GST Will Impact Mergers, Asset Sales And Other Corporate Transactions
Dealmakers watch out. Asset sales, business transfers and out-of-court settlements will be subject to GST.
Starting July 1, the expected launch date for India’s Goods and Services Tax (GST), the structuring of corporate transactions will be impacted too.
Experts told BloombergQuint that since routine transactions of slump sales, mergers, acquisitions and amalgamations do not attract any output-linked GST liability, they are unlikely to impacted by this indirect tax.
But not all the outcomes are easy to discern yet. The timing of credit for itemised sales, unclear language regarding slump sales, valuation problems for shares-for-services transactions and confusion surrounding the treatment of out-of-court settlement amounts are some of the issues that companies will need to think about.
For instance, the Central GST Act specifies the tax treatment on transfer or sale of business assets. But such sales can take place either item-wise or as a slump sale. While the GST implications are clear for the former, experts are divided over the treatment of the latter.
Itemised Sales
An itemised sale involves the disposal of key or selected business assets, Jigar Doshi, an indirect tax partner at advisory firm SKP Group explained. He said an itemised sale may also involve transfer of assets and liabilities and entails assigning a value to each item.
It may so happen that in an M&A transaction, the entire business is transferred but item wise. In this case, value of fixed assets, goodwill, cash in hand etc. is calculated separately. Such a transaction may come under the GST ambit as supply, where such business is not transferred as going concern.Jigar Doshi, Partner, SKP Group
Also the Central GST Act and draft rules as on date permit the transfer of unutilised GST (that is, input tax) credit. The law provides for availability of credit in the case of itemised sales as well, but the timing is unclear, Girish Vanvari, head of tax and partner at consultancy firm KPMG, told BloombergQuint.
“There is ambiguity if the credit is available over a period of time or in the first year itself. When I acquire business assets, they are long-term assets. One way of thinking is credit should be available in equal installments, let’s say, over five years. The better view is it should be available in the first year itself.”
Industry has asked the government for clarity on this, he added.
Vanvari also pointed to the lack of credit for immovable property if it is part of an itemised sale. For instance there is no provision for credit in the case of say, the acquisition of a business for Rs 100 crore of which a building is valued at Rs 30 crore, he added.
Slump Sales
The Central GST Act does not expressly provide for whether transfer of a business as a going concern (slump sale) would be taxable, exempt or zero-rated (that is, exempt with refund of input tax credit), Badri Narayanan, an indirect tax partner at Lakshmikumaran & Sridharan pointed out.
The nature of this transaction may need to be inferred from similarities in the language used in existing law and incidental references in the GST Law.Badri Narayanan, Partner, Lakshmikumaran & Sridharan
But Doshi and Vanvari opine that the law on slump sales is clear and that GST will not be applicable on such transactions.
In a slump sale, you sell a business lock, stock and barrel, there will be no transaction tax and hence no GST, Vanvari said.
It may not always be that simple.
Narayanan pointed out that in complex transactions, GST is likely to play an important part in the choice and structure of the transactions. He attributed this to the dual GST model which India is implementing – a single entity is split into distinct persons depending upon the number of states the entity does business in.
For example, a company headquartered in Maharashtra with a branch office in Gujarat is treated as two distinct persons for GST purposes. The impact of this, he explained, is that the input tax credit available to the Gujarat operation is not available as set-off against the output tax liability in Maharashtra, though the entity remains the same and all the transactions pertain to the same business. This gets further complicated in the case of a slump sale.
Hypothetically, let us consider Company A in Maharashtra which acquires Company B in Jharkhand. The aim of Company A is to utilise the intellectual property and technology in its business and to transfer key employees from Company B to its operations in Maharashtra. Effectively, after the acquisition, there are unlikely to be any output supplies from the state of Jharkhand and all the output will be from Company A in Maharashtra. Here, there could be a potential input tax credit imbalance that will need to be addressed. Since there are unlikely to be output supplies from Jharkhand, the input tax credit lying in that state would remain stagnant. On the other hand, Company A would be making taxable supplies from Maharashtra on payment of GST in cash even though there are stores of input tax credit lying elsewhere.Badri Narayanan, Partner, Lakshmikumaran & Sridharan
It is in these types of situations that the decision relating to choice and structure of the transaction as a slump sale, amalgamation or business asset sale would be crucial, he added.
Shares-For-Goods Or Services Transactions
Such transactions are fairly common in the startup world where a company pays for a service or goods via shares. The experts quoted in this story have each concluded on a different GST treatment of shares-for-goods or services transactions.
In such a transaction, since the consideration is not monetary, valuation rules will kick in, said Doshi.
Let’s say A is providing consulting services to B and gets shares in B as consideration. The question will be what is the open market value, that is, at what value is A providing these services to a third entity where it’s getting consideration in the form of money. Ideally, same value will be applied to the shares A has received from B and GST will be applicable on it.Jigar Doshi, Partner, SKP Group
If for some reason the fair market value of shares is more than the open market value, then this higher value will be considered for GST purposes, he added.
According to Vanvari, GST will apply only on the fair market value of the shares as on the date of issue. The draft valuation rules say if it’s an exchange, it’ll be the fair value of the thing given up, he explained.
Narayanan argued that supply of shares is not liable to GST and hence such a shares-for-goods or services transaction would not be taxable, goods and services. But he also pointed out that goods and services, for which consideration in whatever form is provided, are liable to tax. He concluded that such transactions could be a potential GST trap.
Suppliers of goods and services will be liable to pay GST. On what value – is the next question. Should it be the value of the goods or services supplied or the value of the shares which is the consideration for the supply? If it is shares, since shares represent the consideration for the supply, what value should be attributed to the shares – its current value, which may be low, or a future value, which the supplier expects and covets?Badri Narayanan, Partner, Lakshmikumaran & Sridharan
Out-of-Court Settlements
The treatment of payments made in out-of-court settlements is also a disputable issue under the GST regime, experts said.
Narayanan explained that GST is liable to be imposed on all supplies for consideration. But out-of-court settlement payments can be for different reasons including for a supply, for a breach, or for extracting a penalty or fine for violations, he added.
Where such payments are not in the nature of consideration for supply, then such payments are not likely to attract tax under GST. However, determining what is the payment for becomes complex. Is it for damages due to defective supplies or penalty or a fee for regularising past infringement? Making a clear determination and specifying the nature of the payment with precision is vital when it comes to out-of-court settlements and similar payments.Badri Narayanan, Partner, Lakshmikumaran & Sridharan
Doshi pointed out that it would be relevant to see the underlying object for such an out- of-court settlement.
If such an object does not fit under the exclusions to supply, any payments under such settlement will liable to GST. I’d advise clients to take a conservative approach on such payments whilst analysing the applicability of GST on the underlying object.Jigar Doshi, Partner, SKP Group
This concept is based on the surrogatum principle, wherein a settlement has the same tax treatment as the amount it is intended to replace, he added.