It is not uncommon for Companies to engage in complex restructuring arrangements to leverage their tax positions and make some tax savings by the side. Slump sale has always been one such popular restructuring route sought by corporates, usually looking for partial hive-offs from existing businesses.

The Finance Act, 2021 has brought in significant amendments as regards the scope of “slump sale”. Further, the newly notified rule 11UAE has provided the valuation mechanism to give effect to the relevant amendments.

Author, Ms. Yutika Lohia (Manager, Vinod Kothari Consultants Pvt. Ltd.) in this article, discusses the amendments to Slump sale provisions in the context of possible tax evasions corporates indulge in through such restructuring transactions, and the Revenue's endeavour to plug related loopholes. She further discusses the implication of the newly inserted Rule 11UAE for determination of fair market value of capital assets in computation of capital gains.

“Gov’s attempt to make Slump Sale “Fair”

Introduction

The income tax laws of the country has been witnessing dynamic changes over the years. The tax authorities are understanding the bottlenecks within their current tax system and proposing changes to mobilize revenue, promote investments and also to cope up with the present gaps.

On the other hand, with such dynamicity in laws, income tax or otherwise, companies often find themselves struggling to keep at par with the economy, and hence taking the restructuring route – slump sale being one option. The authorities are identifying the areas where there has been loss of revenue to the government and accordingly making changes in the tax laws.

Slump sale is one of the modes of business restructuring process and attracts capital gain under section 50B of the IT Act. Prior to Finance Act 2021, full value of consideration was the lumpsum value agreed between the buyer and seller considered while computing capital gains.  Post Finance Act 2021, a new clause was inserted in sub section 2 of section 50B of the IT Act, where “Fair market value of the capital assets as on the date of transfer, calculated in the prescribed manner, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset.”

The IT Department has introduced new rule for computation of fair market value of capital assets which shall be the full value of consideration while computing capital gains in case of a slump sale. The rules are an anti abuse measures to restrict the practice of sale of business at under value.

In this write up, we shall discuss the changes made by Finance Act 2021 in case of a slump sale, new rule for computation of fair market value of capital asset and its implications.

Widening the scope of slump sale by Finance Act 2021

Definition of slump sale

Prior to Finance Act 2021, the Indian Tax Law defined slump sale as transfer of one or more undertaking as a result of sale for a lump sum consideration without values being assigned to individual assets and liabilities.

However, the Finance Act 2021, extended the scope of “slump sale” under section 2(42C) of the IT Act and inserted an Explanation to the said section so as to provide that the word “transfer” shall have the same meaning assigned to in section 2(47) of the IT Act.

Earlier the definition of “slump sale” considered only those transfer where there was monetary consideration and transfer like exchange with property or shares were not covered under the scope of slump sale. Therefore, to widen the definition, the Finance Act 2021 covered those transactions which were just not restricted to sale and but also covered all kinds of transfer.     

Fair Market value Computation

Earlier for computing capital gains in case of a slump sale, net worth of the undertaking was reduced from full value of consideration. The Finance Act 2021, amended the capital gain computation provision and introduced the Fair Market Value approach. To say, full value of consideration shall be replaced by the fair market value of the undertaking.

Net worth Computation

For computation of net worth, a new clause has been added where cost of goodwill which has not been acquired by the taxpayer by purchase from previous owner has to be taken at NIL

Notification issued by CBDT

The Central Board of Direct Taxes vide its Notification dated 24^th May, 2021 has notified a new rule i.e., Rule 11UAE of the Income Tax Rules 1962, for computation of fair market of capital assets in case of a slump sale.

Rule 11UAE has introduced two methods of fair market value calculation i.e., FMV1 and FMV2 and higher among the two shall be considered while computing capital gains for slump sale transaction.

• FMV1 shall be the fair market value of the capital assets transferred by way of slump sale

• FMV2 shall be the fair market value of the consideration received or accruing as a result of transfer by way of slump sale

The fair market value of the capital assets under sub-rule (2) and sub-rule (3) shall be determined on the date of slump sale and for this purpose valuation date referred to in rule 11UA shall also mean the date of slump sale

The two FMVs shall be determined in accordance with the formula discussed below.

FMV1 approach        

As per sub rule (2) of Rule 11UAE, we may call it adjusted NAV approach where book value of all assets other than jewellery, artistic work, shares, securities and immovable property shall be considered.

FMV1 = A+B+C+D-L, where,

A= book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) as appearing in the books of accounts of the undertaking or the division transferred by way of slump sale as reduced by the following amount which relate to such undertaking or the division, —

(i) any amount of income-tax paid, if any, less the amount of income-tax refund claimed, if any; and

(ii) any amount shown as asset including the unamortised amount of deferred expenditure which does not represent the value of any asset;

B = the price which the jewellery and artistic work would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer;

 C = fair market value of shares and securities as determined in the manner provided in sub-rule (1) of rule 11UA;

 D = the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property; L= book value of liabilities as appearing in the books of accounts of the undertaking or the division transferred by way of slump sale, but not including the following amounts which relates to such undertaking or division, namely: —

(i) the paid-up capital in respect of equity shares;

(ii) the amount set apart for payment of dividends on preference shares and equity shares  where such dividends have not been declared before the date of transfer at a general body meeting of the company;

(iii) reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;

(iv) any amount representing provision for taxation, other than amount of income-tax paid, if any, less the amount of income-tax claimed as refund, if any, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

(v) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vi) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.

FMV2 approach

As per sub rule (3) of Rule 11UAE, FMV2 i.e.  shall be the fair market value of the consideration received or accruing as a result of transfer by way of slump sale determined in accordance with the formula-

FMV2 = E+F+G+H, where,

E = value of the monetary consideration received or accruing as a result of the transfer;

F = fair market value of non-monetary consideration received or accruing as a result of the transfer represented by property referred to in sub-rule (1) of rule 11UA determined in the manner provided in sub-rule (1) of rule 11UA for the property covered in that sub-rule;

G = the price which the non-monetary consideration received or accruing as a result of the transfer represented by property, other than immovable property, which is not referred to in sub-rule (1) of rule 11UA would fetch if sold in the open market on the basis of the valuation report obtained from a registered valuer, in respect of property;

H = the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of the immovable property in case the non-monetary consideration received or accruing as a result of the transfer is represented by the immovable property.

Further the expression “registered valuer” and “securities” shall have the same meaning as per Rule 11U of the Income Tax Rules.

Conclusion

This new Rule 11UAE will not only capture monetary consideration but also non-monetary consideration received for transfer of undertaking. Also, the new rule considers revaluation of assets and liabilities made in the books.

Prior to Finance Act 2021, the consideration of slump sale was the amount agreed between the buyer and the seller. Since the consideration was not based on any mechanism, the transfer would take place at a lower price and this often resulted in tax leakage.

To curb all the tax loop holes and prevent tax leakage in merger and acquisition transactions, the income tax laws has been modified and a new concept has been introduced where fair market value for capital assets shall computed as per Rule 11UAE for consideration value in case of a slump sale.

Now the seller will have to pay tax on the fair market value as computed as per Rule 11UAE even if the actual consideration received is less than the fair market value of capital assets. Also, this rule will put a challenge where the undertaking is transferred at a true sale value.