ITO WARD - 23(1), NEW DELHI vs. SHARP EYE BROADCASTING PVT LTD, NEW DELHI

PER PRADIP KUMAR KEDIA-A.M. : The captioned appeal has been filed by the Revenue against the order of the Commissioner of Income Tax (Appeals)-VIII, New Delhi (‘CIT(A)’ in short) dated 28.01.2020 arising from the assessment order dated 28.12.2018 passed by the Assessing Officer (AO) under Section 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2016-17.

1961.” 3. Briefly stated, the assessee-company is engaged in the business of broadcasting and telecast of Television channel. The assessee filed return of income declaring total income at Rs.2,32,560/- for the Assessment Year 2016-17 in question. The return filed by the assessee was subjected to scrutiny assessment under Section 143(3) of the Act.

3.1 In the course of the assessment proceedings, the Assessing Officer inter alia observed that the assessee has issued 4,90,000 no. fresh equity shares of Rs.10/- each totaling to Rs.49 lakh at a premium of Rs.4,50,80,000/- thereon @ Rs.92 per share. The equity share of the company was thus issued and subscribed at Rs.102/- per share. The Assessing Officer further observed that ‘Fair Market Value’ (FMV) of the equity shares of the company stands at Rs.17.18 per share and consequently the excess consideration received on issue of equity shares is susceptible to tax under Section 56(2)(viib) of the Act.

3.2 On being confronted, the assessee furnished a valuation report with effective date of valuation being 01.03.2016 wherein the FMV per share was assigned at Rs.102 per share by following Discounted Cash Flow (DCF) Method. The Assessing Officer however cast shadow on the propriety of FMV determined as per the valuation arrived in the valuation report and held such valuation to be unsustainable. The Assessing Officer observed that valuation report did not assume correct parameters and the FMV determined are based on projected cash flow which are highly exaggerated and divorced of ground realities. The Assessing Officer observed that as per parameters taken in the valuation report, the business of the assessee was expected to achieve certain level of growth in revenue and potential profits in the ensuing years but however on actual facts, the assessee-company has not even achieved 1% of the projections assumed in the valuation report. The projections relied upon the valuation report were thus illusory only to make it suitable enough to plough back own money of assessee in the coffers of the assessee-company through the medium of subscription at grossly unreasonable and excessive high premium.

3.3 The Assessing Officer thus questioned the authenticity of the projected figures and the genuineness of the valuation arrived. Having regard to intent and purpose of Section 56(2)(viib), the Assessing Officer held that the assessee has failed in the justification of the FMV so determined for the purposes of subscription. In the absence of any rational basis for adopting the projected figures, the Assessing Officer discarded the FMV reported by the assessee and determined the FMV per share at Rs.17.18 per share on the basis of NAV recognized in Rule 11UA of the Income Tax Rules, 1962. The excess premium charged over fair valuation of Rs.17.18 per share was thus determined at Rs.4,15,61,800/- on the contours of deeming fiction of Section 56(2)(viib) of the Act. The taxable income was thus enhanced by the aforesaid amount.

3.4 The income was thus assessed at Rs.4,17,94,360/-.

“4. DECISION: The contention of the Appellant has been considered and the order of AO has also been perused. 4.1 Section 56(2)(viib) of the Act, reads 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:" Similarly Rule 11UA (2), reads as follows: -

"(2) Notwithstanding anything contained in sub-clause (b) of clause (c) of sub-rule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:- (a) the fair market value of unquoted equity shares = (A-L) X (PV), (PE) where, A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance- sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset; L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:- (i) the paid-up capital in respect of equity shares; (ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; (iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation; (iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities; (vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares; PE = total amount of paid up equity share capital as shown the balance- sheet; PV = the paid up value of such equity shares; or (b) the fair market value of the unquoted equity share determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.] 4.2 Reference is also drawn to the relevant extract of Technical guide o mare valuation (issued in 2009) by research committee of the Institute of Chartered Accountants of India (ICAI) which further clarifies the concept riving at valuations, which has been reproduced as under: "1.1 The valuation of the shares of a company involves use of judgement, experience and knowledge. The accountant undertaking this work should possess knowledge the analysis and interpretation of financial statements backed by a practice appreciation of business affairs and investments. A valuation based on quantitative information alone will not be adequate for a real valuation. It should also recognized that the method of valuation of shares would vary, depending on purpose for which it is to be used. 1.2 A clear understanding of the purpose of valuation is undoubtedly important, an equally important imperative is to have a full appreciation of the 'value” emanating from common principles. This 'general purpose value’ may be suitably modified the special purpose for which the valuation is done. The factors affecting that value with reference to the special purpose must be judged and brought into assessment in a sound arid reasonable manner. 1.4 Valuation, being a complex subject, is limited to experts and is surrounded by a number of myths. Some of the very common generalities about valuation are discussed below: (b) Valuation is riddled with a commonplace notion that a detailed valuation exercise will provide a precise estimate of value. The truth is that any valuation is as good as its underlying assumptions, which, in turn, are the function of a number of present arid forward-looking factors. A careful valuation exercise, at best, can give an indicative range of value subject to the reasonableness of the assumptions. (c) Valuation is pertinent to a particular point of time and varies with changes in business, industry and macroeconomic environment. E.g., the movement of US Dollar against Indian Rupee has led to a substantial change in the valuation of IT and other export-driven companies. 2.1 The potential earning power of a company is generally a paramount factor for valuation of share but there may be occasions, especially in valuations for compensation, where other considerations become relatively more important. In the absence of any other special motive, an investor is principally interested in a company's ability to continue earning profits 2.4 The Income Approach indicates the value of a business based on the value of the cash flows that a business is expected to generate in future. This approach is appropriate in most going concern situations as the worth of a business is generally a function of its ability to earn flow and to provide an appropriate return on investment.

2.5 The Income approach includes a number of models/techniques, such as Discounted Cash Flow, Maintainable Profits Basis, Dividend Discount Model, and others, which are discussed in detail in the following paragraphs. 2.6 Discounted Cash Flow model indicates the fair market value of a business based on the value of cash flows that the business is expected to generate in future. This method involves the estimation of post-tax cash flows for the projected period, after taking into account the business's requirement of reinvestment in terms of capital expenditure and incremental working capital. These cash flows are then discounted at a cost of capital that reflects the risks of the business and the capital structure of the entity. 2.7 Discounted Cash Flow is the most commonly used valuation technique, and is widely accepted by valuers because of its intrinsic merits, some of which are given below: (a) Theoretically, it is a very sound model because it is based upon expected future cash flows of a company that will determine an investor's actual return. (b) It is based on expectations of performance specific to the business, and is not influenced by short-term market conditions or noneconomic indicators. (c) It is not as vulnerable to accounting conventions like depreciation, inventory valuation in comparison with the other techniques/approaches since it is based on cash flows rather than accounting profits. (d) It is appropriate for valuing green-field or start-up projects, as these projects have little or no asset base or earnings which render the net asset or multiple approaches inappropriate. However, it is important that valuation must recognise the additional risks in such a case (e.g. project execution risk, lack of past track record, etc.) by using an appropriate discount rate. 2.8 Though the Discounted Cash Flow model is one of the widely used models for valuation because of its inherent benefits, it still has its share of drawbacks Major shortcomings of this model are as follows: (a) It is only as good as its input assumptions. Following the "garbage in, garbage out" principle, if the inputs-Cash Flow Projections, Discount Rate, and Terminal Value-are wide off the mark, then the value generated by using this model does not reflect the fair value. (b) It does not take into account several other factors, such as investment risk associated with opportunity cost, i.e. investments that could return greater cash flow yields would add an unrealised element of risk, unforeseen variations in future cash flow, and other non-financial factors.

4.3 Thus, from reading of the said provision, rules and the technical guide, t is clear that the AO has worked out the value based on NAV method and wanted to impose upon the method of valuation of their own choice, completely disregarding the legislative intent which has given an option to the assessee to any one of the two methods of valuation of his Choice. When the law has specifically provided a method of valuation and the assessee exercised an option by choosing a particular method (DCF here), changing the method or adopting a different method was not justified. That would make the clause (b) of Rule 11UA(2) as nugatory and purposeless, which is not the intent of the legislatures. Further, though the AO can scrutinize the valuation report, he may make necessary adjustments. But when an option has been exercised, then same cannot be discarded to impose other option. The AO may also suggest some modifications and alterations provided the same are based on sound reasoning and rational basis. 4.4 Before examining the fairness or reasonableness of valuation report submitted by the assessee, it has to be kept in mind that the DCF Method is essentially based on the projections (estimations) only and hence these projections cannot be compared with the actual to expect the same figures as were projected. The valuer has to make forecasts on the basis of sound reasons and prevailing micro and macro factors affecting the business. In present case, the Management had applied for permission to uplink "Popcorn TV" Channel (Non-News & Current Affairs Category) on 20th January 2016. The business sector in which the Company was planning to expand is a growing sector even in the present date and have a massive potential to generate returns for its stakeholders. As cited above, that the Company had applied for the license and based on the view that the license will be allotted, projections were estimated and valuation of shares were undertaken in the valuation report. 4.5 In course of appellate proceedings, various arguments were made by the learned AR of the appellant. She was asked to explain that as per the details available on page 2 of the paper book, during F.Y. 2016-17 & F.Y. 2017-18, the projected revenue was Rs 350 Lakhs and Rs 650 Lakhs respectively whereas the actual revenue was observed as at Rs 1.9 Lakhs. and Rs 184 Lakhs and under this factual position, how the projections of 85% & 30% increase in turnover can be accepted. In reply, learned AR of the assessee made various arguments that the projections assumed in the valuation report were based on the assumption that the "Popcorn TV" channel will be allotted. Unfortunately, the license was rejected and therefore the actuals are not in line with the projections. The AR of the assessee highlighted Note no 6 of the audited financials of F.Y. 2015-16 that the assessee had invested Rs 200 Lakhs in recording studio out of the proceeds of the issue of shares. The AR also represented that the assessee at the present date has again applied for a fresh license before the authorities. The AR of the assessee represented that had it been the case of a mala fide transaction, the assessee would not have applied again or have used the proceeds towards other business activities. 4.6 The Ld. AR of the appellant referred to the ITAT Delhi decision in the case of India Today Online Pvt. Ltd vs. Income Tax Officer in & 6454 Del 2018 dated 15-03-2019 reported in [2019] 104 taxmann.com 385 (Delhi Trib.)/[2019] 176 ITD 459 (Delhi Trib.) wherein it was held - that - "3.1 One of the cardinal principles of interpretation of fiscal statute is that they should be strictly construed and so long as the provision is free from any ambiguity, there should be no need to draw any analogy. A deeming provision on the other hand is intended to enlarge the meaning of a particular word which includes matters which otherwise may or may not fall within the normal provision, therefore, it should be extended to the consequences and incidents which has been intended by the Legislature for a definite purpose and should not be extended beyond the mandate of the statute. Thus, deeming provisions require to be construed strictly. Here in this case the assessee has followed one of the options provided under such deeming provision and when such an option has been exercised, then same cannot be discarded to impose other option. The assessee's option has been rejected by the Ld. CIT(A) on the ground it does not stand the test of one of option, which he deems fit. Not only that valuation method adopted by the assessee to value its underlying asset, that is, Mail Today shares has been rejected on the ground that DCF method applied is not correct. DCF method is a recognised method where future projections of various factors by applying hindsight view and it cannot be matched with actual performance, and what Ld. CIT(A) is trying to do is to evaluate from the actual to show that the Company was running into losses, therefore, DCF is not correct. Valuation under DCF is not exact science and can never be done with arithmetic precision, hence the valuation by a Valuer has to be accepted unless, specific discrepancy in the figures and factors taken are found. Then AO or CIT (A) may refer to the Valuer to examine the same." 4.7 The Ld. AR of the appellant also represented that the most critical input DCF model is the Cash Flow Projections and if the valuation report is prepared with reasonable certainty by showing that the reliable estimates are achievable with reasonable certainty on the basis of facts available on the date of valuation and actual result of future cannot be a basis of saying that estimates of the management are not reasonable and reliable. The learned AR of the assessee also represented that the estimates are clearly within the industry norms and are practically achievable and therefore, the projection of growth of 85% and 30% is justified. The cash flow projections certified by the management were mere projections/estimations depending on various factors which nobody could have anticipated or foreseen on the when such valuations were made. Therefore, there was no justification to make a comparison of the estimations with the actuals. Such a comparison is otherwise principally against the contemplation of Rule 11UA (b). 4.8 As per various tribunal orders cited by AR of assessee, it was held that per Rule 11UA(2), assessee could opt for DCF method and if assessee had opted for DCF method, AO could not discard the same and adopt other method i.e. NAV method of valuing shares. In case of M/s. Rameshwaram Strong Glass (P) Ltd. vs. The ITO [2018] 172 ITD 571 (Jaipur – Trib.), the tribunal had reproduced relevant portion of another tribunal order ordered in case of ITO vs. M/s Universal Polypack (India) Pvt. Ltd. In such case, tribunal held that if assessee had opted for DCF method, AO could not challenge the same but AO was well within his rights to examine methodology adopted by assessee and underlying assumptions and if he was not satisfied, he could challenge the same and suggest necessary modifications/alterations provided same were based on sound reasoning and rationale basis. In same tribunal order, a judgment of Bombay High Court was also taken note of having been rendered in case of Vodafone M-Pesa Ltd vs. PCIT. The projections should be based on reasonable expectations after considering macro and micro economic factors affecting the business and the same principle was followed by the management of the Company Reliance was also placed in case of M/s. INNOVITI PAYMENT SOLUTIONS PVT. LTD vs. The ITO,[2019] 102 taxmann.com 59 (Bangalore Trib.), the tribunal in para 12 has held that "the AO can scrutinize the valuation report and the if the AO is no satisfied with the explanation of the assessee, he has to record the reasons and basis for not accepting the valuation report submitted by the assessee and only thereafter, he can go for own valuation or to obtain the fresh valuation report from an independent valuer and confront the same to 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 result of future cannot be a basis to decide about reliability of the projections." 4.9 The AO though observed that the valuation report is submitted with a disclaimer but it is not a valid reason which will affect the correctness of the valuation so considered. Therefore, such observations are not relevant and a mere suspicion. It appears that the AO has ignored the Explanation (a) below S. 56(2)(viib). The said explanation provides that 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 i.e. u/r 11UA; 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 asset being goodwill, know-how, patents, copyrights, trademarks, licenses franchises or any other business or commercial rights of similar nature whichever is higher. Moreover, it is only the Explanation (a)(ii) speaks o the satisfaction of the AO but there appears no such condition in the Explanation (a)(i) which therefore AO shouldn't interfere in the valuation once done in accordance with the method prescribed in the Rule 11UA(2). 4.10 For these reasons, I find no justifications behind the objection of the Assessing Officer that the valuation submitted by the assessee was absolutely baseless and exaggerated or without any basis. The valuer at the time of valuation in all aspects considered the economic benefit arising out of the application and allotment of TV channel and incorporated the same in his report.”

Order pronounced in the open Court on 20/11/2023