Assessee can adopt any method of shares valuation – DCF or Book Value – AO has no power to change the same
As per the provisions of Section 56(2)(viib) of the Act, if a company in which public are not substantially interested, receives in any previous year, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares, if exceeds the fair Market Value of the shares shall be taxed as income from other sources.
In the case of M/s Flutura Business Solutions Pvt Ltd vs The Income Tax Officer (24.06.2020) an appeal was filed before the ITAT by the Assessee is against the order of the Commissioner of Income Tax (Appeals). The issue involved in the appeal was against the action of the Assessing Officer in invoking provisions of section 56(2)(viib) of the Income Tax Act, 1961 and taxing the share premium received during the previous year as income of the Assessee.
Facts of the Case:-
- The assessee is in the business of providing specialist solutions in the areas of Decisions Science & Analytics.
- The Assessee filed return of income for the A.Y.2013-14 declaring a loss.
- During the previous year the Assessee had issued equity shares of face value of Rs.10 each at a premium of Rs.146.17 per share.
- The Assessing Officer (AO) concluded the assessment taxing the premium amount as income of the company invoking the provisions of section 56(2)(viib) of the Act.
- Aggrieved by the order of the AO, the Assessee preferred appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].
Contention of the Assessee
- The question for consideration is as to what is the Fair Market Value of the shares that was issued.
- As far as valuation 64,033 shares which were allotted to M/s.Krishnan Muthukumar & Group. The plea of the Assessee was that since the valuation is supported by a valuation report as provided under Rule 11 UA(2) of the Income Tax Rules, 1962 there was no case for the AO to invoke the provisions of section 56(2)(viib) of the Act in regard to this allotment also.
- It was the plea of the Assessee that in respect of the balance 60831 equity shares of the value of Rs.95 lacs issued, that the Assessee purchased Intellectual Property Rights (IPR) from the aforesaid three promoters for a consideration of Rs.95 lakhs. In lieu of this purchase, 60,831 equity shares were allotted to the promoters at the value of Rs.156.17 per share (Rs.10 towards the face value and Rs.146.17 per share towards the premium), the same value at which the shares were allotted to two non-residents and also to M/s.Krishnan Muttukumar & Group.
- The case of the Assessee was that the valuation of shares at a premium was based on a valuation report issued by their Chartered Accountants who valued the shares adopting Discounted Cash Flow (DCF) method.
- This valuation is as mandated in the provisions of Rule 11 UA(2)(b) of the prescribed for the purpose of determining fair market value of shares in the context of allotting shares at a premium and also the treatment of such receipt of premium under the provisions of section 56(2)(viib) of the Act.
- The AO did not accept the explanations of the Assessee and he invoked the provisions of section 56(2)(viib).
- AO disputed the values adopted in the DCF method, with a finding that, the book value per share is Rs.9.52 only as on 30.04.2012.
Appeal to Commissioner of Income Tax (Appeals) [CIT(A)]
- Out of the above share premium received, premium to the extent of Rs 46,79,840 related to shares issued to non-residents.
- Considering the position of law that the provisions of section 56(2)(viib) has no application to premium received from non-residents, the CIT(A) deleted additions to this extent.
- The balance addition was confirmed by the CIT(A).
- CIT(A) held that the AO was well within his powers to disturb the valuation of the chartered accountant furnished by the Assessee substantiating the fair market value.
- Aggrieved the appellant filed an appeal before the ITAT. The only issue contested in the appeal is the addition of the balance confirmed by the CIT(A).
Observations of ITAT on the value of shares issued to promoters
- Assessee submitted that the 60831 shares issued to Mr Krishnana Raman, Mr Thaiparambil Jude Derick Jose and Mr. Srikanth Mudaliar of the total value Rs.95 lakhs,were allotted to promoters of the company in lieu of price/consideration for IPR owned by them which they sold to the Assessee under an agreement.
- It was therefore, argued that the provisions of section 56(2)(viib) could not have been invoked, because the premium received was not in cash and such premium and allotment of shares were not against the existing assets of the company but acquiring a new asset.
- ITAT was in agreement with the view of the CIT(A), but the value of the IPR should be computed for the purpose of valuation of shares which was not done by the AO while adopting NAV method of valuation of shares.
- Share allotment in lieu of purchase consideration payable for an asset acquired is not outside the ambit of the provisions of Section 56(2)(viib).
Observations of ITAT with regard to the correctness of DCF method adopted by the Assessee for valuing shares and the procedure to be followed when such method of valuation is not accepted by the AO
- The law contemplates invoking provisions of section 56(2)(viib) only in situations where the shares are issued at a premium and at a value higher than the fair market value.
- The fair market value of the shares shall be the value:-
- As may be determined in accordance with such method as may be prescribed; or
- Any other value to the satisfaction of the AO
- The provision provides an Assessee two choices of adopting either NAV method or DCF method.
- If the Assessee determines the fair market value in a method as prescribed, the AO does not have a choice to dispute the justification.
- The methods of valuation are prescribed in Rule 11 UA(2). The provisions of Rule 11 UA(2)(b) of the Income Tax Rules provides that, the Assessee can adopt the fair market value as per the above two methods and the choice of method is that of the Assessee.
- The ITAT followed the judgment of Bombay High Court rendered in the case of Vodafone M-Pesa Ltd., Vs. Pr. CIT (supra) and has taken the view that the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the Assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the Assessee.
- ITAT was of the view that, the AO had erred in considering the actual of revenue and profits declared in the future years as a basis to dispute the projections.
- At the time of valuing the shares, the actual results of the later years would not be available.
- The expected and projected revenues are required for arriving at the fair market value by following the DCF method.
- Accordingly the valuation is on the basis of estimates of future income contemplated at the point of time when the valuation was made.
- It was clarified by the Assessee that the product which was being developed by the Assessee has substantial value and the Assessee was able to raise funds to the tune of Rs.50.13 crores from international market.
Opinion of the ITAT on the future course of action to be appointed by the AO
- The issue with regard to valuation had to be decided afresh by the AO on the lines indicated in the decision of ITAT, Bangalore in the case of VBHC Value Homes Pvt.Ltd., Vs ITO (supra) i.e.,
- the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee.
- For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual result of future cannot be a basis to decide about reliability of the projections.
- The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method.
- Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, Scientific study and applicable Guidelines regarding DCF Method of Valuation.
The order of CIT(A) was accordingly set aside for deciding the issue afresh after due opportunity of hearing to the Assessee.The appeal was allowed for statistical purpose.A similar decision was passed in the case of Karmic Labs Pvt. Ltd vs. ITO (ITAT Mumbai).
The assessee has the choice to choose a prescribed method for ascertaining the market value of the shares transferred. It was ruled that, if the assessee has chosen one method of valuation provided under Rule 11UA (i.e. DCF method), the AO has no power or jurisdiction to change that method to another method.Section 56 allows the assessees to adopt one of the methods of their choice. But, the AO held that the assessee should have adopted only one method for determining the value of the shares.
In the opinion of the ITAT, it was beyond the jurisdiction of the AO to insist upon a particular system, especially the Act allows to choose one of the two methods. Until and unless the legislature amends the provision of the Act and prescribes only one method for valuation of the shares, the assessee are free to adopt any one of the methods.