2021 (3) TMI 239 - HC - Income Tax

Assessee's DCF share valuation upheld under Section 56(2)(vii)(b) despite actual performance not matching projections

The Delhi HC upheld the assessee's share valuation using the Discounted Cash Flow method for determining fair market value under Section 56(2)(vii)(b). ... Addition u/s 56(2)(vii)(b) - projection/estimated figures as presented in the valuation report - Assessee has received share premium from various subscribers/equity partners - Determination of fair market values as per prescribed methodology - Cash Flow projections taken into account in the Discounted Cash Flow Method by the assessee are nothing but paper plans that have no relation with the reality - AO analysed the business profitability of the Respondent-Assessee only to the extent that such profitability was not commensurate with the actual financials provided by the Respondent-Assessee during the course of assessment proceedings - whether the AO after invoking the deeming provision under Section 56(2)(viib), could have determined the FMV of the premium on the shares issued at nil after rejecting the valuation report given by the Chartered Accountant based on one of the prescribed methods under the Rules adopted by the valuer? - HELD THAT:- Determination of fair market values as per prescribed methodology. Appellant-Revenue had the option to conduct its own valuation and determine FMV on the basis of either the DCF or NAV Method. Assessee being a start-up company adopted DCF method to value its shares. This was carried out on the basis of information and material available on the date of valuation and projection of future revenue. There is no dispute that methodology adopted by Assessee has been done applying a recognized and accepted method. Since the performance did not match the projections, Revenue sought to challenge the valuation, on that footing. This approach lacks material foundation and is irrational since the valuation is intrinsically based on projections which can be affected by various factors. We cannot lose sight of the fact that the valuer makes forecast or approximation, based on potential value of business. However, the underline facts and assumptions can undergo change over a period of time. The Courts have repeatedly held that valuation is not an exact science, and therefore cannot be done with arithmetic precision. It is a technical and complex problem which can be appropriately left to the consideration and wisdom of experts in the field of accountancy, having regard to the imponderables which enter the process of valuation of shares. The Appellant-Revenue is unable to demonstrate that the methodology adopted by the Assessee is not correct. AO has simply rejected the valuation of the Respondent-Assessee and failed to provide any alternate fair value of shares. As noted in the impugned order and as also pointed out by Mr. Vohra, the shares in the present scenario have not been subscribed to by any sister concern or closely related person, but by outside investors. Indeed, if they have seen certain potential and accepted this valuation, then Appellant-Revenue cannot question their wisdom. The valuation is a question of fact which would depend upon appreciation of material or evidence. The methodology adopted by the Respondent-Assessee, accepted by the learned ITAT, is a conclusion of fact drawn on the basis of material and facts available. The test laid down by the Courts for interfering with the findings of a valuer is not satisfied in the present case, as the Respondent-Assessee adopted a recognized method of valuation and Appellant-Revenue is unable to show that the assessee adopted a demonstrably wrong approach, or that the method of valuation was made on a wholly erroneous basis, or that it committed a mistake which goes to the root of the valuation process. No question of law. Issues Involved:1. Applicability of Section 56(2)(viib) of the Income Tax Act, 1961.2. Validity of the valuation method adopted by the Respondent-Assessee.3. Justification of the share premium received by the Respondent-Assessee.4. Commercial prudence and business decisions of the Respondent-Assessee.5. Role and authority of the Assessing Officer (AO) in questioning the valuation report.Issue-wise Detailed Analysis:1. Applicability of Section 56(2)(viib) of the Income Tax Act, 1961:The primary issue revolves around whether Section 56(2)(viib) is applicable to the share premium received by the Respondent-Assessee. The AO added the share premium to the Respondent-Assessee's income, citing that the projections used in the valuation report were not substantiated by actual financials. The ITAT, however, noted that the Respondent-Assessee followed the prescribed method under Section 56(2)(viib) read with Rule 11UA(2)(b), and the identity, creditworthiness, and genuineness of the investors were established. The ITAT concluded that the AO's rejection of the valuation report was unjustified as the methodology used was recognized and accepted under the law.2. Validity of the Valuation Method Adopted by the Respondent-Assessee:The Respondent-Assessee used the Discounted Cash Flow (DCF) method for valuation, which is one of the prescribed methods under the Income Tax Rules. The AO rejected this valuation, arguing that the projections did not match actual revenues. The ITAT emphasized that valuation is based on projections and various factors, and cannot be evaluated with arithmetic precision. The ITAT observed that the AO did not have the authority to replace the valuation method adopted by the Respondent-Assessee with his own or to question the commercial wisdom behind the projections.3. Justification of the Share Premium Received by the Respondent-Assessee:The AO argued that the high share premium was unjustified as the Respondent-Assessee invested the funds in zero percent debentures of associate companies, which did not yield returns. The ITAT countered this by stating that strategic investments are made for capital appreciation and not just for immediate returns. The ITAT held that the business decisions of the Respondent-Assessee, including the investment in zero percent debentures, were made with the objective of long-term gains and could not be questioned by the AO.4. Commercial Prudence and Business Decisions of the Respondent-Assessee:The ITAT highlighted that the Income Tax Department cannot dictate how a business should be run or question the commercial prudence of the business decisions made by the Respondent-Assessee. The investments made by the Respondent-Assessee were strategic and aimed at future growth. The ITAT noted that renowned investors like Anand Mahindra, Rakesh Jhunjhunwala, and Radhakishan Damani invested in the Respondent-Assessee, indicating their confidence in its future prospects. The ITAT concluded that the AO's approach of questioning these business decisions was inappropriate.5. Role and Authority of the Assessing Officer (AO) in Questioning the Valuation Report:The ITAT stated that the AO did not have the authority to reject the valuation report provided by a qualified valuer using a prescribed method. The ITAT noted that the AO did not provide any alternate valuation or method but simply rejected the Respondent-Assessee's valuation. The ITAT emphasized that the law does not permit the AO to substitute his own valuation in place of the one provided by the Respondent-Assessee's valuer. The ITAT concluded that the AO's actions were beyond his jurisdiction and not supported by the statutory provisions.Conclusion:The appeal by the Appellant-Revenue was dismissed, with the ITAT's order being upheld. The ITAT's detailed analysis demonstrated that the Respondent-Assessee followed the prescribed valuation method, and the AO's rejection of the valuation report was unjustified. The ITAT emphasized the importance of respecting the commercial decisions of the business and the limitations of the AO's authority in questioning the valuation methodology. The court found no substantial question of law for consideration, leading to the dismissal of the appeal.