DCF Method of Valuation is Valid for Start-Up Companies u/s 145(3) of Income Tax Act: ITAT [Read Order]

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has upheld the use of the Discounted Cash Flow (DCF) method for the valuation of shares of start-up companies and held that the DCF method is a recognized method of valuation for section 145(3) of the Income Tax Act, 1961.

The assessee, Thinkstations Learning, a private limited company, focused on providing effective education using integrated education and teacher training. They allotted 1,42,856 equity shares at a face value of Rs.10/- for a premium of Rs.130/- per share. The assessee adopted the DCF method, which is a recognized valuation method that discounted future cash flows to present value. 

The valuation report was prepared by a qualified valuer, assuming growth at a CAGR of 25% for the next five years and a net profit of Rs.100 crore by the end of the 5th year. However, the Assessing Officer discarded the DCF method and adopted the net assessed liability method, determining the fair market value of shares at Rs.5.80 per share. The assessee challenged the order and the Commissioner of Income Tax (Appeals) (CIT(A)) in this appeal.

The AO Argued that the DCF approach is not a reliable means of valuing start-up enterprises since it is dependent on projections of the future that may or may not be correct. The assessee had produced no earnings in the prior years, making the DCF approach even less dependable.

Assessee claimed that the DCF approach is a known valuation method, and it is the best way for assessing start-up enterprises. The DCF model's assumptions were fair, and the approach was founded on strong financial principles. Because the Assessing Officer had not presented an alternative method of valuation, he was not justified in rejecting the DCF technique.

The Tribunal observed that the assessee was a start-up company and that it had not yet generated any profits and the Assessing Officer had not provided any justification for rejecting the DCF method.

The Two member Bench of N.K. Billaiya (Accountant Member) and C.N. Prasad (Judicial Member)  allowed the appeal of the assessee and held that the Assessing Officer erred in discarding the DCF method of valuation of shares adopted by the assessee.

Further held that the DCF method is a reliable method of valuation for start-up companies and that the assumptions used in the DCF model were reasonable. The Tribunal also observed that the Assessing Officer had not provided any alternate method of valuation and that he was therefore not justified in discarding the DCF method.

To Read the full text of the Order CLICK HERE

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