Currently, the tax law provides rules for the fair valuation of certain asset transfers.
By Amrish Shah, Madhvi Jajoo, and Shefali Ganatra
The government has repeatedly made appropriate changes, rules, and clarifications to streamline the tax law and put an end to tax avoidance systems, which typically fail to serve the purpose of the law. One such important change affecting business premises is the introduction of the concept of fair value for business transfers, which was introduced during the recent amendments to the Income Tax Act (Act) and the newly mandated rules for its determination.
The transfer of a capital asset typically triggers capital gains in the hands of the seller and the tax rate depends on the type of capital asset transferred and the length of time that asset has been held in the hands of the seller. The going concern transfer was considered an investment and therefore capital gains tax would be levied on that transfer if the business was transferred for a flat fee, that is, without any value assigned to each component of the business (commonly referred to as a “slump”).
There have been several ambiguities regarding the taxation of business transfers, and most of them have been ironed out by the Government Vide Finance Act of 2021, effective April 1, 2020. Currently, the tax law provides rules for a fair valuation for certain asset transfers. In a situation in which the sales consideration of the transferred asset is lower than the fair value determined in this way, the actual sales consideration is replaced by this value deemed to be the fair value for the purpose of calculating the capital gains. Until fiscal 2020, the tax law did not provide for a fair valued mechanism for the purposes of a business transfer due to a burglary sale, so the predominantly sold sale value disclosed by the seller would be taken into account for the calculation of capital gains tax.
In accordance with the direct tax rules announced by the Board of Directors, the consideration for business transfer or burglary is calculated based on the higher of the following:
A. Net book value of assets less liabilities transferred in replacement of fair value for mandatory assets (ie jewelry, artwork, stocks, stocks and real estate); or
BB The actual consideration that the seller received. If non-monetary consideration is received, the fair value of such non-monetary consideration (as determined by the mechanism set out in point A above) is the consideration considered consideration.
In relation to item A. above the replaced fair value for – (i) immovable property, this is the stamp duty value, (ii) stocks would be the adjusted net asset value of the underlying company, and (iii) jewelry, art, non-stocks and other securities the price they would get on the open market.
The point to consider is that while the creation of the burglary / business sale under the law is that the transfer should be made without assigning any particular value to the assets and liabilities, the fair value rules set out therein provide a mechanism provide for determination of the specific value for each asset (ie either book value or specified fair value). This is likely to create challenges for companies while claiming the deal they have completed is a slump if questioned by the tax authorities.
The above rules for calculating the tax fair value for business transfers apply regardless of whether the transaction is with related parties or with unrelated / third parties and will apply from the 2020-2021 fiscal year.
The change under the Finance Act of 2021 will take effect on April 1, 2020 and would affect the transactions that were completed prior to the change becoming known. This may lead to a revision of the tax provision for taxpayers if the transferred business includes the stated assets and the sales consideration is revised up based on the newly incorporated legal literature. This can also result in an interest outflow due to a brief input tax payment for the 2020-2021 fiscal year. Even those companies that have passed their annual accounts before the prescribed rules would have to take this aspect into account.
In addition, since the fair value rules prescribe a specific mechanism for determining the fair value of real estate or other goods (which are part of the business venture), there is a gray area as to whether the buyer would be required to deduct taxes at source at the time of their transfer.
We have to wait and see whether the new rules clarify or spark a debate between taxpayers and the tax authorities.
(The authors are Amrish Shah – Partner at Deloitte India, Madhvi Jajoo – Senior Manager at Deloitte Haskins and Sells LLP and Shefali Ganatra – Deputy Manager at Deloitte Haskins and Sells LLP)
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