Discounted Cash Flow method most appropriate for determining arm’s length value of shares

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The Chennai Bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of VIHI LLC formerly known as Visteon International Holdings Inc. held that Discounted Cash Flow (DCF) method is …

The Chennai Bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of VIHI LLC formerly known as Visteon International Holdings Inc. held that Discounted Cash Flow (DCF) method is preferable over the Yield method or Net Asset Value method prescribed in guidelines of the Comptroller of Capital Issues (CCI Guidelines) for determining the arm’s length price for sale of shares.

Relying on the ruling in the case of Ascendas (India) Private Limited, the Tribunal held that the valuation of shares based on the erstwhile CCI Guidelines, as required under the then prevalent FEMA Regulations, were for a different purpose and cannot be applied for arm’s length price determination

The Tribunal also upheld the principle of consistency, ruling that DCF method should be applied, since the same was accepted in the subsequent Assessment Year 2008-09.

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  • 1. KPMG FLASH NEWS KPMG IN INDIA Discounted Cash Flow method most appropriate for determining arm’s length value of shares 10 December 2013 Background Recently, the Chennai Bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of VIHI LLC formerly 1 known as Visteon International Holdings Inc. (the taxpayer) held that Discounted Cash Flow (DCF) method is preferable over the Yield method or Net Asset Value (NAV) method prescribed in guidelines of the Comptroller of Capital Issues (CCI Guidelines) for determining the Arm’s Length Price (ALP) for sale of shares. Relying on the ruling in the case of Ascendas (India) 2 Private Limited , the Tribunal held that the valuation of shares based on the erstwhile CCI Guidelines, as required under the then prevalent Foreign Exchange Management Act, 1999 (FEMA) Regulations, were for a different purpose and cannot be applied for ALP determination. _________________ 1 2 VIHI LLC v. ADIT (ITA No. 17(Mds.)/2012) Ascendas (India) Private Limited v. DCIT (ITA No. 1736/Mds/2011) The Tribunal also upheld the principle of consistency, ruling that DCF method should be applied, since the same was accepted in the subsequent Assessment Year (AY) 2008-09. Facts of the case  The taxpayer held 91 percent shares in Visteon Powertrain Control Systems India Pvt. Ltd. (Visteon India). The entire stake in Visteon India was transferred by the taxpayer to its AEs; namely Visteon Holdings Singapore Pte. Ltd., Singapore and Visteon Holdings Mauritius Ltd., Mauritius.  The taxpayer had arrived at the transfer price of INR 10.32 per share against the face value of INR 10 per share, based on the valuation certificate of Deloitte Haskins and Sells, Chartered Accountants. Relying on the CCI Guidelines, the valuation was done using the Net Asset Value (NAV) method and the Profit Earning Capacity Value (PECV) method. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  • 2.    As per the valuation, the value of share was INR 15.05 per share using NAV method and INR 9.23 per share using PECV method. The taxpayer adopted the average of the two values, further discounting it by 15 percent, since the shares were unlisted. Tax department’s contentions   The above adjustment was also upheld by the Dispute Resolution Panel (DRP). Applicability of computation provisions under Section 92C of the Income-tax Act, 1961 (the Act) and use of CCI Guidelines over DCF method.    During the year under consideration, only five methods were prescribed and none of the five methods were applicable to the transaction. The sixth method was, ‘Such other method prescribed by the Board and the Board had not prescribed any such method. Hence, computation provisions with reference to ALP failed and Section 92C of the Act cannot be applied, relying on the Supreme Court ruling in the case of B.C. 3 Srinivasa Setty . The objective of CCI Guidelines and Transfer Pricing are the same i.e., to ensure that the shares are not underpriced when transferred. The fact that the DCF method was introduced prospectively, cannot be used to disregard the existing provisions which allowed yield method. The yield method is more appropriate to value shares for a private limited company as it takes into account the profit making capability of the company. In this regard, the taxpayer relied on the Supreme Court 4 ruling in the case of Mahadeo Jalan and Calcutta High Court ruling in the case of Balbhadradas 5 Bangur . The taxpayer contended that if a DCF method of valuation has to be applied, it should be given an opportunity to submit its valuation using the DCF method, similar to the proceedings before the DRP in AY 2008-09. ________________ 3 4 5 Valuation based on CCI Guidelines provided by the taxpayer cannot be equated with determination of ALP.  The DCF method was accepted in the taxpayer’s own case in the subsequent AY 2008-09 and hence, consistency needs to be adopted.  The tax department contended that the taxpayer was already provided with an opportunity by the Transfer Pricing Officer (TPO) and the taxpayer failed to submit a DCF valuation, hence, it is too late. Also the parameters laid down by the TPO to compute the DCF value for the impugned AY are correct and proper. Taxpayer’s Contentions  The endeavour is only to arrive at a value that would give a comparable uncontrolled price and therefore, any method may be accepted for computing ALP.  The Transfer Pricing Officer (TPO) adopted the DCF method and called for a fresh valuation using DCF. When the taxpayer failed to furnish the same, the TPO performed a DCF analysis and valued the share at INR 36.31 per share and made a TP adjustment. Issue before the Tribunal Relying on the ruling in the case of Ascendas (India) Private Limited, the tax department raised the following contentions: Tribunal’s ruling  Relying on the Chennai Tribunal ruling in the case of Ascendas (India) Private Limited, the Tribunal held that it is not necessary to ignore the methods because the methods are not watertight compartments and reflect the acceptability of permissible methods.  Again, drawing reference to the ruling of Ascendas (India) Private Limited, the Tribunal held that the purpose of introducing CCI Guidelines were different and does not apply for arm’s length computation. The Tribunal further held that the DCF method is the most appropriate method to determine the value of shares, since the taxpayer himself accepted the DCF method in the subsequent year.  However, the Tribunal accepted the taxpayer’s argument that a fresh DCF analysis be presented before the TPO. Accordingly, the Tribunal restored the matter to the TPO for arriving at the value afresh as per standard practices and based on the principles and parameters adopted in AY 2008-09. CIT v. B.C Srinivasa Setty [1981] 128 ITR 294 (SC) Commissioner of Wealth Tax v. Mahadeo Jalan [1972] 86 ITR 621 (SC) Commisioner of Wealth Tax v. Balbhadradas Bangur [1984] 148 ITR 149 (Cal) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  • 3. Our comments This is another ruling in the context of a much debated issue on share valuation pertaining to transfer of shares of an India entity as part of group restructuring, where the transactions were valued based on erstwhile CCI Guidelines. However, in this case, the taxpayer was the non-resident transferor of shares. The Chennai Tribunal, relying on its own ruling in the case of Ascendas (India) Private Limited has ruled that DCF is the most appropriate valuation method for transactions pertaining to transfer of shares, regardless of the requirement under the Exchange Control Guidelines. The Tribunal has followed the rule of consistency with the subsequent year’s approach and has directed to use same assumptions for computing the DCF valuation. It would be prudent for taxpayers to prepare and submit their own valuation of shares using DCF method, even for past years when it was not a requirement under FEMA Guidelines. Further, taxpayers would need to review all assumptions, parameters and bring on record all commercial and economic considerations relevant to arrive at an appropriate share value. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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