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ITAT Clarifies Valuation Principles for Non-Cumulative Redeemable Preference Shares

Introduction

In the case of Deputy Commissioner of Income-tax v. Weldon Polymers (P.) Ltd.[i], the Income Tax Appellant Tribunal (‘ITAT’) Delhi Bench addressed the issue of the valuation of non-cumulative redeemable preference shares (‘PS’) under s. 56 of the Income-tax Act, 1961 (‘Act’) read with r. 11UA of the Income-tax Rules, 1962 (‘Rules’). The case involved the valuation of 5% non-cumulative redeemable PS allotted at Rs. 20 per share, including a share premium of Rs. 10, for the assessment year (‘AY’) 2017-18.

Brief Facts

  • The Revenue Department (‘department’) filed this appeal against the order of the Commissioner of Income-tax (Appeals) [‘CIT(A)’]. The appeal before the CIT(A) arose from the order dated 27.11.2019, passed under s. 143(3) of the Act, for AY 2017-18. The case was selected for limited scrutiny assessment, focusing on the issue of share premium received by way of the issuance of 1,513,040 shares to Enlightened Consultancy Services Private Limited (‘ECS’) at Rs. 20 per share, including a share premium of Rs. 10 per share. The assessee claimed these shares had been issued against unsecured loans received in preceding years from ECS.

  • The assessing officer (‘AO’) was of the view that the assessee had not furnished a report from a merchant banker regarding the computation and rationale behind the price of each share for the purpose of r. 11UA of the Rules. Consequently, the AO determined the fair market value (‘FMV’) per share at Rs. 5.36, added the difference of Rs. 14.64 per share and made an addition of Rs. 2,21,50,906 to the assessee’s income under s. 56(2)(viib) of the Act.

  • On appeal, the CIT(A) deleted the addition, noting that the valuation of PS is distinct from that of equity shares under r. 11UA of the Rules. The CIT(A) observed that the AO had used a method prescribed for equity shares to determine the FMV of PS, which was not appropriate. The assessee had submitted a valuation report from an independent chartered accountant as prescribed by r. 11UA of the Rules for PS. The AO attempted to rebut the valuation report based on the dividend discount valuation model (‘DDVM’) without providing an alternate report or substantial evidence against it.

  • The department’s appeal included claims that the CIT(A) erred on facts and in law in deleting the addition of Rs. 2,21,50,906 under s. 56(2)(viib), and the valuation report had not been substantiated with facts and figures. The department also contended that the CIT(A) had not properly assessed the valuation method used by the assessee.

  • During the appellate proceedings, the CIT(A) detailed the valuation methodology and addressed the AO’s objections. It was noted that the PS, being quasi-debt instruments, were appropriately valued using the DDVM, and the AO’s method lacked justification. Furthermore, the CIT(A) emphasised that the AO did not provide substantial evidence to challenge the independent valuer’s report.

Held

  • The ITAT ruled in favour of the assessee, affirming that the AO had erroneously invoked r. 11UA(1)(c)(b) of the Rules for valuing the PS issued by the assessee, as this rule pertains to the valuation of equity shares. This was held inappropriate for quasi-debt instruments like unquoted redeemable PS. The ITAT held that the correct provisions for valuing PS are under r. 11UA(1)(c)(c) of the Rules, which mandates that the FMV of unquoted redeemable PS be determined with the assistance of a report prepared by a merchant banker or an accountant.

  • Dismissing the appeal, the ITAT emphasised several points:

  • Firstly, valuation reports prepared by qualified experts are presumed correct under the law unless proven otherwise, as these experts possess the necessary technical knowledge and experience to undertake such valuations.

  • Secondly, the AO has limited authority to alter or challenge the valuation methodology employed by such experts unless there is clear evidence of fundamental errors or apparent mistakes in the valuation process.

  • Thirdly, to challenge the expert valuation, the AO must demonstrate that it had fundamental errors and did not provide a sound basis for questioning the expert’s discount rate or valuation method.

  • As a result, the ITAT, while relying on various precedents, including Miheer H. Mafatlal v. Mafatlal Industries Ltd.[ii], G. L. Sultania & Anr. v. SEBI[iii], and Duncans Industries Ltd. v. State of U.P. & Ors. [iv] held that the CIT(A) correctly upheld the valuation report prepared by the independent expert. Thus justifying the deletion of the addition made by the AO under s. 56(2)(viib) of the Act.

Our Analysis 

The ITAT’s decision in this case set a precedent for the proper application of valuation rules and the significance of expert opinions in share valuation disputes. It highlighted the necessity for the AO to provide substantial evidence and credible alternatives when challenging expert valuations. The ruling also reinforced the principle that technical and complex valuations should have been presumed correct when conducted by qualified experts unless convincingly proven otherwise.

The ruling placed a significant burden on the AO when challenging an expert’s valuation. It was insufficient for the AO to merely raise objections or express dissatisfaction with the expert’s methodology or results. The AO had to provide substantial evidence demonstrating fundamental errors or apparent mistakes in the expert’s valuation process. Further, by upholding CIT(A)’s reliance on the DDVM for valuing PS, the ITAT affirmed the appropriateness of this method in cases involving long-term financial instruments with fixed dividend rates and redemption terms.




End Notes

[i] [2024] 163 taxmann.com 773 (Delhi - Trib.)[10-06-2024].

[ii] (AIR 1997 SC 506).

[iii] (AIR 2007 SC 2172).

[iv] 2000 ECR 19 (SC).







Authored by Siddharth Jha, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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