By Amrish Shah, Madhvi Jajoo and Shefali Ganatra
The government has repeatedly brought in appropriate amendments, rules and clarifications to streamline the tax law and discourage tax avoidance schemes which typically defeat the purpose of the law. One such critical amendment which impacts the deal space is the introduction of the deemed fair value concept for business transfers, introduced during the recent changes to the Income Tax Act (the Act) and the newly prescribed rules for determining the same.
Transfer of a capital asset typically triggers capital gains in the hands of the seller, and the rate of tax depends upon the type of capital asset transferred and the period of holding of such asset in the hands of the seller. Transfer of business as a going concern has been regarded as a capital asset and thus, such transfer attracts capital gains tax if the business is transferred for a lump sum consideration i.e. without assigning specific values to each constituent of the business (commonly referred to as ‘slump sale’).
There have been several ambiguities as far as the taxation of business transfer is concerned and most of them have been ironed out by the government vide Finance Act, 2021 with effect from April 1, 2020. Presently, the tax law provides for deemed fair valuation rules for specified asset transfers. In a situation where the sale consideration of the asset being transferred is lower than the deemed fair value so determined, then for the purpose of computing capital gains, the actual sale consideration is replaced by such deemed fair value. Till financial year 2020, for the purpose of business transfer pursuant to a slump sale, the tax law did not provide for any deemed fair valuation mechanism and thus, predominantly sale value disclosed by the seller would be the considered for computing capital gain tax.
As per the rules notified by the Central Board of Direct Taxes, the consideration for business transfer or slump sale shall be computed based on the higher of the following:
A. Net book value of assets less liabilities transferred with substitution of fair value for prescribed assets (i.e. jewellery, artistic work, shares, securities and immovable property); or
B. The actual consideration received by the seller. In case non-monetary consideration is received then the fair market value of such non-monetary consideration (as determined by the mechanism stated in point A. above) would be the deemed consideration.
With regards to point A. above the substituted fair value for – (i) immovable property, it shall be the stamp duty value, (ii) equity shares it will be the adjusted net asset value of the underlying company, and (iii) jewellery, artistic work, non-equity shares and any other securities would be the price it would fetch in the open market.
The moot point to consider is that while the genesis of slump sale / business sale under the Act is that the transfer should be consummated without assigning specific values to the assets and liabilities, the rules framed under the same for deemed fair value provide for a mechanism to determine the specific value for each asset (i.e. either book value or specified fair value). This is likely to cause challenges for the corporates while maintaining that the transaction they have entered into is a slump sale if questioned by the Revenue authorities.
The above rules for computing tax fair value for business transfer are applicable irrespective of whether the transaction is with related parties or with unrelated / third parties and shall be applicable from financial year 2020-2021.
The amendment pursuant to Finance Act, 2021 is effective from 1 April 2020 and it would impact the transactions already concluded before the amendment came into light. The same may lead to a revision in the provision for tax for taxpayers, in cases where the business transferred involves the specified assets and there is an upward revision in the sale consideration due to the newly incorporated deeming fiction in law. This may also give rise to outflow of interest on account of short payment of advance tax for financial year 2020-2021. Even the corporates which have adopted their financial statements prior to the rules being prescribed would have to factor this aspect.
In addition, as the fair value rules prescribe a specific mechanism to determine the deemed fair value of immovable property or any other goods (forming part of the business undertaking), it gives rise to a grey area as to whether the buyer would be obligated to deduct tax at source at the time of their transfer.
We will have to wait and watch as to whether the new rules will provide clarity or spur a debate amongst the taxpayers and the Revenue authorities.
(The authors are Amrish Shah – Partner with Deloitte India, Madhvi Jajoo – Senior Manager with Deloitte Haskins and Sells LLP and Shefali Ganatra – Deputy Manager with Deloitte Haskins and Sells LLP)