2025 (5) TMI 22 - AT - Income Tax

Assessee can choose NAV or DCF method for preference share valuation under Rule 11UA(1)(c)

M/s. Anatole Solutions Pvt Ltd. Versus The ACIT Circle-2 Jaipur

M/s. Anatole Solutions Pvt Ltd. Versus The ACIT Circle-2 Jaipur - TMI The core legal issues considered by the Tribunal in this appeal are as follows:1. Whether the addition of Rs. 29,84,733 made under Section 56(2)(viib)/68 of the Income Tax Act on account of alleged unexplained credit/share premium received by the assessee company is justified, particularly in light of the valuation method adopted and the creditworthiness of the investors.2. Whether the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] erred in disregarding the valuation report based on the Discounted Cash Flow (DCF) method and instead applying the Net Asset Value (NAV) method to determine the Fair Market Value (FMV) of shares for the purpose of Section 56(2)(viib).3. Whether the invocation of Section 115BBE of the Income Tax Act, which prescribes a higher tax rate on unexplained credits, was legally valid and applicable to the facts of the case, especially considering the timing of receipt of share capital and the amendment to the section.4. Whether the AO and CIT(A) violated principles of natural justice by not providing specific and proper show cause notices before making additions.5. Whether the charging of interest under Sections 234A, 234B, and 234C was justified.Issue 1 & 2: Addition under Section 56(2)(viib) and Valuation MethodologyThe relevant legal framework for valuation of shares under Section 56(2)(viib) is that when a closely held company receives consideration for issue of shares exceeding the FMV, the excess is taxable as income from other sources. The FMV is defined under Explanation (a) to Section 56(2)(viib) as the higher of the value determined under prescribed rules (Rule 11UA) or a value substantiated to the satisfaction of the tax officer based on the value of assets.Rule 11UA(1)(c)(c) specifically governs valuation of unquoted preference shares, stating that FMV shall be the price the shares would fetch if sold in the open market on the valuation date. The rule allows the assessee to obtain a valuation report from a Merchant Banker or Chartered Accountant and does not prescribe a specific valuation method.The assessee company adopted the DCF method for valuation of its Compulsorily Convertible Preference Shares (CCPS), obtaining a valuation report accordingly. The AO rejected this valuation, finding it inconsistent with the company's financial results and lack of business activity, and instead applied the NAV method, calculating FMV at Rs. 11.15 per share, substantially lower than the issue price.The AO's approach resulted in an addition of Rs. 29,84,733 under Section 56(2)(viib) as unexplained share premium. The CIT(A) confirmed this addition, emphasizing the lack of business activity and failure of the assessee to prove the creditworthiness of resident investors, thereby concluding the transactions were not genuine.The Tribunal noted that the NAV method under Rule 11UA(2) applies only to unquoted equity shares, not preference shares. Since Rule 11UA(1)(c)(c) does not mandate a specific method for preference shares, the DCF method adopted by the assessee was permissible. The Tribunal held that the AO and CIT(A) erred in disregarding the DCF method without valid reasons and substituting it with the NAV method. The valuation method once chosen by the assessee could not be rejected without cogent basis.Further, the Tribunal observed that the AO accepted the share premium received from two Non-Resident Investors (NRIs) at the same premium rate but disallowed the premium from resident investors. This inconsistent approach was deemed contradictory and unjustified. The Tribunal also referred to CBDT's administrative instructions cautioning against coercive recovery of demands raised under Section 56(2)(viib) in genuine start-up cases.Accordingly, the Tribunal concluded that the addition under Section 56(2)(viib) was not sustainable and deserved to be deleted.Issue 3: Applicability of Section 115BBESection 115BBE imposes a higher tax rate (60% plus surcharge and cess) on unexplained credits deemed as income under Sections 68 to 69D. The provision was originally introduced with effect from 01.04.2013, with a tax rate of 30%. The amendment increasing the tax rate to 60% and adding surcharge was notified later, with effect from 01.04.2017.The assessee received share capital from resident investors during October 2016, before the amendment came into force. The AO invoked the amended Section 115BBE to tax the unexplained credits at the enhanced rate of 60%, confirmed by the CIT(A).The Tribunal undertook a detailed analysis of the principles of statutory interpretation and retrospective operation of penal provisions. It cited authoritative Supreme Court rulings establishing that penal or onerous amendments are presumed to have prospective effect unless expressly stated otherwise or justified by exceptional circumstances.The Tribunal noted that the amendment to Section 115BBE was substantive and increased the tax burden, and was not clarificatory or remedial. The amendment was enacted post demonetization to curb concealment of income related to deposits made after demonetization. The assessee, however, had disclosed all income and had not concealed any particulars.The Tribunal referred to judicial precedents holding that retrospective application of penal provisions is generally impermissible and that tax liability is determined by the law prevailing at the time of accrual of income.Accordingly, the Tribunal held that the enhanced rate of tax under the amended Section 115BBE could not be applied retrospectively to share capital received before the amendment's effective date. The AO's invocation of Section 115BBE at the higher rate was therefore illegal and the addition taxed at 60% was to be deleted.Issue 4: Violation of Natural JusticeThe assessee contended that the AO and CIT(A) failed to provide specific and proper show cause notices before making additions, thereby violating principles of natural justice. The Tribunal examined the record and found that notices under Section 143(2) and reassignment orders were duly served and the assessee was given ample opportunity to furnish information and explanations.There was no indication that the assessee was denied any hearing or opportunity to contest the additions. The Tribunal did not find any merit in the contention of violation of natural justice and did not interfere on this ground.Issue 5: Charging of Interest under Sections 234A, 234B, and 234CThe assessee challenged the charging of interest under Sections 234A (delay in filing return), 234B (default in payment of advance tax), and 234C (deferment of advance tax installments). The Tribunal noted that the assessee did not provide any substantial grounds to justify deletion of interest. The order of the lower authorities on charging interest was not interfered with.Significant HoldingsOn valuation and addition under Section 56(2)(viib), the Tribunal held:'Rule 11UA(1)(c)(c) does not prescribe any specific method for the valuation of Preference Shares. Even Hon'ble Jurisdictional ITAT (Jaipur), recently, held that the valuation of the Preference Shares should be determined as per Rule 11UA(1)(c) which requires the assessee to obtain a report from a Merchant Banker or a Chartered Accountant to determine the price which preference shares would fetch if sold in the open market on the valuation date. The NAV method under Rule 11UA(2) is applicable for determination of FMV of unquoted equity shares and not preference shares. In the absence of a specific mandate, FMV of the preference shares can be determined on the basis of DCF method. The method once chosen by the assessee company, for the purpose of valuation of its shares could not be disregarded by the Income Tax authorities, without any basis.'On retrospective application of Section 115BBE, the Tribunal observed:'The amendment to Section 115BBE is penal in nature, which aims to penalize the assessee, if additions referred to in Section 68 to 69A are made. Penal statutes which create offences or which have the effect of increasing penalties for existing offences will only be prospective by reason of the constitutional restriction imposed by ARTICLE 20 of the CONSTITUTION OF INDIA. ... The amended provision of Section 115BBE should apply on incomes accruing after the law having received assent of the President.'Further, the Tribunal emphasized the principle of lex prospicit non prospicit (law looks forward not backward) and reliance on authoritative Supreme Court rulings and High Court decisions supporting prospective operation of penal amendments.Consequently, the Tribunal allowed the appeal of the assessee by deleting the addition made under Section 56(2)(viib) and the invocation of Section 115BBE at the enhanced rate, while dismissing other grounds of appeal.