PCIT Vs Magnet Buildtech Pvt. Ltd (Gujarat High Court)
Summary: The Gujarat High Court dismissed the Revenue’s appeal under Section 260A of the Income-tax Act, 1961, against the ITAT Ahmedabad order dated 25 July 2024 for AY 2016-17. Magnet Buildtech Pvt. Ltd. filed a nil return on 26 September 2016. The case was selected for limited scrutiny through CASS to examine the tax treatment of investments, advances and loans, and the source and tax treatment of share premium. The Assessing Officer (AO) examined the allotment of 7,99,900 compulsorily convertible preference shares (CCPS) and added ₹79,19,01,000 as excess premium under Section 56(2)(viib), relying on Rule 11UA(2). The Revenue questioned both the deletion and the reliability of a valuation report that carried a disclaimer about management-supplied information.
The AO rejected the chartered accountant’s valuation of ₹1,000 per CCPS after recording that the assessee had failed to reply to the show-cause notice. The assessee maintained that it had requested a rescheduled personal hearing and argued that Rule 11UA(1)(c)(c) governed unquoted preference shares, while Rule 11UA(2) dealt with unquoted equity shares under the provisions applicable to the year. It also relied on a CIT(A) order concerning its group company, First Class Infrabuild Pvt. Ltd., which had accepted that valuation disclaimers were consistent with the inherent uncertainty of projections.
The CIT(A) obtained the assessee’s written reply during the appeal and considered it alongside the chartered accountant’s response to the notice under Section 133(6). The CIT(A) found that those materials answered the AO’s valuation objections and that the source of the premium was explained. The CIT(A) also noted that each CCPS was compulsorily convertible after 18 years into 100 equity shares of ₹10 face value each and found the valuation of ₹1,000 per CCPS reasonable on the facts. The CIT(A) accordingly deleted the addition.
The Tribunal upheld the deletion and accepted the discounted cash flow (DCF) method used in the valuation. It found that an independent technical expert had prepared and validated the financial projections and that the wholly owned subsidiary had allotted the CCPS to its holding company. It distinguished Agro Portfolio, where shares were allotted to a third party and the merchant banker relied solely on management-supplied data without independent verification. The Tribunal also drew on decisions concerning the assessee’s choice of a prescribed valuation method, assessment of projections using information available on the valuation date and the treatment of share premium on allotments to a holding company.
The High Court held that the AO had misapplied Rule 11UA(2) by using it to reject the chartered accountant’s valuation under Rule 11UA(1)(c). The applicable rule called for an estimate of the open-market price on the valuation date. The Court held that subsequent financial losses could not justify discarding a report based on contemporaneous facts and data. It agreed with the Tribunal’s application of the anti-abuse purpose of Section 56(2)(viib) to this allotment, given the relationship between the parties and the absence of specific proof of unaccounted money or inflated value for tax evasion. In view of the concurrent findings of fact, the High Court found no substantial question of law and dismissed the Revenue’s appeal.
Cases Discussed
- JCIT (OSD), Circle 2(1)(1), Ahmedabad Vs Magnet Buildtech Pvt. Ltd. — ITA No. 489/Ahd/2020, 25 July 2024, AY 2016-17 (ITAT Ahmedabad). The order under appeal upheld the deletion of the CCPS premium addition.
- ITO, Ward 24(1), New Delhi Vs Solitaire BTN Solar Pvt. Ltd. — [2024] 164 taxmann.com 170, ITA No. 1416/Del/2020, 12 June 2024 (ITAT Delhi). The Tribunal relied on it in examining the legislative purpose of Section 56(2)(viib) in transactions between a holding company and its subsidiary.
- ACIT, Circle 7(2), New Delhi Vs Dhruv Milkose Pvt. Ltd. — ITA No. 8431/Del/2019, 8 February 2024 (ITAT Delhi). The Tribunal cited it for the principle that the AO cannot substitute a different valuation method where the assessee has opted for a prescribed method.
- Rugby Regency (P.) Ltd. Vs ACIT — [2024] 160 taxmann.com 1056, ITA No. 653/Del/2019, 25 January 2024 (ITAT Delhi). The Tribunal cited it for assessing valuation using facts available at the valuation date.
- Innoviti Payment Solutions Pvt. Ltd. Vs ITO — [2019] 102 taxmann.com 59, 175 ITD 10, ITA No. 1278/Bang/2018, 9 January 2019 (ITAT Bangalore). The appellate authorities referred to it for the scope of scrutiny of a DCF valuation and the limits on changing the method chosen.
- Agro Portfolio Pvt. Ltd. Vs ITO — [2018] 94 taxmann.com 112, ITA No. 2189/Del/2018, 16 May 2018 (ITAT Delhi). The Tribunal distinguished the Revenue’s authority on the data used by the valuer and the identity of the allottee.
FULL TEXT OF THE JUDGMENT/ORDER OF GUJARAT HIGH COURT
1.Heard learned Senior Standing Counsel Mr.Dev D Patel for the appellant.
2.This appeal is filed under Section 260A of the Income Tax Act, 1961 (for short, “the Act”) by the appellant – Revenue, proposing the following substantial questions of law arising out of the order dated 25.07.2024 passed by the Income Tax Appellate Tribunal (for short, “Tribunal”) in ITA No. 489/AHD/2020 for A.Y. 2016-17;
“(a) Whether in the facts and circumstances of the case and in law, the learned ITAT has erred in deleting the addition on account of disallowance u/s 56(2)(viib) of the Act without duly considering the findings of the Assessing Officer that the assessee had received excess premium in contravention to the provisions of section 56(2) (viib) of the Act?
(b) Whether in the facts and circumstances of the case and in law, the learned ITAT has erred in holding the valuation valid, without duly considering that the valuer has failed to verify the financial projections from independent sources and has simply issued certificate with the disclaimer that all the details were provided by the management?”
3.The brief facts of the case are as under;
3.1 The assessee filed a return of income for A.Y. 2016-17 declaring nil income on 26.09.2016. The case of the assessee was selected for limited scrutiny through CASS with respect to two issues, namely, (i) whether the tax aspects to investments/advances/loans have been considered in the return of income; and (ii) whether the funds received in the form of share premium are from disclosed sources and have been correctly offered to tax. 3.
3.2 The Assessing Officer proceeded to make inquiries about the justification of the amount of share premium received on allotment of 7,99,900 Compulsorily Convertible Preference Shares (CCPS). The Assessing Officer, after considering the submissions made by the assessee, made addition of excess premium of Rs. 79,19,01,000/- under Section 56(2)(viib) of the Act, alleging that the same to be in excess of the fair market value of CCPS by relying on provisions of Rule 11UA(2) of the Income-tax Rules, 1962 (for short, “the Rules”).
4. Being aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the CIT(Appeals) who, after considering the submissions made on behalf of the assessee as well as considering the provisions of Rule 11UA of the Rules, allowed the appeal by observing as under;
“5.4 Ground No.s 2 to 6: Since only a single issue is involved, therefore, for the sake of convenience, all these grounds of appeal have been taken together for adjudication.
i From the Assessment order it is noticed that the A.O. had allowed the Appellant final opportunity through Show-Cause Notice dated 03.12.2018 to explain as to why the Valuation Report of the C.A. valuing the F.M.V. of CCPS at Rs.1,000/- per CCPS should not be rejected, but, since the Appellant failed to reply the Show-Cause Notice, A.O. rejected the Valuation Report. (Para 9 of the assessment order).
ii. Having rejected the Valuation Report determining the F.M.V. of the CCPS at Rs.1000/- per CCPS, the A.O., after referring to the scope and ambit of the provisions of Section 56(2)(viib) of Income Tax Act, 1961 and Rule 11UA(1) (c)(c), considered the Premium on CCPS as taxable income being in contravention of the provisions of Section 56(2)(viib) of Income Tax Act, 1961.
5.4.1 It is therefore, evident that the Premium on CCPS was added solely, because, according to A.O. the Appellant had failed to reply the Show-Cause Notice which led the rejection of the Valuation Report determining F.M.V. of the CCPS and the addition under appeal.
5.4.2 During the course of hearing of the appeal on 19.03.2020 the Ld Advocate Mr. I.S.Verma, while explaining the grievance expressed in Ground No. 6 of the Appeal that the A.O. rejected the F.M.V determined by the Appellant in accordance with the prescribed provisions of law, arbitrarily and on conjectures and surmises, submitted that it is not correct to say that the Appellant had not complied the Final Show Cause notice dated 03.1.2018, as is evident from the Appellant’s letter dated 05.12.2018 requesting for personal hearing on 14.12.2018 instead of 07.12.2018 fixed as per show cause notice, to explain the matter under reference. On the other hand, it is miscarriage of justice by violating the ‘Principles of Natural Justice’ by not allowing the personal hearing and, therefore, allegation for not filing reply to the show cause notice is false and cannot be used against the Appellant.
5.4.3 On merits Mr Verma submitted that the Valuation, having been done in accordance the provisions of Law and the Rules prescribed by the CBDT/Legislatures, is the correct one and therefore, FMV is neither against the so called correct parameters nor is exaggerated in value and as submitted hereinbefore, Assessing Officer having no power to reject the valuation and substitute his own method/valuation, this reason is not relevant at all so as to reject the valuation.
5.4.4 On the point of justification of the method adopted for valuing the ‘CCPS’ and disclaimer given by the C.A. reference was made to the Para 5.4 of the Appellate Order in case of Appellant’s group Company M/s First Class Infrabuild Pvt. Ltd. wherein both these issues had been discussed and decided by the CIT(A)-3 in Appellant’s favour by observing that “……. The valuer is bound to give disclaimers as the valuer cannot be expected to determine the exact value as the same is not feasible. As already discussed above, the valuer has adopted reasonable projections than the optimum figures for generation of revenue and the valuation of shares done by the valuer has got reasonable basis……”.
5.4.5 Further, Commenting on the conclusion arrived at by the A.O. in Para 12 & 13 of the Assessment Order the Ld AR submitted that the same being based on misplaced understanding of the provisions of section 56(2) (viib) and Rule 11 UA, specially the Rule 11UA(1) (c)(c) and Rule 11UA(2)(a), just speaks of the ignorance or the pre-determined state of mind of the Officer to make addition. Referring to the provisions of Explanation to section 56(2)(viib) of the Act and the provisions of Rule 11UA(1) (c)(c) and Rule 11UA(2) it was submitted that the Legislature has provided different methods for computing ‘fair market value’ of ‘unquoted equity shares’ and ‘unquoted shares other than the equity shares’ and so far Appellant’s case is concerned, the ‘fair market value’ of ‘CCPS’ having been estimated in accordance with the provisions of Rule 11UA(1) (c)(c), A.O. had no jurisdiction/power to object to the same and substitute his valuation. It was further submitted that as far as Rule llUA (2) is concerned, firstly, this Rule is for computing the ‘fair market value’ of ‘unquoted equity shares’ and secondly, Rule has given option to the Assessee to compute the value in accordance with Rule 11UA(2)(a) or Rule 11UA(2)(b) and for that purpose the assessee has to be allowed an opportunity to select its option, which was missing in this case. According to him A.O. did not have jurisdiction/power either to reject the Valuation Report or to substitute his own value computed under RulellUA(2) (a) or 11UA(2)(b) and therefore the addition under dispute/appeal may kindly be deleted. 5.
5. 4.6. In the interest of substantial interest, the Appellant was directed to submit its reply to the show cause notice issued by the AO on 03.12.2018 and some other issues. On 9.07.2020 Appellant’s counsel Advocate Sh. I.S. Verma along with Sh. D.R. Rajan, C.A. cum General Manager of the appellant group of company attended the hearing and submitted written reply which has been reproduced in this order supra in para 4.2 pages 24 to 31 of this order. 5.
5. 4.7. Case was discussed with the ARs and written replies have also been perused. In view of the provisions of 250(4), which provide that before disposing of the appeal, the CIT(A) may make such further inquiry as he thinks fit or may direct the A.O. to make further inquiry, and the unprecedented Covid-19 restrictions it was thought fit to verify the Appellant’s reply to show cause notice vis-à-vis to the allegations/shortcomings/defects etc pointed and relied upon by the A.O. to reject the valuation report and consequently the F.M.V. of the CCPS. 5.
5. 4.8. After having considered the facts on records, contents of show cause notice, AO’s case, Appellant’s reply, provisions of section 56(2)(viib) read with Explanation thereto and the Rule 11UA (1) (c)(c) and Rule 11UA(2)(a)/11UA(2)(b), I find force in the submissions of the appellant. Had the A.O. considered the appellant’s various replies and the C.A’s reply, which were filed before issuing show cause notice, in right perspective, there could have been no reason for issuing the Show- Cause Notice, what to say of the rejection of the Valuation Report/F.M.V. A.O’s approach to the whole issue seems to be the provisions of section 56(2)(viib) and the quantum of premium, which itself cannot be sustained.
5. 4.9. I have also found that the Appellant’s reply against show cause notice and the C.A’s reply filed in response to notice u/s133(6) satisfy all the objections, on the basis of which the A.O. rejected the Valuation report and made the addition. In the totality of the facts and circumstances and the provisions of Law addition of the premium received on issuance of the CCPS, which otherwise was from well explained sources, was not justified and the same deserves to be deleted.
5. 4.10. Even otherwise also, since each CCPS was to be converted after a period of 18 yrs, compulsorily, in 100 shares of face value of Rs. 10/- each, the value of Rs. 1000/- of each CCPS as on the date of allotment could not be said to be unreasonable or in excess of the F.M.V. on that date. Therefore, appellant’s case is out of the provisions of section 56(2)(viib). The addition under appeal is therefore, directed to be deleted on this count also. Therefore, the addition of Rs.79,19,01,000/- u/s 56(2)(viib) is hereby deleted. Accordingly, grounds of appeals no. 2 to 6 on this addition are allowed.”
5. Being aggrieved by the order passed by the CIT(Appeals), Revenue preferred an appeal before the Tribunal. The Tribunal, in the impugned order, dismissed the appeal of the Revenue, upholding the order passed by the CIT(Appeals), by observing as under;
“ 6.1. Relating to Ground Nos.1 to 3, we noted that the Ld.CIT(A) has dealt with the same in detail. The Ld.CIT(A) supported the valuation process, asserting that it was conducted in accordance with the legal provisions and CBDT/Legislature rules. The Ld.CIT(A) has criticized the AO for not having the power to reject the valuation or substitute his own method. The fair market value (FMV) determined by the Valuer is defended by the Ld.CIT(A) as neither exaggerated nor incorrect. The Ld.CIT(A) emphasized that the AO cannot arbitrarily reject a Valuation Report that complies with established legal guidelines. The FMV determined by the Valuer is upheld, provided it follows the prescribed rules. The Ld.CIT(A) has also justified the method adopted for valuing CCPS and the disclaimers by the Valuer. The Ld.CIT(A) has made a reference to a previous appellate order in favour of the assessee, supporting the Valuer’s methodology and disclaimers. The Ld.CIT(A) has cited the ITAT Bangalore Bench’s decision in the case of Innovit Payment Solutions Pvt. Ltd. to reinforce the process and principles for scrutinizing valuation reports. The Ld.CIT(A) reinforced that Valuers must provide disclaimers due to the inherent uncertainties in valuations. The decision cited by the Ld.CIT(A) underscores that the AO can scrutinize, but not arbitrarily reject a valuation without proper reasons and adherence to the DCF method, which cannot be changed by the AO. The CIT(A) found fault with the AO’s interpretation of Section 56(2)(viib) and Rule 11UA. The Ld.CIT(A) deemed that the AO’s rejection of the valuation report beyond his jurisdiction, especially when the valuation is done as per Rule 11UA(1) (c)(c). Thus, the Ld.CIT(A)’s decision systematically dissects the AO’s actions, emphasizing adherence to legal procedures and the importance of a fair valuation process.
6.2. We have reviewed the judicial pronouncements relied on by the Ld.DR. The decision of Delhi Bench of ITAT in the case of Agro Portfolio (P.) Ltd. (supra) is not applicable in the present case as shares were allotted to third party and the merchant banker solely relied upon the information and financial data provided by the company without independent verification. As against in the present case the shares are allotted to the holding company by wholly owned subsidiary and the financial projections were prepared and validated by independent technical expert.
6.3. The judicial precedents relied on by the Ld.AR are also reviewed. In case of Dhruv Milkose Pvt. Ltd.(supra), the Tribunal decided that the AO cannot change the method of valuation chosen by the assessee if it complies with the prescribed law and rules. In case of Solitaire BTN Solar Pvt. Ltd.(supra), the Tribunal emphasized that transactions between holding and subsidiary companies at a premium do not attract Section 56(2) (viib) of the Act as the legislative intent is not to tax such transactions. In case of Rugby Regency (P.) Ltd.(supra), the Tribunal confirmed that the AO must scrutinize the valuation based on the facts available at the time of valuation and cannot rely on subsequent financial performance.
6.4. Based on the facts and judicial pronouncements, we conclude that the DCF method adopted by the assessee for valuing the CCPS is legitimate and in accordance with Rule 11UA. The AO cannot reject the method chosen by the assessee if it is prescribed by law.
6.5. The AO’s reliance on the company’s subsequent financial losses to question the valuation is misplaced. The projections must be assessed based on the facts and data available at the time of valuation, not on future outcomes, as held in various judicial pronouncements. The issuance of CCPS to the holding company does not align with the legislative intent of Section 56(2)(viib) of the Act to prevent the generation and use of unaccounted money. The transaction between a wholly owned subsidiary and its holding company does not create any unaccounted income or inflated share value for tax evasion purposes unless it is specifically proved. The Ld.CIT(A) correctly applied the provisions of law and judicial precedents in deleting the addition made by the AO. The valuation of shares based on the DCF method is valid, and the AO’s objections lack merit. The order of the Ld.CIT(A) is upheld. The addition of Rs.79,19,01,000/- under Section 56(2) (viib) of the Act is hereby deleted.”
6. Considering the above concurrent findings of fact recorded by the CIT(Appeals) and the Tribunal, it is not in dispute that the Assessing Officer has doubted the valuation report issued by the Chartered Accountant as per the Rule 11UA while valuing the fair market value of the CCPS along with the disclaimers made in such report.
7. Both the Tribunal as well as the CIT(Appeals) have referred to and relied upon the similar orders passed in favor of the assessee supporting the methodology and disclaimers in the valuation report to arrive at a fair market value of the CCPS. The Assessing Officer has misinterpreted the provisions of Section 56(2)(viib) read with Rule 11UA by rejecting the valuation report, as the same could not have been done by the Assessing Officer, as per the provision of Rule 11UA(1)(c). The provisions of Rule 11UA(1)(c), which reads as under; “Determination of fair market value. 11UA. (1) For the purposes of section 56 of the Act, the fair market value of a property, other than immovable property, shall be determined in the following manner, namely,
“Determination of fair market value.
11UA. (1) For the purposes of section 56 of the Act, the fair market value of a property, other than immovable property, shall be determined in the following manner, namely,
(c)”valuation of shares and securities,—
(c) the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation.
(2) Notwithstanding anything contained in sub-clause (b) or sub-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 the 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:-
8.On perusal of the above rule applicable to the facts of the case, when the valuation is done as per Rule 11UA(1)(c) as per the valuation report submitted by the Chartered Accountant, the Assessing Officer could not have rejected the same, as it would have been beyond his jurisdiction. The Tribunal has therefore rightly held that the CIT(Appeals) has systematically dissected the reasoning of the Assessing Officer to highlight as to how Rule 11UA(1)(c) is misinterpreted to apply Rule 11UA(2) for invoking Section 56(2)(viib) of the Act.
9.It is also pertinent to note that the subsequent financial loss of the assessee-company for the purpose of valuation could not have been referred to and relied upon as the basis by the Assessing Officer to reject the valuation report, which is based on the facts and data available at the time of valuation and such valuation report could not have been rejected on the basis of the subsequent financial losses. The Tribunal was therefore justified in holding that the issuance of CCPS to holding company would not align with the legislative intent of Section 56(2)(viib) of the Act to prevent the generation and use of unaccounted money, as the transaction was between a wholly owned subsidiary and its holding company, which would not create any unaccounted money or inflated share value for tax evasion purpose unless the same is specifically proved. Therefore, in view of the concurrent findings of facts recorded by both the CIT(Appeals) and the Tribunal, no question of law, much less any substantial question of law, arises from the impugned order of the Tribunal. Therefore, the appeal is accordingly dismissed.
