Appeal Details
Counselvise Citation
[2022] 106 COUNSELVISE.COM (IT) 2279 (ITAT-MUMBAI)
Assessee PAN
Bench
Appeal Number
CRN Number
Duration Of Justice
1 year(s) 5 month(s)
Appellant
Respondent
Appeal Type
Income Tax Appeal
Pronouncement Date
27-06-2022
Appeal Filed By
Department
Order Result
Dismissed
Bench Allotted
E
Assessment Year
2016-2017
Appeal Filed On
27-01-2021
Judgement Text
IN THE INCOME TAX APPELLATE TRIBUNAL “E” BENCH, MUMBAI BEFORE SHRI ABY T. VARKEY, HON'BLE JUDICIAL MEMBER AND SHRI S. RIFAUR RAHMAN, HON'BLE ACCOUNTANT MEMBER ITA NO. 59/MUM/2021 (A.Y. 2016-17) DCIT – Circle 1 Room No. 22, B-Wing 6 th Floor, Ashar I.T. Park Wagle Industrial Estate Thane (W)-400604 v. M/s. Travecom Global Pvt. Ltd., B/607, Krishnakunj Salasar Brij Bhoomi Bhayander (W)-401101 PAN: AAECT8729Q (Appellant) (Respondent) Assessee by : Ms. Aarti Vissanji Department by : Shri B.K. Bagchi Date of Hearing : 26.05.2022 Date of Pronouncement : 28.06.2022 O R D E R PER S. RIFAUR RAHMAN (AM) 1. This appeal is filed by the revenue against order of the Learned Commissioner of Income Tax (Appeals)-1, Mumbai [hereinafter in short “Ld.CIT(A)”] dated 03.02.2020 for the 2016-17. 2. Brief facts of the case are, assessee has filed Return of Income on 15.10.2016 and has declared loss at ₹.1,29,66,329/-. This case was 2 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., selected for scrutiny under CASS for Limited Scrutiny to verify the method of accounting and Share Premium received by the assessee. Accordingly, notices u/s 143(2) and 142(1) of the Income-tax Act, 1961 (in short “Act”) were issued and served on the assessee. In response assessee filed relevant submissions. 3. The assessee is a Private Limited Company and during the year assessee has issued 1290 shares, the details of which are as under: - Sr.No Name of Investor No. of Share issued Face value Share premium Total Value of Share premium 1. Ajay Agarwal 308 Rs.10 Rs.8116 Rs.2496648 2. Mohan Math 308 Rs.10 Rs.8116 Rs.2496648 3. Sandu Bye Bye 538 Rs.10 Rs.18571 Rs.9985818 4 Stewarts Venture LLP 136 Rs.10 Rs.18571 Rs.25242960 Total=1290 Total= Rs.17503410 4. Assessing Officer observed that assessee has valued the Fair Market Value (FMV) of each share as per Rule 11UA of the I.T Rules, 1962 and FMV of each share is determined at ₹.20,582.81/-. In support of the above valuation assessee has filed valuation report from the Chartered Accountant. Assessing Officer observed that FMV is determined as per DCF Method and on perusal, he noticed that the FMV has been determined on the basis of projection of Cash-Flow w.e.f. 2016 to 2021. The Assessing Officer further observed that the scrutiny assessment proceedings for A.Y.2015-16 were pending before him and as per the submissions for the 3 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., above said assessment year, assessee has submitted that it has already stopped its operation w.e.f 01.04.2017 onwards and this is evidenced by Return of Income filed by the assessee for A.Y.2018-19 wherein, sales are shown at ₹.Nil. The Assessing Officer observed that assessee has issued shares on premium by adopting DCF method and also the valuation report was based on projected cash flow. Accordingly, the assessee estimated the valuation of the shares and issued the same on premium, the Assessing Officer in order to verify the valuation of shares assessee was asked to substantiate the valuation of shares. 5. In response assessee filed valuation report in respect of the above said valuation, after evaluating the valuation report submitted by the assessee, Assessing Officer observed that assessee has submitted that the method of valuation adopted by the assessee is at the option of the assessee i.e. it may be NAV or DCF method as per Rule 11UA of I.T. Rules. However, Assessing Officer rejected the above submissions and observed that the projection of cash flow made in the valuation report is unrealistic and without any basis. He observed that the valuer has not carried out independent enquiry to verify truth or otherwise the figures furnished by the assessee and he should have carried out test check. However, valuer solemnly relied upon and has estimated without any independent 4 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., verification and truthfulness, accuracy and completeness of the informations and financial data provided by the assessee. With the above observations Assessing Officer rejected valuation report and the share premium received at ₹.1,75,03,410/- is added as per provisions of section 56(2)(viib) of the Act. 6. Aggrieved assessee preferred an appeal before the Ld.CIT(A), before the Ld.CIT(A) assessee made detailed submissions before him, for the sake of clarity it is reproduced below: - “Addition under u/s. 56(2)(viib) of the IT Act, 1961, is in respect of share premium received mounting to Rs.l,75,03,410/-. Grounds of Appeal Relevant Section (s) of IT/Act Issue Ground of Appeal 56(2)(viib) Disallowance of share premium 1. The Assessing Officer has erred in making addition of 1,75,03,410 u/s 56(2)(viib) towards share premium in spite of submitting the valuation report as well as detailed submissions with documentary evidence containing all the necessary reasons considered for the issue of share premium, especially (and among others) with respect to provenance of funds received, its usage and the investors, methodology adopted to arrive at cash flows and the basis thereof(using expensive research data available only to large business houses), detailed explanation and factors considered to arrive at the discounting factor 15 percent. General Rejection of DCF Method 2. The Assessing officer has erred in rejecting the DCF method adopted by assessee as its beyond the jurisdiction of Assessing Officer as mentioned in Paragraph 5 of Page 7 of Assessment order. Facts of the case: 1. The assessee filed Return of Income on 15.10.2016 and showing loss of Rs.1,29,66,329/-. 5 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., 2. This case was selected for scrutiny under CASS for Limited Scrutiny to verify the method of accounting and Share Premium received by the assessee. 3. In response to notices, the assessee filed submissions from time to time in respect of reasons for selection of scrutiny. 4. The assessee is a Private Limited Company. 5. During the year under consideration, the assessee issued 1290 shares, the details of which are as under: Name No. of Shares Amount in Rupees Face Value Premium Total cost per share Total value of Premium 1 Ajay Agarwal 308 10 8116 8126 24,96,648 2 Mohan Math 308 10 8116 8126 24,96,648 3 Sandu Bye Bye 538 10 18571 18581 99,85,818 4 Stewarts Venture LLP 136 10 18571 18581 25,24,296 Total 1290 Total 1,75,03,410 6. The learned AO not being satisfied with the issue price of aforesaid shares computed under DCF Method, issued show cause notice dated 10.10.2018. Nature of business of the assessee AboutByeByeCIty.com The company was conceived as an online discovery and booking platform for short breaks offering a range of adventure activities (trekking, river rafting, etc) to offbeat stays (like cottages, bungalows, farms, etc) to people who were looking for a suitable weekend break option. The Company had successfully launched a portal known as ByeByeCity.com for their business. Towards this, ByeByeCity allowed the customers to book they experiences in a convenient real-time basis by developing the only web booking engine in India that used advanced algorithms to sell Un-Structured Travel Categories (something which large companies like Make My Trip still cannot do till date). The website featured over 1000 carefully curated experiences with deep meaningful content to help offer a wide range of never before available choices in a convenient way to consumers. The results, in terms of customer growth, attested to the ByeByeCity proposition. Very steadily the user base of the website grew to over 35,000 per month and facebook page had over 60,000 followers. During the FY 2015-16, a sales of INR 1,91,73,703 was achieved During the same year 1,290 shares were issued raising INR 1,75,16,854 to fund growth. However, the company was not able to raise subsequent financing rounds. 6 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., About the Team The team that orchestratedByeByedty.com had worked with well known companies, groups such as Aditya Birla, Me Conn Erickson, Yatra.com, etc. The founders were - Rajesh Math With 20 years of experience in marketing brands and has worked in groups / companies such as, Aditya Birla Group, Bombay Dyeing and DDE Mudra. Vimesh Shah He has spent 17 years in driving in some of the best advertising agencies in India, like, Redifussion, Me Cann Erickson, Saatchi & Saatchi and Mudra DDB. Details in respect of booking engine (portal) of the Company and the nature of business etc. are enclosed herewith which proves that the assessee company is a start up. Basis of Valuation of Shares issued during the year -DCF Method (Copy of valuation report is annexed -page nos. __ to __) • The assessee has valued each share of face value with RS.10 at Rs. 20582.81 (Fair Market Value - FMV). • FMV of each share was determined as per Rule 11UA of the IT Rules, 1962 for which Valuation report of Shri Bharat Chugh and Associates, Chartered Accountants was submitted to the learned AO. • The FMV has been determined as per DCF Method based on projection of Cash- Flow for the period comprising of the Year-2016 to Year-2021' The valuation was worked under DCF as under: Details in respect of Cash Flow Rupees in crores Particulars 2016 2017 2018 2019 2020 2021 Terminal Value Cash Flow (49.37) (160.35) 53.69 180.26 325.1 530.12 5949.12 Discount Factor @ 75% 1 0.87 0.76 0.66 0.57 0.50 0.50 Discounted cash flow (49.37) (139.44) 40.66 118.52 185.87 263.56 2957.76 A Valuation of shares based on expected Cash Flow :- Rupees in crores Present Value of CFAT 419.74 Terminal Value 2957.76 Total of DCF 3377.50 7 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., Rupees in crores Total Number of equity shares 12307 Value per shares as per DCF Method Rs. 27443.75 Less 25% reduction for limited transfer ability of shares (6860.94) Fair Market Value of each Share Rs. 20582.81 Summarized reasons for issue of the show cause notice are as under 1. This case was selected for scrutiny under the category "Limited Scrutiny" to verify applicability of Section 56(2) (viib) of the I. T. Act, 1961 with regard to large share premium received during the year under consideration. 2. The assessee had shown positive projection of Cash-Flow from the Year-2018 to the Year-2021. 3. FMV of each share was determined as per Rule 11UA at Rs. 20582.81 per share. 4. The shares were issued at premium of Rs. 8116 per share to two of the investors and 18571 per share to remaining two investors. 5. The FMV was computed on the basis of Cash Flow for the period comprising of year 2016 to year 2021 even though the assessee company stopped its operation w.e.f. 01.04.2017 onwards as informed during the course of assessment proceedings for Asst. Year 2015-16 and also as evidenced by the Return of Income filed by the assessee for A Y-2018-19 wherein the sales are shown at Rs. Nil 6. In the show cause notice the learned AO discussed certain aspects of the valuation report of M/s. Bharat Chug & Associates (CA) related to the purpose of valuation, method of valuation, basis of valuation and limitations and disclaimers which were reproduced in the show cause notice and the assessment order. Summary of the observations of the learned AO in respect of valuation report are as under: • Valuer M/s Bharat Chug & Associates, relied on the information and explanations given by the management of the company without carrying any independent assessment, audit or other test to verify accuracy of the information and explanation given by the management of the company with regard to basis of valuation. • The learned AQ opined that the valuation of shares is not realistic keeping in view the growth and stature of the company. . • In the valuation report, figures have been put up without giving reasons as to how these assumptions have been made. • The revenue growth rate as well as net profit margin of the company, since inception is negative. • For AY-2018-19, company has shown loss at Rs. 2,32,466/- as per Return filed, whereas V as per projected cash flow, the profit is shown at Rs. 53.69 lacs which is unrealistic. • Discounting figure @ 15% for company whose returns- arc continuously in negative which is unrealistic approach to calculate the value of shares. 8 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., In view of the above the learned AO asked for the details of values which have been taken to arrive at a discounting figure @A5%, the basis behind assumptions for a company whose returns have consistently been negative and sector specific study carried out to reach rate of returns of growth and thereafter show-Caused as to why the valuation of share as per DCF method should not be rejected and premium received totaling to Rs. 1, 75,03 y 4101/-should not be brought to tax. Simultaneously the learned AO initiated proceedings u/s 68 of the Income Tax Act, 1961 in respect of two parties namely M/s. Sandu Bye Bye and M/s Stewarts Venture LLP as they had not responded to notices u/s 133 (6). In response to the above Show-Cause, the assessee filed submission dated 23.11.2018. (Copy of such submissions is annexed at page numbers to ____). Summary of submissions to the learned AO in response to show cause notice: 1. A newly formed company being a start up can be valued only by the DCF method based on the prospects of earning and growth in the future, as newly set organization have very little or no capital base. 2. DCF is an accepted method of valuation as per Rule 11 UA of the Income Tax Rules 1962. 3. The first step towards arriving at DCF is to estimate the future cash flow based on business potential. To project cashflows for 5 years is a standard accepted norm. 4. When an element of estimation is involved (as permitted in the method), it can never in real life match the actual result. 5. The shares were issued at four different investors that too on different dates of the year as mentioned here in below: Allotment Date Shares Allotted to Share Premium per share 08/09/2015 Ajay Agarwal 8116 30/11/2015 Mohan Math 8116 07/01/2016 Sandu Bye Bye City LIP 18581 08/02/2016 Stalwarts Ventures LLP 18581 6. None of the investor is related to each other, and made their own independent judgement) assessing the business model the Company. Some of them even have LLPs to make investments in start- ups as part of their regular investment activities 7. Under the provisions of Income tax Act and related rules the only responsibility cast upon y the taxpayer is to get a valuation report from a Merchant Banker or Chartered Accountant using DCF method Once the report of the Chartered Accountant under DCF method is submitted by the taxpayer, the fair market value determination in such a manner is binding upon the tax authority 8. No one foresees a closure of business operations at the start of a funding round (otherwise why would anyone invest in the business). 9 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., 9. Therefore, co-relation of issue of shares at premium in AY 2016-17 to the discontinuance of business operations in AY 2018-19 cannot be made. 10. Valuation is an Art and not an exact Science. There cannot be one to one formula or fixed set of working which derives the values. Like any business decision, valuation is also determined based on discussion, negotiation by both the parties. In general shares are issued in Start-ups are at premium so that promoter can also retain a reasonable share for himself/for his ideas, innovations and efforts he is investing in and also to keep him interested to put his 100% energy in the new project to achieve the successful implementation of the entire plan. Investors are also willing to invest at premium for the innovative ideas / concepts because it can generate fortune for them in future. There are numerous examples where investors have invested at substantial premium even if the entity is operating at loss. Examples include Flipkart, MakeMyTrip, OyoRooms, etc. Assumptions made for estimates in relation to expected cashflow 1 The valuation was based on Audited (2013-14), Unaudited (2014-15) balance sheet figures and Estimates (2015-16). 2. Reliance was placed on following large syndicated datasets and a growth report (sourced from world wide web) to arrive at the consumption potential, viz - • Indian Readership Survey (IRS): It is the largest continuous research study in India. It contains a range of demographic information and extensively covers more than 100 product categories ranging from automobiles, FMGC to travel & holidays. • Target Group Index (TGI): It is the largest single source database offered in India till date, combining products, brands, media, demographics, psychographics and lifestyles. It is a part of a database spread across 60 countries. • Internet Trends Report (2012/13) (ITS): The report was focused on internet growth and smartphone adoption rates. As the assessee is internet based company, smartphone adoption rate is a good indicator of the consuming class. Comparison chart giving a more granular view of the assumptions made whilst arriving at the revenue projections and comparison with the working for FY 15-16 to illustrate the same. (Figures are Approximate) Assumption Description FY 15-16 Total Universe • Total no. of consumers available, • Growth calculated at 50% YOY 4,40 Lacs Applicable Universe • SEC A & B , M & F Smartphone owners living in Metros and Mini Metros 1,36 Lacs Irrelevant Holiday Category Consumers • Using cross-tabulated data from IRS and TGI to find out population strata that does not consume weekend holidays & activities. • For eg. people undertaking Pilgrimages 62 Lacs Target Audience • Available consumers based on above mentioned deductions 73 Lacs Reach% • % of Target Audience to target/ reach • Reach gradually grows to around 18% across the years 8.5% 10 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., Assumption Description FY 15-16 Conversion % • Ability to Convert the Target Audience Reached (1.5% of the 8.5% TG). • Conversions gradually increases to around 3.25% across the years. 1.5% Total Customers • Customers Converted (1.5% of the 8.5% TG) + Loyal Customers (considering a decay factor) 10,960 Average Bill Value • Average bill per customer Rs.2,510/- Gross Revenue • Revenue from operations Rs2.75Crs Thus, the methodology which was adopted to arrive at revenue projections was robust and assumptions made were conservative by any standards as per the trend of hits to the site and results upon the hits. Additionally, as per studies conducted by professional bodies, the hotels industry was about Rs 1.8 Lac Crores in size, with 1.1 Lac rooms and growing at around 15% (Yr 2013 figures). The estimate of business growing to Rs 111 Crs in 2021 would represent less than 0.06% of the Yr 2013 market; something that was extremely feasible, realistic and certainly not outlandish by any means. Justification for projected Profit ofRs 53.69 Lacs in Year 2018 The Company was growing @ 30% on month-on-month basis (from April 2015 to Aug 2015) — when negotiation for investments were under consideration. The company closed FY 2015-16, with a total revenue of Rs. 1,91,73,703, which was 50 times(X) the previous year's (FY 2014-15) revenue. Projected growth rate was estimated at 2.3Xfor FY2017-18 as listed in the valuation report which was not unrealistic or unachievable. Computation of Discount Factor (a) 15% As mentioned in the valuation report, the following method has been used in calculating the Discount Factor: Calculation of Cost of Equity Risk Free Rate 8% Market Rate of Return = 12% Beta = 7.5 As per CAPM: Cost of Equity = Rf B. (Rm-RD) Where Rf= Risk Free Return B is Beta Rm = Market Rate of Return Cost of Equity = 8%+1.5(12%- 8%) =14% Assumptions: • 8% Risk Free Returns: Based on returns from low default instruments like Government Bonds, etc (refer Annexure (A) — Bloomberg data on 10yr GOI Bond yield). 11 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., • 72% Market Rate of Return: Based on historical rate of return from equity markets. • 1.5 Beta: 50% higher risk has been assumed as online start-ups are inherently risky. • 1% additional risk has been added for uncertainty in the business Therefore, for the purpose of calculation 15% (14%+1%) has been applied as the Discounting factor in valuation. The cost of equity is further corroborated by the movement in Sensex relied upon to estimate its expectation of return. Opening Closing Change % From 1.4.15 to 23.7.2015 27,957 28,370 1.48% Financial Year 2014-15 22,386 27,957 24.89% Financial Year 2013-14 18,865 22,386 18.67% Average 15.01% Valuations of Online Travel Companies Most startups raise capital to fund their future growth and meet their working capital needs/ expenses/ losses. Any high growth company operates on a negative profit margin through its formative years before turning profitable. As such, the revenue growth happens because of infusion of funds during the initial period and any slowdown in funding results in exponential loss of growth It is also important to note that unlike traditional companies, online start-ups draw value from their future potential rather than current balance sheet/ returns. As a case in point, Flipkart was sold for USD 16 Bn, resulting in a windfall for its investors(>4X) and was reportedly valued at a multiple of 60X over its gross margin (taken in lieu of P/E) in-spite of consistently making huge losses. In the context of examining the valuations in the sector, we could look at a few examples exacted from VCC Edge's Private Placement Report and other -worldwide web sources — n 2013, Make My Trip (the largest online travel portal in India) was valued at USD 902 Million with a net revenue of USD 88 Million and loss of USD 51 Million. A multiple oflOX Valuation to Revenue). Jtayzilla.com, in 2015 was valued at USD 6.25 Million with a revenue of USD and a loss of USD 3.2 Million. A multiple of9X (Valuation to Revenue). In Dec 2014 they had also issued Series B Compulsory Convertible Preference Shares at Rs 34,183 per share. Oyo Rooms, in 2015 was valued at USD 100 Million with revenue of USD 6,80,000 with a loss of USD 3A Million. A multiple of 147X (Valuation to Revenue) Internationally, the top 25 travel companies trade at a median P/E of 25 (refer Annexure). 12 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., Therefore, on a projected revenue of Rs 2.75 Crs in Yr 2016, the valuation Travecom could 've been anywhere between Rs 27.5 Crs (IOX) to Rs 68.75 Crs (25X) in Yr 2016. It is a well established fact that in start-ups there is no co-relation between share valuation W revenue. What matters is the future potential of the company. 'Additionally, the team that built Travecom / ByeiiyeCity.com were all from well- known companies and professionally qualified For eg: MrRajesh Math (Founder) - Strategy & Marketing: Madura Garments, MrVimesh Shah (Founder) — Strategy & Business Ops: Me Cann Erickson, Mudra DDB Ms Geeta Dasri - Business Development: Travelguru/ Yatra.com Mr VedPrakash & Ms Vidya Patankar - Technology: Hungama.com, M/s. Yogesh Devre & Ms Poonam Vaidya - Operations: Nivalink, Travelline International Ms Shdika Srivastatva & Mr Zibran Inamdar - Customer Service: Golbibo.com, cleartrip.com Nature of addition by the learned AO The learned AO made addition in respect of full value of Share premium u/s 56 (2)(viib). Analysis of the reason to make addition and reply of the assessee The Learned AO disagreed to the proposition of the Method of Valuation adopted by the assessee is at the option of the assessee and the rejection of DCF Method once adopted by the assessee being a Start up" company is beyond the jurisdiction of the AO and held that burden lies on the assessee to prove its claim that FMV of the share has been determined correctly. Submission of the assessee: The assessee has valued shares under Section 56(2) (viib) of the IT Act, 1961 for the purpose of issuing them to potential investors under DCF method as their business is covered in the category of Start-up business Relevant provisions of Section 56(2) (viib) of the IT Act, 1961 are asunder: 56. (I) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head if Income from other sources", if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E. (2) In particular, and without prejudice to the generality of the provisions of sub- section (I), the following incomes, shall be chargeable to income-tax under the head "Income from other sources ", namely:— [(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares: Provided that this clause shall not apply where the consideration for issue of shares is received— (i) by a venture capital undertaking from a venture capital company or a venture capital fund; or 13 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf Explanation,—For the purposes of this clause,— (a) the fair market value of the shares shall be the value— (i) as may be determined in accordance with such method as may be prescribed or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher; (b) "venture capital company", "venture capital fund" and "venture capital undertaking" shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of-[Explanation] to clause (23FB) of section 10;] Specific submission of the assessee in this regard. The assessee has adopted the DCF method in view of the explanation provided in the Section 56 (2) (viib) which is reproduced as under: Explanation,—For the purposes of this clause,— (a) the fair market value of the shares shall be the value— (i) as may be determined in accordance with such method as may be prescribed, or (II) .............. assessee adopted prescribed method of valuation i.e. DCF as can be verified from the relevant portion of such prescribed method under rule 11UA which is as under: (b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method. prescribed Method of Valuation- Rule 11U and Rule 11 UA Rule- 11U- (H.—Determination of fair market value of the property other than immovable property) Meaning of expressions used in determination of fair market value. 11U. For the purposes of this rule and rule 11UA,— a, "'accountant" shall have the same meaning as assigned in the Explanation to section 288 of the Act; (b) "balance-sheet", ----- in relation to any company, means,— (c) (d) (e) (J) (g) (h) 14 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., (i) "unquoted shares and securities", in relation to shares or securities, means shares and securities -which is not a quoted shares or securities; 10) Determination of fair market value. Rule 11UA (1) For the purpose of Section 56 of the Act. The fair market value of the property, other than immovable property, shall be determined in the following manner, namely, - (a) (b) (c) .......................... (2) Notwithstanding anything contained in sub-clause (b) of clause (c) of sub- rule (1), the fair market value of unquoted equity shares for the purposes of sub- clause (i) of caluse (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely, — (a) the fair market value of unquoted equity shares = (A-L) x (PV), (PE) where, = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or Election at source or as advance tax payment as reduced by the amount of tax claimed as refund under Income-tax Act and any amount shown in the balance-sheet as asset including the unamortised amount of dferred expenditure which does not represent the value of any asset; = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:— (i) the paid-up capital in respect of equity shares; (ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; Unreserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation; (iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities; (vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of 15 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., cumulative preference shares; PE = total amount of paid up equity share capital as shown in the balance-sheet; V = the paid up value of such equity shares;" (b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method Specific submission of the assessee in this regard. The assessee has adopted the DCF method in view of the explanation provided in the Section 56 (2)(viib) -which is reproduced as under: Explanation.—For the purposes of this clause,— (a) the fair market value of the shares shall he the value— (i) as may be determined in accordance with such method as may be prescribed, or (ii) .............. The assessee adopted prescribed method of valuation /.«?. DCF as can be verified front the relevant portion of such prescribed method under rule 11UA which is as under: (b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method. From the above it can be seen that the choices before the assessee for valuation of shares to issue to the potential investors are as under: 1. The relevant provisions of section 56(2) (viib) and rule I 111 A read with Rule IW, Explanation (a) to Section 56(2) (viib) provides for determination in either of the following two manner: • determination in accordance with method prescribed 11UA & 11 UA; • or the company substantiates the fair market value to the satisfaction of the Assessing Officer based on the value of the date of Issuance of shares. 2. The assessee had opted to substantiate the fair market value in accordance with method prescribed 11U & 11UA based on Valuation Report prepared by a Chartered Accountant who has applied DCF method in order to value the shares and demonstrated that the value of shares does not exceeds the FMV, 2. The learned AO has thus erred in rejecting such method as Sec. 56(2)(viib) is a deeming provision and one cannot expand the meaning of scope of any word while interpreting such deeming provision as one of the cardinal principles of interpretation of fiscal statute is that they should be strictly construed and so long as the provision is free from any ambiguity, there should be no need to draw any analogy. A deeming provision on the other hand is intended to enlarge the meaning of a particular word which includes matters which otherwise may or may not fall within the normal provision, therefore, it should be extended to the consequences and incidents which has been intended by the Legislature for a definite purpose and should not be extended beyond the mandate of the statute. Thus, deeming provisions require to be construed strictly. 16 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., 3. Since s. 56(2) (viib) provides that the valuation has to be done as per the prescribed methods and one of the prescribed methods has been adopted by the assessee, the learned AO has to accept the same as there is no express provision under the Act or Rules, whereby the learned AO can adopt his own valuation under the DCF method or get it valued by some different valuer as there has to be some enabling provision under the Rules or the Act where the learned AO has been given a power to tinker with the valuation report obtained by an independent valuer as per the qualification given in rule 1JU and in spite of such clarity in the provisions the learned AO has tinkered with DCF methodology and rejected the valuation of the assessee by comparing the projections with actual figures. The learned AO further held that unless and until, the assessee produces to substantiate the basis of projections in Cash-Flow and provides reasonable connectivity between those projections in Cash-Flow with the reality evidenced by the material and the projection of Cash-Flow made in the Valuation Report, is unrealistic and without any base. Submission of the assessee. The allegation of the learned AO is not correct as can be seen from details given above under the head summary of submissions to the learned AO in response to show cause notice. The details provide the basis of projection in cashflow and reasonable connectivity between those projection in cashflow based on expected business. The methodology which was adopted to arrive at revenue projections was robust and assumptions made were conservative by any standards as per the trend of hits to the site and results upon the hits. Without prejudice to the above The assessee achieved a turnover of Rs. 19173703/- during A. Y. 2016-17 which clearly indicates the justification of potential of the business. The learned AO disagreed with the valuation report by observing that no independent inquiry -was made by the Valuer of the assessee to verify the truth or otherwise the figures furnished by the assessee at least on test basis. The Valuer relied upon and assumed without any independent verification, truthfulness, accuracy and completeness of the information and the financial data provided by the assessee company. The learned AO relied on disclaimer, that the valuer did not do anything reflecting his expertise except mere applying formula to the data provided by the assessee. Submission of the assessee. 1. DCF method is a recognised method where future projections based upon, expected revenue growth and expected cash flow for a period of Jive years; discount rate and terminal growth rate; and terminal value, etc. are the factors taken in the consideration and thus cannot be matched with actual performance. Projections made by the management and the valuer, like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and host of other factors. These factors are based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based approximation and catena of underline facts and assumptions. 17 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., 2 Valuation under DCF is not exact science and can never be done with arithmetic precision, hence the valuation by a Valuer has to be accepted unless, specific discrepancy in the figures and factors taken are found. 3. At the time when valuation is made, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and thus, the value which is relevant today may not be relevant after certain period of time. It is worthwhile to note that the Company was growing @ 30% on month-on- month basis (from April 2015 to Aug 2015) — when negotiation for investments were under consideration. The company closed FY2015-16, with a total revenue ofRs. 1,91,73,703, which was 50 times(X) the previous year's (FY 2014-15) revenue. Projected growth rate was estimated at 2.3Xfor FY 2017-18 as listed in the valuation report which was not unrealistic or unachievable, 4. The Chartered Accountant who has given the Valuation report in the case of the assessee is a competent person in terms of 11U, The allegation that the assessee did not substantiate the basis of projections in Cash-Flow and reasonable connectivity between the projections in Cash-Flow with the reality evidenced by the material is incorrect as the whole DCF methodology adopted, basis for deriving cashflow and discounting rate used were fully explained and thus finding of the learned AO that the projection of Cash-Flow made in the Valuation Report, is unrealistic and without any base, is perverse and without understanding DCF Method. The assessee has failed to file any satisfactory reason or adopting discounting figure @15%. Submission of the assessee. 'The computation of discounting figure @ 15% has been done as per recognize parameters in this regard and the basis for the same is as follows : Computation of Discount Factor (a), 15% As mentioned in the valuation report, the following method has been used in calculating the Discount Factor: Calculation of Cost of Equity Risk Free Rate 8% Market Rate of Return = 12% Beta = 1.5 As per CAPM: Cost of Equity = Rf. B. (Rm-RD) Where Rf= Risk Free Return B is Beta Rm = Market Rate of Return Cost of Equity= 8%+-1%(12%-8%]= 14% Assumptions: 18 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., • 8% Risk Free Returns: Based on returns from low default instruments like Government Bonds, etc (refer Annexure (A) —Bloomberg data on 10 yr GOI Bond yield). • 12% Market Rate of Return: Based on historical rate of return from equity markets. • 1.5 Beta: 50% higher risk has been assumed as online start-ups are inherently risky. • 1% additional risk has been added for uncertainty in the business Therefore, for the purpose of calculation 15% (14%+1%) has been applied as the Discounting factor in valuation. The cost of equity is further corroborated by the movement in Sensex relied upon to estimate its expectation of return. Opening Closing Change % From 1.4.15 to 23.7.2015 27,957 28,370 1.48% Financial Year 2014-15 22,386 27,957 24.89% Financial Year 2013-14 18,865 22,386 18.67% Average 15.01% • The learned AO rejected the request of the assessee to treat it as Start-up Company on the ground that it is not registered with the Department of Industrial Policy and Promotion and therefore, it is not exempted from tax on investment over FMV as it does not fulfil the requisite conditions laid down in the Notification issued by the CBDT vide File No. 173/14/2018-ITA.L Submission of the assessee. Please note that the above statutory guidelines in respect of startups company were issued in 2018 and thus the learned AO has erred in applying in the same to the assessee. • The learned AO observed that even if the FMV is worked out as per NAV, it will come in negative. Submission of the assessee. Action of the learned AO of determination of value of shares on the basis of financial statement of a company or the book value does not have much relevance under DCF method and therefore, to reject the valuation of the assessee company mainly on the basis of losses shown in the financial statement in subsequent year would not be correct. The learned AO rejected decisions relied upon by the assessee because the judgements were stated to be in respect of Section 68 of the IT Act, 1961 and not in respect of Section 56(2)(viib) of the IT Act, 1961 Submission of the assessee. 19 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., The assessee is enclosing herewith the latest judgements on this issue in the later part of this submission, which may kindly be considered. The learned AO relied on the judgement of ITAT, Delhi in the case of Agro Portfolio Pvt. Ltd. Vs ITO WdA(4) (218)1TA. NO.2189/DEL/2018 dtd.16.05.2018 by stating that the ratio of this decision is squarely applicable in the case of the assessee. Submission of the assessee. The above mentioned judgement is not applicable to the facts of the case of the assessee as explained hereinbelow: S.No. AGRO PORTFOLIO PVT. LTD, (Sector — Financial Services) Assessee (Sector – Travel Related) 1. AO has questioned Financial Parameters of Valuation Report From the ITAT Order, it appears that the assessee (Agro Portfolio) failed to justify any of the financial parameters questioned by the AO in relation to the valuation report (para 5); •which include: (1) Beta (2) Market Rate of return (3) Risk free rate of return IT AT has observed that despite AO's questioning the above, no responses at all came from assessee. The AO therefore proceeded on best judgment assessment to determine FAIR MARKET VALUE relying on NAV Method. In case of assessee the learned Assessing Officer has not questioned any of the technical /financial parameters for valuation report (such as beta, risk free rate of return etc.). AO has disregarded the valuation report solely on account of comparison of future actual performance with projections [Note: hindsight is not a criteria to reject valuation under DCF method as held by numerous Court Rulings], Procedural non-compliance and best judgement order. IT AT order (para 13) notes that assessee (Agro Portfolio) did not respond to multiple notices issued by the Assessing Officer and therefore AO proceeded to apply NAV method under best judgement assessment. Assessee has complied with each and every notice of the AO providing detailed explanation on each aspect. Detailed submission was filed with the learned AO explaining the basis of projections with reference to track record of the team. All backups for projections were placed on record While there has been full compliance by Assessee, it is the learned AO who have cursorily brushed aside the defence put forward by assessee. 3 Past Performance of Assessee From the limited description of the facts in IT AT Order it appears that the assessee already had history of poor performance or track record as AO has noted that it was carrying forward losses (para 5 of the ITAT Order). Therefore, on the facts of the case, this raises a question mark that how positive cashflow projections could have been taken For assessee, valuation report is dated to a time when the assessee had set up the business and just commenced the activity. There was no adverse history or performance or track record available for assessee which would caste a doubt on projections. 4 NA Vapplied by AO as alternative method AO has applied Alternative Method (NAV Applied) and determined the value of share at 9.46. In assessee's case, no alternative method has been applied by the learned AO for computation of FMV. The learned AO has arbitrarily assumed the premium to be NIL 20 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., S.No. AGRO PORTFOLIO PVT. LTD, (Sector — Financial Services) Assessee (Sector – Travel Related) Case of Best Judgement Assessment This was a case under best judgement assessment as assessee failed to cooperate/ respond to any notices issued by AO. Reliance on Valuer's Disclaimer IT AT noted that while valuer has given a disclaimer, the assessee (Agro Portfolio) has also completely failed to justify the projections. There was no response whatsoever by assessee to justify the projections or respond to queries of A O on financial p The learned AO has not resorted to best judgment assessment as all notices issued were duly complied with. The assessee has explained the basis for projections 1/1 detail in its submissions before the learned AO which have not been controverted Request for the assessee Thus, the action of the learned AO in rejecting the FMV computed under DCF method at Rs. 20,582 adopted by the assessee company as per the Valuation Report of Shri Bharat Chugh and Associates, CA needs to be dismissed and the addition of total amount of Share Premium received at Rs.1,75,03,410/- added under section 56(2) (viib) of the IT Act, 1961 needs to be deleted. Without prejudice to the above: 1. Provisions were never meant to be applied on genuine transactions There is another very important angle that here the shares have not been subscribed by any sister concern or closely related person, but by outside investors who have seen certain potential and accepted this valuation. The learned AO cannot question their wisdom. It is only when they have seen future potentials that they have invested. The investors like these persons will not make any investment merely to give dole or carry out any charity to a start-up company, as their decision is guided by business and commercial prudence to evaluate a start- up company like assessee, what they can achieve in future. In a way Revenue is trying to question even the commercial prudence of such investors. According to the learned AO either these investors should not have made investments because the fair market value of the share is Nil or assessee should have further invested in securities earning interest or dividend. It is a well settled legal position that IT authorities cannot dictate the terms as to how a businessman/assessee should have conducted its business. IT authorities cannot decide whether assessee should have collected premium on its shares or not. It is completely the businessman's discretion, business requirement and investor's willingness which determines the premium that should be collected on issue of shares. lie provisions of s. 56(2) (viib) aimed to check the menace of unaccounted money and are anti-abuse provisions. These provisions have no applicability to genuine business transactions. The genuineness and creditworthiness of the strategic investors is not doubted by the learned AO. provisions of s. 5 6(2) (viib) require that in case of closely held company, the shares -should be issued at its fair market value to resident investors based on notified valuation formula by a notified expert. 21 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., The provisions of s. 56(2) and s. 68 are in the nature of anti-abuse measures aimed at preventing the mala fide transactions intended to avoid tax liability and to tackle the problem of black money and were never intended to be made applicable on genuine, bona fide and purely commercial transactions. To substantiate the same the assessee relies on the following board circulars and judicial precedents: -Paras 13.2 and 13.4 of CBDT Circular No. 1 of2011 y dt. 6th April, 2011 The provisions of 56(2)(vii) are anti-abuse provisions which were applicable only if an individual or a HUF is the recipient. These provisions were introduced as a counter evasion mechanism to prevent laundering of unaccounted income. The provisions were intended to extend the tax net to such transactions in kind. The intent is not to tax the transactions entered into in the normal course of business or trade, the profits of which are taxable under specific head of income, • Para 155 of Finance Minister's Budget 2012-13 speech clarifies the scope of provisions ofs. 56(2)(viib). The Finance Minister clarified in his speech above provisions were introduced as a series of measures to deter the generation and use of unaccounted money by increasing the onus of proof on closely held companies for funds received from shareholders as well as taxing share premium in excess of fair market value. Thus, in order to find out the legislative intent or to ascertain the object or purpose behind the legislation, the speech made by the Minister or the mover of the Bill be taken into consideration. The subsequent statement of Hon 'ble Finance Minister made on 12th Feb., 2019 wherein it was said that "no action of any kind was taken against honest companies that had brought genuine money at premium; we will protect honest people". CBDT Circular No. 10 of 2018. dt. 31st Dec., 2018 The position of Department on interpretation of provisions of s.56(2)(viia) dealing with the transfer of shares was clarified. The CBDT while explaining the legislative intent behind introduction of provisions ofs. 5 6 (2) (vita), inter alia, stated that said provisions are anti-abuse provisions to prevent the practices of transferring shares of specified company for no or inadequate consideration. The CBDT while interpreting the aforesaid provision followed the settled law that tax statute should be interpreted strictly. The relevant extract of the latter circular were also reproduced as "Keeping in view the plain reading as well the legislative intent of the s. 56(2)(viia) and similar provisions contained in s. 56(2) of the ct f being anti- abuse in nature ." Thus, the bona fide business transactions cannot be taxed under 56(2)(vii) and that the Provisions ofs. 56(2) were to strike at the generation and use of unaccounted money and '' was never intended the honest and bona fide transactions where consideration for transfer was correctly disclosed by the assessee, Note on non-applicability of Explanation to Section 56(2) (viib) Sub-cl. (ii) of Explanation to Section 5 6 (2) (viib) is not applicable to the assessee 's case and assessee was not required to satisfy the AO about the valuation done. In accordance with sub-el, (i) of Explanation, the assessee had an option to carry out a valuation and determine the FMV only on the discounted cashflow method 22 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., (DCF), which was appropriately followed by the assessee. It is submitted that in any case the assessee has the option to issue shares at a price which is higher of cl. (i) or cl (ii) of Explanation reproduced above. The law leaves no discretion, option or mandate with the AO under Expln. (i) to s. 56(2)(viib) to interfere or vary the option exercised by the assessee as well as the valuation done by the prescribed expert following the prescribed valuation methodology. It is submitted in support of this ground on rejection of valuation report that the main reason for rejecting the valuation report of the assessee as observed by the learned AO is that the projections of revenue as per the valuation do not match with the actual revenues of the assessee of subsequent years which is totally unwarranted and beyond the powers provided under statute as the provisions of s.56(2)(viib) r/w r. 11UA(2) nowhere give the right to AO to examine the valuation report submitted by the assessee. The provisions only require the assessee to get the valuation of shares done by an expert (chartered accountant) using the prescribed methodology. In the present case, the assessee has obtained a valuation report from a chartered accountant which is based on DCF methodology. The very purpose of getting the valuation done by a chartered accountant is to ensure that the valuation is fair and reasonable. Such valuation is to be done by an expert of the subject matter only, which the learned AO is not expected to be. The rule nowhere permits the learned AO tinker with the valuation or methodology applied, assumptions used or to make any adjustment whatsoever. It is submitted that FMV determined in such a manner as prescribed by law is binding upon the Revenue. The assessee relies on the following case laws : Case Law Decision (summary) Page Nos. Cinestaan Entertainment Pvt. ltd. Vs. /TO, Ward 6(2), New Delhi If law provides the assesses to get the valuation done from a prescribed expert as per the prescribed method, then the same cannot be rejected because neither the Assessing Officer nor the assessee have been recognized as expert under the law. There is another very important angle to view such cases, is that, here the shares have not been subscribed by any sister concern or closely related person, hut by an outside investors like, Anand Mahindra, Rakesh Jhunjhunwala, and Radhakishan Damania, who are one of the top investors and businessman of the country and if they have seen certain potential and accepted this valuation, then how AO or Ld. C1T(A) can question their wisdom. It is only when they have seen future potentials that they have invested around Rs. 91 crore in the current year and also huge sums in the subsequent years as informed by the Id. counsel. The investors like these persons will not make any investment merely to give dole or carry out any charity to a start- up company, albeit their decision is guided by business and commercial prudence to evaluate a start-up company like assessee, what they can achieve in future. 23 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., Case Law Decision (summary) Page Nos. Pr. Commissioner of Income tax vs. Choudhary Buildmart Pvt. Ltd. Concededly Section 56(2) (viib) of the Income tax Act permits different methods to determine the fair market value of the shares of companies which are not enlisted. Further, rule 11U and rule 11UA permit fair market value of unquoted equity shares to be determined as per the discounted free cash flow method. Rameshwaram Strong Glass (P) Ltd. Vs. The ITO, Ward 2(1), Ajmer Rule 11UA provides an option to the assessee to determine the fair market value of the shares either as per the book Value or Discounted Free Cash Flow Method. The exercise of such an option by the assessee is not subject to fulfillment of any specified conditions and it is left to the sole discretion of the assessee as it deems fit to apply. In the instant case, the assessee company has exercised its option to value its shares as per DCF method and we find that the objection of the AO is primarily directed at not adopting the book value of determination of value of shares as against DCF adopted by the assessee company. The exercise of such an option cannot therefore be challenged by the revenue once the same has been exercised at first place by the assessee. Further, where the assessing officer is of the opinion that the methodology so adopted by the assessee and/or the underlying assumption while determining the share valuation as per DCF is not acceptable to him, there is no discretion with the AO to discard the DCF method of valuation and adopt book value method. At the same time, in our view the AO is well within his rights to examine the methodology so adopted by the assessee and/or the underlying assumption and where he is not satisfied with the same, he can challenge the same and suggest necessary modification/alterations provided the same are based on sound reasoning and rational basis. In the instant case, we find that' certain basis objections have been raised by the Assessing Officer in terms of applying the estimated turnover numbers instead of actual numbers and discounting factor, etc which, in our view, has been satisfactorily explained by the assessee company during the appellate proceedings and nothing has been brought on record which can substantially challenge the methodology or the underlying assumption while determining the value of the shares. In view of the detail submissions as above the assessee requests your good self to kindly delete the addition ofRs. 175,03,410/- and oblige. 5.2 The written submission dated 11 th April, 2019, soft copy of which is received on 13.01.2020, is reproduced as under- "Addition under u/s. 56(2)(viib) of the IT Act, 1961, is in respect of share premium received. 24 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., The FMV has been determined as per DCF Method based on projection of Cash- Flow based on business potential and thus cash flow for 5 years was projected which is standard accepted norm. In DCF method two main ingredient are cash flow for next 5 years and discounting factor. To determine value of shares issued at premium reliable data was used to scientifically determine cash flow and discounting factor. 1. Calculation of estimates in relation to expected cash flow scientifically determined by considering following reliable data; Company Data 1) Available audited data. 2) Unaudited data till the date of valuation. 3) Estimates for the current year. Large syndicated datasets and a growth report • Indian Readership Survey (IRS): It is the largest continuous research study in India. It contains a range of demographic information and extensively covers more than WO product categories ranging from automobiles, FMGC to travel & holidays. • Target Group Index (TGI): It is the largest single source database offered in India till date, combining products, brands, media, demographics, psychographics and lifestyles. It is a part of a database spread across 60 countries. • Internet Trends Report (ITS): The report was focused on internet growth and smartphone adoption rates. As the assessee is internet based company, smartphone adoption rate is a good indicator of the consuming class. Analysis of Data to arrive at estimates Assumption Description Total Universe • Total no. of consumers available. • Growth calculated at 50% YOY Applicable Universe • Smartphone owners living in Metros and Mini Metros Irrelevant Holiday Category Consumers • Using cross-tabulated data from IRS and TGI to find out population strata that does not consume weekend holidays & activities. • For eg. people undertaking Pilgrimages Target Audience • Available consumers based on above mentioned deductions Reach % • % of Target Audience to target/ reach. • Reach gradually grows to around 18% across the years Conversion % • Ability to Convert the Target Audience Reached (1.5% of the 8.5% TG). •Conversions gradually increases to around 3.25% across the years. Total Customers • Customers Converted (1.5% of the 8.5% TG) + Loyal Customers (considering a decay factor} Average Bill Value • Average bill per customer Gross Revenue • Revenue from operations 25 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., Thus, the methodology which was adopted to arrive at revenue projections was robust and assumptions made were conservative by any standards as per the trend of hits to the site and results upon the hits. Additional Data used to estimate Cash Flow Size of the total industry in terms of revenue, rooms and growth as per studies conducted by professional bodies was used to estimate growth in business of the assessee and share of the assessee in the potential business was worked out which was something that was feasible, realistic and certainly not outlandish by any means. Justification for projected Profit of Rs 53.69 Lacs in Year 2018 The Company was growing @ 30% on month-on-month basis [from April 2015 to Aug 2015) — when negotiation for investments were under consideration. The company closed FY2015-16, with a total revenue of Rs.1,91,73,703 which was 50 times(X) the previous year's (FY 2014-15) revenue. Projected growth rate was estimated at 2.3 X for FY 2017-18 as listed in the valuation report which was not unrealistic or unachievable. Computation of Discount Factor @ 15% As mentioned in the valuation report, the following method has been used in calculating the Discount Factor: Calculation of Cost of Equity Risk Free Rate 8% Market Rate of Return - 12% Beta = 1.5 As per CAPM: Cost of Equity = Rf. B. (Rm-RD) Where Rf= Risk Free Return B is Beta Rm = Market Rate of Return Cost Of Equity 8%+1.5 (12%-8%) = 14% Assumptions: • 8% Risk Free Returns: Based on returns from low default instruments like Government Bonds, etc — Bloomberg data on 10 yr GOI Bond yield. > 12% Market Rate of Return: Based on historical rate of return from equity markets. " 1.5 Beta: 50% higher risk has been assumed as online start-ups are inherently risky. > 1 % additional risk has been added for uncertainty in the business. Therefore, for the purpose of calculation 15% (14%+1%) has been applied as the Discounting factor in valuation. 26 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., The cost of equity is further corroborated by the movement in Sensex relied upon to estimate its expectation of return. Valuations of Online Travel Companies Most startups raise capital to fund their future growth and meet their working capital needs/ expenses/ losses. Any high growth company operates on a negative profit margin through its formative years before turning profitable. As such, the revenue growth happens because of infusion of funds during the initial period and any slowdown in. funding results in exponential loss of growth. It is also important to note that unlike traditional companies, online start-ups draw value from their future potential rather than current balance sheet/ returns. As a case in point, Success of others start ups Flipkart was sold for USD 16 Bn, resulting in a windfall for its investors(>4X) and was reportedly valued at a multiple of 60X over its gross margin (taken in lieu of P/E) in-spite of consistently making huge losses. In the context of examining the valuations in the sector, we could look at a few examples extracted from VCC Edge's Private Placement Report and other worldwide web sources — In 2013, Make My Trip (the largest online travel portal in India} was valued at USD 902 Million with a net revenue of USD OS Million and loss of USD 51 Million. A multiple of lOX (Valuation to Revenue]. Stayzilla.com, in 2015 was valued at USD 6.25 Million with a revenue of USD and a loss of USD 3.2 Million. A multiple of 9X (Valuation to Revenue). In Dec 2014 they had also issued Series B Compulsory Convertible Preference Shares at Rs 34,183 per share. Oyo Rooms, in 2015 was valued at USD 100 Million with revenue of USD 6,80,000 with a loss of USD 3.4 Million. A multiple of 147X (Valuation to Revenue). Internationally, the top 25 travel companies trade at a median P/E of 25 (refer Annexure}. It is a well established fact that in start-ups there is no co-relation between share valuation and revenue. What matters is the future potential of the company. Additionally, the team that built Travecom / ByebyeCity.com earlier worked in well-known companies and are professionally qualified. The learned AO did not give us any basis/alternate method but rejected the DCF method. The Income tax Act provides the assessee an option to adopt either NAV or DCF method for valuation of shares. As the Act provides for option to choose one of the two methods the assessee is free to adopt any one of the method. The assessee has opted for of shares under DCF method. The learned AO has rejected the DCF method and considered the book value method to reject the valuation which is tempering with the provisions of the Act 27 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., as until and unless the legislature amends the provisions of the Act and prescribed only one method for valuation of the shares, the assessee is free to adopt any one of the method. Also, the learned AO has not given any alternative methodology to value the shares under DCF method. Thus the action of the learned AO suffers from factual and legal infirmity. 3. DIPP Guidelines why not applicable The exceptions to section 56(2)(viib) The provisions of section 56(2) (viib) are not applicable where the consideration for the issue of shares is received: 1. by a venture capital undertaking from a venture capital company or a venture capital fund. 2. by a company from a class or classes of persons as may be notified by the Central Government in this behalf Notification No. 45/2016 dated 14 th June 2016 read with GSR 80E dated 17th February, 2016 and Notification 24/2018 dated 24th May, 2018, read with notification G.S.R. 364(E), subject to the fulfilment uf specified conditions were issued by Central government stating that the provisions of section 56(2](viib) are not applicable to any particular class/classes of the companies From above it can be seen that the DIPP Circulars were not available to the assessee at the time of valuation in terms of Section 56(2)(viib) 4. Summary of the submissions made by the assessee during the course of the appeal proceedings. • The assessee issued shares to various investors at premium. • The valuation (FNV) was determined as per rule 11UA which permits the assessee to value the shares under book value method or DCF method. • Once option is exercised by the assessee to adopt DCF method valuation is required to be done by the competent person specified in the rule. • Accordingly, the assessee obtained report from M/s. Bharat Chug & Associates, Chartered Accountants. • The learned AO did not agree with the aforesaid valuation which was based on projected cashflow and discounting factor. The learned AO opined that the valuation was not realistic keeping in view the growth and stature, revenue growth, net profit of the company. • Thus, the learned AO rejected valuation of shares as per DCF method. • The assessee has submitted respective valuation report issued by the competent person specified in the rule, during the course of appeal proceedings. • The assessee has justified adoption of DCF method and valuation report in terms of section 56(2)(viib) and rule 11U&11UA. 28 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., • The assessee has provided details in respect of the basis of projection of cashflow and reasonable connectivity of such projections as per expected business which were conservative as per trend of hits of their site and result upon such hits. • Adoption of discounting rate is also explained in detail • The introduction of Section 56(2)(viib] was to curb menace of black money. The learned AO verified genuineness of the investors which may kindly be noted." 7. After considering detailed submissions, Ld.CIT(A) deleted the additions made by the Assessing Officer with the following observations:- “6.2. The moot question here is (i) whether the appellant was a startup (ii) whether the share premium determined is correct. The appellant is a company formed by individuals who have worked in well known companies i.e. they were in comfortable cushy jobs. They decided to form a company which was an on-line discovery and booking platform for short breaks from the city. During the first year, the turnover of the company was Rs.95,86,851/-. During the second year, it grew more than 100 percent to Rs.1,91,73,703/- and the monthly rate of growth was 30%. At this point of time, Investment was required and the Directors of the company used the DCF method from an independent chartered accountant to work out the value of shares. Therefore, four individuals/LLPs unrelated to each other invested in the appellant company. Hence, I conclude that the argument of the appellant that it is a “start-up” company is well founded. The registration with DIPP came into force in 2018 and hence the appellant did not register in it as it had closed shop by then. It is a well known fact that a very small percentage of start-ups succeed. “3 Now coming to the valuation of shares. Section 56(2)(viilb) was introduced in the Income Tax Act, 1961 (ITA) vide the Finance Act, 2012, seeking to tax any excess premium received by a closely held company upon the issue of shares. Such excess premium is deemed to be the income of the company and shall be taxed under section 56(2)(viib). The intent of the legislature in enacting the provisions of this section was to discourage the practice adopted by tax payers of subscription to shares of closely held companies at excessive and unjustifiable premium. Section 56(2)(viib) provides that the fair market value of the shares shall be determined in accordance with higher of value derived as per Rule 11UA of the Income-tax Rules, 1962 (Rules) or the value as may be substantiated 29 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., to the satisfaction of the Assessing Officer (AO). As per Rule 11UA, the valuation of unquoted equity shares shall be determined, at the option of the assessee, out of following two methods, i.e., the value derived based on the formula for assets and liabilities as per Rule 11UA or the fair market value of the unquoted equity shares determined by a merchant banker as per the DCF method. With respect to whether the AO can reject the valuation method chosen by the taxpayer, the Bombay High Court in Vodafone M-Pesa Ltd. V. Pr. CIT (2018)(256 taxman 0240) has held that “as per Income Tax Rules, 1962 the method of valuation namely, NAV method or the DCF method to determine the fair market value of shares in terms of section 56(2)(viib) has to be done/adopted at the assessee’s option. A.O was undoubtedly entitled to scrutinize the valuation report and determine a fresh valuation to confront the assessee. however, the basis of valuation had to be the DCF method and it was not open to the AO to change the method of valuation which the assessee had duly opted. Therefore, the matter was remanded back for reconsideration.” i.e., while the tax authorities have the power to scrutinize the valuation report and are entitled to determine a fresh valuation, they do not have the power to change the valuation method which has been chosen. This view is echoed in the rulings of the Hon’ble [TAT, ‘B’ Bench, Mumbai, in the case of Narang Access Pvt. Ltd. Vs. DCIT (ITAT Mumbai) in ITA No. 3521/Mum/2018, for A.Y. 2013-14, announced on 22.08.2019 wherein it is held that “the assessee has the option to determine the fair market value of shares either under the DCF method or the NAV method. The assessee’s choice is binding on the AO. While the AO can scrutinize the working, he cannot discard the assessee’s method and substitute another method.” 6.4. Based on various judicial precedents therefore, it may be concluded that while the appellant has the right to choose DCF valuation, it should be able to substantiate it with reasonable data. Primarily, to answer what constitutes credible data, it may be important to understand how a DCF analysis is carried out. The DCF valuation uses forecasted cash flows of accompany and discounts them back to arrive at the present value using a discount rate. Two major inputs are thus required ~ future cash flow projections and the discount rate. While a number of methods are used to calculate the discount rate, the most common is the application of the weighted average cost of capital. However, it is the cash flow projections that take into consideration a wide number of both micro and macro-economic factors that affect business operations. For instance, these include factors such as the growth rate of the industry in which the company is operating, the GDP growth rate, historical revenue growth and past performance of the company, envisaged 30 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., savings, competition in the industry, income tax rates, expansion plans, major internal policy changes and changes in the organizational set up of the company, caliber of managerial personnel, expected capital expenditure and so on. While some of these factors can be reasonably predicted, there are a large number of factors which may not possibly be predicted with scientific certainty. The appellant in his arguments has given cogent and well-reasoned logic for the basis of calculation of shares by the DCF method. Detailed submissions explaining the basis of projection has been filed during assessment and appellate proceedings. The AO on the other hand has rejected the same and added the whole amount of share premium received u/s 56(2)(viib). He has not endeavored to value the same by another method or calculate the reasonable share premium as per him by DCF Method. Hence, in view of the discussions above, it is held that the appellant company is a startup. The method of valuation used as per Rule 11UA is the DCF method which has been done by a chartered accountant. In view of the factual and legal matrices, I am of the considered view that the addition made by AO of Rs.1,75,03,410/- u/s 56(2)(viib) should be deleted and the appeal of the appellant on this ground is allowed.” 8. Aggrieved revenue is in appeal before us raising following grounds in its appeal: - “1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A)-3, Thane erred in deleting the addition of Rs.1,75,03,410/- made u/s. 56(2)(viib) of the I.T. Act, 1961 as the company is not registered with the Department of Industrial Policy and Promotion and therefore, it is not exempted from tax on investment over FMV as it does not fulfill the requisite conditions laid down in Notification issued by the CBDT vide File No. 173/14/2018-ITA. 2. The appellant prays that the order of the Ld. CIT(A)-3, Thane, may be set-aside and that of the Assessing Officer be restored. 3. The appellant craves leave to add, amend or alter or alter any ground/grounds, which may be necessary.” 9. At the time of hearing, Ld.DR supported the findings of the Assessing Officer and submitted that Ld.CIT(A) has given relief to the 31 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., assessee even though assessee is not registered with the Department of Industrial Policy and Promotion (for short “DIPP”). Therefore, it is not exempted from tax on investment over FMV as it does not fulfill requisite conditions laid down in Notification No. 173/14/2018ITA issued by CBDT. He prayed that the order passed by the Ld.CIT(A) may be set-aside. 10. On the other hand, Ld. AR brought to our notice findings of the Ld.CIT(A) and facts on record. She submitted that the assessee has valued the shares based on Rule 11UA of I.T. Rules as per which assessee has the option to choose the method of valuation i.e. NAV or DCF Method and accordingly, assessee has chosen to value the valuation of shares based on the DCF method and the same was duly certified by the registered valuer and accordingly, the same was adopted. She submitted that no doubt assessee is not registered itself with the DIPP, however, the DIPP was came into force in the year 2018 by that time assessee has stopped its operation, she submitted that it cannot be reason for Revenue to come up in appeal. Even though assessee is not registered startup, however, she submitted that the facts on record clearly indicate assessee has selected proper method and adopted the proper valuation of shares and is not good on part of the Assessing Officer to question the valuation adopted by the assessee. Particularly after observing that assessee has 32 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., stopped its operation in the year 2018, he chose to sustain the valuation after the event of issue of shares. She submitted that the value of shares what is relevant is on the day of issue of shares. 11. In order to determine the valuation of shares the assessee has adopted the projections and calculated the value of shares based on the DCF Method. Therefore, Assessing Officer cannot challenge the valuation of shares at this stage. In support of the above contentions she relied on the following case laws:- (i). Vodafone M-Pesa Ltd., v. DCIT [2020] 114 taxmann.com 323 (Mumbai- Trib.) (ii). DCIT v. Credtalha Alternative Investment Advisors (P.) Ltd., [2022] 134 taxmann.com 223 (Mumbai – Trib.) (iii). Cinestaan Entertainment (P.) Ltd, v. Income Tax Officer [2019] 106 taxmann.com 300 (Delhi – Trib.) 12. Further, she submitted that Department has raised the ground that assessee is not registered under DIPP, however, she submitted that Ld.CIT(A) has not given relief based on the CBDT circular. Therefore, it is not proper on the part of the Department to raise the ground that Ld.CIT(A) has given relief contrary to the CBDT circular. She prayed that the addition made by the Assessing Officer is not proper and sustain the findings of the Ld.CIT(A). 33 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., 13. Considered the rival submissions and material placed on record, we observe from the record that assessee has issued shares to four independent individuals by valuing the shares by adopting DCF method which is one of the approved method under Rule 11UA of I.T. Rules, the suggested method under rule are NAV or DCF. As per the above Rules assessee has selected to the DCF Method. Accordingly, assessee has duly valued the shares from registered valuer. The registered valuer has adopted the projection of sales and expenditure, which was obviously collected from the assessee and adopted the same. The AO is not happy with the adoption of the information collected and projections based on the future values on the sales and cost, which the valuer considered for valuation of shares with the regular disclaimer as a professional valuer. The Assessing Officer during the assessment proceedings compared the actual performance of the assessee with the projections adopted for valuation of shares and further he observed that assessee has discontinued the business. In our considered view, it is not on the part of the Assessing Officer to evaluate the method of valuation adopted by the assessee at the stage of assessment, as held in the case of Vodafone M-Pesa v. DCIT (supra). The Coordinate Bench clearly held as under: - “20. Coming to the findings of Ld. CIT(A), we notice that Ld. CIT(A) has accepted the DCF method adopted by the assessee and 34 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., he analyzed the factual performance of the assessee Subsequent to issue of shares. The valuation of shares are for that matter any valuation is itself is a projection of future events or activities and no doubt it has to be done with some accuracy, however no person in the world at the time of projecting events or result to project with 100% of accuracy and actual events are highly volatile and highly dependent on so many factors. Assessee has projected based on the fact that software of wallet and association of ICICI bank will increase the market share and accordingly, they have projected the figures and further the valuer has adopted the projection figures provided by the assessee and it is left to the wisdom of valuer to accept or reject or to carry out independent investigation raised with the valuer and legislature in more than one place depends on the skills of the professionals like merchant banker only to value the valuation of shares or other volatile securities. Since, Ld. CIT(A) has compared the factuals with projections and assessee has achieved 40% of the actual results is too harsh to the assessee and the valuation is done in order to carry out certain activities by the management. In this case, the valuation was used to issue of rights shares. The AO or Ld. CIT(A) is trying to evaluate the accuracy of the valuation at the time of assessment, this is not proper and also the factuals are based on so many factors subsequent to adoption of projection and valuation. Accordingly, we are not in a position to accept the method adopted by Ld. CIT(A)......” 14. Respectfully following the above said decision, we are not inclined to accept the findings of the Assessing Officer and also we observe that Ld.CIT(A) has deleted the addition based on the method of valuation adopted by the assessee and on merit. We observe that nowhere Ld.CIT(A) has given benefit to the assessee based on the notification issued by the CBDT vide File No. 173/14/2018. Further, we observe that even Ld.CIT(A) has observed that assessee is not registered under DIPP and the provisions were introduced only in the year 2018. It clearly 35 ITA NO. 59/MUM/2021 (A.Y. 2016-17) M/s. Travecom Global Pvt. Ltd., indicates that nowhere Ld.CIT(A) has given benefit to assessee on the basis of the notification issued by the CBDT. Therefore, we do not see any merit in the appeal filed by the Revenue and accordingly, we are inclined to dismiss the appeal filed by the Revenue. 15. In the result, appeal filed by the Revenue is dismissed. Order pronounced in the open court on 28 th June, 2022. Sd/- Sd/- (ABY T. VARKEY) (S. RIFAUR RAHMAN) JUDICIAL MEMBER ACCOUNTANT MEMBER Mumbai / Dated 28.06.2022 Giridhar, Sr.PS Copy of the Order forwarded to: 1. The Appellant 2. The Respondent. 3. The CIT(A), Mumbai. 4. CIT 5. DR, ITAT, Mumbai 6. Guard file. //True Copy// BY ORDER (Asstt. Registrar) ITAT, Mum
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