Supreme Court Upholds Profit-Earning Method for Valuation of Shares in Private Investment Company

Tribunal’s refusal to refer valuation method question upheld; break-up method not applicable to going concern companies

In a landmark judgment delivered on December 5, 1979, the Supreme Court of India dismissed appeals filed by the Commissioner of Gift Tax, Bombay, and the Commissioner of Wealth Tax against several respondents, including Smt. Kusumben D. Mahadevia and others. The appeals revolved around the appropriate method to value shares of a private limited investment company, Mafatlal Gagalbhai Pvt. Ltd., for the purpose of Gift Tax Act, 1958, and Wealth Tax Act, 1957.

The issue before the Court was whether the shares should be valued solely by the profit-earning method, as claimed by the assessees, or by a combination of the profit-earning method and the break-up method, as argued by the Revenue. The Tribunal had earlier rejected the Revenue’s appeal and accepted the profit-earning method valuation prepared by M/s. C.C. Choksy and Co., Chartered Accountants. Dissatisfied, the Revenue sought a legal reference from the Tribunal and subsequently from the High Court, which were both declined, leading to these appeals before the Supreme Court.

The Supreme Court, in an elaborate analysis, relied heavily on its prior decision in Commissioner of Wealth Tax v. Mahadeo Jalan (1972) 86 ITR 621, which laid down the principles for valuation of shares. The Court clarified that:

1. For shares of a public limited company quoted on the stock exchange, the market price on the valuation date is the value.

2. For shares of an unquoted public limited company or a private limited company, the value should ordinarily be determined by reference to the company’s profit-earning capacity, often reflected through dividends or average maintainable profits.

3. The break-up method, which values shares based on the company’s asset value as if it were to be wound up, is appropriate only in exceptional circumstances, such as when the company is ripe for liquidation or when profit-earning capacity cannot be reasonably estimated due to uncertainty.

4. In investment companies, asset backing is relevant only as a factor to estimate profit-earning capacity, not as a basis to adopt the break-up method exclusively.

5. Combining the break-up method and profit-earning method by averaging is unscientific and lacks judicial sanction.

The Court held that Mafatlal Gagalbhai Pvt. Ltd. was a going concern and not ripe for winding up; therefore, the profit-earning method was the correct valuation method. The Tribunal’s refusal to refer the legal question to the High Court was justified as the question was conclusively settled by the Mahadeo Jalan case. The Supreme Court further rejected the Revenue’s contention that under Rule 10(2) of the Gift Tax Rules, the break-up method should be the primary method for valuation, noting that this issue was never raised or decided by the Tribunal and thus did not arise from its order.

Consequently, the Supreme Court dismissed all the appeals with costs, affirming the Tribunal’s reliance on the profit-earning method for valuation of shares in private limited investment companies.

This judgment reinforces the principle that valuation of shares in a going concern private limited company should be primarily based on its profit-earning capacity, providing clarity and consistency in the application of tax laws concerning gift and wealth tax assessments.

Statutory provisions

Gift Tax Act, 1958 Section 6(1), Section 6(3); Wealth Tax Act, 1957 Section 7(1); Rule 10(2) of the Gift Tax Rules

Commissioner of Gift Tax, Bombay v. Kusumben D. Mahadevia, (SC) : Law Finder Doc Id # 104435