2023 (2) TMI 966 - AT - Income Tax

Addition u/s 56(2)(viib) - correctness of DCF method followed by the assessee - amount received on account of share premium on shares and compulsory convertible debentures - AO made additions towards excess premium over and above face value u/s. 56(2)(viib) on the ground that the assessee could not justify valuation of shares under DCF method with necessary financials - As argued appellant would squarely fall under the definition of Venture Capital Undertaking as provided u/s 56(2)(viib) read with explanation (c) of Section 10(23FB) and hence the addition made u/s 56(2)(viib) was completely erroneous and not justifiable - HELD THAT - AO is completely erred in arriving at a conclusion that DCF method followed by the assessee is incorrect only on the basis of one element, difference in projected financials and actual performance of the company for two financial years, because DCF method is mainly on the basis of projected financials of future years and depends upon various estimations and assumptions. AO is free to examine correctness of DCF method and method followed by the assessee to arrive at a free cash flow and relevant ratios considered for arriving at projected revenue and expenditure. In this case, the AO has failed to carry out necessary enquiries to ascertain correctness of DCF method followed by the assessee, but simply went on to reject the method only on one ground that there was a difference in two financial years when compared to projected free cash flow and actual cash flow. Therefore, we are of the considered view that the issue needs to go back to the file of the AO to re-examine method followed by the assessee to arrive at fair market value of equity shares and this view is supported by the decision of ITAT, Chennai Benches in the case of S.A. Metro Plots (P) Ltd 2022 (12) TMI 430 - ITAT CHENNAI We set aside the issue to the file of the AO and direct the AO to re-consider the issue of addition towards share premium u/s. 56(2)(viib) of the Act, in light of various arguments made by the assessee, including valuation report submitted under DCF method. The AO is free to examine method followed by the assessee, however, he does not have power to change method followed by the assessee from DCF method to NAV method, and to decide the issue in accordance with law. Appeal filed by the assessee is treated as allowed for statistical purposes.

Issues Involved:
1. Sustaining the addition under section 56(2)(viib) of the Income Tax Act.
2. Applicability of the Venture Capital Undertaking definition.
3. Legitimacy of the Discounted Cash Flow (DCF) method for share valuation.
4. Rejection of the valuation report by the Assessing Officer (AO).
5. Examination of the Net Asset Value (NAV) method versus the DCF method.
6. Procedural fairness and principles of natural justice.

Detailed Analysis:

1. Sustaining the Addition under Section 56(2)(viib):
The primary issue revolves around the addition of Rs. 2,07,15,240 under section 56(2)(viib) of the Income Tax Act. The AO determined that the share premium received by the assessee was not justified based on the DCF method. The AO adopted the NAV method, valuing each share at Rs. (-)6.15, and added the excess premium received over the face value of Rs. 22 per share as income. The CIT(A) upheld this addition, stating that the assessee could not justify the valuation under the DCF method with necessary financials.

2. Applicability of the Venture Capital Undertaking Definition:
The assessee claimed that it qualified as a Venture Capital Undertaking under section 56(2)(viib) read with explanation (c) of Section 10(23FB) of the Act. The CIT(A) rejected this argument, noting that the assessee was only a trading company purchasing products for marketing and not manufacturing goods. Thus, it did not fall within the definition of a Venture Capital Undertaking, making the provisions of section 56(2)(viib) applicable.

3. Legitimacy of the DCF Method for Share Valuation:
The assessee argued that the DCF method, adopted through an independent valuer, complied with Rule 11UA of the Income Tax Rules, 1962. The AO rejected this method, citing significant differences between projected and actual financials for subsequent years. The Tribunal noted that the DCF method is a permissible valuation method under Rule 11UA and that projections need not match actual performance due to various factors. The Tribunal emphasized that the AO should not reject the DCF method solely based on differences between projected and actual financials but should examine the correctness of the method and assumptions used.

4. Rejection of the Valuation Report by the AO:
The AO rejected the valuation report based on the actual performance of the company, which differed from the projections. The CIT(A) upheld this rejection, stating that the assessee did not provide valid reasons against the rejection of the DCF method. The Tribunal found that the AO erred in rejecting the DCF method based solely on differences in financial projections and actual performance without conducting necessary inquiries into the method's correctness.

5. Examination of the NAV Method versus the DCF Method:
The AO adopted the NAV method, determining the fair value per share at Rs. (-)6.14. The Tribunal noted that the AO does not have the authority to change the method selected by the assessee from DCF to NAV. The Tribunal directed the AO to re-examine the valuation report and the method followed by the assessee, ensuring compliance with Rule 11UA.

6. Procedural Fairness and Principles of Natural Justice:
The assessee argued that there was no proper opportunity given before passing the impugned order, violating principles of natural justice. The Tribunal did not explicitly address this issue but implicitly acknowledged the need for a fair re-examination by setting aside the matter to the AO for reconsideration.

Conclusion:
The Tribunal set aside the issue of the addition towards share premium under section 56(2)(viib) to the file of the AO for re-examination. The AO is directed to reconsider the valuation report submitted under the DCF method and ensure compliance with Rule 11UA. The AO cannot change the method from DCF to NAV but can examine the correctness of the method and assumptions used. The issue of whether the assessee qualifies as a Venture Capital Undertaking was left open for decision at appropriate stages. The appeal was treated as allowed for statistical purposes.

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