TaxTMI 
TaxTMI 
2022 (12) TMI 1508
X X X X Extracts X X X X
X X X X Extracts X X X X
....g Officer as well as Ld. CIT(Appeal) has failed to appreciate the fact that the valuation report cannot be disturbed by the Assessing Authority. 3. That the Ld. Assessing Officer as well as Ld. CIT(Appeal) has failed to appreciate that the valuation computed by the Ld. Assessing Authority is wrong against the facts as well as against the law." 3. As per its grounds of appeal, the assessee has challenged the addition made by the Assessing Officer with reference to the provisions of Section 56(2)(viib) of the Act. 4. Briefly stated, the assessee filed its return of income for Assessment Year 2015-16 in question which was subjected to scrutiny assessment. In the course of the assessment, the Assessing Officer inter alia noticed that assessee had issued 24,32,000 equity shares at face value of Rs.10/- per share at a premium of Rs.40 per share. A total amount of Rs.9,72,80,000/- was thus received in the form of share premium. The Assessing Officer alleged that premium received on issue of equity share exceeds its 'Fair Market Value' (FMV) and consequently the excess premium received on issue of equity share is susceptible to tax in view of provisions of Section 56(2)(viib....
X X X X Extracts X X X X
X X X X Extracts X X X X
....essee had allotted 3,15,000 Equity shares of face value of Rs. 10/- each at a premium of Rs. 40/- per share consisting total amount of Rs. 1,26,00,000/-. The said allotment was done by the assessee company in pursuance to provision of section 56(2)(viib) read with Rule 11UA whose fair market value of the share i.e. Rs. 50/- was done on the basis of Discounted Cash Flow Method which was work out by one of the know Merchant Banker i.e. M/s SPA Capital Advisors Ltd. 3. For the assessment year 2014-15, the assessee filed Its return of income u/s 139(1) of the Income Tax Act, 1961 (for short referred as the 'Act') on 29-09-2014 declaring a loss of Rs. 53,083/-. Assessment was concluded by order dated 19-12- 2016 on a total income at Rs. 1,26,72,917/- and in that process Ld. AO made addition of Rs. 1,27,26,000/- u/s 56(2)(viib) of the Income Tax Act, rejecting the valuation report of the said Merchant Banker i.e. M/s SPA Capital Advisors Ltd. and independently determining the value of Share at Rs. 9.60 and calculating over and above the value of share allotted over Rs. 9.60 i.e. Rs. 40.40 i.e., for deriving the aforesaid amount of Rs. 1,27,26,000/- multiply no. of shares....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... return, risk free premium, expected returns from the market, risk free rate and Beta are nowhere nearer to the reality. 7. Basing on the above argument, Ld. DR had taken our attention to the disclaimer clause appended by M/s SPA Capital Advisors Ltd. to their report, and submits that a perusal of the above makes it clear that the valuation of shares is not a realistic one keeping in view the growth and stature of the company and the figures in the valuation report have been cooked up without providing any reliable basis as to how the assumptions took place. 8. Lastly, he submits that in so far as DCF method is concerned it is always possible for the company to decide the proposed value of the shares first and then travelling back to tailor the figures with the reverse engineering process, to suite their convenience. 9. Ld. DR, therefore, submits that unless and until the assessee provides the evidence justifying the facts and figures provided to the merchant banker with their justification it would not be possible for the authorities below either to consider the merits of the DCF method adopted by the assessee or to make suitable adjustments to the same ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....; Calculation of Cost of Equity Particulars Values Risk free return 9.04% Risk premium 6.75% Company Specific Risk 5% Ke 20.80% Calculation of Risk Premium Expected return from market (BSE 500 return since inception) 15.80% Risk free rate (Zero Coupon Yield as on 30-09-13) 9.04% Beta (to be on conservative side) 1 Risk Premium 6.75% Perpetuity Growth rate 2% 11. In so far as the figures relating to cash flow to equity, risk free return, expected return from market and Beta taken by the assessee, the observations of the Ld. Assessing Officer are as follows: "Cash flow to Equity : The cash flow to the firm is the cash left over after taxes and after all reinvestment needs have been met, but before interest and principle payments on debt. To get to cash flow to the firm, you start with operating earnings, instead of net income, and subtract out taxes paid and reinvestment. The assessee has taken free cash flow to equity value for the year 2013-14 is in negative at 0.98. Same was the case is earlier years. The data available for the futur....
X X X X Extracts X X X X
X X X X Extracts X X X X
....it appears that the valuation of shares is not realistic keeping in view the growth and stature of your company. Further, in the valuation report only figures have been put up without giving reasons as to how these assumptions have been made. (ii) In the DCF method first step is to forecast expected cash flow based on assumptions regarding the company's revenue growth rate, net operating profit margin, income tax rate, fixed investment requirement, and incremental working capital requirement. The revenue growth rate as well as the net profit margin of your Company, since inception, is negative and you have been carrying forward business losses. Even in the subsequent years, for which data is available, you have incurred losses (loss of Rs. 53083/- (AY 2014-15) and Rs. 1,00,384/- (AY 2015-16). However, as per the computation of valuation, the free cash flow to equity figures are -0.98 (2013-14), 32.61 (2014-15), 34.89 (2015-16), 37.00 (2016-17), 39.22 (2017-18) which are unrealistic. You are also requested to submit actual free cash flow (FCF) for the AY 2014-15, 2015-16 & 2016-17 till date) (iii) Similarly with regard to calculation of Cost of Capital....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d Ld. AO concluded the assessment by making an addition of Rs. 1,27,26,000/- by taking the value of the share at Rs. 9.60, as against 50.60 adopted by the assessee. 14. Even before the Ld.CIT(A) also, as recorded by the Ld. CIT(A) the assessee did not produce any evidence to substantiate the basis of projections in cash flow but relied on the valuer's report vehemently contending that such a report cannot be disturbed by the Ld. AO. At no point of time tried to explain where did the Ld. AO went wrong in his comments on the figures reflected in the above valuation report of the expert. 15. In these circumstances, we are unable to accept the contentions of the assessee that in view of the provisions under section 56(2)(viib) of the Act read with Rule 11UA(2) of the Rules the Ld. AO had no jurisdiction to adopt a different method than the one adopted by the assessee, and if for any reason the AO has any doubt recording such valuation report and does not agree with the same is bound to make a reference to the Income tax Department Valuation Officer to determine the fair market value of such capital asset. This is so because unless and until the assessee produces t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....emium. The AO had asked the appellant to explain the applicability of section 56(2) of the Act, vide the letter dated which reads as under: 1. "Notwithstanding above; why the share premium charged by you should not be taken as your income as per the provisions of Section 56(2)(viib) of the Income Tax Act Please submit original valuation report by NAV method with detailed calculation in conformity with the provisions of Section HU A in support of your explanation, if any. 2. Please furnish the copies of acknowledged allotment letters issued to the new shareholders alongwith copy of form submitted to ROC in this regard. 3. Copies of all the bank statements with bank-ledger to verify the movement of funds in the course of claimed receipts of share application money/premium. " The counsel of the assessee attended the proceedings before the AO on and submitted as under: "......... The share premium is not offered for tax as the same was allotted at fair market value. Also, Section 56(2) lists incomes chargeable to income tax under the head 'Income from Other Sources Finance Act, 2012 inserts clause (viib) with effect from 1-4-2011 (assess....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ethod reflects historical cost of assets and liabilities of the company on valuation date. 7.4 In the present case, though the appellant has exercised its option for DCF method of valuation as per the provisions of Rule 11UA(2)(b) but the appellant has not been able to demonstrate that the assets have appreciated way above their book value. In the covering letter addressed to the Directors, the Valuer has stated that "this opinion is based on the management projections for next five years, plans in hand and other information made available to us". The Chartered Accountant (Valuer) has stated that the valuation process has been carried out on the basis of the projected data provided to the Valuer. The appellant has not provided any basis/documentary evidences in support of the projected data provided to the Valuer. The AO has concluded that it is crystal clear that the reliability and correctness of the projected data are not based on any material. The appellant does not have any hidden assets in the form of patents, copy rights, intellectual property rights or even such investments etc belonging to the company based on which the appellant would substantially enhances profi....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 22,00,00 Investment in Immovable property for projects Add: 3,00,000 Adjustments Interest Depreciation Profit before tax 5,08,936 -6,65,450 -49,100 39,00,000 48,70,000 Less: Corporate tax (30.90%2015-16& 2016-17, thereafter 25.75%) 1,57,261 -2,05,624 -15,172 10,04,250 12,54,025 Profit after Tax Add: loans/capital Less: Capital Expenditure 6. 000 4. 000 3,51,675 13.12.2017 0.0 00 18.0. 00.000 -4,59,826 5,00,000 -33,928 28,95,750 36,15,975 1,30,00,000 Cash inflows 19,00,000 3,96,48,325 -9,59,826 -33,928 28,95,750 -93,84,025 Discount rate (10%) 0.10 0.10 0.10 0.10 0.10 0.10 Discount factor PV of Future 1.00 0.91 0 83 0.75 0.68 0.62 cash inflow -19,00,000 3,60,79,976 -7,96,656 -25,446 19,69,110 -58,18,096 Total PV of Future Cash inflows Add: cash & bank Balance 31.03.2014 Estimated value of Business Total no. of shares Value per share -4,26,51,063 1,96,73,404 -2,29- 77,659 10,000 -2,297.77 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....pany as its "income from other sources" as envisaged in the provisions of Section 56(2)(viib) of the Income Tax Act, 1961. In the present case the valuer has made the valuation of shares based on the projections given by the management. These projections are not realistic and could not be achieved. There is substantial difference between actual figures and projected figures. The valuer has made the valuation of shares without any application of mind. Considering the facts of the case, I am of the view that the AO has rightly rejected the valuation of shares under DCF method. In the case of Agro Portfolio (P.) Ltd [2018] 94taxmann.com 112 (Delhi - Trib.) Hon'ble ITAT Delhi has held that "For all these reasons, we are of the considered opinion that there has not been any possibility of verifying the correctness or otherwise of the data supplied by the assessee to the merchant banker, in the absence of which the correctness of the result of DCF method cannot be verified. This left no option to the AO but to reject the DCF method and to go by NA V method to determine the FMV of the shares. Without such evidence, it serves no purpose even if the matter is referred to the Department'....
X X X X Extracts X X X X
X X X X Extracts X X X X
....f equity share represents the fair market value or exceeds the fair market value, and whether deeming provisions of Section 56(2)(viib) of the Act are attracted in the facts of the case. 8.2 The legal fiction inserted by Section 56(2)(viib) seeks to deem premium received from subscribers being Indian entities in excess of Fair Market Value as the chargeable income in the hands closely held company issuing such share at premium in excess of its Fair Market Value. 8.3 To set the context, the assessee company in the instant case, received consideration of Rs.10 towards face value of each equity share and Rs.40 as premium thereon towards issue of 24,32,000 shares. In the process of issue of equity shares, a total of Rs.9,72,80,000/- was received in the form of share premium. The assessee adopted DCF method for determination of Fair Market Value as per valuation report dated 25.03.2015, of the independent valuer filed to support and vindicate the share premium on issue of equity share. The Assessing Officer however found fallacy in the quantification of FMV so determined by DCF method and observed that the FMV determined as per DCF method is without any sound factual basis and the....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ends that the DCF method adopted by independent valuer seeks to value the equity shares of a company by discounting its free cash flows for explicit forecast period and the perpetuating value thereafter. The free cash flow represents the cash available for distribution to the owner of the business. Such free cash flows are discounted by appropriate cost of capital. The present value of the free cash flows during the discrete period and the perpetuity value indicate the fair value of the business. The DCF method thus attempts to estimate the FMV future cash flows based on projection of how much money that the proposed investment is likely to generate in future. The assessee thus contends that FMV as per DCF method is determined on the basis of projected figures of cash flow in the future years which is bound to be at variance with the actual revenue and cash flow of the subsequent years as the projected figures cannot be gauged with any arithmetical precision. The valuation of the cash flow in future years cannot be visualized at the time of projections having regard to the many imponderables which may enter with the passage of time. The valuation determined under DCF is only an est....