2024 (4) TMI 447 - AT - Income Tax

AO cannot substitute qualified valuer's DCF method valuation under section 56(2)(viib) Rule 11U

ITO Ward-3 (1) (3) Bangalore Versus Irunway India Pvt. Ltd., Bangalore

The ITAT Bangalore ruled in favor of the assessee in a case involving addition under section 56(2)(viib) for shares issued above fair market value. The AO ... Addition u/s 56(2)(viib) - closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares - CIT(A) rejecting the working of fair market value of shares at Rs. 36.76/- per share by AO and allowing the fair market value of shares at Rs. 185.92 per share as per DCF method by assessee thus deleted addition - HELD THAT:- There has to be some enabling provision under the rule or the Act where AO has been given a power to tinker with the valuation report obtained by an independent Valuer as per the qualification given in the rule 11U. Here, in this case, AO has tinkered with DCF methodology and rejected by comparing the projections with actual figures. The Rules provide for two valuation methodologies, one is assets based NAV method which is based on actual numbers as per latest audited financials of the assessee company. Whereas in a DCF method, the value is based on estimated future projection. These projections are based on various factors and projections made by the management and the Valuer, like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and host of other factors. These factors are considered based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based on approximation and catena of underline facts and assumptions. Nevertheless, at the time when valuation is made, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and thus, the value which is relevant today may not be relevant after certain period of time. From time to time various courts/Tribunals have held that as per section 56(2)(viib) r.w.R 11UA, the assessee has the option to do valuation of shares and determine FMV either on DCF Method or NAV method and AO cannot substitute his own value in place so determined. Similar issue came for consideration before case of Cinestaan Entertainment P. Ltd. [2021 (3) TMI 239 - DELHI HIGH COURT] where in held if law provides the assessee to get the valuation done from a prescribed expert as per the prescribed method, then the same cannot be rejected because neither the Assessing Officer nor the assessee have been recognized as expert under the law. Decided in favour of assessee. Issues Involved:1. Valuation of Fair Market Value (FMV) of Shares.2. Invocation of Section 56(2)(viib) of the Income Tax Act.3. Delay in Filing the Appeal by the Revenue.Summary:1. Valuation of Fair Market Value (FMV) of Shares:The core issue was whether the CIT(A) was correct in rejecting the AO's valuation of shares at Rs. 36.76 per share and accepting the assessee's valuation at Rs. 185.92 per share using the DCF method, thus deleting the addition of Rs. 3,63,91,076/-. The AO contended that the DCF method used by the assessee was based on future projections, which did not match actual figures, and thus recalculated the FMV at Rs. 36.76 using Rule 11UA(2)(a). The NFAC observed that Section 56(2)(viib) allows the assessee to choose between DCF and NAV methods for valuation, and the AO cannot substitute his own valuation if the prescribed method is used by the assessee. The NFAC relied on several judgments, including the ITAT Delhi Bench in the case of Cinestaan Entertainment P. Ltd., which held that the AO must accept the valuation method chosen by the assessee if it complies with the rules.2. Invocation of Section 56(2)(viib) of the Income Tax Act:The assessee argued that the AO erred in invoking Section 56(2)(viib) without appreciating that the share issue price was consistent with independent third-party transactions. The AO's rejection of the DCF method was deemed incorrect as it failed to consider that projections are inherently based on estimates and various factors. The NFAC and the Tribunal emphasized that the AO cannot question the commercial prudence of the investors or the valuation method adopted by the assessee if it is one of the prescribed methods under the Act. The Tribunal cited the Delhi High Court's affirmation in the Cinestaan Entertainment case, which underscored that valuation is not an exact science and must be based on reasonable projections.3. Delay in Filing the Appeal by the Revenue:There was a delay of 302 days in filing the appeal by the revenue, attributed to the backlog of judicial work due to the Covid pandemic and subsequent administrative pressures. The Tribunal found the reason for the delay reasonable and condoned it, admitting the appeal for adjudication.Conclusion:The Tribunal dismissed the revenue's appeal, upholding the NFAC's decision that the AO must accept the valuation method chosen by the assessee if it complies with the prescribed rules. The CO filed by the assessee was dismissed as infructuous since the appeal of the revenue was dismissed.