DELHI HIGH COURT: VALUATION OF UNQUOTED EQUITY SHARES USING THE DCF METHOD PERMISSIBLE UNDER INCOME TAX RULES
Introduction
The Delhi High Court in its order dated 30th May 2025 in Principal Commissioner of Income Tax-1 v. M/s A.H. Multisoft Pvt. Ltd. [ITA No. 9/2025], has upheld the Discounted Cash Flow (DCF) method as a valid valuation technique for unquoted equity shares under Rule 11UA of the Income Tax Rules, 1962. The Court dismissed the Revenue’s challenge against the use of a merchant banker-certified DCF valuation. It reinforced that the Assessing Officer (AO) cannot arbitrarily substitute the valuation method unless the DCF assumptions are patently erroneous or made mala fide.
Parties Involved:
Appellant: Principal Chief Commissioner of Income Tax-1
Respondent: A.H. Multisoft Pvt. Ltd.
Facts of the case
The dispute pertained to the valuation of shares issued by the Respondent, a private company, at a premium based on a DCF method certified by a merchant banker. The AO disregarded the DCF method, substituted it with the Net Asset Value (NAV) method, and made additions under Section 56(2)(viib) of the Income Tax Act, 1961, treating the premium received as income from other sources.
Issue
Whether the AO was justified in rejecting the DCF-based share valuation certified by a qualified merchant banker and substituting it with the NAV method, thereby invoking Section 56(2)(viib) of the Income Tax Act, 1961?
Arguments
Appellant’s Arguments:
The Revenue contended that the financial projections used in the DCF report were speculative and inconsistent with the company’s past performance. It argued that the actual business outcomes did not align with the optimistic projections, thus rendering the DCF valuation unreliable. Hence, the AO adopted the NAV method to revalue the shares and taxed the differential under Section 56(2)(viib).
Respondent’s Arguments:
The Respondent maintained that Rule 11UA(2)(b) explicitly allows valuation of unquoted equity shares using the DCF method. The valuation was duly certified by a SEBI-registered Category-I merchant banker, and the AO had no jurisdiction to substitute it with an alternate method in the absence of evidence indicating fraud or manifest error in the valuation assumptions. It further argued that valuation is forward-looking and cannot be invalidated merely because future outcomes differ from projections.
Held
The Delhi High Court observed that the Income Tax Rules permit the use of the DCF method and that such valuation, once certified by a qualified professional, cannot be lightly disregarded. The Court emphasised that valuation is not an exact science and involves estimations based on the information available at the relevant time. It held that the AO is not empowered to replace a DCF valuation with NAV merely based on hindsight or speculative discrepancies in projections. Unless the DCF valuation is patently absurd or mala fide, it cannot be rejected. Accordingly, the Court dismissed the Revenue’s appeal and upheld the decision of the Income Tax Appellate Tribunal (ITAT), which had ruled in favour of the Assessee.
Conclusion
The Delhi High Court reaffirmed that a DCF valuation certified by a qualified merchant banker is a valid method under Rule 11UA of the Income Tax Rules. The ruling safeguards taxpayers from arbitrary reassessment of valuations by the tax authorities and provides legal certainty for share issuances, particularly by start-ups and private companies.
Takeaway
This judgement reinforces the principle that:
- Certified DCF valuations are valid under the Income Tax Rules.
- The AO cannot substitute valuation methods without clear evidence of irrationality or mala fide intent.
- Future business outcomes do not invalidate bona fide projections used for DCF valuation.