M/S. TUV RHEINLAND NIFE ACADEMY PRIVATE LIMITED,BENGALURU vs. INCOME TAX OFFICER, WARD-7(1)(2),, BENGALURU

Per Jason P. Boaz, Accountant Member

This appeal by the assessee is directed against the order of the CIT(A)-7, Bangalore dated 17.09.2018 for Assessment Year 2015-16.

ITA No. 3160/Bang/2018

Page 2 of 19 2.1 The assessee is a company engaged in the business of providing vocational training through direct training centres, franchise centres and information centres in many cities across the country. It is a subsidiary of TUV Rheinland (I) Pvt. Ltd., which holds the entire share capital of the assessee company. For Assessment Year 2015-16, the assessee filed its return of income on 04.05.2016 declaring a loss of Rs.1,60,39,038/-. The case was selected for scrutiny and order of assessment was concluded u/s 143(3) of the Income Tax Act, 1961 (in short ‘the Act’) vide order dated 28.12.2017; wherein the assessee’s income was determined at Rs.18,68,31,128/- in view of the following additions / disallowances: (i) Share premium taxed u/s 56(2)(viib) - Rs.19,74,00,000/- (ii) Disallowance of bad debts - Rs. 40,70,166/-

2.2 Aggrieved by the order of assessment dated 28.12.2017 for Assessment Year 2015-16, the assessee preferred an appeal before the CIT(A) – 7, Bangalore, which was dismissed vide the impugned order dated 17.09.2018.

ITA No. 3160/Bang/2018

Page 3 of 19 2. That the Learned CIT(A) and the Learned ITO erred by adding to the income, an amount of Rs 19,74,00,000/- u/s 56(2) (viib) of the Act and also disallowing the bad debts claimed of Rs.46,70,166/- without appreciating the facts and circumstances of the case and the applicable law. 3. That the Learned ITO while making additions u/s 56(2) (viib) of the Act, disregarded the facts and circumstances of the case and has concluded Assessment in a mechanical manner without application of mind. 4. That the Learned CIT(A) and the Learned ITO mis- construed the provisions of section 56(2)(viib) of the Act and should have appreciated the fact that the price at which a transaction is undertaken between a willing buyer and a willing seller of sound mind is the FMV which does not require any further justification. 5. That the Learned ITO ought to have appreciated the intent of the provisions of section 56(2)(viib) of the Act and should have examined if the instant case is fit for invocation of the provisions of section 56(2)(viib) of the Act. 6. The Learned CIT(A) mis-interpreted the intent of the provisions and amendments with respect to section 56(2)(viib) of the Act. 7. That the Learned CIT(A) and the Learned ITO grossly erred by applying the provisions of section 56(2)(viib) of the Act without appreciating the fact that all the shares are issued to the parent company and the parent company is the sole shareholder and therefore, the price at which the shares are issued is not relevant. 8. That the Learned CIT(A) and the Learned ITO has not brought any material on record to show that the fair market value adapted by the Company is incorrect. Mere contention that the DCF method is based on the projections given by the management cannot be a valid ground for disregarding an expert's report. Further, the Act does not provide the Revenue Authorities with the power to evaluate the method of valuation when the option has been exercised by the Appellant. The Revenue Authorities' examination is restricted to verify the arithmetical accuracy of the valuation and not beyond that. 9. That the Learned CIT(A) and the Learned ITO has himself quoted that "Calculation of value on the basis of DCF

ITA No. 3160/Bang/2018

Page 4 of 19 Method is not a science where future can be predicted precisely. DCF method is based on discounted future expected cash flow which no one can predict accurately. Merely because the projections are provided by the management, there can be no ground for disregarding a valid method of valuation". 10. That the Learned CIT(A) and the Learned ITO failed to appreciate that the Appellant has the option to choose the appropriate method for the valuation, and the Appellant by exercising its option has chosen the DCF method. The Act of Learned ITO of choosing the NAV method over DCF method for valuation is ultra vires its jurisdiction. The provisions of the Act provide the Appellant to choose the method and not the Revenue authorities to decide the appropriate method. 11. That the Learned CIT(A) and the Learned ITO lost sight of the fact that the FMV to be considered for the purpose of 56(2) (viib) of the Act is higher of : a_ as may be determined in accordance with such method as may be prescribed; or b. as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, knowhow, patents, copyrights, trademarks, licenses, franchises, or any other business or commercial rights of similar nature. As against the above provision, the Learned ITO adopted a value of Rs.84.20/-, being the lower of the value determined under any of the methods and the same has been erroneously upheld by the Learned CIT(A). 12. That the revenue authorities did not take into consideration the reliance placed by the Appellant of ruling in the case of CIT vs Poddar Cement Private Limited 119971 92 Taxman 541 (SC) and Green Infra Ltd — Mumbai ITAT 12013] 38 taxmsnn.com 253(Mum-Trib). 13. That the Learned CIT(A) and the Learned ITO ought to have appreciated that Section 56 of the Act intends to Tax only Income and not capital receipts the share premium received is

ITA No. 3160/Bang/2018

Page 5 of 19 a capital receipt and cannot be taxed under Section 56 (2) (viib) of the Act. 14. That the Learned CIT(A) and the Learned ITO has failed to acknowledge the fact that the amount of Rs.46,70,166 written off and claimed as bad debt was a genuine business expenditure of the Appellant and the Appellant is eligible for deduction such expenditure. 15. That the Learned CIT(A) and the Learned ITO ought not to have stepped into the shoes of a businessman to decide if the Appellant could have recovered the debt. 16. That the Learned CIT(A) erred in holding that the ruling of Apex court in the case TRF Ltd 323 ITR 397, relied by the Appellant is not applicable in the instant case. The Learned CIT(A) has also grossly erred in holding that the Appellant does not fulfil the conditions stipulated in section 36(2) of the Act and therefore the same shall be dis-allowed. 17. That the Appellant/ Company craves to leave to add, alter, modify, amend substitute or delete all or any of the above Grounds of Appeal. 18. For these and other grounds that may be argued at the time of personal hearing, the Appellant prays that the appeal may be allowed and relief be granted by setting aside the above Assessment Order by : Deleting the addition made under section 56(2)(viib) of  the Act;  Allowing the bad debts claimed as a deduction from the  Income

ITA No. 3160/Bang/2018

Page 6 of 19 5.1 These grounds (supra) pertain to the issue of addition of share premium in the hands of the assessee u/s 56(2)(viib) of the Act. The facts of the matter, as emerge from the record, is that in the course of assessment proceedings, the Assessing Officer (AO) observed that the assessee had allotted 5,00,000 shares of the face value of Rs.100/- to its parent company M/s. TUV Rheinland (India) Pvt. Ltd., at a premium of Rs.479/- per share. Thereby, the total amount of consideration received was Rs.28,95,00,000/-; out of which an amount of Rs.23,95,00,000/- was towards share premium. On being queried in this regard, it was submitted by the assessee that the share premium amount was worked out as per the Discounted Cash Flow Method (DCF); based on the Valuation Report of an independent Chartered Accountant. The AO examined the Valuation Report and found that the said Valuation Report had relied only on values certified by the Management of the assessee company, which had been prepared to justify the high premium and therefore rejected the valuation given in the said valuation report. Having so held, the AO computed the value of the shares under NAV Method as per the provisions of Rule 114A(2)(a) of the Income Tax Rules, 1962 (in short ‘the Rules’) and determined the fair market value (FMV) of the shares at Rs.84.20 per share as against Rs.479/- per share determined by the assessee. Therefore, the difference in the two amounts aggregating to Rs.19.74 Crores was added to the income of the assessee towards “excess share premium” exigible to tax u/s 56(2)(viib) of the Act. Aggrieved with the aforesaid addition, the assessee took this issue in appeal before the CIT(A). The CIT(A), after examining the facts of the case and considering all the issues raised by the assessee, has passed a detailed order, upholding the addition made by the AO.

ITA No. 3160/Bang/2018

Page 7 of 19

5.2 Before us, the assessee filed detailed statement of facts outlining the facts of the case along with the grounds of appeal. The assessee also filed a paper book (pages 1 to 319) containing a note of submissions, various documents, including copy of the valuation report of M/s. Sreenivasan Govardhan and copies of various judicial pronouncements to justify the assessee’s position on the valuation of share premium by the DCF Method. These have been perused and carefully considered. The learned AR of the assessee made detailed oral submissions on the various points outlined in the written submissions and also referred to various judicial decisions.

5.3 Per contra, the learned DR for Revenue emphatically supported the orders of the authorities below. According to the learned DR, the assessee company is only one year old and the impugned shares have been issued to its parent company less than one year from its incorporation. He also pointed out the defects in the figures adopted in the Valuation Report and submitted that the projections taken in the valuation report, based on values certified by the Management, have been taken only in order to justify the high premium and has no basis. In support of his contentions, the learned DR placed reliance on the decision of the ITAT Delhi Bench in the case of Agro Portfolio Pvt. Ltd., in ITA No. 2189/Del/2018 dated 16.05.2018.

5.4.1 We have considered the rival contentions and submissions and carefully perused the material on record. The gist of submissions/contentions put forth by the assessee are as under:

ITA No. 3160/Bang/2018

Page 8 of 19

(i) The provisions of section 56(2)(viib) of the Act have been misconstrued; in that the price at which a transaction is made between a willing buyer and willing seller is the FMV and does not require any justification. (ii) The intent of section 56(2)(viib) of the Act has been misinterpreted by the authorities below. (iii) All the shares are issued to the parent company as it is the sole shareholder and therefore the price at which the shares are issued is not relevant. (iv) No material has been brought on record to show that the FMV adopted by the DCF Method adopted is based on projections given by the Management of the assessee company; that cannot be a valid ground for disregarding on experts’ report. DCF Method is based on expected future cash flows which no one can predict accurately. (v) The Revenue authorities do not have the power to evaluate the Method of valuation once the option is exercised by the assessee and Revenue can only verify the arithmetical accuracy and not go beyond that. (vi) The assessee has the option to choose the method for valuation and the assessee has exercised the option of choosing DCF Method, the AO cannot choose the net asset valuation method (NAV) over the DCF Method. (vii) The FMV to be considered is to be the higher of the value determined under any of the methods; whereas the AO has

ITA No. 3160/Bang/2018

Page 9 of 19 adopted the lower of the value determined under any of the methods. (viii) Section 56 of the Act intends to tax only income and not capital receipts and share premium is a capital receipt. (ix) Reliance was placed, inter alia, on the decisions in the cases of (i) CIT Vs. Poddar Cements Pvt. Ltd., (1997) 226 ITR 625 (SC) (ii) Vaani Estates Pvt. Ltd., Vs. ITO in ITA No.1352/Chny/2018 dated 27.08.2018; (iii) Rameshwaram Strong Glass (P) Ltd., Vs. ITO (2018) 96 taxmann.com 542 (Jaipur – Trib.).

5.4.2 It is necessary and relevant for us to examine the assessee’s contention that section 56 of the Act intends only to tax income and not capital receipts and that share premium is a capital receipt. The definition of the term “Income” has been expanded by Finance Act, 2012 w.e.f. 01.04.2013 by including the following clause in section 2(24) of the Act:

“(xvi) any consideration received for issue of shares as exceeds the fair market value of the shares referred to in clause (viib) of sub- section (2) of section 56”.

5.4.3 Clause (viib) of sub section (2) of section 56 of the Income Tax Act, 1961 was inserted vide Finance Act, 2013 w.e.f. 01.04.2013 i.e., for and from Assessment Year 2013-14. It reads as under:

“Where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the

ITA No. 3160/Bang/2018

Page 10 of 19 face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause shall not apply where the consideration for issue of shares is received— (i) by a venture capital undertaking from a venture capital company or a venture capital fund; or (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf. Explanation.—For the purposes of this clause, (a) the fair market value of the shares shall be the value— (i) as may be determined in accordance with such method as may be prescribed; or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher”

The amended section (supra) provides that where a closely held company issues its shares at a price which is more than its FMV, then the amount in excess of the FMV of the shares will be charged to tax in the hands of the recipient company as income from other sources. This amendment was made, keeping in view of the practice of closely held companies bringing in undisclosed money of Promoters / Directors by issuing shares at high premium; which is normally over and above the book value of the shares of the company. Further, promoters are also issued shares at premium with the purpose of keeping share capital low, yet with a stronger capital base so that the breakup value and market

ITA No. 3160/Bang/2018

Page 11 of 19 value is high. This leads to the advantage of low cost of servicing share capital and also improved prospects to issue shares at a premium in future by way of initial issue of offering by promoters. When shares are issued at a premium, the number of shares and authorized share capital increase lesser in comparison to capital raised by way of issue of fresh shares to the public by way of IPOs, etc. While there are judicial decisions to the effect that share premium is a capital receipt, these pertain to the period prior to the above amendments brought about by Finance Act, 2013 and in view of these deeming provisions w.e.f. Assessment Year 2013-14, for closely held companies, share premium in excess of the FMV of shares is deemed to be income in the hands of the recipient company / person.

5.4.4 The assessee’s contentions to the effect that any price between the willing buyer and willing seller is the FMV and it does not require any justification, is not tenable. Acceptance of such a contention would lead to a situation that any share premium collected is allowable as long as both the buyer and seller accept it. Such a contention if accepted, in our considered view, would render the provisions of section 56(2)(viib) of the Act otiose and defeat the very purpose for which these provisions have been brought into the statute. Therefore, we find that this contention put forth by the assessee is untenable. The fact of the matter, in our opinion, is that the insertion of the aforesaid provisions (supra) provides for a mechanism to determine the share premium and any excess premium is to be brought to tax.

ITA No. 3160/Bang/2018

Page 12 of 19 5.4.5 Another contention put forth by the assessee that since all the shares are issued to the parent company, therefore the price at which the shares are issued is not relevant; is also not tenable. The provisions of law does not make an exception to shares issued to the promoter company / parent company. It provides for taxing of any excess share premium over the FMV of the shares, irrespective of the character or position of the person to whom such shares are issued. Merely because the recipient of the shares is the parent company of the assessee, does not give the assessee freedom to value the shares at any price. Even then, the FMV of the shares is to be evaluated and any excess premium is to be brought to tax. Therefore, we find this contention put forth by the assessee not tenable.

5.4.6.1 The assessee has also contended that it has the option to choose the method of valuation of the shares and that once the assessee has exercised its option and chosen the DCF Method, the AO’s hands are tied; in that he cannot adopt the NAV Method over the DCF Method chosen by the assessee and the AO can only verify the arithmetical accuracy of valuation and nothing beyond. It was also contended by the assessee that the addition of excess share premium has been made only on the ground that the Valuation Report for valuation of share premium has been taken on the basis of values certified by the Management of the assessee company; is not a valid ground for disregarding the Valuation Report. It was also contended that DCF Method is based on future expected cash flows which cannot be predicted accurately.

ITA No. 3160/Bang/2018

Page 13 of 19 5.4.6.2 From an appraisal of the facts of the case on hand on record before us, it is seen that neither has the AO questioned the right of the assessee to select the Method of Valuation nor has the AO dismissed the choice of DCF Method as a Method of Valuation. The AO has examined the parameters adopted by the assessee for valuation by the DCF Method and has rendered a finding that the valuation is not realistic as the actual figures were a long long way away from the projections made. These facts are available from details filed by the assessee before the CIT(A) and find mention in the following table extracted from para 5.4 on page 15 of the impugned order of the CIT(A):

Therefore, the contention of the assessee that the AO had disregarded the valuation made under the DCF Method is not correct.

5.4.6.3 The assessee’s contention that the ‘Valuation Report’ under the DCF Method adopted by the assessee has been disregarded by the authorities below only because it was based on valuations and projections certified by the Management of the assessee company is also not correct. A finding has been rendered that the basis of the estimates adopted in the valuation under DCF Method was not produced and the assessee was not able to substantiate the same. Even before us, the basis for estimates adopted in the valuation under DCF Method was not furnished by the assessee. Therefore, it is amply clear that the AO has

ITA No. 3160/Bang/2018

Page 14 of 19 not disregarded the use of DCF Method for valuation. The AO has not accepted the valuation adopted by the assessee as the parameters taken by the assessee in adopting the DCF Method are defective and / or not verifiable.

5.4.7 The assessee has also contended that the AO has taken the lower of the valuation, whereas he is required to adopt the higher valuation. In our view, this contention of the assessee is not correct. The valuation adopted by the assessee using the DCF Method has not withstood the scrutiny of the AO. The assessee has not been able / failed to furnish the details that went into and formed the basis for the projections made by the assessee. As pointed out by the CIT(A), there is absolutely no correlation between the figures adopted by the assessee in its projections and the actual figures reported. Since the very basis for the DCF valuation was itself not substantiated by the assessee, the AO has adopted the NAV Method to determine the valuation.

5.4.8.1 The question of whether the AO has the power to examine and verify the correctness or the reasonableness of the valuation adopted by the assessee has been answered by the Tribunal (ITAT – Delhi Bench) in the case of Agro Portfolio Pvt. Ltd., in ITA No.2189/Del/2018 dated 14.05.2018; relied upon by the learned DR. In this regard, the relevant portion of this order (supra) at paras 14 to 17 thereof is extracted hereunder:

“14. Even before the Ld.CIT(A) also, as recorded by the Ld. CIT(A) the assessee did not produce any evidence to substantiate the basis of projections in cash flow but relied on the valuer's

ITA No. 3160/Bang/2018

Page 15 of 19 report vehemently contending that such a report cannot be disturbed by the Ld. AO. At no point of time tried to explain where did the Ld. AO went wrong in his comments on the figures reflected in the above valuation report of the expert. 15. In these circumstances, we are unable to accept the contentions of the assessee that in view of the provisions under section 56(2)(viib) of the Act read with Rule 11UA(2) of the Rules the Ld. AO had no jurisdiction to adopt a different method than the one adopted by the assessee, and if for any reason the AO has any doubt recording such valuation report and does not agree with the same is bound to make a reference to the Income tax Department Valuation Officer to determine the fair market value of such capital asset. This is so because unless and until the assessee produces the evidences to substantiate the basis of projections in cash flow and provides reasonable connectivity between those projections in cash flow with the reality evidences by the material, it is not possible even for the Departmental Valuation Officer to conduct any exercise of verification of the acceptability of the value determine by the merchant banker. This is more particularly in view of the long disclaimer appended by the merchant banker at page no. 16 & 17 of the paper book which clearly establishes that no independent enquiry is caused by merchant banker to verify the truth or otherwise the figures furnished by the assessee at least on test basis. The merchant bankers solely relied upon an assumed without independent verification, the truthfulness accuracy and completeness of the information and the financial data provided by the company. A perusal of this long disclaimer clearly shows that the merchant banker did not do anything reflecting their expertise, except mere applying the formula to the data provided by the assessee. We, therefore, are unable to brush aside the contention of the Revenue that the possibility of tailoring the data by applying the reverse engineering to the pre determined conclusions. 16. For all these reasons, we are of the considered opinion that there has not been any possibility of verifying the correctness or otherwise of the data supplied by the assessee to the merchant banker, in the absence of which the correctness of the result of DCF method cannot be verified. This left no option to the AO but

ITA No. 3160/Bang/2018

Page 16 of 19 to reject the DCF method and to go by NAV method to determine the FMV of the shares. Without such evidence, it serves no purpose even if the matter is referred to the Department's Valuation Officer. We, therefore, do not find any illegality or irregularity in the approach of conclusions are by the authorities below. While confirming the same, we dismissed the appeal as devoid of merits. 17. In the result, the appeal of the assessee is dismissed.”

5.8.8.2 The facts of the above cited case of the ITAT - Delhi Bench in the case of Agro Portfolio Pvt. Ltd., (supra), are similar to that of the assessee in the case on hand and we are of the considered view that the findings rendered therein are applicable to the present case before us. Respectfully following the above cited decision of the ITAT – Delhi Bench (supra), we uphold the action of the AO in determining the share premium collected in the assessee’s hand u/s 56(2)(viib) of the Act r.w.r. 114A(2)(a) of the Rules and the action of the CIT(A) in upholding the AO’s action / addition. Consequently, grounds 2 to 14 of assessee’s appeal are dismissed.

6.1 In these grounds (supra), the assessee challenges the action of authorities below in rejecting its claim for write off of bad debts to the extent of Rs.46,70,166/-.

6.2.1 The facts of the matter, as emerge from the record before us, is that in the course of assessment proceedings, the AO observed that the assessee had debited an amount of Rs.2,66,18,490/-; out of which, an

ITA No. 3160/Bang/2018

Page 17 of 19 amount of Rs.46,70,166/- was outstanding from three of its franchisees, which was written off as bad debts. According to the AO’s observations, the assessee had a fee sharing model with the franchisees whereby the fees received was deposited in the joint bank account of the assessee and franchisee and therefore the assessee could have recovered the same at any time, if it so desired. Further, the AO was also of the view that the assessee did not produce any evidence to show that efforts were made to recover the reimbursable expenditure incurred by it from the franchisees. In that factual view of the matter, the AO disallowed the assessee’s claim for write off of bad debts amounting to Rs.46,70,166/- in respect of its franchisees.

6.2.2 On appeal, the CIT(A) examined the nature of the expenses in the light of the assessee’s claim that its case was covered by the decision of Hon’ble Supreme Court in TRF Ltd., 323 ITR 397 and upheld the disallowance by holding that the writing off of the dues of the franchisees can be considered as portion of revenue forgone and cannot be termed as bad debts to be written off. While holding so, the CIT(A) has rendered the following findings / observations:

(i) The expenditure incurred was in the nature of payment for advertisement for and on behalf of the franchisees; which was to be reimbursed by them. (ii) As the franchisees asked for writing off these amounts, as they were having insufficient cash flow, the assessee waived off these expenses.

ITA No. 3160/Bang/2018

Page 18 of 19 (iii) The assessee did not bring on record any evidence to establish that these amounts were included in the income of the assessee; either in this year or in earlier years. (iv) In doing so, the learned CIT(A) relied on the decision of the Hon’ble Karnataka High Court in the case of United Breweries Ltd., (321 ITR 546) (Kar.).

6.3.1 Before us, the assessee reiterated its contentions as put forth before the CIT(A); namely that the two main conditions for write off of any amount as “bad debts” is as under:

(i) The amounts involved were shown as revenue and duly reflected in the books of accounts as such; and (ii) That, in case these amounts or part thereof are recovered, it will be shown again under revenue and offered to tax.

6.4 In regard to the assessee’s contentions before him, the CIT(A) rendered a finding that these amounts are expended towards advertisement expenses incurred for and on behalf of the franchisees, which was to be reimbursed by them to the assessee. The assessee’s explanations that the franchisees were unable to reimburse the aforesaid expenses incurred by the assessee on their behalf due to insufficient / tight cash flow position and therefore the same has to be written off as advertisement expenses; in the view of the CIT(A); does not qualify to be “Revenue” to be written off as bad debts. We find that the findings rendered by the CIT(A) has not been controverted by the assessee before us. No further documents / details were furnished by the assessee. In

ITA No. 3160/Bang/2018

Page 19 of 19 this factual matrix of the case, as discussed above, we uphold the action of the factual findings rendered by the authorities below in disallowing the assessee’s claim for write off of reimbursable “advertisement expenses” incurred by the assessee as bad debts. Consequently, grounds 14 to 16 of assessee’s appeal are dismissed.

Pronounced in the open court on 27th February, 2019.

Sd/- Sd/- (N. V. VASUDEVAN) (JASON P. BOAZ) VICE PRESIDENT Accountant Member Bangalore. Dated: 27th February, 2019. /NS/* Copy to: 1. Appellants 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file By order

Assistant Registrar, ITAT, Bangalore.