2023 (6) TMI 335 - AT - Income Tax

Valuation method upheld for unquoted shares; AO's attempt rejected; DCF method justified.

The CIT(A) upheld the use of the DCF method for valuing unquoted shares, rejecting the AO's attempt to change the valuation method. The CIT(A) found the ... Valuation of shares at a premium u/s 56(2)(viib) - FMV determined under DCF method of the unquoted shares - Whether AO is correct in rejecting the DCF method and the FMV determined under DCF method by comparing the actual performance figures with the projections used under the DCF method? - HELD THAT:- CIT(A) concluded correctly that in the instant case there is no merit in rejecting the DCF method on the ground of mismatch between the projections adopted in DCF method and those achieved during the first two years post-valuation date. Whether the AO can change the method of valuation of unquoted shares under Rule 11UA of I.T. Rules 1962? - Rule 11UA(2) prescribes two methods - Book Value method and DCF method. However, the said rule also provides that the method to be adopted is left to the choice of the assessee. The option to choose the method to be adopted to determine the FMV of unquoted shares is not with the AO but with the assessee. In the instant case the assessee opted for the DCF method and the AO could not have switched the method from DCF to Book Value method for determining the FMV of the unquoted shares. Whether the AO erred in rejecting the DCF method because the Valuer failed to furnish the documents called for by him? - It is noted here that there is merit in the AO' s observation that the valuation report is very brief. However, in the absence of any prescribed format or size, one cannot reject the valuation merely on that ground. Further, the AO has not pointed out any specific deficiency in the Valuation Report itself - Hence, it would be incorrect to reject the DCF method solely on that ground. Keeping in view that DCF is correct method of determining the FMV of the unquoted shares, the assessee has option to determine the method of valuation and the AO has no power to reject the method resorted by the assessee, the results in the instant case of the holding company have exceed the projections, as no infraction of methodology has been brought out by the AO and non-payment of advance tax cannot be a collateral reason to reject the DCF method, we decline to interfere with the well reasoned order of the ld. CIT(A). Decided against revenue. Issues Involved:1. Rejection of DCF method by AO.2. AO's authority to change valuation method.3. Rejection of DCF method due to valuer's failure to furnish documents.4. Appropriateness of DCF method.5. AO's rejection of DCF method prescribed by law.6. Requirement to prove intention to evade tax under section 56(2)(viib).7. AO's observation on non-payment of advance tax as per projections.Summary:Issue 1: Rejection of DCF Method by AOThe AO rejected the DCF method by comparing actual performance with projections. The CIT(A) noted that the AO's approach was unfair and against valuation principles, as the AO used hindsight to critique the projections. The CIT(A) found that the actual performance of the holding company and its subsidiaries was better than the projections, thus supporting the DCF method used.Issue 2: AO's Authority to Change Valuation MethodThe CIT(A) held that the AO cannot change the method of valuation of unquoted shares under Rule 11UA of the IT Rules, 1962. The rule allows the assessee to choose between the Book Value method and the DCF method, and the AO does not have the authority to override this choice.Issue 3: Rejection of DCF Method Due to Valuer's Failure to Furnish DocumentsThe AO rejected the DCF method, citing the valuer's lack of understanding and failure to produce documents. The CIT(A) found that the valuer had provided sufficient answers and documents later, and the AO's rejection based on the briefness of the valuation report was not justified.Issue 4: Appropriateness of DCF MethodThe CIT(A) affirmed that the DCF method is a recognized and appropriate method for valuing shares of a going concern. The method is based on future cash flow projections and is widely accepted by professional and accounting bodies, including ICAI.Issue 5: AO's Rejection of DCF Method Prescribed by LawThe CIT(A) concluded that the AO cannot reject the DCF method as it is one of the prescribed methods under Rule 11UA. The AO's role is not to select or reject the valuation method but to ensure the methodology used is correct and as per standards.Issue 6: Requirement to Prove Intention to Evade TaxThe CIT(A) clarified that there is no requirement to show the intention to evade tax to invoke section 56(2)(viib). The provision applies when there is a difference between the FMV of shares and the consideration received, regardless of any intention to evade tax.Issue 7: AO's Observation on Non-Payment of Advance TaxThe AO observed that the non-payment of advance tax as per the projections indicated that the projections were unrealistic. The CIT(A) found this reasoning insufficient to reject the DCF method, noting that the actual performance exceeded the projections.Conclusion:The CIT(A) deleted the addition made by the AO, supporting the use of the DCF method and rejecting the AO's authority to change the valuation method. The appeal by the Revenue was dismissed, upholding the CIT(A)'s well-reasoned order.