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BUMPY ROAD AHEAD FOR M&A TRANSACTION: BUDGET 2021

Author: Sameer Afzal Ansari, III year of B.A.,LL.B. from Guru Gobindd Singh Indraprastha University

The tFinance tMinister t(“FM”) tintroduced ther tpromised t‘never tlike tbefore Budget’, twith tthe tobjective tof tstimulating teconomic tgrowth tthrough higher tspending ton thealthcare tand tinfrastructure, tagainst tthe tbackdrop tof the teconomic tslowdown tcaused tby tthe tCovid-19 tpandemic. tThe tFM thas also tproposed ta tslew tof treforms tunder tthe tFinance tBill, t2021 t(“Bill”), tto rationalize tthe textant tprovisions tof tthe tIncome-tax tAct, t1961 t(“IT tAct”). Certain tproposals tintroduced tin tthe tBill tcould tsignificantly timpact tM&A deals tand tchange tthe ttraditional tmodus toperandi tof tM&A ttransactions tin India. tThe tensuing tparagraphs twill tfocus ton ta tfew tsuch tsignificant amendments tproposed tin tthe tBill, twhich tmay trequire tclose tconsideration by tstakeholders tbefore tentering tan tM&A ttransaction, tbe tit tamalgamation, share tacquisition tor tan tacquisition tof tbusiness tas ta tgoing tconcern.


Surgical strike on 'slump exchange’

‘Slump tsale’ thas tbeen tdefined tunder tthe tIT tAct tto tmean ttransfer tof ta business tundertaking, tas ta tresult tof tsale, tfor ta tlump tsum tconsideration. Any ttransaction tfalling twithin tthe tscope tof t‘slump tsale’ tis tsubject tto provisions tof tSection t50B tof tthe tIT tAct, twhich tstipulates tsimplified manner tof tcomputation tof tgains tarising tfrom tslump tsale, twhich tmay, tin some tcases, tresult tin tpotentially tlower ttax tincidence tfor tthe ttransferor. The tterm tslump tsale thas tbeen ta tlitigious tissue tfor tyears, tespecially tin case tof tslump texchange, ti.e. twhere tthe tconsideration tfor ttransfer tof tan undertaking twas tdischarged tthrough texchange tof tanother tasset t(typically by tissuance tof tshares tof tthe tacquirer tentity), twould tfall twithin tthe purview tof tthe tterm t‘slump tsale’. tThe tBombay tHigh tCourt thad, tin tthe case tof tCIT v. Bharat Bijlee (2014) 365 ITR 258, theld tthat slumpexchange cannot tbe tconsidered tas t‘slump tsale’ tunder tthe tIT tAct. After tgoing through tthe tsubmissions tplaced tbefore tit tby tboth tsides, tthe tHon’ble High Court thad tagreed twith tthe tviews texpressed tby tthe tMumbai tITAT tand held tthat tthe ttransferor twould tnottbe tliable tto tcapital tgains ttax tbecause slump texchange tcannot tbe tsubject tto ttax. tThis tdecision thas tsubsequently been tfollowed tby ta tfew tother tCourts tas twell.


The tBill tseeks tto tclarify tthis tissue tand tproposes tto tamend tthe tdefinition of tslump tsale twith, tany ttransfer t(i.e. tincluding texchange, trelinquishment, etc.) tof ta tbusiness tundertaking, tby tany tmeans, twould tbe tliable tto ttax tas slump tsale. tThe tterm tslump tsale thas tbeen textended tto tinclude t‘slump exchange’ tas twell. tAgainst tthe tbackdrop tof tjudicial tdecisions tlike tBharat Bijlee, tseveral ttaxpayers thad tused tslump texchange tas tan teffective ttool tto optimise ttheir ttax tplanning. tWith tthe tproposed tamendment, tthe tratio laid down tin tsuch tjudicial tprecedents tmay tbecome tinfructuous tand tit twill not be ttax tefficient tfor tthe ttaxpayers tto tstructure tdivestment ttransactions tas slump texchanges. tIt twould talso tbe trelevant tto tnote tthat tthis tprovision has tbeen tintroduced tfrom tApril t1, t2020, tthus, ttaxpayers tentering tinto slump texchanges tin tFY t2020-21, tmay talso tbe trequired tto tpay tcapital gains ttax ton tgains tarising tfrom tsuch ttransactions.


Though tthis tclarification twould tput tto tbed tthe tcontroversy tregarding tthe taxability tof tslump texchanges, tthe tambiguity ton tcertain tother tissues surrounding tslump tsale tcontinues tto tpersist, tsuch tas tthe tmethodology tto be tadopted tto tdetermine tthe tvalue tof tnon-monetary tconsideration, whether tmilestone-based tpayments twould tqualify tas ta tpart tof tlump tsum consideration, tetc.


Depreciation on Goodwill to go bad!

It tis tnot tuncommon tfor tan tacquirer tto tpay ta tprice tover tthe tfair tmarket value tof tthe tassets tin tan tM&A ttransaction, twhich tis trecorded tas ‘goodwill’. tThe tavailability tof tdepreciation ton tsuch tgoodwill thas tbeen ta matter tof tdispute tsince tdepreciation ton tgoodwill twas tneither texpressly allowed tnor tdenied. tHowever, tfrom ta tcommercial tperspective, ttaxpayers used tto tclaim tsuch tdepreciation ton tacquired tgoodwill tby tclassifying tit tas an tintangible tasset, tby tclassifying tit tas tany tother tbusiness tor tcommercial rights tof tsimilar tnature. tMoreover, twhile tthere twas tno tchallenge tin claiming tdepreciation ton tacquired tgoodwill t(for twhich tconsideration twas paid tby tthetacquirer), tthere tused tto tbe thuge tuncertainty tabout tgoodwill, which toriginated tthrough tnotional tadjustments. tThe tSupreme tCourt tin 2012, tin tits tdecision tof tCIT v. Smifs Securities Ltd. (2012) 348 ITR 302 (SC), rendered tits tlandmark tdecision tand tallowed tdepreciation ton acquired goodwill.


The tBill tintends tto tnullify tthe tSupreme tCourt tjudgment tand tproposes tto tamend tthe tIT tAct tto tclarify tthat t‘goodwill’ tis tnot ta tdepreciable tasset. tThe tmemorandum tto tthe tBill tstipulates tthat tgoodwill tmay tsee tappreciation tor tno tdepreciation tto tits tvalue, tdepending ton thow tthe tbusiness tis trun tby tthe tacquirer tand thence, tthere tis tno tjustification tto tclaim tdepreciation ton tgoodwill. tThe tBill talso tproposes ta tnumber tof tother tamendments tto tthe tIT tAct tin torder tto tclarify tthat tgoodwill tis tnot ta tdepreciable tasset. tThe tIT tAct tis talso tproposed tto tbe tamended tto tprovide tthat tdepreciation talready tclaimed ton tthe tacquired tgoodwill twill tbe treduced tfrom tthe tcost tof tacquisition tof tsuch tgoodwill tand tthe tremainder twill tcontinue tto tbe tcarried tin tthe tbooks tof tacquirer tas tan tintangible tasset. tThe tsaid tbalance tshall tbe tavailable tas tan tadjustment tagainst tthe tultimate tsale tprice tas tand twhen tthe tsaid tbusiness tis tsold tby tthe tacquirer.


This tis tlikely tto thave tsignificant timpact ton tthe tM&A ttransactions, tespecially ttransactions tthat thave tbeen tstructured ton tthe tbasis tof tavailability tof tdepreciation ton tgoodwill. tFurther, ttransactions tinvolving tacquisition tof tconsiderable tquantum tof tintangible tassets tmay tbe tsignificantly timpacted tas tthe tseller’s tpowers tto tnegotiate tfor thigher tprice ton taccount tof tbrand tand tgoodwill tmay tbe tweakened ton taccount tof tsuch tproposed tamendments. tHowever, tit tmust tbe tnoted tthat tthe tabove tamendment tproposes tto tdisallow tdepreciation tonly ton twhat tis tcharacterised tas tgoodwill tin tthe tbooks tof taccount. tIn tcase tthe tintangible tassets tacquired tthrough tthe ttransaction tis tclassified tas tany tother tbusiness tor tcommercial trights tof tsimilar tnature, tthey tmust tbe tallowed tto tclaim tdepreciation ton tsuch tintangible tassets. tMoreover, tthis tdifferentiation tin tdepreciation tmay tgive trise tto ta tpermanent tdifference tbetween tthe tstatutory tbooks tof taccount tof tthe tacquirer tand tits ttax tbooks tof taccount tbecause tthe tacquirer tshall tcontinue tto tbe trequired tto tcapitalise tand tsubsequently tdepreciate tits tintangible tassets trecorded tas tgoodwill.


Thus, twith tthe tproposed tamendment toverturning tthe tyears tof tjurisprudence tdeveloped tby tthe tIndian tcourts, ttaxpayers twould thave tto tbear tin tmind tnon-availability tof tdepreciation ton tacquired tgoodwill tand tthe tother tconcerns tdiscussed tabove, tat tthe ttime tof tnegotiating tthe tdeals.


Reassessing the timeline for re-opening assessment

As tper tthe tBill, tthe ttimeline tfor tissuing ta tnotice tfor treassessment tto ta ttaxpayer thas tbeen treduced tto tthree tyears tfrom tsix tyears. tHowever, tin tcase tthere tis tevidence twith tthe ttax tofficer tfor tincome tescaping tassessment tof tINR t5 tmillion tor tmore, ta tnotice tfor treassessment tcan tbe tissued tup tto t10 tyears tfrom tthe trelevant tassessment tyear. tFurther, tas tper tthe tproposed tprovisions, tnow tthe ttax tofficers twould talso thave tto tsatisfy tcertain tspecified tconditions tbefore tissuing ta tre-assessment tnotice. tIt tis talso timportant tto tnote tthat tthe tsaid tincreased tperiod tof tassessment tshall tbe tapplicable tonly tif tthe ttax tauthorities thave tbooks tof taccount tor tevidence, twhich treveal tthat tthe tincome tchargeable tto ttax, trepresented tin tthe tform tof tan tasset, thas tescaped tassessment, tamounting tto trupees tfifty tlakhs t(five tmillion) tor tmore. tThis taspect tmay tbecome textremely tcontentious tto testablish.


These tprovisions thave tbeen tintroduced tto tincrease tease tof tbusiness tand treduce toverall tlitigation tin tthe tcountry ton taccount tof tre-assessment. tThese tprovisions tcould thave ta tbearing tat tthe ttime tof tnegotiating tthe tamount tand tthe ttime tlimit tfor ttax trelated tindemnity tunder tM&A tdeals.


Conclusion

With tthe tlegislature tover-turning tvarious tprecedents tand tintroducing tadditional tcompliance tprovisions, tM&A ttransactions tmay tbecome tcostlier tin tthe tfuture tand tthe tconcerned ttaxpayer tmay thave tto tnegotiate tthese tbumpy troads tahead. tThe tsilver tlining tin tthese tproposed tamendments tis tthat tlong tdrawn tcontroversies tsurrounding tthe tissues tof tdepreciation tof tgoodwill, ttaxation tof tslump tsale, tetc., thave tbeen tput tto trest. tIt thas tbecome timperative tfor tthe ttransacting tparties tto texamine tthese tprovisions tcarefully, tbefore tstructuring ttheir ttransactions, tas tany tincorrect tstructuring tmay tlead tto ta tsignificant texposure tfor tthem.