The Madras High Court has held that a valuation report issued by a chartered accountant can validly be relied upon for determining the fair market value of unquoted preference shares under Rule 11UA of the Income-tax Rules, 1962.
The Division Bench of Chief Justice Sushrut Arvind Dharmadhikari and Justice G. Arul Murugan observed that the applicable valuation rule expressly permits an assessee to obtain a report from either a merchant banker or an accountant. Consequently, the Income Tax Department cannot insist that only a report from an independent valuer or merchant banker should be accepted.
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The Court dismissed an appeal filed by the Income Tax Department against the order of the Income Tax Appellate Tribunal’s Chennai Bench in favour of Boppudi Logistics Private Limited. The dispute concerned Assessment Year 2011-12.
The controversy arose from the respondent company’s purchase of preference shares from another group company at Rs.130 per share.
According to the department, the seller company had earlier acquired a portion of the same class of preference shares from a non-resident Indian at Rs.240 per share. The Department consequently treated Rs.240 as the fair market value and alleged that the subsequent transfer to the respondent at Rs.130 per share was made for inadequate consideration.
On this basis, the department sought to invoke Section 56(2)(viia) of the Income-tax Act, 1961, which governed the tax treatment of certain receipts of shares by closely held companies for consideration below their fair market value.
The assessee, however, relied upon a valuation certificate based on the audited books of Virgo Realtors Private Limited, the company that had issued the preference shares. According to the certificate, the value of each share was Rs.101.93. Since the respondent had paid Rs.130 per share, it argued that the transaction did not attract Section 56(2)(viia).
Before the High Court, the Revenue raised three proposed substantial questions of law.
It first questioned whether the Tribunal was justified in accepting a valuation certificate issued by a chartered accountant instead of an independent valuer or merchant banker under Rule 11UA.
The Department also contended that the valuation certificate had been produced for the first time before the Tribunal without giving the Assessing Officer an opportunity to examine it. Lastly, it challenged the rejection of the Assessing Officer’s valuation of Rs.240 per share, which had been based on a contemporaneous transaction involving the same preference shares.
Rejecting the Revenue’s first contention, the High Court referred to Rule 11UA(1)(c)(c), as applicable to the dispute.
The provision prescribed the method for determining the fair market value of unquoted shares and securities other than equity shares. Under the rule, their fair market value was to be estimated at the price they would fetch if sold in the open market on the valuation date.
The rule also permitted the assessee to obtain a valuation report from a merchant banker or an accountant.
The Court held that when the statutory rule itself recognises an accountant’s report, the Department cannot contend that a valuation would be valid only when supported by an independent valuer or merchant banker.
The Revenue’s proposed question, the Bench observed, ran directly contrary to the plain language of Rule 11UA and therefore had no merit.
The High Court also rejected the Revenue’s contention that the valuation certificate had been produced for the first time before the Tribunal.
The Court examined the appellate record and found that the order of the Commissioner of Income Tax (Appeals) expressly recorded the production of the valuation certificate. The certificate was based on the audited books of account of Virgo Realtors Private Limited as on March 31, 2010, and was duly attested by its managing director.
The certificate valued each preference share at Rs.101.93, whereas the respondent had paid Rs.130 per share.
This record, the Court said, clearly established that the document had already been submitted and considered during the first appellate proceedings. The Department’s assertion that it was introduced for the first time before the Tribunal was therefore factually incorrect.
The High Court further upheld the Tribunal’s findings concerning the shareholding and the price adopted by the Assessing Officer.
At the beginning of the relevant year, the seller company held a total pool of 16,74,750 preference shares. Out of these, only 5,00,250 shares had been purchased from the non-resident Indian at Rs.240 per share.
The seller subsequently transferred 11,03,500 shares to Boppudi Logistics Private Limited. The Court agreed with the Tribunal that the Revenue could not presume that the shares sold to the respondent consisted exclusively of the block earlier purchased from the NRI.
The Bench observed that a seller has the legal freedom to select which block of shares from its existing holdings is being transferred. The Department could not impose an assumption contrary to the factual position and treat the NRI transaction as determinative of the value of every share subsequently sold.
The Tribunal had also examined Note 11 of the audited financial statements of Virgo Realtors Private Limited.
According to the note, shareholders were entitled to redeem the preference shares between June 1, 2011, and October 31, 2011, at Rs.140 per share. Against this background, the purchase of the shares at Rs.130 each in March 2011 was regarded as reflecting a realistic fair market value.
The High Court approved this reasoning. It found that the Assessing Officer had disregarded the statutory valuation mechanism and adopted Rs.240 per share merely on the basis of an isolated transaction involving the NRI.
The Tribunal was therefore justified in setting aside the Assessing Officer’s valuation and holding that the price of Rs.130 per share paid by the respondent was within the applicable statutory parameters.
Concluding that the Tribunal’s order was well reasoned, the High Court held that no substantial question of law arose for consideration. It accordingly dismissed the Revenue’s tax appeal and upheld the relief granted to the assessee.
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