Kiran Raj

In a decision addressing the interpretation of Section 56(2)(viib) of the Income Tax Act, 1961, the High Court of Karnataka dismissed the Revenue’s appeal and upheld the order of the Income Tax Appellate Tribunal (ITAT), Bengaluru, which had deleted an addition of ₹33,71,77,500 made towards share premium. The Division Bench comprising Justice Krishna S Dixit and Justice Ramachandra D. Huddar recorded that “the valuation done by the assessee cannot be rejected without recording any finding to the contrary by the lower authorities” and affirmed that the valuation was conducted using a method statutorily permitted under Rule 11UA(2) of the Income Tax Rules.

Dismissing the appeal, the Court stated: “The substantial questions of law raised in the appeal are answered against the Revenue and eventually in favour of the Assessee. Accordingly, appeal is dismissed, costs having been made easy.” The Court declined to interfere with the Tribunal’s construction of the statutory provision and recorded that the Revenue had not adequately examined the basis of the share valuation report before discarding it.

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The appeal arose from the assessment proceedings for the Assessment Year 2013-14 involving Waterline Hotels Pvt. Ltd. The assessing officer noted from the company’s balance sheet that ₹33,71,77,500 had been received as securities premium upon the issuance of 2,04,35,000 equity shares of ₹10 each at a premium of ₹165 per share. These shares had been allotted to M/s UKN Properties Pvt. Ltd. (13,00,000 shares), M/s Kshema Geo Holdings Pvt. Ltd. (6,33,000 shares), Mr. Gautam Nambisan (65,000 shares), and M/s Glow Crane Project (45,500 shares).

The Assessing Officer, relying on Section 56(2)(viib) of the Income Tax Act, contended that the premium charged lacked justification, particularly as the assessee company was incurring losses. It was further stated in the assessment proceedings that a common director of the assessee and one of the investor companies had allegedly informed survey officers on 18 November 2015 that no valuation report had been obtained prior to issuing the shares. Accordingly, the addition of ₹33.71 crore was made on the ground that unaccounted income had been introduced into the books in the form of share premium.

Challenging the ITAT’s deletion of the addition, the Revenue formulated the following substantial questions of law: whether the Tribunal was right in law to delete the addition under Section 56(2)(viib) in light of the absence of a valuation report, the assessee’s financial losses, and the lack of substantiation of the share value; and whether the Tribunal’s decision was perverse given the findings recorded by the assessing authority and the Commissioner of Income Tax (Appeals).

The Revenue submitted that the valuation report produced by the assessee, based on the Discounted Cash Flow (DCF) method, lacked scientific justification and that the authorities had correctly disallowed the premium. The Revenue contended that the Tribunal failed to appreciate the absence of a reliable basis for the share valuation.

Conversely, the assessee argued that the share valuation had been conducted using a method recognised by law under Rule 11UA(2), and the report was prepared by a qualified Chartered Accountant. It was submitted that projections under the DCF method were supported by a Joint Development Agreement (JDA), and the lower authorities had rejected the valuation report without any detailed analysis of the underlying data or projections.

The Court recorded that the Tribunal had construed Section 56(2)(viib) by applying the statutorily prescribed valuation methods. The Court stated: “The Tribunal has construed the subject provision of the Act keeping in view the fair market value of the shares in question and not the premium amount.” It was further recorded that the Tribunal had accepted the DCF valuation submitted by the assessee and noted that the Revenue had not scrutinised the methodology employed in arriving at the share value.

Referring to the Tribunal’s findings at paragraph 18, the Court recorded: “The lower authorities have rejected the DCF method of valuation on the ground that the same is not based on any scientific method and that since the assessee is making a loss, there is no possibility of valuing the shares of the assessee at a premium. Further, the lower authorities have not gone into the details used by the assessee under DCF method to arrive at the valuation and rejected the entire methodology as adopted by the assessee.”

The Court noted the Tribunal’s observation regarding the Revenue’s reliance on a statement given during survey proceedings, stating: “One of the reasons as quoted by the AO for not considering the valuation report is that the Director during the survey proceedings has stated that there is no valuation report. We are unable to appreciate this reason for rejection as the satisfaction to be recorded by the AO should not be objective satisfaction exercised at his discretion, but a subjective satisfaction based on the facts of the case.”

In paragraph 19 of the Tribunal’s order, cited in the judgment, it was stated: “We hold that the valuation done by the assessee cannot be rejected without recording any finding to the contrary by the lower authorities and therefore we delete the addition made in this regard.”

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The Court concluded that the Tribunal’s order was based on a proper understanding of the law and the facts presented. It was held that the authorities erred in rejecting the valuation without examining the underlying assumptions or data used in the DCF method.

The High Court dismissed the appeal and upheld the ITAT’s order, recording: “In the above circumstances, the substantial questions of law raised in the appeal are answered against the Revenue and eventually in favour of the Assessee. Accordingly, appeal is dismissed, costs having been made easy.”

Advocates representing the parties:

For the Appellants: Sri. Y V Raviraj, Advocate for Sri. M Dilip, Advocate

For the Respondents: Sri. S Shankar, Senior Counsel along with Sri. Madhusudhan U A, Advocate

Case Title: The Pr. Commissioner of Income Tax Central and The Deputy Commissioner of Income Tax versus Waterline Hotels Pvt. Ltd.
Neutral Citation: 2025:KHC:9397-DB
Case Number: ITA No. 425 of 2023
Bench: Justice Krishna S Dixit and Justice Ramachandra D. Huddar

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