The Karnataka High Court has ruled that the fair market value (FMV) of shares determined through statutory methods cannot be arbitrarily rejected by the Income Tax Department. This decision was delivered in Income Tax Appeal No. 425 of 2023, where the Revenue had challenged the Tribunal’s ruling favoring the assessee, Waterline Hotels Pvt. Ltd.

The case was heard by Justice Krishna S. Dixit and Justice Ramachandra D. Huddar, who upheld the Tribunal’s findings that the valuation report based on the Discounted Cash Flow (DCF) method, submitted by a Chartered Accountant, was valid and justified the share valuation.

Background of the Case

The Revenue appealed against the Tribunal’s order dated September 13, 2022, which had set aside the addition of Rs. 33,71,77,500 made under Section 56(2)(viib) of the Income Tax Act, 1961. The Revenue contended that the share premium collected by the assessee was excessive and lacked a proper basis for valuation, especially given the company’s financial losses.

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The key issues raised by the Revenue were:

1. Whether the Tribunal was correct in deleting the addition under Section 56(2)(viib), which was intended to tax unaccounted income brought into the books through inflated share premiums.
2. Whether the Tribunal’s order was perverse, as it disregarded the Assessing Officer’s findings that no proper valuation report was obtained.
3. Whether the valuation done using the DCF method was valid, considering the lack of basis for future income projections.

Observations of the Tribunal

The Tribunal carefully examined the matter and held that the DCF method used by the assessee for valuation was valid. It noted that:

“The lower authorities rejected the DCF method merely on the ground that it was not scientific and that the assessee was incurring losses, thereby ruling out any premium valuation.”

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The Tribunal emphasized that the rejection was made without analyzing the detailed calculations used by the assessee to arrive at the valuation.

Furthermore, the Tribunal observed:

“The Assessing Officer’s rejection was based on an objective satisfaction rather than a subjective analysis of the facts and figures presented in the valuation report.”

After reviewing the Tribunal’s findings, the High Court concurred with the assessee’s argument that the valuation was determined using one of the statutorily designated methods under Rule 11UA(2) of the Income Tax Rules. The Court ruled that:

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“The fair market value of shares, as determined by a statutory method, cannot be dismissed without proper reasoning or an alternative valuation by the authorities.”

The Court found no merit in the Revenue’s appeal and ruled in favor of the assessee, dismissing the appeal with costs made easy.

Case Title: The PR. Commissioner of Income Tax

Case Number: INCOME TAX APPEAL NO. 425 OF 2023

Counsel for Appellant/ Department: YV Raviraj and M Dilip

Counsel for Respondent/ Assessee: S Shankar and Madhusudhan