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TMI Blog2019 (1) TMI 688X X X X Extracts X X X X X X X X Extracts X X X X ..... uer and confront the same to the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee. AO can scrutinize the valuation report and the if the AO is not satisfied with the explanation of the assessee, he has to record the reasons and basis for not accepting the valuation report submitted by the assessee and only thereafter, he can go for own valuation or to obtain the fresh valuation report from an independent valuer and confront the same to the assessee.For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual result of future cannot be a basis to decide about reliability of the projections The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method. Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, scientific study and applicable Guidelines reg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... intentionally ignored while making projections, the allegation is without basis and does not appreciate the intricacies of technological challenge and business constraints. e) Appellant has merely adopted the values provided by the management clearly ignoring factors such as performance, growth prospects, earnings capacity, whereas average actual monthly revenue from April 13 to Sept 13 was ₹ 1.52 Crores, an arithmetic extrapolation of annual revenue is ₹ 18.24 crores and the projections have assumed annual growth between 15% to 25% which is realistic assumption as compared to past actual growth rates, further the growth projections are corroborated with an independent report Payment Systems in India: Vision 2012-2015 prepared from public information source - www.rbi.org.in . f) Appellant has not been able to point out justification of application of DCF, the provisions of Income Tax allow an assessee the option to adopt DCF method without giving any reasons and more so for a technology company DCF method is more apt and suitable vis- -vis the net asset value method. g) The data used is totally unreliable, without any surety of accuracy or completenes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd PAT were worked out for each year. Net margin for F. Y. 2012 13 was noted at 5% but the same was @ 6% in F. Y. 2013 14 to 2015 16 and 8% in F. Y. 2016 17 and 9% in F. Y. 2017 18. After making adjustments on account of depreciation, Increase/Decrease in current assets, noncurrent assets, capital expenditure and current liabilities, net cash flow was worked out and the same was discounted @ 15%. Such present value of cash flow was worked out at ₹ 549 lacs. To this, terminal value was added at ₹ 1,322 Lacs and in this manner, Enterprise value was worked out at ₹ 1,871 Lacs. Fair value of each share was worked out at ₹ 42/- per share. The AO has noted and reproduced the relevant portion of the certificate issued by the Chartered Accountant which says that the projections are as per the estimate of the management and the Chartered Accountant provides no assurance that this information or the assumptions on which this information has been prepared by the management are accurate. As per Para 9 of the Assessment order, the AO has stated that the submission of the assessee did not bring out any scientific basis for arriving the projected figures and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... responding six months of the preceding year. He simply argued that in corresponding six months from April to September of the preceding year i.e. F. Y. 2012 13, the sales was ₹ 754 Lacs and hence, in spite of fall in these six months of F. Y. 2013 14, the sales is ₹ 915 Lacs and hence, there is increase of 21.35% in this period also as compared to same six months of the preceding year and therefore, the projection of growth of 15% and 25% is justified. Reliance was placed on a tribunal order rendered in the case of Ozoneland Agro Pvt. Ltd. [TS-6963-ITAT-2018(MUMBAI)-O], (2018) 64 ITR 6 (MUMBAI) and in the case of M/s. Rameshwaram Strong Glass (P) Ltd. vs. The ITO, copy on pages 49 to 67 of the paper book. Reliance was placed on one more tribunal order rendered in the case of M/s Vani Estates Pvt. Ltd. vs. ITO in ITA No. 1352/Chny/2018 dated 27.08.2018 copy available on pages 740 to 748 of the paper book and in particular, our attention was drawn to Para 7.3 7.4 of this tribunal order. 5. As against this, learned DR of the revenue supported the orders of the authorities below. It was also submitted that the tribunal orders cited by the learned AR of the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ass or classes of persons as may be notified by the Central Government in this behalf. Explanation.-For the purposes of this clause,- ( a) the fair market value of the shares shall be the value- ( i) as may be determined in accordance with such method as may be prescribed9; or ( ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher; ( b) venture capital company , venture capital fund and venture capital undertaking shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause (23FB) of section 10; Meaning of expressions used in determination of fair market value. 11U. For the purposes of this rule and rule 11UA,- ( a) 1 [ *** ] ( b) balance-sheet , in relation to any company, means,- ( i) for the purposes of sub-rule (2) of rule 11UA, the balance-sheet of such company ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956); ( i) unquoted shares and securities , in relation to shares or securities, means shares and securities which is not a quoted shares or securities; [ ( j) valuation date means the date on which the property or consideration, as the case may be, is received by the assessee. ] Determination of fair market value. 11UA. [ ( 1) ] For the purposes of section 56 of the Act, the fair market value of a property, other than immovable property, shall be determined in the following manner, namely,- ( a) valuation of jewellery,- ( i) the fair market value of jewellery shall be estimated to be the price which such jewellery would fetch if sold in the open market on the valuation date; ( ii) in case the jewellery is received by the way of purchase on the valuation date, from a registered dealer, the invoice value of the jewellery shall be the fair market value; ( iii) in case the jewellery is received by any other mode and the value of the jewellery exceeds rupees fifty thousand, then assessee may obtain the report of registe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mmovable property) in the balance-sheet as reduced by,- ( i) any amount of income-tax paid, if any, less the amount of incometax refund claimed, if any; and ( ii) 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, but not including the following amounts, namely:- ( i) the paid-up capital in respect of equity shares; ( ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; ( iii) reserves and surplus, by whatever name called, eve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; ( iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation; ( iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; ( v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities; ( vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares; PE = total amount of paid up equity share capital as shown in the balance-sheet; PV = the paid up value of such equity shares; or ( b) the fair market value of the unquoted equity shares determined by a merchant banker 2 [ *** ] as per the Discounted Free Cash Flow method. ] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h is that any valuation is as good as its underlying assumptions, which, in turn, are the function of a number of present arid forward-looking factors. A careful valuation exercise, at best, can give an indicative range of value subject to the reasonableness of the assumptions. ( c) Valuation is pertinent to a particular point of time and varies with changes in business, industry and macroeconomic environment. E.g., the movement of US Dollar against Indian Rupee has led to a substantial change in the valuation of IT and other export-driven companies. ---------------------------------------- 2.1 The potential earning power of a company is generally a paramount factor for valuation of share but there may be occasions, especially in valuations for compensation, where other considerations become relatively more important. In the absence of any other special motive, an investor is principally interested in a company's ability to continue earning profits. 2.4 The Income Approach indicates the value of a business based on the value of the cash flows that a business is expected to generate in future. This approach is appropriate in most going concern situations ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inal Value - are wide off the mark, then the value generated by using this model does not reflect the fair value. ( b) It does not take into account several other factors, such as investment risk associated with opportunity cost, i.e. investments that could return greater cash flow yields would add an unrealised element of risk, unforeseen variations in future cash flow, and other nonfinancial factors. 2.9 In this technique valuation of shares is based on three things: Cash Flow Projections, Discount Rate and Terminal Value. 2.10 The first and most critical input of the Discounted Cash Flow model is the cash flow projections. As stated earlier, the Discounted Cash Flow value is as good as the assumptions used in developing the projections. These projections should reflect the best estimates of the management and take into account various macro and microeconomic factors affecting the business. Some of the important points to be kept in mind with regard to cash flow projections based on the projection of the profitability are stated below: ( a) Cash flow projections should reasonably capture the growth prospects and earnings capability of a company. The earn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of future profits will depend entirely upon the effect which in the opinion of the valuer, such changes will have on such future profits. ( h) An appropriate allowance must be made for capital expenditure in projections. They should not include capital expenditure only for capacity expansion or growth but also for maintenance of the existing capacity. ( i) Working capital requirement forms another important component. Projections should appropriately account for working capital needs of the business in its different phases. ( j) Income tax outflow also impacts the value of a business and should incorporate any tax benefits like tax holiday, accumulated losses, etc. In making projections, notional tax calculated at the rates expected to be applicable to the company in future should normally be deducted. For instance, the rate may change if the company is planning to undertake activities on which tax incidence is lower. Where such rates are not available, the current rates of taxes may be considered a good indicator. Tax benefits due to accumulated losses, accumulated development rebates or allowance, investment allowance, unabsorbed depreciation etc. should not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alued as a going concern, its value should account for the cash flows over the entire life of a company, which can be assumed to be infinite. Because the cash flows are estimated only for the forecast period, a terminal value is estimated to reflect the value of the cash flows arising after the forecast period. Terminal value can be computed in a number of ways; some prominent ones are discussed below: ( a) Perpetual growth model assumes that a business has an infinite life and a stable growth rate of cash flows. Terminal value is derived mathematically by dividing the perpetuity cash flows (cash flows which are expected to grow at a stable pace) with the discount rate as reduced by the stable growth rate. Estimation of the stable growth rate is of great significance because even a minor change in stable growth rate can change the terminal value and the business value too. Various factors like the size of a company, existing growth rate, competitive landscape, profit reinvestment ratio, etc. have to be kept in mind while estimating the stable growth rate. ( b) Multiple approach involves the determination of an appropriate multiple to be applied on perpetuity earnings ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rt restrictions), but may flounder under 'open market' conditions. ( e) Government policy Government policy in general and in relation to particular industry (as with restriction or banning of manufacture of alcohol in the case of alcohol based chemical industries). ( f) Prevailing political climate Political climate in an area can affect the prosperity of a business, e.g. tourism trade is directly affected due to breakdown in the law and order situation in a state. ( g) Risk of obsolescence of items manufactured In case the products manufactured by an enterprise face a higher risk of obsolescence, it may influence the value of its shares adversely. ( h) Existence of convertible rights Existence of convertible rights would also affect the value of a share. ( i) The effect of other external factors The value of shares is also affected by factors such as war, embargo or other restrictions on international trade or disruptions in international trade. 9.2 While preparing a Report, it is important that one states its purpose explicitly and ensures that the facts are presented with clarity so that the reader of the Report appreciates ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... minority stake, discount for illiquidity, etc. ( v) Brief analysis of the peer set companies used in relative valuation. ( vi) Adjustments to the multiples based on the peer set company, including rationale for the same. ( vii) Details of the surplus assets and treatment thereof in the valuation. ( viii) Any other special factors, such as government subsidy, tax breaks, etc. ( h) Fair Value This paragraph should deal with the valuation of shares on the basis of discussion in the preceding part of the Report (and in case of amalgamation, also the exchange ratio). This paragraph should also offer justification for the approaches actually adopted. It could also deal with the justification of adjustments considered necessary for arriving at the value, for example, of the discounting due to restriction on transfer of shares; reduction made in the net maintainable profit due to changed circumstances; or weightage given to certain recent years in arriving at the fair value, etc. ( i) Computation Usually, the report should also contain annexures giving information regarding the working of the approaches employed for valuation. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion may not be possible. It was held that if this is satisfied than the liability is not a contingent liability. In the second case, the issue in dispute was about provision of warranty expenses to be incurred in future. Para 10 of this judgment is very relevant and therefore, it is reproduced herein below:- 10. What is a provision ? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when : (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. 10. From this Para of this judgment, it is seen that it was held that if a reliable estimate cannot be made than the provision cannot be recognized. In the present case in connection with DCF, we have seen that estimate/ projection of future cash flow has to be made and as per Para 2.10 of this report of research committee of (ICAI) as reproduced above, the first and m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on either by himself or by calling for a final determination from an independent valuer to confront the petitioner. However, the basis has to be the DCF Method and it is not open to him to change the method of valuation which has been opted for by the Assessee. If Mr. Mohanty is correct in his submission that a part of demand arising out of the assessment order dated 21st December, 2017 would on adoption of DCF Method will be sustained in part, the same is without working out the figures. This was an exercise which ought to have been done by the Assessing Officer and that has not been done by him. In fact, he has completely disregarded the DCF Method for arriving at the fair market value. Therefore, the demand in the facts need to be stayed. 12. As per above Para of this judgment of Hon ble Bombay High Court, it was held that the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a final determination from an independent valuer to confront the assessee. But the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee. Hence, in our considered opinion, in the present ..... X X X X Extracts X X X X X X X X Extracts X X X X
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