2025 (7) TMI 1584 - AT - Income Tax

AO cannot replace DCF valuation with NAV under Rule 11UA; projections don't override actuals in share pricing

The ITAT Delhi held that the AO erred in substituting the DCF valuation of shares with the NAV method under Rule 11UA, as the shares were allotted only to ... Addition u/s 56(2)(viib) - Method of valuation of shares - DCF v/s NAV - as per AO value of the share which was used to allot the share of the company to its shareholders are excess and observed that the value of the share was not correctly determined with the help of DCF method, therefore, he proceeded to determine the same by applying the other method proposed in Rule 11UA of the Income-tax Rules, 1962 i.e. Net Asset Value Method - AO analysed the valuation report and observed that the basic information for valuation of the report was submitted by the assessee to the valuer and these figures are not matching with the actuals - HELD THAT:- In this case, assessee has not allotted shares to any other person, rather it was allotted shares only to its own promoters. It is also fact on record that assessee needs further funds for expansion of its own business and in that process, the assessee has acquired another company, namely, ICPL. We observe that the assessee has no doubt supplied the information for valuation of its own shares and independent valuer has valued the shares by adopting the above information and the valuer has adopted one of the accepted method as per Rule 11UA. AO found that the projections adopted by the assessee are not matching with the actual. AO has found discrepancies in adoption of future gross revenue and proceeded to analyse the issue under consideration as per provisions of section 68 of the Act. Since the shares were allotted to its own promoters, there is no avenue for the assessee to generate or convert any unaccounted money and bring on record. Further there is no evidence brought on record by the AO to question the genuineness of the transaction, rather he analysed only the projections. As brought to our notice that the assessee/ promoters have subsequently sold shares to a French company @ Rs. 254 per share which was much higher than the share valued by the company. It justifies the value of shares determined by the valuer. As held in the various cases, namely, Cinestaan Entertainment Pvt. Ltd. [2019 (6) TMI 1367 - ITAT DELHI] wherein AO cannot substitute NAV in place of DCF. Further it was held that the projections cannot replace actual and it can never be accurate as held in the cases of Rameshwaram Strong Glass (P.) Ltd. [2018 (9) TMI 403 - ITAT JAIPUR], DQ (International) Ltd. [2016 (8) TMI 727 - ITAT HYDERABAD] and Vodafone M-Pesa Ltd. [2020 (1) TMI 684 - ITAT MUMBAI. Therefore, with the above findings, we are inclined to allow the grounds raised by the assessee. ISSUES: Whether the Assessing Officer (AO) can reject the valuation of shares determined by an independent valuer using the Discounted Cash Flow (DCF) method and substitute it with the Net Asset Value (NAV) method for determining the Fair Market Value (FMV) under Rule 11UA of the Income-tax Rules, 1962.Whether the provisions of section 56(2)(viib) of the Income-tax Act, 1961 apply when shares are issued to promoters at a premium based on projected future earnings that differ from actual historical financial results.Whether the AO can invoke section 56(2)(viib) to add share premium differences when the valuation is based on bona fide commercial transactions and genuine business projections.Whether subsequent sale of shares at a higher price by promoters to an unrelated third party can validate the valuation adopted for share allotment. RULINGS / HOLDINGS: On the substitution of valuation methods, the Court held that the AO cannot substitute the DCF method adopted by the independent valuer with the NAV method, as per Rule 11UA, since the DCF is an accepted method and the AO's rejection based solely on discrepancies between projections and actuals is not justified.The Court held that the provisions of section 56(2)(viib) are 'in the nature of anti abuse measure' aimed at preventing mala fide transactions and black money generation, and are not intended to be applied to 'genuine and bona fide commercial transactions' where shares are issued to promoters based on reasonable business projections.The Court found no evidence of mala fide or unaccounted money generation since shares were allotted only to promoters, and the AO's reliance on actual losses versus projected profits for rejecting the valuation was insufficient to attract section 56(2)(viib).The subsequent sale of shares by promoters to an independent French company at a price significantly higher than the valuation used for share allotment was held to justify the valuation adopted by the independent valuer and supported the genuineness of the transaction.Accordingly, the additions made under section 56(2)(viib) based on the AO's NAV valuation were set aside and the appeal was allowed. RATIONALE: The Court applied the framework under section 56(2)(viib) of the Income-tax Act, 1961 and Rule 11UA of the Income-tax Rules, 1962, which prescribe methods for determining FMV of shares issued at premium, including DCF and NAV methods.Precedents were relied upon, including Cinestaan Entertainment Pvt. Ltd. vs. ITO, which held that the AO cannot substitute the valuation method chosen by the assessee when it is an accepted method under Rule 11UA.The Court recognized that business projections used in valuation are inherently estimates and cannot be expected to match actual financial results precisely, as supported by case law such as Rameshwaram Strong Glass Pvt. Ltd. and Vodafone M-Pesa Ltd. vs. DCIT.The Court emphasized the anti-abuse nature of section 56(2)(viib) and held that it should not be invoked in the absence of evidence of mala fide intent or unaccounted income generation.The decision reflects a doctrinal position that bona fide valuations based on reasonable projections and accepted valuation methods should be respected, particularly when shares are issued to promoters and subsequent transactions confirm the valuation.