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TMI Blog2018 (1) TMI 789X X X X Extracts X X X X X X X X Extracts X X X X ..... he Singapore AE, that the TPO had examined the buyback agreement of the shares(i. e. sale of shares by Singapore entity to FAPL)and held that the transaction was at Arm’s length. If the subsequent transaction was found to be at fair market value then what was the justification for not treating the first transaction at arm’s length, is not coming out of the order of the TPO/DRP. It is one of the recognised principle of valuation that a high PGR would require a proportionate higher cost of equity. If the said theory is applied to the facts of the case under consideration, the cost of equity will have to be taken at minimum of 17.57% (for 7% PGR). Therefore, we agree with the argument advanced by the assessee that if cost of equity was taken at 17.57%, then the value of a share of FAPL would be lower than value determined by the independent valuer. In short the transaction i. e. valuation of shares of FAPL, was at Arm’s length. - Decided in favour of assessee - I.T.A./1546/Mum/2017 And I.T.A./1547/Mum/2017 - - - Dated:- 5-1-2018 - Sh. Rajendra,Accountant Member And Ravish Sood, Judicial Member For The Revenue : Shri V. Jenardhanan, Saurabh Deshpande-DR For The Assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ependent third party i. e. a valuation expert, M/s. Shrenik Associates. The TPO directed it to file further details in that regard. After considering the submissions of the assessee, he suggested an upward adjustment of ₹ 69. 11 crores. Accordingly, the AO issued a draft order to the assessee . 3 . 2 . Aggrieved by the order of the AO/TPO the assessee filed objections before DRP and made detailed submissions. It also filed additional evidences and more independent opinion of a valuation expert, namely Duff and Pheleps(D P). To determine the ALP of the shares, sold by the assessee, the valuer considered appropriate perpetuity growth and weighted average cost (WAC) of the capital. The DRP called for comments of TPO about additional evidences, who filed his remand report on 16/12/2016. Vide its letter dt. 23/12/2016, the assessee submitted arguments about the remand report of the TPO. After considering the available material, the DRP held that the basic issue to be decided was as to whether the presumption made by the valuer, based on the information provided by the management of FAPL was justified. Referring to the report of M/s. Shrenik Associates, the DRP obser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bsidiary of group having similar business as of FAPL was integrated into FAPL, that the process of revenue integration began in 2008, that FAPL witnessed its increase in head-counts from 551 as on 31/3/2009 to 1061 as on 31/3/ 2010, that as per the management operational income of the company grew from 406 million (March 2010) to ₹ 713. 2 million in March 2011 and to 356. 8million in September 2011, that there after it was expected to grow at a rate 4% till Sept. 2016, that compounded CAGR for revenue after this period was expected to be 2%, that on the above basis the valuer had arrived at a growth rate of 2% per annum based on same figures there terminal growth rate was estimated between 3. 5% - 4. 5% by D P, that the TPO had adopted perpetual growth rate (PGR) of 7% based on a report prepared by PWC, that as per the PWC report the Long term growth rate of developed economies was 2%, that long term expected deflator based inflation rate was 5. 5% in India, that the long term nominal growth rate for India was 7. 5%, that the valuer Shrenik Associates had ignored the factor of inflation in India economy in the calculation, that D P had factored it partly in its report, that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the past growth trend of the assessee in determining the PGR, that he did not appreciate the long term growth rate(LTGR)of matured markets, that estimate of Long Term economic growth rate would necessarily be a growth rate of Indian economy as a whole and would unlikely be representative of LTGR for individual company, that it was important to consider the industry and company specific parameter and not just economic growth rate for county as a whole to determine the PGR of a company. He referred to the report of PWC and argued that in the report it was mentioned that considering the LTGR of developed economies the IT substantiable real GDP growth rate had to be estimated at 2%, that in conjunction with inflation it could be estimated at 7. 5%, that in the report it was specifically mentioned that estimated LTGR for the economy did not represent the LTGR of individual company. He further argued that the compounded annual growth rate(CAGR) of the earning and free cash flow of FAPL for the immediately preceding 5 years was minus 16%, that it was wholly unreasonable at the time of valuation to consider the PGR of 7% based on generic report when company had shown CAGR of minus 16%, tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO had ignored the basic principles of computation of Beta, that he had not considered the length of estimation period, return interval and market index, that a wide set of companies engaged in IT enabled services were considered as comparables for the purpose of Beta computation, that the TPO rejected the comparables by observing that they were engaged in low-end-IT-enabled services, that the comparables selected by the assessee were not engaged in such services, that the TPO without giving any cogent reasons had considered companies engaged in software-development-services as compared to FAPL for determining the Beta for the valuation-working, that the TPO had considered the cost of equity for FAPL at 12. 57% by adjusting the Beta factor and the risk premium, that approximate cost of that during the year was 14. 75% which was substantially higher than cost of equity considered by the TPO in valuation model, that a high PGR warranted proportionately higher cost of equity, that he did not factor in increased uncertainties over achieving cash flow which would warrant a cash flow in cost of equity, that each of factors considered in valuation exercise were dependent on each other, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hile valuing the share price. 3 . 4 . 1 . Before proceeding further, we would like to refer to the case of Mahadeo Jalan (86 ITR 621), wherein the Hon'ble Supreme Court laid down certain basic principles to determine the value of shares and the same read as under: ( 1 ) Where the shares in a public limited company are quoted on the stock exchange and there are dealings in them, the price prevailing on the valuation date is the value of the shares . ( 2 ) Where the shares are of a public limited company which are not quoted on a stock exchange or of a private limited company the value is determined by reference to the dividends, if any, reflecting the profit - earning capacity on a reasonable commercial basis . But, where they do not, then the amount of yield on that basis will determine the value of the shares . In other words, the profits which the company has been making and should be making will ordinarily determine the value . The dividend and earning method or yield method are not mutually exclusive; both should help in ascertaining the profit earning capacity as indicated above . If the results of the two methods differ, an inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n be adopted as the sole guide for determining the price of the said shares. Taking the mean of the break-up value of the said shares computed on the basis of the balance-sheet of the company and the market price of the shares, he determined the value of the said shares at ₹ 15 per share. From the order of the FAA, a further appeal was preferred by the assessee before the Tribunal. It was contended in the appeal that the break-up value could never indicate the correct market price of shares of a running company as a buyer would be always influenced by the prospect of return to his capital outlay, i. e. , expected dividend from year to year. The company in question had declared only 2. 5% dividend on its equity shares in the calendar years 1952 and 1956 and during the intervening years no dividend whatsoever was declared. Only after the sale of the shares in question the company had declared dividend of 5% out of profits of the calendar year 1957. This would, however, not be known to the buyers. The Tribunal held that the break-up value of the said shares did not indicate their market value on the date of sale on account of the low return on the basis of average maintainable c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... services purchased/sold or rendered/availed by the group entities should be at market rate. It was found that to avoid taxes the AE. s were not showing the market price of IT. s. So, to curb the misuse of proximity of group concerns located in India and outside India provisions of chapter X were included in the statute. What the legislature wanted was that the price of IT. s with AE should be at arm s length i. e. , that an independent person in the market would pay/receive the same price as paid/received by the group entity for the good/services. If the surrounding circumstances lead to the conclusion that price charged by the AE. s is not the normal fair market value, the departmental authorities can make adjustment to the price shown by the assessee. But, the adjustments cannot be made without any basis. In short, the basis of TP adjustment is determining fair market value of IT. s entered in to by the assessees. 3 . 6 . Now, coming back to the fact of the case, we find that the TPO/DRP have heavily relied upon the report of PWC, issued in June, 2013, to adopt 7% PGR and to make upward adjust - ment. We find that in its report PWC had mentioned that the estimate of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed on some recognised method. It was definitely better than a general report of PWC. No part of the PWC report talks about the factors/parameters to be considered for estimating PGR of any particular industry or company. But, in the D P report the valuer has dealt with PGR as well as weighted average cost of capital that should be used for valuation of shares sold. Besides, a report of an independent research organization, IBIS World was also filed by the assessee. In its report, IBIS had dealt with background-screening-industry. CRISIL had also prepared a valuation report for an assessee that was carrying out same business as of the assessee and had estimated PGR of 3%. It is found that D P had factored inflation factor while estimating the PGR. Thus, there are definite and positive documentary evidences in support of the argument that PGR adopted by the TPO and the DRP were not based on any justifiable foundation and that the estimated PGR indicated by the independent valuers have better bottom line. It is a case of no evidence versus some evidence. Tax liability cannot be determined in air-there has to be some base to demand taxes by the State from its subjects. In the case unde ..... X X X X Extracts X X X X X X X X Extracts X X X X
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