2025 (11) TMI 1513 - AT - Income Tax

DCF valuation under Section 56(2)(viib) upheld; assessee free to choose method under Rule 11UA(2) prescribed for shares

ITAT Bangalore held that for valuation of unquoted equity shares under s.56(2)(viib), Rule 11UA(2) permits the assessee to choose any prescribed method, ... Addition u/s 56(2)(viib) issue of shares at premium - assessee adopted the DCF method by which share premium of the shares was determined at Rs. 490/- per share in addition to the face value of Rs. 10/- - AO discarded the method adopted by the assessee and adopted the net asset value method and determined the fair market value of shares at Rs. 20.88/- per share - contention of the assessee is that the method adopted by the assessee, namely, DCF method is one of the recognized methods and it cannot be discarded altogether HELD THAT:- We are of the considered opinion that the Rule 11UA has been prescribed for determination of the value of unquoted equity shares. Rule 11UA(2) of the Rule is for determining the fair market value of the unquoted equity shares following the DCF method as one of the manners. As per the Rule 11UA(2) of the Rules, the assessee has the option to adopt any method for evaluation of the value of unquoted equity shares. After going through the above Rule we take note of the fact that the assessee had opted DCF method and got valuation report from an accountant as per the Rule. It is also clear that the method to be adopted for determining the FMV is at the option of the assessee. Therefore, we are of the considered opinion that the DCF method adopted by the assessee cannot be suspected on the basis of the outcome of the method employed more particularly when the legislature has given option to the assessee. There are plethora of judgments in support of our findings. AO had erred in considering the actuals of revenue and profits declared in the future years as a basis to dispute the projections. At the time of valuing the shares, the actual results of the later years would never be available. In our view what is required for arriving at the fair market value by following the DCF method are the expected and projected revenues. Accordingly, the valuation is on the basis of estimates of future income contemplated at the point of time when the valuation was made. Thus, we held that the AO grossly erred in discarding the DCF method of valuation of shares adopted by the assessee and accordingly we sustain the order of the ld. CIT (Appeals)/NFAC & direct the Assessing Officer to delete the addition as made under section 56(2)(viib) of the Act. The grounds raised by the revenue are accordingly dismissed. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether sufficient cause was shown for condonation of delay in filing the appeal under section 253. 1.2 Whether, for the purposes of section 56(2)(viib) read with Rule 11UA(2), the Assessing Officer is entitled to discard the Discounted Cash Flow (DCF) method chosen by the assessee and substitute the Net Asset Value (NAV) method. 1.3 Whether the Assessing Officer can challenge and disregard a DCF-based valuation of unquoted equity shares by relying upon subsequent actual financial results, and whether the matter requires remand for fresh valuation under DCF. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Condonation of delay in filing appeal Interpretation and reasoning 2.1 The Tribunal noted a delay of about 50-51 days in filing the appeal. The Revenue explained that the delay was caused by 'pressing time barring matters and other miscellaneous works', asserting that it was unintentional and due to unavoidable reasons. 2.2 The assessee did not seriously oppose condonation. The Tribunal examined the explanation in the condonation application and considered it 'plausible' and amounting to 'sufficient cause' preventing timely filing. Conclusions 2.3 The delay in filing the appeal was condoned and the appeal was admitted for adjudication on merits. Issue 2: Power of Assessing Officer to change method of valuation under section 56(2)(viib) read with Rule 11UA(2) Legal framework 2.4 The Tribunal referred to Rule 11UA(2), which prescribes the manner of determining the fair market value (FMV) of unquoted equity shares for the purposes of section 56(2)(viib). The Rule explicitly provides that FMV shall be determined in the manner under clause (a) (NAV formula) or clause (b) (DCF by a merchant banker or an accountant), 'at the option of the assessee'. Interpretation and reasoning 2.5 The assessee had issued shares at a premium and obtained a valuation report from an 'accountant' adopting the DCF method, a statutorily recognised method under Rule 11UA(2)(b). The Assessing Officer discarded the DCF valuation and instead adopted the NAV method under Rule 11UA(2)(a), thereby determining FMV at a much lower figure and making an addition under section 56(2)(viib). 2.6 The Tribunal held that under Rule 11UA(2) the choice between NAV and DCF is statutorily vested in the assessee. Once the assessee exercises this option and adopts DCF supported by a valuation report, the Assessing Officer cannot disregard that method merely because the result is not acceptable to him or yields a higher valuation. 2.7 The Tribunal accepted that while the Assessing Officer is entitled to scrutinise the valuation report, test its assumptions, and even determine a fresh valuation, such scrutiny must be undertaken on the same method (DCF) chosen by the assessee. It is 'not open' to the Assessing Officer to change the method from DCF to NAV when DCF has been validly opted under the Rule. 2.8 The Tribunal relied on binding precedent holding that: (i) where multiple methods are prescribed, the assessee has the statutory right to choose; (ii) the Assessing Officer may examine and, if warranted, rework the valuation under the same chosen method; but (iii) the Assessing Officer has 'no jurisdiction to change the method of valuation' adopted by the assessee under Rule 11UA(2). Conclusions 2.9 The DCF method adopted by the assessee, being a prescribed method under Rule 11UA(2)(b), could not be replaced by the NAV method. The Assessing Officer's adoption of NAV and consequent addition under section 56(2)(viib) was held to be unsustainable in law. Issue 3: Validity of rejecting DCF valuation based on subsequent actual results and request for remand Interpretation and reasoning 2.10 The Revenue argued that: (i) the DCF valuation was unreliable because projected revenues did not match actual revenues in subsequent years; (ii) share valuation 'should be as per the Fair Market Value' under Rule 11UA(2)(b), which in its view justified reliance on NAV; and (iii) alternatively, the matter should be remanded for fresh valuation under DCF by considering subsequent actuals. 2.11 The assessee contended that: (i) under Rule 11UA(2), FMV must be determined on the 'valuation date' using one of the prescribed methods, at the option of the assessee; (ii) DCF valuation is inherently based on 'expected and projected revenues' and assumptions as on the valuation date; and (iii) subsequent actual performance cannot be used to retrospectively invalidate or reframe projections that were bona fide at the time. 2.12 The Tribunal concurred with the assessee, holding that in a DCF valuation the relevant inputs are 'expected and projected revenues' at the point of valuation. Actual revenue and profit figures of later years 'would never be available' at the valuation date and cannot be the basis for disputing projections that were reasonably made then. 2.13 The Tribunal also noted that valuation is an exercise based on estimates, approximations and multiple assumptions (market conditions, business prospects, cost of capital, demand-supply, etc.), and cannot be judged by purely arithmetical precision or by hindsight. The genuineness of the investment and the fact that investors were unrelated third parties was not disputed, further undermining the Revenue's case. 2.14 Referring to binding decisions, the Tribunal emphasised that: (i) a DCF-based valuation supported by a report from a qualified professional cannot be summarily rejected without a detailed examination of its assumptions; (ii) the Assessing Officer must record specific findings pointing out defects or infirmities in the DCF working; and (iii) rejection of DCF merely on 'objective satisfaction', without such examination, is impermissible. 2.15 The Tribunal relied on a coordinate bench decision, affirmed by the jurisdictional High Court, which had held that a DCF valuation cannot be rejected by resorting to a different method or by ignoring the statutory option given to the assessee, and that additions under section 56(2)(viib) fail where the DCF report is not properly rebutted. 2.16 In light of this binding precedent-expressly concerning section 56(2)(viib) and Rule 11UA(2)-the Tribunal rejected the Revenue's plea for remand. It held that the issue was squarely covered in favour of the assessee and that there was no warrant to send the matter back for fresh DCF valuation based on subsequent actuals. Conclusions 2.17 Subsequent actual financial results cannot be used to discredit DCF projections that were made on the valuation date on a reasonable basis. 2.18 The Assessing Officer's rejection of the DCF valuation without a detailed, method-specific examination and without demonstrating specific defects was invalid. 2.19 The request to remand the matter for fresh valuation under DCF considering subsequent actual data was declined, as contrary to the nature of DCF and to binding precedent. 2.20 The Tribunal upheld the order deleting the addition under section 56(2)(viib), holding that the Assessing Officer had 'grossly erred' in discarding the DCF method adopted by the assessee and in substituting the NAV method. The Revenue's grounds were dismissed and the appeal rejected.