The Income Tax Appellate Tribunal (ITAT), Delhi Bench “B”, has held that an Assessing Officer cannot summarily reject a taxpayer’s Discounted Cash Flow (DCF) valuation merely because the financial projections underlying the valuation did not subsequently match the company’s actual performance.
The Bench of Sudhir Kumar (Judicial Member) and M. Balaganesh (Accountant Member) has observed that grant of an occupancy certificate cannot by itself be treated as the determinative factor for deciding whether interest on borrowings used for construction of a commercial building is allowable as a revenue expenditure.
The proceedings arose from appeals filed by the assessee as well as the Revenue against orders of the National Faceless Appeal Centre. Since identical or overlapping issues were involved across the assessment years, the Tribunal heard the matters together and treated the assessee’s appeal for AY 2013-14 as the lead case. One of the principal disputes concerned an addition under Section 56(2)(viib) of the Income-tax Act, 1961, relating to share premium allegedly received in excess of fair market value.
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The assessee was engaged in developing an Information Technology Special Economic Zone project in Gurugram and earning income by leasing commercial buildings constructed in the SEZ. According to the Tribunal’s narration of facts, the company was a co-developer of the SEZ project pursuant to approval granted by the Department of Commerce under the Ministry of Commerce and Industry.
The project contemplated substantial investment. The order records that the assessee estimated that approximately ₹120 crore would be required to develop the SEZ land over four years. It proposed to develop 6,90,000 square feet, projected to generate free cash inflow of ₹24 crore annually from FY 2012-13. Funds were raised from shareholders and HDFC Bank, including a ₹75 crore bank loan based on the project’s financial projections.
The tax dispute arose after the Assessing Officer questioned a share premium of ₹90 per share. The assessee had allotted equity shares to existing resident and non-resident shareholders at ₹100 each, comprising a face value of ₹10 and premium of ₹90. It maintained that the valuation had been arrived at using the DCF method under Rule 11UA of the Income-tax Rules and that shares were issued at the same price to both resident and non-resident shareholders.
The AO, however, rejected the DCF valuation because the projections used for valuation did not correspond with the company’s subsequent actual financial performance. The AO observed that the company had incurred losses since inception and consequently considered the projected profitability insufficient to justify the premium.
Instead, the AO applied the Net Asset Value (NAV) method, another recognised method under Rule 11UA, and proceeded to make an addition under Section 56(2)(viib) in relation to shares allotted to resident shareholders. Significantly, however, the AO accepted the ₹90 premium in relation to shares allotted to non-resident shareholders. The CIT(A) upheld the action in principle while granting partial relief on valuation.
Rejecting the Revenue’s approach, the Tribunal made a significant observation that the justification of a share premium does not depend on whether the company actually earns profits in the immediate future.
The Bench observed that long-term investors enter the market with a long-term perspective and emphasised that DCF itself is one of the recognised valuation methods prescribed under Rule 11UA. Consequently, once that recognised method had been adopted, the AO could not simply reject it and substitute another permitted method, namely NAV.
The Tribunal also noticed an inconsistency in the Revenue’s treatment. The same premium of ₹90 per share had been issued in earlier assessment years and accepted by the Revenue. More importantly, for AY 2013-14 itself, the tax department accepted the ₹90 premium for shares allotted to non-resident shareholders.
The Bench therefore held that the Revenue was not justified in adopting a divergent stand for shares allotted on the same terms and conditions to resident shareholders and then making an addition under Section 56(2)(viib).
The Tribunal further relied on the Delhi High Court’s rulings concerning valuation methodology. Referring to the jurisdictional High Court’s decision in PCIT v. Cinestaan Entertainment Pvt. Ltd., the Bench noted that an AO cannot compare actual performance with projections to reject a valuation because projections may necessarily be affected by several future factors.
The Tribunal recorded that a valuer’s forecast is an approximation based on the potential value of the business. Therefore, the AO cannot, during assessment, effectively rewrite historical projections by substituting subsequently known actual results and use that exercise to reject the DCF method.
On this basis, the Tribunal directed the AO to delete the addition under Section 56(2)(viib) concerning shares issued at a premium of ₹90 per share for AY 2013-14. The corresponding grounds of the assessee were allowed. The same principle was subsequently applied to the connected assessment-year dispute with variations in figures.
The common order also dealt with another substantial issue: whether interest on borrowed funds used for construction of commercial buildings could be disallowed under Section 36(1)(iii) merely because an occupancy certificate had not been obtained during the relevant year.
For AY 2014-15, the assessee and Revenue challenged the treatment of interest and consequential depreciation. There was no dispute that the borrowed funds had been utilised for construction of commercial buildings. The project was being developed under a co-developer approval granted by the Department of Commerce. The record also showed that an application for an occupancy certificate had been made and was accompanied by a building completion certificate from a licensed architect.
The AO took the view that interest on the construction loan was capital in nature because the building was not ready to be “put to use” in the absence of an occupancy certificate. Since the occupancy certificate was issued only towards the end of March 2015, the AO concluded that the building was incapable of commercial exploitation during the relevant year and treated the interest as pre-operative expenditure requiring capitalisation.
The assessee countered that the borrowings were entirely for business purposes, the commercial project had substantially been completed, business had already commenced, and commercial readiness could not be made exclusively dependent upon the date on which an occupancy certificate was formally issued.
The ITAT accepted the assessee’s contention and held that the grant of an occupancy certificate “cannot be made as a determinative factor” for deciding the allowability of interest on the loan.
The Tribunal found it undisputed that the borrowings had been used for construction of commercial buildings. Crucially, it noted that the buildings had been put to use during the year itself, as rental income generated from them had been treated by the Revenue as business income.
The Bench therefore rejected the Revenue’s argument that absence of an occupancy certificate necessarily established that the building was not ready for commercial use. It directed the AO to allow ₹11,81,48,116 in interest expenditure as revenue expenditure and recompute the assessee’s total income. The assessee’s ground was allowed, while the corresponding grounds raised by the Revenue were dismissed.
The Tribunal upheld the deduction. It noted that the Revenue had allowed other business expenditure and that the assessee had already offered rental income as business income. Having already held that an occupancy certificate was not determinative of whether the building was capable of commercial exploitation, the ITAT concluded that the assessee was entitled to deduct the ₹4.14 lakh advertisement and marketing expenditure. The Revenue’s ground was consequently dismissed.
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