2023 (5) TMI 1463 - AT - Income Tax

Assessee's Rule 11UA DCF valuation must be reviewed only within DCF parameters; AO to identify defects and report

The Deputy Commissioner of Income Tax, Circle 16 (1), Hyderabad. Versus M/s. NCL Green Habitats Private Limited

ITAT allowed the appeal for statistical purposes and remanded the matter to the AO for verification of figures underlying a DCF valuation of share ... Addition made towards “share premium - Determination of fair market value - Whether CIT(A) erred in deleting the addition made towards ‘share premium’ without considering the factual figures of turnover and profit but relied on valuation report submitted by the assessee? - HELD THAT:- From the conjoint reading of section 56(2)(viib) read with Rule 11UA of I.T. Rules, 1962, it is abundantly clear that in case, the assessee opts for determination of the fair market value of the shares and exercise its right by opting for any of the methods prescribed under rules, then such decision of the assessee shall be final. AO/ CIT(A) can only scrutinize the valuation report within the conditions or parameters laid down for DCF method only. It is not within the domain of the AO to reject the method opted by the assessee and resort to vacate the method as per the Assessing Officer’s choice. Method adopted by the assessee namely, DCF, is required to be adopted by the AO for the purpose of estimating Fair Market Value of the shares allotted by the assessee to its shareholding companies. Having held so, now the question is whether the Assessing Officer has pointed out any defect in the working of the DCF method. CIT(A) has called for remand report from the Assessing Officer and the Assessing Officer, in the said remand report, had not raised any objection about the working of the valuation made by the assessee by applying DCF method. On the contrary, the Assessing Officer has compared the actual figures with the projected figures on the basis of which the valuation of the shares was made. In the present case, though the AO was given an opportunity in the remand stage to bring on record any defect in working of the DCF method, however, the AO has not brought on record any defect in the valuation report. As both the parties have agreed that the issue may be remanded back to the AO for verifying the figures considered by valuer, therefore, one more opportunity is given to the Assessing Officer for applying his mind and bring on record any contradiction in the valuation report. This is necessary as neither the assessee nor the Revenue were able to justify how the valuation was arrived by the Chartered Accountant. Hence, we are of the opinion that the matter be remanded back to the file of Assessing Officer with a direction to examine the valuation report and point out any error in the same. Appeal allowed for statistical purposes. ISSUES PRESENTED AND CONSIDERED 1. Whether, for the purpose of determining fair market value of unquoted equity shares under section 56(2)(viib) read with Rule 11UA, an assessee's election to use the Discounted Cash Flow (DCF) method precludes the Assessing Officer from adopting a different valuation method. 2. Whether the Assessing Officer may discard or reject a DCF valuation submitted by the assessee on the basis that projected cash flows do not match subsequent actuals, absent contemporaneous defects in the DCF working or recorded reasons based on facts available on the valuation date. 3. What is the scope and manner of scrutiny available to the Assessing Officer when examining a valuation report prepared under the DCF method under Rule 11UA - including the Assessing Officer's duty to record reasons, to obtain a fresh valuation and to confront the assessee. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of chosen method (DCF) and prohibition on AO changing method Legal framework: Section 56(2)(viib) charges consideration received for issue of shares in excess of face value where consideration exceeds fair market value; Explanation prescribes that fair market value may be determined by methods prescribed by rule. Rule 11UA(1)(c)/(2) prescribes computation for fair market value of unquoted equity shares and expressly permits, at the option of the assessee, determination by specified formulae or by merchant banker using DCF. Precedent treatment: The judgment relies on higher-court guidance (reproduced reasoning) holding that valuation method elected by assessee (NAV or DCF) must be respected as the basis; Assessing Officer may scrutinise but not change the method chosen by the assessee. Interpretation and reasoning: Conjoint reading of section 56(2)(viib) and Rule 11UA leads to the conclusion that once the assessee opts for a prescribed method (here DCF), that method is to be the basis for valuation. The Assessing Officer's role is confined to scrutiny of the valuation report within parameters of the method elected and to test the assumptions and computations; the AO cannot substitute an alternative basis of valuation merely because he prefers a different method. Ratio vs. Obiter: Ratio - the tribunal's holding that the AO cannot change the valuation method elected by the assessee when Rule 11UA permits choice; he can only scrutinise the report within that method. Obiter - ancillary observations about comparative tribunal orders cited by parties, to the extent they differ from the preferred higher-court guidance. Conclusion: The DCF method, once validly elected and applied under Rule 11UA, must be taken as the basis for valuation; AO cannot change the method but can scrutinise and test the DCF report. Issue 2 - Admissibility of post-facto actuals to reject DCF projections Legal framework: DCF valuation depends critically on cash flow projections and discounting/terminal value; Rule 11UA contemplates reliance on projections and merchant banker/accountant valuation prepared on facts available as at valuation date. Precedent treatment: The tribunal refers to authority holding that reliability of projections must be judged on facts available at valuation date and that subsequent actual results cannot, without more, be used to discredit contemporaneous projections. Interpretation and reasoning: The Assessing Officer compared projections in the valuation report with later actual results and treated variance as a ground to reject the DCF valuation. The tribunal reasons that such post-facto comparison cannot be the sole criterion to reject a valuation prepared on earlier facts; instead, scrutiny must focus on whether projections were reasonable and supported by evidence available at valuation date. The tribunal emphasises that DCF is as good as the assumptions used and that projections should be capable of being shown as reasonable with empirical data or industry norms when challenged, but that actual future performance is not a fair yardstick to impugn contemporaneous estimates. Ratio vs. Obiter: Ratio - AO must consider only data and rationale available on valuation date when deciding on reliability of projections; post-valuation actuals generally cannot be used to invalidate DCF projections. Obiter - remarks distinguishing start-ups (where past data may be absent) and stating that expectations may be accepted if shown reasonable considering macro/micro factors. Conclusion: The AO cannot responsibly reject a DCF report solely on the basis that projected cash flows diverged from later actuals; the correct test is whether projections were reasonable and supported by facts available at the time of valuation. Issue 3 - Scope of AO's scrutiny, duty to record reasons and procedure on dissatisfaction with DCF report Legal framework: Rule 11UA allows valuation by an accountant or merchant banker; tax administration requires Assessing Officer to examine and record reasons when declining to accept taxpayer's computation; principles of natural justice require opportunity to be given to the assessee before arriving at an adverse conclusion. Precedent treatment: The tribunal follows the higher-court direction that AO can scrutinise the valuation report, may procure a fresh valuation or determine valuation himself, but must do so on the same methodological basis (i.e., DCF) and must record reasons and confront the assessee with the alternative valuation. Interpretation and reasoning: Where the AO is not satisfied with an assessee's DCF report, he must (i) record specific reasons grounded in facts available at the valuation date explaining why the report is unacceptable; (ii) if he seeks to determine a different figure, he must do so applying the DCF method (not by switching to NAV or another method); (iii) he may obtain a fresh valuation from an independent valuer and must afford the assessee an opportunity to meet the contentions. The tribunal found that the AO in remand did not point out defects in DCF working and therefore remanded for the AO to apply his mind, record reasons if dissatisfied, and, if necessary, obtain or prepare a corrected DCF valuation and confront the assessee after hearing. Ratio vs. Obiter: Ratio - AO's powers and procedural duties: (a) scrutiny within chosen method; (b) requirement to record reasons when rejecting valuation; (c) duty to obtain fresh valuation and to afford hearing before finalising assessment. Obiter - guidance on evidentiary support the assessee should ideally provide (empirical data, industry norms, scientific method) when onus lies on him to prove projections. Conclusion: The AO may scrutinise, re-value or obtain an independent valuation only after recording substantive reasons based on valuation-date facts; he cannot change the valuation method; failure to do the said exercise requires remand for fresh consideration consistent with these obligations. Final disposition (as applied) The Tribunal held that the DCF method elected by the assessee must be the basis for valuation; the Assessing Officer failed, on remand, to point out contemporaneous defects in the DCF working and improperly relied on post-facto variances. The matter is remanded to the Assessing Officer to scrutinise the valuation report, record specific reasons if dissatisfied, and, if necessary, obtain or prepare a corrected valuation using the DCF method while affording the assessee an opportunity of hearing. The appeal is allowed for statistical purposes (remand directed).