2022 (12) TMI 1552 - AT - Income Tax

Addition made u/s. 56(2)(viib) - assessee company issued 6250 equity shares of Rs. 100/- each at a premium of Rs. 9500/- per share - NAV Method or the DCF Method to determine the fair market value of shares - revenue had rejected the said DCF method and had re-determined the share value at Rs. 2603/- per share using NAV - HELD THAT - DCF method is certainly one of the prescribed methods provided in Rule 11UA of the Rules and assessee is given an option either to use the DCF method or NAV method. In the instant case, the assessee has chosen to adopt DCF method. The aforesaid facts which are mentioned in various tables reproduced supra goes clearly to prove that the independent valuer had relied on various projections and free cash flow provided by the management for the purpose of share valuation, the said projections had indeed become true and assessee could achieve more than the projections in the subsequent years. Hence, so called non-existing discrepancies pointed out by the AO which have been duly met by the assessee are hereby dismissed as factually incorrect. Whether the ld. AO could change the method of share valuation was subject matter of consideration in the case of Vodafone M-Pesa Ltd. 2018 (3) TMI 530 - BOMBAY HIGH COURT as held AO is undoubtedly entitled to scrutinise the valuation report and determine a fresh valuation either by himself or by calling for a final determination from an independent valuer to confront the petitioner. However, the basis has to be the DCF Method and it is not open to him to change the method of valuation which has been opted for by the Assessee. Also in Credtalpha Alternative Investment Advisors (P) Ltd. 2022 (1) TMI 937 - ITAT MUMBAI addressed the issue that DCF method adopted by the assessee cannot be rejected merely on the basis of comparing projections with actuals. Thus, we direct the ld. AO to delete the addition made u/s. 56(2)(viib). Seeking set off of unabsorbed depreciation with the addition made by the AO - This has to be factually verified by the ld. AO. But in view of our decision given for ground Nos. 1-3 hereinabove, this unabsorbed depreciation figure if found to be correct, has to be carried forward to subsequent years as per law.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question in this judgment is whether the valuation method adopted by the assessee for determining the share premium under Section 56(2)(viib) of the Income Tax Act, 1961, using the Discounted Cash Flow (DCF) method, is valid and acceptable, or whether the Assessing Officer (AO) was justified in rejecting this method and substituting it with the Net Asset Value (NAV) method.

2. ISSUE-WISE DETAILED ANALYSIS

Relevant legal framework and precedents:

The case revolves around Section 56(2)(viib) of the Income Tax Act, which deals with the taxation of share premiums exceeding the fair market value. The relevant rule for valuation is Rule 11UA of the Income Tax Rules, which allows the assessee to choose between the NAV method and the DCF method for determining the fair market value of shares.

Court's interpretation and reasoning:

The Tribunal noted that the DCF method is one of the prescribed methods under Rule 11UA, and the assessee has the option to choose either the DCF method or the NAV method. The Tribunal emphasized that the AO cannot unilaterally change the valuation method chosen by the assessee unless there are significant discrepancies or errors in the application of the chosen method.

Key evidence and findings:

The assessee provided a valuation report using the DCF method, which was prepared by an independent valuer. The AO rejected this valuation, arguing that the actual financial results did not align with the projections used in the DCF method. The AO recalculated the share value using the NAV method, resulting in a lower valuation.

Application of law to facts:

The Tribunal found that the AO's rejection of the DCF method was based on a misunderstanding of the differences between projected and actual financials. The Tribunal highlighted that the DCF method inherently involves projections and assumptions about future cash flows, which may not always match actual results. The Tribunal also noted that the assessee had achieved actual financial results that exceeded the projections used in the DCF valuation.

Treatment of competing arguments:

The Tribunal considered the AO's arguments about the discrepancies in projections and actuals, but found them to be factually incorrect. The Tribunal also referenced the decision in Vodafone M-Pesa Ltd. vs. PCIT, which supports the assessee's right to choose the valuation method and restricts the AO from changing it without substantial grounds.

Conclusions:

The Tribunal concluded that the AO was not justified in rejecting the DCF method and substituting it with the NAV method. The Tribunal directed the AO to delete the addition made under Section 56(2)(viib) and allowed the assessee's appeal.

3. SIGNIFICANT HOLDINGS

Preserve verbatim quotes of crucial legal reasoning:

The Tribunal quoted the Vodafone M-Pesa Ltd. case: "There is certainly no immunity from scrutiny of the valuation report submitted by the Assessee. Therefore, the Assessing Officer is undoubtedly entitled to scrutinise the valuation report and determine a fresh valuation either by himself or by calling for a final determination from an independent valuer to confront the petitioner. However, the basis has to be the DCF Method and it is not open to him to change the method of valuation which has been opted for by the Assessee."

Core principles established:

The judgment reinforces the principle that the assessee has the right to choose the valuation method for share valuation under Section 56(2)(viib) and Rule 11UA. The AO cannot arbitrarily change this method without substantial justification.

Final determinations on each issue:

The Tribunal allowed the assessee's appeal, directing the AO to delete the addition made under Section 56(2)(viib) and to verify the set-off of unabsorbed depreciation, which should be carried forward if found correct.