VALUATION OF UNQUOTED SHARES UNDER INCOME TAX RULE 11UA

[DR.MARIAPPAN GOVINDARAJAN]

Valuation of unquoted shares

Rule 11UA (1)(c) (b) of Income Tax Rules, 1962 provides the procedure for the valuation of unquoted shares.  The fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following formula-

• the fair market value of unquoted equity shares =(A+B+C+D - L)× (PV)/(PE), 

where-

A= book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance-sheet as reduced by,-

• any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and
• any amount shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

B = the price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

C = fair market value of shares and securities as determined in the manner provided in this rule;

D = the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property;

L= book value of liabilities shown in the balance sheet,

PV= the paid-up value of such equity shares;

PE = total amount of paid-up equity share capital as shown in the balance-sheet.

The fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation.

The fair market value of the unquoted equity shares determined by a merchant banker in accordance with any of the following methods-

• Comparable Company Multiple Method;
• Probability Weighted Expected Return Method;
• Option Pricing Method;
• Milestone Analysis Method;
• Replacement Cost Methods;

In AUTOPE PAYMENT SOLUTIONS PVT. LTD. VERSUS ACIT, CIRCLE-2 (2) , DELHI. - 2024 (12) TMI 1170 - ITAT DELHI, the assessee is a privately held Noida based “start-up” incubated under Amity Innovation Incubator.  The assessee is engaged in the business of doorstep delivery of railway ticket on ‘Cash on Delivery’ basis. The assessee filed its return of income for assessment year 2017-18 declaring loss of Rs. 1.04 crores on 24.10.2017.  The return of the assessee was taken up for scrutiny.  The assessee filed the details of information as required by the Department.  The Assessing Officer observed that the assessee had issued 182360 shares at the face value of Rs. 1 and share premium of Rs. 64/- per share. The assessee was asked to furnish details of transactions in respect of requisite form along with supporting documentary evidence, bank statement, valuation report etc. 

The assessee submitted that the assessee is a ‘start-up’ company and has developed software to do e-commerce business of the booking of railway tickets on online platform and delivery of the booked tickets on ‘Cash on Delivery’ basis. The assessee also submitted the agreement entered with IRCTC and the valuation report on the basis of DCF method and also the justification for applying the said method under Rule 11UA of the Income Tax Rules, 1962 (‘Act’ for short) along with the certified Valuation Report by a chartered accountant. 

The Assessing Officer did not satisfy with the justifications submitted by the assessee.  The Assessing Officer observed that the valuation report is prepared on 02.06.2014 which is based on projected financials of the company for the next five financial years and does not factor in the actual performance of the assessee company in subsequent period. The Assessing Officer considered that the issuance of shares at a value higher than the fair market value, the provision of section 56(2)(vii-b) of the Act is applicable. The 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.

The Assessing Officer, then, analysed the Auditor’s report on valuation.  He observed disclaimers recorded by the chartered accountant while issuing the certificate that he has prepared the valuation report on the basis of projected financials of the company for next five years as provided by the management of the company. The  Assessing Officer also observed that any appraisal or independent valuation of any assets or liabilities of the company and the business assets of the company was not conducted by the valuer nor he conducted any audit or diligence or validated the financial data provided by the management. The projection of cash flow computed by the Valuer was exaggerated. The assessee has adopted discounting factor of 7% which is considered as on the higher side by the Assessing Officer.  Therefore, the Assessing Officer rejected the valuation adopted by the Assessee.  The Assessing Officer proceeded to value the shares by NAV method.  He valued the share @ Rs.15.31 per share. The Assessing Officer disallowed Rs. 90,22,347/- as differential amount as per provisions of Section 56(2)(viib) and further he proceeded to make addition of share application money of Rs. 1,82,360/- under section 68 of the Act.

The assessee, being aggrieved against the order of the Assessing Officer, filed an appeal before the National Faceless Assessment Centre, Delhi.  The assessee did not respond to the four notices issued by the Centre and finally he replied to the notice dated 10.08.2022.  After considering the submissions of the assessee the Appellate Authority  has sustained the addition made by the Assessing Officer and also accepted the findings of the Assessing Officer. 

The Assessee also filed an appeal before Income Tax Appellate Tribunal, Delhi against the order of the first Appellate Authority.  The appellant raised the following grounds in support of his appeal-

• The order of Assessing Officer is bad in law and is against the facts and circumstances of the case, hence is unsustainable.
• The Commissioner of Income Tax 2 (Appeals) erred in dismissing the appeal without providing proper opportunity of being heard in the circumstances of the case merely on the basis of part reply of assessee.
• The Assessing Officer has erred in sustaining the 3 additions of Rs. 90,22,347/- made under section 56(2)(vii)(b) of the Act arbitrarily rejecting the valuation determined by DCF method in terms of rule 11UA and further erred in appreciating that Assessing Officer had determined valuation unliterally without any show cause/opportunity to assessee.
• The Assessing Officer erred in ignoring 4 the facts on record and sustained the addition merely on the basis of surmises and conjectures unilaterally.
• The Assessing Officer erred in not even considering the ground against addition of Rs. 1,82,360/- made under section 68 of the Act, being share application money though addition is illegal in as much as the Assessing Officer himself has accepted receipt of share premium from same parties and assessee had discharged onus by filing relevant documents.

The appellant submitted the following before the ITAT-

• The assessee has applied one of the approved methods of DCF as per Rule 11UA of the Income-tax Rules and the same was certified by a chartered accountant.
• The Assessing Officer has rejected the above said valuation report based on the disclaimer normally used in the valuation reports.
• The Assessing Officer has reviewed performance with the projections applied by the valuer which was provided by the assessee during assessment proceedings.
• The Assessing Officer has rejected the method of valuation adopted by the assessee on the basis of surmises and conjectures unilaterally.
• The DCF is one of the approved methods of valuation as per rule 11UA of the Rules.
• The Assessing Officer cannot review the valuation report with actuals.
• The Commissioner of Income Tax (Appeals) has not given any finding and merely sustained the addition made by the Assessing Officer under section 68 of the Act.

The Revenue contended the following-

• The finding of the Assessing Officer for rejecting the DCF method adopted by the assessee is correct.
• The verification of the actuals with projection adopted in the valuation report is also correct.
•  The projection provided by the assessee is without any basis and adopting the DCF @ 7% as the discounting factor is also not justified.

The ITAT considered the submissions of the parties.  The ITAT observed that the assessee being  a ‘start-up’ company, has no past financials.  Under 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.  Accordingly, the assessee has adopted one of the approved methods for valuing its shares. It is normal that the valuer gives 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.

The ITAT further observed that the Assessing Officer 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.  Therefore, the rejection of method is not proper and unjustified.  The ITAT directed the Assessing Officer to accept the valuation provided by the assessee and delete the additions proposed by him.  The shares were issued to the existing shareholders, therefore, the Assessing Officer cannot invoke the provisions of section 68.

The ITAT allowed the appeal filed by the appellant.