Ginni Global Pvt. Ltd. v. Assistant Commissioner Of Income Tax, Circle-2, Alwar .

PER: VIKRAM SINGH YADAV, A.M. This is an appeal filed by the assessee against the order of ld. CIT(A)-22, Alwar dated 09.08.2018 for A.Y 2013-14 wherein the assessee has taken the following grounds of appeal:-

1. That the CIT(A) erred in upholding addition of Rs. 99,22,000/- made by the Assessing Officer alleging that preference shares have been issued at a price more than the fair market value without correctly appreciating the facts of the case and also the provisions of section 56(2)(viib) of the Act read with Rule 11UA of Income-tax Rules. ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT 2.That the CIT(A) erred in upholding the addition of Rs.99,22,000/- in respect of preference shares issued by the company without appreciating that the company had correctly determined the NAV as per Rule 11UA of Income-tax Rules whereas the Assessing Officer had committed patent mistake in determining the NAV as he had excluded the amount of preference share capital from the net value but had divided the net value by the number of preference shares and the CIT(A) failed to understand the mistake in calculations pointed out by the company.

3. That the CIT(A) erred in upholding the addition in respect of preference shares issued during the year without appreciating that the company had duly submitted report of Chartered Accountants before the Assessing Officer determining the fair market value and the Assessing Officer had not pointed out any mistake in the report but had proceeded to determine the NAV in the manner which was inconsistent with report of the Chartered Accountants as well as Rule 11UA of Income-tax Rules. 4.That the CIT(A) erred in upholding disallowance of Rs.2,85,835/-made by the Assessing Officer in respect of depreciation claimed by the company on residential building without appreciating that since no rate had been prescribed in Appendix-IA for residential building, depreciation was allowable as per rates provided in Appendix-I on WDV method.

5. That the CIT(A) also erred in not considering and adjudicating the alternative ground raised by the company that in case rate of depreciation of 3.02% as was provided in Schedule-IA was applicable to residential building also then depreciation ought to have been allowed on SLM basis and not on the basis of WDV.

2. Regarding ground no. 1- 3, briefly stated, the facts of the case are that during the year under consideration, the assesee company has ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT issued 2,00,000 preference shares of Rs. 100 each @ premium of Rs.

100 per share. During the course of assessment proceedings, the assessee was asked to submit calculation of fair market value for the purposes of section 56(2)(viib) of the Act. In response, the assessee submitted its justification for valuation of preference shares at premium and also submitted valuation report from a Chartered Accountant. However, such valuation was not found acceptable to the Assessing Officer and referring to the provisions of section 56(2)(viib) read with Rule 11UA, the AO determined the fair market value of preference shares at Rs. 150.39 per share. Therefore, the excess amount received by the assessee over and above the fair market value amounting to Rs. 99,22,000/- was brought to tax as income under the head Income from other sources.

3. Being aggrieved, the assessee carried the mater in appeal before the ld. CIT(A) who has confirmed the order of the AO and his findings are as under:- In the present case both the A.O. and the appellant through the chartered accountant has valued the shares on NAV basis. However, I have found that the valuation adopted by the chartered accountant has taken after discount of 3-4%/ Further, the A.O has rightly adopted the value by excluding preferential shares from the valuation. Preferred shares are not included in your standard market cap calculation because their characteristics are more like debt, thus equity value to common shareholders is reduced by amounts owed to preferred shareholders. With publicly traded companies, preferred shareholders are essentially debt holders entitled to a periodic (generally annual) interest payment equal to the par value of the preferred shares ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT multiplied by a pre-stated preferred dividend percentage, determined at issuance. In view of the factual matrix of the case and on the basis of provisions as contained in section 56(2) (viib) of the Act to be read with Rule 11UA(2) of IT Rules, 1962, it is may considered view that the shares are allotted to M/s Jasmine Barter Pvt. Ltd at a value higher than the market value and therefore, A.O. is justified in making addition of Rs. 99,22,000/- U/s 56(2) of the Act. Accordingly, the addition of Rs. 99,22,000/- is sustained. Appellants ground of appeal on this issue is dismissed.

4. Against the aforesaid findings of the ld CIT(A), the assessee is now in appeal before us. During the course of hearing, the ld. AR submitted that provisions of section 56(2)(viib) are not applicable in the case of issue of preference shares. It was further submitted that even where it is held that provisions of section 56(2)(viib) are applicable in the instant case, the valuation of preference shares have to be done as per clause (c) of Rule 11UA(1) and not Rule 11UA(2) which has been invoked by the ld. CIT(A). It was submitted that Rule 11UA(1)(c) provides that the fair market value of unquoted shares and securities other than equity shares shall be deemed to be the price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation. It was submitted that the assessee has obtained the report of a Chartered Accountant wherein he has fully explained the valuation methodology of determining the value of preference shares and fair value of proposed preference share of the company has been determined at Rs. 200/- and which has not been rightly appreciated by the lower authorities. It was accordingly submitted that the order ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT passed by the ld. CIT(A) may be set aside and the valuation so adopted by the assesse duly supported by the valuation report should be accepted.

5. Per contra, the ld. DR has relied on the finding of the lower authorities and submitted that the valuation of preference shares has been rightly determined by the Assessing Officer which has been confirmed by the ld CIT(A). He supported the findings of the lower authorities.

6. We have heard the rival contentions and purused the material available on record. We have gone through the provisions of section 56(2)(viib) and it dosent make any distinction between equity shares and preference shares and therefore, the first contention of the ld. AR cannot be accepted. Regarding the valuation of the preference shares, the valuation should be determined as per Rule 11UA(1)(c) which requires the assessee to obtain a report from a merchant banker or a Chartered Accountant to determine the price which preference shares will fetch if sold in the open market on the valuation date. In this regard, we refer to the valuation report issued by the Chartered Accountant and the relevant extract of the valuation report is reproduced as under:- C. Valuation Methodology While ascertaining the valuation of each redeemable Preference share of the company as at on 31.03.2012 even though we have relied upon the basic framework of valuation methodology but at the same time we have given due weightage to the exercise of discretion ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT and judgment needed to arrive at a fair and equitable value of each such Preference share of the company as on 31.03.2012. However, while ascertaining the valuation of such Preference share we have not carried out any due diligence or conducted any financial or technical feasibility study of the company. One of the most widely used model for valuing preference shares of the companies is the Dividend Discount Model. However, such methodology is used when preference shares do not carry any other rights such as redemption premium, conversion right etc and holder of such share only get predetermined coupon rate of dividend. Since proposed issue of preference shares will get substantial redemption premium besides option to convert the same into equity shares of the company before due date of redemption therefore, Dividend discount model is not suitable method for ascertaining fair value of such Preference shares. Further since the Preference shares to be valued are optionally convertible shares , convertible into equity shares of the company, therefore , essential characteristic on exercise of conversion option is that of equity shares and hence Net Asset value method for valuation of these shares need to be considered . Since, proposed preference share has two options namely:-

1. Redemption after a tenure of 12 years

2. Conversion into equity shares Therefore, valuation need to carried out considering both the above options. ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT OPTION - I Redemption after tenure of 12 years Preference shares are proposed to be redeemed at a redemption premium of 8% p.a i.e at a value of Rs 196 /- after 12 years. Therefore, on the basis of redemption value, fair value of such preference shares can be worked out as Rs 196/- per shares specially when such shares are entitled for dividend upto 20% p.a. Option-II Conversion of preference shares into equity shares Since Preference shares have an option to convert the same into equity shares, therefore, such shares will have a characteristic of equity shares also. We have worked out valuation on the basis of net assets, a method prescribed under Rule 11UA of Income tax, using the net assets values as per audited financial statements of the company as at 31st March 2012. Computation of Fair Value Per Share as per Net Asset value Method: The fair value per equity share (presuming conversion of existing preference shares in accordance with the rights attached with them) is computed as below:- Particulars Value in Rs. NET ASSET VALUE METHOD Share holder fund (including equity value after conversion of existing preference shares, as per terms of their issue) 8,79,50,000 Add: Reserve and surplus 12,45,03,096 ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT Total Funds available for shareholder as at on 31.03.2012(A) 21,24,53,096 No of existing equity shares 3,10,000 Add: new equity share on conversion of existing preference shares 84,85,000 Total no of equity shares (B) 87,95,000 Value of equity share (face value Rs. 10/-) A/B 24.16 Value of preference share (face value Rs. 100) 241.60 Computation of Fair value as per weighted average of both the above options: Computation of Fair value Price Weightage Fair value on the basis of redemption value 196.00 3 Fair value on the basis of conversion right 241.60 1 Average Value 207.40 4 We have assigned more weightage to fair value based on redemption value basis than conversion right basis as Balsio project of the company is still under implementation and Taraila project was under restoration as on 31.03.2012, therefore, risk & return on both the project were uncertain as on 31.03.2012. E. Option Moreover since, liquidation market of above preference shares are limited and tenure of proposed preference share are 12 years, therefore, considering restricted liquidity, we are of the opinion that fair value of proposed preference share as calculated above is further to be discounted by 3 to 4 % so as to determine its most precise fair value and thus we are of the opinion that fair value of the proposed preference share of the ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT company will be about Rs. 200/- per share. It is the value which such preference share can fetch if sold in the open market based on the information available and as per above valuation methodology.

7. The Revenue has not disputed the adoption of the NAV method by the assessee. Therefore, once the NAV method has been accepted, what has to be determined is the valuation of the preference shares based on net asset value as on the date of issue of such preference shares. The valuation date thus has to be the date of issuance of preference shares and not as per the last balance sheet date as has been adopted currently. The net asset value is determined by applying the formula where difference between the total assets and total liabilities as on the date of issuance of shares is divided by total amount of paid up capital of the company and multiplied by paid up value of new shares. In the instant case, given that there are existing equity and preference share capital, paid capital in respect of both of these category of shares shall be considered for determining total paid up capital of the company. In the result, we set-aside the matter to the file of the AO who shall determine the value of the preference shares as per the NAV method based on formula discussed above and such valuation has to be determined as on the date of issuance of such preference shares. In the result, the ground of appeal is allowed for statistical purposes.

8. In ground no. 4 & 5, the assessee has challenged the rate of depreciation of 3.02% on W.D.V basis as against 5% on W.D.V basis applied by the assessee in respect of housing colony for accommodation of staff involved in the power project. In this regard, it is noted that the assessee in respect of other assets belonging to the power projects have computed depreciation on SLM basis as per section 32(1)(i), however, in respect of housing colony, the depreciation has been claimed on W.D.V ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT basis. As per section 32(1)(i), in case of assets of an undertaking engaged in generation or generation and distribution of power, such percerntage on the actual cost thereof to the assessee as may be prescribed. The rates of depreciation on all such assets of the undertaking engaged in the power projects thus have to be computed on SLM basis and the assessee cannot pick and choose certain assets and claim depreciation on SLM and on other assets, claim depreciation on WDV basis. The housing colony is very much part of the business assets of the undertaking involved in the power projects and thus, depreciation thereon has to be computed on SLM Basis. As far as rate of depreciation is concerned, the housing colony will fall in the residuary category (vi)- others under clause (d) Buildings and civil engineering works of permanent nature and the rate of depreciation which has been prescribed is 3.02%. In light of the same, the Assessing officer is directed to compute the depreciation on housing colony at the rate of 3.02% on SLM Basis. In the result, the ground of appeal no. 4 is dismissed and ground no. 5 is allowed. In the result, appeal of the assessee is disposed off in light of above directions. Order pronounced in the Open Court on 02/05/2019. Sd/- Sd/- fot; iky jko foe flag ;kno (Vijay Pal Rao) (Vikram Singh Yadav) U;kf;d lnL;@Judicial Member ys[kk lnL;@Accountant Member Tk;iqj@Jaipur fnukad@Dated:- 02/05/2019 *Ganesh Kr. vkns'k dh izfrfyfi vxzsfkr@Copy of the order forwarded to:

1. vihykFkhZ@The Appellant- M/s Ginni Global Pvt. Ltd., Alwar ITA No. 1009/JP/2018 M/s Ginni Global Pvt. Ltd. vs. ACIT

2. izR;FkhZ@ The Respondent- The ACIT, Circle-2, Alwar

3. vk;dj vk;qDr@ CIT

4. vk;dj vk;qDr@ CIT(A)

5. foHkkxh; izfrfuf/k] vk;dj vihyh; vf/kdj.k] t;iqj@DR, ITAT, Jaipur.

6. xkMZ QkbZy@ Guard File {ITA No. 1009/JP/2018} vkns'kkuqlkj@ By order, lgk;d iathdkj@Asst. Registrar