The Income Tax Appellate Tribunal, Delhi Bench 'F', has held that when a company elects to determine the fair market value of unquoted shares using the Discounted Cash Flow method as permitted under Rule 11UA(2), the Assessing Officer cannot reject such valuation merely on the grounds of perceived commercial unreasonableness or post-facto performance mismatch. The Tribunal emphasized that valuation is inherently speculative and based on projections, and the revenue cannot substitute its own judgment for that of a qualified valuer.
The Verdict
The assessee won. The Income Tax Appellate Tribunal deleted additions of Rs.49 lakh under Section 68 and Rs.26.39 lakh under Section 56(2)(viib), holding that the identity, creditworthiness, and genuineness of share subscribers were sufficiently established. It further held that the valuation of shares using the Discounted Cash Flow method under Rule 11UA(2) must be accepted unless the revenue produces contrary evidence. The Tribunal also quashed enhancements made without a show cause notice under Section 250(1).
Background & Facts
The appellant, Rivet Health Club Pvt. Ltd., filed its return for A.Y. 2015-16 declaring income of Rs.2.15 lakh. The case was selected for scrutiny under CASS. During assessment, the Assessing Officer noted that the company had issued 2,35,000 equity shares at a premium of Rs.30 per share, raising Rs.94 lakh in share capital and premium from five entities. The AO questioned the identity, creditworthiness, and genuineness of these investors, treating the entire amount as unexplained income under Section 68.
The AO also invoked Section 56(2)(viib) to make a protective addition of Rs.26.39 lakh, based on the Net Asset Value method, rejecting the company’s own valuation report prepared under the Discounted Cash Flow method. Additional disallowances were made for business expenses and interest income discrepancies. The Commissioner of Income Tax (Appeals) upheld the Section 68 addition of Rs.49 lakh and the Section 56(2)(viib) addition, but partially allowed other grounds.
The appeal was filed 49 days late, but the Tribunal condoned the delay, accepting the explanation that the original CA was incapacitated due to health issues. The appellant challenged all additions, arguing that the investors’ credentials were fully documented and the DCF valuation was legally permissible.
The Legal Issue
The central legal questions were: (1) Whether the identity, creditworthiness, and genuineness of share subscribers have been sufficiently established to discharge the burden under Section 68? (2) Whether the Assessing Officer can reject a valuation of unquoted shares determined by a qualified valuer using the Discounted Cash Flow method under Rule 11UA(2), merely because the company’s subsequent performance did not match projected forecasts?
Arguments Presented
For the Petitioner
The petitioner argued that the identity of all five investors was established through incorporation certificates, audited financials, bank statements, PAN details, and ROC filings. The transaction was routed through banking channels, and the investors confirmed their investments. Reliance was placed on Supreme Court decisions in PCIT v. Rohtak Chain Co. and CIT v. Lovely Exports, which held that once the investor’s credentials are verified, the amount cannot be treated as unexplained income. Regarding Section 56(2)(viib), the petitioner submitted that Rule 11UA(2) explicitly permits the use of the DCF method, and the valuation report was prepared by a qualified Chartered Accountant. The Tribunal was urged to follow its own coordinate bench decision in Cinestan Entertainment, which held that the AO cannot substitute his own view for that of a prescribed valuer.
For the Respondent
The Revenue contended that the investors were "paper companies" with no genuine business activity, citing that one investor’s address was non-existent. It argued that the premium was excessive and not commercially justified, and that the DCF projections were unrealistic. The Revenue maintained that the protective addition under Section 56(2)(viib) was necessary to prevent tax evasion and that the AO was entitled to question the reasonableness of the valuation. It relied on the CIT(A)’s order and the earlier decision in Agro Portfolio Pvt. Ltd., which had rejected DCF valuations.
The Court's Analysis
The Tribunal first addressed the Section 68 addition. It noted that the assessee had furnished comprehensive documentation - certificates of incorporation, audited financials, bank statements, share certificates, and investor confirmations - for all three disputed investors: Goodluck Industries, Texcity Constructions, and Ganga Shiv Contractors. The Tribunal relied on the Supreme Court’s ruling in PCIT v. Rohtak Chain Co., which held that once the identity, creditworthiness, and genuineness of investors are established, no addition can be made merely because shares were issued at a premium. The Court emphasized that premium determination is a commercial decision of the board of directors, and the revenue cannot act as an armchair businessman.
"Once the genuineness, creditworthiness and identity are established, the revenue should not justifiably claim to put itself in the armchair of a businessman or in the position of the Board of Directors and assume the role of ascertaining how much is a reasonable premium having regard to the circumstances of the case."
Regarding Section 56(2)(viib), the Tribunal held that Rule 11UA(2) grants the assessee an explicit option to choose between the NAV method and the DCF method. The DCF method, by its nature, relies on future projections, not historical results. The Tribunal cited multiple judgments, including from the Bombay High Court and ITAT Jaipur, affirming that valuation is not an exact science and cannot be judged by hindsight. The AO’s rejection of the DCF valuation merely because actual profits fell short of projections was legally unsustainable.
"Valuation being an exercise required to be conducted at a particular point of time has of necessity to be carried out on the basis of whatever information is available on the date of the valuation and a projection of future revenue that valuer may fairly make on the basis of such information."
The Tribunal further held that Section 56(2)(viib) is a deeming provision and must be strictly construed. Since the law provides a prescribed method and a qualified valuer, the AO has no statutory power to substitute his own valuation or demand a different method. The rejection of the DCF report without any contrary expert evidence was arbitrary.
The Tribunal also set aside the enhancement of income under Section 250(1) for lack of a mandatory show cause notice and deleted the interest income addition due to the AO’s reliance on incorrect figures from the original return.
What This Means For Similar Cases
This judgment significantly strengthens the position of startups and private companies issuing shares at a premium. Practitioners can now confidently rely on DCF-based valuations under Rule 11UA(2) without fear of arbitrary rejection by Assessing Officers. The ruling reinforces that commercial wisdom, future projections, and risk-taking are inherent to business and cannot be second-guessed by tax authorities.
For future litigation, taxpayers must ensure that DCF valuations are prepared by qualified professionals, with clear documentation of assumptions, discount rates, and growth projections. The burden now lies squarely on the revenue to produce contrary expert evidence if it wishes to challenge such valuations.
The judgment also clarifies that Section 68 cannot be invoked merely on suspicion of shell companies if the investor’s credentials are documented. The revenue must independently investigate the investors’ returns if it suspects tax evasion, rather than treating their investments as undisclosed income of the recipient company.
This decision is binding on all Assessing Officers and CIT(A)s within the Tribunal’s jurisdiction and carries persuasive value nationwide. It aligns with the government’s policy of encouraging startup investments and reduces litigation risk for companies raising capital through private equity.
