Income Tax Act, 1961 – Sections 56(2)(viib), 148, 133(6) and Rule 11UA(2) - The assesse issued shares at a premium of Rs.143 per share based on valuation via the Discounted Cash Flow (DCF) method, as prescribed under Rule 11UA(2). The Assessing Officer reopened the assessment under Section 148, alleging escapement of income based on discrepancies between DCF projections and actual results, and questioned the DCF valuation, asserting a difference of Rs.80 per share, amounting to Rs.2.87 crore - Whether the reopening of assessment under Section 148 based on alleged discrepancies in DCF valuation is valid - Whether the Assessing Officer can disregard the DCF method and impose the Net Asset Value (NAV) method for determining share value under Rule 11UA(2) – HELD - Rule 11UA(2) provides the assessee an option to adopt either the DCF or NAV method for valuation. Once the DCF method is chosen and followed, the Assessing Officer cannot impose the NAV method or question projections used in DCF valuation based on subsequent actual results - It was further held that reopening under Section 148 was invalid as the reasons recorded were fundamentally erroneous, relying on impermissible questioning of the valuation method rather than substantive evidence of escapement of income - The Court relied on the Delhi High Court decision in Agra Portfolio (P.) Ltd. and the Himachal Pradesh High Court in PCIT vs. I.A. Hydro Energy (P) Ltd., confirming that the valuation method choice lies with the assessee, and post-facto deviation from projections does not justify reopening - The High Court quashed the notice issued under Section 148, holding it without jurisdiction and contrary to law. Rule was made absolute in favor of the petitioner, with no costs awarded

 

2024-VIL-226-GUJ-DT

 

IN THE HIGH COURT OF GUJARAT AT AHMEDABAD

 

R/SPECIAL CIVIL APPLICATION NO. 5378 of 2022

 

Date: 28.10.2024

 

AKASH CERAMICS PRIVATE LIMITED

 

Vs

 

INCOME TAX OFFICER, WARD (1)(1)(1), AHMEDABAD & ANR

 

For the Petitioner No. 1: MR B S SOPARKAR (6851)

For the Respondent No. 1, 2: MR. VARUN K. PATEL (3802)

 

CORAM

HONOURABLE MR. JUSTICE BHARGAV D. KARIA

HONOURABLE MR.JUSTICE D.N.RAY

 

ORAL JUDGMENT

 

(PER: HONOURABLE MR. JUSTICE BHARGAV D. KARIA)

 

1. Heard learned advocate Mr. B.S. Soparkar for the petitioner and learned Senior Standing Counsel Mr. Varun Patel for the respondent.

 

2. Having regard to the controversy in narrow compass, with the consent of learned advocates for the parties, the matter is taken up for final hearing.

 

3. Rule returnable forthwith. Learned Senior Standing Counsel Mr. Varun Patel for the respondent waives service of notice of rule.

 

4. Brief facts of the care are as under:

 

4.1 The petitioner, a Private Limited Company, filed its return of income for the Assessment Year 2015-16 on 31.10.2015 declaring the loss of Rs. 1,34,25,127/-.

 

4.2 During the Financial Year 2014-15, the petitioner had issued 3,59,500 equity shares of Rs. 10/- each, at a premium of Rs.143/- totaling to premium collected at Rs. 5,14,08,500/-.

 

4.3 Notices under section 133(6) of the Income Tax Act,1961 [for short ‘the Act’] were issued by the Income Tax Officer on 01.09.2017, 14.09.2017, 26.09.2017 and 20.05.2019 to conduct inquiry into the issuance of such share capital at such valuation. The petitioner filed replies to each of the notices issued under section 133(6) of the Act.

 

4.4 It appears that the return filed by the petitioner was not taken for scrutiny and intimation under section 143(1) of the Act was issued.

 

4.5 The respondent No.1- Assessing Officer has issued impugned notice under section 148 of the Act on 29.03.2021 asking the petitioner to file a return of income for A.Y. 2015-16. The petitioner filed return in response to the notice under section 148 of the Act on 03.01.2022 and sought reasons recorded for reopening.

 

4.6 The respondent No.1 provided reasons to the petitioner on 04.02.2022 which reads as under:

 

“1. Brief details of the assessee: The assessee company is engaged in ceramic mess filed its return of income for the A.Y.2015-16 on 30.10.2015 declaring total loss Rs.4,3425,127/-.

 

2. Brief details of information collected received by the AO: An information has been received from Insight Portal uploaded by ITO(I8Cl}, Ahmedabad that the assessee company had sold its 359500 shares @Rs.153 per share at a premium value of 80 Rs. per share which is required to be added u/ s. 56(2)9vii)(b) of the act.

 

3. Analysis and Enquiries made by the AO as sequel to information collected received: The information as received is analyzed. After verification of the case, it is found that:

 

"AS per the valuation certificate dated 04.07.2014 (Pertaining to AY2015-16), the value per Share is determined at Rs.73/as per Value/price based on book value of share (Net Asset Value) and Rs.143 as per value/price on Discounted Free Cash Flow method as per annexue-1 & 2 submitted by the assessee, The assessee company has issued 350500 equity shares of Rs.153/each at @ premium of Rs.143/per share on 26.03.2015. On Verification of the both the certificate prepared by the Chartered accountant, there is huge difference of Rs.80/- was found. Hence, the Discounted cash flow method adopted by the assessee is not acceptable at this stage. Further, the assessee has produced the projected cash flow value & actual cash flow maintained. On verification of data provided by the assesses, there is also huge difference in projected value and actual value. The difference is worked out as under.

 

 

On verification of the above chart produced by the assessee during proceedings before ITO(I&CI), it seen that the assessee has not achieved the goal what they have targeted for. Hence, difference of Rs.80/ (as per Net Asset Value Rs.73) and as per DCF Rs. 153/-) per share required to be added per share.

 

4. Enquiries made by the AO as sequel to information collected/ received:

During the AY 2015-16, Since, the assessee had sold 359500 shares, the amount of Addition comes to Rs.2,87,60,000/-which is required to be added u/s.56(2)(vii}(b) of the IT Act.”

 

4.7 On receipt of the reasons recorded, the petitioner filed objection with respondent No.1 on 15.02.2022 challenging the validity of the notice issued under section 148 of the Act. Respondent No.2 disposed of the objections of the petitioner by order dated 03.03.202.

 

Being aggrieved, the petitioner has preferred this petition challenging the notice issued under section 148 of the Act.

 

5. Learned advocate Mr. B.S. Soparkar appearing for the petitioner submitted that the impugned notice for reopening is without jurisdiction as the reasons recorded for reopening do not reflect that any income has escaped assessment. It was further submitted that the reasons recorded are fundamentally erroneous because at the time of issue of shares, the petitioner obtained valuation report as per which, the valuation of shares as per the Discounted Cash Flow [‘DCF’ for short] based on projected financials was valued at Rs.153/- per share. It was therefore submitted that the petitioner has correctly adopted this value as per DCF method while issuing shares at premium of Rs. 143/- per share.

 

5.1 Learned advocate Mr. Soparkar referred to the provisions of section 56(2)(viib) of the Act and Rule 11UA(2) of the Income Tax Rules,1962 to submit that as per sub-rule (2) of Rule 11UA of the Income Tax Rules,1962 (Rules), the petitioner had opted for DCF method for valuation of shares and therefore, the provision of section 56(2)(viib) of the Act would not be applicable in the facts of the case. It was further submitted that the Assessing Officer could not have assumed the jurisdiction to reopen the assessment by questioning the valuation carried out under valuation of the shares as per DCF method and on the basis that the projections which were considered for arriving at valuation of the shares were ultimately not achieved by the petitioner in the subsequent year.

 

5.2 In support of his submissions, reliance was placed on the decision of Hon’ble Delhi High Court in case of Agra Portfolio (P.) Ltd vs. Principal Commissioner of Income Tax reported in [2024] 161 Taxmann.com 303 wherein, the Hon’ble Delhi High Court while considering the provisions of Rule 11UA of the Rules held that if the assessee determines the fair market value in the method as prescribed, the Assessing Officer does not have choice to dispute the justification and the method of valuation as prescribed in Rule 11UA(2) of the Rules provides that the assessee can adopt the fair market value as per either Net Asset Fair Market Value method or DCF method of the unquoted equity shares determined by a merchant banker and the choice of the method is that of the assessee.

 

5.3 It was therefore submitted that once the petitioner has adopted the DCF method of valuation during the course of the regular assessment, the Assessing Officer could not have made any addition on the basis of the stand taken by respondent No.1 while recording the reasons for reopening.

 

5.4 Reliance was also placed on the decision of the Hon’ble High Himachal Pradesh High Court in case of Principal Commissioner of Income Tax vs. I.A. Hydro Energy (P) Ltd. reported in [2024] 163 taxman.com 408 wherein, it was held that when the option is given to the assessee as per Rule 11UA(2) of the Rules, the Assessing Officer can only verify the method of valuation adopted by the assessee and the same cannot be substituted by a different method.

 

6. On the other hand, learned Senior Standing Counsel Mr. Varun K. Patel for the respondent Assessing officer submitted that in the facts of the present case, no scrutiny assessment under section 143(3) of the Act was made and as per the information received in the insight portal uploaded by ITO (I & CI), the assesseecompany had sold 359500 shares at a premium of Rs. 143/- as against that there was a difference between the two valuation methods as prescribed under Rule 11UA(2) of the Rules and the Assessing Officer was therefore, justified in recording the reasons for issuing notice for reopening by recording reasons that there was a difference of Rs. 80/- between the Net Asset Value of Rs. 73/- per share and as per DCF of Rs. 153/- per share which has resulted into escapement of the income to the tune of Rs. 2,87,60,000/- (80X 3,59,500).

 

6.1 It was therefore submitted that the Assessing Officer was justified in issuing the notice for reopening in the facts of the case. In respect of his submissions, reliance was placed on the decision of the Hon’ble Apex Court in case of Raymond Woolen Mills Ltd vs. ITO reported in (1999) 236 ITR 334 wherein it was held that at the stage of issuing notice for reopening, there is no requirement to give a final decision as to whether there is suppression of material facts or not. Reliance was also placed on the decision of the Apex Court in case of ACIT vs. Rajesh Jhaveri Stock Brokers (P) Ltd. reported in [2007] 161 taxman 316 as well as per decision of the Bombay/Delhi High Court in case of Yuvraj vs. Union of India reported in [2009] 315 ITR 84 wherein, it was held that at the stage of issuance of notice for reopening, it would be sufficient if the revenue demonstrates that there were good reasons which were recorded by the Assessing Officer by applying his mind.

 

6.2 It was submitted that when the petitioner has failed to point out that there is a huge difference of Rs. 80/- between the two methods of valuation, the Assessing Officer was justified in reopening of the assessment.

 

6.3 It was therefore submitted that the respondent-Assessing Officer has credible information and material from the insight portal and after applying due process, has formed reason to believe that there is escapement of income and there is no fishing inquiry being made coupled with the fact that there was no scrutiny assessment carried out in the facts of the present case and as such, the impugned notice issued by the Assessing Officer for reopening is in accordance with law and no interference may be made.

 

7. Having heard learned advocates for the respective parties and considering the material on record it appears that the reasons recorded for reopening are based upon the applicability of the DCF method vis-a-vis Net Asset Value Method prescribed under Rule 11UA of the Rules. According to the Assessing Officer, there is difference in valuation of Rs. 80/- between the computation of the fair market value by applying these two methods and accordingly, there is escapement of income of Rs. 80/- as the valuation as per the Net Asset Value is less as compared to the value as per DCF method. The Assessing Officer has further recorded that the assessee has not achieved the goal as per the projected growth for the past three years and therefore a difference of Rs. 80/- between the two methods per share is required to be added as income of the assessee for the year under consideration.

 

8. The very basis of reopening adopted by the Assessing Officer is contrary to the provisions of the Act and the Rules. Section 56(2)(viib) of the Act reads as under:

 

“56. Income from other sources.

 

“(1) xxx xxx xxx

 

(2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely:— xxxxxx

 

[(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause shall not apply where the consideration for issue of shares is received—

 

(i) by a venture capital undertaking from a venture capital company or a venture capital fund; or

 

(ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

 

Explanation.—For the purposes of this clause,—

 

(a) the fair market value of the shares shall be the value—

 

(i) as may be determined in accordance with such method as may be prescribed; or

 

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;

 

(b) “venture capital company”, “venture capital fund” and “venture capital undertaking” shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of 2 [Explanation] to clause (23FB) of section 10;]”

 

9. The Fair Market Value as per the aforesaid provision is prescribed under Rule 11UA(2) which reads as under:

 

“Rule 11UA: Determination of fair market value

 

1. xxx xxx xxx

 

2. Notwithstanding anything contained in sub-clause (b) of clause (c) of subrule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of sub section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:-

 

(a) the fair market value of unquoted equity shares =| (A-L)(PE)| x (PV)

 

where,

 

A=book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

 

L=book value of liabilities shown in the balance-sheet, but not including the following amounts, namely: -

 

(i) the paid-up capital in respect of equity shares;

 

(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

 

(iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

 

(iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

 

(v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

 

(vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;

 

PE=total amount of paid up equity share capital as shown in the balance-sheet;

 

PV=the paid up value of such equity shares; or

 

(b) the fair market value of the unquoted equity shares determined by a merchant banker as per the Discounted Free Cash Flow method;……………….”

 

10. Clause (a) and (b) of the Rule 11UA(2) of the Rule prescribes the method of Net Asset Value method and the discounted cash flow method for which, the assessee is entitled to exercise the option for computation of the fair market value for the applicability of section 56(2)(viib) of the Act.

 

11. Hon’ble Delhi High Court in case of Agra Portfolio (P.) Ltd. (supra), in the facts of the said case, adopting right of the assessee to adopt either of the two methods for arriving at Fair Market Value, has observed as under:

 

“20. A more detailed discussion on the issue which confronts us in this appeal is found in the judgment rendered by the Mumbai Bench of the ITAT in Dy. Commissioner of Income Tax 6(2)(1) vs. Credtalpha Alternative13 and the relevant parts whereof are reproduced hereunder: -

 

"15. Thus, the fair market value of the share shall be higher of the value as determined in accordance with the provisions of rule 11 UA or any other method, which can be substantiated by the assessee before the Assessing Officer. For the purpose of determining "fair (2022) 94 ITR (Trib) 596 market value" of unquoted shares provisions of rule 11 UA (2) applies which gives an option to the assessee to either value the shares as per prescribed formula given in clause (a) or clause (b) which provides for the determination of the fair market value based on discounted cash flow method as valued by a merchant banker or a chartered accountant (till 24th of May 2018). In the present case the assessee has valued the shares according to one of the "options" available to assessee by adopting discounted cash flow method. Therefore, such an option given to the assessee cannot be withdrawn or taken away by the learned Assessing Officer by adopting different method of valuation i.e., net asset value method. The method of valuation is always the option of the assessee. The learned Assessing Officer is authorised to examine whether assessee has adopted one of the available options properly or not. In the present case, the learned Assessing Officer has thrust upon the assessee, net asset value method rejecting discounted cash flow method for only reason that there is a deviation in the actual figures from the projected figures. It is an established fact that discounted cash flow method is always based on future projections adopting certain parameters such as expected generation of cash flow, the discounted rate of return and cost of capital. In hindsight, on availability of the actual figures, if the future projections are not met, it cannot be said that the projections were wrong. To prove that the projections were unreliable, the learned Assessing Officer must examine how the valuation has been done. In a case future cash flow projections do not meet the actual figures, rejection of discounted cash flow method is not proper. If projected future cash flow and actual result matches, such situation would always be rare. For projecting the future cash flow certain assumptions are required to be made, there needs to be tested and then such exemptions becomes the base of estimation of such projected future cash flows. If there are no assumptions, there cannot be an estimate of future projected cash flows and then discounted cash flow method becomes redundant. For exercise of valuation, assumption made by the valuer and information available at the time of the valuation date are relevant. As the exercise of valuation must be viewed as on the date of the valuation looking forward and cannot be reviewed in retrospect. Further, the valuation is always made based on review of historical data and projected financial information provided by the management. Further report of expert will always include limitation and responsibilities but that does not make his report incorrect. Of course, if there are errors in the working of projected cash flow, estimating the projected revenue and projected expenditure as well as in adoption of cost of equity and discount factor, the learned Assessing Officer is within his right to correct it after questioning the same to the assessee. The learned Assessing Officer can also question the basic assumptions made by the valuer. If they are unreasonable or not based on historical data coupled with the management expectation, the learned Assessing Officer has every right to question it and adjust the valuation so derived at. However, if he does not find any error in those workings, he could not have rejected the same. Further the reason given by the learned Assessing Officer that the net asset value method and the discounted cash flow method for valuation of the shares of the company gives a wide variation between them, we do not find any reason to find fault with the assessee in such cases. Both these methods have different approaches and methodologies therefore there are bound to be differences, but it does not give any authority to the learned Assessing Officer to pick and choose one of the method and make the addition. It is the assessee who has to exercise one of the options available under the provisions of the law for valuing the shares. The learned Assessing Officer needs to examine that method. Naturally, if the discounted cash flow method and net asset value method gives the same result, where would have been the need to prescribe the two methods in the law. In view of above facts, we do not find any infirmity in the order of the learned Commissioner of Income-tax (Appeals) in deleting the addition of Rs. 69,000,000 made by the learned assessing officer u/ s 56 (2) (viib) of the act. Accordingly, ground Nos. 3 and 4 of the appeal of the learned Assessing Officer are dismissed."

 

21. We deem it apposite to lastly take note of the following pertinent observations as appearing in a decision rendered by the ITAT Bench at Bangalore in Taaq Music Pvt. Ltd. vs. Income Tax Officer14: -

 

"11. The law provides that, the fair market value may be determined with such method as may be prescribed or the fair market value can be determined to the satisfaction of the Assessing Officer. The provision provides an Assessee two choices of adopting either NAV method or DCF method. If the Assessee determines the fair market value in a method as prescribed the Assessing Officer does not have a choice to dispute the justification. The methods of valuation are prescribed in Rule 11UA(2) of the Rules. The provisions of Rule 11UA(2)(b) of the Rules provides that, the Assessee can adopt the fair market value as per the above two methods i.e., either DCF method or fair market value of the unquoted equity shares determined by a merchant banker. The choice of method is that of the Assessee. The Tribunal has followed the judgment of Hon'ble 2020 SCC OnLine ITAT 9482 Bombay High Court rendered in the case of Vodafone M-Pesa Ltd. v. Pr. CIT (supra) and has taken the view that the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the Assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the Assessee. The decision of ITAT, Delhi in the case of Agro Portfolio Ltd. 171 ITD 74 has also been considered by the ITAT, Bangalore in the case of VBHC Value Homes Pvt. Ltd.(supra).

 

12. In view of the above legal position, we are of view that the issue with regard to valuation has to be decided afresh by the AO on the lines indicated in the decision of ITAT, Bangalore in the case of VBHC Value Homes Pvt. Ltd., Vs ITO (supra) i.e., (i) the AO can scrutinize the valuation report and he can determine a fresh valuation either by himself or by calling a determination from an independent valuer to confront the assessee but the basis has to be DCF method and he cannot change the method of valuation which has been opted by the assessee. (ii) For scrutinizing the valuation report, the facts and data available on the date of valuation only has to be considered and actual result of future cannot be a basis to decide about reliability of the projections. The primary onus to prove the correctness of the valuation Report is on the assessee as he has special knowledge and he is privy to the facts of the company and only he has opted for this method.

 

Hence, he has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, scientific study and applicable Guidelines regarding DCF Method of Valuation. The order of ld. CIT(A) is accordingly set aside and this issue is remanded to the AO for decision afresh, after due opportunity of hearing to the Assessee."

 

12. Similarly, the Hon’ble Himachal Pradesh High Court while confirming orders passed by the CIT(A) and Tribunals has held as under:

 

“14. The Tribunal confirmed the finding of fact that the assessee did not receive any consideration for allotment of shares in the previous year relevant to the current assessment year, and upheld the view of the CIT (Appeal) if no consideration was received in the previous year under consideration, Section 56(2)(viib) of the Act has no application.

 

It held that the consideration in the form of unsecured loans were received from the partner of the erstwhile firm in the year 2010, as evidenced from loan agreement, and the Assessing Officer could not bring out any material facts to show that such conversion of loans to equity shares was a ploy to defraud revenue of the tax on such transaction.

 

The Tribunal went further and observed that the Assessing Officer is not authorized to pick and choose a particular method of valuation of shares, since the option in that regard is specifically given only to the assessee as per Rule 11UA(2) of Income Tax Rules, that the AO can only

 

It held that the Assessing Officer was not correct in rejecting the DCF method and proceeding to value the shares by NAV method merely on the ground that there was a huge difference in projected figures and actual results available for some years.

 

Xxxxx

 

18. We are of the opinion that the orders passed by the Income Tax Appellate Tribunal as well as the CIT(Appeals), are fairly comprehensive. Both of them have concurrently found that no consideration was received by the assessee-firm for allotment of the shares, therefore Section 56(2)(viib) of the Act would not apply, and that it would have applied only if consideration was received for such a transaction.

 

Xxxxx

 

19. Also, both the Tribunal and the CIT(Appeals) have held that the Assessing Officer had no jurisdiction to substitute the NAV method of assessing the valuation of shares, once the assessee had exercised option of a DCF valuation method as per Rule 11UA(2) of the Income Tax Rules.”

 

13. Thus, so far as the applicability of the method prescribed in Rule 11UA(2) of the Rules is concerned, the same is as per the option to be exercised by the assessee and once the assessee has exercised the option, the Assessing Officer even during the regular course of assessment, could not have questioned the applicability and computation of the fair market value as per either of the methods and therefore, there is no question of forming a reason to believe that as the valuation is less in one method and the assessee has adopted the method having higher valuation method, then there is escapement of income.

 

14. In view of the above, we are of the opinion that the Assessing Officer could not have assumed the jurisdiction to reopen the assessment on the ground that to verify the veracity and the computation as per the DCF method adopted by the assessee on the ground that the assessee did not fulfill the projected growth as per the discounted cash flow method in the subsequent year because at the time of making projection, no assessee would be in a position to predict the future growth as per the projection.

 

15. In view of the foregoing reasons, the impugned notice is accordingly quashed ans set aside. Rule is made absolute to the aforesaid extent. No order as to costs.

 

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