Several slump sale transactions were signed and closed while others were still in progress in FY 20-21, when Budget 2021 proposed two changes that impacted slump sales in a fundamental way — (1) Goodwill (premium paid on a business purchase) would no longer be tax depreciable and (2) the tax law will define the consideration paid for a slump sale as its Fair Market Value (‘FMV’). For example, even if the consideration for a slump sale was agreed to be 100, tax law could override business contract and say that the FMV was 125. And these changes were effective from April 1, 2020 meaning that they had retrospective effect. The final catch was that the methodology for computing FMV in a slump sale would be notified in due course, so these rules were eagerly awaited indeed.
Earlier this week, the CBDT notified the rules (FMV Rules) for determining FMV in a slump sale transaction and fortunately, corporates would be heaving a collective sigh of relief. The good news is that the FMV Rules are structurally consistent with past provisions where the tax law sought to provide a minimum FMV on which tax will apply even though the contracted consideration may be lower. For example, if a plot of land is transferred for 100 whereas its FMV (stamp duty value) is 125, tax applies assuming the sale consideration to be 125.
It’s been widely assumed that the government’s intent behind providing FMV as deemed consideration for slump sale was to plug loopholes that were being exploited to reduce tax impact on transactions, rather than create new domestic transfer pricing norms. Though seemingly well intentioned, the FMV Rules for slump sale had the potential to create enormous uncertainty for taxpayers if they were based on arm’s length basis or Discounted Cash Flow method. Thankfully, whatever be the controversy over the retrospective nature of the amendment, the content of the FMV Rules do not disappoint. The FMV Rules stick to the script as being anti-abuse rules, largely in line with other comparable cases where sale consideration is deemed to be a prescribed FMV.
The FMV Rules provide that the sale consideration will be considered as the higher of the following:
FMV 1 is based on an adjusted book value approach, in which assets and liabilities are broadly taken at book value, apart from jewellery, artistic work, shares, securities and immoveable property, which would be valued as per specific tax provisions.
FMV 2 is based on a sum of the monetary and non-monetary consideration received by the seller on sale of the business. The non-monetary consideration would adopt tax FMV price for specified assets (i.e. jewellery, shares, immoveable property etc.) and open market price for others.
So, what are the immediate takeaways — (1) slump sale transactions no longer provide the cushion of not being subject to a benchmark FMV, meaning that they are on par with share sale transactions on this specific aspect, (2) transactions of transfer of property or shares can no longer be ‘disguised’ as a slump sale using the argument that there was no minimum FMV prescribed, (3) ‘slump exchange’ can no longer escape taxation on the basis that it is not possible to determine quantum of consideration, (4) corporates will be reviewing slump sale transactions executed last year to see if they need to budget for additional tax cost/ interest, (5) it would be interesting to see whether the new FMV Rules provide ammunition to open up historically concluded slump sale transactions on the basis of the intent of the new FMV Rules, particularly where a significant component of the business undertaking was real estate or shares.
While the new rules will provide clarity to taxpayers wishing to restructure through a business transfer mostly within group entities, there is the inevitable devil in the detail that one must bear in mind. For example, if the business undertaking includes assets in the form of certain securities like unlisted convertible debentures, then the same would be valued at open market price and not book value. Accordingly, a detailed run through of the assets and liabilities of the undertaking will be an important planning step. Depending on the size and complexity of the transaction, it may also be worthwhile to obtain a valuation report for valuing the business as per the new income-tax rules.
To conclude, there were no unpleasant surprises in how the new FMV Rules were drafted; however, the retrospective nature of the amendment and the delay in announcement of valuation rules did frustrate tax payers who had concluded agreements on the basis of law prevailing at the time of executing the slump sale transaction.
Rajendra Nalam is Partner – M&A and PE Tax, and Amisha Singal is Director – M&A and PE Tax, KPMG in India.