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Facts
The assessee company issued equity shares at a premium upon conversion of debentures. The Assessing Officer (AO) treated the premium amount received from an Indian company as income under Section 56(2)(viib) of the Income Tax Act, 1961, considering it in excess of the Fair Market Value (FMV). Disallowances were also made under Section 40(a)(ia) and 43B.
Held
The Tribunal held that the AO erred in re-evaluating the Discounted Cash Flow (DCF) projections made by the assessee. The AO cannot substitute his own assumptions for the valuer's projections, especially when the valuation method itself is not defective. Therefore, the addition under Section 56(2)(viib) was deleted.
Key Issues
1. Whether the addition of share premium under Section 56(2)(viib) is sustainable. 2. Whether disallowances under Sections 40(a)(ia) and 43B are justified.
Sections Cited
56(2)(viib), 40(a)(ia), 43B
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, ‘A’ BENCH: CHENNAI
Before: SHRI MANU KUMAR GIRI & SHRI S.R.RAGHUNATHA
आदेश / O R D E R
PER MANU KUMAR GIRI, JM:
This Appeal filed by the Assessee is directed against the order of the Ld. Commissioner of Income Tax (Appeals), NFAC, Delhi, [CIT(A)] dated 15.07.2025 for Assessment Year 2014-15. 2. Brief facts of the case are that the assessee, a private limited company, engaged in the business of real estate development, filed its return of income for Assessment Year (AY) 2014-15 on (AY 2014-15) Oragadam City Developers Pvt Ltd(Vs.) ITO CW5(1) :: 2 ::
28.11.2014 and subsequently furnished a revised return on 28.11.2015 declaring a loss of Rs.17,95,493/-. 2.1 During the relevant previous year, the assessee issued 4,41,200 equity shares of Rs.10/- each at a premium of Rs.990/- per share upon conversion of compulsory convertible debentures. The shares were issued to two existing shareholders as under: Sl. Name of Share holder No. of Shares Face Value Share Premium No.
M/s. IIROF 3 Zeus Ltd. 4,16,700 Rs.41,67,000 Rs.41,25,33,000 (Foreign Company) 2. Nandi Hills Hotels & 24,500 Rs.2,45,000 Rs.2,42,55,000 Resorts Ltd.
2.2 Subsequently, it came to the notice of the Assessing Officer (AO) that during Financial Year (FY) 2013-14, the assessee had issued 4,41,200 equity shares of face value Rs.10/- each at a premium of Rs.990/- per share. Out of these, 4,16,700 shares were allotted to M/s. IIROF 3 Zeus Ltd., a foreign company, and 24,500 shares were allotted to M/s. Nandi Hills Hotels & Resorts Ltd., an Indian company and existing shareholder. In respect of the shares issued to the resident company, the premium amounting to Rs.2,42,55,000/- was considered by the AO to be liable to tax u/s. 56(2)(viib) of the Act. Accordingly, the assessment was reopened u/s.147 of the Act, and notice u/s.148 dated 21.03.2019 was issued. In response, the assessee filed a return of income on 12.11.2019 declaring the same loss of Rs.17,95,493/-. Thereafter, statutory notices u/s. 143(2) and 142(1) were issued from time to time, and the assessee furnished the requisite details and explanations, which were examined by the AO. During the reassessment proceedings, the AO observed that although the assessee contended that no fresh funds were received during the year and that the shares were issued upon conversion of debentures originally issued in 2009, the actual allotment of shares (AY 2014-15) Oragadam City Developers Pvt Ltd(Vs.) ITO CW5(1) at a premium took place in FY 2013-14. The assessee submitted that Section 56(2)(viib) was inapplicable as the consideration had been received in earlier years. The assessee further relied upon a valuation report adopting the Discounted Cash Flow (DCF) method, which valued the shares at Rs.998.05 per share based on projected cash flows from FY 2014-15 to FY 2021-22, applying a discount rate of 15%, and estimating a total discounted cash flow of Rs.100.92 crores for 10,11,200 shares. Supporting financial projections, assumptions, and business plans were also furnished. The AO, however, observed that as on 31.03.2013 the assessee had negative reserves of Rs.41.37 crores and had not generated substantial revenue. The AO further noted significant variations in projected overhead expenses and considered the assumptions underlying the DCF valuation to be arbitrary and unrealistic. Upon revising the projections and recalculating the valuation, the AO arrived at a negative value of Rs.444.27 per share and consequently rejected the DCF report as unreliable. The fair market value (FMV) of the shares was determined at Rs.10/- per share, being the face value. The AO held that Section 56(2)(viib) applies to any consideration received for issue of shares to a resident in excess of the FMV, irrespective of whether the underlying funds were received in earlier years and subsequently converted into equity. Since the shares were allotted during the relevant previous year at a premium of Rs.990/- per share, the differential amount in respect of 24,500 shares issued to the resident company, aggregating to Rs.2,42,55,000/-, was brought to tax under the head “Income from Other Sources.” Additionally, disallowances were made u/s.40(a)(ia) and 43B for failure to remit tax deducted at source within the stipulated time and (AY 2014-15) Oragadam City Developers Pvt Ltd(Vs.) ITO CW5(1) for unpaid statutory liabilities, respectively. The reassessment proceedings were thus concluded u/s. 143(3) r.w.s 147 of the Act on 23.12.2019, determining the total assessed income at Rs.3,14,29,626/- making the following additions:
(i) Rs.2,42,55,000/- u/s. 56(2)(viib) as income from other sources on account of excess share premium; (ii) Rs.2,41,899/- u/s. 43B towards unpaid statutory dues; and (iii) Rs.87,28,220/- u/s. 40(a)(ia) for non-remittance of tax deducted at source within the prescribed time.
2.3 Aggrieved, the assessee preferred appeal before the CIT(A), who confirmed the additions. Hence, the present appeal. 3. The issues arising for adjudication are:
(i) Whether the addition of Rs.2,42,55,000/- u/s. 56(2)(viib) is sustainable in law? (ii) Whether disallowance u/s. 40(a)(ia) and section 43B is justified? 3. Addition u/s. 56(2)(viib) of the Act:
3.1 The ld. counsel for the assessee submitted that no consideration was received during the relevant previous year for issue of shares. Funds were received in earlier years (FY 2009-10 and 2011-12) towards compulsory convertible debentures. As per the investment agreement, each debenture of Rs.1,000/- was convertible into one equity share. During the year under consideration, only conversion took place. There was no fresh inflow of funds. There was no change in ownership structure post conversion. It was further submitted the assessee exercised option under Rule 11UA(2) and adopted the Discounted Cash Flow (DCF) method. As per valuation report, fair market value per share was Rs.998.05. Conversion price adopted was Rs.1,000/-. Thus, there was no excess over fair market value. It (AY 2014-15) Oragadam City Developers Pvt Ltd(Vs.) ITO CW5(1) was contended that once valuation is done under Rule 11UA(2)(a)(i), the Assessing Officer cannot substitute his own valuation under DCF method. Reliance was placed on judicial precedents including:
• Cinestaan Entertainment Pvt. Ltd. (2019) 180 DTR 65/ 200 TTJ 459 / 177 ITD 809 (Delhi)(Trib.) affirmed by Hon’ble Delhi High Court in PCIT v. Cinestaan Entertainment Pvt. Ltd. (2021) 433 ITR 82/ 199 DTR 345/ 320 CTR 381 (Delhi) (HC); • ACIT vs. Lifestyle Probuild (P.) Ltd. [2023] 155 taxmann.com 338 (Delhi - Trib.)/[2023] 203 ITD 585 (Delhi - Trib.)[09-10-2023]; • Dy. CIT v. Kilitch Healthcare India Ltd. [IT Appeal No. 7061 (Mum) of 2019, dated 22-3-2022]; • ITO vs Irunway India Pvt. Ltd. (Bangalore ITAT).
3.2 Per contra, ld.DR for the revenue supported the orders of the authorities below. He further submitted that the conversion of debentures amounts to receipt of consideration for issue of shares. He pleaded that AO was justified in examining projections under DCF. AO did not change method but corrected assumptions. 3.3 We have heard the rival submissions and perused the record and case law cited. In this case, the AO rejected the valuation report on the ground that the assumptions in DCF projections were unrealistic. He further noted that expenditure ratios were arbitrarily reduced and the company had negative reserves. He recalculated the DCF with revised assumptions, share value worked out to (-) Rs.444.27. Since valuation was negative, FMV was adopted at Rs.10/- per share.
Accordingly, premium of Rs.990/- per share for 24,500 shares aggregating to Rs.2,42,55,000/- was added u/s.56(2)(viib). The CIT(A) upheld the addition holding section 56(2)(viib) is applicable in year of issue of shares. Conversion of debentures amounts to receipt of consideration for issue of shares. AO was justified in examining projections under DCF. AO did not change method but corrected assumptions. 3.4 Our analysis and findings with regard to the applicability of Section 56(2)(viib) of the Act: Section 56(2)(viib) applies where a closely held company receives consideration for issue of shares from a resident in excess of FMV. In the present case shares were admittedly issued during the relevant previous year. Premium of Rs.990/- per share was fixed at time of conversion. Conversion altered character of debenture liability into share capital and premium. Thus, for purposes of section 56(2)(viib), issuance of shares during the year constitutes the relevant taxable event. 3.5 Next question is whether AO can substitute DCF valuation? The crucial question is whether the AO, after the assessee adopts DCF method under Rule 11UA(2), can modify assumptions and recompute valuation. Rule 11UA(2) provides that FMV shall be: (i) as determined in accordance with prescribed method; or (ii) substantiated to satisfaction of AO based on assets value.
The use of the word “or” indicates that once assessee chooses prescribed method under clause (i), valuation must be examined within that framework.
In the present case the assessee adopted DCF method. A valuation report was furnished. AO did not reject DCF as a method. Instead, AO altered projections and substituted assumptions. Judicial precedents relied upon by the assessee consistently hold that AO cannot replace projections with actual results. AO cannot step into shoes of valuer. Commercial projections are based on estimates and business perception at the time of valuation. It is settled law that valuation under DCF is forward-looking and cannot be rejected merely because projections did not materialize or appear optimistic. Therefore, in our considered view the AO exceeded jurisdiction by reworking projections on subjective assumptions. Once DCF method is adopted and report furnished, AO may examine genuineness, but cannot undertake fresh valuation unless method itself is defective. No material is placed to show that valuation report was sham or fraudulent. Accordingly, the addition u/s. 56(2)(viib) is not sustainable. The addition of Rs.2,42,55,000/- is deleted. Therefore, on merits of addition, ground on these issues are allowed.
Disallowance u/s.40(a)(ia): The assessee contended that it had voluntarily disallowed Rs.3,13,38,123/- in computation, which included TDS default amounts. The AO made separate disallowance without granting opportunity for reconciliation. Hence, in the interest of justice, the matter requires verification. If amount of Rs.87,28,220/- is already included in voluntary disallowance, double disallowance cannot be sustained. Accordingly, this issue is restored to the file of the AO for limited verification.
(AY 2014-15) Oragadam City Developers Pvt Ltd(Vs.) ITO CW5(1) 5. Disallowance u/s.43B: The disallowance u/s 43B is restored to the file of the AO for verification of assessee’s contention that it had already disallowed Rs.313,38,123/- for nonpayment of TDS.
In the result, Addition u/s.56(2)(viib) is deleted and disallowances u/s.40(a)(ia) and 43B are restored to the file of the AO for verification as directed above.
The appeal of the assessee is partly allowed for statistical purposes.
Order pronounced on the 23rd day of February, 2026 in Chennai.