2019 (3) TMI 272 - AT - Income Tax

Taxation of excess share premium received as income from other sources u/s 56(2)(viib) - basis of valuation - difference in the rights of a holder of an equity share and preference share - Rule 11UA (1) sub clause (c) of sub rule (c) applicability - estimation for future cash flow - HELD THAT - From offer letter, the holder of a preference share is provided with voting righjt also and therefore, can it be said that the nature of the share issued in the present case is actually that of an equity share and not preference shares but this evidence is brought on record as an additional evidence and there is no comment of any of the authorities below on it. This aspect of the matter should be decided first as to which Rule/Sub Rule/ sub clause is applicable in the facts of the present case and thereafter, the matter should be decided as per the applicable Rule/Sub Rule/ sub clause. All the terms of the issue of preference shares have to be looked into for this purpose to find out whether the present receipt of share premium is for issue of preference shares or for issue of equity shares because even if it is found that because of limited voting right only, the said shares are not equal to equity shares, then also, this is important to note that ultimately, these preference shares are to be converted into equity shares after a fixed time at a fixed rate and hence, this is important to find out as to whether the premium received is for equity shares to be issued later or for preference shares issued now since ultimately, these preference shares are compulsorily to be converted in to equity shares. If it is found that the premium received is mainly for conversion of preference shares into equity shares at an agreed price after an agreed time than there may be a case of non applicability of sub clause (c) of sub rule (c ) of Rule 11UA (1). These details are not available in the paper book and even if some things are available, the same are in the form of additional evidence without any comment of the lower authorities and explanation of the assessee and hence restore the matter to the CIT (A) for a fresh decision on this issue after deciding this aspect first that in the facts of the present case, which Rule/Sub Rule/ sub clause of Rule 11UA is applicable in the light of above discussion. Estimation is to be made of future cash flow and hence, the assessee has to establish that estimation made by the management and given to the Chartered Accountant for certifying DCF is estimated by the management on a scientific basis and therefore, the said estimate is made with reasonable certainty. If such estimation with reasonable certainty is not found possible than this method cannot be adopted on the basis of those data which are not estimated with reasonable certainty. In that situation, other methods have to be adopted. - Decided in favour of assessee for statistical purposes.

Issues involved:
1. Taxation of excess share premium under section 56(2)(viib) of the Income-tax Act, 1961.
2. Choice of valuation method for determining fair value of shares.
3. Reliance on expert's report for valuation.
4. Comparison of projected figures with actuals for valuation.
5. Disregarding appellant's method of valuation by AO/CIT(A).
6. Different valuation methods for preference shares and equity shares.

Issue 1: Taxation of excess share premium under section 56(2)(viib):
The appeal was against the order of CIT (A) upholding the taxation of excess share premium under section 56(2)(viib) of the Income-tax Act, 1961. The appellant argued that the valuation was done using the Discounted Cash Flow (DCF) method and not the Net Asset Value (NAV) method. The AO disregarded the valuation report obtained by the appellant, leading to the addition of share premium. The tribunal directed a fresh decision on the applicable valuation rule and the quantum of permissible share premium based on the type of shares issued.

Issue 2: Choice of valuation method:
The appellant opted for the DCF method for valuing unquoted compulsorily convertible preference shares (CCPS). The tribunal emphasized the importance of scientific basis for projections used in valuation, citing judgments on estimation of future liabilities. It was highlighted that the projections must be based on a scientific basis for a method like DCF to be valid. The tribunal directed the appellant to establish the scientific basis of the projections to ensure reasonable certainty in estimation.

Issue 3: Reliance on expert's report:
The CIT (A) was criticized for not considering the valuation report obtained from a Chartered Accountant (CA) by the appellant. The tribunal stressed the need for a sound reasoning before rejecting the appellant's chosen valuation method. It was noted that the CA's report was disregarded without demonstrating any specific errors or unreliability, leading to a lack of justification for rejecting the appellant's valuation approach.

Issue 4: Comparison of projected figures with actuals for valuation:
The tribunal found fault with the CIT (A) for making arbitrary comparisons between projected and actual figures without considering the factors influencing the projections. The tribunal highlighted that projections are based on various factors like industry conditions and business objectives, making direct comparisons with actuals unreasonable. The tribunal emphasized the importance of understanding the context in which projections are made and cautioned against unwarranted challenges to the validity of projections.

Issue 5: Disregarding appellant's method of valuation by AO/CIT(A):
The tribunal criticized the AO and CIT (A) for disregarding the appellant's chosen valuation method and introducing their own without sufficient reasoning. It was emphasized that the option to select a valuation methodology lies with the assessee, and forcing a different method would render the relevant rules purposeless. The tribunal highlighted the need for a valid justification before rejecting the appellant's valuation approach and adopting an alternative method.

Issue 6: Different valuation methods for preference shares and equity shares:
The tribunal raised concerns about the classification of the shares issued by the appellant, whether they were preference shares or equity shares. The tribunal noted discrepancies in the rights associated with the shares issued and directed a fresh decision on the applicable valuation rule based on a thorough examination of the terms of the preference shares issued. The tribunal emphasized the importance of determining the nature of the shares and the premium received for accurate valuation.

In conclusion, the tribunal allowed the appeal for statistical purposes and directed a fresh decision on the valuation methodology and quantum of permissible share premium based on a detailed analysis of the type of shares issued by the appellant.

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