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Facts
The assessee company received an unsecured loan from its director which was later converted into equity shares. The fair market value (FMV) of these shares was determined using the Discounted Cash Flow (DCF) method by a Chartered Accountant. The Assessing Officer (AO) treated the share premium as income under Section 56(2)(viib) of the Act, rejecting the valuation report.
Held
The Tribunal held that the conversion of an existing debt into equity shares does not constitute 'receipt of consideration' for the issue of shares as contemplated by Section 56(2)(viib). The Tribunal further found the rejection of the DCF valuation by the AO to be unsustainable, particularly his reliance on comparing projections with actuals, which is impermissible hindsight.
Key Issues
Applicability of Section 56(2)(viib) to loan conversion into equity and validity of DCF valuation report rejection.
Sections Cited
56(2)(viib), 143(3), 11UA
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Income Tax Appellate Tribunal, B BENCH, CHENNAI
Before: SHRI MANU KUMAR GIRI & SHRI S. R. RAGHUNATHA
आदेश /O R D E R
PER S. R. RAGHUNATHA, AM:
1. This appeal by the assessee is filed against the order of the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi, (in short “ld.CIT(A)”) for the assessment year 2018-19, dated 29.04.2025 in respect of the order of the National E-Assessment Centre, Delhi (in short ‘AO’) passed u/s.143(3) of the Income Tax Act, 1961 ( in short ‘the Act’) dated 28.04.2021.
:-2-: ITA. No:1848/Chny/2025
2. The grounds raised by the Assessee are as follows:
All the grounds of appeal are independent and without prejudice to the other grounds 1. The order of the assessing officer in so far as it relates to the addition made in the order passed u/s.143(3) as upheld by the Learned Commissioner (Appeals) is concerned is against the provisions of law and contrary to the facts and circumstances of the case
2. That on facts and circumstances of the case, the Learned assessing officer / Learned Commissioner (Appeals) have erred in law and facts in adding Rs.1,99,36,410/- of the amount of share premium on account of conversion of unsecured loan to equity shares u/s.56(2)(viib) of the income-tax Act.
3. That on facts and circumstances of the case, the Learned assessing officer / Learned Commissioner (Appeals) have failed to appreciate the fact that DCF method is essentially based on projections (estimates) and hence these projections should not be compared with the actuals to expect the same figures as the actuals
4 That on facts and circumstances of the case, the Learned assessing officer / Learned Commissioner (Appeals) have disregarded the various judicial precedents that have held that once an expert has undertaken a valuation and provided an opinion, the said opinion cannot be questioned by tax authorities
5. That on facts and circumstances of the case, the learned officer has erred in referring to the provisions of Rule 11UA(1)(c)(c) instead of Rule 11UA(2) where the law has specifically provided a method of valuation between book value method or fair market value determined by the merchant banker or accountant as per Discounted Cash flow (DCF) at the option of the appellant.
6. That on facts and circumstances of the case, the learned assessing officer has erred in rejecting the valuation report of the Chartered Accountant on the grounds that the report is not that of an accountant/merchant banker and thereby failed to appreciate the fact that word "accountant" and "merchant banker" for the purpose of Rule 11UA has been specifically defined under Rule 11U to include a Chartered Accountant within the meaning of The Chartered Accountants Act, 1949.
7. That on facts and circumstances of the case, the learned assessing officer has further failed to counter the valuation report by a substitute valuation and has instead rejected the valuation without any basis.
8. The learned assessing officer has erred in relying on the Hon'ble Mumbai ITAT decision of Sudhir Menon HUF vs. Asst. CIT(A) (ITA No. 192/Mum/2013) which :-3-: ITA. No:1848/Chny/2025 was in the context of Section 56(2)(vii)(b) / 56(2)(vii)(c) and not in the context of Section 56(2)(viib) of the Income-tax Act.
For these and for any other grounds that may be adduced at the time of Hearing the HON’BLE TRIBUNAL be pleased to allow the appeal and render justice.
The brief facts of the case emanating from the records are that the assessee is a private limited company engaged in the business of education services. For AY 2018-19, the assessee filed its return of income on 30.10.2018 declaring a loss of Rs.(-)1,71,13,413/-. During the assessment year, the assessee had received unsecured loan of Rs.2,00,00,000/- from one of its directors. The said loan was converted into 6,359 equity shares on 01.03.2018 at a premium of Rs.3,135.15 per share (face value Rs.10 per share), pursuant to a Board resolution dated 23.02.2018. The fair market value (FMV) of shares was determined at Rs.3,147.85 per share based on a valuation report dated 19.09.2017 prepared by an independent Chartered Accountant adopting the DCF method. The Assessing Officer rejected the valuation report and held that section 56(2)(viib) of the Act applies even to conversion of loan into equity. Further, the Assessing Officer held that the valuation report was invalid since, as per pre-amended Rule 11UA(2)(b), DCF valuation must be done by a “merchant banker”. The projections under DCF were unrealistic and did not match actual financial performance. Accordingly, he treated the entire share premium of Rs.1,99,36,410/- (Rs.2,00,00,000 minus face value of Rs.63,590) as income u/s.56(2)(viib) of the Act.
4. Aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the ld.CIT(A). The Ld.CIT(A) confirmed the addition made by the AO by passing an order dated 29.04.2025.
5. Aggrieved by the order of the ld.CIT(A), the assessee is in appeal before us.
:-4-: ITA. No:1848/Chny/2025 6. The ld.AR for the assessee submitted that the ld.CIT(A) has erred in confirming the addition made by the AO both as per the law and facts. The ld.AR submitted that the Valuation of the shares was determined on the basis of Valuation report submitted by an independent CA intended for a proposed transfer of Shares by a Non Resident to a Resident. The debt was received on three occasions of Rs.35,00,000/- on 06.10.2017, Rs.40,00,000/- on 10.10.2017 and Rs.1,25,00,000/- 29.01.2018 without explicit option to convert or any predetermined formula for conversion.
7. Further, the ld.AR argued that the Section 56(2)(viib) of the Act, interalia provides as follows:
"(viib) 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 face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares”
8. It is seen that section 56(2)(viib) of the Act postulates a situation where the consideration for issue of shares is received in the year in which such shares are allotted for a premium. In the present case, the consideration was the obligation of settlement of debt forgone and not issue of shares. However, the adjustment of debt towards the issue of shares was on account of the decision of Board to convert. In the circumstances the ld.AR submitted that the transaction is not covered u/s.56(2)(viib) of the Act and prayed for deleting the same.
Further the ld.AR contended that the AO failed to appreciate that DCF method is essentially based on projections which cannot be compared with actuals for the purpose of valuation of shares. The AO failed to appreciate that the fairness of assumptions underlying the estimates are of vital importance than any comparison with actual performances when the benefit of hindsight is not available.
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In this connection the ld.AR submitted that the assessee had on an earlier occasion issued and allotted shares at a Premium to a Non-Resident assessee which was based on a price determined on the basis of a Valuation report of an Independent Chartered Accountant as per extant FEMA regulations.
The ld.AR further submitted that in 2015 the assessee had issued 47,687 Shares at Fair Value of Rs.2,516.4 per share to Pearson Affordable Learning Fund, England for Foreign inward remittance of Rs.12,00,00,000/-. The Fair value of Share is Computed by Lalit Bajaj & Associates, a CA Firm using Discounted Cash Flow Method and has been filed alongwith the FCGPR form with RBI. This has been accepted by RBI vide acknowledgement which is included in Annexure. (Page 53-62 for 2015 FCGPR Submission, page 63-66 for Share valuation by Lalit Bajaj & Associates & 67-68 for RBI Approval Letter of 2015 FCGPR).
In the financial year 2017-18, (AY 2018-19) the assessee has issued shares at a value per share of Rs.3,147.85 using DCF Method while it was issued at a value of Rs.2,516/- in the year 2015. The difference between the two values i.e. Rs.631.85(Rs.3,147.85- Rs.2,516) represents the increase of premium amount from 2015 to 2018.
The Valuation Report as on 02.09.2015 via FCGPR shows the Share value at Rs.2,192.7. In arriving at this value the key factor influencing the value is Cost of Equity(ke) which is determined as 22.24%. In case the Value as on 02.09.2015 is compounded at that rate from the previous date of valuation to the current date of valuation, the Share value would have been Rs.3,276.46 (2192.7*1.2224*1.2224). Whereas the Share Value as on 31.07.2017 as per Valuation report dated 19.09.2017 is Rs.3,147.85 with an assumed Ke at 13.18%. If we Compute Compounded share value in 2017 using 2015 share Value (Rs.2,192.7) at the current Ke assumed in 2017 report the value would
:-6-: ITA. No:1848/Chny/2025 be Rs.2,808.79 (2192.7*1.1318*1.1318) (Page 9-11 for Valuation Report as on 19.09.2017).
The Share price in dispute is Rs.3,147.85 which is in the range of Rs.3,276.46-Rs.2,808.79 as computed in the Preceding Para. This clearly shows that the Valuation has been done on broad principles governing DCF method of adopting proper assumptions which are in tune with the circumstances prevalent on the dates of valuation. The drop in the Cost of Equity is due to the downward trend in Market due to Demonetisation and applying Rational thinking the Ke has been reduced from 22.24% in 2015 to 13.18% in 2017.
Further, if we see the projections under two valuation reports the projections have been made taking into account the revised EBITDA consequent to actual drop in EBITDA in the intervening period:
FY EBITDA in 2015 Report EBITDA in 2017 Report 2016-17 2,43,41,657 (3,54,65,000) 2017-18 18,93,13,594 (2,61,43,900) 2018-19 54,42,06,261 (6,72,300)
Hence, the ld.AR submitted that the AO should have considered these facts and accepted the valuation report provided by assessee in support of the share price or in the alternative provided a valuation under DCF method to counter the contentions of your appellant. The DCF method postulates that the value of an asset is the sum of the cash flows expected to be generated by the asset during the life of the asset discounted to present value by the cost of capital. This is done by projecting the Cash Flows for foreseeable explicit forecast period and a terminal value for perpetuity in case of assets with indefinite life discounted by cost of capital to arrive at its present value. The :-7-: ITA. No:1848/Chny/2025 DCF method is one of the most common methods for valuing various assets such as shares, businesses, real estate projects, debt instruments, etc.
The AO has also failed to note the following Judicial Pronouncements in regard to application of DCF method for Valuation of Equity Shares of Brio Bliss Life Science (P.) Ltd. Vs. ITO wherein it was held that "the DCF method followed by the assessee is one of the permissible method of valuation of shares in terms of Rule 11UA of IT Rules,1962 and said method is based on free cash flow of future years on the basis of projected financial statements. Further, the projected financials under DCF method need not be equal to the actual performance of the company in subsequent years"
The DCF Method is essentially based on the projections (estimates) only and hence, Income Tax Authorities cannot adopt a hindsight view and compare these projections with the actuals to expect the same figures as were projected.
The ld.AR submitted that the valuation process is an estimation and hence, the forecasts and projection cannot match the actual performance. The valuation at two different dates cannot be same due to change in the various internal and external socio-economic factors that impact the asset concerned. However, a valuer and Assessee both shall analyse the variance between the actual and projections and prepare a just and proper reason to justify their valuation assumptions to Assessing Officer. This has been presented in the preceding paragraphs while comparing the Valuation at two different dates
In the case of Securities & Exchange Board of India & Ors. [2015] [ABR 291] the Hon'ble Bombay High Court has held that:-
“It is a well settled position of law with regard to the valuation that valuation is not an exact science and can never be done with arithmetic precision. The attempt on the part of SEBI to challenge the valuation which is by its very nature based on projections by applying what is essentially a hindsight view that the performance did not match the projection is unknown to the law on valuations. Valuation being an exercise required to be conducted at a particular point of time has of necessity
:-8-: ITA. No:1848/Chny/2025 to be carried out on the basis of whatever information is available on the date of the valuation and a projection of future revenue that Valuer may fairly make on the basis of such information”
In the decision OF ITAT, Bangalore in the case of VBHC value homes pvt.ltd., VS ITO. “The Assessing Officer can scrutinize the valuation report, and he can determine a fresh valuation either by himself or by calling a determination from an independent Valuer to confront the assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee.
For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual results of future cannot be a basis to decide about reliability of the projections.
The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method.
Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/o Scientific Data, Scientific Method, Scientific study and applicable Guidelines regarding DCF Method of Valuation. vide Para 4.3 of Assessment Order 28/04/2021, The Learned Assessing Officer has concluded that "On perusal of the return of income, the actual sale and profit for A.Y. 2017-18 to 2020-21 is not matched somewhere from the projected figures"
For this issue the ld.AR drew our attention to the decision of ITAT, in the case of "DCIT Vs. Hometrail Buildtech (P.) Ltd" which are reproduced as follows: "On a perusal of the relevant sections read with the Rules, we are of the view that the action of the Assessing Officer in substituting the method of valuation is beyond jurisdiction. We are of the view that DCF Method is based on projections which are based on factors like growth of the company, economic/market conditions, business conditions, expected demand and supply. cost of capital and host of other factors.
These factors are considered based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based on approximation and catena of underlying facts and assumptions. Nevertheless, at the time when valuation is made, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and :-9-: ITA. No:1848/Chny/2025 thus, the value which is relevant today may not be relevant after a certain period of time"
Hence, the ld.AR submitted that the factors like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and host of other factors at the time of valuation may change over the period of time and thus, the value which is relevant today may not be relevant after a certain period of time. Therefore, the AO failed to appreciate the fact that word "accountant" and "merchant banker" for the purpose of Rule 11UA has been specifically defined under Rule 11U to include a Chartered Accountant within the meaning of The Chartered Accountants Act, 1949. The Assessing Officer has rejected the valuation report merely under surmise without any basis.
Further, the ld.AR submitted the written submission in support of his arguments as detailed below:
Ground No.1 - TS-1536-ITAT-2025 CHNY- Ambattur Developers Private Ltd. - 11.11.2025 (copy enclosed as Annexure 1- Please refer paragraphs 9 and 10 on pages 6 to 11 of attached Annexure 1) - FM's speech establishes introduction of section 56(2)(viib) is to curb black money and reduce unaccounted cash flows. From the above speech, it is evident that introduction of section 56(2)(viib) has been grouped with other amendments all of which have been brought in with the main purpose to identify and curb transactions with unaccounted monies. It is evident that the provision was not meant to disturb genuine, bona fide business transactions but to curb tax abuse through unexplained money inflows. In the instant case, neither the AO nor the Id. CIT(A) have held or alleged that unaccounted money has been introduced by the Assessee. In fact, their only case is that the figures adopted for the purpose of valuation is not acceptable to them. The major subscriber to the shares is the holding company Ambattur Clothing Limited. The present investment seems to have been accounted in the books of the holding company as well as the Non- residents and it is out of their accounted resources and funds were transferred through banking channels. Further neither of the lower authorities have doubted the source of the investment and as such they cannot kinder the genuine and bona fide business transactions. Therefore, in the absence of this primary criteria (Le investment is out of unaccounted money), we feel invocation of section 56(2)(viib) of the Act is against main objective of the said section and hence we hold it is incorrectly invoked.
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Facts in the case of Appellant are identical wherein unsecured loan was taken by the Appellant from its shareholder cum director for INR 2 crs in October 2017/January 2018 and subsequently in February 2018, the Board of the Appellant decided to convert this loan to equity and approved issuance of equity shares to the said Director Shareholder pursuant to which shares were allotted to the said Director/Shareholder in March 2018 at a premium duly backed by valuation undertaken by chartered accountant. The above transaction was subject to section 56(2)(viib) disallowance to extent of premium by the Learned Assessing Officer. In addition to above jurisdictional Chennai Tribunal decision, the Appellant also wishes to rely on following decisions for this ground: In DCTT v. Rankin Infrastructure (P.) Ltd. - [2022] 142 taxmann.com 37 (Mumbai- Trib.) (please refer paper book page number ("PB") 410, paragraph 10], wherein the Tribunal held that Section 56(2)(vib) triggers at the time of receipt of consideration, not at the stage of share allotment. Further, in ACIT v. Diach Chemicals & Pigments Pvt. Ltd. (ITA No. 546/Kol/2017) (Please refer PB page 435, paragraph 4 and page 438 paragraph 13), the Tribunal reiterated that taxability under Section 56(2)(viib) must be examined in the year in which the consideration is received, and the FMV has to be determined with reference to that point in time. Ground no 2 • The DCF method used by the Appellant is one of the prescribed and permissible valuation methods under Rule 11UA, based on reasonable future projections. • Actual results need not match projected financials, as estimates inherently involve assumptions. The AO erred in rejecting the valuation solely due to differences between projections and actual performance, without identifying any flaw in the method or assumptions. • In fact, the negative EPS as per books as alleged by the Learned AO was also duly factored by the Chartered Accountant in the projections as is evidenced by the valuation workings found on page 33 of the PB. The CA in her projection has clearly indicated that out of the 6 years projections, the first 3 years (ie, FY 2016- 17, FY 2017-18 and FY 2018-19) as having negative cash flows/EBIDTA. Considering that the valuation was undertaken on September 2017, as per estimates at that point in time, the CA has reasonably and correctly considered that the negative margins will persist for next 3 years and only thereafter the profits will start. Hence, it is submitted that Learned AO's observation that valuation estimates are unimaginative or unreal is incorrect as the projections considered at the time of undertaking valuation were very reasonable in the facts of instant case. Be that as it may, it is humbly submitted that a valuation report cannot be disregarded merely because projections do not match the actuals as held by the following judicial precedents:
:-11-: ITA. No:1848/Chny/2025
Brio Bliss Life Science (P.) Ltd. v. ITO [2023] 149 Taxmann 89 (Chennai Trinunal)/200 ITD 167 dated February 22, 2023-(Please refer PB pages 35, 36, 37 and 42, ie, paragraph 9). It was held that DCF is a valid method under Rule 11UA and projections need not match subsequent actual performance. What matters is fair and reasonable estimation based on information available at the valuation date.
DCIT v. Hometrail Buildtech (P.) Ltd. (Delhi Tribunal) [2023] 155 Taxmann.com 578/204 ITD 154 dated September 15, 2023 (Please refer PB pages 45, 46and 47, ie paragraph 12 and 13) It was held that the AO has no jurisdiction to substitute the method of valuation when DCF is chosen by the assessee. DCF is projection-based, and values must be judged only using assumptions prevailing at the valuation date, not hindsight.
3. Autope Payment Solutions (P.) Ltd. v. ACIT (ITA No 86/Del/2023) dated December 20, 2024-Please refer PB page 339, paragraph 13) Courts reiterated that valuation is a technical exercise involving multiple imponderables and cannot achieve mathematical accuracy. Therefore, valuation is best left to expert judgement.
VBHC Value Homes Pvt. Ltd. v. ITO (Bangalore ITAT) - Please refer PB page 58, paragraph 14) The AO may scrutinize the valuation but cannot change the DCF method chosen by the assessee. Scrutiny must rely only on information available on the valuation date, not later actual results.
SEBI & Ors. v. (Bombay High Court, 2015, ABR 291)-(Please refer page 133, paragraph 32 The Court held that valuation is not an exact science and cannot be tested with arithmetic precision. Projections made at the valuation date cannot be challenged later merely because actual results differ.
Cinestaan Entertainment (P.) Ltd. v. ITO (2919) 106 Taxmann.com - (Please refer PB page 112 and paras 30 to 36) The Tribunal held that valuation inherently depends on assumptions that may change over time, so a value relevant today may not remain relevant later. Hence, projections cannot be judged using hindsight.
Vodafone M-Pesa Ltd. v. DCTT (Mumbai ITAT, 2019)-(Please refer PB page 370, paragraph 33) The Tribunal emphasized that DCF is inherently projection-based, and deviations between projections and actual performance cannot invalidate valuation. Valuation must be judged as on the valuation date, using reasonable forecasts and available information at that time.
M/s Flutura Business Solutions Pvt. Ltd. v. ITO (ITAT Bangalore, 2020) - (Please refer PB page 326, paragraphs 21 and 22)
:-12-: ITA. No:1848/Chny/2025
The Tribunal clarified that valuation must be based on expected revenues and projected cash flows available at the valuation date, later-year actual results cannot be considered. The AO may re-examine valuation but must retain DCF, rely on valuation-date data, and the assessee must justify projections with empirical or industry data Ground no 3 The Assessing Officer erred in rejecting the Chartered Accountant's valuation report on the incorrect premise that only a merchant banker could issue it. Under Rule 11U (as applicable prior to 24-05-2018), the term "accountant" expressly included a Chartered Accountant, and therefore a CA was fully authorised to determine FMV under Rule 11UA. The appellant's valuation report is dated 19- 09-2017, when CA-issued valuations were valid. Further, as per Bangalore ITAT decision in Shambhu Atmaram Pai Panandiker v. DCIT (PB Page no 347, paragraph 9(ii)), CAs were permitted to determine FMV of unquoted shares until 24-05-2018. Thus, the respondent's objection is factually incorrect, and the CA- issued valuation in the appellant's case is fully valid. Also, copy of CBDT Notification No 23/2018/F No 370142/5/2018-TPL dated May 24, 2018 is also enclosed as Annexure 2. Ground no 4 The CIT(A), in para 5.5 of the order u/s 250, observed that the assessee had not furnished the P&L account, balance sheet, bank statements, or supporting documents relating to the Rs.2,00,00,000 loan during appellate proceedings. The Appellant submits all requisite documents, including the P&L (PB 299), balance sheet (PB 298), bank statement (PB 304), unsecured loan ledger reflecting conversion (PB 303), and board resolution approving loan conversion (PB 313). These were not filed earlier as such details were not required during the CIT(A) proceedings, as evidenced at PB pages 444, 448, and 452. Ground no 5 The learned AO has further failed to counter the valuation report by a substitute valuation and has instead rejected the valuation without any basis. In this regard, the AR of the Appellant has relied on the decision of Delhi Tribunal in the case of Savagenic E-Marketing Pvt Ltd vs ITO (ITA No 3847/DEL/2024 (copy enclosed as Annexure 3), wherein has been held that "It is not legally permissible for the AO to reject the valuation adopted by the Assessee on the basis of DCF method without pinpointing any specific inaccuracies or short comings in the DCF valuation report" by relying on Delhi High Court decision in Cinestaan Entertainment. Please refer paragraphs 15 and 16 on pages 6 to 8 of Annexure 3. Reliance is also placed on following decisions for this ground. a. Mantram Commodities Pvt. Ltd. v. ITO (ITAT Chandigarh, 2021)-(Please refer PB pages 335 and 336, paragraphs 16 and 17) Where the assessee has applied a recognized valuation method and the AO has found no specific defect, additions based purely on assumptions or comparisons with actuals are unsustainable. The ITAT accordingly deleted the addition made under Section 56(2)(viib).
:-13-: ITA. No:1848/Chny/2025 b. DCIT v. Phenix Procon Pvt. Ltd. (ITAT Ahmedabad, 2024) (Please refer PB page 388, paragraph 10) The ITAT held that when the assessee follows a recognized and prescribed method and the Revenue cannot show a demonstrably wrong approach, the AO cannot interfere with the valuer's conclusions. Since the AO made no verification of projected figures and the valuation followed Rule 11UA(2), deletion of the addition was upheld.
Per contra the ld.DR for the revenue relied on the orders of the Assessing Officer and ld.CIT(A) and prayed for dismissing the appeal of the assessee. The ld.DR submitted a written submission as detailed below:
1. Applicability of Section 56(2) (viib) to Conversion of Unsecured Loan into Equity Shares (Addressing Grounds 1 & 2)
Section 56(2)(vib) provides that where a private company receives consideration for the issue of shares exceeding the face value, the excess over the FMV is taxable as income from other sources. The provision uses the term "issue of shares," which is exhaustive and covers all forms, including conversion of loans into equity. No restriction excludes conversions; it applies to any receipt of consideration exceeding FMV.
In the present case, the conversion of the unsecured loan into equity shares constitutes "consideration" for the issue of shares, attracting the provision. This view is supported by judicial precedents:
In Parasmani Gems Pvt. Ltd. v. DCIT (ITAT Ahmedabad, dated 21.11.2024), the ITAT held that section 56(2) (viib) applies to the conversion of loans into share capital, as it involves consideration for share issuance.
The Respondent is aware of the contrary view in Pr. CIT v. L.A. Hydro Energy (P) Ltd. (Himachal Pradesh High Court, of 2023, dated 31.05.2024), where it was held that conversion does not involve "receipt" of consideration under section 56(2)(viib), as it is merely a book entry without fresh inflow.
However, this decision is distinguishable on facts (involving inter-company adjustments) and not binding on this Tribunal. Moreover, it overlooks the broad scope of "consideration" in the provision. The Respondent urges reliance on ITAT precedents favouring applicability.
2. Rejection of DCF Valuation Report - Invalidity Due to Non-Compliance with Rule 11UA (Addressing Grounds 4, 5 & 6)
Rule 11UA(2)(b) (pre-amendment) mandates that for determining FMV of unquoted equity shares using the DCF method under section 56(2)(vib), the valuation must
:-14-: ITA. No:1848/Chny/2025 be conducted by a "merchant banker." The Appellant obtained the report from a CA, not a merchant banker.
The amendment to Rule 11UA(2)(b) allowing "merchant banker or an accountant (including CA) for DCF valuations was effective from 24.05.2018 (Notification No. 23/2018). The Appellant's valuation report is dated 19.09.2017, pre-amendment, rendering it invalid.
The Appellant's reliance on the definition of "accountant" under Rule 11U (including CA) is misplaced, as it does not override the specific requirement in Rule 11UA(2)(b) pre-amendment. The AO correctly rejected the report, though reference to Rule 11UA(1)(c)(c) (for securities other than equity) was inadvertent; the substance of rejection holds for equity shares. Precedents holding that tax authorities cannot question expert valuations assume a valid expert here, the valuer was not qualified under the rules.
3. DCF Projections Unrealistic and Not Substantiated (Addressing Grounds 3 & 7)
Even assuming arguendo the report's validity, the DCF method relies on projected cash flows, which must be reasonable and substantiated. The AO compared projections with actual financials (available up to AY 2020-21) and found significant mismatches:
Projected Revenue (FY 2017-18): Rs. 17.30.64.101: Actual: Much lower (leading to losses).
Projected PВТ РАТ: Positive growth assumed; Actual: Consistent losses (e.g., Rs.(-4,51,80,389/- in AY 2018-19).
Such discrepancies render the projections imaginative and unreliable. Courts have The Appellant's argument that projections (estimates) cannot be compared to actuals is untenable, post-facto actuals are a valid tool to test reasonableness, as held in DCIT: Flutura Business Solutions Pvt. Ltd. (ITAT Bangalore, 22 The AO was not required to provide a substitute valuation; upon rejection, the FMV defaults to a nominal value (face value here), justifying the addition. Contrary precedents (e.g., AO cannot tinker with method) apply where valuations are valid and substantiated - not here.”
We have heard the rival contentions perused the material available on record and gone through the orders of the authorities along with the paper book filed. The assessee is a private limited company engaged in the business of education services. For the relevant assessment year, the assessee filed its return of income declaring a loss of Rs.(-)1,71,13,413/-. During the previous year, the assessee had received unsecured loans aggregating to :-15-: ITA. No:1848/Chny/2025 Rs.2,00,00,000/- from one of its directors on different dates between October 2017 and January 2018. Subsequently, pursuant to a Board Resolution dated 23.02.2018, the said loan was converted into 6,359 equity shares of Rs.10 each at a premium of Rs.3,135.15 per share. The fair market value (FMV) of the shares was determined at Rs.3,147.85 per share on the basis of a valuation report dated 19.09.2017 issued by an independent Chartered Accountant adopting the Discounted Cash Flow (DCF) method.
The AO rejected the valuation report on two principal grounds: first, that section 56(2)(viib) of the Act is applicable even in cases of conversion of loan into equity shares; and secondly, that as per Rule 11UA as it stood prior to amendment dated 24.05.2018, DCF valuation was required to be carried out by a merchant banker and not by a Chartered Accountant. The Assessing Officer further held that the projections adopted in the DCF report were unrealistic when compared with the actual financial performance of subsequent years and, accordingly, treated the entire share premium of Rs.1,99,36,410/- as income u/s.56(2)(viib) of the Act. The ld. CIT(A) confirmed the addition.
The first question for consideration is whether section 56(2)(viib) of the Act is attracted in the facts of the present case. Section 56(2)(viib) applies where a closely held company “receives… any consideration for issue of shares” exceeding FMV. In the present case, no fresh consideration was received during the year of allotment. What occurred was conversion of an existing debt into equity pursuant to a Board resolution. We note that there was no inflow of funds contemporaneous with issuance of shares. The transaction, therefore, partakes the character of conversion of debt into equity and not receipt of fresh consideration in the year of allotment.
The Hon’ble Himachal Pradesh High Court in L.A. Hydro Energy (P) Ltd. has held that conversion of loan into equity does not amount to receipt of consideration within the meaning of section 56(2)(viib) of the Act, as it is merely
:-16-: ITA. No:1848/Chny/2025 an accounting adjustment without fresh inflow of funds. Similar view has been expressed by the Mumbai Bench of the Tribunal in Rankin Infrastructure (P.) Ltd., wherein it was held that the triggering event under section 56(2)(viib) of the Act is the receipt of consideration and not the mere allotment of shares. Respectfully following the ratio laid down in the aforesaid decisions, we hold that in the absence of fresh receipt of consideration at the time of issue of shares, the provisions of section 56(2)(viib) of the Act are not attracted to the impugned transaction.
The essence of section 56(2)(viib) of the Act is to tax unaccounted premium introduced in garb of share capital. In the present case, we find that the identity of the director, genuineness of the loan, and source of funds are undisputed. Therefore, the transaction is a mere conversion of liability into equity. Accordingly, we hold that in absence of fresh receipt of consideration during the year of issue, the provisions of section 56(2)(viib) of the Act are not attracted.
Even otherwise, we proceed to examine the rejection of valuation. The Rule 11UA(2) gives option to the assessee to adopt either NAV method or DCF method. The Hon’ble Delhi Tribunal in Cinestaan Entertainment (P.) Ltd. v. ITO held that once the assessee opts for DCF method, the Assessing Officer cannot substitute it with another method. The said view was affirmed by the Hon’ble Delhi High Court in Pr. CIT v. Cinestaan Entertainment (P.) Ltd.. Similarly, in Agra Portfolio (P.) Ltd. v. PCIT, it was reiterated that the Assessing Officer may scrutinize the valuation but cannot adopt a different methodology. In the present case, we find that the AO rejected the DCF method and effectively reduced FMV to face value without carrying out any alternate DCF computation. Therefore, such action is contrary to settled law.
The DCF valuation is based on future projections as available on valuation date. The AO compared projected figures with actual results of :-17-: ITA. No:1848/Chny/2025 subsequent years and held projections to be unrealistic. It is well settled that valuation cannot be tested with benefit of hindsight. The Hon’ble Bombay High Court in Securities and Exchange Board of India v. Pan Asia Advisors Ltd. observed that valuation is not an exact science and projections cannot be rejected merely because actual results differ. Similarly, coordinate benches have consistently held that subsequent performance cannot invalidate projections unless mala fides or perversity are demonstrated. In the present case, the assessee has demonstrated that the valuer had factored negative cash flows in the initial years and had adopted a cost of equity consistent with prevailing economic conditions. The Assessing Officer has not pointed out any specific infirmity in the computation of free cash flows, discounting factor, or terminal value. No independent valuation was obtained, nor were the assumptions shown to be perverse or contrary to industry norms. The rejection of the valuation is thus based solely on comparison with actual results, which amounts to adopting a hindsight view and is impermissible in law.
The next issue is that the AO held that prior to amendment dated 24.05.2018, DCF valuation must be done by merchant banker. We note that Rule 11U defines “accountant” to include a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949. The valuation report in present case was prepared by an independent Chartered Accountant. Further, the amendment permitting accountant to carry out DCF valuation is procedural and clarificatory in nature. In any event, once valuation report is placed on record and is not shown to be fundamentally flawed, mere technical objection cannot justify rejection.
We further note that the purpose of section 56(2)(viib) of the Act is to curb introduction of unaccounted money in guise of share premium. It is not meant to sit in judgment over commercial wisdom of promoters investing their own funds. The director’s loan was converted into equity. The identity, creditworthiness, and genuineness are not in dispute. It is further noted that the :-18-: ITA. No:1848/Chny/2025 source of funds has not been doubted. The loan was received from a director through banking channels and there is no allegation of introduction of unaccounted money. We also find that the premium is supported by DCF valuation and on the contrary no independent valuation was conducted by AO. In absence of finding that valuation was sham, perverse, or demonstrably erroneous, rejection of expert report is unsustainable.
In view of the foregoing discussion, we find that the conversion of unsecured loan into equity shares does not constitute receipt of consideration within meaning of section 56(2)(viib) of the Act. The Assessing Officer cannot substitute or discard the DCF method chosen by the assessee without undertaking a proper valuation under the same method. Therefore, the comparison of projections with actuals is legally untenable and hence the addition of Rs.1,99,36,410/- is liable to be deleted. Accordingly, the order of the Ld.CIT(A) is set aside and direct the Assessing Officer to delete the impugned addition by allowing the grounds of appeal of the assessee.
In the result the appeal of the assessee is allowed.
Order pronounced in the open court on 17th February, 2026 at Chennai.