2022 (5) TMI 1646 - AT - Income Tax

Addition for allotment of shares to the Indian entity u/s 56(2)(viib) - Valuation of equity shares at Rs. 59.99 per share following the DCF method assessee issued shares Rs 60 per share to non-resident share holder after necessary compliances under FEMA etc - Assessment of fair market value and share premium - AO has rejected the share valuation as computed under Rule 11UA of the Income Tax Rules, 1962 for the reason that the share issued to the resident company was much below the price at which shares were allotted to the non-resident company - AO observed that there was loss in the previous assessment years therefore, the value determined by DCF Method was not correct HELD THAT - AO has fallen in error in not considering objectively the facts and circumstances of the case as reflected in the joint ventures agreement between the resident and non-resident entity. This agreement holds the key for reasons why there was difference in valuation of the shares for each one of them. Clause 4.2.1 of the joint ventures agreement provided that initial share capital of the assessee company shall be by contribution of 5 lac shares from each and Clause 4.2.2 which is reproduced below for convenience, indicated how the project costs was to be funded in the ratio of non-resident, entity paying 40% of the project cost and the resident entity paying 60% of the project cost. Joint ventures agreement there was difference in the share price as issued to the resident company and that to the non-resident company. The discounted factor has occurred due to difference in the shares of capital contribution to the project cost. In the case in hand AO without considering the relevant clauses of joint ventures agreement presumed that as there was difference in the valuation of share for resident and non-resident entity, so, the valuation given by prescribed expert is liable to be rejected. Hon ble Supreme Court of India in Duncans Industries Ltd. vs. State of UP 1999 (12) TMI 857 - SUPREME COURT which is relied in Cinestaan Entertainment Pvt. Ltd. 2019 (6) TMI 1367 - ITAT DELHI as relied by the Counsel for assessee, has held that question of valuation is basically a question of fact. Thus, where the law by virtue of Section 56(2)(viib) read with Rule 11UA (2)(b) makes the prescribed expert s report admissible in evidence, then without discrediting it on facts, the valuation of shares cannot be rejected. Here is a case where the AO has not disputed or questioned the financial, technical and professional credentials of the venturists for entering into the joint ventures agreement. AO without disputing the details of projects, revenue s expected, costs projected has discredited the prescribed expert s report which is admissible in evidence for valuation of shares and to determine fair market value. CIT(A) has rightly gone into the merits of the facts while making an observation that as projected in the report of prescribed expert there has been marked improvement in the profit margins of the company in subsequent years and thus upholding the valuation done by the Assessee s CA on DCF Method. Lastly, there is also force in the contention for assessee that AO has accepted and rejected the valuation in respect of three entities differently. In regard to the assessee it was rejected, in case of non-resident entity it was accepted but distinguished and in case of resident entity also it was accepted, while holding that it was benefited by allotment of shares by under valuing. Such act of approbation and reprobation itself makes the exercise of statutory powers, liable to be set aside.

Summary

Issues:
1. Appeal by Revenue against First Appellate order for assessment year 2014-15.
2. Valuation of shares for resident and non-resident entities under section 56(2)(viib) of the Income Tax Act, 1961.
3. Assessment of fair market value and share premium.
4. Discrepancy in valuation treatment for different entities.
5. Application of DCF Method for share valuation.

Issue 1: Appeal by Revenue against First Appellate order
The Revenue appealed against the First Appellate order dated 23.03.2018 for assessment year 2014-15 under section 250(6) of the Income Tax Act, 1961. The appeal was filed after the Commissioner of Income Tax (Appeals)-1, Gurgaon, set aside the order passed by the Assessing Officer (AO) u/s 143(3) of the Act. The appeal also involved Cross-Objections filed by the Assessee.

Issue 2: Valuation of shares under section 56(2)(viib)
The case involved the valuation of shares issued to a resident company and a non-resident company under section 56(2)(viib) of the Act. The AO rejected the share valuation for the resident entity, leading to additions in the hands of the Assessee. The AO's decision was based on the difference in valuation between resident and non-resident entities, citing the loss in previous assessment years.

Issue 3: Assessment of fair market value and share premium
The AO determined the fair market value of shares at Rs. 3.60 per share due to the loss in previous years. The AO considered the share premium received by the Assessee to be income under section 56(2)(viib) of the Act, as the consideration on share issuance exceeded the FMV. The First Appellate Authority set aside the AO's order, leading to the Revenue's appeal.

Issue 4: Discrepancy in valuation treatment
The AO's rejection of the share valuation for the resident entity was based on the difference in share price between resident and non-resident entities. However, the joint ventures agreement between the entities clarified the rationale behind the differing valuations, which the AO failed to consider objectively.

Issue 5: Application of DCF Method for share valuation
The use of the Discounted Cash Flow (DCF) Method for share valuation was a key aspect of the case. The prescribed expert's report, admissible under section 56(2)(viib) read with Rule 11UA (2)(b), was crucial for determining the fair market value. The First Appellate Authority upheld the valuation based on the DCF Method, considering the marked improvement in the company's profit margins in subsequent years.

In conclusion, the Tribunal dismissed the Revenue's appeal while allowing the Assessee's Cross-Objections. The Tribunal found that the AO's rejection of the prescribed expert's report without factual basis was erroneous. The Tribunal emphasized the importance of considering all relevant clauses of agreements and expert reports for fair valuation, ultimately upholding the First Appellate order.