartered Accountant (CA) for valuation of a share of face value of Rs.10/- or call for a remand report from AO on this aspect at premium of Rs.515. We note that in this case the assessee did not produce the materials/evidences to substantiate the basis of projection in cash flow which provides reasonable connectivity between those projections in cash flow with the reality. Moreover, the AO has taken note of the disclaimer appended by the Chartered Accountant as reproduced by the AO in his assessment order. When confronted with these facts, the Ld. AR of the assessee submitted that the assessee could not furnish proper material/evidences/details before the AO due to paucity of time meaning assessee did not get proper opportunity before the AO during the assessment proceedings to substantiate its claim of valuation of share by DCF method. For supporting such a plea, it was brought to our notice that the AO has issued show cause notice in respect of valuation only on 19.12.2018. And thereafter the AO had framed the assessment u/s 143(3) of the Act on 24.12.2018 (i.e. within five (5) days). Therefore, assessee did not get proper time to produce
9 A.Y. 2016-17 DPN Reality Deals documents before the AO regarding valuation of shares. We note from the assessment order that the AO had issued show cause notice dated 19.12.2018 regarding the adoption of DCF Method for valuation of shares; and the assessee was asked to reply the show cause notice by 24.12.2018 and the AO taking note that none appeared on 24.12.2018 at 11 AM, he was pleased to made the addition. In such a scenario, we find that the assessee did not get proper opportunity before the AO during assessment proceedings. In similar situation, the Hon’ble 216) (SC) held that if the assessee did not get proper opportunity before the AO, then the proper course is that assessment should be restored back to the file of AO for denovo assessment. The Hon’ble Supreme Court in the case of Tin Box Company (supra) has held as under: - “ It is unnecessary to go into great detail in these matters for there is a statement in the order of the Tribunal, the fact-finding authority, that reads thus : "We will straightway agree with the assessee's submission that the ITO had not given to the assessee proper opportunity of being heard." That the assessee could have placed evidence before the first appellate authority or before the Tribunal is really of no consequence for it is the assessment order that counts. That order must be made after the assessee has been given a reasonable opportunity of setting out his case. We, therefore, do not agree with the Tribunal and the High Court that it was not necessary to set aside the order of assessment and remand the matter to the assessing authority for fresh assessment after giving to the assessee a proper opportunity of being heard.
Two questions were placed before the High Court, of which the second question is not pressed. The first question reads thus : Whether, on the facts and in the circumstances of the "1. case, the Tribunal was justified in not setting aside the assessment order in spite of a finding arrived at by it that 10 A.Y. 2016-17 DPN Reality Deals
the Income-tax Officer had not given a proper opportunity of hearing to the assessee ?" In our opinion, there can only be one answer to this question which is inherent in the question itself: in the negative and in favour of the assessee.
The appeals are allowed. The order under challenge is set aside. The assessment orders, that of the Commissioner (Appeals) and of the Tribunal are also set aside. The matter shall now be remanded to the assessing authority for fresh consideration, as aforestated. No order as to costs.”
In the light of the aforesaid decision of the Hon’ble Supreme Court in the case of Tin Box Company (supra) and taking note of the fact that assessee did not get proper opportunity before the AO on the issue of Valuation of shares by DCF Method wherein the assessee’s share of face value of Rs.10/- was valued at Rs.515/-. So we set aside the impugned order of the Ld. CIT(A) and remand the issue back to the file of the AO and direct the AO to frame the assessment de-novo after hearing the assessee in accordance to law. And needless to say that assessee is at liberty to file the relevant documents and written submission before the AO during the assessment proceedings.
In the result, the appeal of the revenue is allowed for statistical purposes. Order pronounced in the open court on this 31/10/2022. (AMARJIT SINGH) JUDICIAL MEMBER मुंबई Mumbai; दिनांक Dated : 31/10/2022. Vijay Pal Singh, (Sr. PS)
11 A.Y. 2016-17 DPN Reality Deals आदेश की प्रनिनलनि अग्रेनर्ि/Copy of the Order forwarded to : अपीलार्थी / The Appellant 1. प्रत्यर्थी / The Respondent. 2. 3. आयकर आयुक्त(अपील) / The CIT(A)- 4. आयकर आयुक्त / CIT 5. दवभागीय प्रदतदनदि, आयकर अपीलीय अदिकरण, मुंबई / DR, ITAT, Mumbai 6. गार्ड फाईल / Guard file.
आदेशधिुसधर/ BY ORDER, सत्यादपत प्रदत //// उि/सहधयक िंजीकधर /(Dy./Asstt.