Delhi High Court Upholds DCF-Based Share Valuation Method by CA Valuer

The Assessee is in the business of providing software support/maintenance services and prior to financial year [FY] 2015-16 held a strategic equity stake of 20% in SAFL. Undisputedly, SAFL is a valuable company having 39 FM broadcasting licenses and FM radio business across various cities in India. SAFL at the material time also held 49% shares in digital broadcasting companies (three in number) owning FM radio licenses in metro cities of Delhi, Mumbai and Calcutta. All FM stations were operated under a common and well-known brand named ‘Red FM’. The entire share capital of SAFL was held by three entities: the Assessee held 20%; Sun TV Ltd. (a listed company) held 60% of the shareholding, and South Asia Multimedia Technology Ltd., a Mauritian company, held 20% of the equity capital.

SAFL was required to raise funds for investing in its business and had accordingly offered rights issue at a price of Rs. 20/- per share, including a share premium of Rs. 10/-. The rights issue were fully subscribed and each of the three shareholders subscribed to the rights issue in the ratio of their holding.

The Assessee subscribed to 2,63,00,000/- shares of SAFL at an aggregate value of Rs. 20/- (face value of Rs. 10/- plus premium value of Rs. 10/-) aggregating to Rs. 52,60,00,000/-. It is relevant to note that a Chartered Accountant (Mr. K.V. Sriram) had determined the FMV of the shares issued by SAFL. In terms of the valuation report dated 17.08.2015, SAFL’s net equity value was determined at Rs. 51,905.83 lacs as per DCF method. The said valuation has not been disputed. It is also not disputed that the Reserve Bank of India [RBI] has also not objected to the subscription of shares by South Asia Multimedia Technologies Ltd. at the price at which the rights shares of SAFL were allotted.

The Assessee required to raise funds for subscribing to the rights issue offered by SAFL and thus in turn it offered rights issue to its shareholders: Mr. Arjun Rao who held 51% of the Assessee’s subscribed capital and Max Flexi Services Pvt. Ltd. which held 49% of the Assessee’s issued and subscribed share capital.

For the purpose of determining the FMV, the Assessee engaged an expert, J.N. Sharma & Co. (Chartered Accountant). The said expert furnished the valuation report dated 21.09.2015 determining the FMV of the shares of the Assessee at Rs. 2771.65 per share and on the basis of the said valuation the Assessee issued a total number of 1,08,976 equity shares to its shareholders at a value of Rs. 2,772/- per share including a share premium of Rs. 2,762/- per share, to its shareholders. The subscription proceeds aggregated Rs. 30,48,53,463/-.

The AO did not accept the said valuation as he, inter alia, found that there were certain disclaimers in the valuation report furnished by the Chartered Accountant. The AO found that these disclaimers contained in the report rendered the determination of FMV unreliable. The AO proceeded to determine the FMV of the shares issued by the Assessee at its book value and concluded that the same was negative. Therefore, added a sum of Rs. 30,37,53,712/- as the Assessee’s income from other sources under Section 56(2)(viib) of the Act. The learned CIT(A) upheld the said decision.

As noted above, the learned ITAT faulted the AO and the CIT(A) in not accepting the valuation as submitted by the Assessee.

Revenue argued that the valuation method was defective and unsubstantiated. As per revenue DCF valuation included unreliable assumptions and disclaimers.

Revenue contended that Rule 11UA valuation was either ignored or improperly applied, and the Assessee attempted to bypass Section 56(2)(viib) by overvaluing shares.

On the other hand respondent said that the valuation was done strictly by DCF as per Rule 11UA(2)(b), and disclaimers were standard and did not render the valuation invalid.

The Court found no merit in Revenue’s contention and upheld the ITAT’s order.

Refer to the official notification for more information.