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). (A. Y. 2007-08)
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