MADHURIMA INTERNATIONAL P. LTD,MUMBAI vs. PR CIT 3, MUMBAI

सुनवाई क" तार"ख /Date of Hearing : 05-04-2017 घोषणा क" तार"ख /Date of Pronouncement : 28-04-2017 आदेश / O R D E R

PER RAMIT KOCHAR, Accountant Member

2. The grounds of appeal raised by the assessee in the memo of appeal filed with the Income-Tax Appellate Tribunal, Mumbai (hereinafter called “the tribunal”) read as under:-

ITA 421/Mum/2017 2 “1. On the facts and circumstances of the case and in law, the Principal Commissioner Income-tax - 3, Mumbai ("the Pr.CIT") erred in assuming jurisdiction under section 263 and holding the assessment order, under section 143(3) of the Income-tax Act, 1961 ("hereinafter referred to as "the Act") dated 23.03.2016 (hereinafter referred to as "the assessment order"), as erroneous and prejudicial to the interest of the Revenue. The reasons given by him for doing so are wrong, contrary to the facts of the case and against the provisions of law;

4. The Pr.CIT erred in holding the issue price of non- cumulative compulsorily convertible preference shares adopted basis a valuation report of an independent valuer as exorbitant on reasons purely in the realm of conjectures / surmises without appreciating that the same is in accordance with provisions of the Act;

5. The above grounds/sub-grounds are without prejudice to each other.”

3. This appeal has arisen out of the order u/s 263 of the Act dated 08-12- 2016 passed by the learned Pr. CIT. The ld. Pr. CIT observed that the assessment u/s 143(3) of the Act in the instant case was completed on 23rd March, 2016, wherein addition of Rs. 3,72,613/- was made by the learned Assessing Officer(hereinafter called “the AO”) on account of disallowance u/s 14A of the 1961 Act, vide assessment order dated 23-03-2016 passed u/s 143(3) of the 1961 Act. The ld. Pr. CIT observed from the assessment records that the said assessment order dated 23-03-2016 passed by the AO u/s ITA 421/Mum/2017 3 143(3) of 1961 Act appears to be erroneous in so far as it is prejudicial to the interest of Revenue u/s 263 of the 1961 Act, hence, show cause notice(SCN) dated 06-09-2016 u/s 263 of the 1961 Act was issued by learned Pr. CIT to the assessee. The relevant part of the said notice is as under:-

“On verification, certain discrepancies were found in the assessment order dated 29.11.2013, which is as under:

During the year under consideration, the assessee has issued 6 lakhs preference shares of Rs. 10 each issued at a premium of Rs. 240/- per share. During this year, the provision of section 56(2)(viib) are applicable as 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, the difference is to be taxed as income.

The fair market value can be book value or value as per discounted cash flow method. Book value as per balance sheet comes to less than Rs. 100/- per share whereas value as DCF method was worked out at Rs. 250/- per share. In this regard, a report of valuation was submitted by the assessee during assessment proceedings. On going through this report, it is seen that accountant has taken future cash flow as certified by the management. No verification of projections and assumptions adopted by management was made CA, thereby making the report as per the requirement of the management. In DCF method, future free cash flow is the most relevant variable which can change the value to any extent. Free cash flow in financial year ending 31.03.2012 was not even Rs. 1 crore. But in the report of the CA dated 25.10.2012 future cash flows for next 5 years were estimated at Rs. 5.30 crores, Rs. 43.01 crores, Rs. 6.67 crores, Rs.9.41 crores and 223.46 crores. Such exorbitant estimated free cash flow was used in valuing shares by DCF method. Therefore, it is clear that valuation made on the basis of unverified exorbitant FCF given by management has given inflated value of shares @ Rs. 250/-. This is not as per recognized DCF method but as per whims & fancy of the management to arrive at higher value to issue shares at huge premium. Considering this the valuation of shares done by CA as per DCF method is not reliable and should have been questioned by the ITA 421/Mum/2017 4 A.O, which was not done. If DCF method is rejected and book value method is taken then there can be addition of more than Rs. 9 crores u/s 56(2)(viib). In view of the above, the assessment order passed u/s.143(3} by the ACIT- 3(2)(1), Mumbai dated 23- 03-2016 appears to be erroneous and prejudicial to the interest of Revenue and it is evident that the Assessing Officer has committed the lapse of not applying his mind to the issues discussed above. I, therefore, propose to pass such order there on as the circumstance of the case justify, including an order enhancing or modifying the assessment, or cancelling the assessment and directing a fresh assessment under the provisions of Section 263.”

The assessee submitted its reply to SCN vide letter dated 21-09-2016 , which is reproduced here-under:-

“The assessee company had filed its return of income for assessment year 2013-14 declaring total come of Rs. 3,00,35,920/- as per normal provisions of the Act and Rs. 3,22,19,738/- as book profit u/ s 115 JB of the Act on 24-09- 2013. Subsequently the assessee revised its return of income on 15-10-2013. During the financial year ended 31-03-2013 relevant to the assessment year under consideration, the assessee company has issued and allotted Non cumulative Compulsory Convertible Preference shares of Rs. 10 each fully paid up at a premium of Rs. 240/- per share after obtaining a valuation report from an independent C.A. M/s V. R. Jain & Co. The funds were to be used for the purpose of investment in 14870000 preference shares (Rs. 10 each) of Entercom Solutions Private Limited amounting to Rs. 148700000/-. The case of the assessee was selected for scrutiny assessment and notice u/s 143{2} dated 3/9/2014 was duly issued and served upon the assessee. In the course of assessment proceedings, the assessing officer on perusing the financials for the relevant year under consideration took note of the aforesaid transaction and raised several queries relating to the same. The A.O. vide notice u/s 142(1) dt. 1.2.2016 amongst other details at point No. 12 specifically asked the assesse to furnish certain details as regards issue of 600000 preference shares. At point No. 13 the A.O. asked the assessee to justify the share premium received on the face value of the shares with complete supporting documents. Further, the A.O. informed the assessee that in the case of the assessee's inability to ITA 421/Mum/2017 5 properly justify the share premium of Rs. 14,40,00,000/- the same would be taxed u/s 56(2)(viib) as income from other source.

The assessee also clarified in his submissions that the share premium is at par with the fair market value and therefore the provisions of section 56(2)(viib) are not attracted.

The assessee vide letter dt. 26-02-2016 explained the basis of estimates/projections adopted in the DCF method in response to a query raised by the AO. on the same.

The AO. vide order dt. 23-03-2016 u/s 143(3) completed assessment after making certain other adjustments. The assessee is now in receipt of your impugned notice seeking to exercise jurisdiction u/s 263 of the Act.

The finding of the commissioner should be on fresh tangible material and after due application of mind pursuant to which the Commissioner must come to a firm conclusion.

AO has conducted detailed enquiry and specifically applied his mind to the issue at hand. Having perused all the relevant details in connection with issue at hand and having taken a view that preference shares are correctly issue at the fair market value, AO completed the scrutiny assessment making no addition on that count. Hence, the exercise of jurisdiction u/s 263 is not warranted.

The preference shares have been issued at Rs. 250/ - per share after obtaining a valuation report from an independent valuer. The valuation has been done based on the DCF method suing reasonable assumptions. The use of such methodology is in line with Rule 11UA.”

The assessee, in support relied upon the decision of the Hon’ble Apex Court in the case of Malabar Industrial Co. Ltd. v. CIT, (2000) 243 ITR 83(SC) to challenge the proceedings u/s 263 of the 1961 Act. The ld. Pr. CIT observed that the amendment made to section 263 of the 1961 Act w.e.f. 1st June, 2015 widens the scope of section 263 of the 1961 Act to include non-conduct ITA 421/Mum/2017 6 of proper enquiries, hence, the decision of the Hon’ble Apex Court relied upon by the assessee is not applicable in the instant case. The ld. Pr. CIT relied upon the decision of Hon’ble Calcutta High Court in the case of Rajmandir Estates (P.) Ltd. v. Pr. CIT (2016) 386 ITR 162( Cal. HC) and also decision of the Kol.-tribunal in the case of Subhalakshmi Vanijya (P.) Ltd. v. CIT, (2015) 155 ITD 171(Kol-trib.) . The ld. Pr. CIT observed that the A.O. conducted exceedingly inadequate enquiry which falls into category of ‘no enquiry’ which resulted in drawing incorrect assumption of facts , makes the orders erroneous in so far as it is prejudicial to the interest of revenue. The ld Pr. CIT observed that there was complete non application of mind by the AO and hence proceedings u/s 263 of the 1961 Act was valid. The ld Pr. CIT observed that the assessee had issued shares at a large share premium which was the main reason for selection of the assessee’s case under CASS as the assessee has issued 6,00,000 preference shares of Rs. 10/- each issued at a premium of Rs. 240/- per share . The ld. Pr. CIT observed that Section 56(2)(viib) of the 1961 Act was introduced to curb black money. The ld. Pr. CIT observed that the assessee had submitted copy of ITR, balance sheet and capital account of shareholders to prove the genuineness of the sources of money and the assessee had also tried to justify the share premium. The ld. Pr. CIT observed that the provisions of section 56(2)(viib) of the 1961 Act are applicable as the aggregate consideration for issuance of shares was more than fair market value of the shares, hence, the difference is to be taxed as income under provisions of Section 56(2)(viib) of the 1961 Act. It was observed that the fair value can be book value or value as per discounted cash flow(DCF) method. It was further observed by the ld. Pr. CIT that the book value as per balance sheet comes to less than Rs. 100/- per share whereas the value of shares as per DCF method worked out at Rs. 250/- per share . The assessee submitted report of valuation dated 15-10-2012 issued by V R Jain & Co., Chartered Accountants wherein fair value of the unquoted non- ITA 421/Mum/2017 7 cumulative compulsory convertible preference shares of the assessee company was computed which, inter-alia, contained the following details:-

Rs. Crores Particulars % Mar 13 Mar 14 Mar Mar 16 Mar 17 15 Free cash flow for equity 5.30 43.01 6.67 9.41 223.46 Discounting factor 15.01 0.93 0.81 0.70 0.61 0.53 Discounting cash flow 4.93 34.79 4.69 5.75 118.80 Aggregate DCF value 168.96 Terminal value 100.13 Total value of company 269.09 No. of shares outstanding 1,07,60,003 Value per share(In Rs.) 250.08 Key assumptions: a. We have not independently verified the projections of the Company. b. We have been informed that there are 10,760,003 shares outstanding on a full diluted basis on the valuation date out of which 60,00,000 are equity shares and 47,60,003 are 10% Non cumulative compulsorily convertible preference shares of Rs. 10/ - each.

It was observed by ld. Pr. CIT from the above report that the free cash flow for equity was estimated arbitrarily wherein the CA who issued valuation report of shares has taken future cash flows as certified by Management and no verification of projections and assumptions adopted by the management were conducted by CA who issued the said valuation report , thereby simply making the report as per the requirement of the management. The ld. Pr. CIT observed that no independent verification has been done by the said C.A. to arrive at fair value of the unquoted non-cumulative compulsory convertible preference shares of the assessee company . The ld Pr. CIT referred to ‘Technical guide on shares valuation’ published by the Institute of Chartered Accountants of India(ICAI) wherein three key factors viz. cash flow projections, discount rate and terminal value for computing DCF were discussed , wherein the ld. Pr. CIT observed that none of the above factors as mandated by ICAI has been considered by the said CA issuing valuation report while computing fair value of the unquoted non-cumulative ITA 421/Mum/2017 8 compulsory convertible preference shares of the assessee company. The ld. Pr. CIT referred to said technical guide on shares valuation issued by ICAI wherein it is stated that the DCF method is as good as input assumptions used for computing Future Cash Flows. It was observed by ld Pr. CIT that the CA issuing valuation report dated 15-10-2012 has merely adopted the values provided by the management clearly ignoring past performance which is self serving as several factors such as performance, growth prospects, earnings capacity , expansion etc. were not considered by the said CA issuing the said valuation report dated 15-10-2012. The ld. Pr. CIT observed that the future cash flows for next 5 years were estimated in the valuation report at Rs. 5.30 crores, Rs. 43.01 crores, Rs. 6.67 crores, Rs. 9.41 crores and Rs. 223.46 crores , whereas the free cash flow for financial year 2011-12 was not even Rs. 1 crore. It was observed by ld. Pr. CIT that valuation has been determined based on unverified exorbitant cash flow given by management which resulted in inflated value of shares @ Rs. 250/- per share. It was observed by ld. Pr. CIT that no scientific method had been employed for determining the valuation of shares which is being done by management as per its whims and fancies to arrive at higher value to issue shares at huge premium which is not reliable and the AO should have questioned the same which was not done by the AO while passing assessment order dated 23-03-2016 u/s 143(3) of the 1961 Act. It was observed that the assessee had tried to justify the DCF method employed by the C.A. in the said valuation report dated 15-10-2012. The assessee submitted that it had issued and allotted 6,00,000 non- cumulative compulsory convertible preference shares of Rs. 10/- each fully paid up at a premium of Rs. 240/- per share after obtaining valuation report from an independent C.A. M/s V.R. Jain & Co . The funds were to be used for the purpose of investment in 1,48,70,000 preference shares of Rs. 10/- ITA 421/Mum/2017 9 each of Entercom Solutions P. Ltd. amounting to Rs. 14,87,00,000/-. It was submitted that valuation of the said preference shares has been done based on DCF method using reasonable assumptions. The use of such methodology is in line with Rule 11UA of Income-tax Rules, 1962. It was submitted that Revenue cannot insist on the usage of the Net Value Method when Rule 11 UA of the 1962 Rules provides assessee an option to adopt DCF method. It was submitted that Net Asset Value method is considered unsuitable after considering the facts and circumstances of the case. It was submitted that DCF method is far superior method as compared to Net asset value method as the said method represents true potential of the company. It was submitted by the assessee that to apply net asset value method is erroneous as it reflect historical cost of assets and liabilities of the company on valuation date and does not reflect the true economic value of shares. The assessee submitted before ld. Pr. CIT that the A.O. has not found any fault in the methodology adopted by the assessee to arrive at fair value of the unquoted non-cumulative compulsory convertible preference shares of the assessee company using DCF method. The assessee submitted that preference shares issued were compulsorily convertible into equity shares and hence derive their value from the underlying equity shares. It was submitted that as per terms of issue of the said preference shares, the same are convertible at a price to be determined by the Board of Directors at the time of conversion and hence at this stage it is premature. Without prejudice, it was submitted that assessee company required Rs 15 crores and if the shares were to be issued at Rs 100 per shares , it would have led to issue of more shares and in any case preference shares were issued to existing preference shareholders in ratio of their shareholding and hence there was no dilution of shareholding.

The ld. Pr. CIT was not satisfied with the reply of the assessee. The ld. Pr. CIT observed that the assessee has not been able to point out justification of ITA 421/Mum/2017 10 application of DCF method with the perspective of ICAI guidelines on valuation of shares nor the assessee has submitted any kind of explanation in respect of the same. It was observed that the assessee has only commented on the superiority of DCF method in preference to net asset value method. The ld. Pr. CIT observed that the assessee has failed to justify the flaws and mistakes/errors pointed out in the said valuation report. The ld. Pr. CIT observed that the assessee has not addressed the issue of share at unjustified large premium in the instant case and the same is hit by provisions of Section 56(2)(viib) of the 1961 Act. Thus, the ld. Pr. CIT set aside the assessment order dated 23-03-2016 passed by the A.O. u/s 143(3) of the 1961 Act with a direction to the A.O. to make fresh assessment after conducting detailed enquiries and detailed verifications of the submissions made. The A.O. was also directed to examine the valuation report dated 15-10-2012 issued by CA M/s V R Jain & Co submitted by the assessee in the light of observation and recommendation as mentioned in the “Technical guide on share valuation” issued by ICAI. The AO was also directed by learned Pr. CIT to examine the valuer w.r.t. valuation report prepared by the said valuer and the AO was directed by ld. Pr. CIT to make fresh assessment as per law, vide order dated 8th December, 2016 passed by learned Pr. CIT u/s 263 of the 1961 Act.

6. The ld. CIT D.R. submitted that the A.O. has completed assessment u/s 143(3) of the 1961 Act on 23rd March, 2016. The case was selected for ITA 421/Mum/2017 13 scrutiny assessment under CASS selection on the grounds that the assessee has received large premium. It is submitted by ld CIT DR that provisions of newly inserted section 56(2)(viib) of the 1961 Act get attracted due to issue of shares at large share premium and hence assessee case was selected under CASS for framing scrutiny assessment u/s 143(3) of the 1961 Act , in order to scrutinize whether the assessee has issued the shares above fair market value of shares on the date of issue of shares. The A.O. has failed to make enquiries which were necessary for the purposes of the assessment in order to see compliance of Section 56(2)(viib) of the 1961 Act. The ld CIT DR stated that section 56(2)(viib) of the 1961 Act was introduced to curb black money and only 2% cases are selected for scrutiny. The learned CIT DR submitted that there is no application of mind by the A.O. while accepting valuation adopted by the valuer in its valuation report dated 15-10-2012, and the said valuer merely relied upon the assumptions of management of the assessee company. It is submitted that it was a complex valuation of preference shares which was not done correctly by the valuer who merely relied upon the management projections without verifying the same. It is submitted that it was the duty of the A.O. to make proper enquiries which AO failed to make. The assessee had issued 6,00,000 preference shares of Rs. 10/- each issued at premium of Rs. 240/- per share which is very high. Section 263 of the 1961 Act was rightly invoked by the ld. Pr. CIT was the contention of ld. CIT DR. The A.O. cannot prejudice the interest of the Revenue. It is submitted that the ld. Pr. CIT was correctly applied the provisions of section 263 of the Act. It is also brought to notice that explanation 2 to Section 263 of the 1961 Act was inserted by Finance Act, 2015 w.e.f. 01-06-2015. The ld. CIT D.R. relied upon the decision of Hon’ble Delhi High Court in the case of CIT v. Ashok Logani (ITA No. 553 of 2010 dated May, 11, 2011). The ld. CIT D.R also relied on the decision of the Tribunal in the case of M/s Crompton Greaves Ltd. v. CIT in & ITA No. 2836/Mum/2014 for A.Y. 2007-08 ITA 421/Mum/2017 14

order dated 1st February, 2016, which was authored by one of us (accountant member).