Tax Department Cannot Force Net Asset Value Method When Taxpayer Uses Discounted Cash Flow: ITAT Delhi

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) on 26 May dismissed the Revenue's appeal against First Class Infrabuild Pvt. Ltd. and held that the Tax Department cannot force a taxpayer to adopt the Net Asset Value (NAV) method when the law permits valuation under the Discounted Cash Flow (DCF) method for determining fair market value under Section 56(2)(viib) of the Income Tax Act.

Judicial Member Satbeer Singh Godara and Accountant Member M. Balaganesh upheld the order of the Commissioner of Income Tax (Appeals) and deleted the addition for Assessment Year 2015–16. The Bench held:

“Since no equity shares were issued by the assessee company to anyone, the applicability of determination of fair market value as per Rule 11UA of the Rules need to be done in accordance with Rule 11UA(1)(c )(c ) of the Rules and Rule 11UA(2) of the Rules which refers to the valuation of the unquoted shares other than equity shares. According to this, the value of these shall be estimated at the price which it would fetch if sold in the open market and the same shall be supported by a valuation report from a merchant banker or a chartered accountant…”

The Assessing Officer invoked Section 56(2)(viib) and added Rs. 5.32 crore as alleged excess share premium received by First Class Infrabuild Pvt. Ltd. During the relevant year, the company issued 1,000 compulsorily convertible preference shares (CCPS) and 54,800 redeemable preference shares (RPS) with a face value of Rs. 10 each at a premium of Rs. 990 per share.

The Assessing Officer held that the company carried out no substantial business activity and therefore could not justify the valuation. He rejected the DCF valuation report submitted by the chartered accountant.

The Department examined investors Ujjwala Power Pvt. Ltd. and Hindustan Clean Energy Ltd. and also recorded the statement of the valuation expert. The valuer stated that he did not strictly prepare the report in accordance with Rule 11UA of the Income Tax Rules.

Relying on this, the Assessing Officer rejected the DCF method and applied the NAV method. He determined the fair market value at Rs. 36 per share instead of Rs. 1,000 per share and made an addition of Rs. 5,32,33,200 under Section 56(2)(viib).

The Tribunal disagreed with this approach and upheld the relief granted by the CIT(A). It held that the law gives the taxpayer the choice to adopt either the DCF or NAV method, and the Assessing Officer cannot replace that choice merely because he disagrees with the projections used in valuation. The Bench also noted that the company did not issue equity shares and issued CCPS only to its holding company, Hindustan Clean Energy Ltd., with conversion scheduled after 18 years.

It further held that the Revenue cannot reject a DCF valuation only because actual results later differ from projections. The Tribunal also noted that the Assessing Officer ignored detailed valuation reports, feasibility studies and projections submitted by professionals. It stated:

“The option to use either DCF or NAV method is always given to the assessee as per the rules. The learned AO cannot force the assessee to apply only NAV method when DCF method is applied by the assessee. Even if the projections used by the valuer in the DCF method of valuation does not match with the actuals, still the revenue cannot doubt the validity of the said valuation…”

Accordingly, the ITAT dismissed the Revenue's appeal and upheld deletion of the Rs. 5.32 crore addition under Section 56(2)(viib).

For Appellant: Shri Satyen, CA and Shri A. T. Panda, Adv  

For Respondent: Ms. Harpreet Kaur Hansra, Sr. DR