AAVISHKAR ORAL STRIPS PRIVATE LIMITED,HYDERABAD vs. ITO., WARD-1(3), HYDERABAD

The assessee has raised the following grounds of appeal :

The brief facts of the case are that, the assessee is a company engaged in research and manufacturing of novel drug delivery products, particularly oral strips used in the pharmaceutical industry. The assessee filed its Return of Income (“ROI”) for A.Y. 2016–17 on 30.08.2016, declaring income under normal provisions of the Income Tax Act, 1961 ( “the Act”) at Rs. Nill and book profit of Rs.59,151/- under section 115JB of the Act. The case of the assessee was selected for limited scrutiny to examine the large share premium received during the financial year 2015–16 relevant to the A.Y. 2016–17. During the year, the assessee received Rs.1,25,00,000/-, comprising share capital of Rs.19,69,600/- and share premium of Rs.1,05,29,400/-. The shares were issued at a premium of Rs.53.46 per share (face value Rs.10/-).

3.1 In support of valuation, the assessee adopted the Discounted Cash Flow (“DCF”) method, as permitted under Rule 11UA(2) of the Income Tax Rules, 1962 (“the Rules”), and submitted a valuation report certified by a Chartered Accountant. However, the Learned Assessing Officer (“Ld. AO”) rejected the DCF method citing that the projected figures taken by the assessee were not backed by evidence and varied significantly from actual results of subsequent financial years. The Ld. AO instead adopted the Net Asset Value (“NAV”) method, and determined the Fair Market Value (“FMV”) of shares accordingly, resulting in an addition of Rs.1,04,89,040/- under section 56(2)(viib) of the Act.

Aggrieved with the order of Ld. AO, the assessee filed appeal before the Ld. CIT(A), who confirmed the action of the Ld. AO.

Aggrieved with the order of Ld. CIT(A), the assessee has filed the present appeal before the Tribunal.

The Learned Authorised Representative(“Ld. AR”) submitted that, as per section 56(2)(viib) of the Act read with Rule 11UA(2) of the Rules, the assessee has the discretion to choose either the NAV method or the DCF method for determining FMV of unquoted equity shares. Once a method is opted by the assessee, the same is binding and the Ld. AO has no authority to substitute one method for another. The Ld. AR further submitted that, the DCF method is inherently based on estimates and projections and some deviation from actuals is not only possible but inevitable in the nature of business. Therefore, the mere fact that actuals varied from projections could not be a ground to discard the method altogether. The Ld. AO could have called for further explanation or supporting evidence but could not disregard the DCF method entirely. The Ld. AR relied on the following judicial precedents in support of their contention that, the choice of method rests with the assessee, and if DCF is adopted, the Ld. AO cannot substitute NAV method :

i) Vodafone Mpesa Ltd. Vs. PCIT (2018) 256 Taxman 240) (Bom) ii) Karmic Labs Pvt. Ltd. Vs. ITO in dated 28.07.2020.

Per contra, the Learned Department Representative (“Ld. DR”) submitted that the projected financials used for DCF valuation were unrealistic and lacked any evidentiary support. The DCF report was merely based on management’s estimates and self-certified projections without any third-party validation or historical justification. The Ld. DR invited our attention to page nos.29 to 32 of the paper book where the Chartered Accountant issuing the DCF certificate has stated that the projections were based on data, declarations, and assumptions made available by the assessee. Further, he referred to page no. 39 of the paper book to show significant discrepancies between the projected figures and actual results for FY 2015–16 to FY 2017–18. Therefore, the Ld. DR submitted that the action of the Ld. AO in rejecting the DCF method and adopting the NAV method is justified, as the DCF approach was found to be unscientific, unverifiable, and lacking in credibility. He prayed before the bench to dismiss the appeal of the assessee.

We have heard the rival submissions and perused the material on record, including judicial precedents relied, the DCF valuation report, and observations of the lower authorities. We have gone through Section 56(2)(viib) of the Act and found that the section provides for taxation of share premium received by a closely held company in excess of the FMV of shares. Further, we have also gone through Rule 11UA(2) of the Rules, wherein the said Rules prescribes two methods for determining FMV i.e. (i) NAV and (ii) DCF. Further a plain reading of Rule 11UA(2) clearly provides that the option of choosing between NAV and DCF is available to the assessee. Once the assessee exercises this option and submits a valuation report based on one of the permitted methods (as in the present case – DCF), the Ld. AO does not have the authority to substitute it with another method. However, the Ld. AO is empowered to scrutinise the assumptions, call for further evidence, and verify the reasonableness of the data used in the DCF report.