Thinkstations Learning Private Limited Vs ACIT (ITAT Delhi)
ITAT Delhi held that rejection of Discounted Cash Flow (DCF) Method for valuation of share price unjustified as that the methodology adopted was a recognized method of valuation and the Revenue was unable to show that the assessee adopted a demonstrably wrong approach.
Facts- In the course of assessment proceedings, AO noticed that assessee allotted 1,42,856 equity shares of Rs.10/- each at a premium of Rs.130/- per share. AO noticed that the assessee followed Discounted Cash Flow (DCF) Method for valuation of share price. AO referring to the provisions of section 56(2)(viib) and the explanation he was of the view that assessee has to consider the valuation whichever is higher between (i) the valuation according to Rule 11UA of Income Tax Rules or (ii) the value of shares to the satisfaction of the Assessing Officer. AO was of the view that DCF method followed by the assessee for the valuation of shares is nothing but assumption for projected of cash flow and stated to be not only unjustified and un-related to the actual financial position of the assessee company but also without any rational basis.
Accordingly, AO himself has determined the fair market value of the share at Rs.5.80 Paise and accordingly an amount of Rs.1,85,71,280/- was added as income from other sources u/s. 56(2)(viib) of the Act. CIT(A) sustained the action of AO.
Conclusion- Hon’ble Delhi High Court in the case of Pr. CIT Vs. Cinestaan Entertainment Pvt. Ltd. held that the shares had not been subscribed to by any sister concern or closely related person but by outsider investors. It was further held that the methodology adopted was a recognized method of valuation and the Revenue was unable to show that the assessee adopted a demonstrably wrong approach or that the method of valuation was made on a wholly erroneous basis or that the method of valuation or that it committed a mistake which went to the root of the process.
Held that the Assessing Officer erred in discarding the DCF method of valuation of shares adopted by the assessee. Thus, we reverse the order of the ld. CIT (Appeals) and direct the Assessing Officer to delete the addition made under section 56(2)(viib) of the Act.
FULL TEXT OF THE ORDER OF ITAT DELHI
1. These two appeals are filed by the assessee against different orders of the ld. Commissioner of Income Tax (Appeals)-3 [hereinafter referred to CIT (Appeals)] New Delhi for assessment years 2015-16 and 2016-17 in sustaining the addition made by the Assessing Officer under section 56(2)(viib) of the Income Tax Act, 1961 (the Act) in respect of share premium received by the assessee.
2. First we take up the appeal of the assessee in ITA. No, 7345/Del/2019 for assessment year 2015-16. Brief facts are that the assessee, a Pvt. Ltd. company filed return of income on 1.01.2016 declaring loss of Rs.1,07,38,216/-. Assessment was completed under section 143(3) of the Act on 31.12.2017 determining the income of assessee at Rs.78,33,064/-. In the course of assessment proceedings the Assessing Officer noticed that assessee allotted 1,42,856 equity shares of Rs.10/- each at a premium of Rs.130/- per share. The assessee was asked to submit the valuation report and the report was submitted. The Assessing Officer noticed that the assessee followed Discounted Cash Flow (DCF) Method for valuation of share price. The Assessing Officer referring to the provisions of section 56(2)(viib) and the explanation he was of the view that assessee has to consider the valuation whichever is higher between (i) the valuation according to Rule 11UA of Income Tax Rules or (ii) the value of shares to the satisfaction of the Assessing Officer. The Assessing Officer was of the view that DCF method followed by the assessee for the valuation of shares is nothing but assumption for projected of cash flow and stated to be not only unjustified and un-related to the actual financial position of the assessee company but also without any rational basis. Thus, the Assessing Officer is not satisfied with the valuation of shares submitted by the assessee, he himself has determined the fair market value of the share at Rs.5.80 Paise and accordingly an amount of Rs.1,85,71,280/- was added as income from other sources under section 56(2)(viib) of the Act.
3. On appeal the ld. CIT (Appeals) sustained the action of the Assessing Officer observing that the Assessing Officer is competent within his powers to look into the fact whether the valuation report is fair and reasonable and the assessee has failed to justify the premium of Rs.130/- per share charged on allotment of un-quoted equity shares.
4.1. Before us the ld. Counsel for the assessee submitted that the appellant a private limited company during the year under appeal was engaged in the business of providing education in an effective manner by using integrated education and teacher training company, focused on making education engaging and effective in the 21st century and is focusing to build a stronger foundation to empower children with skills to compete in a rapidly changing world. Appellant filed its return of income under section 139(1) of Income Tax Act, 1961 in short “Act” on 01/01/2016 declaring loss of Rs.1,07,38,216. Return filed was selected under CASS for scrutiny and the case was taken up.
4.2. Ld. Assessing officer on 19/04/2016 issued notice under section 143(2) of the act along with notice under section 142(1). Subsequent notices were issues and appellant attended the hearings from time to time and submitted the replies
4.3. Ld. Assessing officer issued a final show cause notice purported to be dated 20/12/2017 sent by speed post and received by assessee on 25/12/2017 being fag end of the limitation period posted in relation to share capital and share premium received during the year. Having given such a short notice, the appellant with great difficulties, in response to the show cause notice, filed its reply vide letter dated 27/12/2017.
4.4 For share premium, the appellant during the subject Assessment Year has issued share capital and has received the Share premium. The amount of share capital allotted is 142856 equity share at face value of Rs.10/- and premium at Rs.130/-per share amounting to Rs.1,85,71,280/-. Appellant has adopted the discounted cash flow method (DCF) by which the share premium of the shares was determined at Rs 130/- per share in addition to face value of Rs.10/- by relying on the explanation (a) (i) in section 56(viib) of the Act where option is to determine the valuation by applying Rule 11 UA and carry valuation under DCF method as per clause (b) of said rule, in case assets of the company are not substantiated by factors such as Goodwill, Know- how, patents, copy right etc. (explanation applicable herein is (a) (ii) of section 56(viib). However, assessing officer, giving a complete go-bye to the provisions of the Act, considered income under section 56(2)(viib) amounting to Rs.97,62,947/- (i.e. share premium) by applying net asset liability method mentioned under rule 11UA. The fair market value of share as per Ld. Assessing Officer is Rs.5.85 per share.
5.1 Ld. Counsel referred to Rule 11UA (2) of Income Tax Rules which Rule is as under:-
“Notwithstanding anything contained in sub-clause (b) of clause (c) of sub-rule (1),
“(2) 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)
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 balance-sheet 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;
(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
(iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
(iv) any amount representing provision for taxation, other than 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, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
(v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
(vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;
PE total amount of paid up equity share capital as shown in the balance-sheet;
PV the paid up value of such equity shares; or
(b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.“
5.2 Referring to Rule 11UA (2) it is submitted that the appellant has exercised the option (b) as mentioned in rule 11UA by using Discounted Free Cash Flow method which has been rejected by learned AO by applying (a) The difference between option (b) and (a) has been considered as Income.
5.3 Ld. Counsel submits that the method of valuation of unlisted equity shares is primarily that of book value for the purposes of clauses (vii) and (viia) of section 56(2), while DCF method is also permissible for the purposes of clause (viib) of section 56(2). The purpose of certification of DCF valuation by a merchant banker or a Chartered Accountant is to ensure that the valuation if fair and reasonable, and on the basis of established valuation methodologies. Such valuation is by an expert on the subject, which an Assessing Officer is not expected to be.
6. The ld. Counsel for the assessee further submitted that the method adopted by the assessee is one of the recognized methods for valuation of shares and there is no justification in discarding this method by the Assessing Officer simply stating that the valuation is full of assumptions and surmises for projected of cash flow, unjustified and un-related to the actual financial position of the assessee and without any rational basis. The ld. Counsel for the assessee placing reliance on the decision of the Hon’ble Delhi High Court in the case of Pr. CIT Vs. Cinestaan Entertainment Pvt. Ltd. which is placed at page Nos. 1 to 8 of the paper book, submits that this method has been accepted as one of the recognized methods and strongly placed reliance on the decision of the Hon’ble Delhi High Court.
7. On the other hand, the ld. DR placed reliance on the order of the ld. CIT (Appeals).
8. Heard rival submissions perused the orders of the authorities below. The assessee during the year under consideration issued 1,42,856 equity shares at face value of Rs.10/- for premium of Rs.130/- per share amounting to Rs.1,85,71,280/-. The assessee adopted the DCF method by which share premium of the shares was determined at Rs.130/- per share in addition to the face value of Rs.10/-. However, the Assessing Officer discarded the method adopted by the assessee and he adopted net assessed liability method and determined the fair market value of shares at Rs.5.80 per share. Thus, the Assessing Officer treated the share premium issued by the assessee of Rs.1,85,71,280/- as income from other sources under section 56(2)(viib) of the Act. The 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. It is also the contention of the assessee that once a particular method is adopted by the assessee at its option, which is recognized method, the Assessing Officer cannot adopt a different method. The ld. Counsel submits that in this case the assessee had opted only prescribed method of fair market value as per DCF valuation of an accountant under clause (b) of Rule 11UA and, therefore, there is no justification in adopting alternate method as provided in clause (a) of Rule 11UA read with section 56(2)(viib) of the Act. The ld. Counsel also contended that the shares subscribed by the parties are not related to the assessee and the genuineness of the investment is not doubted.
9. We observe that the Hon’ble Delhi High Court in the case of Pr. CIT Vs. Cinestaan Entertainment Pvt. Ltd. [433 ITR 82 (Del)] an identical issue came up before the Hon’ble court and the Hon’ble court held that the shares had not been subscribed to by any sister concern or closely related person but by outsider investors. It was further held that the methodology adopted was a recognized method of valuation and the Revenue was unable to show that the assessee adopted a demonstrably wrong approach or that the method of valuation was made on a wholly erroneous basis or that the method of valuation or that it committed a mistake which went to the root of the process. While holding so the Hon’ble Delhi High Court held as under:-
“8. We have heard and duly considered the arguments and contentions advanced by the learned counsel for both the parties.
9. In the present case, the Respondent-Assessee has received share premium from various subscribers/equity partners. These funds were required by the Respondent – Assessee for film production. The shares were issued based on the valuation received from the prescribed expert i.e., a Chartered Accountant who used the DCF method which is one of the methods stipulated under Section 56(2)(viib) read with Rule 11UA (2)(b). Based on the valuation report dated 15.12.2014, the Respondent-Assessee equity partners at a premium as per the following table:-
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