Finance Act 2021: Goodwill, Slump Sale Tax Changes And Impact On M&A Deals
The amended Finance Bill 2021, approved by the Lok Sabha on March 23, includes several amendments to the initial budget proposals.
Key among these are the changes relating to the treatment of depreciation on goodwill and computation of fair value in slump sale transactions. Both these changes can impact M&A transactions in the long term, experts pointed out.
Here are the key amendments...
Clarification On Depreciation Of Goodwill
Goodwill is a depreciable and intangible asset. It includes the value for a brand name, market standing or a company’s relation with its customers. In some instances, it’s the difference between the actual purchase price of a company and its assets and liabilities.
The Income Tax Act says that depreciation must be provided on “block of assets” — assets falling within a same or similar class. So far businesses could claim depreciation allowance on goodwill as it was included in the block of assets on which depreciation is allowed. The reduced value of an asset on account of depreciation and amortization, is its “written down value”.
Feb. 1 Budget Proposal
The union budget presented on Feb. 1 made an important change in depreciation accounting by saying that it will no longer be provided on goodwill in any situation. This was to be applied retrospectively ie: From April 2020 onwards.
Depreciation is allowed as a deduction while calculating profits of a company, Paras Savla, partner at KPB & Associates said. As depreciation on goodwill has now been disallowed, the taxable income for a business will now go up to that extent, thus resulting in a proportionately higher tax liability, he added.
The bigger impact will be on M&A deals involving the transfer of goodwill as the transaction cost base will rise.
Amended Budget Proposal
However, as the existing value of an asset block may include goodwill carried forward from previous years, the government has now amended that to say:
The written down value of goodwill carried forward from earlier years will be excluded or reduced from the written down value of block of assets on which depreciation is to be provided.
This will apply from assessment year 2021-22 onwards.
The changes are primarily in the nature of clarificatory amendments and will help avoid any controversy or potential litigation that may arise due to the changes proposed through budget 2021, said Shailesh Kumar, partner at Nangia & Co. LLP.
Valuation In Slump Sale Transactions
The Income Tax Act defines a slump sale as a transfer — sale of an undertaking for a lump sum consideration — without values being assigned to its individual assets and liabilities. A slump sale is generally done when an entire undertaking is to be sold as it is not possible to dispose assets on an individual basis.
Businesses enter into such transactions due to reasons such as multiplicity and interconnection of different business segments , erosion in value of assets, tax planning etc. The law provides a special method to calculate the gains arising from a slump sale transaction.
As per the existing mechanism, capital gain arising from a slump sale transaction is computed in the following manner:
- Difference between the net worth of the undertaking sold in a slump sale transaction and the actual consideration received is used to calculate capital gains or losses as per a prescribed method. Net worth in this case is the cost of acquisition and the cost of improvement incurred on the undertaking.
- Any capital gains / losses arising from the transaction are included in income of the seller for the year in which a transfer takes place.
- Long term capital gains tax applies if the assets were held for more than 36 months while short term capital gains tax will apply in other cases.
Thus so far, the difference between the net worth and consideration received for the slump sale was liable to capital gains tax.
Amended Budget Proposal
Now, the government has introduced an amendment which says that:
- “Fair Market Value” of capital assets on the date of transfer will be deemed to be the full value of consideration received or accrued by a seller in a slump sale transaction.
- If the capital asset is goodwill, its value will be treated as nil if the taxpayer had not acquired it through a purchase from a previous owner.
For instance, lets assume that the cost of acquisition or improvement of an undertaking is Rs 50. Company X wants to do a slump sale. It sells the undertaking to Y for Rs. 80. Till now, the difference between Rs 80 and Rs 50 (the net worth) of undertaking could have been liable to capital gains tax after certain adjustments. Now, in case the fair market value of the undertaking comes out to Rs 100, this value will be deemed to be the full value of consideration received by X. It will thus have to pay tax on Rs 50 irrespective of the real consideration received by it.
This change will impact M&A transactions in India.
Gupta of Dhruva Advisors pointed out the amendment means that a deeming fiction on fair value guidelines on transfer of capital assets has been extended to slump sale transactions as well. “Such requirement was already applicable for real estate and unlisted shares”
The proposed changes will have far-reaching consequences for merger and acquisition transactions, he said.
M&A transactions will now need to consider the deemed fair value consideration and a seller will have to pay tax on the deemed fair value even if the actual consideration is lower. Internal transfers for the purpose of restructuring will also become taxable after this amendment.Vaibhav Gupta, Partner, Dhruva Advisors
The proposed amendments to the Finance Bill, 2021 are pending approval from the President of India.