The Income Tax Appellate Tribunal (ITAT), Mumbai, has deleted a share premium addition under Section 56(2)(viib) of the Income-tax Act, 1961, holding that the tax authorities could not substitute their own valuation for an expert’s Discounted Cash Flow (DCF) valuation without obtaining another expert opinion.
The bench of Saktijit Dey (Vice President) and Girish Agrawal (Accountant Member) observed that an Assessing Officer cannot change the valuation method from DCF to Net Asset Value (NAV) when the taxpayer has exercised its statutory option under Rule 11UA. Differences between projected and actual financial results had to be considered alongside the taxpayer’s explanation and the commercial circumstances of the investment.
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The company was engaged in manufacturing and trading PVC, plastic extruded products and allied materials, principally for the automobile ancillary industry. Its customers included original equipment manufacturers such as General Motors and Honda Motor.
For the relevant assessment year, it filed a return declaring a loss of approximately ₹1.49 crore under the normal provisions and book profit of approximately ₹9.92 lakh under Section 115JB.
During scrutiny, the Assessing Officer examined the issue of 6.80 lakh equity shares, with a face value of ₹10 each, to the Indian group company Polyrub Extrusions (I) Pvt. Ltd. for an aggregate consideration of approximately ₹15.63 crore.
The company had also issued 4.20 lakh shares to a non-resident group company for approximately ₹10.65 crore. The Assessing Officer excluded that transaction from the examination under Section 56(2)(viib), applying the provision as it stood for the assessment year concerned.
To justify the valuation of the shares issued to the Indian entity, the taxpayer submitted a chartered accountant’s report determining their fair market value at ₹239.85 per share under the DCF method. A second valuation report from a merchant banker was also furnished during the proceedings.
The Assessing Officer questioned the substantial difference between the projected financial figures used in the valuation and the company’s actual performance.
According to the officer, the valuer had relied on figures supplied by management without adequately examining past performance, earning capacity, growth prospects and other relevant factors. The actual cash flows and profits, the officer observed, did not support the projections.
Rejecting the DCF valuation, the Assessing Officer determined the share value at ₹9.17 per share and made an addition of approximately ₹15.63 crore under Section 56(2)(viib).
The taxpayer explained that its projections were supported by letters of intent and purchase orders from General Motors. Those expectations were subsequently affected by the closure of the customer’s Indian business, which substantially reduced sales.
It also submitted that its performance improved in subsequent years.
The National Faceless Appeal Centre partly accepted the explanation that the reduction in business from General Motors had affected the company’s actual results.
It also recognised that Rule 11UA gave the taxpayer the option to choose a prescribed valuation method and that the Assessing Officer could not replace DCF with NAV.
Nevertheless, the appellate authority questioned the valuation assumptions and adopted a lower figure of ₹137.91 per share after considering past performance and automobile industry growth material. This reduced the addition to approximately ₹6.25 crore.
Both parties approached the Tribunal. The taxpayer sought deletion of the remaining addition, while the Revenue sought restoration of the Assessing Officer’s addition.
The Tribunal held that the taxpayer had supported its share valuation with reports prepared under the prescribed DCF method.
By contrast, the Assessing Officer had not obtained an independent expert valuation before rejecting those reports.
“It is fairly well settled that valuation of an asset requires expertise,” the bench observed, holding that the officer should have obtained another expert valuer’s opinion to examine whether the taxpayer’s valuation was correct.
The Tribunal found that the Assessing Officer had instead undertaken the valuation exercise himself despite lacking expertise in the field.
It further affirmed that, once the taxpayer opted for DCF under Rule 11UA, the officer could not alter that choice by switching to NAV.
The Tribunal found that the first appellate authority had committed a similar error when it substituted its own valuation.
Its reliance on past performance and an industry review report from the Auto Component Manufacturers Association of India did not provide a scientific basis for determining the company’s share value.
The bench observed that an industry report might or might not supply the appropriate indicators for valuing the particular company. It therefore rejected the substituted valuation adopted while granting partial relief.
The Tribunal acknowledged that actual profits in subsequent years differed from the projections used in the DCF valuation. However, it found the taxpayer’s explanation credible.
The projected figures were supported by letters of intent and purchase orders from General Motors India, which accounted for a major portion of the company’s sales. The closure of that customer’s business materially affected the anticipated revenue.
The bench also noted that the first appellate authority had partly accepted this explanation and that the company’s profits showed an incremental increase in subsequent years.
On these facts, the difference between projections and actual performance did not justify the addition.
The Tribunal also considered the purpose of the investment. The taxpayer explained that it required funds to acquire another company and that closely linked group entities had infused capital through the acquisition of shares at a premium.
Taking account of the common shareholders and promoters, the commercial purpose of the funding and the other material on record, the bench found no ulterior motive in charging the premium in this transaction.
On an overall assessment, it directed the Assessing Officer to delete the addition under Section 56(2)(viib). The taxpayer’s appeal was allowed, and the Revenue’s appeal was dismissed.
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