2017 (5) TMI 58 - AT - Income Tax

Revision u/s 263 - AO has failed to make necessary enquiries as to justification for issue of non cumulative compulsory convertible preference shares of ₹ 10/- each fully paid up at a premium of ₹ 240/- per share - manner of computing fair value of shares for the purposes of Section 56(2)(viib) - Held that - There are certain flash points which should have triggered further probe by the AO as to the valuation report dated 15-10-2012 furnished by the assessee as the assessee did not issued equity shares during the relevant previous year but instead issued 10% non cumulative compulsory convertible preference shares of ₹ 10/- each fully paid up issued at a premium of ₹ 240/- per share which are convertible into 1 equity share for every preference share held by the allottee or at such higher ratio of conversion at the end of the tenure of 10 years as may be decided by Board of Directors of the assessee company. These shares are also convertible at the option of allottee after three years at the conversion ratio to be decided by Board of Directors of the assessee company and assumption of the said CA V R Jain & Company who issued valuation report dated 15-10-2012 in assuming and presuming that each non cumulative compulsory convertible preference shares shall be converted into one equity share of the assessee company needed enquiry by the AO vis- -vis its implication in computing income as contemplated u/s 56(2)(viib) of 1961 Act and any discounting factor is to be used in this regard. Further, the shares issued by the assessee were preference shares and not equity shares albeit preference shares are compulsorily convertible into equity shares. The AO should have also looked into this aspect that Rule 11UA(1)(c)(c) of 1962 Rules stipulates that in case of issue of shares other than equity shares , the Rule mandate valuation as per following method (c) the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. The AO should have enquired into this aspect that convertible preference shares were issued which were although convertible into equity shares after a certain period but did the law equate the same to be equity shares for the purposes of valuation of shares as mandated under the provisions of statute and rules made there-under. Further , the AO needed to look into an explanation to Section 56(2)(viib) that explanation refers to value of assets also as per clause (ii) as well method prescribed as per clause (i) of the said explanation, as is contained in explanation to Section 56(2)(viib) of the 1961 Act as to the fact that manner of computing fair value of shares for the purposes of Section 56(2)(viib) of 1961 Act is provided in above explanation of being higher of the two sub-clauses. The AO merely accepted the valuation report dated 15-10-2012 of the valuer submitted by the assessee without going into all these aspects. In our considered view, the ld. Pr. CIT has rightly invoked the provisions of section 263 of the Act as the A.O. failed to make proper enquiry and verification as required for completion of the assessment u/s 143(3) of 1961 Act, which made the said assessment order dated 23-03- 2016 as erroneous in so far as prejudicial to the interest of Revenue. - Decided against assessee.

Issues Involved:
1. Jurisdiction under Section 263 of the Income-tax Act, 1961.
2. Assessment Order under Section 143(3) of the Income-tax Act, 1961.
3. Application of Section 56(2)(viib) of the Income-tax Act, 1961.
4. Valuation of Non-cumulative Compulsorily Convertible Preference Shares (NCCPS).
5. Adequacy of Enquiry by the Assessing Officer (AO).

Issue-wise Detailed Analysis:

1. Jurisdiction under Section 263 of the Income-tax Act, 1961:
The Principal Commissioner of Income Tax (Pr. CIT) exercised jurisdiction under Section 263, holding that the assessment order dated 23-03-2016 was erroneous and prejudicial to the interest of the Revenue. The Pr. CIT observed discrepancies in the valuation of shares and the application of Section 56(2)(viib). The Pr. CIT noted that the AO failed to conduct proper enquiries and relied on unverified management projections, making the order erroneous.

2. Assessment Order under Section 143(3) of the Income-tax Act, 1961:
The AO completed the assessment under Section 143(3) on 23-03-2016, making an addition of ?3,72,613 under Section 14A. The AO accepted the valuation report provided by the assessee without further verification. The Pr. CIT found this acceptance without proper enquiry as a lapse, justifying the invocation of Section 263.

3. Application of Section 56(2)(viib) of the Income-tax Act, 1961:
Section 56(2)(viib) applies to cases where shares are issued at a premium exceeding the fair market value. The Pr. CIT noted that the fair market value could be determined using the book value or the discounted cash flow (DCF) method. The AO accepted the DCF valuation without questioning its basis, despite significant discrepancies in projections.

4. Valuation of Non-cumulative Compulsorily Convertible Preference Shares (NCCPS):
The assessee issued 6,00,000 NCCPS at a premium of ?240 per share based on a valuation report using the DCF method. The Pr. CIT found that the valuation report relied on unverified management projections, leading to an inflated share value. The AO did not probe the sudden spike in projected cash flows or the disclaimer by the valuer about not independently verifying the projections.

5. Adequacy of Enquiry by the Assessing Officer (AO):
The Pr. CIT observed that the AO did not conduct adequate enquiries into the valuation report, which contained significant discrepancies and unverified projections. The AO's acceptance of the valuation report without further investigation rendered the assessment order erroneous and prejudicial to the Revenue's interest.

Conclusion:
The tribunal upheld the Pr. CIT's invocation of Section 263, agreeing that the AO failed to make necessary enquiries and verification, making the assessment order erroneous and prejudicial to the Revenue. The appeal by the assessee was dismissed, and the AO was directed to conduct a fresh assessment with detailed enquiries and verification.

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