2024 (12) TMI 1051 - AT - Income Tax

Addition of securities premium u/s 56(2)(vii)(b) - shares were issued to existing shareholders as Right issue - AO rejected the DCF method - AO suomoto applied Net Asset Value (NAV) method invoking Explanation (a)(2) below Section 56(1)(viib) and determined the fair market value and the share @Rs.3.07. Thus, he applied one of the method under Rule 11UA - Addition made u/s. 68 also - HELD THAT - DCF is one of the recognized methods wherein the value is based on estimated future projections and these projections are based on various factors like projection made by the management and the valuation like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and catena of other factors. These factors are considered based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based on approximation and catena of underline facts and assumptions. AO cannot tinker with the method adopted by the assessee and simply applied his own NAV method. In one hand ld. AO adopting DCF method showing that the valuation report is prior to introduction of Rule 11UA but still he proceeds to make his own valuation under one of the method prescribed under Rule 11UA. When the law provides two valuation methods, i.e., NAV and DCF, then AO cannot say one method should be applied for another and reject the valuation adopted by the assessee. DCF is always based projections based on current data and future market and economic condition for a particular industry and can t be equated with actual. Thus, respectfully following the judgment of Cinestaan Entertainment P. Ltd 2021 (3) TMI 239 - DELHI HIGH COURT we hold that ld. AO cannot reject the DCF method and the valuation report as per DCF method cannot be tinkered with ld. AO without giving substantial reasons and not based on his own premise. Accordingly, the valuation done by the assessee is accepted and no addition u/s. 56(1)(viib) can be upheld. Additions u/s. 68 alternatively - From the perusal of the balance sheets it is seen that these companies had huge reserves and surplus and Revenue from operations and borrowings. Thus, once these parties have sufficient funds in the balance sheet and they have given all the details at the time of assessment proceedings, the onus to prove the source of the source also stands discharged. Thus, under the provision of Section 68 also, the additions cannot be made. Accordingly, addition u/s. 68 is also deleted. Appeal of the assessee is allowed.

Summary

Issues Involved:

1. Applicability of Section 56(2)(vii)(b) regarding the addition of securities premium.
2. Valuation method for shares issued and whether Rule 11UA applies.
3. Rejection of the Discounted Cash Flow (DCF) method by the Assessing Officer (AO).
4. Addition under Section 68 concerning the genuineness of transactions and identity, capacity, and genuineness of the loan providers.
5. Violation of the principle of natural justice by not issuing a show cause notice.

Detailed Analysis:

1. Applicability of Section 56(2)(vii)(b):

The primary issue was whether the addition of Rs. 6,80,48,500 as securities premium under Section 56(2)(vii)(b) was justified. The assessee argued that the shares were issued as a Right issue to existing shareholders, making the provisions of Section 56(2)(vii)(b) inapplicable. The AO, however, treated the premium as 'income from other sources,' invoking Section 56(1)(viib) due to the perceived abnormality in the share premium receipts compared to the company's worth.

2. Valuation Method for Shares:

The assessee contended that the shares were valued using the DCF method, certified by a chartered accountant before Rule 11UA came into effect. The AO disregarded this valuation, arguing that Rule 11UA, introduced later, made the DCF method irrelevant. Instead, the AO applied the Net Asset Value (NAV) method, determining a lower fair market value for the shares.

3. Rejection of DCF Method:

The AO rejected the DCF method, citing the variables used by the valuer as subjective and unjustified, especially given the company's negative net worth and risky business model. The Tribunal, however, found that the DCF method is a recognized approach for share valuation, even before Rule 11UA's introduction. The Tribunal cited precedents where the DCF method was upheld, emphasizing that the AO cannot summarily reject a valuation report without substantial reasons.

4. Addition under Section 68:

The AO also made an alternative addition under Section 68, questioning the genuineness of transactions and the identity, capacity, and genuineness of the loan providers. The AO doubted the Director's capacity to invest due to insufficient funds and questioned the loans received from various entities. However, the Tribunal found that the assessee had provided adequate evidence, including income tax returns, bank statements, and confirmations from the loan providers, demonstrating sufficient funds and discharging the onus under Section 68.

5. Violation of Natural Justice:

The assessee claimed that the AO made additions without issuing a show cause notice, violating the principle of natural justice. The Tribunal did not specifically address this issue in detail, as the primary focus was on the substantive issues of valuation and the applicability of Sections 56 and 68.

Conclusion:

The Tribunal allowed the appeal, rejecting the additions made under Sections 56(2)(viib) and 68. It upheld the DCF method as a valid valuation approach, criticized the AO's rejection of the valuation report without substantial justification, and found that the assessee had adequately demonstrated the genuineness of transactions and the capacity of loan providers. The Tribunal's decision emphasized adherence to recognized valuation methods and the necessity of substantial evidence when questioning such valuations.