2025 (8) TMI 761 - AT - Income Tax

ITAT upholds DCF method for security premium under Section 56(2)(viib) and allows depreciation on intangible asset deposit

DCIT, 2 (2) (1) Versus Max Hospitals and Allied Services Limited

DCIT, 2 (2) (1) Versus Max Hospitals and Allied Services Limited - TMI 1. Issues Presented and Considered Whether the addition made under Section 56(2)(viib) of the Income Tax Act on account of share premium received by the assessee is justified, considering the valuation report based on the Discounted Cash Flow (DCF) method. Whether the Assessing Officer (AO) was correct in rejecting the valuation report relying on actual financial performance and disallowing the share premium as income. Whether depreciation @ 25% claimed on a non-refundable deposit paid to a society running a hospital, treated as an intangible asset, is allowable under Section 32(1)(ii) of the Income Tax Act. Whether depreciation disallowance in subsequent assessment years is justified when depreciation was allowed in earlier years on the Written Down Value (WDV) of the intangible asset. Whether the AO or appellate authorities can substitute or revalue the fair market value (FMV) of shares issued at premium when the valuation is done by a prescribed expert using prescribed methods under Rule 11UA of the Income Tax Rules. 2. Issue-wise Detailed Analysis Issue 1 & 2: Validity of Addition under Section 56(2)(viib) on Share Premium and Rejection of Valuation Report Legal Framework and Precedents: Section 56(2)(viib) of the Income Tax Act deems any share premium received in excess of the FMV as income from other sources. Rule 11UA(2)(b) prescribes methods for valuation of shares, including the Discounted Cash Flow (DCF) method and Net Asset Value (NAV) method. Precedents establish that valuation is not an exact science and is based on projections and assumptions at the time of valuation, which cannot be tested against actual performance retrospectively. Relevant judicial pronouncements emphasize that the AO cannot substitute or tinker with a valuation report prepared by a prescribed expert using prescribed methods unless there is a specific provision empowering such action. Commercial wisdom of investors, especially unrelated third-party investors, is to be respected and not lightly questioned by the Revenue. Court's Interpretation and Reasoning: The assessee adopted the DCF method, a recognized and prescribed method under Rule 11UA, for valuation of shares. The AO rejected the valuation report by comparing projected profits with actual results and alleged the projections were unrealistic and speculative. The Court held that valuation based on DCF inherently involves future projections and assumptions which cannot be equated with actual financial performance. The AO lacks statutory authority to reject the valuation report without providing an alternative valuation prepared by a prescribed expert. The presence of prominent outside investors subscribing to the shares at the premium value supports the genuineness and commercial prudence of the valuation. Judicial precedents cited by the Court affirm that Revenue cannot sit in the armchair of a businessman to question commercial decisions or the valuation methodology adopted by the assessee. Key Evidence and Findings: Valuation report prepared by a Chartered Accountant using DCF method as per Rule 11UA. AO's observations of losses and no revenue in earlier years contrasted with projected profits in valuation report. Subscription of shares at premium by reputed unrelated investors indicating acceptance of valuation. Prior assessment years where similar valuation reports were accepted or additions were made and subsequently deleted. Application of Law to Facts: The assessee's valuation complies with statutory provisions and prescribed methods. AO's rejection based on hindsight comparison of projections with actuals is impermissible. Revenue's attempt to substitute valuation or discredit commercial wisdom of investors is unsustainable. Treatment of Competing Arguments: Revenue argued that projections were unrealistic and premium was a colourable device for tax evasion. Assessee contended valuation was done by expert using prescribed method and was accepted by investors. The Court favored the assessee's position, emphasizing statutory scheme and judicial precedents. Conclusions: Addition under Section 56(2)(viib) on account of share premium based on rejected valuation report is unsustainable. Valuation report prepared using DCF method by prescribed expert must be accepted unless specific statutory authority exists to reject or substitute it. Commercial prudence of investors subscribing at premium cannot be questioned by Revenue. Ground challenging addition under Section 56(2)(viib) is dismissed. Issue 3 & 4: Allowability of Depreciation on Non-Refundable Deposit Treated as Intangible Asset Legal Framework and Precedents: Section 32(1)(ii) of the Income Tax Act allows depreciation on intangible assets used for business or profession. Judicial precedents recognize that business or commercial rights acquired under agreements, including lease rights or concession rights, constitute intangible assets eligible for depreciation. Prior allowance of depreciation on the same asset in earlier years creates a binding precedent for subsequent years on WDV basis. Court's Interpretation and Reasoning: The non-refundable deposit paid to acquire rights for operation and management of a hospital is a business or commercial right, an intangible asset. The AO's disallowance of depreciation in subsequent years is incorrect since depreciation was allowed in earlier years on the same asset's WDV. Findings of the CIT(A) and ITAT, supported by High Court decisions, affirm the intangible nature of the asset and allow depreciation. Revenue did not challenge the finding of intangible asset status before the ITAT, thereby accepting the factual basis. Key Evidence and Findings: Agreements with government and society for hospital management rights. Payment of non-refundable deposit treated as acquisition cost of intangible asset. Depreciation claimed and allowed in earlier assessment years. Judicial precedents recognizing lease or concession rights as intangible assets. Application of Law to Facts: The deposit qualifies as an intangible asset under Section 32(1)(ii). Depreciation on WDV basis is allowable in subsequent years once allowed earlier. Treatment of Competing Arguments: Revenue argued that deposit was refundable or conditional, hence not eligible for depreciation. Assessee demonstrated the non-refundable nature and intangible asset status, supported by precedent. The Court upheld the assessee's claim and rejected Revenue's disallowance. Conclusions: Depreciation on non-refundable deposit treated as intangible asset is allowable under Section 32(1)(ii). Disallowance of depreciation in subsequent years is improper once depreciation has been allowed on WDV. Ground challenging disallowance of depreciation is dismissed. Issue 5: Authority of AO or Appellate Authorities to Substitute or Revalue FMV of Shares Legal Framework and Precedents: Section 56(2)(viib) and Rule 11UA prescribe valuation methodologies and require valuation to be done by prescribed experts. There is no express provision empowering AO to substitute or revalue the FMV determined by prescribed experts. Judicial pronouncements hold that AO cannot reject valuation reports without statutory authority or provide alternative valuations. Court's Interpretation and Reasoning: Valuation done by Chartered Accountant using DCF method is a recognized and prescribed method. AO's rejection of valuation report without statutory power to substitute or revalue is impermissible. The valuation is a technical matter to be left to experts and cannot be overruled by AO or appellate authorities on mere disagreement. Key Evidence and Findings: Valuation report by prescribed expert using DCF method. AO's rejection based on comparison with actuals and allegations of unrealistic projections. Judicial precedents disallowing AO's substitution of valuation. Application of Law to Facts: AO's action in rejecting valuation report and making addition is not supported by law. Appellate authorities correctly upheld valuation report and deleted addition. Treatment of Competing Arguments: Revenue argued for rejection of valuation due to unrealistic projections and lack of supporting evidence. Assessee relied on statutory provisions and expert valuation report. The Court favored the statutory scheme and expert valuation, rejecting Revenue's contention. Conclusions: AO or appellate authorities cannot substitute or revalue FMV determined by prescribed expert under Rule 11UA. Valuation report prepared using prescribed methods must be accepted unless statutory authority exists to reject or substitute. Additional Observations The Court emphasized that valuation is inherently based on approximations and projections, not exact arithmetic precision. Commercial prudence of reputed investors subscribing to shares at premium supports genuineness of valuation and share premium received. Revenue's challenge based on hindsight comparison of projections with actuals is legally untenable. Other grounds raised by Revenue were consequential or academic and hence not adjudicated.