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2025 (5) TMI 1563 - AT - Income TaxAddition u/s 56(2)(viib) - excess receipt of share premium on issue of Non-Cumulative Compulsory Convertible Preference Shares (NCCCPS) - AO in rejecting the fair market value of NCCCPS computed by an independent chartered accountant using the Discounted Cash Flow Method - HELD THAT - AO had rejected valuation done by DCF Method adopted by the Assessee by stating that the projections were not independently verified by the valuer no infirmity was pointed out in the projections apart from the surge in the projected cash flows which was explained by the Assessing Officer and the independent valuer. CIT(A) had confirmed the order of the AO observing that the Assessee had failed to produce documents and substantiate the basis of cash flow estimates/projections. On perusal of record we find the aforesaid finding to be factually incorrect. As noted valuation report was supported/corroborated by the (a) projected cash flows (b) Profit Loss Account and Balance Sheet of the Assessee for the Financial Years 2012-2013 to 2017-2018 (c) Sheet depicting the basis for valuation of proposed divestment of assessee s holding in Entercom Inc. and Onprocess Technology Inc. and (d) Financial Statements of wholly owned subsidiary as on 31/03/2014. During the assessment proceedings it was explained that for the purpose of preparing projections it was assumed that there would be a steady growth of revenues. The surge in the cash flows in Financial Year 2013-2014 and Financial Year 2016-2017 was on account of estimated gains from the proposed disinvestment of Entercoms Inc. and Onprocess Technology Inc. respectively. The fair market value of the investments as recorded in the Financial Statements of the wholly owned subsidiary as on 31/03/2014 supported the proposed estimated gains. Thus we find that in the present case the Assessee had provided justification for the projections adopted while computing the value using DCF Method and no infirmity other than surge in cash flows which was explained by the Assessee and the independent valuer was highlighted by the AO or the CIT(A). Therefore the reliance placed by CIT(A) on the decision of Agro Portfolio (P) Ltd. 2018 (5) TMI 1088 - ITAT DELHI and TUV Rheinland NIFE 2019 (3) TMI 158 - ITAT BANGALORE was misplaced. AO was not justified in rejecting the DCF Method adopted by the Assessee for valuing the Shares. Therefore addition u/s 56(2)(viib) of the Act is deleted. Assessee appeal allowed.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered in this appeal are: (a) Whether the addition of Rs. 8,10,00,000/- under Section 56(2)(viib) of the Income Tax Act, 1961, on account of alleged excess receipt of share premium on issue of Non-Cumulative Compulsory Convertible Preference Shares (NCCCPS) was justified. (b) Whether the Assessing Officer (AO) was justified in rejecting the valuation of shares computed by the independent valuer using the Discounted Cash Flow (DCF) Method. (c) Whether the AO was correct in applying the Net Asset Value (NAV) / Book Value Method instead of the DCF Method to determine the fair market value (FMV) of the shares. (d) Whether the Commissioner of Income Tax (Appeals) (CIT(A)) erred in upholding the AO's addition and in rejecting the DCF valuation on the ground that the Assessee failed to substantiate the basis of cash flow projections. (e) Whether the Assessee had the statutory right under Rule 11UA of the Income Tax Rules, 1962, to choose the method of valuation (DCF or NAV) and whether the AO could override that choice. 2. ISSUE-WISE DETAILED ANALYSIS Issue (a) and (b): Validity of addition under Section 56(2)(viib) and rejection of DCF valuation Relevant legal framework and precedents: Section 56(2)(viib) of the Income Tax Act provides that if a closely held company receives consideration for issue of shares exceeding the face value, the excess over the fair market value of such shares is taxable as income from other sources. Rule 11UA of the Income Tax Rules prescribes two methods for determining FMV of shares: the Discounted Cash Flow (DCF) Method and the Net Asset Value (NAV) Method. The Assessee is entitled to select either method. Precedents relied upon include the decision in Vodafone M. Pesa v. PCIT, where the Bombay High Court held that the Assessee has the option to choose the valuation method under Rule 11UA and the Department should not interfere with this choice unless the valuation is not substantiated. Further, ITAT Bangalore in TUV Rheinland NIFE v. ITO upheld the AO's rejection of DCF valuation where projections were unsubstantiated, and ITAT Delhi in Agro Portfolio (P.) Ltd. v. ITO held that if projections cannot be substantiated or verified, the AO may reject the DCF method and adopt NAV method. Court's interpretation and reasoning: The AO rejected the DCF valuation of Rs. 250 per share on the ground that the independent valuer had relied on management projections without adequate verification or supporting documents, and instead applied the NAV method to arrive at a lower FMV of Rs. 115 per share. This resulted in an addition of Rs. 8,10,00,000/- under Section 56(2)(viib). The CIT(A) accepted that the Assessee had the right to choose the valuation method but upheld the addition on the basis that the Assessee failed to substantiate the projections underlying the DCF valuation. The CIT(A) relied on the above precedents to hold that the AO was justified in rejecting the DCF method where projections were not adequately supported. Key evidence and findings: The independent valuer's statement under Section 131 of the Act revealed that the cash flow projections were based on management estimates, assumptions, and business acumen, but reasonable due diligence was undertaken and projections were not blindly relied upon. The surge in projected cash flows in certain years was explained as arising from anticipated gains from divestments of investments held through the Assessee's wholly owned subsidiary. The Assessee furnished detailed supporting documents during assessment proceedings, including:
The Assessee also explained deviations between projected and actual revenues, attributing shortfalls to macroeconomic factors and market volatility affecting divestment timing. Application of law to facts: The Tribunal noted that the Assessee had provided reasonable justification and documentary evidence supporting the cash flow projections used in the DCF valuation. The surge in projected cash flows was explained and corroborated by the fair market value of investments in the subsidiary's audited financials. The AO and CIT(A)'s conclusion that the projections were unsubstantiated was factually incorrect as the Assessee had furnished adequate supporting documents and explanations. Therefore, the AO was not justified in rejecting the DCF valuation and substituting the NAV method, which resulted in the impugned addition under Section 56(2)(viib). Treatment of competing arguments: The Department argued that the independent valuer had relied on unverified management projections and failed to provide supporting documents. The Assessee countered that due diligence was undertaken, and supporting documents were submitted during assessment proceedings. The Tribunal found the Assessee's submissions and documentary evidence credible and sufficient to substantiate the DCF valuation. Conclusions: The addition under Section 56(2)(viib) based on rejection of the DCF valuation was unsustainable. The AO's and CIT(A)'s findings on lack of substantiation were factually incorrect. The Assessee's valuation using DCF method was upheld. Issue (c) and (d): Validity of AO's application of NAV method and CIT(A)'s confirmation of addition Relevant legal framework and precedents: Rule 11UA allows the Assessee to choose either DCF or NAV method for valuation of shares. However, the AO has the authority to verify the accuracy and basis of the valuation and reject it if projections are not verifiable or reliable, as held in the cited ITAT decisions. Court's interpretation and reasoning: The AO's application of NAV method was predicated on the rejection of the DCF valuation due to alleged lack of substantiation of projections. The CIT(A) confirmed this approach based on precedents allowing the AO to override the Assessee's choice in such circumstances. However, since the Tribunal found that the Assessee had adequately substantiated the projections and valuation, the AO's rejection of DCF and adoption of NAV was not justified. Key evidence and findings: The Tribunal reviewed the supporting documents and explanations provided by the Assessee and independent valuer, including audited financials and detailed projections, which were not effectively challenged by the AO or CIT(A). Application of law to facts: The AO's authority to override the Assessee's choice of valuation method is conditional on the valuation being unsubstantiated or unverifiable. Since the Assessee's valuation was substantiated, the AO's application of NAV method was improper. Treatment of competing arguments: The Department's reliance on precedents was misplaced in the facts of this case, where the Assessee had furnished adequate evidence. The Tribunal distinguished the present facts from those cases. Conclusions: The AO was not justified in rejecting the DCF valuation and applying the NAV method. The CIT(A)'s confirmation of the addition on this basis was also erroneous. Issue (e): Assessee's statutory right to choose valuation method under Rule 11UA Relevant legal framework and precedents: Rule 11UA of the Income Tax Rules, 1962, provides two methods for valuation of shares for the purposes of Section 56(2)(viib): (i) Discounted Cash Flow Method and (ii) Net Asset Value Method. The Assessee has the option to choose either method. The Bombay High Court in Vodafone M. Pesa v. PCIT held that the Department should not interfere with the Assessee's choice of valuation method unless the valuation is unsubstantiated or incorrect. Court's interpretation and reasoning: The Tribunal noted that the CIT(A) correctly accepted the Assessee's right to choose the method under Rule 11UA but erred in confirming the addition on the basis that the Assessee failed to substantiate the valuation. The Tribunal emphasized that the right to choose valuation method is subject to the valuation being bona fide and substantiated. Key evidence and findings: The Assessee had chosen the DCF method and supported it with a detailed valuation report, independent valuer's statement, financial statements, and projections. The Department failed to demonstrate that the valuation was unsubstantiated or incorrect. Application of law to facts: The Tribunal held that the Assessee's choice of DCF valuation method was valid and the AO could not override it without valid reasons. The Department's rejection of the DCF method was not justified on the facts. Treatment of competing arguments: The Department argued that the projections were unsubstantiated. The Tribunal rejected this contention based on the documentary evidence and explanations provided. Conclusions: The Assessee's statutory right to choose the DCF method under Rule 11UA was upheld, and the AO's rejection of this choice was not justified. 3. SIGNIFICANT HOLDINGS "The Assessee had provided justification for the projections adopted while computing the value using DCF Method and no infirmity [other than surge in cash flows which was explained by the Assessee and the independent valuer] was highlighted by the Assessing Officer or the CIT(A). Therefore, the reliance placed by the Learned CIT(A) on the decision of Delhi Bench of the Tribunal in the case of Agro Portfolio (P) Ltd. (supra) and the Bangalore Bench of the Tribunal in the case of TUV Rheinland NIFE Vs. ITO [ITA No.3160/Bang/2018, dated 27/02/2019] was misplaced. Accordingly, we hold that in the facts and circumstances of the present case the Assessing Officer was not justified in rejecting the DCF Method adopted by the Assessee for valuing the Shares." "The addition of INR. 8,10,00,000/- made by the Assessing Officer under Section 56(2)(viib) of the Act is deleted." Core principles established:
Final determinations on each issue:
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