Slump Sales: New Rules Of The Game

A tax adviser looks over paperwork while working with a customer (Photographer: David Paul Morris/Bloomberg)  

Slump Sales: New Rules Of The Game

The tax treatment of slump sales by corporate India is set to change. It started with an amendment to the income tax law via Finance Act, 2021. And now, the Central Board of Direct Taxes has notified rules to determine taxability of capital gains as a result of slump sales or slump exchanges.

The rules are an anti-abuse measure to curtail the practice of businesses being under-valued, Pranav Sayta, partner at EY India, said. While the rules provide clarity on determining capital gains arising out of slump sales or exchanges, they may adversely impact transactions where the actual commercial value is lesser than what’s determined by the formula prescribed by the revenue department, Sayta said.

A slump sale involves selling an undertaking for a lump sum amount without ascribing value to individual assets or liabilities. Slump exchange involves a business transfer for a lump sum non-monetary consideration, for instance shares, land etc.

Abusive Slump Sales

In the union budget presented this year, the finance minister pointed to tax avoidance schemes via which business ‘sales’ are being disguised as ‘exchanges’. An argument is then made that such an ‘exchange’ won’t come under the definition of a slump sale since it covers only monetary transfers. And that, gains from such a transaction won’t come under the tax net, the memorandum to the Finance Bill, 2021 had pointed out.

To put an end to litigation on this issue, the government clarified that business transfers made for lump sum non-monetary consideration, such as securities or immovable property, will also qualify as slump sales.

The amendment went a step further to also make way for rules to compute capital gains for both slump sale and slump exchange.

So far, capital gains tax was levied on the difference between the net worth of the undertaking sold and the actual consideration received for it. And business transfers evaded the tax net as they didn’t strictly fall under the definition of slump sale.

The revenue department has now notified the rules to determine capital gains for both. The tax will be levied on the higher of the following two values:

  • Net adjusted book value of all assets on the date of transfer, or
  • The actual sale consideration received. This would include monetary consideration and fair value of non-monetary consideration.

In essence, the rules have ensured that the amount on which capital gains is calculated cannot be less than the net adjusted book value. The ability of corporates to trim the tax outgo basis a lesser sale price is now restricted to that extent.

New Rules: Impact

Experts point to three key consequences:

  • The valuation tweaks are most likely to hurt restructuring exercises between group companies.
  • Potentially higher tax cost for distress sales.
  • Slump sale being perceived as an itemized sale.

Tax Expensive Restructurings

The ramifications of these rules will perhaps most be felt by intra-group company transactions. Here, businesses are often transferred at only cost, resulting in negligible-to-nil capital gains.

Companies may need to re-assess those restructuring strategies which accounted for tax on actual sale price.

These new rules will affect the internal group restructuring transactions which are closed at almost net worth of the undertaking. Since the rules now take the adjusted book value as the floor, the tax outgo on intra-group transactions would be higher.
Yashesh Ashar, Partner, Bhuta Shah & Co. LLP

Tax Stress On Distress Sales

While the new rules aim to curb the mischief of intentional under-valuing of businesses, Ashar pointed to adverse impact where the actual value of business may be genuinely lower than its book value.

Companies with obtuse assets sold under distress can fall under this category, say a business which is not running successfully due to pandemic crisis, or which has become obsolete because of emergence of new technology.

In these situations, even if the undertaking is bona fide transferred at its lower commercial value, the tax liability will be based on the higher book value. The rules do not provide for any opportunity to the taxpayer to rebut such notional valuation, Ashar explained.

Perceived 'Itemised' Sale

The idea behind slump sale is to transfer business for lump sum consideration without going into individual value of each asset being transferred. Contrary to slump sale, an asset sale is an itemised or a piece meal sale where each asset is sold for a separate price.

By requiring to calculate the adjusted book value, the rules implicitly necessitate that value of each individual asset be identified, Maulik Doshi, partner at Nexdigm, said.

This may lead to a perception that this is a case of an asset sale. It may then get difficult for corporates to defend that the transaction they have entered into is a slump sale if questioned by the revenue authorities.
Maulik Doshi, Partner, Nexdigm

This may also have adverse goods and services tax implications if the authorities treat it as a asset sale instead or a slump sale. While the former is taxable in GST, the latter is exempt, Doshi said.

Consequences aside, another concern pertains to the effective implementation date of the new rules. The amendment was made effective FY2020-21 but the rules have been notified on May 23. It’s unclear if the rules will impact transactions concluded between April 1, 2020 and May 23, 2021, Sayta said.

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