16 March 2021
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The Finance Minister (“FM”) introduced her promised ‘never like before Budget’, with the objective of stimulating economic growth through higher spending on healthcare and infrastructure, against the backdrop of the economic slowdown caused by the Covid-19 pandemic. The FM has also proposed a slew of reforms under the Finance Bill, 2021 (“Bill”), to rationalize the extant provisions of the Income-tax Act, 1961 (“IT Act”). Certain proposals introduced in the Bill could significantly impact M&A deals and change the traditional modus operandi of M&A transactions in India. The ensuing paragraphs will focus on a few such significant amendments proposed in the Bill, which may require close consideration by stakeholders before entering an M&A transaction, be it amalgamation, share acquisition or an acquisition of business as a going concern.
Surgical strike on ‘slump exchange’
‘Slump sale’ has been defined under the IT Act to mean transfer of a business undertaking, as a result of sale, for a lump sum consideration. Any transaction falling within the scope of ‘slump sale’ is subject to provisions of Section 50B of the IT Act, which stipulates simplified manner of computation of gains arising from slump sale, which may, in some cases, result in potentially lower tax incidence for the transferor. The term slump sale has been a litigious issue for years, especially in case of slump exchange, i.e. where the consideration for transfer of an undertaking was discharged through exchange of another asset (typically by issuance of shares of the acquirer entity), would fall within the purview of the term ‘slump sale’. The Bombay High Court had, in the case of CIT v. Bharat Bijlee (2014) 365 ITR 258, held that slump exchange cannot be considered as ‘slump sale’ under the IT Act. After going through the submissions placed before it by both sides, the Hon’ble High Court had agreed with the views expressed by the Mumbai ITAT and held that the transferor would not be liable to capital gains tax because slump exchange cannot be subject to tax. This decision has subsequently been followed by a few other Courts as well.
The Bill seeks to clarify this issue and proposes to amend the definition of slump sale with, any transfer (i.e. including exchange, relinquishment, etc.) of a business undertaking, by any means, would be liable to tax as slump sale. The term slump sale has been extended to include ‘slump exchange’ as well. Against the backdrop of judicial decisions like Bharat Bijlee, several taxpayers had used slump exchange as an effective tool to optimise their tax planning. With the proposed amendment, the ratio laid down in such judicial precedents may become infructuous and it will not be tax efficient for the taxpayers to structure divestment transactions as slump exchanges. It would also be relevant to note that this provision has been introduced from April 1, 2020, thus, taxpayers entering into slump exchanges in FY 2020-21, may also be required to pay capital gains tax on gains arising from such transactions.
Though this clarification would put to bed the controversy regarding the taxability of slump exchanges, the ambiguity on certain other issues surrounding slump sale continues to persist, such as the methodology to be adopted to determine the value of non-monetary consideration, whether milestone-based payments would qualify as a part of lump sum consideration, etc.
Depreciation on Goodwill to go bad!
It is not uncommon for an acquirer to pay a price over the fair market value of the assets in an M&A transaction, which is recorded as ‘goodwill’. The availability of depreciation on such goodwill has been a matter of dispute since depreciation on goodwill was neither expressly allowed nor denied. However, from a commercial perspective, taxpayers used to claim such depreciation on acquired goodwill by classifying it as an intangible asset, by classifying it as any other business or commercial rights of similar nature. Moreover, while there was no challenge in claiming depreciation on acquired goodwill (for which consideration was paid by the acquirer), there used to be huge uncertainty about goodwill, which originated through notional adjustments. The Supreme Court in 2012, in its decision of CIT v. Smifs Securities Ltd. (2012) 348 ITR 302 (SC), rendered its landmark decision and allowed depreciation on acquired goodwill.
The Bill intends to nullify the Supreme Court judgment and proposes to amend the IT Act to clarify that ‘goodwill’ is not a depreciable asset. The memorandum to the Bill stipulates that goodwill may see appreciation or no depreciation to its value, depending on how the business is run by the acquirer and hence, there is no justification to claim depreciation on goodwill. The Bill also proposes a number of other amendments to the IT Act in order to clarify that goodwill is not a depreciable asset. The IT Act is also proposed to be amended to provide that depreciation already claimed on the acquired goodwill will be reduced from the cost of acquisition of such goodwill and the remainder will continue to be carried in the books of acquirer as an intangible asset. The said balance shall be available as an adjustment against the ultimate sale price as and when the said business is sold by the acquirer.
This is likely to have significant impact on the M&A transactions, especially transactions that have been structured on the basis of availability of depreciation on goodwill. Further, transactions involving acquisition of considerable quantum of intangible assets may be significantly impacted as the seller’s powers to negotiate for higher price on account of brand and goodwill may be weakened on account of such proposed amendments. However, it must be noted that the above amendment proposes to disallow depreciation only on what is characterised as goodwill in the books of account. In case the intangible assets acquired through the transaction is classified as any other business or commercial rights of similar nature, they must be allowed to claim depreciation on such intangible assets. Moreover, this differentiation in depreciation may give rise to a permanent difference between the statutory books of account of the acquirer and its tax books of account because the acquirer shall continue to be required to capitalise and subsequently depreciate its intangible assets recorded as goodwill.
Thus, with the proposed amendment overturning the years of jurisprudence developed by the Indian courts, taxpayers would have to bear in mind non-availability of depreciation on acquired goodwill and the other concerns discussed above, at the time of negotiating the deals.
Reassessing the timeline for re-opening assessment
As per the Bill, the timeline for issuing a notice for reassessment to a taxpayer has been reduced to three years from six years. However, in case there is evidence with the tax officer for income escaping assessment of INR 5 million or more, a notice for reassessment can be issued up to 10 years from the relevant assessment year. Further, as per the proposed provisions, now the tax officers would also have to satisfy certain specified conditions before issuing a re-assessment notice. It is also important to note that the said increased period of assessment shall be applicable only if the tax authorities have books of account or evidence, which reveal that the income chargeable to tax, represented in the form of an asset, has escaped assessment, amounting to rupees fifty lakhs (five million) or more. This aspect may become extremely contentious to establish.
These provisions have been introduced to increase ease of business and reduce overall litigation in the country on account of re-assessment. These provisions could have a bearing at the time of negotiating the amount and the time limit for tax related indemnity under M&A deals.
Conclusion
With the legislature over-turning various precedents and introducing additional compliance provisions, M&A transactions may become costlier in the future and the concerned taxpayer may have to negotiate these bumpy roads ahead. The silver lining in these proposed amendments is that long drawn controversies surrounding the issues of depreciation of goodwill, taxation of slump sale, etc., have been put to rest. It has become imperative for the transacting parties to examine these provisions carefully, before structuring their transactions, as any incorrect structuring may lead to a significant exposure for them.
For further information, please contact:
Kunal Savani, Partner, Cyril Amarchand Mangaldas
kunal.savani@cyrilshroff.com
