India: Taxpayer's Choice For Valuation Of Shares At Premium Upheld

Last Updated: 20 November 2018
Article by Daksha Baxi, Surajkumar Shetty and Ankit Namdeo

The Income Tax Appellate Tribunal (ITAT) in the case of M/s. Rameshwaram Strong Glass (P) Ltd. v The Income Tax Officer1 has upheld the right of the company issuing shares to choose the valuation methodology under the provisions of the Income Tax Act, 1961 (IT Act) read with the rules framed thereunder (Tax Law) for the purposes of determining the 'fair market value' (FMV) of such shares at premium. It held that the tax authorities cannot require the taxpayer to change the valuation method adopted by it, when the Tax Law grants an option to select either the Net Asset Value (NAV) method or the Discounted Cash Flow (DCF) method. Under section 56(2)(viib) of the IT Act, when a closely held company issues shares at premium to residents, if the premium is more than what is justified by the value of shares, as per the valuation rules prescribed, then the difference is taxed as 'income from other sources' in the hands of such company.

Facts

The taxpayer in the instant case was a startup private limited company (Company), with no business activities in the relevant financial year except the purchase of an immovable property worth INR 3.27 lakhs. In the year under dispute, the Company had issued 140,000 equity shares with a face value of INR 10 each at a premium of INR 60 per share receiving a total premium of INR 84 lakhs over and above the share application money of INR 14 lakhs. The Assessing Officer (AO) sought justification for issuance of shares at premium in the face of the Company not having any worth except the underlying immovable property.

The AO was of the view that a prerequisite to issuing a share premium is substantial increase in the net worth mainly due to profitability, credibility, goodwill, etc. The Company in its response outlined that receipt of share premium was a 'capital receipt' and commercial decision not requiring justification under the law. Disagreeing with the submission of the Company, the AO taxed the difference between the aggregate share premium and the FMV of shares based on the NAV. Aggrieved by the order passed by the AO, the Company appealed before the Commissioner of Income Tax (Appeals), which decided the issue in favor of the AO, but directed the AO to revise computation to correct arithmetical errors. The Company moved the ITAT against the order of the first appellate authority.

The ITAT held that the tax authorities cannot compel a taxpayer to choose any one particular method prescribed under section 56(2)(viib) of the IT Act and Rule 11UA(2) of the Income Tax Rules, 1962 (IT Rules) – i.e. the NAV or DCF method – when the law has specifically vested the choice of option on the taxpayers and the taxpayer has exercised the option. Permitting the tax authorities to do so will render the clause (b) of Rule 11UA (2) irrelevant and purposeless. The ITAT relied on the case of ITO Vs M/s Universal Polysack (India) Pvt. Ltd.2 wherein the Coordinate Bench of ITAT Jaipur held that the exercise of such an option by the taxpayer is not subject to fulfillment of any specified conditions and it is left to the sole discretion of the taxpayer.

The ITAT also observed that the tax authorities can scrutinise the valuation report to the extent of finding any arithmetical mistakes. The ITAT also observed that the tax authorities are entitled to scrutinise the valuation report and determine a fresh valuation either by themselves or by calling for a final determination from an independent valuer to confront taxpayers if the tax authorities find that the workings of the valuer or the assumptions made are erroneous or contradictory. In such cases, the tax authorities may suggest necessary modifications and alterations to the valuation reports provided the same are based on sound reasoning and rationale. However, even in such cases, it is not open to the tax authorities to change the method of valuation, which has been opted by the taxpayer. Further, the tax authorities cannot ask taxpayers to submit valuation reports based on the actual numbers of subsequent years, which were the subject matter of DCF valuation.

CAM Comments

The above judgment will have a bearing on transactions involving fresh issuances of shares by closely held companies in India. It upholds the right of the taxpayer to opt for a method that the taxpayer considers appropriate and at the same time cautions that the valuation report must be justifiable as it is open to scrutiny for appropriateness and independent verification if tax authorities find the submitted report unacceptable.

It is important to note that the said Rule 11UA(2)(b) of the IT Rules has been amended recently, and the DCF valuation can only be undertaken by a merchant banker and not by a chartered accountant. In several cases, the tax authorities had compared actual performance of companies with the projections used by them for arriving at a value under the DCF method. In case of deviations in actual numbers and projections, tax authorities used to reject the DCF valuation used by the relevant company and treat excess premium as income of the company.

This decision should be helpful in reducing uncertainties for companies issuing shares at premium in justifiable situations and is thus welcome.

Footnotes

[1] ITA 884/JP/2016 dated July 12, 2018.

[2] I.T.A. 609/JP/2017 dated January 31, 2018.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
 
Email Address
Company Name
Password
Confirm Password
Position
Industry
Mondaq Newsalert
Select Topics
Select Regions
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions