2024 (7) TMI 1332 - AT - Income Tax

Addition u/s 56(2)(viib) - valuation method adopted for Compulsory Convertible Preference Shares (CCPS) - transaction between holding and subsidiary companies - HELD THAT - Shares are allotted to the holding company by wholly owned subsidiary and the financial projections were prepared and validated by independent technical expert. We conclude that the DCF method adopted by the assessee for valuing the CCPS is legitimate and in accordance with Rule 11UA. The AO cannot reject the method chosen by the assessee if it is prescribed by law. AO s reliance on the company s subsequent financial losses to question the valuation is misplaced. The projections must be assessed based on the facts and data available at the time of valuation, not on future outcomes, as held in various judicial pronouncements. The issuance of CCPS to the holding company does not align with the legislative intent of Section 56(2)(viib) of the Act to prevent the generation and use of unaccounted money. The transaction between a wholly owned subsidiary and its holding company does not create any unaccounted income or inflated share value for tax evasion purposes unless it is specifically proved. CIT(A) correctly applied the provisions of law and judicial precedents in deleting the addition made by the AO. The valuation of shares based on the DCF method is valid, and the AO s objections lack merit. The order of the CIT(A) is upheld. The addition u/s 56(2)(viib) of the Act is hereby deleted. Appeal filed by the Revenue is dismissed.

Issues Involved:
1. Legitimacy of the valuation method adopted for Compulsory Convertible Preference Shares (CCPS).
2. Authority of the Assessing Officer (AO) to reject the valuation report.
3. Applicability of Section 56(2)(viib) of the Income Tax Act to the transaction between holding and subsidiary companies.
4. Compliance with procedural requirements during the assessment and appellate proceedings.

Detailed Analysis:

1. Legitimacy of the Valuation Method Adopted for CCPS:
The assessee-company issued 7,99,900 Compulsory Convertible Preference Shares (CCPS) at a premium of Rs. 990 per share. The AO questioned the valuation based on the Discounted Cash Flow (DCF) method, arguing that the financial projections were not independently verified and were unrealistic. The assessee defended the valuation, stating that it was conducted in accordance with Rule 11UA of the Income Tax Rules, and validated by an independent technical consultant.

The CIT(A) supported the valuation process, asserting that it was conducted in accordance with the legal provisions and CBDT/Legislature rules. The CIT(A) emphasized that the AO cannot arbitrarily reject a Valuation Report that complies with established legal guidelines. The FMV determined by the Valuer is upheld, provided it follows the prescribed rules.

2. Authority of the Assessing Officer (AO) to Reject the Valuation Report:
The AO added Rs. 79,19,01,000 to the total income under Section 56(2)(viib) of the Act, citing issues with the valuation report. The CIT(A) criticized the AO for not having the power to reject the valuation or substitute his own method. The CIT(A) referenced the ITAT Bangalore Bench's decision in Innovit Payment Solutions Pvt. Ltd., which stated that the AO can scrutinize, but not arbitrarily reject a valuation without proper reasons and adherence to the DCF method.

The CIT(A) found fault with the AO's interpretation of Section 56(2)(viib) and Rule 11UA, deeming the AO's rejection of the valuation report beyond his jurisdiction, especially when the valuation is done as per Rule 11UA(1)(c)(c).

3. Applicability of Section 56(2)(viib) of the Income Tax Act:
The AO argued that the valuation was based on unverified exorbitant cash flows, resulting in an inflated share value. The CIT(A) countered that the legislative intent of Section 56(2)(viib) is to deter the generation and use of unaccounted money through inflated share values. The CIT(A) noted that the shares were issued to the holding company, and the transaction did not align with the legislative intent to prevent tax evasion through unaccounted money.

The CIT(A) referenced judicial precedents, including Dhruv Milkose Pvt. Ltd. and Solitaire BTN Solar Pvt. Ltd., which emphasized that transactions between holding and subsidiary companies at a premium do not attract Section 56(2)(viib) of the Act. The CIT(A) concluded that the AO's reliance on the company's subsequent financial losses to question the valuation was misplaced, as projections must be assessed based on the facts and data available at the time of valuation.

4. Compliance with Procedural Requirements:
The Revenue argued that the CIT(A) failed to provide an opportunity to the AO to reconsider the evidence and that the assessee did not respond adequately to the AO's show-cause notice. The CIT(A) found that the assessee had provided all relevant information, which was already available with the AO, and that the AO's objections lacked merit.

The CIT(A) systematically dissected the AO's actions, emphasizing adherence to legal procedures and the importance of a fair valuation process. The CIT(A) concluded that the addition of Rs. 79,19,01,000 under Section 56(2)(viib) was not justified and directed its deletion.

Conclusion:
The Tribunal upheld the CIT(A)'s decision, concluding that the DCF method adopted by the assessee for valuing the CCPS was legitimate and in accordance with Rule 11UA. The AO's objections were found to lack merit, and the addition of Rs. 79,19,01,000 under Section 56(2)(viib) was deleted. The appeal filed by the Revenue was dismissed.

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