DCIT, Central Circle - 1(4), Kolkata, Kolkata V. M/s. Kushal Polysack Pvt. Ltd., , Kolkata

ITSSA 156/KOL/2017

• Counselvise Citation: [2022] 104 COUNSELVISE.COM (IT) 4203 (ITAT-KOLKATA)
• Duration Of Justice: 4 year(s) 6 month(s) 24 day(s)
• Appeal Type: Income Tax (Search & Seizure) Appeal
• Pronouncement Date: 25-05-2022
• Appeal Filed By: Department
• Order Result: PartlyAllowed
• Bench Allotted: A
• Assessment Year: 2014-2015
• Appeal Filed On: 31-10-2017
• Result in Favour of: Revenue
• Court: TRIBUNAL
• Keywords: Capital asset; Depreciation; Fair market value; Difference of opinion; Valuation report; Set aside
• Section: 68; 56; 132; 56(2)(vii)(b); 143(3); 142(1); 153A; 143(2)

Judgement Text

1. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. IN THE INCOME TAX APPELLATE TRIBUNAL BENCH “A” KOLKATA Before Shri Rajpal Yadav, Vice President (KZ) and Shri Shri Manish Borad, Accountant Member आयकर अपील सं.य/ IT(SS) A No. 156/Kol/2017 Assessment Year:2014-15 DCIT, C.C 1(4), 3 rd Fl., Aaykar Bhavan Poorva, 110 Shanti Pally, Kolkata-107. बनाम V/s. M/s. Kushal Polysack Pvt. Ltd 16 Ganesh Chandra Avenue, Kolkata-700 013. PAN: AABCK 3920D अपीलाथ /Appellant .. यथ /Respondent अपीलाथ क ओर से/By Appellant/Department Md. Ghyas Uddin, CIT/DR यथ क ओर से/By Respondent/Assessee Shri K.K. Chhaparia, FCA Shri Nirav Sheth,FCA स ु नवाई क तार ख/Date of Hearing 31-03-2022 घोषणा क तार ख/Date of Pronouncement 26-05 -2022 आदेश /O R D E R PER MANISH BORAD, AM. This appeal of the revenue for the assessment year 2014-15 is directed against the order of ld. Commissioner of Income-tax (Appeals)-20, Kolkata dated 02-08-2017, which is arising out of the assessment order framed u/s. 153A read with section 143(3) of the Income Tax Act dated 31-12-2016 passed by Deputy Commissioner of Income Tax, Central Circle-1(4), Kolkata. 2. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. 2. The revenue has raised the following grounds of appeal:- 1. On the fact and circumstances of the case and under the law I the Ld. CIT(A)-20 erred in deleting the addition made on account of Income from other sources u/s. 56(2)(viib) of the I.T.Act of Rs. 3,45,67,120/- without going to the facts of the case and without examining the case record and assessment order properly. 2 On the fact and circumstances of the case and under the law, the Ld. CIT(A)-20 erred in holding the share valuation report of a Chartered Accountant as correct by wrongly holding that the A.O has neither questioned the methodology adopted by the valuer nor the basis on which valuation report has been prepared because of not considering the fact that the report of the Chartered Accountant submitted under Discounted Free Cash Flow Method(DFCF) was based on the enhanced amount of revenue of assessee company taken for A.V 2014-15 by 33.64% than actual revenue shown for that year and further forecast of revenue taken for subsequent year also being inflated and thus, a very high value of share than its book value was arrived to justify the issue price of shares and the same is clearly discussed in the assessment order. 3 That the department craves leave to add, alter or modify any grounds of appeal in the course of Appellate proceedings. 3. Brief facts of the case as culled out from records that the assessee is a private limited company engaged in the business of manufacturing of HDPE/PP woven sacks. A search action u/s. 132 of the Income-tax Act, 1961 (hereinafter, referred to as the ‘Act’) was conducted at the premises of ‘KUSHAL’ Group at Kolkata and Dist- Purulia, West Bengal on 05-08-2014 followed by serving of notice 3. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. issued u/s. 153A dt. 20-03-2015. In response thereto total income of Rs.1,07,57,450/- declared in the return filed on 16-05-2015 for AY 2014-15. 4. During the course of assessment proceedings, which were carried out after serving of valid notices issued u/s. 143(2) and 142(1) dt. 03.07.2015 & 08.07.2016 the Ld. AO observed that during the year the assessee company has allotted 28000 equity shares at a price of Rs.1250/- for each share. The Ld. AO also observed that that the book value of each share of the assessee company as on 31-03-2013 is only Rs.15.46. The Ld. AO called for the details from the assessee to explain the fairness of the issue price of share at Rs.1,250/- in view of provisions of section 56(2)(viib) of the Act. In reply, the assessee company furnished a valuation report/certificate prepared by Chartered Accountants based on Discounted Free Cash Flow method ( In short, DFCF method) as per rule 11UA(2)(b) of the IT Rules and issue price calculated in this report at Rs. 1250/- was taken from the investors on the 28000 equity shares allotted during the year. The assessee also submitted that conditions provided in Explanations (a)(i) to section 56(2)(viib) of the Act stands duly fulfilled. 5. However, the Ld. AO was not satisfied with the correctness of valuation report based on his observations that projections of revenue for FY 2013-14, which was Rs.117 crores could not be achieved and revenue was only at Rs.87.55 crores and there is a downward deviation of 33.64%. On observing such actual downward variation on each front, which was not explained by the assessee 4. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. during the assessment proceedings the Ld. AO rejected the said valuation certificate dt. 13-05-2013 and after adopting the book value of Rs. 15.46 per share as fair market value, made the addition of Rs.3,45,67,120/- to the income of the assessee u/s. 56(2)(viib) of the I.T Act and assessed income at Rs.4,53,24,570/-. 6. Aggrieved, the assessee preferred an appeal before the Ld. CIT(A) and submitted/asserted the fact that the issue price of equity shares are based on valuation certificate is prepared by an expert as per the provisions of section 56(2)(viib) of the Act r.w.st. Rule 11UA (2)(b) of the I.T Rules, which provides that the fair market value of unquoted equity shares is to be determined by a merchant banker or an accountant as per the Discounted Free Cash Flow(DFCF) Method. The assessee also referred to certain judicial pronouncements and based on these submissions the Ld. CIT(A) deleted the impugned addition of Rs. 3,45,67,120/- made u/s. 56(2)(viib) of the Act observing as under:- “I have considered findings of the AO in the assessment order and the written submission filed by the AR on this issue. I think the main reason for disagreement regarding valuation/ determination of fair market value of shares is because of difference of opinion in respect to interpretation of rule 11 UA. of the IT Rules 1962 and sub-clause (ii) of section 56(2)(viib). This sub-section is reproduced as under: "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". 5. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. I think the Income Tax Act is very clear about the issue of the valuation of unquoted shares. Under section 56(2)(viib) read with Rule 11 U and Rule 11 UA a certificate from a technical expert on this issue i.e. an FCA or Accountant. The valuation work itself is a technical work therefore the Income Tax Act and IT Rules require valuation to be done by a technical person using certain method i.e. either by the method of adopting formula mentioned in Rule 11 UA(2)(a) or (ii) Discounted Free Cash Flow Method. Here in this case the assessee company has furnished a certificate in prescribed form from a technical person as required by the IT Rules. The valuation has been done in discounted free cash flow method which is very much prescribed and allowed by the I T Rules. But in the assessment order the AO has rejected the valuation done by a technical person without bringing on record any further valuation report from a technical person. In the valuation report it has been clearly brought out as under: "Valuation of shares is a result of combination of various factors and attended circumstances related to the business which is being valued There can be no single method of shares valuation, which may be universally applicable. Valuation is an exercise, which is influenced to a great extent by affecting factors and thus is not an exact science or a pure mathematical exercise. The valuer has to further depend upon his judgement and imagination to decide about the discounting/ capitalization rates to be applied for the valuation. One of the valuation methods is Discounted Free Cash Flow Method (D. F. C.F. Method). This method involves the valuation based on forecast of future financial projections provided by the management. I have examined the forecast of financial projections of Kushal Polysacks Private Limited of 16, Ganesh Chandra Avenue, Gandhi House, 4'11 Floor, Kolkata-700 001 for the Financial Year 2014-15 to 2018-19 (five years) and thereafter till perpetuity as given" Annexure-I & Annexure-2 " in accordance with Standard 0/ Assurance Engagement 3400 (AAS 35). The Examination of Prospective Financial information, issued by the Institute of Chartered Accountants of India .. 6. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. The preparation and presentation of the forecast including the underlying assumptions, set out in Annexure-B. is the responsibility of the management and has been approved by the Board of Directors of the Company. My responsibility is to examine the evidence supporting the forecast. My responsibility does not include verification of the forecasts. Therefore, I do not vouch for the accuracy of the same. This forecast has been prepared to find out the fair market value of unquoted Equity Shares for the purpose of sub clause (i) of clause (a) of Explanation to clause (viib) of subsection (2) of section 56 of the Income Tax Act, 1961. (Using Discounted Free Cash Flow method of valuation). The forecast has been prepared using a set of assumptions as set out in Annexure-3. I have carried out my examination of the' forecast of future financial information on a test basis. Based on my examination of the evidence supporting the assumptions, nothing has come to my attention, which causes me to believe that assumptions do not provide on the basis of the assumptions as set out in Annexure-3 and a consistent basis with the historical financial statements, using appropriate accounting principles. I have checked the valuation of Equity Shares of Kushal Polysacks Private Limited as per workings in Annexure 1 to 5 attached to the report. Based on above, I would opine that the fair market value per equity share of Kushal Polysacks Private Limited as on date of this report, is Rs. 1,256/- under D.F.C.F method as per Explanation (a)(i) to Section 56 (2)(viib) of the I.T.Act, 1961 ." I think the AO has neither questioned the methodology adopted by the valuer nor the basis on which valuation report has been prepared. Simply because there is certain percentage of deviation from revenue data vis-a-vis actual expenditure achieved by the company, the entire valuation. report should not have been rejected. Accordingly, assessee's appeal on grounds no 1 and 2 are allowed. 7. Aggrieved, the Revenue is now in appeal before this Tribunal. 7. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. 8. The Ld. Departmental Representative placed before us a chart showing forecasted figures of revenue and expenses and cash flow statement shown in the valuation report issued by the Chartered Accountant under rule 11UA(2)(b) of the IT Rules and comparing the same with from FY ‘13-14 to FY’17-18. Ld. DR submitted that from FY 2013-14 onwards forecasted revenue figures are on a steep increase, but the actual sales figures are on a steep decrease. It was stated by the Ld.DR that looking to the projections and actual of Revenue, Expenses and Net Profits earned, it seems that the growth rate estimated by the management has not been incorporated and calculated correctly in the certificate prepared by the accountant and therefore, since there are various apparent defects in the certificate prepared in the valuation report, the same cannot be relied upon and since the management itself is involved in providing the inputs for the preparation of the certificate as the figures and projections of growth rate have been given by the management to the accountant, it is a case where the shares have been issued at a much higher price than the fair market values u/s. 56(2)(viib) of the Act. Therefore, the Ld. AO had rightly made the addition. Reliance placed on the decision of the co-ordinate bench, ITAT, Delhi Bench-A in the case of Agro Portfolio P. Ltd Vs. ITO, Ward 1(4), New Delhi reported in (2018) 94 taxmann.com 112(Delhi-Trib). 9. Per contra, the Ld. Counsel for the assessee apart from reliance on the submissions made before the Ld. CIT(A) and the finding of the Ld. CIT(A), paper book pages 01 to 155, containing copy of I.T Acknowledgment, I.T Return filed u/s. 153A of the Act (pages 01-36 of 8. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. P.B), Audited Accounts for AYs 2011-12 to 2014-15 (pages 107-155, pages 37-54 ) & Tax Audit Report for AY 2014-15 (pages 37-54 of P.B), Assessee’s submissions along with valuation report on 27-12- 2016 ( pages 90-99 of the P.B). A reference was also made to the following written submissions dt. 18-04-2022. “In this connection we are submitting herewith summary of Turnover, Commission/Other Income & Net Profit of Kushal Polysacks Private Limited from FY 2008-09 to FY 2012-13 (Refer Page 1 of Paper Book attached herewith, being referred to as Paper Book 4). It is relevant to note that the assessee company was engaged in manufacturing of HDPE/PP woven sacks bags and fabrics and has been promoted by Kushal Group having established track record of business. As evident from the summary art, the turnover of the assessee during FY 11-12 was Rs. 59.29 Crores, which got increased to 111.02. crores in FY 2012-13. The valuation report was issued just one month after F. y. 2012-13 (Valuation Report dated 13.05.2013). It is further evident from the summary chart that the assessee's income in the form of agency business had significantly increased in FY 11-12 and FY 12-13 (the assessee was also awarded agency of Indian Oil Corporation Limited for their products like HDPE/PP Granules). The cumulative effect was that the Net profit had increased from Rs. 47.68 lakhs in FY2011-12 to Rs.140.86 lakhs in FY 2012-13. It is thus submitted that on the date of issue of valuation report on 13.05.2013, the valuer has based his valuation report on the basis of historical data and the projections/assumptions given by the management which provided a reasonable basis. In this connection, reference is made to extracts of Valuation Report dated 13.05.2013 which reads as follows: 9. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. "Based on my examination of the evidence supporting the assumptions, nothing has come to my attention, which causes me to believe that assumptions do not provide a reasonable basis for the forecast. Further, in my opinion the forecast, read with the notes thereon, is properly prepared on the basis of the assumptions as set out in Annexure -3 and on a consistent basis with the historical financial statements, using appropriate accounting principles. " In the circumstances, reference is invited to ITAT judgment dated 12.07.2018 passed by the Hon'ble ITAT, Jaipur in the case of Rameshwaram Strong Glass (P.) Ltd. wherein at Para 4.5.2, it has been inter alia observed as follows: "Before examining the fairness or reasonableness of valuation report submitted by the assessee, we have to bear in mind that the DCF Method, and is essentially based on the projections (estimations) only and hence these projection cannot be compared with the actuals to expect the same figures as were projected. The valuer has to make forecast on the basis of some material but to estimate the exact figures is beyond its control. At the time of making a valuation for the purpose of determination of the fair market value, the past history may or may not be available in a given case and therefore, the other relevant factors may be considered. The projections are affected by various factors hence in the case of company where, there is no commencement of production or of the business, does not mean that its share cannot command any premium. " The Hon'ble Mumbai ITAT in the case of DCIT - 1(2) -2 Vs. MIs. Ozoneland Agro Pvt. Ltd. [lTA No. 48541Muml2016] has observed that " Section 56 allows the assessees to adopt one of the methods of their choice. But, the AO held that the assessee should have adopted only one method for determining the value of the shares. In our opinion.it was beyond the jurisdiction of the AO to insist upon a particular system, especially the Act allows to choose one of the two methods. Until and unless the legislature amends the provision of the 10. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. Act and prescribes only one method for valuation of the shares, the assessees are free to adopt anyone of the methods. Therefore, in our opinion the order of the F AA does not suffer from any factual or legal infirmity. " The Hon'ble Delhi High Court in the case of PCIT-2 Vs. MIs Cinestaan Entertainment Pvt Ltd. [ITA No. 100712019 & CM Appl. 5413412019J has observed that " ..... There is no dispute that methodology adopted by the Respondent-Assessee has been done applying a recognized and accepted method. Since the performance did not match the projections, Revenue sought to challenge the valuation, on that footing. This approach lacks material foundation and is irrational since the valuation is intrinsically based on projections which can be affected by various factors. We cannot lose sight of the fact that the valuer makes forecast or approximation, based on potential value of business. However, the underline facts and assumptions can undergo change over a period of time. The Courts have repeatedly held that valuation is not an exact science, and therefore cannot be done with arithmetic precision. " The Hon'ble Kolkata ITAT in the case of Bharat Elevators & Engineers Pvt Ltd Vs. ITO, Ward- 5(3), Kolkata [lTA o. 2646/Ko1/2019] has held that "I have heard the arguments of both the sides and also perused the relevant material available on record It is observed that the similar issue relating to the addition made u/s 56(2)(vii)(b) was involved in 'the case of M/s. Lalithaa Jewellery Mart Pvt. Ltd. vs ACIT (ITA Nos. 663 to 665/Chny/2019) cited by the learned counsel for the assessee and the same was deleted by the Tribunal for the following reasons given in paragraph no. 15 & 16 of its order dated 1-1.06.2019: "15. Now coming to valuation of shares, as rightly submitted by the Ld. Counsel for the assessee, there are two limbs in Section 56(2)(viib) of the Act. As per explanation to Section 56(2)(viib) of the Act, the first limb is valuation to be made as 11. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. per the prescribed method. In fact, the method for valuation of shares is prescribed under Rule 11 UA of the Income-tax Rules, 1962. The second limb is the valuation of the company based on value on the date of issue including its assets. Assets include intangible assets such as goodwill, knowhow, patents, copyrights, trademarks, licences, franchises, etc. The Assessing Officer has not taken into consideration the second limb in explanation to Section 56(2)(viib) of the Act. The second limb provides that when valuation was made by the company, if the Assessing Officer is not satisfied about the valuation, he has to call for material from the assessee how the valuation was made by the assessee company. Satisfaction of the Assessing Officer as referred in explanation to Section 56(2)(viib) of the Act would be judicial satisfaction of the Assessing Officer. Judicial satisfaction means the Assessing Ojjicer has to take into consideration the well-established method of valuation of shares including the assets as explained in Explanation 2 to Section 56(2)(viib) of the Act. It cannot be arbitrary. The Assessing Officer has to take note of the judicial and established principles in arriving at his satisfaction. In this case, the Assessing Officer has not found any specific fault in rejecting or not satisfying with the valuation made by the assessee. When the Assessing Officer has not found any defect or error in the valuation of shares by the assessee company, it may not be necessary to apply the method of valuation prescribed under Rule 11 UA of the 1. T. Rules. Therefore, this Tribunal is unable to uphold the valuation made by the Assessing Officer under Rule 11 UA of the Income-tax Rules, 1962. 16. In view of the above discussion, orders of both the authorities below are set aside and the addition made both under Section 68 of the Act and under Section 56(2)(viib) of the Act is deleted" The Hon'ble Chennai ITAT in the case of Lalithaa Jewellery Mart (P.) Ltd Vs. ACIT, CC-1(4). Chennai [ITA No. 663 to 665 of2019 has observed that "15. Now coming to valuation of shares, as rightly submitted by the Ld. counsel for the assessee, there are two limbs in 12. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. Section 56(2)(viib) of the Act. As per explanation to Section 56(2)(viib) of the Act, the first limb is valuation to be made as per the prescribed method. In fact. the method for valuation of shares is prescribed under Rule 11 UA of the Income-tax Rules, J 962. The second limb is the valuation of the company based on value on the date of issue including its assets. Assets include intangible assets such as goodwill, knowhow, patents, copyrights, trademarks, licences, franchises, etc. The Assessing Officer has not taken into consideration the second limb in explanation to Section 56(2)(viib) of the Act. The second limb provides that when valuation was made by the company, if the Assessing Officer is not satisfied about the valuation, he has to call for material from the assessee how the valuation was made by the assessee-company. Satisfaction of the Assessing Officer as referred in explanation to Section 56(2)(viib) of the Act would be judicial satisfaction of the Assessing Officer. Judicial satisfaction means the Assessing Officer has to take into consideration the well established method of valuation of shares including the assets as explained in Explanation 2 to Section 56(2)(viib) of the Act. It cannot be arbitrary. The Assessing Officer has to take note of the judicial and established principles in arriving at his satisfaction. In this case, the Assessing Officer has not found any specific fault in rejecting or not satisfying with the valuation made by the assessee. When the Assessing Officer has not found any defect or error in the valuation of shares by the assessee- company, it may not be necessary to apply the method of valuation prescribed under Rule 11 UA of the 1. T. Rules. Therefore, this Tribunal is unable to uphold the valuation made by the Assessing Officer under Rule 11 UA of the Income-tax Rules, 1962”. The aforesaid judgements have clearly held that there is no scope of examining actual results vis a vis projection to determine the correctness of the fair market value at the time of issuance of valuation report. However, for the sake of records, we are clarifying the reason for decline in sales from FY 2014-15 onwards. The manufacturing undertaking of the company had to be closed from FY 2014-15 owing to increased competition arising due to enhancement in production capacity. The assessee company was operating 13. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. from eastern part of the country and most of its customers were located in other locations. The customer found it more economical to buy from units located near to their locations.” 10. A reference was also made vide paper book dt. 24-11-20 containing paper book pages 01 to 171, wherein the assessee has enclosed technical guide on share valuation published by Research Section of the Institute of Chartered Accountants of India (ICAI) (pages 59-153 of said P.B) and Standard of Assurance Engagement (SAE) 3400, The Examination of Prospective Financial Information, issued by the Institute of Chartered Accountants of India (ICAI) (pages 154-171 of the P.B. Further reliance was placed on the following decisions (pages 01-58 of P.B):- a. M/s. Medplus Health Services P.Ltd Vs. ITO W 16(1) ITA No. 871/Hyd/2015, Hon’ble ITAT, Hyderabad b. DCIT 1(2)-2 Vs. M/s. Ozoneland Agro P.Ltd ITA No.4854/Mum/2016, Hon’ble ITAT, Mumbai c. Rameshwaram Strong Glass P.Ltd Vs. ITO,W 2(1) ITA No.884/JP/2016, Hon’ble ITAT, Jaipu r. 11. We have heard the rival contentions and perused the records placed before us and carefully gone through the written submissions filed by the assessee and the decisions referred and relied on both the sides. The revenue’s grievance is that the Ld. CIT(A) erred in deleting the addition made by the Ld. AO on account of receiving of share premium exceeding the fair market value as provided u/s. 56(2)(viib) of the Act. The revenue has also challenged the correctness of valuation certificate prepared by the accountant on the basis of the discounted cash flow free (DCF) method and also raised 14. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. a ground that actual sales during AY 2014-15 was down by 33.64% as against projected sales figure shown in the valuation report. 12. We observe that the assessee during the year under consideration allotted 28000 equity shares at a price of 1,250/- per share Book value of each share as on 31-03-2013 was Rs.15.46/share. The basis of issue price of Rs. 1,250/- was taken by the assessee as per the valuation report prepared by the accountant under rule 11UA(2)(b) of the I.T Rules, 1962. As per rule 11UA(2)(b) the fair market of the unquoted equity shares shall be taken as per the value adopted/computed by merchant banker or an accountant as per discounted free cash flow (DFCF) method. The grievance of the revenue can be summarized in form of the following questions:- Whether the ld. CIT(A) erred in observing that the Ld. AO was not justified in questioning the correctness of the valuation report prepared under DFCF Method(Discounted Free Cash Flow Method)?. 13. We note that the book value of each share as on 31-03-2013 was at Rs.15.46. During the year under appeal i.e. FY 2013-14 28000 equity shares were allotted at a price of Rs.1250/- per share. For establishing that the price of Rs. 1250/- in fair market value of the equity share the assessee filed a valuation report prepared under rule 11UA(2)(b) of the I T Rules, 1962 r.w.r.t explanation a(i) to section 56(2)(viib) of the I.T Act, which reads as under:- 56. (2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head "Income from other sources", namely :— *** *** *** *** *** *** *** *** 15. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. (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 a specified fund; or (ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf: Provided further that where the provisions of this clause have not been applied to a company on account of fulfilment of conditions specified in the notification issued under clause (ii) of the first proviso and such company fails to comply with any of those conditions, then, any consideration received for issue of share that exceeds the fair market value of such share shall be deemed to be the income of that company chargeable to income-tax for the previous year in which such failure has taken place and, it shall also be deemed that the company has under reported the said income in consequence of the misreporting referred to in sub-section (8) and sub- section (9) of section 270A for the said previous year. 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 68 ; 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; (aa) "specified fund" means a fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which has been granted a certificate of registration as a Category I or a Category II Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Fund) Regulations, 2012 made under the Securities and Exchange Board of India Act, 1992 (15 of 1992) 69 [or regulated under the International Financial Services Centres Authority Act, 2019 (50 of 2019)]; (ab) "trust" means a trust established under the Indian Trusts Act, 1882 (2 of 1882) or under any other law for the time being in force; (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; 16. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. 14. For the purpose of calculating fair market value of the unquoted equity shares two methods are provided under rule 11UA(2) of the IT Rules, 1962 and the same are reproduced below: [(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 clause (a) of Explanation to clause (viib) of sub-section (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:— (a) the fair market value of unquoted equity shares =(A-L) x(PV) (PE) where, A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance-sheet as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset; L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:— (i) the paid-up capital in respect of equity shares; (ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company; (iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation; (iv) any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities; 17. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. (vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares; PE = total amount of paid up equity share capital as shown in the balance-sheet; PV = the paid up value of such equity shares; or (b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method. 15. The assessee opted to arrive at the fair market value based on the method provided under clause (b) of 11UA(2) of the I.T Rules, as per which fair market value of unquoted equity shares should be determined by a merchant banker or an accountant as per Discounted Free Cash Flow Method. In the instant case the assessee has got the fair market value of the unquoted equity shares as per the valuation report issued by Chartered Accountant. Ld. AO has doubted the correctness of the contents of the said valuation report. He has also doubted the projections given in the valuation report, which have not been achieved to a large extent. Ld. AO is of the view that the fair market value was not calculated correctly. Before us, Learned Counsel for the assessee has only referred to the judgment in support of the contention that the valuation is not an exact science and therefore, it cannot be done with arithmetic precision. It is further claimed by the assessee that to prepare such report is a technical and complex problem, which can be appropriately left to the consideration and wisdom of experts in the field of accountancy having regard to the imponderables which enter the process of 18. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. valuation of shares. The arguments of the Ld. Counsel of the assessee referring to various judgments (supra) are that the assessee has fulfilled the necessary conditions for getting fair market valuation of unquoted equity shares as per discounted free cash flow method. The projections were made and analysed by technical expert and there can be various circumstances, which may happen in the future, which could hamper the projected achievement of profits and turnover, Therefore, fair market value of unquoted equity share as computed by an expert, which is in this case is an accountant (practising Chartered Accountant) should be accepted, as the actual results are not in control of the assessee. 16. We, however, are of the view that in case the input and projections taken by an accountant are incorrect and wrong assumptions of facts have been taken while preparing the valuation report, the same will result in wrong calculation and in such circumstances fair market valuation of shares may be wrong and if such glaring facts are noticed by Ld. AO, then certainly the Ld. AO is having necessary authority to question such valuation. 17. On perusal of the valuation report, which is placed at pages 93 to 99 of the P.B, certain observations are worth discussing. Firstly, some parts of the valuation report dt. 13-05-2013 reads as under:- “Valuation of shares Is a result of combination of various factors and attended circumstances related to the business which Is being valued. There can be no single method of share valuation, which may be universally applicable. Valuation is an exercise, which Is influenced to a great extent by affecting 19. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. factors and thus is not an exact science or a pure mathematical exercise. The valuer has to further depend upon his Judgment and Imagination to decide about the discounting / capitalization rates to be applied for the valuation. One of the valuation methods is Discounted Free Cash Flow Method (D.F.C.F. Method). This method Involves the valuation based on forecast of future financial projections provided by the management. I have examined the forecast of financial projection of Kushal Polysacks Private Limited of 16, Ganesh Chandra Avenue, Gandhi House, 4th Floor, Kolkata - 700 001 for the Financial year 2014-15 to 2018-19 (five years) and hereafter till perpetuity as given In "Annexure ·1 & Annexure - 2" In accordance with Standard on Assurance Engagement 3400 (AAS 35), The Examination of Prospective Financial Information, Issued by the Institute of Chartered Accountants of India. The preparation and presentation of the forecast Including the underlying assumptions, set out in Annexure - 3 is the responsibility of the management and has been approved by the Board of Directors of the Company. ' My responsibility is to examine the evidence supporting the forecast. My responsibility does not include verification of the forecasts. Therefore, I do not vouch for the accuracy of the same. This forecast has been prepared to find out the fair market value of unquoted Equity Shares for the purpose of sub- clause (i) of clause (a) of Explanation to clause (viib) of subsection (2) of Section 56 of the Income Tax Act, 1961. (Using Discounted Free cash Flow method of valuation). The forecast has been prepared using a set of assumptions as set out In Annexure -3. I have carried out my examination of the forecast of future financial information on a test basis. Based on my examination of the evidence supporting the assumptions, nothing has come to my attention, which causes me to believe that assumptions do not provide a reasonable basis for the forecast. Further, in my opinion the forecast, read 20. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. with the notes thereon, is properly prepared on the basis of the assumptions as set out In Annexure - 3 and on a consistent basis with the historical financial statements, using appropriate accounting principles. I have checked the valuation of Equity Shares of Kushal Polysacks Private Limited as per workings in Annexure 1 to 3 is attached to this report. Based on above, I would opine that the fair value per equity share of Kushal Polysacks Private Limited as on date of this report, is Rs/ 1,256/- under D.F.C.F method as per Explanation (a)(i) to section 56(2)(viib) of the I.T Act, 1961.” 18. In the referred certificate, above reference has been made to Annexure-3 and this annexure is placed at page-97 and the same is reproduced below:- 1. Background I have gone through the projections made by the managements. The future projections have been basically designed from revenue inflows and outflows from the nature of business. 2. Discrete Period The discrete period is considered for 5 years, since the management have forecasted the business cycle for the next 5 years and then a growth rate of 9% on conservative side for the Company. As per Discounted Free Cash Flow Method, Discrete period is a period where the business completes a business cycle and enters into a stable growth rate phase. 3.Discount Rate Discount rate is a rate at which the future free cash flows are discounted to arrive at the Present Value (PV) of the cash flows." Hence the discount rate can be considered at the rate what the Equity Share holders wants from their investments also 21. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. known as Ke. As per Discounted Free Cash Flow Method (D.F.C.F.) the cost Ke is derived by using Modified Capital Asset pricing Model using the formule Ke :; Rf + B [Rrn-Rf + SCRP + CSRP. The details calculation is given in Annexure -4 to this report. The same rate is being considered for discounting the Future Cash Flows which is calculated @ 10%. 4. Income Tax Rate Income Tax rate has been assumed to be 30% plus Education Cess @ 2% plus Senior and Higher Education Cess @ 1% on the total income of the company. 5. General Assumptions a. Working capital requirements have been deemed to be one month's projected operating cost from financial year 2014-2015 onwards and accordingly, the company has proposed to hold Rs. 40,000,000, as additional working capital during 2013-2014 from the cash flow arising during the year. Thereafter, the company proposes to hold additional working capital of one month's additional operating cost proposed during each year. b. The company forecasts that sale of goods will grow at the rate of 20% on an annual basis. 19. On perusal of above, we notice that apart from various assumptions taken by the accountant, one of them, is growth rate of 9% which is expected to be on conservative basis and has been confirmed by the management and the secondly we notice that the projected depreciation expenditure (page-95 of P.B) is reducing year by year, it means that the assessee had no plans to increase the installed capacity by way of purchasing new plant and machinery and other related assets. 22. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. 20. As far as the projections of growth rate of 9% is considered, the basis of the same is certainly from the growth rate achieved in past and more appropriately preceding five years. Certainly one cannot project anticipate the future, but one can reach to arrive at the projected figures on the basis of past performance, which stands achieved and also the future expansion plans. During FYs 2008-09 to 2012-13 the net profit rate of the assessee is 0.22%, 0.47%, 0.81%, 0.79% and 1.26%. Projected net profit & actual net profit rate as per valuation report for FYs. 2013-14 to 2017-18 are as under:- F.Y Projected Actual 2013-14 1.09 0.82 2014-15 2.16 0.74 2015-16 3.11 0.19 2016-17 3.96 1.39 2017-18 4.86 Not available 21. The above cited actual net profit rate has been achieved/taken from the details filed by the Ld.DR. For F.Y 2017-18 only total turnover and gross profit is given and no other details of expenses are mentioned. From the above details of net profit rate, we find that the net profit rate achieved in the preceding five F.Ys is within the range 0.22% to 1.26% and actual net profit rate for FYs 2013-14 to 2016-17 is within the range 0.82 to 1.39%. It has never increase beyond 1.39%. Whereas in the projected figures the net profit is from 1.09% to 4.86%. This facts shows that projections are made on highly inflated side without any past history or any concrete future expansion plans or change of technology. 22. Secondly now moving on to turnover, which has been projected to increase from FYs 2013-14 to 2017-18, there is no indication in the 23. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. report, which could show that what is present installed capacity of the machines held by the company? what is actual achievement of the installed capacity in the preceding year ? what is the quantity which is projected to be manufactured in the subsequent year, since the assessee is engaged in manufacturing of HDPE/PP woven sacs. There is no details available to show the quantities projected to be manufactured vis-à-vis installed capacity of the machines, as no new machines are proposed to be purchased in FYs 2013-14 to 2017-18. 23. Another defect in the valuation report is regarding the growth rate. The management has stated of a growth rate of 9% on conservative basis and the same has been given in the valuation report for calculating the growth rate. The same is not correctly applied as appearing from the working/calculation given in such report. Even if it is presumed that a growth rate is estimated at 9%, we note that net profit rate was 1.26% in FY 2012-13 then optimistically it has to be taken as a base net profit rate for calculating the projections applying the 9% growth rate and on applying the same, the projected net profit rate for FYs 2013-14 to 2017-18 could have been 1.37%, 1.50%, 1.63%, 1.78% and 1.94%. Whereas net profit rate appearing in the forecasted figures are much more than that ranging from 3.11% to 4.86%. The above are few observations, which primafacie indicate that many incorrect inputs have apparently been made by accountant by mistake while preparing the valuation report under DFCF method. 24. Due to such incorrect inputs, which may deem to be termed as apparent mistake, has increased the valuation of shares to exorbitant 24. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. price of Rs.1250/- per share as against the correct fair market value or the book value of Rs.15.48/- per share. Based on such valuation report the prudent investors have invested their hard earned money in the equity shares of the assessee company. Though the shares are unquoted, but that hardly makes any difference, since the fact remains is that an investor has invested in the equity shares of the assessee company at Rs. 1250/- per share looking to the future prospects and earning from such investment. 25. At this juncture, we would like to observe the finding of the co- ordinate bench, ITAT, Delhi in the case of Agro Portfolio P.Ltd (supra) on similar set of facts and circumstances, and the same reads as under:- “14. Even before the Ld.CIT(A) also, as recorded by the Ld. CIT(A) the assessee did not produce any evidence to substantiate the basis of projections in cash flow but relied on the valuer’s report vehemently contending that such a report cannot be disturbed by the Ld. AO. At no point of time tried to explain where did the Ld. AO went wrong in his comments on the figures reflected in the above valuation report of the expert. 15. In these circumstances, we are unable to accept the contentions of the assessee that in view of the provisions under section 56(2)(viib) of the Act read with Rule 11UA(2) of the Rules the Ld. AO had no jurisdiction to adopt a different method than the one adopted by the assessee, and if for any reason the AO has any doubt recording such valuation report and does not agree with the same is bound to make a reference to the Income tax Department Valuation Officer to determine the fair market value of such capital asset. This is so because unless and until the assessee produces the evidences to substantiate the basis of projections in cash flow and provides reasonable connectivity between those projections in cash flow with the reality evidences by the material, it is not possible even for the Departmental Valuation Officer to conduct any exercise of verification of the 25. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. acceptability of the value determine by the merchant banker. This is more particularly in view of the long disclaimer appended by the merchant banker at page no. 16 & 17 of the paper book which clearly establishes that no independent enquiry is caused by merchant banker to verify the truth or otherwise the figures furnished by the assessee at least on test basis. The merchant bankers solely relied upon an assumed without independent verification, the truthfulness accuracy and completeness of the information and the financial data provided by the company. A perusal of this long disclaimer clearly shows that the merchant banker did not do anything reflecting their expertise, except mere applying the formula to the data provided by the assessee. We, therefore, are unable to brush aside the contention of the Revenue that the possibility of tailoring the data by applying the reverse engineering to the pre determined conclusions. 16. For all these reasons, we are of the considered opinion that there has not been any possibility of verifying the correctness or otherwise of the data supplied by the assessee to the merchant banker, in the absence of which the correctness of the result of DCF method cannot be verified. This left no option to the AO but to reject the DCF method and to go by NAV method to determine the FMV of the shares. Without such evidence, it serves no purpose even if the matter is referred to the Department's Valuation Officer. We, therefore, do not find any illegality or irregularity in the approach of conclusions are by the authorities below. While confirming the same, we dismissed the appeal as devoid of merits. 26. Considering the above finding of the tribunal, which is almost applicable in the instant case and also under given facts and circumstances of the case, we find that there are many apparent mistakes, wrong assumption of facts, wrong estimates/projections by the accountant and the management ignoring the past performance of the assessee company, suggestions of management not properly incorporated in the valuation report and various other defects as discussed above, visible in the valuation report of the accountant 26. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. prepared on the DFCF method as provided under Rule 11UA(2)(b) of the I.T Rules calculating the share price at Rs.1,250/- only per share. Therefore, the said report deserves to be discarded for the purpose of calculating the FMV(Fair Market Value). Since the Ld. CIT(A) erred in not examining all the relevant facts and various discrepancies in the valuation report cited and relied on by the assessee, we deem it proper to restore all the issues back to the file of the Ld. CIT(A) for afresh adjudication with the direction that the Ld. CIT(A) shall give necessary directions to the Ld.AO for procuring fresh valuation report from assessee to be prepared by a “merchant banker” so as to arrive at fair market value of the equity shares of the assessee company as on the date of allotment of equity shares. All this information needs to be called by the Ld. CIT(A) through remand report from the Ld. AO. Referring the valuation of fair market value of equity shares to merchant banker and not to the accountant our view is justified in view of the amendment brought in by Income-tax (Sixth Amendment) Rule 2018 w.e.f 24.5.2018, thereby omitting the word ’accountant’ from clause (b) of Rule 11UA(2) of the I.T Rules and only merchant banker is now authorised to do the fair market valuation of the unquoted equity shares as per DFCF method. Further, in case, the assessee is unable to furnish the valuation report at FMV (fair market value) as discussed above from the merchant banker within a considerable and reasonable time, then the Ld. CIT(A) can proceed as per the provisions of section 56(2)(viib) of the Act and decide accordingly. We, therefore, reverse the finding of the Ld. CIT(A) and allow the revenue’s appeal for statistical purpose as per the terms indicated hereinabove. 27. IT(SS)A No. 156/Kol/2017 AY 2014-15 Kushal Polyback P.Ltd. 27. In the result, the appeal of the revenue is allowed for statistical purpose. The order pronounced in the open Court on 26 .05.2022 Sd/- Sd/- (RAJPAL YADAV) (MANISH BORAD) VICE PRESIDENT ACCOUNTANT MEMBER Dated : 26 th May, 2022 **PP/SPS आदेश क त ल प अ े षत / Copy of Order Forwarded to:- 1.अपीलाथ /Appellant/Revenue: DCIT, C.C 1(4), 3 rd Fl., Aaykar Bhavan Poorva, 110 Shanti Pally, Kolkata-107. 2. यथ /Respondent/Assessee: M/s. Kushal Polysack Pvt. Ltd 16 Ganesh Chandra Avenue, Kolkata-700 013. 3. संबं धत आयकर आय ु त / Concerned CIT 4. आयकर आय ु त- अपील / CIT (A) 5. वभागीय त न ध, आयकर अपील य अ धकरण कोलकाता / DR, ITAT, Kolkata 6. गाड फाइल / Guard file. By order/आदेश से, /True Copy/ Assistant Registrar ITAT, Kolkata