KEVA INDUSTRIES PRIVATE LIMITED,MUMBAI vs. INCOME TAX OFFICER 15(2)(1), MUMBAI

आदेश / O R D E R PER M. BALAGANESH (A.M): This appeal in 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/ITO-15(2)(1)/IT-242/2017-18 dated 11/03/2019 (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 29/12/2017 by the ld. Income Tax Officer-15(2)(1), Mumbai (hereinafter referred to as ld. AO).

5.1. Based on the aforesaid observations, the ld AO observed that the valuation under DCF method worked out by the assessee as per the data provided by the management / directors was nothing but an eye wash and totally unrealistic and accordingly not acceptable. The ld AO observed that the valuer of shares had simply adopted the future cash flows certified by the management and no verification of projections and assumptions adopted by the management were carried out by the said valuer and hence he concluded that the entire valuation report was made as per the requirement of the management. The ld AO observed that there is no match between the projections and the actuals. The projections were made only on presumptions and assumptions which are not based on any reasonable variable. DCF method being a legitimate permissible method for the calculation of value of shares, should be based on certain variables. It cannot be used as a tool of reverse working / arithmetical calculation without any basis. Accordingly, the ld AO rejected the valuation of shares carried out by an independent valuer using DCF method and proceeded to adopt the book value of shares as per the provisions of Rule 11UA(2)(a) of the Income Tax Rules. The ld AO for this purpose observed that since on the date of issue of shares , KNP Industries Pte Ltd did not have its audited financials, the determination of fair market value of KNP Industries Pte Ltd was made on the basis of audited balance sheet for the previous year ended on 31.12.2014 as under:- Book value of Assets US$.2,37,95,451 Less Advance Tax/ TDS/TCS Nil Nil Nil Deferred revenue expenditure A US$.2,37,95,451 Book value of Liability US$ 6,09,317 L US$ 6,09,317 PV US$ 0.5 PE 289885 Fair market value of unquoted equity shares = (A-L) * (PV) (PE) = (23795451-609317} * (0.5) 289885 = US$ 39.99 Same was converted to Indian Rs as taken by the assessee ie Rs 68 /US$ = Rs 2719.32 = Say Rs 2719 5.2. Based on the above, the ld AO proceeded to make an addition u/s 56(2)(viia) of the Act to the tune of Rs 107,40,00,000/- ( 400000 shares * (2719-34)) by treating the difference between the fair market value of the shares and the purchase price of the shares by the assessee .

6.1. The assessee submitted the Balance Sheet of KNP Industries Pte Ltd as on 10.2.2015 together with a valuation report obtained from the auditor of KNP Industries Pte Ltd dated 29.3.2018 valuing the shares based on NAV method. These documents were filed as additional evidences before the ld CITA as adequate time was not available before the ld AO to furnish the said documents. The ld CITA admitted these documents as additional evidences and sought for a remand report from the ld AO. The said remand report was submitted by the ld CITA on 20.12.2018 objecting to the admission of additional evidences filed by the assessee before the ld CITA. The ld AO in the remand report also stated that the valuation report dated 29.3.2018 suffers from various infirmities in as much as the same was not done by an independent auditor and that the same was furnished only by the auditor of KNP Industries Pte Ltd, Singapore and hence not reliable.

6.2. The assessee also filed a rejoinder to the remand report of the ld AO before the ld CITA on 29.1.2019. The assessee made preliminary objection that the remand report was submitted by the ld AO without affording any opportunity of being heard to the assessee and without causing any hearing to the assessee. It was submitted by the assessee that the valuation report , which was obtained in March 2018, demonstrates the fact that , notwithstanding the option available with the assessee company to value shares under DCF or NAV method, even if NAV method is adopted to value the shares, the valuation claimed by the ld AO was incorrect and arbitrary.

6.3. With regard to the objection of the ld AO that the valuation report furnished by the auditor of KNP Industries Pte Ltd, Singapore cannot be accepted, by stating that the same was in conflict of interest and more so that the same was furnished by the auditor by placing reliance on the projections / prospective results submitted by the management of KNP, the assessee submitted that Rule 11UA nowhere creates a restriction that Chartered Accountant of the company cannot value the shares. The assessee also submitted in this regard that the valuation of shares was done by the said auditor by using NAV method and hence there is no question of considering future projections, as wrongly alleged by the ld AO. Moreover, the said valuation of shares using NAV method was furnished by the auditor based on the audited financial statements as on valuation date of 10.2.2015, which clearly proves the proper application of mind on the part of the said auditor. The assessee further submitted that in any case, the ld AO ought to have considered the basic fact that valuation must be conducted as on the date of transaction (i.e valuation date) for which purpose the audited financial statements of valuation date ought to have been considered by the ld AO. The assessee also pointed out the factual fallacy committed by the ld AO from the valuation report of the auditor by stating that the value per share as per NAV method as on the valuation date at USD 2.58 as against (-) USD 8.64. It was also pointed out that in view of weak financial results in quarter ended December 2014 of S H Kelkar and Co, prompted the promoters to actively consider Initial Public Offer (IPO) as a way to redeem the situation that was beginning to impinge on the shares that were pledged.

6.4. The assessee also drew the attention of the ld CITA to the submissions made before the ld AO with regard to the fact that the value of investments of KNP Industries Pte Ltd had diminished to a large extent due to various reasons which were explained in detail. These are reproduced in pages 30 to 34 of the order of the ld CITA. It was specifically pointed out by the assessee that the shares of S H Kelkar & Co which were owned by KNP Industries Pte Ltd were placed in escrow account and that during such period, when shares were placed in escrow, KNP could not have sold the shares in the open market due to the overriding charge created. Further, due to poor financial performance of S H Kelkar & Co. by December 2014 and consequent discussions among Blackstone Shareholder and promoters at the subsequent Board meeting of S H Kelkar & Co, it became probable that M/s Blackstone would exercise its right to escrow thereby resulting in forfeiture of shares and it is due to this reason, a provision for diminution in value of investment was made. In nut shell, the value of shares of S H Kelkar & Co held by KNP Industries Pte Ltd was virtually zero. Hence it was pleaded that the observation of the ld AO that the provision for diminution in value of investments ought not to have been made in the balance sheet as on the valuation date is incorrect.

d) However, as part of the settlement, the promoters of company had to raise capital to fund settlement cost of the existing factions from the company. Most financial institutions / banks do not grant loans for funding settlement costs. The banks, which did agree, demanded exorbitant rates of interest. Therefore, the promoters decided to raise capital in the form of private equity from M/s. Blackstone Capital Partners (Singapore) VI FDI TWO PTE. LTD (hereinafter referred to as "Blackstone" or "Investors") e) In accordance with the above, a shareholders agreement was executed on 02.08.2012. One of the conditions in the shareholders agreement was protection to the Investors in the event of their exit without procuring the agreed IRR on their investment i.e. in the event of exit of Blackstone from SHK without procuring the agreed IRR on investment, the promoters of the company would become personally liable to make good the loss incurred by Blackstone. It may be noted that KNP is part of promoters group of SHK. f) For this purpose, the shares of SHK held by KNP were placed in escrow-account which was in the custody of Deutsche Bank AG, Hongkong Branch (which acted as the Escrow Agent to the above arrangement) g) It was agreed that if any specified event occurred (resulting in loss of wealth for Blackstone), the escrow agent shall handover the shares of SHK held in the escrow account to the said M/s. Blackstone. h) In view of the above condition, the shares of S H Kelkar & Co. owned by KNP Industries Pte Ltd were placed in escrow account. During such period when shares were placed in escrow, KNP Industries Pte Ltd could not have sold the shares in the open market due to the overriding charge created. Further, if any adverse event was triggered, the shares would have been directly handed over by escrow agent to Blackstone (who had been roped in as an investor). In nutshell, the value of shares of S H Kelkar & Co. held by KNP Industries Pte Ltd was virtually zero.

8.1. We find that the ld AR submitted that the valuation report issued by an independent valuer had taken due cognizance of the aforesaid facts and the attached encumbrances thereon and accordingly had determined the value per share at USD 0.50. However, the ld AO had rejected the valuation per share based on DCF method due to variations arising in actual vis a vis the projections. From due appreciation of the entire facts narrated above, we find that the valuation of USD 0.50 per share of shares of KNP arrived in the valuation report is to be accepted as just and fair in view of the fact that the main investment in KNP Industries Pte Ltd is in the shares of S H Kelkar and Company Limited. It is not in dispute that these shares were held in „escrow account‟ for meeting obligations to M/s Blackstone (investor). Due to poor performance of S H Kelkar and Company Limited as on Dec 2014, there was an anticipated net liability of KNP towards Blackstone, which had effectively brought the value of shares of KNP to negative. In these circumstances, the valuation per share of USD 0.50 per share is above the fair market value of the shares. The most crucial fact to be considered is that as on the date of valuation of shares, the valuer did not have the benefit of the actual figures which had happened subsequent to the valuation date. Valuation has been done based on future performance and projections of the valued company under DCF method. The actuals may vary with the projections. It is a calculated business risk and commercial decision taken by the respective investors by placing reliance on the share valuation report. In this factual matrix, the promoters of the assessee company came forward to sell the shares of KNP Industries Pte Ltd to the assessee company at the same price at which it was acquired by them originally, without having any benefit thereon, in order to comply with the regulations of RBI / FEMA. This goes to prove that the entire transaction has been carried out with a bonafide intention of all the parties. There is no dispute that DCF method is one of the recognized methods for valuation of shares as is done in the instant case. Considering the totality of facts and circumstances of the case as detailed hereinabove, we hold that the rejection of DCF method of valuation of shares carried out by an independent valuer, is not proper.

8.2. With regard to the claim of long term capital loss by the directors in the sum of Rs 51,64,854/- is concerned, we find that the assessee had submitted before the ld CITA that the said claim was erroneously made due to indexation benefit and that the said claim of loss was withdrawn by the directors by filing revised return of income and taxes paid for the same by both the directors. This fact was not controverted by the revenue before us and hence there is absolutely no benefit derived by the directors also by selling the shares of KNP Industries Pte Ltd to the assessee company at the same purchase price of Rs 34 per share.

8.3. We find that the ld AO had applied the provisions of Rule 11UA of the Rules, which in our considered opinion, are not at all applicable to the instant transaction. We find that the ld AO had invoked the provisions of Rule 11UA(2)(a) of the Rules as is evident from para 4.16 of his order. We find that the ld AO had invoked the provisions of section 56(2)(viia) of the Act read with Rule 11UA(2)(a) of the Rules for making the addition. We find that the provisions of Rule 11UA(2) of the Rules are applicable only in the case of issue of shares by an unlisted company under the provisions of section 56(2)(viib) of the Act. In this regard we find that the assessee had acquired shares in a foreign company i.e M/s KNP Industries Pte Ltd, Singapore. The ld AO had applied Net Asset Value Method (NAV method) and for this purpose had relied on the balance sheet of KNP Industries Pte Ltd as on 31.12.2014 which is prepared in accordance with the Companies Act of Singapore. We find that Rule 11U define the word „Balance sheet‟ as under:-

“balance-sheet", in relation to any company, means,— (i) for the purposes of sub-rule (2) of rule 11 UA, the balance-sheet of such company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor of the company appointed under section 224 of the Companies Act, 1956 (1 of 1956) and where the balance-sheet on the valuation date is not drawn up, the balance-sheet (including the notes annexed thereto and forming part of the accounts) drawn up as on a date immediately preceding the valuation date which has been approved and adopted in the annual general meeting of the shareholders of the company; and (ii) in any other case, the balance-sheet of such company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor appointed under section 224 of the Companies Act, 1956 (1 of 1956)”

8.4. We hold that since the shares of a foreign company were acquired by the assessee company in the instant case, the ld AO ought to have relied on the balance sheet as audited by the auditor appointed under the Indian Companies Act. In the instant case, the ld AO had relied on the balance sheet of KNP Industries Pte Ltd, Singapore, which is prepared in accordance with Singapore Companies Act, which fact is not in dispute before us. Admittedly, the case of the assessee falls squarely on clause (ii) of the definition of „Balance Sheet‟ as defined in Rule 11U of the Rules supra. Hence it is mandatory to draw a balance sheet as on the valuation date i.e. 10.2.2015 /11.2.2015 (being the date of purchase of shares by the assessee company) and that the said balance sheet should have been audited by an auditor appointed under section 224 of the Companies Act, 1956. Hence it could be safely concluded that the ld AO had applied the valuation method on a different date which is not in accordance with law and that since the computation mechanism provided in Rule 11UA of the Rules is not applicable to the facts of the instant case, the provisions of section 56(2)(viia) of the Act also could not be invoked. It is well settled that the charging provision and the computation provision should be read together in order to make the said provisions workable in accordance with law. Reliance in this regard has been rightly placed by the ld AR on the decision of Hon‟ble Supreme Court in the case of CIT vs Official Liquidator, Palai Central Bank Ltd (In Liquidation) reported in (1985) 1 SCC 45 wherein it was held that :-

"When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section. Otherwise, one would be driven to conclude that while a certain income seems to fall within the charging section there is no scheme of computation for quantifying it." 8.4.1. Similar views were endorsed by yet another celebrated decision of Hon‟ble Supreme Court in the case of CIT vs B.C.Srinivasa Shetty reported in 128 ITR 294 (SC).

8.5. We find that the assessee before the ld CITA had furnished the balance sheet of KNP Industries Pte Ltd as on the valuation date i.e 10.2.2015. We find that the assessee had also furnished a valuation report dated 29.3.2018 from the auditor of KNP Industries Pte Ltd, Singapore based on the balance sheet as on 10.2.2015 as stated supra and by applying NAV method. These documents were indeed admitted by the ld CITA as additional evidences and a remand report was called for from the ld AO, which was duly submitted by the ld AO. The ld AO had pointed out that the value per share as per the said valuation report of auditor of KNP Industries Pte Ltd as on the date of valuation was USD 2.58. We have gone through the said valuation report of auditor of KNP Industries Pte Ltd which are enclosed in pages 444 to 447 of the paper book of the assessee. From the said valuation report, we find that the valuer had categorically stated as under:-

3.2. Valuation Conclusion Based on the aforesaid method, the fair value per Ordinary Share of KNP INDUSTRIES PTE LTD is United States Dollar 2.58 per share. The detailed working of the valuation of the KNP INDUSTRIES PTE LTD under NAV method is provided as Annexure 1.

As against the valuation of US$ 2.58 per share, as aforesaid, based on net value of assets of KNP INDUSTRIES PTE LTD., Mr Ramesh Vinayak Vaze and Mr Kedar Ramesh Vaze have an obligation to meet the value of investment put in by Mr Tan Cheng Hai of USD 4,500,000 which is secured by way of pledge of Mr Ramesh Vinayak Vaze and Mr Kedar Ramesh Vaze shares in his favour. Accordingly, the value of shares in the hands of Mr Ramesh Vinayak Vaze and Mr Kedar Ramesh Vaze comes to USD (-) 8.64 being the net value after adjusting the value of obligation towards Mr Tan Cheng Hai which is valued at US$ 4,500,000. (Emphasis supplied by us) 8.5.1. We find that the lower authorities had not looked into the para 3.2 of the valuation report in full and had only taken that part of the report which is favourable to the revenue alone. It is not in dispute that the assessee company had purchased the shares of KNP Industries Pte Ltd only from its directors i.e Mr Ramesh Vinayak Vaze and Mr Kedar Ramesh Vaze. The aforesaid valuation report clearly states that the value per share in the hands of these two directors as on the valuation date using NAV method would be USD (-) 8.64 per share. In these circumstances, the value per share at USD 2.58 in the hands of KNP Industries Pte Ltd as on the valuation date is not relevant and accordingly the entire observations made in this regard by the ld AO in the remand report which was relied upon by the ld CITA deserves to be dismissed. We find that as against the value per share on the valuation date of USD(-) 8.64 per share, the assessee company had purchased the shares from its directors at Rs 34 per share cannot be objected by the revenue. We also appreciate the contention of the ld AR that there is absolutely no prohibition in the provisions of Rule 11UA that the chartered accountant of the company cannot involve in valuation of shares. Accordingly, the observation made on account of conflict of interest in this regard deserve to be dismissed. We also find that the ld CITA had observed that the financial statements as on 10.2.2015 were unaudited and had been certified only by the directors. In this regard, we find from page 451 of the paper book that the auditor of KNP Industries Pte Ltd had furnished a review report to the management of KNP Industries Pte Ltd , wherein it had been categorically mentioned that based on their review of the said financial statements, nothing had come to their attention that caused them to believe that the accompanying financial statements were not presented fairly, in all material respects , in accordance with International Financial Reporting Standards. Hence it could be safely concluded that the financial statements submitted by the assessee as on 10.2.2015 cannot be simply brushed aside as it had got the blessing of the chartered accountant by way of Review Report.

8.6. We find that the main reason for rejection of the original valuation report submitted by Kaveri Venkataraman & Associates dated 5.2.2015 using DCF method, was that there was huge discrepancy in the amount of estimate vis a vis the actual performance. In this regard, what is to be seen is the availability of data on the date of valuation i.e on 5.2.2015 by the valuer. At that point in time, an independent valuer would have to necessarily rely on the projected performance and estimates provided by the management for the purpose of valuation of shares under DCF method. There is no dispute that M/s Kaveri Venkataraman & Associates is an independent valuer. There is absolutely no conflict of interest alleged on them by the revenue. Hence based on the projections given by the management of KNP Industries Pte Ltd, the valuation exercise was carried out by Kaveri Venkataraman & Associates on 5.2.2015 and accordingly value per share using DCF method was arrived at USD 0.5 (equivalent to Rs 34 per share). This rate of Rs 34 per share was finally used for purchasing the shares by the assessee company from its directors on the valuation date i.e 11.2.2015. There is no dispute that valuation of shares using DCF method is one of the recognized methods provided in the statute. Hence we do not find any infirmity in the said valuation report of Kaveri Venkataraman & Associates dated 5.2.2015 valuing the share at Rs 34 using DCF method. We would at this point in time, at the cost of repetition, would like to reiterate that the shares were merely purchased by the assessee company from its directors only in order to comply with RBI and FEMA guidelines.

8.7. We find that there is no dispute that the assessee company had acquired the shares of a foreign company from its directors. We also find the provisions of section 56(2)(viia) of the Act refers to transaction of acquisition of any property being shares of a company not being a company in which public are substantially interested. Since foreign company does not fall in the above category, the provisions of Section 56(2)(viia) of the Act cannot be said to apply to the above transaction. In any case, at the cost of repetition, the ld AO ought not to have considered the balance sheet as on 31.12.2014 for determining the value per share using NAV method , in view of the fact that the Rule specifically provides that balance sheet as on the date of valuation i.e 11.2.2015 should be considered for valuation. Rule 11 U defines valuation data as the date on which the property or consideration, as the case may be, is received by the assessee. Since the shares were acquired by the assessee company on 11.2.2015 (being the valuation date) , the valuation arrived at by the ld AO relying on financial statements as on 31.12.2014 deserves to be ignored and disregarded as not being in consonance with the Rule.

8.8. We hold that the provisions of section 56(2)(viia) of the Act cannot apply to a foreign company as the relevant Rule 11U which defines „balance sheet‟ was not applicable to a foreign company. We find that the amendment in this regard was brought in Rule 11U with effect from 1.4.19 under Rule 11U(b)(ii) of the Rules. This amendment is only prospective in nature and cannot apply to the year under appeal. We hold that the case of the assessee company herein falls under old provision of Rule 11U(b)(ii) of the Rules which reads as under:-

11U(b) “balance sheet” , in relation to any company, means ,- (ii) in any other case, the balance-sheet of such company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor appointed under section 224 of the Companies Act, 1956 (1 of 1956)

The amended rule 11U with effect from 1.4.19 is as under:- 11U(b) “balance sheet” , in relation to any company, means ,- [(ii) in any other case,-

(A) in relation to an Indian company, the balance sheet of such company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor of the company appointed under the laws relating to companies in force; and (B) in relation to a company, not being an Indian company, the balance sheet of the company (including the notes annexed thereto and forming part of the accounts) as drawn up on the valuation date which has been audited by the auditor of the company, if any, appointed under the laws in force of the country in which the company is registered or incorporated;] Hence we hold that no method was prescribed earlier for valuation of shares of a foreign company i.e KNP Industries Pte Ltd prior to Asst Year 2019-20, which mischief was sought to be rectified by way of an amendment made in the rules under Rule 11U(b)(ii) of the Rules w.e.f. 1.4.19 having prospective applicability.

8.9. We find that the ld DR fairly agreed that the ld CITA wrongly applied the amended rule in his order which is not applicable to the facts of the instant case. But he prayed for remanding this issue back to the file of ld CITA for fresh adjudication to address on the pre-amended rule thereon. The ld DR also argued that Rule 11U defines the term „balance sheet‟ wherein the expression „any company‟ is used. Accordingly, he argued that the expression „any company‟ should be construed to include foreign company also. We are not inclined to agree to this argument of the ld DR in view of the fact that this would make the subsequent amendment in the Rules specifically bringing the valuation rules in respect of foreign company, redundant. As we have already held supra that the legislature had sought to rectify the mischief hitherto prevailing upto Asst Year 2018- 19 in the statute / rule and had accordingly brought an amendment effective from Asst Year 2019-20 onwards to curb the loophole available in the Act / Rules, hence we hold that the pre-amended definition of balance sheet cannot include foreign company therein. The ld DR later filed the comments dated 26.6.2019 received from the ld AO before the bench. We have gone through the same and we find that the same is nothing but reiteration of the findings already recorded in the assessment order which had already been dealt by us hereinabove. We are not inclined to agree to the contentions of the ld DR that the issue needs to be remanded back to the file of ld CITA for fresh adjudication to decide in the light of pre-amended rule, as it would tantamount to giving a premium to the revenue to improve its case , which cannot be entertained by us, as the tribunal exercises only appellate jurisdiction.

8.10. In view of our aforesaid observations in the facts and circumstances of the instant case, we direct the ld AO to delete the addition made in the sum of Rs 107,40,00,000/- u/s 56(2)(viia) of the Act. Accordingly, the grounds raised by the assessee are allowed.

Order pronounced in the open court on this 16/10/2019