PER PRASHANT MAHARISHI, AM:

1. This appeal is filed by the Asst Commissioner of income tax – 6 (2) (1), Mumbai (the learned assessing officer against the order passed by the Commissioner of income tax (appeals) – 12, Mumbai dated 21st of August 2019 for assessment year 2013 – 14 raising the following grounds of appeal as Under:-

i. on the facts and circumstances of the case and in law, the learned CIT – A erred in  deleting  the  addition  made  by  the  assessing officer on account of business expenses  and  unabsorbed depreciation even though the pre-commencement expenses  to setting up of the plant for business purposes, such  income  is required to be capitalized

ii. On the facts and circumstances of the case  and  in  law,  the learned CIT – A erred in deleting the addition on the basis of the decision of the learned CIT (A) with respect  to  AY  2012-13 where the CIT (A) has granted relief to the assessee on the basis of additional evidence submitted by the assessee before CIT (A). The assessing officer should be given opportunity by the CIT (A) Under rule 46A of the income tax act before allowing assessee’s appeal

iii. on the facts and circumstances of the case and in law, the learned CIT (A) erred in deleting the addition made by the assessing officer u/s 56 (2) (viib) of the act without appreciating that facts that the ld AO had interfered with the taxpayer statutory right Under rule 11 UA (2) of the ITR  to the method of valuation and also that the of rejecting the taxpayer’s valuation, the AO had the authority to carry out its own independent valuation and adopt the NAV method for this purpose.

iv. On the facts in the circumstances of the case and in law, the learned CIT (A) erred in deleting the addition made by the assessing officer u/s 56 (2) (viib) of the act without appreciating the facts that the matter of taxability cannot be decided on the basis of entries which the assessee may choose to make his account but has to be decided in accordance with the provisions of law.

2. As per the facts available on record assessee, company is engaged in the business of providing investment advisory services. It filed its return of income on 13/9/2013 claiming a loss of 31,840,479/– comprising of business loss of Rs 2, 60, 37,039 and the capital loss of 5,803,440. The case of the assessee was picked up for scrutiny.

3. During the course of the assessment proceedings, the learned assessing officer noted that revenue shown in the profit and loss account for two consecutive    years is nil where assessee has claimed    for this year a sum of Rs 28,730,737 as expenditure under the head finance cost, employee benefit expenses depreciation and other expenses. As no revenue has been generated for the last two years he issued a show cause notice for disallowance of the entire claim of expenditure. The assessee submitted that it has incurred expenses for profitable future and to establish itself in the businesses and the expenses were of such a nature that had to be compulsorily incurred either by way of remuneration or by way of complying with various legal requirements. It was further stated that considering the nature of the business of equity activity, assessee’s success depend completely on the fund  managers and credit required a lot of travelling. Assessee stated that a venture capital fund and a nonbanking financial company was established showing the motive of the assessee however during the year due to bad global conditions investment could not be raised and therefore there is no revenue generation. Assessee also submitted that the failure to generate revenue was only due to the inability of the assessee in accumulating funds due to bad global financial condition and mere absence of revenue shall not be conclusive evidence that the expenses were not incurred for the purposes of the business. The learned assessing officer after considering the submission of the assessee followed his own order for assessment year 2012-13 and disallowed the entire business expenditure/loss claimed by the assessee of Rs 2, 60,37,039.
 
4. The learned assessing officer further noted that assessee has received 69,000,000 and share capital consisting of share premium of 59,800,000 and assessee has not shown any income u/s 56 (2) (viib) of the act. AO further noted that the assessee has made the valuation of the sale using discounted cash flow method. As the assessee has not earned any revenue for several assessment years and has  incurred losses consistently, the AO asked the assessee to furnish the valuation of sale as per rule 11 U and 11 UA by using net asset method. He also asked assessee to substitute the actual figures of revenue for financial year 2012 – 13, 2013 – 14, and 2014 – 15 in the discounted cash flow method valuation. Assessee submitted valuation of  share  using  net asset method which comes to Rs (-) 3241/-. Assessee did not submit the valuation of discounted cash flow method substituting the actual figures and therefore the learned assessing officer issued a notice asking assessee to justify the premium as the fair market value of the shares is negative as per net asset value method, as the discounted cash flow method is not reliable, which do not have any correlation with the actual affairs of the assessee. The assessee submitted a detailed reply that assessee is a start-up company set up by Mr. Rajeev Mehrotra who is having a strong background of investment banking involved experience in the field of financial service act having a working experience of 9 years in Edelweiss financial services Ltd. During the year domestic venture capital fund approved by Securities and Exchange Board  of India namely, Credit alpha alternative fund was set up by the assessee to act as a manager and raise investments domestically.  However, due to the bad global financial conditions the assessee could not raise investments through the fund. To substantiate it, assessee also submitted the registration certificate and return filed with the SEBI. It was further submitted that provisions of Section 56 (2) (viib) exempts the venture capital fund from complying with the valuation norms of the provisions of the above Section. The assessee also explained the various situations due to which the assessee could not generate any  revenue for past years however, for financial year 2014 – 15 it submitted that it has started generating revenue. Assessee submitted the details of shares allotment made  along  with  the  valuation  report  adopting  discounted cash flow method where the valuation of the share is derived at 75 per share.   It further submitted that the discounted cash loan  method is the only method of  valuation  assessee  could  have  adopted,  as  the  book value method is redundant for such business model and will defeat the purpose. The learned assessing officer examined the explanation of the assessee and looking at the wide variation between the valuations of the shares adopting two different methods, he once  again  directed  the assessee to substitute  the  actual  figures  of  performance  in  the discounted cash flow method valuation. Assessee did not furnish such computation, therefore, he held that the discounted cash flow method valuation used by  the  assessee  is  bogus  and  sham  and  has  no connection with the real figures. The valuation was done with fictitious figures having no correlation with the actual affairs of the assessee. The valuation was done using imaginary figures to arrive at a pre-mediated value of 75 per share and therefore he rejected the same. The learned assessing officer further examined the  valuation  report  and  stated  that the valuer has purely relied on the projected figures given by the management of  the  company.  He  also  referred  to  the  fact  that  the valuer reports in the valuation report that it was not responsible for accuracy and completeness of the  valuation  and  he  has  not  conducted any independent audit, due diligence  review  or  validation  of  such financial and other information. The valuer also categorically states that it did not express any opinion or any form of assurance thereon and it accepted no responsibility or liability and the  share  value  has  been derived and determined on the basis of information provided by the management.  The  learned  assessing  officer  extracted  such  observation of the valuation report in his order. He therefore held that even as per the actual figures the valuation by the discounted cash flow method is negative. Accordingly, he made an addition of 69,000,000 to the total income of the assessee Under the provisions of Section 56 (2) (viib) of the act being the value exceeding the fair market value of the shares as according to him valuation of the share is in negative.

5. Accordingly  assessment  order  was  passed  on  17th  of  March  2016  u/s 143 (3) of The Income Tax Act determining the total  income  of  the assessee at 69,000,000/–.

6. The assessee aggrieved with the order of the learned assessing officer preferred an appeal  before the learned  CIT – A who  passed an order on 21st of August 2019 wherein he deleted  the  addition  of    69,000,000 made by the learned assessing officer. With respect to the disallowance of the business expenditure of Rs 2  39,70,421  and  unabsorbed depreciation of 2,066,618/–  the  learned  CIT –  A allowed the  claim  of the assessee following the order of his predecessor for assessment year 2012 – 13 as the learned assessing officer has also made  disallowance based  for  that   reasons.   Therefore,   both  the  disallowance/addition made by the learned assessing officer were deleted.

7. Therefore, the learned assessing officer is aggrieved with that order and is in appeal before us as per the grounds of appeal stated above.

8. The learned departmental representative  vehemently  supported  the orders of the learned assessing officer and submitted on ground no 3 & 4 that

i. Assessee has supported the  valuation  of  the  shares  for  issue stating that the discounted cash flow method has been adopted, however according to the actual performance there is a consistent loss incurred by the assessee.

ii. He further submitted that the learned assessing officer asked the assessee to substitute the actual performance figures in the discounted cash flow method valuation report which assessee did not do. Therefore, the assessing officer asked the assessee to submit the report as per the net asset value method, which has negative valuation.

iii. He further submitted that the valuation report submitted by the assessee even on the discounted cash flow method was  suffering from severe infirmities and therefore such a valuation report could not have been accepted by the learned CIT – A.

iv. He submitted that the learned CIT – A has deleted the addition relying upon the several judicial precedents; however, he failed to look at the actual valuation done by the assessee, which is devoid of any merit.

9. On ground, no 1 & 2, with respect to  the  disallowance  of  business expenses and losses, he relied upon the order of the learned assessing officer.

10. The learned authorised representative submitted that ground number 1 – 2 of the appeal are  covered in favour of  the assessee by the  decision of the coordinate bench in assessee’s own case for assessment year 2012 –13 wherein the coordinate bench has deleted the identical disallowance/addition made by the learned assessing officer. He submitted that for this year, learned assessing officer has also followed the same logic and in fact relying on the order of assessment for assessment year 2012 – 13, disallowance has been made. He therefore submitted that the ground number 1 deserves to be dismissed.

11. Coming to the ground number 2 &  3,  the  learned  authorised representative referred to the paper  book  containing  43  pages  in  the form of various replies submitted by the assessee during the course of assessment proceedings and  further  referred  to  paper  book  containing 15 judicial precedents.

i. He referred to the valuation report dated 14th of March 2013 wherein the background of the company and the source of the information as well as the limitation and disclaimers were mentioned by the learned valuer and thereafter based on the discounted cash flow method, fair value of the equity shares of the company were determined at 75 per share.  He referred to calculation as per discounted cash flow method for computation of the fair value of the shares and submitted that value as per the shares based on the Free cash flow is determined at 93 per share, however, discounted the same as assessee is being an unlisted company by 20% and therefore the resultant fair value per share was determined at 75 per share. He also referred to the projected profit and loss statement of the assessee for seven years. It was also pointed out that assessee in the valuation report itself has shown losses in year 2016 and 2017 while working out the projected cash flow. There is no infirmity pointed out in any of the workings submitted.

ii. He submitted that assessee is engaged in the business as advisors to persons or entities both domestic as well as offshore for the purpose of investment of funds in all forms of investments including shares, debentures, bonds, depository receipts, options, derivatives, government securities, and other financial instruments. The assessee is carrying on the business as a consultant and advisor in  that  field. He therefore submitted that cash flow of the assessee solely depends on the advisory services fees. He further stated that for financial year 2014 – 15 the assessee has started generating revenue and therefore it cannot be said that the data used for the purpose of valuation of the shares based on discounted cash flow method are imaginary. He further submitted that the discounted cash flow method is based on the potential earning of the company whereas the book value method, as adopted by the learned assessing officer, is based on value of the net assets of the company. As the assessee company is engaged in the  business  of  provision  of  services and is driven by the fees earning and not based on the  total assets base of the assessee company, these two methodologies are not comparable and  the  variation  between  the  two methods should not prevent assessing officer in accepting the discounted cash flow method adopted by the assessee.

iii. He further referred to the letter dated 17th of March 2016 stating that provisions of Section 56 (2) (viib) exempts venture capital fund and undertaking companies from complying with the valuation norms. For this proposition, he also submitted that assessee has submitted a copy of the SEBI registration certificates and return filed with it before the  learned assessing officer.

iv. He further referred to the provisions of Section 56 (2) and stated that venture capital undertaking if received funds as a share capital from a venture capital company or a venture capital fund, provisions of this Section do not  apply. He further submitted that the fair market of the value of the shares shall l be the value as determined in accordance with the method as prescribed u/r 11 UA of the IT Rules or any method as may be substantiated by the assessee to the satisfaction of the assessing officer. However, it does not give any authority to the learned assessing officer to substitute the method of the valuation, himself value the shares by changing the method from discounted cash flow method to net asset value method, and then make an addition in the hands of the assessee company.

v. He further submitted that the deviations of actual figures from the projected figures are not the ground for challenging the valuation report. The valuation must be viewed as on the date of valuation looking forward and cannot be reviewed in hindsight. For this proposition, he referred to the decision of honourable Bombay High Court in Securities and Exchange Board of India and Others (company application number 124 of 2013 in company scheme petition number 234 of 2011 and other connected matters). He extensively referred to the various propositions from that decision mentioned in paragraph number 44.6, 44.7 and 48.6.

vi. He further referred to the decision of the honourable Bombay High Court stating that the learned assessing officer cannot change the basis of the valuation for the purpose of the provisions of Section 56 (2) of the act from DCF method to net asset value method as held in Vodafone M pesa Ltd versus Principal Commissioner Of Income Tax 256 taxmann 240 (Bom).

vii. He further submitted that assessee has given the complete details about investors in the above company and therefore there is no tax abuse or any allegation with respect to the unaccounted money.

viii. He referred to the decision of the Delhi ITAT in Spooner industries Private Limited versus ITO ITA number 2780/Del/2019 dated 28/12/2020 wherein it has been held that unless the valuation made by the assessee applying the discounted cash method is not found fault with by pointing out deficiencies and inadequacies, it cannot be rejected outright.

ix. He further referred to the paragraph number 5.4 onwards of the order of the learned CIT (A). He therefore submitted that the action of the learned assessing officer, without pointing out any material deficiency in the figures of computation of discounted cash flow valuation, could not substitute his own method for valuation of those shares.

x. He even otherwise submitted that the learned assessing officer is not an expert and it is not open for the assessing officer to challenge or change the method of valuation once adopted by the assessee and to modify the figure as per his own whims and fancies.

xi. He further referred to the rule 11 UA (2) (b) of The Income Tax Rules stating that the valuation of the share must be based on the discounted free cash flow method as one of the option and there is no reason to compare the actual performance of the assessee company with the projected performance.

xii. He further submitted that in case of a service company, the valuation of shares could only be made based on the discounted cash flow method, as the main source of intrinsic value of such shares is only the revenue generation and not the asset base.

xiii. He further submitted that  the  valuation  report  submitted  by the assessee is an opinion of the expert and necessarily it will have the basis for  giving  such  an  opinion,  therefore,  the learned assessing officer  has  not  appreciated  the  fact  that there are certain disclaimers and limitations bound to be mentioned by an expert. He submitted that despite this the learned assessing  officer  has  not  questioned  the  working  of the discounted cash flow of the  assessee  but  has  merely doubted  in  hindsight  stating  them  to  be  imaginary.  Thus,  he is verifying the valuation report dated 14th of March 2013 in March 2016 and then saying that the figures adopted by the assessee for year 2014 and 2015 are imaginary. He therefore submitted that the learned CIT – A has correctly deleted the addition made by the learned assessing officer.

12. We have carefully considered the rival contentions and perused the orders of the lower authority as well as perused the paper book filed by the assessee.

13. The ground number 1 and 2 is with respect to the disallowance deleted by the learned CIT – A on account of business expenses and unabsorbed depreciation. We find that this issue is squarely covered in favour of the assessee by the decision of the coordinate bench in assessee’s own case for assessment year 2012 –  13  in ITA  number  5294/M/2017  dated  27th of  March  2019.  The  learned  assessing  officer  has  also  made  the addition for this impugned assessment year based on his order for assessment year 2012 – 13. As the issue for assessment year 2012 – 13 has been decided in favour of the assessee, we do not find any reason to deviate from the same. In view of this ground number 1 and two of the appeal of the learned assessing officer are dismissed.

14. Ground number 3 and 4 are with respect to the addition of 69,000,000 on account of the provisions of Section 56 (2) (viib) of the act. Assessee has issued share capital at 75 per share being face value of Rs 10/- each at a premium of Rs 65/- per share to Cumulative Alternative Advisors Private Limited. This is supported by the valuation report by the chartered accountant adopting discounted cash flow method as per certificate dated 14th of March 2013. According to the certificate, it has adopted seven financial years starting from 2013 – 2020. For 2013, 2016 and 2017 the discounted cash flow statement shows losses. For financial year 2014, 2015, 2018 – 2020 it shows profit before tax and depreciation. Based on this, value of each share based on the present value of free cash flow was determined at 93 per share and such value was discounted at the rate of 20% for unlisted company. Consequently, fair value per share was determined at 75 per share. The valuation report also shows cost of equity and weighted average cost of capital along with discount factors. It is also supported by the projected profit and loss statement and balance sheet for all those seven years. A statement is also annexed thereto showing the  projected  revenue statement and the  breakup  of  the  revenue  and  consequent  expenses with respect to all those years. This valuation report was questioned by the assessing officer for the reason that the actual performance of the assessee company is not in consonance with the projected financial statements used by assessee for deriving the fair market  value  of  the shares  adopting  discounted  cash  flow  method.   According   to   him, actual  performance  of  the  assessee  company   shows  losses   where  as the discounted cash flow statement shows the projected  profits.  He directed the assessee to  substitute  the  actual  figures  against  the projected figures in the working of the discounted cash flow method valuation.  He  also  adopted  the  net  asset  value  method   or  deriving value of share which was Rs (-) 3241/-. Based on  this  he  made  the addition u/s 56(2) (viib) of the act of the whole  of  the  amount.  The learned CIT – A deleted the same. Provisions of Section 56 (2) (viib) of the act provides that 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 shall be chargeable to tax as income in  the  hands  of  the  company receiving  such  sum.   Explanation  to  that  subsection  Section  provides that 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 prescribed73; 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;

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 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 CIT – An in deleting the addition of 69,000,000 made by the learned assessing officer u/s 56 (2) (viib) of the act. Accordingly, ground number 3 and 4 of the appeal of the learned  assessing  officer  are dismissed.

16. In the result, appeal of the learned assessing officer is dismissed.