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September 14, 2022

The intrinsic value of shares is a reasonable method of determining the fair market value of shares

by CA Shivam Jaiswal in Income Tax, Legal Court Judgement

The intrinsic value of shares is a reasonable method of determining the fair market value of shares

Facts and Issue of the Case

The grounds of appeal taken by the assessee are reproduced as below:

Ground No. 1 : Cost of acquisition of 225 shares of Somani & Company P. Ltd.

1.a. The learned CIT(A) erred in confirming the Long Term Capital Gain at Rs. 3,85,65,708 /- instead of Rs. 3,51,20,122/-, in respect to the sale of shares of Somani & Company Pvt. Ltd.

1.b. The learned CIT(A) erred in determining the indexed cost of acquisition of 225 equity shares at Rs. 1,76,625/- instead of Rs. 67,70,036/-, by wrongly assuming the FMV as on 01-04-1981 @ Rs. 100/- per share, instead of Rs. 3,833 /- per share.

1.c. The learned CIT(A) erred in rejecting the accepted Net Asset method adopted by the Assessee for determining the FMV as on 01-04-1981 and instead adopted the value as per Rule ID of the Wealth tax (which has been omitted by the Wealth tax (Second Amendment) Rule 1989 w.e.f. 1.4.1989 and therefore cannot be applied in AY 12-13).

Ground No. 2 : Reference to Valuation Officer

The learned CIT(A) erred in not making a reference to the Departmental Valuation Officer u/s. 55A to value the shares, once she was not satisfied with the report submitted by the Assessee despite claim made by Assessee for reference.

The issue in appeal lies in a very narrow compass of undisputed material facts. During the relevant previous year, the assessee sold 930 equity shares held by her in Somani & Co Pvt Ltd (SCPL, in short) for a consideration of Rs 8,46,30,000, but these shares were acquired in three lots, out of which the first lot of 225 equity shares was admittedly acquired prior to 1st April 1981. While computing the capital gains on the sale of these shares, the assessee took the cost of acquisition of Rs 100 each for the SCPL equity shares acquired after 1st April 1981, but, so far as the 225 equity shares acquired prior to 1st April 1981 are concerned, the cost of acquisition was taken as fair market value as on 1st April 1981 which was stated to be Rs 3,833. This valuation was done by dividing the net fair market value of the assets of the SCPL (i.e. Rs 7,66,80,100) by the total number of equity shares (i.e. 20,000). The fair market value of the shares, as on 1st April 1981, was duly supported by the report of Shah & Shah, Government Approved Valuers, for the valuation of land held by the company- which was its most valuable asset.

Observation by the Court

The court had heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. The court find that there is no dispute that the shares were acquired before 1st April 1981 and that the assessee had the option to substitute its cost of acquisition by the fair market value as on 1st April 1981. The assessee has filed a Government Approved Valuer report evidencing its fair market value of the land held by the SCPL, and, taking into account the same, computation of the fair market value as on 1st April 1981 on the basis of the intrinsic value of the SCPL shares. The intrinsic value of shares, particularly in the case of the closely held private limited companies, is, in our considered view, a reasonable method of ascertaining the fair market value of the shares. The mere fact that the shares were issued after 1st April 1981 also at face value cannot negate its fair market value. When shares are issued by a company at face value, it does essentially imply that the market value of shares already issued does not exceed the face value of these shares; the reasoning adopted by the Assessing Officer is simply fallacious and proceeds on the unrealistic assumption that the issue price of the shares reflects their fair market value. Section 2 (22B) does define the expression “fair market value” in relation to a capital asset, as “(i) the price that the capital asset would ordinarily fetch on sale in the open market on the relevant date; and (ii) where the price referred to in sub-clause (i) is not ascertainable, such price as may be determined in accordance with the rules made under this Act”, it does not really require an actual price at which such an asset is sold, but it would also include a hypothetical price which such a capital asset would fairly fetch in an open market.

The shares of a private limited company are not sold in an open market, and, therefore, when computing such a price under section 2(22B), one has to proceed on the basis that if the shares of the private limited company are to be sold in an open market. As to what would have been a fair price for such shares, particularly in a closely held private company in which the fair market value of land is more than 90% of the entire fair market value of the net assets of the company, in our considered view, the intrinsic value of the shares on the basis of net assets divided by the total number of equity shares is most appropriate. Of course, as to what is the most appropriate method of ascertaining the fair market value of shares in a private limited company would vary from case to case, but given the fact that the most important asset held by this company, as a perusal of the valuation report read with the balance sheet- copies of which is placed before us in the paper book, is land, and the value of this asset is a dominant factor in the valuation of the entire company, the course adopted by the assessee does appeal to us. The provisions of Rule 1 D, so much relied upon by the learned CIT(A), were no longer in existence at the relevant point of time, and nothing, therefore, turns on the same, nor can these provisions, therefore, be pressed into service as of now. No doubt, the provisions of rule 1 D of the Wealth Tax Rules could, at best, be of good guidance, but that is still a step short of the legal force. In any event, if the Assessing Officer had any doubts on the correctness of valuation, it was open for him to refer the matter to the Departmental Valuation Officer, but that exercise has not been done, and the relevant financial period is more than a decade old. No other issues are raised by the authorities below with respect to the method adopted for the valuation of shares in question. In view of these discussions, and on the peculiar facts of this case,  the court uphold the plea of the assessee, and direct the Assessing Officer to adopt the valuation of Rs 3,833 computed by the assessee on the basis of the fair market value of the net assets. The assessee gets the relief accordingly. As the court  have upheld the main plea of the assessee, all other issues raised by the assessee are dismissed as infructuous.

Conclusion

The appeal is allowed by the court.

Sushiladevi-R-Somani-Vs-ACIT-ITAT-Mumbai

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