The Delhi High Court has upheld that taxpayers can choose an option for Angel Tax valuation. However, the Income Tax Department can go for independent Fair Market Value (FMV) determination. Experts feel that the method adopted by the department should not be different from that used by taxpayers.

In the matter of Agra Portfolio and the Income Tax Department, the method in question was Discounted Cash Flow (DCF) to determine Fair Market Value (FMV). DCF refers to a valuation method that estimates the value of an investment using its expected future cash flows. Accordingly, the present value of expected future cash flows is arrived at by using a projected discount rate. Based on that, an unlisted company allots shares to the angel investor.

The Income Tax Department did not accept the valuation. It independently ascertained the face value of the shares by adopting the Net Asset Value (NAV) method. This method is applied to fund valuation and pricing, which is arrived at by dividing the difference between assets and liabilities by the number of shares held by investors.

Because of the different methods adopted, the value of a share ascertained by the IT Department was much lower than what the firm reported. Since it received no relief from the Income Tax Appellate Tribunal (ITAT), the firm moved the High Court.

The Court observed that the IT Department can doubt or reject the valuation report adopted by the taxpayer. However, the law does not empower the department to independently evaluate the face value of the unquoted shares by adopting a valuation method other than the one chosen by the taxpayer, the Court said.

It also said various sections of the IT Act and IT Rules clearly stipulate that the option and choice of method for fair market valuation vests solely with the taxpayers. The court observed that the IT Department can scrutinise the valuation report and determine a fresh valuation, either itself or through an independent valuer, to confront the taxpayer, but the basis has to be the method already adopted by him.

Accordingly, the Court remitted the matter back to the IT Department to undertake valuation afresh in accordance with the DCF method  

Commenting on the ruling, Amit Maheshwari, Tax Partner with AKM Global, said when a taxpayer’s chosen valuation method is rejected, it is crucial to understand that hindsight should not be applied, as many companies raise investments based on future projections. Moreover, “a significant aspect emphasised in this case is that if the tax department is dissatisfied with the valuation chosen by the taxpayer, it can carry out an independent valuation. However, it is imperative that the valuation method should align with the one initially adopted by the taxpayer,” he said.