Transfer Pricing: Law on valuation of shares of a closely held company explained

Ascendas (India) Pvt. Ltd vs. DCIT (ITAT Chennai)

The assessee held 50% of the shares in L&T Infocity Asendas Ltd (“LTIAL”) while the rest were held by L&T Infocity Ltd. The assessee and L&T Infocity agreed to sell their entire holding in LTIAL to Ascendas Property Fund India (“APFI”), an AE of the assessee for a consolidated price of Rs. 79 crores. The assessee also held shares in Ascendas (India) IT Park Ltd (“AITPL”) which was also separately sold to APFI. The assessee claimed that the shares were sold at arms’ length price on the basis that (a) with regard to LTIAL, a third party (L&T Infocity) had sold its holding at the same price as that of the assessee and so the price was supported by “internal CUP” and (b) with regard to AITPL, the valuation was determined by a CA in accordance with the Controller of Capital Issues (CCI) Valuation guidelines. The TPO/AO & DRP held that the transfer of shares in LTIAL by L&T Infocity to APFI was not an “uncontrolled comparable transaction” and so the argument of “internal CUP” was not available. With regard to the transfer of shares in AITPL, it was held that the valuation based on CCI guidelines was not acceptable. Instead, the valuation of both sets of shareholdings was determined on the basis of the “Discounted Cash Flow (DCF)” method for valuation of an enterprise and an addition of Rs. 239 crores was made. On appeal by the assessee to the Tribunal, HELD:



(i) Though s. 92C(1) provides that the arm’s length price in relation to an international transaction “shall” be determined by any of the methods set out therein, the selection of the method cannot be done with a water-tight attitude as such an interpretation will defeat the very purpose of enactment of transfer pricing rules and regulations and also detrimentally affect the effective and fair administration of an international tax regime. There may be difficulties in ascertaining the fair market value, but such difficulties should not be a reason for not adapting the prescribed methods. Some subtle adjustments in the methodology prescribed for evaluation of an international transaction are required to be done;



(ii) To a transaction of sale of shares in a closely held company, none of the six methods prescribed in s. 92C & Rule 10B apply. Accordingly, while determining the most appropriate method, the modern valuation methods fitting the type of underlying service or commodities cannot be ignored. Fixing enterprise value based on discounted value of future profits or cash flow is a method used worldwide. The endeavor is only to arrive at a value which would give a comparable uncontrolled price for the shares sold. Viewed from this angle, the discounted cash flow method adopted by the TPO is in accordance with s. 92C(1);



(iii) The assessee’s argument, with regard to the sale of shares in LTIAL, that the price is at ALP as per the CUP method as a third party (L&T Infocity) sold the same shares at the same price to the same buyer is not acceptable because the sale of shares by L&T Infocity to APFI cannot be said to be uncontrolled. The fact that a common agreement for sale of the shares for a consolidated sum was entered into by the assessee with L&T Infocity shows that the transaction was not independent but was a joint effort;



(iv) The assessee’s argument, with regard to the sale of shares in AITPL, that the TPO was bound by the CCI guidelines on valuation of shares is also not acceptable because the CCI guidelines were issued for a totally different purpose and cannot be transported into a pricing methodology prescribed for fixing ALP. Instead, the Discounted Cash Flow method for valuation is an accepted international methodology for valuing enterprises and for determining the value of the holding of an investor. Investors are interested in ascertaining the present value of their investments, considering the future earning potential of the underlying asset. Ascertaining the net present value of future earnings is more appropriate where market value of an investment is not readily ascertainable by conventional methods;



(v) The value of equity can be obtained in two methods under the Discounted Cash Flow method. The first method is to discount the cash flow expected from the equity investment and the second method is to ascertain the value of the enterprise by applying DCF on its future earnings and then dividing it with the number of shares. The most important aspect in the application of DCF is the discounting factor used for working out the net present value (NPV). The factor generally used is the Weighted Average Cost of capital. The difficult parts are (i) determining the future cash flows, (ii) determining the cost of equity, (iii) determining the cost of debt and (iv) determining the period of discounting. For a valuation to have some amount of objectivity the variables must be considered within a reasonable limit so that acceptable values can be arrived at. Even a slight change in the discounting ratio will result in substantial change in the valuation of the company. If the ALP of the shares are worked out without considering a reasonable value for the enterprise, it will result in injustice. (Matter remanded to the TPO for a reworking).

See also Tally Solutions 130 TTJ 234 (Bang) where the “Excess Earning Method” was upheld as the method for determining the ALP of IPRs