2024 (12) TMI 1170 - AT - Income Tax

Issuance of shares at a value higher than the fair market value - Addition u/s 56(2)(viib) - Rejection of the DCF Method for Valuation of Shares in terms of rule 11UA - fair market value of unquoted shares may be determined either as per Net Assessed Value (NAV) or DCF method as determined by a merchant banker or an accountant - HELD THAT - Assessee is a start-up company, has no past financials and we also observe that the assessee has adopted one of the approved method under Rule 11UA. It is also relevant to note that as per Rule 11UA, option is given to the assessee to adopt one of the approved method for the purpose of valuation of unquoted shares either under Net Assets value or DCF method. As per the above choice of option, assessee has adopted one of the approved method for valuing its shares. Hon ble High Court of Delhi held exact similar view in the case of Pr. CIT vs. Cinestaan Entertainment (P) Ltd. 2021 (3) TMI 239 - DELHI HIGH COURT AO also proceeded to review the various disclaimers made by the Valuer to reject the method. It is normal that the valuer give various disclaimer such as the values are provided by the management and they have not carried out any verification. This cannot be the basis to reject the method adopted by the assessee. Coming to the issue of review of the actual performance with the projection it is settled law that the AO cannot review the projected figures adopted by the assessee at the time of projections. Therefore, this method of evaluating actual performance with projected figure after 4 or 5 years is not proper. Assessee has adopted one of the approved method of valuation under rule 11UA. Therefore, the rejection of such method is not proper and unjustified. Accordingly, we direct the AO to accept the valuation provided by the assessee and delete the additions proposed by him. In the result, ground nos. 3 4 are allowed. Addition u/s 68 - issue of shares at Rs. 1 is the same share which are issued by the assessee with share premium - Valuations of shares are proper based on the DCF method. Further, we observe that the shares were issued to the existing shareholders, therefore, the AO cannot invoke the provisions of section 68. In the result, ground no. 5 raised by the assessee is allowed.

Summary

Issues Involved:

1. Rejection of the Discounted Cash Flow (DCF) method for valuation of shares.
2. Addition under Section 56(2)(viib) of the Income Tax Act.
3. Addition under Section 68 of the Income Tax Act.
4. Disallowance of expenses treated as capital expenditure.

Detailed Analysis:

1. Rejection of the DCF Method for Valuation of Shares:

The primary issue was the rejection of the DCF method by the Assessing Officer (AO) for valuing the shares issued by the assessee, a start-up company. The AO dismissed the DCF valuation, certified by a chartered accountant, based on disclaimers in the valuation report and discrepancies between projected and actual financial performance. The tribunal observed that the assessee, being a start-up with no past financials, was entitled to choose an approved valuation method under Rule 11UA of the Income Tax Rules, 1962. The DCF method is recognized and accepted for valuing unquoted shares. The tribunal noted that the AO's rejection was based on a misunderstanding of disclaimers typically included in valuation reports, which should not invalidate the method. It emphasized that valuation is inherently based on projections and influenced by various factors, and cannot be reviewed with actual performance years later. Consequently, the tribunal directed the AO to accept the DCF valuation and delete the related additions.

2. Addition under Section 56(2)(viib) of the Income Tax Act:

The AO made an addition of Rs. 90,22,347/- under Section 56(2)(viib), contending that the shares were issued at a value higher than the fair market value. The tribunal found that the assessee had adopted a recognized valuation method, and the AO failed to provide an alternative fair market value. The tribunal referenced a similar judgment by the Delhi High Court, which upheld the use of recognized valuation methods by start-ups. It concluded that the AO's approach lacked a material foundation and was irrational, as it did not demonstrate that the assessee's methodology was incorrect. Therefore, the tribunal allowed the assessee's appeal on this ground.

3. Addition under Section 68 of the Income Tax Act:

The AO also added Rs. 1,82,360/- under Section 68, treating the share application money as unexplained cash credit. The tribunal noted that the shares, issued at a premium, were allotted to existing shareholders, and the assessee had discharged its onus by providing relevant documentation. Since the valuation of shares was deemed proper, the tribunal held that the AO could not invoke Section 68. Thus, this ground of appeal was allowed in favor of the assessee.

4. Disallowance of Expenses as Capital Expenditure:

The assessee contested the disallowance of Rs. 39,285/- as capital expenditure. However, this specific ground was not pressed during the hearing, and no detailed analysis was provided in the judgment regarding this issue. Consequently, the tribunal did not address this ground in its decision.

Conclusion:

The appeal was partly allowed, with the tribunal directing the AO to accept the DCF valuation and delete the additions made under Sections 56(2)(viib) and 68. The tribunal emphasized the validity of the DCF method for start-ups and the improper rejection by the AO based on disclaimers and performance reviews. The decision reinforced the principle that valuation is not an exact science and should be left to the expertise of qualified professionals.