TaxTMI 
TaxTMI 
2019 (1) TMI 688
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.... The order of the Learned AO passed under section 143(3) of the Income Tax Act, 1961 ('the Act') and confirmed by Learned CIT-A is erroneous in reckoning that share premium collected is above fair market value and thereby liable to tax in pursuance to section 56(2)(viib) by adopting Rule 11UA(a) to the exclusion of the option under Rule 11UA(b) as opted by the assessee without taking cognizance of the facts submitted and on the following grounds namely: a) The valuation report provided by appellant shows that the Accountant has taken haze cash flow as certified by the management. No verification of projections and assumptions adopted by management was made by valuer, whereas Para 2.4 of the valuation report outlines that analysis, review and inquiry has been carried out for issuing report. b) Appellant has failed to provide any information, which formed the basis of its projection for various years, whereas Para 3 of the valuation report outlines the Basis of Valuation and past business performance forming basis of projections have been submitted; c) Comparison of projections with actual data, hindsight information not available to the appellant....
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....s. 349,29,043/-. The AO noted that from this year, the provisions of section 56 (2) (viib) are applicable and if the shares are issued at a price which is more than fair market value then the amount received in excess of fair market value of shares will be charged to tax in the hands of the company as income from other sources. The AO asked the assessee to substantiate the share premium so collected. The assessee vide its letter furnished the copy of the certificate issued by a chartered accountant dated 10.11.2013 and said that this is the basis for valuing the shares. The valuation adopted by the assessee was found to be as per DCF (Discounted Cash Flow) method. The AO has reproduced the computation table in Para 6 of the assessment order. As per the same, actual revenue for F. Y. 2012 - 13 was considered at Rs. 1,933 Lacs. In F. Y. 2013 - 14, the revenue was estimated at Rs. 2,222 lacs with an estimated increase of 15%. Thereafter, in F. Y. 2014 - 15 and 2015 - 16, with estimated increase of 25% in each year, the revenue was estimated at Rs. 2,778 Lacs and Rs. 3,473 lacs respectively. Thereafter, in F. Y. 2016 - 17 and 2017 - 18, with estimated increase of 15% in each year, the ....
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....ment order that the valuation of the assessee cannot be accepted without verifying the credibility of data provided by the assessee. The AO restricted the addition to the extent of excess amounts received from the residents as provided in law. The AO noted that an amount of Rs. 112,21,109/- was received from the residents in excess of fair market value of share worked out by the AO and this amount was added. Being aggrieved, the assessee carried the matter in appeal before CIT (A) but without success and now, the assessee is in further appeal before us. 4. In course of hearing before us, various arguments were made by the learned AR of the assessee. At this juncture, it was pointed out by the bench that as per the detail available on page 570 of the paper book, during first six months of the F. Y. 2013 - 14, there was fall in revenue in each month. The bench observed that under this factual position, how the projections of 15% & 25% increase in turnover can be accepted. In reply, learned AR of the assessee made various arguments but no basis could be provided by him to estimate sales of Rs. 1270 Lacs in the next six months of F. Y. 2013 - 14 i.e. October 2013 to March 2014 as ag....
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.... issued by the Chartered Accountant is on the basis of information about future projections provided by the management and it could not be conclusively established by the assessee that such projection/estimation by the management is on a scientific basis although an attempt was made in this regard. 7. In view of this factual position, we first examine the law on this issue and also take note of the guidelines issued by research committee of The Institute of Chartered Accountants of India (ICAI) as reproduced by CIT (A) in Para 4.6 of his order. We first reproduce the provisions of section 56 (2) (viib) and Rule 11U & 11UA as under:- "Income from other sources. 56(2) (viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause shall not apply where the consideration for issue of shares is received- (i) by a venture capital undertaking from a ....
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....udited by the auditor of the company, if any, appointed under the laws in force of the country in which the company is registered or incorporated;] (c) "merchant banker" means category I merchant banker registered with Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992); (d) "quoted shares or securities" in relation to share or securities means a share or security quoted on any recognized stock exchange with regularity from time to time, where the quotations of such shares or securities are based on current transaction made in the ordinary course of business; (e) "recognized stock exchange" shall have the same meaning as assigned to it in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956); (f) "registered dealer" means a dealer who is registered under Central Sales Tax Act, 1956 or General Sales Tax Law for the time being in force in any State including value added tax laws; (g) "registered valuer" shall have the same meaning as assigned to it in section 34AB of the Wealth-tax Act, 1957 (27 of 1957) read with ....
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....ly,- (i) if the quoted shares and securities are received by way of transaction carried out through any recognized stock exchange, the fair market value of such shares and securities shall be the transaction value as recorded in such stock exchange; (ii) if such quoted shares and securities are received by way of transaction carried out other than through any recognized stock exchange, the fair market value of such shares and securities shall be,- (a) the lowest price of such shares and securities quoted on any recognized stock exchange on the valuation date, and (b) the lowest price of such shares and securities on any recognized stock exchange on a date immediately preceding the valuation date when such shares and securities were traded on such stock exchange, in cases where on the valuation date there is no trading in such shares and securities on any recognized stock exchange; 1/(b) the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner, namely:- the fair market value of unquoted equity shares =(A+B+C+D - L)x (PV)/(PE), w....
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....eport from a merchant banker or an accountant in respect of which such valuation. [(2) Notwithstanding anything contained in sub-clause (b) of clause (c) of sub-rule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:- (a) the fair market value of unquoted equity shares = (A-L) X (PV), (PE) where, A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balancesheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset; L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:- (i) the paid-up capital in respect of equity shares; ....
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....ng on the purpose for which it is to be used. 1.2 A clear understanding of the purpose of valuation is undoubtedly important, but an equally important imperative is to have a full appreciation of the 'value' emanating from common principles. This 'general purpose value' may be suitably modified for the special purpose for which the valuation is done. The factors affecting that value with reference to the special purpose must be judged and brought into final assessment in a sound arid reasonable manner. ------------------------------------- 1.4 Valuation, being a complex subject, is limited to experts and is surrounded by a number of myths. Some of the very common generalities about valuation are discussed below: (a) Valuation models are quantitative and focus on earnings, assets, etc. However, it does not necessarily imply that valuation is free from the subjectivity and bias of a valuer. The fact is that valuation models are driven by the inputs that are prone to subjective judgments and the bias of a valuer. For instance, a target company may typically tend to overvalue itself while valuing. (b) Valuation is riddled with a ....
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.... (a) Theoretically, it is a very sound model because it is based upon expected future cash flows of a company that will determine an investor's actual return. (b)It is based on expectations of performance specific to the business, and is not influenced by short-term market conditions or noneconomic indicators. (c) It is not as vulnerable to accounting conventions like depreciation, inventory valuation in comparison with the other techniques/approaches since it is based on cash flows rather than accounting profits. (d) It is appropriate for valuing green-field or start-up projects, as these projects have little or no asset base or earnings which render the net asset or multiple approaches inappropriate. However, it is important that valuation must recognise the additional risks in such a case (e.g. project execution risk, lack of past track record, etc.) by using an appropriate discount rate. 2.8 Though the Discounted Cash Flow model is one of the widely used models for valuation because of its inherent benefits, it still has its share of drawbacks. Major shortcomings of this model are as follows: (a) It is only as good as its i....
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....however, the profits are expected to be realised after a lapse of some years or if material amounts have yet to be incurred before profits are realised, due consideration will have to be given to these circumstances. In such circumstances, separate value may be given to such new investments and the same is added to the value of the existing stream of business. (e) In turnaround cases, the uncertainty of higher profits is much greater. Careful evaluation of the steps actually taken to implement a turnaround strategy must be undertaken before a valuer accepts management's claims that in future the company will earn profits. If necessary, reports of technical or other consultants should be called for. (f) In case of companies witnessing cyclical fluctuations, care should be taken to select the forecast period, which should necessarily cover the entire business cycle of a company. (g) Effects of change in the policy of the company may be taken into account if such changes are known in advance and the effects are capable of being quantified. Changes in the utilisation of the productive capacity, changes in the organisational set-up, changes in the product-....
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....an asset with no default risk. In practice, long-term interest rates on government securities are used as a benchmark. (b) It is quite natural to assume that the riskier investments should have a higher return. This necessitates the incorporation of an appropriate risk premium in the discount rate. There exist a number of models for determination of risk premiums, such as the capital asset pricing model, arbitrage pricing model, multi-factor model, etc. Risk premium is also adjusted to incorporate risks associated with the stage and size of business and other company or project-specific risks. (c) The rate estimated by using the above will provide the discount rate, assuming only equity financing or the cost of equity. For a leveraged company, discount rate should be adjusted for leveraging. Practically speaking, discount rate for a leveraged company is the weighted average cost of capital with appropriate weightages to cost of equity and post-tax cost of debt, considering existing or targeted debt-equity ratio, industry standards and other parameters. (d) In the case of a company carrying on two or more different businesses, their cash flow projections s....
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....ver, a combination of all the approaches is used by assigning appropriate weightage to each approach. 6.6 While valuing shares, a number of situations may arise in which special consideration has to be given to several important factors. ----------------------------------------------------- 6.24 Though valuation is mainly driven by financial factors like earnings, assets, etc., some other factors require careful evaluation as an integral part of the mechanics of share valuation. The most noteworthy of these are: (a) The nature of a company's business A company's business may depend on the success of other industries (as with the producer of raw materials for other manufacturers), seasonal conditions, etc. (b) The caliber of managerial personnel A business managed by professional managers allied to people with similar ability would command a premium when compared to another which is crucially dependent for its success on a single executive, however outstanding he might be. (c) Prospects of expansion A case in point would be that of ancillary small-scale units, which have the potential for growth....
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....y, i.e., whether trading or manufacturing, the items dealt in or manufactured, the location of the factory, factors peculiar to the business, and such other matters. (e) Sources of information This section may state the sources of information obtained for the purpose of valuation, such as Articles of Association, audited accounts, profit projections, realisable value of assets, other secondary sources of information, period for which or date on which data is obtained, and other relevant sources. (f) Methodology This part may contain the methodology adopted for valuation. It should also include the rationale for appropriateness or otherwise of a particular approach(s) used. (g) Key valuation considerations This part may deal with the valuation considerations critical to the valuation process. Some of the factors considered in valuing the shares which may be included in the report are: (i) Discussion on the financial projections of a company, highlighting main assumptions and management representations. (ii) Discussion on discount rate, growth rate used for computing terminal value considered in the valuation, in....
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.... (v) A valuer should highlight the fact that valuation does not include the auditing of financial data provided by the management and, therefore, does not take any responsibility for its accuracy and completeness. Further, valuation should not be considered as an opinion on the achievability of any financial projections mentioned in the report." 9. As per Para 2.10 of this report of research committee of (ICAI) as reproduced above, the first and most critical input of DCF model is the Cash Flow Projections. It is also noted in the same Para of this report that the DCF value is as good as the assumptions used in developing the projections. It is also noted that these projections should reflect the best estimates of the management and take into account various macro and micro economic factors affecting the business. In the same Para of this report, some important points to be kept in mind with regard to cash flow projections are also noted. At this point, we feel it proper to take note of two judgments of Hon'ble apex court rendered in the case of Bharat earth Movers vs. CIT, 245 ITR 428 and in the case of Rotork Controls India (P) Ltd. vs. CIT, 314 ITR 62. In the first c....
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....td. in ITA No. 609/JP/2017 dated 31.01.2018. In this case, the tribunal held that if the assessee has opted for DCF method, the AO cannot challenge the same but the AO is well within his rights to examine the methodology adopted by the assessee and/or underlying assumptions and if he is not satisfied, he can challenge the same and suggest necessary modifications/alterations provided the same are based on sound reasoning and rationale basis. In the same tribunal order, a judgment of Hon'ble Bombay High Court is also taken note of having been rendered in the case of Vodafone M-Pesa Ltd. vs. PCIT as reported in 164 DTR 257. The tribunal has reproduced part of Para 9 of this judgment but we reproduce herein below full Para 9 of this judgment. "9. We note that, the Commissioner of Income-Tax in the impugned order dated 23rd February, 2018 does not deal with the primary grievance of the petitioner. This, even after he concedes with the method of valuation namely, NAV Method or the DCF Method to determine the fair market value of shares has to be done/adopted at the Assessee's option. Nevertheless, he does not deal with the change in the method of valuation by the Assessing Offic....
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.... Flow Projections. Hence, the assessee should be asked to establish that such projections by the assessee based on which, the valuation report is prepared by the Chartered accountant is estimated with reasonable certainty by showing that this is a reliable estimate achievable with reasonable certainty on the basis of facts available on the date of valuation and actual result of future cannot be a basis of saying that the estimates of the management are not reasonable and reliable. 13. Before parting, we want to observe that in the present case, past data are available and hence, the same can be used to make a reliable future estimate but in case of a start up where no past data is available, this view of us that the projection should be on the basis of reliable future estimate should not be insisted upon because in those cases, the projections may be on the basis of expectations and in such cases, it should be shown that such expectations are reasonable after considering various macro and micro economic factors affecting the business. 14. In nutshell, our conclusions are as under:- (1) The AO can scrutinize the valuation report and the if the AO is not satisfied with....