2023 (12) TMI 702 - AT - Income Tax

Addition under the Head Income from Other Sources u/s 56(2)(viib) - excess amount per share paid as premium - DCF v/s NAV method for valuing shares - Justification in rejecting the declared value of the shares - Whether CIT (A) eared in holding that there is no case of application of Section 56(2)(viib) to the facts of appellant's case where pre-existing unsecured loans of partners/ shareholders were converted into equity shares at premium and the facts of the assessment order do not indicate any case of tax abuse involved in such share conversion? HELD THAT - The forecasted results usually change because of some events and circumstances that do not occur as expected or are not anticipated; market conditions are changing rapidly due to fast changing technology and also due to changing Government policies. Actual results will, therefore, always differ from the forecast and sometimes the difference may be material. To put it differently, considering that the DCE Method is essentially based on projections (estimations), the projections cannot be compared with the actuals so as to expect the same figures as were projected. Accordingly, the projections under DCF method have to be scrutinised with the facts and data available on the date of valuation and not by comparison with the actuals. In that view of the matter, variation between the projections and the actual results achieved cannot be the basis for disregarding/rejecting the valuation as per DCF method. It is apparent that there is no case of application of Section 56(2)(viib) to the facts of appellant's case where pre-existing unsecured loans of partners/shareholders were converted into equity shares at premium and the facts of assessment order do not indicate any case of tax abuse involved in such share conversion. Even the AO's decision to substitute DCF method of share valuation by NAV method is not in accordance with the Rule 11UA of IT. Rules. Accordingly, addition u/s. 56(2)(viib) of the Act is hereby deleted. PCIT has observed that the Assessee had stated in its Reply that the valuation report had already been supplied to the A.O. and the fair market value of each share was arrived at Rs. 1,087/- as per the Valuation Report of the valuer; that this stand of the Assessee was not acceptable; that the fair market value of the shares, as per rules 11U and 11UA of the Rules, had been computed at Rs. 450/- per share; and that the share premium received by the Assessee in excess of the rate of Rs. 450/- per share had remained from being assessed at the hands of the Assessing Officer. The Id. PCIT, however, did not venture to elaborate as to how the determination of the fair market value of the shares, as arrived at Rs. 1.087/- per share by the Assessee, on the basis of the DCF Method and certified by the Assessee's Chartered Accountants, was not acceptable, remaining oblivious to the statutory mandatory option made available to the Assessee by the provisions of rule 11UA(2) of the Rules, laying down that the fair market value of unquoted shares shall be, as provided in the said rule, the value as determined either under clause (a), or clause (b) of the rule, that is, by invoking the Book Value (NAV) Method, or the Discounted Free Cash Flow (or DCF) Method, at the option of the Assessee. For the proposition that the FMV of a share determined as per the DCF method and duly supported by the Valuation Report of the ld. CIT(A) cannot be rejected merely on the ground that the valuation of the equity shares was based on projection of revenue which did not match with the actual reviews of subsequent years. Assessee followed the DCF Method for valuing the shares, whereas the Id. PCIT utilised the NAV Method to do so. This action of the Id. PCIT is in direct contravention of the provisions of Explanation (a) (i) to section 56(2)(vii) of the I.T. Act read with rule 11UA(2) (b) of the I.T. Rules. AO could not have changed the method of valuation opted by the Assessee, in view of the statutory mandate of rule 11UA(2) of the Rules. To similar effect, under mutatis-mutandis, similar is our order passed in the case of Apna Punjab Resorts Limited 2023 (3) TMI 553 - ITAT CHANDIGARH . Accordingly, the grievance sought to be raised by the Department by way of its ground of appeal is found to be shorn of merit and it is rejected as such.

Summary

Issues Involved:
1. Deletion of addition under Section 56(2)(viib) of the Income Tax Act.
2. Applicability of Section 56(2)(viib) to conversion of pre-existing unsecured loans into equity shares.
3. Validity of the Discounted Cash Flow (DCF) valuation method used by the assessee.

Summary:

Issue 1: Deletion of Addition under Section 56(2)(viib)
The Ld. CIT(A) deleted the addition of Rs. 202.50 Crores made by the AO under the head "Income from Other Sources" u/s 56(2)(viib) of the Act. The AO had alleged that the equity shares issued by the assessee at a premium were in excess of the fair market value. The CIT(A) held that the provisions of Section 56(2)(viib) were not applicable as no consideration was received during the year, and the conversion of loans into equity shares did not indicate any tax abuse.

Issue 2: Applicability of Section 56(2)(viib)
The CIT(A) observed that the assessee did not receive any consideration for the allotment of shares in the relevant year. The shares were issued by converting pre-existing unsecured loans from partners into equity shares. The CIT(A) noted that the legislative intent behind Section 56(2)(viib) was to curb the practice of introducing undisclosed money through high-premium shares, which was not applicable in this bona fide transaction of loan conversion.

Issue 3: Validity of DCF Valuation Method
The CIT(A) upheld the use of the DCF method by the assessee for valuing shares, as permitted under Rule 11UA of the Income Tax Rules. The AO's rejection of the DCF method, based on the variance between projected and actual financial figures, was found to be unjustified. The CIT(A) emphasized that the AO cannot substitute the valuation method chosen by the assessee, as long as it adheres to the prescribed rules. The CIT(A) also noted that variations between projections and actual results are inherent in business forecasts and do not invalidate the DCF method.

Conclusion:
The Tribunal dismissed the department's appeal, affirming the CIT(A)'s decision to delete the addition under Section 56(2)(viib). The Tribunal held that the AO's substitution of the DCF method with the NAV method was beyond jurisdiction and not in accordance with Rule 11UA. The Tribunal reiterated that the assessee's choice of the DCF method for share valuation was valid and could not be disregarded based on post-valuation financial discrepancies.