Assessing Officer Can't Become An Economist To Question Expected Return In Share Valuation: Delhi High Court

The Delhi High Court has held that an Assessing Officer (AO) cannot act as an economist to determine the expected rate of return while examining a company's share valuation.

The Division Bench of Justices Dinesh Mehta and Rajneesh Kumar Gupta added that while the AO may identify flaws in the valuation methodology adopted by a taxpayer, he cannot substitute the commercial assumptions underlying a recognized valuation method with his own.

The Court made the observations while dismissing the Income Tax Department's appeal against an order of the Income Tax Appellate Tribunal (ITAT), which had upheld the assessee's adoption of the Discounted Cash Flow (DCF) method for valuation of shares.

It observed,

"The AO cannot sit in the arm chair of an assessee and cannot become an economist to ascertain the probable or expected rate of return, which an economist can determine based on the comparables of other industrial players. The AO can find faults/flaws in the methodology, but he cannot question the expected rate of return, as adopted by an assessee or the valuer. The premise on which the AO rejected the valuation is clearly erroneous."

The dispute arose from the assessment of M/s Etawah Chakeri (Kanpur) Highway Private Limited, which had issued shares to its parent companies at a premium of ₹90 per share in August 2012. The valuation was based on a Chartered Accountant's report applying the DCF method.

However, the AO rejected the valuation, holding that the company ought to have adopted the Net Asset Value (NAV) method under Rule 11UA of the Income Tax Rules and consequently made an addition of ₹90 crore under Section 56(2)(viib) of the Income Tax Act.

The Commissioner of Income Tax (Appeals) deleted the addition, holding that the assessee was justified in adopting the DCF method. The ITAT affirmed the decision, observing that it was for the assessee to choose the valuation method and that the DCF method, though formally notified later in 2012, was a recognised method of valuation.

Revenue argued that since the DCF method was incorporated into Rule 11UA only with effect from November 29, 2012, whereas the shares had been issued on August 29, 2012, the assessee could not rely upon that method.

Rejecting the contention, the High Court held that there is a distinction between a valuation method being recognised and being notified.

The Court observed that the DCF method was already a recognised mode of valuation in the financial and corporate world and that the Government's subsequent notification merely formalised an existing and accepted methodology.

It further held that in the case of a newly incorporated company, valuation based solely on the NAV method may not reflect the company's true worth, as factors such as future business potential, market prospects and expected returns are relevant considerations.

It added that if the AO was dissatisfied with the valuation furnished by the assessee, he was required to point out defects in the valuation report or the methodology adopted rather than substituting the valuer's assumptions regarding the expected rate of return.

As such, the High Court dismissed the Revenue's appeal.

For Appellant: Advocates Vipul Agarwal SSC with G. Ranjan & Harshita Kotru

For Respondent: Advocates Rajat Navet, Rajat Rana & Kushagra Pandit