M/s Innoviti Payment Solutions Pvt Ltd , Bangalore V. The Income Tax Officer Circle-3(1)(1), Bangalore

ITA 1278/BANG/2018

• Counselvise Citation: [2019] 118 COUNSELVISE.COM (IT) 7182 (ITAT-BANGALORE)
• Duration Of Justice: 8 month(s) 20 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 09-01-2019
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: B
• Assessment Year: 2014-2015
• Appeal Filed On: 19-04-2018
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: R N SIDAPPAJI
• Assessee Lawyers: B M TAMBAKAR
• Keywords: Capital asset; Depreciation; Principle of natural justice; Fair market value; Valuation report; Onus to prove; Capital expenditure
• Section: 56(2); 56

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL B BENCH : BANGALORE BEFORE SHRI A. K. GARODIA, ACCOUNTANT MEMBER AND SHRI LALIET KUMAR, JUDICIAL MEMBER ITA NO.1278/BANG/2018 (ASSESSMENT YEAR : 2014 15) M/S. INNOVITI PAYMENT SOLUTIONS PVT. LTD., APPELLANT NO. 41, 2 ND & 3 RD FLOOR, NGR THE EDGE, III MAIN, V CROSS, SAI BABA MANDIR ROAD, HALASURU, BENGALURU 560008. PAN. AABCI0504M VS THE ITO, WARD 3 (1) (1), RESPONDENT BENGALURU. ASSESSEE BY : SHRI B. M. TAMBAKAR, C. A. REVENUE BY : SHRI R. N. SIDAPPAJI, ADDL. CIT ( DR) DATE OF HEARING : 07 12 20 18 DATE OF PRONOUNCEMENT : 09 01 2019 O R D E R PER BENCH: THIS APPEAL IS FILED BY THE ASSESSEE WHICH IS DIREC TED AGAINST THE ORDER OF CIT (A) 3, BANGALORE DATED 23.02.2018 FOR A. Y. 2 014 15. 2. THE GROUNDS RAISED BY THE ASSESSEE ARE AS UNDER: - 1. GROUNDS RELATING TO NATURAL JUSTICE THE LEARNED INCOME TAX OFFICER 3(1)(1) (HEREINAFTER ' AD') AND THE LEARNED COMMISSIONER OF INCOME TAX (APPEALS) - 3 (H EREINAFTER 'CIT-A') HAVE ERRED IN PASSING THE ORDER WITHOUT CO NSIDERING ALL THE SUBMISSIONS AND / OR WITHOUT APPRECIATING PROPERLY THE FACTS AND CIRCUMSTANCES OF THE CASE AND LAW APPLICABLE. 2. GROUNDS RELATING TO REJECTION OF EQUITY SHARES VALUATION REPORT ISSUED BY INDEPENDENT CHARTERED ACCOUNTANT THE ORDER OF THE LEARNED AO PASSED UNDER SECTION 14 3(3) OF THE INCOME TAX ACT, 1961 (`THE ACT') AND CONFIRMED BY L EARNED CIT-A IS ERRONEOUS IN RECKONING THAT SHARE PREMIUM COLLECTED IS ABOVE FAIR MARKET VALUE AND THEREBY LIABLE TO TAX IN PURSUANCE TO SECTION 56(2)(VIIB) BY ADOPTING RULE 11UA(A) TO THE EXCLUSI ON OF THE OPTION UNDER RULE 11UA(B) AS OPTED BY THE ASSESSEE WITHOUT TAKING ITA NO. 1278/BANG/2018 2 COGNIZANCE OF THE FACTS SUBMITTED AND ON THE FOLLOW ING GROUNDS NAMELY: A) THE VALUATION REPORT PROVIDED BY APPELLANT SHOWS THAT THE ACCOUNTANT HAS TAKEN HAZE CASH FLOW AS CERTIFIED BY THE MANAGEMENT. NO VERIFICATION OF PROJECTIONS AND ASSUMPTIONS ADOP TED BY MANAGEMENT WAS MADE BY VALUER, WHEREAS PARA 2.4 OF THE VALUATION REPORT OUTLINES THAT ANALYSIS, REVIEW AND INQUIRY H AS BEEN CARRIED OUT FOR ISSUING REPORT. B) APPELLANT HAS FAILED TO PROVIDE ANY INFORMATION, WHICH FORMED THE BASIS OF ITS PROJECTION FOR VARIOUS YEARS, WHEREAS PARA 3 OF THE VALUATION REPORT OUTLINES THE BASIS OF VALUATION AN D PAST BUSINESS PERFORMANCE FORMING BASIS OF PROJECTIONS HAVE BEEN SUBMITTED; C) COMPARISON OF PROJECTIONS WITH ACTUAL DATA, HIND SIGHT INFORMATION NOT AVAILABLE TO THE APPELLANT IS USED TO MAKE UNFA IR COMPARISON AND EXTENDING THE SCOPE BEYOND THE REALM OF LAW; D) MANDATES OF REGULATORY CHANGES DISCLOSED HAS BEE N ALLEGED TO HAVE INTENTIONALLY IGNORED WHILE MAKING PROJECTIONS, THE ALLEGATION IS WITHOUT BASIS AND DOES NOT APPRECIATE THE INTRICACI ES OF TECHNOLOGICAL CHALLENGE AND BUSINESS CONSTRAINTS. E) APPELLANT HAS MERELY ADOPTED THE VALUES PROVIDED BY THE MANAGEMENT CLEARLY IGNORING FACTORS SUCH AS PERFORM ANCE, GROWTH PROSPECTS, EARNINGS CAPACITY, WHEREAS AVERAGE ACTUA L MONTHLY REVENUE FROM APRIL 13 TO SEPT 13 WAS RS. 1.52 CRORE S, AN ARITHMETIC EXTRAPOLATION OF ANNUAL REVENUE IS RS. 18.24 CRORES AND THE PROJECTIONS HAVE ASSUMED ANNUAL GROWTH BETWEEN 15% TO 25% WHICH IS REALISTIC ASSUMPTION AS COMPARED TO PAST ACTUAL GROWTH RATES, FURTHER THE GROWTH PROJECTIONS ARE CORROBORATED WIT H AN INDEPENDENT REPORT 'PAYMENT SYSTEMS IN INDIA: VISION 2012-2015 PREPARED FROM PUBLIC INFORMATION SOURCE WWW.RBI.ORG.IN'. F) APPELLANT HAS NOT BEEN ABLE TO POINT OUT JUSTIFI CATION OF APPLICATION OF DCF, THE PROVISIONS OF INCOME TAX ALLOW AN ASSES SEE THE OPTION TO ADOPT DCF METHOD WITHOUT GIVING ANY REASONS AND MOR E SO FOR A TECHNOLOGY COMPANY DCF METHOD IS MORE APT AND SUITA BLE VIS--VIS THE NET ASSET VALUE METHOD. G) THE DATA USED IS TOTALLY UNRELIABLE, WITHOUT ANY SURETY OF ACCURACY OR COMPLETENESS, THIS ALLEGATION IS DEVOID OF FACTS IN THE LIGHT OF SUBMISSIONS MADE. 3. THE APPELLANT SUBMITS THAT EACH OF THE ABOVE GRO UNDS / SUB-GROUNDS ARE INDEPENDENT AND WITHOUT PREJUDICE TO ONE ANOTHE R. THE APPELLANT CRAVES LEAVE TO ADD, ALTER, VARY, OMIT, SUBSTITUTE OR AMEND THE ABOVE GROUNDS OF APPEAL, AT ANY TIME BEFORE OR, AT THE TI ME OF HEARING OF THE APPEAL, SO AS TO ENABLE INCOME TAX APPELLATE TRIBUN AL TO DECIDE THE ITA NO. 1278/BANG/2018 3 APPEAL ACCORDING TO LAW. THE APPELLANT PRAYS ACCORDINGLY. 3. BRIEF FACTS ARE THAT THE AO HAS NOTED ON PAGE 2 PARA 4 OF THE ASSESSMENT ORDER THAT THE ASSESSEE COMPANY HAS COLLECTED PREMIUM OF RS. 245,02,463/- AS SECURITIES PREMIUM. HE FURTHER NOTED THAT THE SECUR ITIES PREMIUM SHARES WERE ALLOTTED DURING THIS YEAR IN DECEMBER 2013. THE AO HAS ALSO NOTED COMPLETE DETAILS OF SUCH SHARES ISSUED ON PREMIUM OF RS. 23. 50 PER SHARES AND NOTED THAT THE FACE VALUE OF SHARES AT RS. 10/- PER SHARE . HE HAS NOTED THAT TO 11 PERSONS, 10,42,658 SUCH SHARES WERE ISSUED FOR A TO TAL CONSIDERATION OF RS. 349,29,043/-. THE AO NOTED THAT FROM THIS YEAR, THE PROVISIONS OF SECTION 56 (2) (VIIB) ARE APPLICABLE AND IF THE SHARES ARE ISSUED AT A PRICE WHICH IS MORE THAN FAIR MARKET VALUE THEN THE AMOUNT RECEIVED IN EXCES S OF FAIR MARKET VALUE OF SHARES WILL BE CHARGED TO TAX IN THE HANDS OF THE C OMPANY AS INCOME FROM OTHER SOURCES. THE AO ASKED THE ASSESSEE TO SUBSTANTIATE THE SHARE PREMIUM SO COLLECTED. THE ASSESSEE VIDE ITS LETTER FURNISHED T HE COPY OF THE CERTIFICATE ISSUED BY A CHARTERED ACCOUNTANT DATED 10.11.2013 A ND SAID THAT THIS IS THE BASIS FOR VALUING THE SHARES. THE VALUATION ADOPTED BY THE ASSESSEE WAS FOUND TO BE AS PER DCF (DISCOUNTED CASH FLOW) METHOD. THE AO HAS REPRODUCED THE COMPUTATION TABLE IN PARA 6 OF THE ASSESSMENT ORDER . AS PER THE SAME, ACTUAL REVENUE FOR F. Y. 2012 13 WAS CONSIDERED AT RS. 1 ,933 LACS. IN F. Y. 2013 14, THE REVENUE WAS ESTIMATED AT RS. 2,222 LACS WIT H AN ESTIMATED INCREASE OF 15%. THEREAFTER, IN F. Y. 2014 15 AND 2015 16, WITH ESTIMATED INCREASE OF 25% IN EACH YEAR, THE REVENUE WAS ESTIMATED AT RS. 2,778 LACS AND RS. 3,473 LACS RESPECTIVELY. THEREAFTER, IN F. Y. 2016 17 A ND 2017 18, WITH ESTIMATED INCREASE OF 15% IN EACH YEAR, THE REVENUE WAS ESTIM ATED AT RS. 3,993 LACS AND RS. 4,592 LACS RESPECTIVELY. IN THE SAME MANNER , THE EXPENSES WERE ALSO ESTIMATED AND PBT AND PAT WERE WORKED OUT FOR EACH YEAR. NET MARGIN FOR F. Y. 2012 13 WAS NOTED AT 5% BUT THE SAME WAS @ 6% IN F. Y. 2013 14 TO 2015 16 AND 8% IN F. Y. 2016 17 AND 9% IN F. Y. 2017 18. AFTER MAKING ADJUSTMENTS ON ACCOUNT OF DEPRECIATION, INCREASE/DE CREASE IN CURRENT ASSETS, NONCURRENT ASSETS, CAPITAL EXPENDITURE AND CURRENT LIABILITIES, NET CASH FLOW WAS WORKED OUT AND THE SAME WAS DISCOUNTED @ 15%. SUCH PRESENT VALUE OF CASH FLOW WAS WORKED OUT AT RS. 549 LACS. TO THIS, TERMI NAL VALUE WAS ADDED AT RS. ITA NO. 1278/BANG/2018 4 1,322 LACS AND IN THIS MANNER, ENTERPRISE VALUE WAS WORKED OUT AT RS. 1,871 LACS. FAIR VALUE OF EACH SHARE WAS WORKED OUT AT RS . 42/- PER SHARE. THE AO HAS NOTED AND REPRODUCED THE RELEVANT PORTION OF TH E CERTIFICATE ISSUED BY THE CHARTERED ACCOUNTANT WHICH SAYS THAT THE PROJECTION S ARE AS PER THE ESTIMATE OF THE MANAGEMENT AND THE CHARTERED ACCOUNTANT PROVID ES NO ASSURANCE THAT THIS INFORMATION OR THE ASSUMPTIONS ON WHICH THIS I NFORMATION HAS BEEN PREPARED BY THE MANAGEMENT ARE ACCURATE. AS PER PAR A 9 OF THE ASSESSMENT ORDER, THE AO HAS STATED THAT THE SUBMISSION OF THE ASSESSEE DID NOT BRING OUT ANY SCIENTIFIC BASIS FOR ARRIVING THE PROJECTED FIG URES AND THE VALUATION REPORT OF THE CA WAS ON THE BASIS OF THE PROJECTED FIGURES PR OVIDED BY THE ASSESSEE. HE WORKED OUT THE VALUE OF EACH SHARE BY ADOPTING THE NET ASSET VALUE AT RS. 632,97,815/-BY DEDUCTING BOOK VALUE OF LIABILITIES FROM BOOK VALUE OF ASSETS AND DIVIDING THE SAME BY THE NO. OF SHARES I.E. 44,35,9 53 ALREADY ISSUED AND PAID UP. THE AO HAS ALSO COMPARED THE PROJECTED SALES FO R F. Y. 2013 14 TO 2015 16 WITH ACTUAL SALES OF THESE THREE YEARS AND FOU ND THAT ACTUAL SALE IS 55.4% OF THE PROJECTED SALE IN F. Y. 2013 14 AND THE SA ME HAS FURTHER REDUCED TO 30.7 % IN F. Y. 2014 15 AND 26.7% IN F. Y. 2015 16. THE AO HAS ALSO COMPARED THE PROJECTED PROFITS BEFORE TAX PBT FOR F . Y. 2013 14 TO 2015 16 WITH ACTUAL PBT OF THESE THREE YEARS AND FOUND THAT ACTUAL PBT IS -385.32 LACS AS AGAINST PROJECTED PBT OF RS. 141 LACS IN F. Y. 2 013 14 AND HENCE, THE SAME HAVING DIFFERENCE OF RS. 526.32 LACS IN THAT Y EAR AND THE DIFFERENCE HAS FURTHER INCREASED TO ES. 730.25 LACS IN F. Y. 2014 15 AND RS. 1206.65 LACS IN F. Y. 2015 16. THE AO HELD IN PARA 13 OF THE A SSESSMENT ORDER THAT THE VALUATION OF THE ASSESSEE CANNOT BE ACCEPTED WITHOU T VERIFYING THE CREDIBILITY OF DATA PROVIDED BY THE ASSESSEE. THE AO RESTRICTED TH E ADDITION TO THE EXTENT OF EXCESS AMOUNTS RECEIVED FROM THE RESIDENTS AS PROVI DED IN LAW. THE AO NOTED THAT AN AMOUNT OF RS. 112,21,109/- WAS RECEIVED FRO M THE RESIDENTS IN EXCESS OF FAIR MARKET VALUE OF SHARE WORKED OUT BY THE AO AND THIS AMOUNT WAS ADDED. BEING AGGRIEVED, THE ASSESSEE CARRIED THE MATTER IN APPEAL BEFORE CIT (A) BUT WITHOUT SUCCESS AND NOW, THE ASSESSEE IS IN FURTHER APPEAL BEFORE US. 4. IN COURSE OF HEARING BEFORE US, VARIOUS ARGUMENT S WERE MADE BY THE LEARNED AR OF THE ASSESSEE. AT THIS JUNCTURE, IT WAS POINTE D OUT BY THE BENCH THAT AS PER THE DETAIL AVAILABLE ON PAGE 570 OF THE PAPER BOOK, DURING FIRST SIX MONTHS OF THE ITA NO. 1278/BANG/2018 5 F. Y. 2013 14, THERE WAS FALL IN REVENUE IN EACH MONTH. THE BENCH OBSERVED THAT UNDER THIS FACTUAL POSITION, HOW THE PROJECTIO NS OF 15% & 25% INCREASE IN TURNOVER CAN BE ACCEPTED. IN REPLY, LEARNED AR OF T HE ASSESSEE MADE VARIOUS ARGUMENTS BUT NO BASIS COULD BE PROVIDED BY HIM TO ESTIMATE SALES OF RS. 1270 LACS IN THE NEXT SIX MONTHS OF F. Y. 2013 14 I.E. OCTOBER 2013 TO MARCH 2014 AS AGAINST SALE OF RS. 915 LACS IN THE FIRST SIX MO NTHS OF THE PRESENT YEAR AND 1147 LACS IN CORRESPONDING SIX MONTHS OF THE PRECED ING YEAR. HE SIMPLY ARGUED THAT IN CORRESPONDING SIX MONTHS FROM APRIL TO SEPTEMBER OF THE PRECEDING YEAR I.E. F. Y. 2012 13, THE SALES WAS RS. 754 LACS AND HENCE, IN SPITE OF FALL IN THESE SIX MONTHS OF F. Y. 2013 1 4, THE SALES IS RS. 915 LACS AND HENCE, THERE IS INCREASE OF 21.35% IN THIS PERI OD ALSO AS COMPARED TO SAME SIX MONTHS OF THE PRECEDING YEAR AND THEREFORE , THE PROJECTION OF GROWTH OF 15% AND 25% IS JUSTIFIED. RELIANCE WAS PLACED ON A TRIBUNAL ORDER RENDERED IN THE CASE OF OZONELAND AGRO PVT. LTD. [TS-6963-IT AT-2018(MUMBAI)-O], (2018) 64 ITR 6 (MUMBAI) AND IN THE CASE OF M/S. R AMESHWARAM STRONG GLASS (P) LTD. VS. THE ITO, COPY ON PAGES 49 TO 67 OF THE PAPER BOOK. RELIANCE WAS PLACED ON ONE MORE TRIBUNAL ORDER RENDERED IN T HE CASE OF M/S VANI ESTATES PVT. LTD. VS. ITO IN ITA NO. 1352/CHNY/2018 DATED 27.08.2018 COPY AVAILABLE ON PAGES 740 TO 748 OF THE PAPER BOOK AND IN PARTICULAR, OUR ATTENTION WAS DRAWN TO PARA 7.3 & 7.4 OF THIS TRIBUNAL ORDER. 5. AS AGAINST THIS, LEARNED DR OF THE REVENUE SUPPO RTED THE ORDERS OF THE AUTHORITIES BELOW. IT WAS ALSO SUBMITTED THAT THE T RIBUNAL ORDERS CITED BY THE LEARNED AR OF THE ASSESSEE ARE NOT APPLICABLE IN TH E FACTS OF THE PRESENT CASE. HE PLACED RELIANCE ON ANOTHER TRIBUNAL ORDER RENDER ED IN THE CASE OF AGRO PORTFOLIO (P.) LTD. AS REPORTED IN 94 TAXMANN.COM 1 12 (DELHI). HE SUBMITTED A COPY OF THIS TRIBUNAL ORDER. IN PARTICULAR, OUR ATT ENTION WAS DRAWN TO PARA 13 TO 16 OF THIS TRIBUNAL ORDER AND IT WAS POINTED OUT TH AT IN PARA 16, THE TRIBUNAL HELD THAT IF THE CORRECTNESS OF DATA SUPPLIED BY THE ASS ESSEE TO THE MERCHANT BANKER CANNOT BE DETERMINED THAN THE AO CAN REJECT DCF MET HOD AND GO TO NAV METHOD TO DETERMINE FMV OF THE SHARES. HE SUBMITTED THAT THE FACTS IN THE PRESENT CASE ARE IDENTICAL EXCEPT ONE DIFFERENCE TH AT THE CERTIFICATE IN THAT CASE WAS OBTAINED BY THE ASSESSEE FROM MERCHANT BANKER A ND IN THE PRESENT CASE, THE ASSESSEE HAS OBTAINED THE CERTIFICATE FROM A CH ARTERED ACCOUNTANT. HE ITA NO. 1278/BANG/2018 6 SUBMITTED THAT THIS DIFFERENCE IS IMMATERIAL AND TH EREFORE, THIS TRIBUNAL ORDER SHOULD BE FOLLOWED IN THE PRESENT CASE. 6. WE HAVE CONSIDERED RIVAL SUBMISSIONS AND GONE TH ROUGH THE MATERIAL AVAILABLE ON RECORD. WE FIND THAT THERE IS NO DISPUTE ON THIS FACTUAL ASPECT THAT THE CERTIFICATE ISSUED BY THE CHARTERED ACCOUNTANT IS O N THE BASIS OF INFORMATION ABOUT FUTURE PROJECTIONS PROVIDED BY THE MANAGEMENT AND IT COULD NOT BE CONCLUSIVELY ESTABLISHED BY THE ASSESSEE THAT SUCH PROJECTION/ESTIMATION BY THE MANAGEMENT IS ON A SCIENTIFIC BASIS ALTHOUGH AN ATT EMPT WAS MADE IN THIS REGARD. 7. IN VIEW OF THIS FACTUAL POSITION, WE FIRST EXAMI NE THE LAW ON THIS ISSUE AND ALSO TAKE NOTE OF THE GUIDELINES ISSUED BY RESEARCH COMM ITTEE OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI) AS REPRODUCED BY CIT (A) IN PARA 4.6 OF HIS ORDER. WE FIRST REPRODUCE THE PROVISIONS OF SEC TION 56 (2) (VIIB) AND RULE 11U & 11UA AS UNDER:- INCOME FROM OTHER SOURCES. 56(2) (VIIB) WHERE A COMPANY, NOT BEING A COMPANY I N WHICH THE PUBLIC ARE SUBSTANTIALLY INTERESTED, RECEIVES, IN ANY PREVIOUS YEAR, FROM AN Y 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 CONSIDER ATION FOR ISSUE OF SHARES IS RECEIVED (I) BY A VENTURE CAPITAL UNDERTAKING FROM A VENTU RE CAPITAL COMPANY OR A VENTURE CAPITAL FUND; OR (II) BY A COMPANY FROM A CLASS OR CLASSES OF PERSO NS 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 T HE VALUE (I) AS MAY BE DETERMINED IN ACCORDANCE WITH SUCH M ETHOD AS MAY BE PRESCRIBED 9 ; 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 O F SHARES, OF ITS ASSETS, INCLUDING INTANGIBLE ASSETS BEING GOODWILL, KNOW-HO W, PATENTS, COPYRIGHTS, TRADEMARKS, LICENCES, FRANCHISES OR ANY OTHER BUSIN ESS OR COMMERCIAL RIGHTS OF SIMILAR NATURE, WHICHEVER IS HIGHER; (B) 'VENTURE CAPITAL COMPANY', 'VENTURE CAPITAL FU ND' AND 'VENTURE CAPITAL UNDERTAKING' SHALL HAVE THE MEANINGS RESPECTIVELY A SSIGNED TO THEM IN CLAUSE (A), CLAUSE (B) AND CLAUSE (C) OF EXPLANATION TO CL AUSE (23FB) OF SECTION 10; MEANING OF EXPRESSIONS USED IN DETERMINATION OF FAI R MARKET VALUE. 11U. FOR THE PURPOSES OF THIS RULE AND RULE 11UA, ITA NO. 1278/BANG/2018 7 ( A ) 1 [ *** ] ( B ) ' BALANCE - SHEET', IN RELATION TO ANY COMPANY, MEANS, (I) FOR THE PURPOSES OF SUB -RULE (2) OF RULE 11UA, THE BALANCE- SHEET OF SUCH COMPANY (INCLUDING THE NOTES ANNEXED THERETO AND FO RMING PART OF THE ACCOUNTS) AS DRAWN UP ON THE VALUATION DATE WHICH H AS BEEN AUDI TED BY THE AUDITOR OF THE COMPANY APPOINTED UNDER SECTION 224 OF THE COMPANIES ACT, 1956 (1 OF 1956) AND WHERE THE BALAN CE- SHEET ON THE VALUATION DATE IS NOT DRAWN UP, THE BALANCE- SHEET (INCLUDING THE NOTES ANNEXED THERETO AND FORMING PART OF THE ACCOUNTS) DRAWN UP AS ON A DATE IMMEDIATELY PRECEDING THE VALUATION DATE WHICH HAS BEEN APPROVED AND ADOPTED IN THE ANNUAL GENERAL MEETING OF THE SHAREHOLDERS OF THE COMPANY; AND 14AA [ ( II) IN ANY OTHER CASE, (A) IN RELATION TO AN INDIAN COMPANY, THE BALANCE- SHEET OF SUCH COMPANY (INCLUDING THE NOTES ANNEXED THERETO AND FO RMING PART OF THE ACCOUNTS) AS DRAWN UP ON THE VALUATION DATE WHICH HAS BEEN AUDITED BY THE AUDITOR OF THE COMPANY APPOINTE D UNDER THE LAW S RELAT ING TO COMPANIES IN FORCE; AND (B) IN RELATION TO A COMPANY, NOT BEING AN INDIAN COMPA NY, THE BALANCE- SHEET OF THE COMPANY (INCLUDING THE NOTES ANNEXED THERETO AND FORMING PART OF THE ACCOUNTS) AS DRAWN UP ON THE VALUATION DATE WHICH HAS BEEN AUDITED BY THE AUDITOR OF THE COMPANY, IF ANY, APPOINTED UNDER THE LAWS IN FORCE OF THE COUNTRY IN WHICH THE COMPANY IS REGISTERED OR INCOR PORATED; ] (C) 'MERCHANT BANKER' MEANS CATEGORY I MERCHANT BANKER REGISTERED WITH SECURITIES AND EXCHANGE BOARD OF INDIA EST ABLISHED UNDER SECTION 3 OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 (15 OF 1992); (D) 'QUOTED SHARES OR SECURITIES' IN RELATION TO SHARE OR SECURITIES MEANS A SHARE OR SECURITY QUOTED ON ANY RECOGNIZED STOCK EXCHANGE WI TH REGULARITY FROM TI ME TO TIME, WHERE THE QUOTATIONS OF SUCH SHARES OR SECURITIES A RE BASED ON CURRENT TRANSACTION MADE IN THE ORDINARY COURSE OF BUSINESS; (E) 'RECOGNIZED STOCK EXCHANGE' SHALL HAVE THE SAME MEA NING AS ASSIGNED TO IT IN CLAUSE ( F ) OF SECTION 2 OF TH E SECUR ITIES CONTRACTS (REGULATION) ACT, 1956 (42 OF 1956) ; (F) 'REGISTERED DEALER' MEANS A DEALER WHO IS REGISTERE D UNDER CENTRAL SALES TAX ACT, 1956 OR GENERAL SALES TAX LAW FOR THE TIME BEING IN FORCE IN ANY STATE INCLUDING VALUE ADDED TAX LAWS; (G) 'REG ISTERED VALUER' SHALL HAVE THE SAME MEANING AS ASSI GNED TO IT IN SECTION 34AB OF THE WEALTH - TAX ACT, 1957 (27 OF 1957) READ WITH RULE 8A OF WEA LTH - TAX RULES, 1957; (H) 'SECURITIES' SHALL HAVE THE SAME MEANING AS ASSIGNE D TO IT IN CLAUSE (H) OF SECTION 2 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956 (42 OF 1956); (I) 'UNQUOTED SHARES AND SECURITIES', IN RELATION TO SH ARES OR SECURITIES, MEANS SHARES AND SECURITIES WHICH IS NOT A QUOTED SHARES OR SECU RITIES; [ (J) 'VALUATION DATE' MEANS THE DATE ON WHICH THE PROPERTY OR CONSIDERATION, AS THE CASE MAY BE, IS RECEIVED BY THE ASSESSEE. ] DETERMINATION OF FAIR MARKET VALUE. 11UA. [ (1) ] FOR THE PURPOSES OF SECTION 56 OF THE ACT, THE FAI R MARKET VALUE OF A PROPERTY, ITA NO. 1278/BANG/2018 8 OTHER THAN IMMOVABLE PROPERTY, SHALL BE DETERMINED IN THE FOLLOWING MANNER, NAMELY, ( A ) VALUATION OF JEWELLERY, (I) THE FAIR MARKET VALUE OF JEWELLERY SHALL BE ESTIMAT ED TO BE THE PRICE WHICH SUCH JEWELLERY WOULD FETCH IF SOLD IN THE OPEN MARK ET ON THE VALUATION DATE; (II) IN CA SE THE JEWELLERY IS RECEIVED BY THE WAY OF PURCHASE ON THE VALUATION DATE, FROM A REGISTERED DEALER, THE INVOICE VALUE O F THE JEWELLERY SHALL BE THE FAIR MARKET VALUE; (III) IN CASE THE JEWELLERY IS RECEIVED BY ANY OTHER MODE AND THE VALUE OF THE JEWELL ERY EXCEEDS RUPEES FIFTY THOUSAND, THEN ASSESSEE MA Y OBTAIN THE REPORT OF REGISTERED VALUER IN RESPECT OF THE PRICE IT WOU LD FETCH IF SOLD IN THE OPEN MARKET ON THE VALUATION DATE; (B) VALUATION OF ARCHAEOLOGICAL COLLECTIONS, DRAWINGS, PAINTINGS, SCULP TURES OR ANY WORK OF ART, (I) THE FAIR MARKET VALUE OF ARCHAEOLOGICAL COLLECTIONS , DRAWINGS, PAINTINGS, SCULPTURES OR ANY WORK OF ART (HEREINAFTER REFERRED AS ARTISTIC WORK) SHALL BE ESTIMATED TO BE PRICE WHICH IT WOULD FETCH IF SOLD IN THE OPEN MARKE T ON THE VALUATION DATE; (II) IN CASE THE ARTISTIC WORK IS RECEIVED BY THE WAY OF PURCHASE ON THE VALUATION DATE, FROM A REGISTERED DEALER, THE INVOICE VALUE O F THE ARTISTIC WORK SHALL BE THE FAIR MARKET VALUE; (III) IN CASE THE ARTISTIC WORK IS RECE IVED BY ANY OTHER MODE AND THE VALUE OF THE ARTISTIC WORK EXCEEDS RUPEES FIFTY THOUSAND, THEN A SSESSEE MAY OBTAIN THE REPORT OF REGISTERED VALUER IN RESPECT OF THE PRICE IT WOULD FETCH IF SOLD IN THE OPEN MARKET ON THE VALUATION DATE; ( C ) VALUAT ION OF SHARES AND SECURITIES, (A) THE FAIR MARKET VALUE OF QUOTED SHARES AND SECURITI ES SHALL BE DETERMINED IN THE FOLLOWING MANNER, NAMELY, (I) IF THE QUOTED SHARES AND SECURITIES ARE RECEIVED BY WAY OF TRANSACTION CARRIED OUT THROUGH ANY RECOGNIZED ST OCK EXCHANGE, THE FAIR MARKET VALUE OF SUCH SHARES AND SECURITIES SHALL BE THE TRANSACTION VALUE AS RECORDED IN SUCH STOCK EXCHANG E; (II) IF SUCH QUOTED SHARES AND SECURITIES ARE RECEIVED B Y WAY OF TRANSACTION CARRIED OUT OTHER THAN THROUGH ANY RECO GNIZ ED STOCK EXCHANGE, THE FAIR MARKET VALUE OF SUCH SHARES AND SECURITIES SHALL BE, (A) THE LOWEST PRICE OF SUCH SHARES AND SECURITIES QUOT ED ON ANY RECOGNIZED STOCK EXCHANGE ON THE VALUATION DATE , AND (B) THE LOWEST PRICE OF SUCH SHARES AND SECURITIE S ON ANY RECOGNIZED STOCK EXCHANGE ON A DATE IMMEDIATELY PRECEDING THE VALUATION DATE WHEN SUCH SHARES AND SECURITIES WERE TRADED ON SUCH STOCK EXCHANGE, IN C ASES WHERE ON THE VALUATION DATE THERE IS NO TRADING IN SUCH SHARES AND SECURITIES ON ANY R ECOGNIZ ED STOCK EXCHANGE; 1 [ (B) THE FAIR MARKET VALUE OF UNQUOTED EQUITY SHARES SHA LL BE THE VALUE, ON THE VALUATION DATE, OF SUCH UNQUOTED EQUITY SHARES AS D ETERMINED IN THE FOLLOWING MANNER, NAMELY: ITA NO. 1278/BANG/2018 9 THE FAIR MARKET VALUE OF UNQUOTED EQUITY SHARES =(A +B+C+D - L) (PV)/(PE), WHERE, A= BOOK VALUE OF ALL THE ASSETS (OTHER THAN JEWELLE RY, ARTISTIC WORK, SHARES, SECURITIES AND IMMOVABLE PROPERTY) IN THE BALANCE - SHEET AS REDUCED BY, (I) ANY AMOUNT OF INCOME-TAX PAID, IF ANY, LESS THE AMO UNT OF INCOME- TAX REFUND CLAIMED, IF ANY; AND (II) ANY AMOUNT SHOWN AS ASSET INCLUDING THE UNAMORTISED AMOUNT OF DEFERRED EXPENDITURE WHICH DOES NOT REPRESENT THE V ALUE OF ANY ASSET; B = THE PRICE WHICH THE JEWELLE RY AND ARTISTIC WORK WOULD FETCH IF SOLD IN THE OPEN MARKET ON THE BASIS OF THE VALUATION REPOR T OBTAINED FROM A REGISTERED VALUER; C = FAIR MARKET VALUE OF SHARES AND SECURITIES AS D ETERMINED IN THE MANNER PROVIDED IN THIS RULE; D = THE VALUE ADOP TED OR ASSESSED OR ASSESSABLE BY ANY AUTHORITY OF T HE GOVERNMENT FOR THE PURPOSE OF PAYMENT OF STAMP DUTY IN RESPECT OF THE IMMOVABLE PROPERTY; L= BOOK VALUE OF LIABILITIES SHOWN IN THE BALANCE S HEET, BUT NOT INCLUDING THE FOLLOWING AMOUNTS, NAM ELY: (I) THE PAID - UP CAPITAL IN RESPECT OF EQUITY SHARES; (II) THE AMOUNT SET APART FOR PAYMENT OF DIVIDENDS ON PR EFERENCE SHARES AND EQUITY SHARES WHERE SUCH DIVIDENDS HAVE NOT BEEN DECLARED BEFORE THE DATE OF TRANSFER AT A GENERAL B ODY MEETING OF THE CO MPANY; (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, OTH ER THAN AMOUNT OF INCOME-TAX PAID, IF ANY, LESS THE AMOUNT OF INCO ME- TAX CLAIMED AS REFUND, IF ANY, TO THE EXTENT OF THE EXCESS OVER THE TAX PAYABLE WITH REFERENCE TO THE BOOK PROFITS IN ACCORDANCE WI TH THE LAW APPLICABLE THERETO; (V) ANY AMOUNT REPRESENTING PROVISIONS MADE FOR MEETING LIABILITI ES, OTHER THAN ASCERTAINED LIABILITIES; (VI) ANY AMOUNT REPRESENTING CONTINGENT LIABILITIES OTHE R THAN ARREARS OF DIVIDENDS PAYABLE IN RESPECT OF CUMULATIVE PREFE RENCE SHARES; PV= THE PAID UP VALUE OF SUCH EQUITY SHARES; PE = TOTAL AMOUNT OF PAID UP EQUITY SHARE CAPITAL A S SHOWN IN THE BALANCE- SHEET; ] (C) THE FAIR MARKET VALUE OF UNQUOTED SHARES AND SECURI TIES OTHER THAN EQUITY SHARES IN A COMPANY WHICH ARE NOT LISTED IN ANY RECOGNIZED STOC K EXCHANGE SHALL BE ESTIMATED TO BE PRICE IT WOULD F ETCH IF SOLD IN THE OPEN MARKET ON THE VALUATION DA TE AND THE ASSESSEE MAY OBTAIN A REPORT FROM A MERCHANT BANKER OR AN ACCOUNTANT IN RESPECT OF WHICH SUCH VALUATION. [ (2) NOTWITHSTANDING ANYTHING CONTAINED IN SUB-CLAUS E (B) OF CLAUSE (C) OF SUB-RULE (1), THE FAIR MARKET VALUE OF UNQUOTED EQUITY SHARES FOR THE PURPOSES OF SUB-CLAUSE (I) OF CLAUSE (A) ITA NO. 1278/BANG/2018 10 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 D ETERMINED IN THE FOLLOWING MANNER UNDER CLAUSE (A) OR CLAUSE (B), AT THE OPTION OF THE ASSE SSEE, NAMELY: (A) THE FAIR MARKET VALUE OF UNQUOTED EQUITY SHARES = (A-L) X (PV), (PE) WHERE, A = BOOK VALUE OF THE ASSETS IN THE BALANCE-SHEET A S 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 A ND 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 O F DIVIDENDS ON PREFERENCE SHARES AND EQUITY SHARES WHERE SUCH DIVIDENDS HAVE NOT BEEN DE CLARED BEFORE THE DATE OF TRANSFER AT A GENERAL BODY MEETING OF THE COMPAN Y; (III) RESERVES AND SURPLUS, BY WHATEVER NAME CALLED, EVEN IF THE RESULTING FIGURE IS NEG ATIVE, OTHER THAN THOSE SET APART TOWARDS DEPRECIAT ION; (IV) ANY AMOUNT REPRESENTING PROVISION FOR TAXATION, OTH ER THAN AMOUNT OF TAX PAID AS DEDUCTION OR COLLECTION AT SOURCE OR AS ADV ANCE TAX PAYMENT AS REDUCED BY THE AMOUNT OF TAX CLAIMED AS REFUND UNDE R THE INCOME- TAX ACT, TO THE EXTENT OF THE EXCESS OVER THE TAX PAYABLE WI TH REFERENCE TO THE BOOK PROFITS IN ACCORDANCE WITH THE LAW APPLICABLE THERE TO; (V) ANY AMOUNT REPRESENTING PROVISIONS MADE FOR MEETING LIABILITIES, OTHER THAN ASCERTAINE D LIABI LITIES; (VI) ANY AMOUNT REPRESENTING CONTINGENT LIABILITIES OTHE R THAN ARREARS OF DIVIDENDS PAYABLE IN RESPECT OF CUMULATIVE PREFEREN CE SHARES; PE = TOTAL AMOUNT OF PAID UP EQUITY SHARE CAPITAL AS SHO WN IN THE BALANCE - SHEET; PV = THE PAID UP VALU E OF SUCH EQUITY SHARES; OR (B) THE FAIR MARKET VALUE OF THE UNQUOTED EQUITY SHARES DETERMINED BY A MERCHANT BANKER 2 [ *** ] AS PER THE DISCOUNTED FREE CASH FLOW METHOD. ] 8. NOW WE REPRODUCE PARA 4.6 FROM THE ORDER OF CIT (A) BECAUSE IN THIS PARA, LEARNED CIT (A) HAS REPRODUCED THE RELEVANT PORTION OF TECHNICAL GUIDE ON SHARE VALUATION (ISSUED IN 2009) BY RESEARCH COMMITTEE OF THE INSTITUTE OF CHARTED ACCOUNTANTS OF INDIA (ICAI). THE SAME IS AS UNDER:- 4.6 IN ORDER TO EXAMINE THIS ISSUE OF VALUATION, I T IS IMPORTANT TO KNOW AS TO WHAT IS DISCOUNTED CASH FLOW METHOD. RELEVANT PART OF THE INFORMATION AVAILABLE ON THIS ISSUE IN `TECHNIC AL GUIDE ON SHARE VALUATION' (ISSUED IN 2009) BY RESEARCH COMMITTEE O F THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA IS REPRODUCED AS FOL LOWS: ITA NO. 1278/BANG/2018 11 '1.1 THE VALUATION OF THE SHARES OF A COMPANY INVOL VES USE OF JUDGEMENT , EXPERIENCE AND KNOWLEDGE. THE ACCOUNTANT UNDERTAK ING THIS WORK SHOULD POSSESS KNOWLEDGE OF THE ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS BACKED BY A PRACTICAL APPRE CIATION OF BUSINESS AFFAIRS AND INVESTMENTS. A VALUATION BASED ON QUANT ITATIVE INFORMATION ALONE WILL NOT BE ADEQUATE FOR A REAL VALUATION. IT SHOULD ALSO BE RECOGNISED THAT THE METHOD OF VALUATION OF SHARES W OULD VARY, DEPENDING ON THE PURPOSE FOR WHICH IT IS TO BE USED . 1.2 A CLEAR UNDERSTANDING OF THE PURPOSE OF VALUATI ON IS UNDOUBTEDLY IMPORTANT, BUT AN EQUALLY IMPORTANT IMPERATIVE IS T O HAVE A FULL APPRECIATION OF THE V ALUE' EMANATING FROM COMMON PRINCIPLES. THIS 'GENERAL PURPOSE VALUE' MAY BE SUITABLY MODIFIED FO R THE SPECIAL PURPOSE FOR WHICH THE VALUATION IS DONE. THE FACTOR S AFFECTING THAT VALUE WITH REFERENCE TO THE SPECIAL PURPOSE MUST BE JUDGED AND BROUGHT INTO FINAL ASSESSMENT IN A SOUND ARID REASO NABLE MANNER. ------------------------------------- 1.4 VALUATION, BEING A COMPLEX SUBJECT, IS LIMITED TO EXPERTS AND IS SURROUNDED BY A NUMBER OF MYTHS. SOME OF THE VERY C OMMON GENERALITIES ABOUT VALUATION ARE DISCUSSED BELOW: (A) VALUATION MODELS ARE QUANTITATIVE AND FOCUS ON EARN INGS, ASSETS, ETC. HOWEVER, IT DOES NOT NECESSARILY IMPLY THAT VA LUATION IS FREE FROM THE SUBJECTIVITY AND BIAS OF A VALUER. THE FACT IS THAT VALUATION MODELS ARE DRIVEN BY THE INPUTS THAT ARE PRONE TO SUBJECTI VE JUDGMENTS AND THE BIAS OF A VALUER. FOR INSTANCE, A TARGET COMPANY MA Y TYPICALLY TEND TO OVERVALUE ITSELF WHILE VALUING. (B) VALUATION IS RIDDLED WITH A COMMONPLACE NOTION THAT A DETAILED VALUATION EXERCISE WILL PROVIDE A PRECISE ESTIMATE OF VALUE. THE TRUTH IS THAT ANY VALUATION IS AS GOOD AS ITS UNDERLYING ASSUMPTIONS, WHICH, IN TURN, ARE THE FUNCTION OF A NUMBER OF PRESENT AR ID FORWARD-LOOKING FACTORS. A CAREFUL VALUATION EXERCISE, AT BEST, CAN GIVE AN INDICATIVE RANGE OF VALUE SUBJECT TO THE REASONABLENESS OF THE ASSUMPTIONS. (C) VALUATION IS PERTINENT TO A PARTICULAR POINT OF TIM E AND VARIES WITH CHANGES IN BUSINESS, INDUSTRY AND MACROECONOMIC ENV IRONMENT. E.G., THE MOVEMENT OF US DOLLAR AGAINST INDIAN RUPEE HAS LED TO A SUBSTANTIAL CHANGE IN THE VALUATION OF IT AND OTHER EXPORT-DRIVEN COMPANIES. ---------------------------------------- 2.1 THE POTENTIAL EARNING POWER OF A COMPANY IS GEN ERALLY A PARAMOUNT FACTOR FOR VALUATION OF SHARE BUT THERE M AY BE OCCASIONS, ESPECIALLY IN VALUATIONS FOR COMPENSATION, WHERE OT HER CONSIDERATIONS BECOME RELATIVELY MORE IMPORTANT. IN THE ABSENCE OF ANY OTHER SPECIAL MOTIVE, AN INVESTOR IS PRINCIPALLY INTERESTED IN A COMPANY'S ABILITY TO CONTINUE EARNING PROFITS. ITA NO. 1278/BANG/2018 12 2.4 THE INCOME APPROACH INDICATES THE VALUE OF A BU SINESS BASED ON THE VALUE OF THE CASH FLOWS THAT A BUSINESS IS EXPE CTED TO GENERATE IN FUTURE. THIS APPROACH IS APPROPRIATE IN MOST GOING CONCERN SITUATIONS AS THE WORTH OF A BUSINESS IS GENERALLY A FUNCTION OF ITS ABILITY TO EARN INCOME/CASH FLOW AND TO PROVIDE AN APPROPRIATE RETU RN ON INVESTMENT. 2.5 THE INCOME APPROACH INCLUDES A NUMBER OF MODELS /TECHNIQUES, SUCH AS DISCOUNTED CASH FLOW, MAINTAINABLE PROFITS BASIS, DIVIDEND DISCOUNT MODEL, AND OTHERS, WHICH ARE DISCUSSED IN DETAIL IN THE FOLLOWING PARAGRAPHS. 2.6 DISCOUNTED CASH FLOW MODEL INDICATES THE FAIR M ARKET VALUE OF A BUSINESS BASED ON THE VALUE OF CASH FLOWS THAT THE BUSINESS IS EXPECTED TO GENERATE IN FUTURE. THIS METHOD INVOLVES THE EST IMATIO N OF POST-TAX CASH FLOWS FOR THE PROJECTED PERIOD, AFTER TAKING I NTO ACCOUNT THE BUSINESS'S REQUIREMENT OF REINVESTMENT IN TERMS OF CAPITAL EXPENDITURE AND INCREMENTAL WORKING CAPITAL. THESE CASH FLOWS A RE THEN DISCOUNTED AT A COST OF CAPITAL THAT REFLECTS THE R ISKS OF THE BUSINESS AND THE CAPITAL STRUCTURE OF THE ENTITY. 2.7 DISCOUNTED CASH FLOW IS THE MOST COMMONLY USED VALUATION TECHNIQUE, AND IS WIDELY ACCEPTED BY VALUERS BECAUS E OF ITS INTRINSIC MERITS, SOME OF WHICH ARE GIVEN BELOW: (A) THEORETICALLY, IT IS A VERY SOUND MODEL BECAUSE IT IS BASED UPON EXPECTED FUTURE CASH FLOWS OF A COMPANY THAT WILL D ETERMINE AN INVESTOR'S ACTUAL RETURN. (B) IT IS BASED ON EXPECTATIONS OF PERFORMANCE SPECIFIC TO THE BUSINESS, AND IS NOT INFLUENCED BY SHORT-TERM MARKET CONDITIO NS OR NON- ECONOMIC INDICATORS. (C) IT IS NOT AS VULNERABLE TO ACCOUNTING CONVENTIONS L IKE DEPRECIATION, INVENTORY VALUATION IN COMPARISON WITH THE OTHER TECHNIQUES/APPROACHES SINCE IT IS BASED ON CASH FLO WS RATHER THAN ACCOUNTING PROFITS. (D) IT IS APPROPRIATE FOR VALUING GREEN-FIELD OR START- UP PROJECTS, AS THESE PROJECTS HAVE LITTLE OR NO ASSET BASE OR EARN INGS WHICH RENDER THE NET ASSET OR MULTIPLE APPROACHES INAPPROPRIATE. HOWEVER, IT IS IMPORTANT THAT VALUATION MUST RECOGNISE THE ADDITIO NAL RISKS IN SUCH A CASE (E.G. PROJECT EXECUTION RISK, LACK OF PAST TRA CK RECORD, ETC.) BY USING AN APPROPRIATE DISCOUNT RATE. 2.8 THOUGH THE DISCOUNTED CASH FLOW MODEL IS ONE OF THE WIDELY USED MODELS FOR VALUATION BECAUSE OF ITS INHERENT BENEFI TS, IT STILL HAS ITS SHARE OF DRAWBACKS. MAJOR SHORTCOMINGS OF THIS MODE L ARE AS FOLLOWS: (A) I T IS ONLY AS GOOD AS ITS INPUT ASSUMPTIONS. FOLLOWI NG THE 'GARBAGE IN, GARBAGE OUT' PRINCIPLE, IF THE INPUTS - CASH FLOW PROJECTIONS, ITA NO. 1278/BANG/2018 13 DISCOUNT RATE, AND TERMINAL VALUE - ARE WIDE OFF TH E MARK, THEN THE VALUE GENERATED BY USING THIS MODEL DOES NOT REFLEC T THE FAIR VALUE. (B) IT DOES NOT TAKE INTO ACCOUNT SEVERAL OTHER FACTORS , SUCH AS INVESTMENT RISK ASSOCIATED WITH OPPORTUNITY COST, I .E. I N VESTMENTS THAT COULD RETURN GREATER CASH FLOW YIELDS WOULD ADD AN UNREALISED ELEMENT OF RISK, UNFORESEEN VARIATIONS IN FUTURE CASH FLOW, AND OTHER NON- FINANCIAL FACTORS. 2.9 IN THIS TECHNIQUE VALUATION OF SHARES IS BASED ON THREE THINGS: CASH FLOW PROJECTIONS, DISCOUNT RATE AND TERMINAL V ALUE. 2.10 THE FIRST AND MOST CRITICAL INPUT OF THE DISCO UNTED CASH FLOW MODEL IS THE CASH FLOW PROJECTIONS. AS STATED EARLI ER, THE DISCOUNTED CASH FLOW VALUE IS AS GOOD AS THE ASSUMPTIONS USED IN DEVELOPING THE PROJECTIONS. THESE PROJECTIONS SHOULD REFLECT T H E BEST ESTIMATES OF THE MANAGEMENT AND TAKE INTO ACCOUNT VARIOUS MACRO AND MICRO- ECONOMIC FACTORS AFFECTING THE BUSINESS. SOME OF TH E IMPORTANT POINTS TO BE KEPT IN MIND WITH REGARD TO CASH FLOW PROJECT IONS BASED ON THE PROJECTION OF THE PROFITABILITY ARE STATED BELOW: (A) CASH FLOW PROJECTIONS SHOULD REASONABLY CAPTURE THE GROWTH PROSPECTS AND EARNINGS CAPABILITY OF A COMPANY. THE EARNING MARGINS OF A COMPANY SHOULD BE DETERMINED BASED ON ITS PAST PERFORMANCE, ANY ENVISAGED SAVINGS, PRESSURE ON MARGINS DUE TO C OMPETITION, ETC. (B) DISCONTINUATION OF A PART OF THE BUSINESS, EXPANSIO N PROGRAMMES AND ANY MAJOR CHANGE IN THE POLICIES OF THE COMPANY MAY PROVIDE OCCASIONS FOR MAKING A BREAK WITH THE PAST. (C) THE DISCONTINUATION OF A PART OF THE BUSINESS CAN B E EASILY DEALT WITH BY A VALUER. A PART OF THE PROFITS EARNED BY S UCH BUSINESS IN THE PAST WILL HAVE TO BE EXCLUDED FROM THE PROJECTIONS. (D) THE EFFECT OF EXPANSION SCHEMES CAN PRESENT MORE CO MPLEX PROBLEMS. FOR THESE, THE VALUER WILL HAVE TO USE HI S JUDGMENT ABOUT THEIR PROFITABILITY. THE STATE OF EXECUTION AT THE TIME OF VALUATION SHOULD BE GIVEN DUE CONSIDERATION. MERE PAPER PLANS FOR EXPANSION SHOULD NOT BE TAKEN INTO ACCOUNT. IF REASONABLE IND ICATIONS OF EXPECTED FUTURE PROFIT ARE AVAILABLE, THEN SUCH PROFITS TAKE N ON A REASONABLE BASIS TO TAKE CARE OF THE RISK AND UNCERTAINTY IN VOLVED - MAY BE INCLUDED IN THE PROJECTIONS OF THE COMPANY. IF, HOW EVER, THE PROFITS ARE EXPECTED TO BE REALISED AFTER A LAPSE OF SOME YEARS OR IF MATERIAL AMOUNTS HAVE YET TO BE INCURRED BEFORE PROFITS ARE REALISED, DUE CONSIDERATION WILL HAVE TO BE GIVEN TO THESE CIRCUM STANCES. IN SUCH CIRCUMSTANCES, SEPARATE VALUE MAY BE GIVEN TO SUCH NEW INVESTMENTS AND THE SAME IS ADDED TO THE VALUE OF THE EXISTING STREAM OF BUSINESS. ITA NO. 1278/BANG/2018 14 (E) IN TURNAROUND CASES, THE UNCERTAINTY OF HIGHER PROF ITS IS MUCH GREATER. CAREFUL EVALUATION OF THE STEPS ACTUALLY T AKEN TO IMPLEMENT A TURNAROUND STRATEGY MUST BE UNDERTAKEN BEFORE A VAL UER ACCEPTS MANAGEMENT'S CLAIMS THAT IN FUTURE THE COMPANY WILL EARN PROFITS. IF NECESSARY, REPORTS OF TECHNICAL OR OTHER CONSULTANT S SHOULD BE CALLED FOR. (F) IN CASE OF COMPANIES WITNESSING CYCLICAL FLUCTUATIO NS, CARE SHOULD BE TAKEN TO SELECT THE FORECAST PERIOD, WHICH SHOUL D NECESSARILY COVER THE ENTIRE BUSINESS CYCLE OF A COMPANY. (G) EFFECTS OF CHANGE IN THE POLICY OF THE COMPANY MAY BE TAKEN INTO ACCOUNT IF SUCH CHANGES ARE KNOWN IN ADVANCE AND TH E EFFECTS ARE CAPABLE OF BEING QUANTIFIED. CHANGES IN THE UTILISA TION OF THE PRODUCTIVE CAPACITY, CHANGES IN THE ORGANISATIONAL SET-UP, CHANGES IN THE PRODUCT-MIX, CHANGES IN THE FINANCING POLICY ARE SOME EXAMPLES OF THE SITUATION THAT M AY H AVE TO BE FACED BY A VALUER. THEIR TREATMENT IN THE PROJECTION OF FUTURE PROFITS WILL DEPEND ENTIRELY UPON THE EFFECT WHICH IN THE OPINION OF TH E VALUER, SUCH CHANGES WILL HAVE ON SUCH FUTURE PROFITS. (H) AN APPROPRIATE ALLOWANCE MUST BE MADE FOR CAPITAL E XPENDITURE IN PROJECTIONS. THEY SHOULD NOT INCLUDE CAPITAL EXPEND ITURE ONLY FOR CAPACITY EXPANSION OR GROWTH BUT ALSO FOR MAINTENAN CE OF THE EXISTING CAPACITY. (I) WORKING CAPITAL REQUIREMENT FORMS ANOTHER IMPORTANT COMPONENT. PROJECTIONS SHOULD APPROPRIATELY ACCOUNT FOR WORKING CAPITAL NEEDS OF THE BUSINESS IN ITS DIFFERENT PHAS ES. (J) INCOME TAX OUTFLOW ALSO IMPACTS THE VALUE OF A BUSI NESS AND SHOULD INCORPORATE ANY TAX BENEFITS LIKE TAX HOLIDA Y, ACCUMULATED LOSSES, ETC. IN MAKING PROJECTIONS, NOTIONAL TAX CA LCULATED AT THE RATES EXPECTED TO BE APPLICABLE TO THE COMPANY IN F UTURE SHOULD NORMALLY BE DEDUCTED. FOR INSTANCE, THE RATE MAY CH ANGE IF THE COMPANY IS PLANNING TO UNDERTAKE ACTIVITIES ON WHIC H TAX INCIDENCE IS LOWER. WHERE SUCH RATES ARE NOT A VAILABLE, THE CURRENT RATES OF TAXES MAY BE CONSIDERED A GOOD INDICATOR. TAX BENEF ITS DUE TO ACCUMULATED LOSSES, ACCUMULATED DEVELOPMENT REBATES OR ALLOWANCE, INVESTMENT ALLOWANCE, UNABSORBED DEPRECI ATION ETC. SHOULD NOT GENERALLY BE ADJUSTED TO THE TAX RATE; I NSTEAD, THESE SHOULD BE CONSIDERED SEPARATELY. THE PAST UNABSORBED TAX SHEL TER IS VALUED BY USING DISCOUNTED CASH FLOW METHOD, FOR TH E ACTUAL YEARS IN WHICH THE TAX SHELTER WOULD BE AVAILED OF A REDUCTI ON IN THE EFFECTIVE TAX RATE DUE TO EXEMPTIONS FOR NEW INDUSTRIAL UNIT RELIEF EXPORT PROFITS ETC., SHOULD BE VERY CAREFULLY CONSIDERED, DEPENDIN G ON THE PERIOD FOR WHICH THEY WOULD BE AVAILABLE. A CAUTIOUS VALUER WO ULD PERHAPS COMPUTE AN EFFECTIVE TAX RATE EACH YEAR FOR THE FOR ECAST PERIOD, BASED ON THE CURRENT YEAR'S TAX RATE AND STATUTORY DEDUCT IONS AVAILABLE AND A ITA NO. 1278/BANG/2018 15 REASONABLE VIEW OF PROFITS. DISCOUNT RATE 2.11 THE NEXT STEP IN THE DISCOUNTED CASH FLOW MODE L IS THE DETERMINATION OF AN APPROPRIATE RATE TO DISCOUNT FU TURE CASH FLOWS. DISCOUNT RATE IS THE AGGREGATE OF RISK-FREE RATE AN D RISK PREMIUM TO ACCOUNT FOR RISKINESS OF THE BUSINESS. KEY INPUTS O R ADJUSTMENTS FOR CALCULATING THE DISCOUNT RATE ARE DISCUSSED BELOW: (A) THEORETICALLY, RISK-FREE RATE IS THE RATE OF RETURN ON AN ASSET WITH NO DEFAULT RISK. IN PRACTICE, LONG-TERM INTEREST RA TES ON GOVERNMENT SECURITIES ARE USED AS A BENCHMARK. (B) IT IS QUITE NATURAL T O ASSUME THAT THE RISKIER INVESTMENTS SHOULD HAVE A HIGHER RETURN. THIS NECESSITATES THE INCORPO RATION OF AN APPROPRIATE RISK PREMIUM IN THE DISCOUNT RATE. THER E EXIST A NUMBER OF MODELS FOR DETERMINATION OF RISK PREMIUMS, SUCH AS THE CAPITAL ASSET PRICING MODEL, ARBITRAGE PRICING MODEL, MULTI-FACTO R MODEL, ETC. RISK PREMIUM IS ALSO ADJUSTED TO INCORPORATE RISKS ASSOC IATED WITH THE STAGE AND SIZE OF BUSINESS AND OTHER COMPANY OR PRO JECT-SPECIFIC RISKS. (C) THE RATE ESTIMATED BY USING THE ABOVE WILL PROVIDE THE DISCOUNT RATE, ASSUMING ONLY EQUITY FINANCING OR THE COST OF EQUITY. FOR A LEVERAGED COMPANY, DISCOUNT RATE SHOULD BE ADJUSTED FOR LEVERAGING. PRACTICALLY SPEAKING, DISCOUNT RATE FOR A LEVERAGED COMPANY IS THE WEIGHTED AVERAGE COST OF CAPITAL WITH APPROPRIATE W EIGHTAGES TO COST OF EQUITY AND POST-TAX COST OF DEBT, CONSIDERING EX ISTING OR TARGETED DEBT-EQUITY RATIO, INDUSTRY STANDARDS AND OTHER PAR AMETERS. (D) IN THE CASE OF A COMPANY CARRYING ON TWO OR MORE DI FFERENT BUSINESSES, THEIR CASH FLOW PROJECTIONS SHOULD BE E STIMATED SEPARATELY, AND APPLY THE DISCOUNT RATES APPROPRIATE TO THE IND IVIDUAL BUSINESSES. TERMINAL VALUE 2.12 SINCE A BUSINESS IS VALUED AS A GOING CONCERN, ITS VALUE SHOULD ACCOUNT FOR THE CASH FLOWS OVER THE ENTIRE LIFE OF A COMPANY, WHICH CAN BE ASSUMED TO BE INFINITE. BECAUSE THE CASH FLOWS A RE ESTIMATED ONLY FOR THE FORECAST PERIOD, A TERMINAL VALUE IS ESTIMA TED TO REFLECT THE VALUE OF THE CASH FLOWS ARISING AFTER THE FORECAST PERIOD. TERMINAL VALUE CAN BE COMPUTED IN A NUMBER OF WAYS; SOME PRO MINENT ONES ARE DISCUSSED BELOW: (A) PERPETUAL GROWTH MODEL ASSUMES THAT A BUSINESS HAS AN INFINITE LIFE AND A STABLE GROWTH RATE OF CASH FLOWS. TERMINAL VA LUE IS DERIVED MATHEMATICALLY BY DIVIDING THE PERPETUITY CASH FLOW S (CASH FLOWS WHICH ARE EXPECTED TO GROW AT A STABLE PACE) WITH T HE DISCOUNT RATE AS REDUCED BY THE STABLE GROWTH RATE. ESTIMATION OF TH E STABLE GROWTH RATE IS OF GREAT SIGNIFICANCE BECAUSE EVEN A MINOR CHANGE IN STABLE GROWTH RATE CAN CHANGE THE TERMINAL VALUE AND THE B USINESS V ALUE TOO. VARIOUS FACTORS LIKE THE SIZE OF A COMPANY, EXISTIN G GROWTH RATE, ITA NO. 1278/BANG/2018 16 COMPETITIVE LANDSCAPE, PROFIT REINVESTMENT RATIO, E TC. HAVE TO BE KEPT IN MIND WHILE ESTIMATING THE STABLE GROWTH RATE. (B) MULTIPLE APPROACH INVOLVES THE DETERMINATION OF AN APPROPRIATE MULTIPLE TO BE APPLIED ON PERPETUITY EARNINGS OR RE VENUES. MULTIPLE IS ESTIMATED BY AN ANALYSIS OF THE COMPARABLE COMPANIE S. THOUGH THIS APPROACH IS SIMPLER AND BRINGS IN THE ADVANTAGES OF MARKET APPROACH, IT DOES NOT QUALIFY AS A PREFERRED APPROACH BECAUSE IT MIXES THE DISCOUNTED CASH FLOW APPROACH WHICH PROVIDES INTRINSIC OR COMPANY- SPECIFIC VALUATION WITH THE MARKET APPROACH. (C) IN VALUATIONS THAT ASSUME A FINITE LIFE OF A BU SINESS, TERMINAL VALUE IS ESTIMATED TO BE THE LIQUIDATION VALUE, WHICH IS BASED ON THE BOOK VALUE OF THE ASSETS ADJUSTED FOR INFLATION . BUT THIS DOES NOT REFLECT THE EARNING POWER OF THE ASSETS. ALTERNATIVELY, DISCOUN TING EXPECTED CASH FLOWS FROM SALE OF SUCH ASSETS AT AN APPROPRIATE DI SCOUNT RATE WOULD PROVIDE A BETTER ESTIMATION OF LIQUIDATION VALUE. ----------------------------------------------- 6.1 SELECTION OF AN APPROPRIATE APPROACH - INCOME, MARKET, OR NET ASSETS - AS WELL AS THE TECHNIQUE/MODEL WITHIN THE SELECTED APPROACH BY A VALUER IS DEPENDENT ON THE FACTS AND CIRCUMSTA NCES OF THE CASE. IN PRACTICE, HOWEVER, A COMBINATION OF ALL THE APPROAC HES IS USED BY ASSIGNING APPROPRIATE WEIGHTAGE TO EACH APPROACH. 6.6 WHILE VALUING SHARES, A NUMBER OF SITUATIONS MA Y ARISE IN WHICH SPECIAL CONSIDERATION HAS TO BE GIVEN TO SEVERAL IM PORTANT FACTORS. --------------------------------------------------- -- 6.24 THOUGH VALUATION IS MAINLY DRIVEN BY FINANCIAL FACTORS LIKE EARNINGS, ASSETS, ETC., SOME OTHER FACTORS REQUIRE CAREFUL EVALUATION AS AN INTEGRAL PART OF THE MECHANICS OF SHARE VALUATIO N. THE MOST NOTEWORTHY OF THESE ARE: (A) THE NATURE OF A COMPANY'S BUSINESS A COMPANY'S BUSINESS MAY D E PEND ON THE SUCCESS OF OTHER INDUSTRIES ( AS WITH THE PRODUCER OF RAW MATERIALS FOR OTHER MANUFACTURERS), SEASONAL CONDITIONS, ETC. (B) THE CALIBER OF MANAGERIAL PERSONNEL A BUSINESS MANAGED BY PROFESSIONAL MANAGERS ALLIED TO PEOPLE WITH SIMILAR ABILITY WOULD COMMAND A PREMIUM WHEN COMPAR ED TO ANOTHER WHICH IS CRUCIALLY DEPENDENT FOR ITS SUCCESS ON A S INGLE EXECUTIVE, HOWEVER OUTSTANDING HE MIGHT BE. (C) PROSPECTS OF EXPANSION A CASE IN POINT WOULD BE THAT OF ANCILLARY SMALL-SC ALE UNITS, WHICH HAVE THE POTENTIAL FOR GROWTH AS THEY CAN SUPPLY INPUTS TO LARGE COMPANIES THAT ARE DEPENDENT ON THEIR PRODUCTS. ITA NO. 1278/BANG/2018 17 (D) COMPETITION A BUSINESS MAY PROSPER WHEN NURTURED UNDER SHELTERE D CIRCUMSTANCES (E.G. IMPORT RESTRICTIONS), BUT MAY FLOUNDER UNDER 'OPEN MARKET' CONDITIONS. (E) GOVERNMENT POLICY GOVERNMENT POLICY IN GENERAL AND IN RELATION TO PAR TICULAR INDUSTRY (AS WITH RESTRICTION OR BANNING OF MANUFACTURE OF A LCOHOL IN THE CASE OF ALCOHOL BASED CHEMICAL INDUSTRIES). (F) PREVAILING POLITICAL CLIMATE POLITICAL CLIMATE IN AN AREA CAN AFFECT THE PROSPER ITY OF A BUSINESS, E.G. TOURISM TRADE IS DIRECTLY AFFECTED D UE TO BREAKDOWN IN THE LAW AND ORDER SITUATION IN A STATE. (G) RISK OF OBSOLESCENCE OF ITEMS MANUFACTURED IN CASE THE PRODUCTS MANUFACTURED BY AN ENTERPRISE FACE A HIGHER RISK OF OBSOLESCENCE, IT MAY INFLUENCE THE VALUE OF ITS SHARES ADVERSELY. (H) EXISTENCE OF CONVERTIBLE RIGHTS EXISTENCE OF CONVERTIBLE RIGHTS WOULD ALSO AFFECT T HE VALUE OF A SHARE. (I) THE EFFECT OF OTHER EXTERNAL FACTORS THE VALUE OF SHARES IS ALSO AFFECTED BY FACTORS SUC H AS WAR, EMBARGO OR OTHER RESTRICTIONS ON INTERNATIONAL TRADE OR DIS RUPTIONS IN INTERNATIONAL TRADE. 9.2 WHILE PREPARING A REPORT, IT IS IMPORTANT THAT ONE STATES ITS PURPOSE EXPLICITLY AND ENSURES THAT THE FACTS ARE PRESENTED WITH CLARITY SO THAT THE READER OF THE REPORT APPRECIATES IT IN THAT CONTEXT. 9.3 THE FACTORS THAT HAVE BEEN CONSIDERED FOR ARRIV ING AT THE ULTIMATE VALUATION SHOULD BE CLEARLY SPELT OUT. 9.4 WHILE IT IS DIFFICULT TO SPECIF Y THE EXACT FORM OF THE REPORT, THE FOLLOWING ILLUSTRATIVE OUTLINE MAY BE USEFUL. (A) INTRODUCTION/PURPOSE OF VALUATION THIS MAY CONTAIN BACKGROUND INFORMATION ABOUT THE R EPORT AND ITS PURPOSE, SAY, MERGER. SHARE BUY BACK, ETC. (B) VALUATION DAT E THE VALUER MAY STATE THE VALUATION DATE CLEARLY AT THE OUTSET. AS THE VALUATION IS TIME-SPECIFIC, THIS INFORMATION IS CRI TICAL FOR THE READER OF THE REPORT. (C) HISTORY THIS SECTION MAY DEAL WITH THE HISTORY OF A COMPANY (OR COMPANIES, IN CASE OF MERGER). THE MATTER MAY BE DIVIDED INTO SUB -SECTIONS THAT DEAL ITA NO. 1278/BANG/2018 18 WITH THE DATE OF INCORPORATION, WHETHER LISTED OR N OT, AUTHORISED, AND PAID UP CAPITAL, TURNOVER, PROFITS, DIVIDEND AND AS SET BASE. (D) BUSINESS OF THE COMPANY T HIS PART WOULD EXPLAIN THE BUSINESS OF A COMPANY, I .E., WHETHER TRADING OR MANUFACTURING, THE ITEMS DEALT IN OR MAN UFACTURED, THE LOCATION OF THE FACTORY, FACTORS PECULIAR TO THE BU SINESS, AND SUCH OTHER MATTERS. (E) SOURCES OF INFORMATION THIS SECTION MAY STATE THE SOURCES OF INFORMATION O BTAINED FOR THE PURPOSE OF VALUATION, SUCH AS ARTICLES OF ASSOCIATI ON, AUDITED ACCOUNTS, PROFIT PROJECTIONS, REALISABLE VALUE OF A SSETS, OTHER SECONDARY SOURCES OF INFORMATION, PERIOD FOR WHICH OR DATE ON WHICH DATA IS OBTAINED, AND OTHER RELEVANT SOURCES. (F) METHODOLOGY THIS PART MAY CONTAIN THE METHODOLOGY ADOPTED FOR V ALUATION. IT SHOULD ALSO INCLUDE THE RATIONALE FOR APPROPRIATENE SS OR OTHERWISE OF A PARTICULAR APPROACH(S) USED. (G) KEY VALUATION CONSIDERATIONS THIS PART MAY DEAL WITH THE VALUATION CONSIDERATION S CRITICAL TO THE VALUATION PROCESS. SOME OF THE FACTORS CONSIDERED I N VALUING THE SHARES WHICH MAY BE INCLUDED IN THE REPORT ARE: (I) DISCUSSION ON THE FINANCIAL PROJECTIONS OF A COMPAN Y, HIGHLIGHTING MAIN ASSUMPTIONS AND MANAGEMENT REPRESENTATIONS. (II) DISCUSSION ON DISCOUNT RATE, GROWTH RATE USED FOR C OMPUTING TERMINAL VALUE CONSIDERED IN THE VALUATION, INCLUDI NG THE METHODOLOGY FOR ARRIVING AT THE DISCOUNT RATE, SOURCES OF INFOR MATION, ETC. (III) ANY ADJUSTMENT ON ACCOUNT OF ACCUMULATED LOSSES/ UN ABSORBED DEPRECIATION. (IV) ANY ADJUSTMENT FOR VALUING A CONTROLLING OR MINORIT Y STAKE, DISCOUNT FOR ILLIQUIDITY, ETC. (V) BRIEF ANALYSIS OF THE PEER SET COMPANIES USED IN RE LATIVE VALUATION. (VI) ADJUSTMENTS TO THE MULTIPLES BASED ON THE PEER SET COMPANY, INCLUDING RATIONALE FOR THE SAME. (VII) DETAILS OF THE SURPLUS ASSETS AND TREATMENT THEREOF IN THE VALUATION. (VIII) ANY OTHER SPECIAL FACTORS, SUCH AS GOVERNMENT SUBSI DY, TAX BREAKS, ETC. ITA NO. 1278/BANG/2018 19 (H) FAIR VALUE THIS PARAGRAPH SHOULD DEAL WITH THE VALUATION OF SH ARES ON THE BASIS OF DISCUSSION IN THE PRECEDING PART OF THE REPORT (AND IN CASE OF AMALGAMATION, ALSO THE EXCHANGE RATIO). THIS PARAGR APH SHOULD ALSO OFFER JUSTIFICATION FOR THE APPROACHES ACTUALLY ADO PTED. IT COULD ALSO DEAL WITH THE JUSTIFICATION OF ADJUSTMENTS CONSIDER ED NECESSARY FOR ARRIVING AT THE VALUE, FOR EXAMPLE, OF THE DISCOUNT ING DUE TO RESTRICTION ON TRANSFER OF SHARES; REDUCTION MADE IN THE NET MAINTAINABLE PROFIT DUE TO CHANGED CIRCUMSTANCES; OR WEIGHTAGE GIVEN TO CERTAIN RECENT YEARS IN ARRIVING AT THE FAIR VALUE, ETC. (I) COMPUTATION USUALLY, THE REPORT SHOULD ALSO CONTAIN ANNEXURES G IVING INFORMATION REGARDING THE WORKING OF THE APPROACHES EMPLOYED FO R VALUATION. (J) LIMITING CONDITIONS THIS PARAGRAPH SHOULD CONTAIN THE APPROPRIATE CAVEA TS WHICH LIMIT THE SCOPE OF VALUATION. FEW INDICATIVE CAVEATS ARE; (I) THE VALUER SHOULD STATE ANY SCOPE LIMITATIONS AND ALSO THE NON -AVAILABILITY OF ANY PERTINENT INFORMATION AND ITS POSSIBLE EFFECT ON VA LUATION. (II) IT IS IMPORTANT TO DRAW READERS ATTENTION TO THE FACT TH AT THE VALUATION IS SPECIFIC TO THE TIME AND PURPOSE OF VALUATION. IT S HOULD ALSO BE MENTIONED THAT THE VALUATION IS NOT AN EXACT SCIENC E AND THE CONCLUSIONS ARRIVED AT IN MANY CASES WILL BE SUBJEC TIVE AND DEPENDENT ON THE EXERCISE OF INDIVIDUAL JUDGMENT. (III) IT IS ALSO IMPORTANT TO MENTION THE EXTENT OF RELIANCE PLACED BY THE VALUER ON THE INFORMATION PROVIDED BY THE MANAGEMEN T AND INFORMATION AVAILABLE IN THE PUBLIC DOMAIN. (IV) UNDER APPROPRIATE CIRCUMSTANCES, A VALUER SHOU LD ALSO LIMIT HIS LIABILITY BY RESTRICTING DISTRIBUTION OF REPORT TO THE MANAGEMENT/COMPANY. (V) A VALUER SHOULD HIGHLIGHT THE FACT THAT VALUATI ON DOES NOT INCLUDE THE AUDITING OF FINANCIAL DATA PROVIDED BY THE MANAGEMENT AND, THEREFORE, DOES NOT TAKE ANY RESPONSIBILITY FOR ITS ACCURACY AND COMPLETENESS. FURTHER, VALUATION SHOULD NOT BE CONS IDERED AS AN OPINION ON THE ACHIEVABILITY OF ANY FINANCIAL PROJE CTIONS MENTIONED IN THE REPORT. 9. AS PER PARA 2.10 OF THIS REPORT OF RESEARCH COM MITTEE OF (ICAI) AS REPRODUCED ABOVE, THE FIRST AND MOST CRITICAL INPUT OF DCF MOD EL IS THE CASH FLOW PROJECTIONS. IT IS ALSO NOTED IN THE SAME PARA OF THIS REPORT THAT THE DCF VALUE IS AS GOOD AS THE ASSUMPTIONS USED IN DEVELOPING THE PROJECTIONS. IT IS ALSO NOTED THAT THESE PROJECTIONS SHOULD REFLECT THE BEST ESTIMATES OF TH E MANAGEMENT AND TAKE INTO ACCOUNT VARIOUS MACRO AND MICRO ECONOMIC FACTORS AF FECTING THE BUSINESS. IN THE ITA NO. 1278/BANG/2018 20 SAME PARA OF THIS REPORT, SOME IMPORTANT POINTS TO BE KEPT IN MIND WITH REGARD TO CASH FLOW PROJECTIONS ARE ALSO NOTED. AT THIS POINT , WE FEEL IT PROPER TO TAKE NOTE OF TWO JUDGMENTS OF HONBLE APEX COURT RENDERED IN THE CASE OF BHARAT EARTH MOVERS VS. CIT, 245 ITR 428 AND IN THE CASE OF ROTORK CONTROLS INDIA (P) LTD. VS. CIT, 314 ITR 62. IN THE FIRST CASE, THE ISSUE IN DISPUTE WAS REG ARDING ESTIMATION OF FUTURE LIABILITY OF LEAVE ENCASHMENT AND IT WAS HELD BY HONBLE APEX CO URT IN THIS CASE THAT THE LIABILITY SHOULD BE CAPABLE OF BEING ESTIMATED WITH REASONABL E CERTAINTY THOUGH THE ACTUAL QUANTIFICATION MAY NOT BE POSSIBLE. IT WAS HELD THA T IF THIS IS SATISFIED THAN THE LIABILITY IS NOT A CONTINGENT LIABILITY. IN THE SECOND CASE, THE ISSUE IN DISPUTE WAS ABOUT PROVISION OF WARRANTY EXPENSES TO BE INCURRED IN FU TURE. PARA 10 OF THIS JUDGMENT IS VERY RELEVANT AND THEREFORE, IT IS REPRODUCED HEREI N BELOW:- 10. WHAT IS A PROVISION ? THIS IS THE QUESTION WHICH N EEDS TO BE ANSWERED. A PROVISION IS A LIABILITY WHICH CAN BE ME ASURED ONLY BY USING A SUBSTANTIAL DEGREE OF ESTIMATION. A PROVISION IS REC OGNIZED WHEN : (A) AN ENTERPRISE HAS A PRESENT OBLIGATION AS A RESULT OF A PAST EVENT; (B) IT IS PROBABLE THAT AN OUTFLOW OF RESOURCES WILL BE REQUIRE D TO SETTLE THE OBLIGATION; AND (C) A RELIABLE ESTIMATE CAN BE MADE OF T HE AMOUNT OF THE OBLIGATION. IF THESE CONDITIONS ARE NOT MET, NO PROVI SION CAN BE RECOGNIZED. 10. FROM THIS PARA OF THIS JUDGMENT, IT IS SEEN THA T IT WAS HELD THAT IF A RELIABLE ESTIMATE CANNOT BE MADE THAN THE PROVISION CANNOT B E RECOGNIZED. IN THE PRESENT CASE IN CONNECTION WITH DCF, WE HAVE SEEN THAT ESTI MATE/ PROJECTION OF FUTURE CASH FLOW HAS TO BE MADE AND AS PER PARA 2.10 OF THIS RE PORT OF RESEARCH COMMITTEE OF (ICAI) AS REPRODUCED ABOVE, THE FIRST AND MOST CRIT ICAL INPUT OF DCF MODEL IS THE CASH FLOW PROJECTIONS. HENCE, IN OUR CONSIDERED OPI NION, BY THE SAME ANALOGY, IT HAS TO BE SEEN AND ENSURED THAT SUCH PROJECTION IS ESTIMATED WITH REASONABLE CERTAINTY AND IF IT IS NOT ESTABLISHED BY THE ASSES SEE THAT THIS IS A RELIABLE ESTIMATE ACHIEVABLE WITH REASONABLE CERTAINTY, THE SAME CANN OT BE RECOGNIZED AND IF THE FUTURE CASH FLOW CANNOT BE RECOGNIZED THAN THE DCF METHOD IS NOT WORKABLE. 11. AS PER VARIOUS TRIBUNAL ORDERS CITED BY THE LEA RNED AR OF THE ASSESSEE, IT WAS HELD THAT AS PER RULE 11UA (2), THE ASSESSEE CAN OP T FOR DCF METHOD AND IF THE ASSESSEE HAS SO OPTED FOR DCF METHOD, THE AO CANNOT DISCARD THE SAME AND ADOPT OTHER METHOD I.E. NAV METHOD OF VALUING SHARES. IN THE CASE OF M/S. RAMESHWARAM STRONG GLASS (P) LTD. VS. THE ITO (SUPRA), THE TRIB UNAL HAS REPRODUCED RELEVANT PORTION OF ANOTHER TRIBUNAL ORDER RENDERED IN THE C ASE OF ITO VS. M/S UNIVERSAL POLYPACK (INDIA) PVT. LTD. IN ITA NO. 609/JP/2017 D ATED 31.01.2018. IN THIS CASE, THE ITA NO. 1278/BANG/2018 21 TRIBUNAL HELD THAT IF THE ASSESSEE HAS OPTED FOR DC F METHOD, THE AO CANNOT CHALLENGE THE SAME BUT THE AO IS WELL WITHIN HIS RI GHTS TO EXAMINE THE METHODOLOGY ADOPTED BY THE ASSESSEE AND/OR UNDERLYING ASSUMPTIO NS AND IF HE IS NOT SATISFIED, HE CAN CHALLENGE THE SAME AND SUGGEST NECESSARY MODIFI CATIONS/ALTERATIONS PROVIDED THE SAME ARE BASED ON SOUND REASONING AND RATIONALE BASIS. IN THE SAME TRIBUNAL ORDER, A JUDGMENT OF HONBLE BOMBAY HIGH COURT IS A LSO TAKEN NOTE OF HAVING BEEN RENDERED IN THE CASE OF VODAFONE M-PESA LTD. VS. PC IT AS REPORTED IN 164 DTR 257. THE TRIBUNAL HAS REPRODUCED PART OF PARA 9 OF THIS JUDGMENT BUT WE REPRODUCE HEREIN BELOW FULL PARA 9 OF THIS JUDGMENT. 9. WE NOTE THAT, THE COMMISSIONER OF INCOME-TAX IN THE IMPUGNED ORDER DATED 23 RD FEBRUARY, 2018 DOES NOT DEAL WITH THE PRIMARY GRIEVAN CE OF THE PETITIONER. THIS, EVEN AFTER HE CONCEDES WITH THE ME THOD OF VALUATION NAMELY, NAV METHOD OR THE DCF METHOD TO DETERMINE THE FAIR MA RKET VALUE OF SHARES HAS TO BE DONE/ADOPTED AT THE ASSESSEES OPTION. NEVE RTHELESS, HE DOES NOT DEAL WITH THE CHANGE IN THE METHOD OF VALUATION BY THE ASSESSING OFFICER WHICH HAS RESULTED IN THE DEMAND. THERE IS CERTAINLY NO IMM UNITY FROM SCRUTINY OF THE VALUATION REPORT SUBMITTED BY THE ASSESSEE. THEREFOR E, THE ASSESSING OFFICER IS UNDOUBTEDLY ENTITLED TO SCRUTINISE THE VALUATION REPO RT AND DETERMINE A FRESH VALUATION EITHER BY HIMSELF OR BY CALLING FOR A FINAL DETERMINATION FROM AN INDEPENDENT VALUER TO CONFRONT THE PETITIONER. HOWEVE R, THE BASIS HAS TO BE THE DCF METHOD AND IT IS NOT OPEN TO HIM TO CHANGE THE ME THOD OF VALUATION WHICH HAS BEEN OPTED FOR BY THE ASSESSEE. IF MR. MOHANTY I S CORRECT IN HIS SUBMISSION THAT A PART OF DEMAND ARISING OUT OF THE ASSESSMENT O RDER DATED 21 ST DECEMBER, 2017 WOULD ON ADOPTION OF DCF METHOD WILL BE SUSTAINED I N PART, THE SAME IS WITHOUT WORKING OUT THE FIGURES. THIS WAS AN EXERCI SE WHICH OUGHT TO HAVE BEEN DONE BY THE ASSESSING OFFICER AND THAT HAS NOT BEEN DONE BY HIM. IN FACT, HE HAS COMPLETELY DISREGARDED THE DCF METHOD FOR ARRI VING AT THE FAIR MARKET VALUE. THEREFORE, THE DEMAND IN THE FACTS NEED TO BE STAYED. 12. AS PER ABOVE PARA OF THIS JUDGMENT OF HONBLE B OMBAY HIGH COURT, IT WAS HELD THAT THE AO CAN SCRUTINIZE THE VALUATION REPOR T AND HE CAN DETERMINE A FRESH VALUATION EITHER BY HIMSELF OR BY CALLING A FINAL D ETERMINATION 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. HENCE, IN OUR CONSIDERED OPINION, IN THE PRESENT CASE, WHEN T HE GUIDANCE OF HONBLE BOMBAY HIGH COURT IS AVAILABLE, WE SHOULD FOLLOW THIS JUDG MENT OF HONBLE BOMBAY HIGH COURT IN PREFERENCE TO VARIOUS TRIBUNAL ORDERS CITE D BY BOTH SIDES AND THEREFORE, WE ARE NOT REQUIRED TO EXAMINE AND CONSIDER THESE TRIB UNAL ORDERS. RESPECTFULLY FOLLOWING THIS JUDGMENT OF HONBLE BOMBAY HIGH COUR T, WE SET ASIDE THE ORDER OF CIT (A) AND RESTORE THE MATTER TO AO FOR A FRESH DECISI ON IN THE LIGHT OF THIS JUDGMENT OF HONBLE BOMBAY HIGH COURT. THE AO SHOULD SCRUTINIZE THE VALUATION REPORT AND HE ITA NO. 1278/BANG/2018 22 SHOULD DETERMINE A FRESH VALUATION EITHER BY HIMSEL F OR BY CALLING A FINAL DETERMINATION FROM AN INDEPENDENT VALUER AND CONFRO NT THE SAME TO THE ASSESSEE. BUT THE BASIS HAS TO BE DCF METHOD AND HE CANNOT CH ANGE THE METHOD OF VALUATION WHICH HAS BEEN OPTED BY THE ASSESSEE. IN OUR CONSID ERED OPINION AND AS PER REPORT OF RESEARCH COMMITTEE OF (ICAI) AS REPRODUCED ABOVE , MOST CRITICAL INPUT OF DCF MODEL IS THE CASH FLOW PROJECTIONS. HENCE, THE ASSE SSEE SHOULD BE ASKED TO ESTABLISH THAT SUCH PROJECTIONS BY THE ASSESSEE BAS ED ON WHICH, THE VALUATION REPORT IS PREPARED BY THE CHARTERED ACCOUNTANT IS ESTIMATE D WITH REASONABLE CERTAINTY BY SHOWING THAT THIS IS A RELIABLE ESTIMATE ACHIEVABLE WITH REASONABLE CERTAINTY ON THE BASIS OF FACTS AVAILABLE ON THE DATE OF VALUATION A ND ACTUAL RESULT OF FUTURE CANNOT BE A BASIS OF SAYING THAT THE ESTIMATES OF THE MANAGEM ENT ARE NOT REASONABLE AND RELIABLE. 13. BEFORE PARTING, WE WANT TO OBSERVE THAT IN THE PRESENT CASE, PAST DATA ARE AVAILABLE AND HENCE, THE SAME CAN BE USED TO MAKE A RELIABLE FUTURE ESTIMATE BUT IN CASE OF A START UP WHERE NO PAST DATA IS AVAILABLE, THIS VIEW OF US THAT THE PROJECTION SHOULD BE ON THE BASIS OF RELIABLE FUTURE ESTIMATE SHOULD NOT BE INSISTED UPON BECAUSE IN THOSE CASES, THE PROJECTIONS MAY BE ON T HE BASIS OF EXPECTATIONS AND IN SUCH CASES, IT SHOULD BE SHOWN THAT SUCH EXPECTATIO NS ARE REASONABLE AFTER CONSIDERING VARIOUS MACRO AND MICRO ECONOMIC FACTOR S AFFECTING THE BUSINESS. 14. IN NUTSHELL, OUR CONCLUSIONS ARE AS UNDER:- (1) THE AO CAN SCRUTINIZE THE VALUATION REPORT AN D THE IF THE AO IS NOT SATISFIED WITH THE EXPLANATION OF THE ASSESSEE, HE HAS TO RECORD THE REASONS AND BASIS FOR NOT ACCEPTING THE VALUATION REPORT SUBMIT TED BY THE ASSESSEE AND ONLY THEREAFTER, HE CAN GO FOR OWN VALUATION OR TO OBTAI N THE FRESH VALUATION REPORT FROM AN INDEPENDENT VALUER AND CONFRONT THE SAME TO THE ASS ESSEE. BUT THE BASIS HAS TO BE DCF METHOD AND HE CANNOT CHANGE THE METHOD OF VALUA TION WHICH HAS BEEN OPTED BY THE ASSESSEE. (2) FOR SCRUTINIZING THE VALUATION REPORT, THE FAC TS AND DATA AVAILABLE ON THE DATE OF VALUATION ONLY HAS TO BE CONSIDERED AND ACT UAL RESULT OF FUTURE CANNOT BE A BASIS TO DECIDE ABOUT RELIABILITY OF THE PROJECTION S. (3) THE PRIMARY ONUS TO PROVE THE CORRECTNESS OF T HE 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. HENC E, HE HAS TO SATISFY ABOUT THE ITA NO. 1278/BANG/2018 23 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. 15. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS AL LOWED FOR STATISTICAL PURPOSES. ORDER PRONOUNCED IN THE OPEN COURT ON THE DA TE MENTIONED ON THE CAPTION PAGE. SD/- SD/- (LALIET KUMAR) (ARUN KUMAR GARODIA) JUDICIAL MEMBER ACCOUNTA NT MEMBER BANGALORE, DATED, THE 9 TH JANUARY, 2019. MCN*/MS/ COPY TO: 1. APPELLANT 4. CIT(A) 2. RESPONDENT 5. DR, ITAT, BANGALORE 3. CIT 6. GUARD FILE BY ORDER ASSISTANT REGISTRAR, INCOME TAX APPELLATE TRIBUNAL, BANGALORE.